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https://www.courtlistener.com/api/rest/v3/opinions/4625528/	Estate of James E. Frizzell, Deceased, Roy Burns, E. A. Jackson and Mary George Frizzell, Executors, Petitioners, v. Commissioner of Internal Revenue, RespondentFrizzell v. CommissionerDocket No. 6704United States Tax Court9 T.C. 979; 1947 U.S. Tax Ct. LEXIS 20; November 28, 1947, Promulgated 1947 U.S. Tax Ct. LEXIS 20">20 Decision will be entered under Rule 50. 1. The decedent, at the age of 81 years, created an irrevocable trust to provide for an incompetent son who was made the sole beneficiary of the trust income for life. The trustee was directed to distribute the trust income for the use of the son in such amounts as the trustee should determine to be necessary, and to accumulate all undistributed income. Upon the facts, it is held that the transfer of property to the trust was made in contemplation of death and was a substitute for testamentary disposition of part of the estate under section 811 (c) of the I. R. C.2. The decedent transferred shares of stock of Coca-Cola Co. to the trustee when he created the trust, and thereafter no other property was transferred to the trust by the decedent. Under the holding made under issue 1, the transfer of the Coca-Cola stock was made in contemplation of death. From the creation of the trust until decedent's death, the trustee accumulated part of the trust income. He invested most of the accumulated cash in stocks and bonds. Respondent included in the gross estate all of the trust corpus at the date of death. Held that, since the decedent1947 U.S. Tax Ct. LEXIS 20">21 made complete inter vivos transfer of property to the trust and retained no interest in the trust income or corpus under the trust instrument, only the property of which the decedent made transfer, the shares of Coca-Cola stock, is includible in the gross estate under section 811 (c), I. R. C., relating to transfers made in contemplation of death, and that respondent erred in including in the gross estate other property in the corpus of the trust at the date of death which the trustee acquired from accumulations of trust income. Joseph B. Brennan, Esq., for the petitioners.Bernard D. Hathcock, Esq., for the respondent. Harron, Judge. HARRON 9 T.C. 979">980 Respondent determined a deficiency in estate tax in the amount of $ 24,834.80.Two questions are presented for decision: First, whether an inter vivos transfer in trust of stock was made in contemplation of death. Second, whether the entire corpus of the trust at the date of death is includible in the gross estate as the measure of estate tax.Certain adjustments were not contested by petitioners. Petitioners abandoned one issue raised by their pleadings at the hearing. Respondent has agreed that deductions are allowable for additional administrative expenses and attorneys' fees. Effect will be given to the respective concessions of the parties in the recomputations under Rule 50.The estate tax return was filed with the collector for the district of Georgia.FINDINGS OF FACT.Petitioners are the1947 U.S. Tax Ct. LEXIS 20">23 executors of the estate of James E. Frizzell, who died testate on August 23, 1940, a resident of Waverly Hall, Georgia.Decedent was born January 24, 1856. He died at the age of 84, after an illness of four weeks following a heart attack.On October 14, 1937, the decedent executed a trust agreement under which he created an irrevocable trust for the benefit of his son, William Pitts Frizzell. On that date he transferred 1,132 shares of common stock of the Coca-Cola Co. to the Trust Co. of Georgia, trustee under the trust agreement.The decedent was 81 years old when he created the trust. At that time his family consisted of his wife, who was 66 years old; a daughter, Mary George Frizzell, who was 38; and a son, William Pitts Frizzell, who was 40. There was also a married daughter, Annie Frizzell Jackson, age 36, the wife of E. A. Jackson, who had a son 13 years old.The decedent's son William is an incompetent person. His mental development had been retarded and his mind was that of a child of twelve years. However, his physical condition, as distinguished from his mental condition, was good. William was unable to care for himself or to earn a livelihood. His parents bought1947 U.S. Tax Ct. LEXIS 20">24 his clothes and took 9 T.C. 979">981 care of him in every way. He was unable to take care of money or property. He was never given any large sum of money. William lived with his parents.The decedent directed the trustee not to distribute any income or corpus to William, but to make the distributions to his mother, sisters, or some person selected by the trustee. The decedent directed the trustee to distribute whatever amounts of trust income it should determine, in its discretion, to be necessary to provide for the reasonable needs of William, during his life; and to accumulate in the trust all of the undistributed income. He gave the trustee authorization to encroach upon the corpus for the benefit of William in the event of illness or emergencies which the trust income was insufficient to meet. He authorized the trustee to make and change investments, and to receive and add to the trust corpus any additional property from the settlor.The trust could be terminated at any time after the death of William, and upon such termination the trust was to be distributed to the surviving sisters of William, or their lineal descendants. Or, if the trust was not terminated after the death 1947 U.S. Tax Ct. LEXIS 20">25 of William, it was to be divided in equal parts and held in trust for the surviving sisters of William, or their lineal descendants. Other provisions for the eventual termination of the trust and the distribution thereof are not material to the issues presented.The trust indenture is incorporated herein by this reference.The trustee did not distribute all of the annual trust income, but paid William's mother $ 50 per month, as follows:YearTrust incomeDistributions1937$ 3,113$ 15019385,09460019395,6606001/1/40 to 8/23/40(Not shown)400The trustee invested about $ 9,193 of the undistributed accumulated trust income during the period up to the decedent's death, about three years, in stocks and bonds; and when decedent died, the trustee held uninvested, accumulated cash in the corpus amounting to $ 4,792. At the death of the decedent, the securities held in the trust consisted of the 1,132 shares of Coca-Cola stock, having a value of $ 108,592.28; 174 shares of stock of Lee Tire & Rubber Co., having a value of $ 4,219.50; and Federal Land Bank bonds having a value of $ 2,216.17, including accrued interest. The value of the trust corpus at the date1947 U.S. Tax Ct. LEXIS 20">26 of death was $ 119,820.80.At one time the decedent was in the private banking business in Waverly Hall with W. I. H. Pitts, Sr. In June 1937 he acquired a 9 T.C. 979">982 one-third interest in a potato-selling business which was conducted as a partnership. He was active in that business until the time of his fatal illness. During the period from 1937 until his death the decedent devoted time and attention to his investments; he followed the securities market and bought and sold securities. He also dealt in commodities futures and negotiated about six transactions in 1937 in lard and cottonseed oil.During the year 1937, the decedent was not suffering from any illness. On and prior to October 14, 1937, the date of the trust, the decedent was in good health. His health record in prior years, including 1935 and 1936, was good. He did not suffer any serious illnesses during his lifetime or have any accidents or operations. In 1938 he had some gall bladder disturbance caused by gall stones, for which he received treatment in an Atlanta hospital, but there was no operation; the gall stone passed, and there was no recurrence of gall bladder trouble. In the latter part of 1938 the decedent1947 U.S. Tax Ct. LEXIS 20">27 had some disturbance from arthritis in leg joints, which was relieved by treatment. In July 1940 the decedent suffered a heart attack, which was the cause of death. He was ill about four weeks. There had not been prior heart attacks.After 1930 Dr. Stewart Roberts of Atlanta was the physician of the decedent and of his family. Decedent and his family went to Atlanta once a year for annual physical check-ups. On September 17, 1937, the decedent was given a complete physical examination. Dr. Roberts wrote to decedent on October 1, 1937, reporting the results of the examination. The letter indicated that the decedent's physical condition was good and stated that the condition of the blood, urine, heart, and lungs was normal for a man 82, that "for your age of 82 on January 24, 1938, you are extraordinarily well preserved," and that the decedent did not need any medicines.During the period 1937 until his death the decedent was active in his business affairs and in his church. He was active physically in 1937 and went down to his place of business every morning, where he stayed all day. He walked to and from his office every day. In 1937 the decedent was chairman of the board1947 U.S. Tax Ct. LEXIS 20">28 of stewards of his church, superintendant of the Sunday school, and leader of a Sunday school class. He often led a prayer meeting. He took trips to Florida. The decedent had a bright and happy disposition.The decedent executed his last will and testament on April 22, 1940, four months before his death. He executed a codicil to his will on July 24, 1940. By the will and the codicil the decedent devised and bequeathed to a trustee of three trusts for the benefit of his wife and two daughters equal thirds of his residuary estate. He did not make any bequests direct to his son. He stated in clause 5 of his will that 9 T.C. 979">983 the reason he had not made further provision in his will for his son was that he had theretofore made a gift in trust in which he had made full provision for his son's benefit and protection.The transfer in trust of 1,132 shares of Coca-Cola common stock on October 14, 1937, was made in contemplation of death. The trust was established in contemplation of death.OPINION.The first issue presented is whether the transfer of stock to a trust in October 1937 was made in contemplation of death within the meaning of section 811 (c) of the Internal Revenue Code. 1947 U.S. Tax Ct. LEXIS 20">29 The respondent, on brief, does not contend that the transfer in trust comes within the scope of section 811 (d). It is understood that he has abandoned the view that section 811 (d) applies. The gift was not made within two years prior to the death of the decedent.The respondent contends that the donor's dominant motive in creating the trust was to make such provision for his incompetent son that he would be cared for after the father's death; and that the gift was testamentary in character and a substitute for a testamentary disposition of property.The controlling principles which are to be considered were set forth in United States v. Wells, 283 U.S. 102">283 U.S. 102. In each case it is necessary to scrutinize the circumstances surrounding the gift "to detect the dominant motive of the donor in the light of his bodily and mental condition." The chief purpose of the statutory provision "is to reach substitutes for testamentary dispositions and thus to prevent the evasion of the estate tax." Whether or not the gift was made in contemplation of death "is always to be found in motive." The problem is, therefore, to ascertain the controlling motive which prompted1947 U.S. Tax Ct. LEXIS 20">30 decedent's gift to the 1937 trust.One of the reasons for the respondent's determination was that he understood that the decedent was in ill health when he made the gift and had been in ill health during a period of prior years. The evidence is substantial that the decedent had not been ill before the date of the gift. The evidence shows that the decedent was in good health for a man of his years. The evidence relating to the physical condition and mental attitude of the decedent at the time he created the trust amounts to a neutral factor in deciding the issue.The reason the trust was created was to provide an income for life for an incompetent son. The question must be decided by the considerations which the condition of the son make apparent. He was in good health and 40 years old. His financial needs were limited. He could not use or manage property or money himself. His unfortunate condition was such that his needs were that of a 12-year old person, 9 T.C. 979">984 and would remain at that level for the rest of his life, devoid of the prospect of the larger needs which come as a person grows to maturity and takes on the responsibilities and develops the capacities of an adult. 1947 U.S. Tax Ct. LEXIS 20">31 The record indicates that as long as either parent lived the son would live in the home of his parents. They were able to provide the small amount of money required for his maintenance while he lived at home. The decedent possessed a considerable amount of assets and income. As long as he lived, the childlike son would be amply cared for. The situation was such that the son would require guarantees of care and support only after the decedent's death. See City Bank Farmers Trust Co. v. McGowan, 323 U.S. 594">323 U.S. 594.The stock transferred in trust was productive of annual dividends of $ 3,000 per year or more. During the two years and ten months during which the decedent lived after he created the trust, the trustee paid $ 50 a month to the son's mother. The record does not show any need for making such payments, which were nominal. During the three months of 1937, and the years of 1938 and 1939, the trustee received income totaling $ 13,867 (the trust income for 1940 is not shown), and he paid a total of $ 1,750 to the son's mother during the entire period, including 1940, up to the death of the decedent. The trust income, for the most part, was1947 U.S. Tax Ct. LEXIS 20">32 being accumulated during the remainder of the grantor's life.The decedent set aside a substantial part of his assets in the trust for William, about one-fifth of his estate. 1 Where a gift of a substantial amount of property is made by transfer before death to a child who is not in need, "the act itself is evidence tending to support the conclusion that the gift was made in contemplation of death." Updike v. Commissioner, 88 Fed. (2d) 807, 811.It was said in Igleheart v. Commissioner, 77 Fed. (2d) 704, 709 "A gift is to be regarded as made in contemplation of death where the dominant motive of the donor is to make proper provision 1947 U.S. Tax Ct. LEXIS 20">33 of the donee after the death of the donor." In this case, there is testimony that the trust was created so that the son would be provided for "if he were left alone in the world." The decedent had not made any separate provision for the son's care and support prior to the creation of the trust in 1937, and no provision was made for him in the decedent's will. There is a strong inference that the decedent recognized that the time was approaching, because of his advanced age, when he should make the necessary arrangements through which the son would be provided for after the death of the decedent. When, finally, the decedent created the trust he set aside a substantial part of his assets, 9 T.C. 979">985 large enough to provide for the son for the remainder of his life without the necessity of making any additional provisions for the son in the decedent's will. Thus, it is evident that the transfer of a large block of stock to the trust was an advancement out of the decedent's estate to the son. See Wilfley v. Hellmuth, 56 Fed. (2d) 845. Also, it is evident that, if the decedent had not created a trust for his son during his life, he would have made the1947 U.S. Tax Ct. LEXIS 20">34 same provision in his will under which a trust would have been established.We recognize that advanced age, in itself, does not furnish the test of whether the controlling motive of the donor in making a gift was associated with thoughts of death, 283 U.S. 102">United States v. Wells, supra;Rochester H. Rogers, Executor, 21 B. T. A. 1124. However, the age of the donor is an important fact and, if circumstances show that the donor must have had in mind realization that his remaining years were to be few because he had attained old age and that there was some relationship between thoughts of age and the decision to make the gift, then considerable weight must be given the fact of advanced age.Upon consideration of all of the evidence, we think the evidence shows the following: (1) That the son's needs in 1937 and during the remainder of the decedent's life would have been amply satisfied by the parents without resort to any trust fund, and that the decedent must have considered in 1937 that the trust was to provide for the son's needs after the settlor's death. (2) That the decedent did not create the trust in 1937 to be relieved of1947 U.S. Tax Ct. LEXIS 20">35 responsibilities during his lifetime, nor to equalize any gifts among his children according to any plan of making his children independent, nor to meet any special need of the son in 1937. (3) That the dominant motive in creating the trust was not related to purposes associated with life. 283 U.S. 102">United States v. Wells, supra.It is concluded that the dominant motive of the decedent in creating the trust was to establish an instrumentality which would supply the funds for the son's needs for life after the death of the decedent and would be in lieu of a testamentary trust under his will, and that the transfer of property in trust was a substitute for a testamentary disposition of part of the donor's estate. It is held that the trust was created in contemplation of death within the meaning of section 811 (c).Petitioners rely upon Griffith v. United States, 32 Fed. Supp. 884. It is our view that the facts and the circumstances of this case require reaching a different conclusion. See Estate of Millie Langley Wright, 43 B. T. A. 551, 554, where it was said with reference to the motive for1947 U.S. Tax Ct. LEXIS 20">36 the making of gifts to two daughters: "But this condition is shown to have been of long standing and no effort is made to account 9 T.C. 979">986 for the bestowal * * at that particular time." The same observation is pertinent here.Issue 2. -- Upon the holding that the decedent created the trust for his son in contemplation of death and as a substitute for a testamentary disposition, a second question arises, which relates to the measure of the resulting estate tax. That is to say, the problem is to determine the value of "property" to be included in the gross estate for purpose of measuring the estate tax. Respondent included the value of the trust corpus at the date of death, which consisted of the original corpus, the gift stock of the Coca-Cola Co., plus increases in the corpus resulting from investment of undistributed income, and cash not yet invested. The petitioners contend that the value of only part of the trust is includible in the gross estate, namely, the value of the Coca-Cola stock. The amount of the difference in value involved in the respective contentions of the parties is about $ 11,228.The question presented is one of first impression, relating as it does1947 U.S. Tax Ct. LEXIS 20">37 to a transfer in trust which was made in contemplation of death but was completed in every respect when the inter vivos transfer was made, and was not one in which the decedent retained any interests in the property transferred. In the Igleheart case, it appeared in the findings of fact made by the Board of Tax Appeals that reinvestments of trust corpus had been made by the trustee between the date of transfer and the date of death, but that fact was not discussed by the Circuit Court in Igleheart v. Commissioner, supra, and, although the Circuit Court sustained the Board's holding that the value of all of the assets of the trust at the date of death should be included in the gross estate, there was no issue raised, as is raised here, on the point that the value of the trust assets to be included in the gross estate should be limited to the value at the date of death of the property transferred in trust by the grantor, the decedent. Also, in this case, the question does not relate to reinvestments by the trustee of proceeds from the original property transferred by the grantor-decedent to a trust in contemplation of death, nor to accretions1947 U.S. Tax Ct. LEXIS 20">38 to the very property which the grantor-decedent transferred to the trust during his lifetime. We are unable to find, and neither party has cited, any authority which has considered the precise question presented in this case. Petitioners cite no authorities to support their contention and confine their argument on brief to reliance upon the literal wording of section 811 (c). 21947 U.S. Tax Ct. LEXIS 20">39 Under the holding in issue 1, the shares of Coca-Cola stock are 9 T.C. 979">987 property to be included in the gross estate for computing the tax upon the estate. Except for petitioners' position under issue 1, as it carries over to this issue, there is no real dispute with respect to this conclusion. Thus the question which is in dispute relates primarily to the other property which made up the trust corpus at the date of death, and the question is whether such other property is includible in the gross estate under the holding that the transfer in trust at the time the trust was created was made in contemplation of death under section 811 (c).Section 811 (c) extends to transfers taking effect at death, but the transfer of property made by this decedent does not fall under the second broad category of section 811 (c). The trust instrument under which this trust was created did not evidence any retention of interest in the decedent from which it could be held that his death operated to end any probabilities or contingencies upon the happening of which any interests in any of the property of the trust would become certain. This trust is distinguishable from the trusts in the cases of1947 U.S. Tax Ct. LEXIS 20">40 Fidelity-Philadelphia Trust Co. v. Rothensies, 324 U.S. 108">324 U.S. 108, and Commissioner v. Field, 324 U.S. 113">324 U.S. 113, where it was held that "the retention of such a string * , subjected the value of the entire corpus to estate tax liability." 324 U.S. 108">Fidelity-Philadelphia Trust Co. v. Rothensies, supra.Here, the gift of the decedent to the trust was completed in every respect during his lifetime and was not affected by his death. Only the testamentary character of the motive of the decedent in making the gift sweeps it into his estate under the first broad category of section 811 (c) relating to transfers made in contemplation of death. The phrase "in contemplation of death," used in the statute, which governs the present case, "embraces gifts inter vivos, despite the fact that they are fully executed, are irrevocable and indefeasible." 283 U.S. 102">United States v. Wells, supra.3 But we do not perceive 9 T.C. 979">988 that the motive, contemplation of death, of the gift in trust of one property sweeps into the gross estate other property which is found in the trust at the1947 U.S. Tax Ct. LEXIS 20">41 date of death which is derived from the operation of the trustee, independently of the grantor, in his discretionary accumulation of income and the investment thereof in new property.1947 U.S. Tax Ct. LEXIS 20">42 The estate tax is a tax on a transfer; it is not a tax on property. United States Trust Co. of New York v. Helvering, 307 U.S. 57">307 U.S. 57; Chase National Bank v. United States, 278 U.S. 327">278 U.S. 327, 278 U.S. 327">334; Central Hanover Bank Co. v. Kelly, 319 U.S. 94">319 U.S. 94; Milliken v. United States, 283 U.S. 15">283 U.S. 15, 283 U.S. 15">20, 283 U.S. 15">22, 283 U.S. 15">23. Although in the instance of property transferred in contemplation of death all interests have been completely determined upon the making of the inter vivos transfer and the property does not technically pass at death, the statute (section 811 (c)), for purposes of the estate tax, puts the property transferred in contemplation of death in "the same category as it would have been if the transfer had not been made and the transferred property had continued to be owned by the decedent up to the time of his death." Igleheart v. Commissioner, supra.It was stated in Helvering v. Hallock, 309 U.S. 106">309 U.S. 106: "Section 302 (c) deals with property not technically passing at death but with interests theretofore1947 U.S. Tax Ct. LEXIS 20">43 created. The taxable event is the transfer inter vivos. But the measure of the tax is the value of the transferred property at the time when death brings it into enjoyment." (Italics supplied.) This rule is, in our opinion, the decisive consideration in the question before us. Value at the time of death provides the measure of the tax, but the tax is upon a transfer of property. 309 U.S. 106">Helvering v. Hallock, supra.Therefore, we think that where transfer of property has been completed during life and the death of the grantor does not operate upon the completion of the transfer, the estate tax is measured by the value of the property which the decedent transferred to a trust, only, and the tax is not measured by other property in the trust when death occurs. The fact that transfers are made in trust may constitute one common element in both a transfer in contemplation of death and a transfer taking effect at death. In both, a trust holds property at the time of death which is to provide the measure of the estate tax, but the differences in law between the two classes of transfers dictate the differences in the measure of the tax. Perceiving1947 U.S. Tax Ct. LEXIS 20">44 this to be the underlying distinction in section 811 (c) for purposes of determining gross estate, it follows here that the "property" to be included in decedent's gross estate is only the value at the date of death of the Coca-Cola stock of which the decedent made transfer during his life, rather than the value of the entire trust corpus, as respondent has determined.The conclusion above reached is not in conflict with the holding in Estate of Daniel Guggenheim, 40 B. T. A. 181, 182, 183 (modified and 9 T.C. 979">989 affirmed, 117 Fed. (2d) 499; certiorari denied, 314 U.S. 621">314 U.S. 621). In the Guggenheim case the entire trust corpus was included in the decedent's gross estate because of the reserved powers retained up to the time of his death, a different situation than we have here, where the decedent retained no interest in nor control over the property which he transferred in trust.Respondent has not presented any extended argument in support of his position under this issue and he, like petitioner, cites no authorities in support of his view other than a reference to Maas v. Higgins, 312 U.S. 443">312 U.S. 443,1947 U.S. Tax Ct. LEXIS 20">45 a case which we consider lacking in sufficient closeness to the situation in this case. Nor does respondent cite his regulation, section 81.15 of Regulations 105, at page 45, where it is provided that "If the transferee has made additions to the property, or betterments, the enhanced value of the property due thereto should not be included." We have examined the pertinent section of Regulations 105 in our consideration of this question, but can not find anything which represents an administrative interpretation of section 811 (c) as it applies to the facts of this case. In Estate of Daniel Guggenheim, supra, at page 184, we observed about the above quoted portion of the regulation as follows:* * * If the cited regulation has any applicability, which is doubtful, it does not require a different conclusion [than that reached in the Guggenheim case.] The words used therein -- "additions and betterments" -- indicate an intention to limit it to buildings or other physical properties * * Petitioner has not cited the above regulation, and so it is our understanding that neither party relies upon it. That being so, our reference to the regulation1947 U.S. Tax Ct. LEXIS 20">46 is only to indicate part of the difficulty in our learning of any published ruling of the respondent which would serve to indicate to this Court what his interpretation of section 811 (c) has been in general in the application of section 811 (c) to the kind of situation here presented. 41947 U.S. Tax Ct. LEXIS 20">47 9 T.C. 979">990 It is held that there should be included in the gross estate under section 811 (c) only the value of the shares of Coca-Cola stock which the decedent transferred to the trust, and that respondent erred in including in the gross estate the value of other property in the trust at the date of death which the trustee acquired after the trust was created out of his accumulations of trust income.Decision will be entered under Rule 50. Footnotes1. The value of the trust stock at the date of gift was $ 133,859. The gross estate of the decedent at the time of his death was $ 442,348, according to the estate tax return, which included securities of $ 414,829, so that it appears that the decedent transferred to the trust in 1937 about one-fifth of his estate.↩2. The argument of petitioners is as follows:"* * * Respondent has included in gross estate not only the value of the particular property transferred by decedent, namely, 1132 shares of Coca Cola Company Common stock, but also cash and securities representing accumulated income derived from such stock after the date of the transfer. * * * It is submitted that where property is includible in gross estate as having been transferred under circumstances described in Section 811 (c) or (d) I. R. C., only the value of the particular property transferred may be included, and the statute does not authorize the inclusion of income derived from the transferred property subsequent to the transfer and prior to the death of the decedent. * * ."The only property with respect to which the decedent made a transfer to the trust of October 14, 1937, was the 1132 shares of Coca Cola stock which was [sic] still held in the trust at the date of death. Even if the value of that stock should be included in gross estate under Section 811 (c) or (d)↩, which of course we deny, there would be absolutely no basis for including the other securities and cash held in the trust at the date of death."3. United States v. Wells, 283 U.S. 102">283 U.S. 102:" * * The statutory description embraces gifts inter vivos, despite the fact that they are fully executed, are irrevocable and indefeasible. The quality which brings the transfer within the statute is indicated by the context and manifest purpose. Transfers in contemplation of death are included within the same category, for the purpose of taxation, with transfers intended to take effect at or after the death of the transferor. The dominant purpose is to reach substitutes for testamentary dispositions and thus to prevent the evasion of the estate tax. Nichols v. Coolidge, 274 U.S. 531">274 U.S. 531, 274 U.S. 531">542; Milliken v. United States, 283 U.S. 15">283 U.S. 15↩, decided March 2, 1931. As the transfer may otherwise have all the indicia of a valid gift inter vivos, the differentiating factor must be found in the transferor's motive. * * *"4. Although the facts in this case do not involve any reinvestment by the trustee of the property which the decedent transferred, the Coca-Cola stock, the following may be of interest, in general: Montgomery's Federal Taxes, Estates, Trusts and Gifts -- 1946-1947, p. 530:"Although there are no published rulings on this question, the author understands that the Treasury, at least in the case of transfers in contemplation of death, makes a distinction between transfers to an individual donee and transfers in trust. In the case of transfers in trust, the property transferred is considered as being the trust fund as a whole, not the specific items making up the fund, and the property valued at the time of death is the property comprising the trust corpus at that time regardless of any reinvestments made by the trustee between the date of transfer and the date of death. On the other hand, in the case of a transfer to an individual, it is the Treasury's practice to value as of the date of death the specific property transferred by the decedent despite the fact that the donee may have disposed of that property prior to the time of the decedent's death."See also Humphrey v. Commissioner, 162 Fed. (2d) 1; certiorari denied, 332 U.S. 817">332 U.S. 817↩ (Nov. 10, 1947).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625529/	Peter Vamvaks v. Commissioner. C. Limmiatis v. Commissioner.Vamvaks v. CommissionerDocket Nos. 6070, 6071.United States Tax Court1945 Tax Ct. Memo LEXIS 123; 4 T.C.M. 733; T.C.M. (RIA) 45247; June 30, 1945Douglas D. Felix, Esq., Congress Bldg., Miami, Fla., for the petitioners. Edward L. Potter, Esq., for the respondent. MELLOTTMemorandum Findings of Fact and Opinion MELLOTT, Judge: The Commissioner determined the following deficiencies in income tax: 19401941Peter Vamvaks$14,451.87$1,438.27Constantine Limmiatis13,883.411,059.83 The deficiencies for 1941 are not contested. Each petitioner claims that the deficiency for 1940 is erroneous and that he is entitled to a refund. The overpayments alleged to have been made are $3,447.93 by Vamvaks and $3,647.64 by Limmiatis. The sole question in each case is: What was the amount of taxable gain realized from the complete liquidation of Riverside Laundry & Linen Supply, Inc., one-half of the stock of which was owned by each petitioner? 1945 Tax Ct. Memo LEXIS 123">124 Other adjustments made to the net income reported are not contested. Findings of Fact Petitioners are residents of Miami, Florida. Their income tax returns for the year 1940 were filed with the collector of internal revenue for the district of Florida and the taxes shown to be due were paid in the amounts and on the dates as follows: VamvaksLimmiatisMarch, 1940$1,575.22$1,837.17June, 19401,575.221,986.57September, 19401,575.221,762.47December, 19401,575.221,762.47$6,300.88$7,348.68During the year 1921 petitioners began the operation of a laundry business in Miami, Florida, as partners, which business was continued in that form until 1929, at which time petitioners exchanged the assets of the partnership for all of the stock of a corporation known as Riverside Laundry & Linen Supply, Inc. The aggregate cost of the partnership assets was $22,205.39. Each petitioner received twenty-five shares of the capital stock of the corporation upon its organization. On December 31, 1940, the assets of the corporation were transferred to petitioners in exchange for their stock and in consideration of their assuming its liabilities. From1945 Tax Ct. Memo LEXIS 123">125 that date to the date of trial the laundry and linen supply business theretofore conducted by the corporation has been operated by a partnership composed of the two petitioners. The known liabilities of the corporation assumed by the petitioners amounted to $124,879.65. The book value of the tangible assets received by them amounted to $223,354.86, as shown in the following schedule: AssetsCash on Hand and in BanksCash on Hand$ 345.00First National Bank9,700.04$ 10,045.04Accounts ReceivableCustomers - Schedual$31,013.28Routemen - Schedule6,175.76Loans - Schedule2,188.86Notes - Schedule6,326.49Mrs. C. Limmiatis1,043.81Mrs. P. Vamvaks968.2547,716.45InventoriesMaterials$ 2,000.00Linen17,500.0019,500.00Total Quick Assets$ 77,261.49Deferred AssetsInterest Accrual$ 125.50Deposits Utilities Schedule 5225.00Unexpired Insurance798.63Prepaid Rent300.00Advance Payroll25.71Prepaid Improvements10,353.05Total Deferred Assets11,827.99Fixed and Other AssetsCostRes. Depr.Furn. and Fixt.$ 5,833.54$ 1,492.43Trucks and Autos42,075.4624,298.78Plant Mch. and Equip.102,454.5948,866.17Dry Clean Equip.15,142.853,756.18Boiler17,695.893,354.82Cafeteria1,415.65203.21Boat560.98145.99Heater4,017.46577.74Water Softener3,564.45512.37$192,760.87$83,207.69$109,553.18General Machinery and Supply Co. Stock125.00Due from OfficersC. Limmiatis$10,735.47P. Vamvaks13,851.7324,587.20Total Fixed and Other Assets134,265.38Total Assets$223,354.861945 Tax Ct. Memo LEXIS 123">126 The real estate on which the plant of the laundry was and is located, including the building in which the assets of the corporation were housed, was owned during the year 1940 by the wives of the two petitioners. This property had been acquired by the wives as a gift from petitioners in 1937. The real estate was leased to the corporation under short-term leases. On December 31, 1940, the lease then in effect had three years remaining in the term. There was no provision in the lease giving the corporation a right to renew it. The item carried on the balance sheet of the corporation as "Prepaid Improvements" in the amount of $10,353.05 represented, improvements made by the corporation on the building in which it conducted its business and to the adjoining land. The adjoining land was owned by the wife of Limmiatis. Prior to making the improvements, the land had buildings on it from which the owner was receiving rent; but she agreed to allow the corporation to use the land at the same rent which she had been receiving from the property. She refused, however, to expend any sums in demolishing the buildings or in making the improvements which the corporation desired. The corporation, 1945 Tax Ct. Memo LEXIS 123">127 therefore, razed the buildings, put in a driveway, built a marquee over the driveway and improved the office. Among the assets shown on the books of the corporation was a note receivable from J. Galatis in the amount of $5,000. This note represented a loan of $5,000 made, without security, as an accommodation to an old customer for the purpose of enabling him to complete the construction of a restaurant. Subsequent to December 31, 1940, this note was paid. On December 31, 1940, the corporation had two boilers which had a book value on that date of $14,341.07. The more expensive of the two boilers had been purchased in about 1938 at a total cost, including installation, of between $10,000 and $11,000. It was a new and untried make; and after being installed it proved to be so inefficient that it was, for all practical purposes, unusable in the laundry business. Manufacture of this particular type of boiler has since been discontinued and petitioners no longer use it except temporarily when it is necessary to inspect or repair the old boiler. The earlier partnership, the corporation, and the present partnership has each been, and the latter still is, engaged in the business of1945 Tax Ct. Memo LEXIS 123">128 washing and dry cleaning lines and garments of customers and supplying linnes to other customers. The business of supplying lines to customers made up approximately 40 percent of the corporation's gross business, while approximately 45 percent consisted of laundering linens which belonged to commercial users such as hotels and restaurants. The remaining 15 percent of the corporation's business consisted of laundry work for individuals and families. During the year 1940 and for many years prior thereto the laundry and linen supply business with commercial users in the City of Miami, Florida, and surrounding localities had been obtained on a competitive basis. It was necessary for the corporation and the partnerships to solicit the customers almost constantly and to make price concessions in order to keep business in the plant. Petitioner personally, especially Limmiatis, called upon some of the larger commercial users to obtain their business. With respect to hotels and apartments the laundry work of guests was obtained largely through the management. In many instances, such work was secured on the basis of the amount of commission allowed to the management on the guests' laundry. 1945 Tax Ct. Memo LEXIS 123">129 Business was also obtained by entertaining persons who were solicited for commercial laundry and linen supply business. Such persons were sometimes the owners of the apartment house or hotel but frequently were the managers or housekeepers, depending upon who had the authority to make laundry contracts for the establishment. In some instances even bellboys were contacted. Contracts for the winter season's business (the most profitable period) were usually made with the commercial users in the fall; however, such contracts were oral, were not considered to be binding on either party and could be terminated at will. Family laundry service and a large proportion of the commercial laundry and linen supply business in the Miami area is controlled by routemen, who deal directly with the majority of the customers. Family customers, to a large extent, followed their particular routeman, regardless of which laundry happened to be employing him at the time. When the routeman changed employers the customers' business generally went to the new employer. Commercial customers, also, were diverted to a routeman's new employer when, as was frequently the case, the new employer gave the routeman1945 Tax Ct. Memo LEXIS 123">130 a higher commission, which enabled him to make greater price concessions. Several laundries in the Miami area had developed their business by "stealing" drivers from other laundries and thereby acquiring many of the other laundries' customers. The experience of laundry operators in the Miami area has demonstrated that family and commercial customers frequently do not continue to patronize a laundry simply because of excellence of service. Several sales of laundries in the Miami area have been made prior to, during and since the year 1940. In none of them was good will considered to be a factor in determining the purchase price, it being the opinion of experienced laundry operators that good will did not exist in the laundry business in Miami, Florida. The linen supply business in the Miami area, during 1940, was conducted in substantially the same manner, under the same conditions and with the same disadvantages as the commercial laundry business, with the exception that the competition was keener in the linen supply business. In the State of Florida a laundry cannot make an enforcible contract with a routeman not to work for any other laundry within a reasonable time over the1945 Tax Ct. Memo LEXIS 123">131 same route after he has ceased to be an employee of it. (Love v. Miami Laundry Co., Supreme Ct. of Florida, May 5, 1934, rehearing January 15, 1935, 160 So. 32">160 So. 32; Nettles v. City Ice & Fuel Co., idem., January 30, 1935, 160 So. 42">160 So. 42.) The net profit (or loss) of Riverside Laundry & Linen Supply, Inc., for each of the ten years immediately preceding 1941 was as follows: 1931$ 5,317.441932(1,016.76)1933(2,880.17)193426,902.54193513,272.46193618,489.56193723,994.54193839,438.86193942,230.77194030,803.34In determining the deficiencies in tax the Commissioner held that Riverside Laundry & Linen Supply, Inc., had distributed good will to petitioners, the value of which he computed as follows: Net Tangible AssetsYearJan. 1Dec. 31Average1936$19,267.81$ 19,954.06$ 19,610.93193719,954.0625,822.1822,888.12193825,822.1836,313.9831,068.08193936,313.9875,634.2155,974.10194075,634.21101,505.8688,569.54Five year total$218,110.77EARNINGSYearTotalIncome TaxNet1936$23,351.77$4,862.21$ 18,489.56193730,730.286,735.7723,994.53193848,259.608,820.7439,438.86193952,136.759,905.9842,230.77194040,530.709,727.3630,803.34Five year total$154,957.06Less: 10% of tangible assets21,811.08Profit due to intangibles$133,145.98Average per year$ 26,629.20$26,629.20 capitalized at 16 2/3%$159,775.20Each petitioner's interest, 50%79,887.60Capital gain, 50%$ 39,943.801945 Tax Ct. Memo LEXIS 123">132 In their income tax returns for 1940, each petitioner reported the amount of $18,304.75 as dividends received from the Riverside Laundry & Linen Supply, Inc. The Commissioner eliminated this amount from the income of each petitioner and added to the income of each a long term capital gain of $59,891.42. He made the following explanation of this adjustment: (a) It is held that you realized a long-term capital gain of $119,537.84 upon the dissolution of the Riverside Laundry & Linen Supply, Inc., and that one-half of that amount, or $59,768.92 is includible in your taxable income. The fair market value of the tangible assets of the Riverside Laundry & Linen Supply, Inc., as a going concern, on December 31, 1940, was $210,000. The corporation on that date had no good will or other intangibles having a fair market value. Opinion The last finding is dispositive of the sole issue. The parties do not dispute that the shares of stock of Riverside Laundry & Linen Supply, Inc., owned by petitioners at the time of its liquidation on December 31, 1940, had cost $22,205.39 and that in connection therewith petitioners assumed liabilities aggregating $124,879.65. Our determination of the1945 Tax Ct. Memo LEXIS 123">133 fair market value of the assets received by them from the corporation, therefore, provides all of the factors necessary to make a computation of the taxable gain realized by each. The parties agree that any gain realized represents a long-term capital gain, 50 percentum of which is to be taken into account. (Section 117 I.R.C.) At the trial six witnesses were called by petitioners, who expressed opinions as to the fair market value of the corporation's assets at the time they were distributed in liquidation. All of them had had considerable experience in the laundry business in Miami and surrounding communities in Florida, and most of them had personal knowledge of, or had participated in, the purchase or sale of businesses similar to that acquired by petitioners from their corporation. The witnesses testified at length to the seasonal nature of the laundry and linen supply business in Florida, the rapid turnover in customers, the importance of making personal contacts with commercial users such as managers of hotels and restaurants, and to the control which the routemen exercised over the customers which they served. The substance of their testimony is embodied1945 Tax Ct. Memo LEXIS 123">134 in our findings and will not be repeated. It is sufficient to say that the evidence convinces us that, because of the unusual conditions existing in Miami and surrounding communities, a purchaser of a laundry and linen supply business would have no assurance that he would acquire anything usually embraced in the term "good will," which would give him "a reasonable expectation of preference in the race of competition." In re Brown's Will, 249 N.Y. 1">249 N.Y. 1, 150 N.E. 581">150 N.E. 581. The witnesses were unanimous in stating that, even though a Miami laundry operated at a profit, its good will had no fair market value because of the highly competitive nature of the laundry and dry cleaning business in the vicinity, the rapid turnover of customers necessitating constant solicitation and the inability, under Florida law, of making binding contracts with routemen which would prevent them from taking the customers on their routes from one laundry to another in the same territory. They also agreed that family and commercial customers were influenced in their selection of a laundry by solicitation and by the routemen far more than they were by the type of service furnished by the laundry. Several1945 Tax Ct. Memo LEXIS 123">135 of them were familiar with voluntary sales of laundry businesses which had been made in "the greater Miami area" and testified that no amount had been included in the sales price for good will even though those laundries had been operating at a profit. One witness, who had been in the laundry business for 20 years, testified: Q. Is it your opinion that a laundry which is operating at a substantial profit is worth no more than a laundry operating without a profit? A. Definitely worth no more. The new operator may not be as good an operator as the old one or may be a better operator. I could buy a plant that is making a lot of money and start losing money. I may not be as good an operator, or I could be a better operator and make more money. Only one witness, an internal revenue agent, was called by the respondent. He determined by the mathematical formula set out in our findings, sometimes referred to as the "capitalization-of-earnings methods," that the value of the good will of the corporation on December 31, 1940, was $159,775.20. While this method of demonstrating the value of good will has often been applied by this tribunal, a condition precedent to its application is that1945 Tax Ct. Memo LEXIS 123">136 it must appear good will actually exists. The testimony of the witnesses, however, has convinced us that none existed at the time the corporation was liquidated. Hence a finding to that effect has been made. It follows that no increase in value of the assets may be approved, in so far as it is based upon the value of good will. Petitioners have requested a finding that the fair market value of the assets shown on the balance sheet of December 31, 1940, was not in excess of $182,649.49. This, they point out, was "the average going concern value of all the witnesses who made an appraisal." The witnesses were chiefly operators of laundries in the Miami area. None of them had made an appraisal of the assets until shortly before the trial. Each attempted to make an appraisal as of December 31, 1940. The values fixed by them ranged from $178,917.12 to $185,120.65. Limmiatis, testifying as a witness, fixed the value at between $180,000 and $185,000. The value fixed by the stockholders and partners at the time of the liquidation of the corporation and when litigation with reference to its accuracy was not imminent is substantial evidence of its true market value. Moreover, it is significant1945 Tax Ct. Memo LEXIS 123">137 that neither of the petitioners testified catgorically that the fair market value of any particular asset was less than shown on the exhibit with the exception of the item listed as "property improvements" - marque and driveway erected on the adjoining property - the boiler which had cost between $10,000 and $11,000 and the Galatis note of $5,000. Under cross-examination, however, Limmiatis admitted that the Galatis note had been paid in full; so it is doubtful if any deduction should be made in the total value of the assets because of it. The witnesses, other than petitioners, all accepted the values shown on the balance sheet for cash on hand and in banks, inventories, amounts due from petitioners and fixed assets, with but minor exceptions. One witness expressed the opinion that the accounts receivable, aggregating $47,716.45, should be discounted at least 25 per cent. One expressed the view that the cafeteria was worthless because he "wouldn't have it in a laundry." One stated he doubted that the automobiles had been worth, on the date shown, the depreciated value at which they were carried. One fixed the value of the boat at $200 instead of $415 as shown. All agreed, however, 1945 Tax Ct. Memo LEXIS 123">*138 that the boiler was not worth the amount shown on the balance sheet and all expressed the opinion that the improvements made on the adjoining lot were without value. Careful consideration has been given to all of the testimony and conclusion has been reached that the fair market value of the total assets on the basic date was $210,000. No attempt need be made to rationalize this conclusion. It follows that the deficiencies determined will be set aside and overpayments in tax will be allowed if shown to be due in a recomputation. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625531/	TOMMIE N. RASMUSSEN AND MARY ANN RASMUSSEN, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Rasmussen v. CommissionerDocket Nos. 14548-87, 27744-87, 27736-88United States Tax CourtT.C. Memo 1992-212; 1992 Tax Ct. Memo LEXIS 231; 63 T.C.M. 2710; April 8, 1992, Filed 1992 Tax Ct. Memo LEXIS 231">231 Decisions will be entered under Rule 155. A. Jerry Busby, for petitioners. Marikay Lee-Martinez, for respondent. DAWSONDAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: These cases were assigned to Special Trial Judge Pate pursuant to the provisions of section 7443A(b)(4) and Rules 180, 181, and 183. 2 The Court agrees with and adopts the opinion of the Special Trial Judge which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE PATE,Special Trial Judge: In these consolidated cases respondent determined deficiencies in petitioners' Federal income taxes, additions to tax, and increased interest, as follows: TOMMIE N. RASMUSSEN AND MARY ANN RASMUSSEN 19831984Deficiency$ 6,983$ 14,176Additions to taxand increased interest:section 6653(a)(1) 349709section 6653(a)(2) 1 1 section 6659 2,0954,253section 6661 2 2 section 6621(c) 3 3 DONALD B. HORNE AND MARJORIE S. HORNE19831984Deficiency$ 11,832.80$ 7,787.60Additions to taxand increased interest:section 6653(a)(1) 591.64389.38section 6653(a)(2) 1 1 section 6659 3,373.142,236.28section 6661 2 2 section 6621(c) 3 3 1992 Tax Ct. Memo LEXIS 231">232 RICHARD BESSERMAN AND ROSALIE BESSERMAN 19831984Deficiency$ 12,220.00$ 3,312.35Additions to taxand increased interest:section 6651(a)(1) 496.25section 6653(a)(1) 611.001,435.32section 6653(a)(2) 1 1 section 6659 3,367.50993.71section 6661 2 -- section 6621(c) 3 3 1985Deficiency$ 2,630.35Additions to taxand increased interest:section 6653(a)(1) 131.52section 6653(a)(2) 1 section 6659 789.11section 6661 -- section 6621(c) 3 1992 Tax Ct. Memo LEXIS 231">233 These cases were consolidated for purposes of trial, briefing, and opinion. They were chosen as test cases to determine the deductibility of certain losses and investment tax credits taken in connection with a series of transactions known as the Agbanc Donor Cow Program (hereinafter the Agbanc program). The issues for our decision are: (1) Whether the Agbanc program had economic substance and business purpose and, therefore, whether the losses and the investment credits attributable thereto should be recognized for Federal income tax purposes; (2) if so, the proper amount of income, deductions, and investment credit to be taken into account by each petitioner; (3) if so, whether the provisions of section 465 apply to limit the amount of loss deductible by any of the petitioners; (4) whether petitioners are subject to the various additions to tax determined by respondent; and (5) whether the Agbanc program was a tax motivated transaction within the meaning of section 6621(c). FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and the stipulated exhibits are incorporated herein by this reference. Tommie N. Rasmussen and Mary Ann1992 Tax Ct. Memo LEXIS 231">234 Rasmussen (hereinafter the Rasmussens) were residents of Arizona at the time they filed their petition in this case. Donald B. Horne and Marjorie S. Horne (hereinafter the Hornes) were residents of Texas at the time they filed their petition, and Richard Besserman and Rosalie Besserman (hereinafter the Bessermans) were residents of Arizona at the time they filed their petition. The Agbanc ProgramAgbanc Ltd. (hereinafter Agbanc), is an Arizona corporation formed in 1983 to structure and manage cattle programs, acquire breeding cattle, manage farms and ranches, conduct feasibility studies, and merchandise cattle. In this regard, it conceived and promoted the Agbanc program, which stated that its objective was to breed purebred 3 Simmental cattle in order to develop genetically superior herds. Agbanc's only venture was the Agbanc program offered in 1983. 1992 Tax Ct. Memo LEXIS 231">235 The Agbanc program was promoted by two corporations, Ambanc, Ltd. (hereinafter Ambanc) and Agbanc, both of which were controlled by John McDonnell. Ambanc's letterhead stated that it acted as a "sales consultant on tax oriented financing". On August 1, 1983, Ambanc entered into a contract with Agbanc, whereby Agbanc agreed to pay 35 percent of its gross income (but in no event less than $ 30,000 per month) to Ambanc for consulting services with regard to the various undertakings of Agbanc. In its Individual Animal Offering (hereinafter offering memorandum), Agbanc offered 200 purebred Simmental virgin heifer cows for sale to a maximum of 200 investors. The purchase price of each cow was $ 69,000, payable $ 6,900 down, and the balance of $ 62,100, evidenced by a nonsecured full recourse promissory note bearing interest at the rate of 9.93 percent per year, payable annually in the following principal amounts plus interest: $ 11,518 due June 30, 1984, $ 12,662 due June 30, 1985, $ 13,920 due June 30, 1986, and $ 24,000 due June 30, 1987. This payment schedule required equal annual payments of $ 17,684 for each of the first 3 years. Agbanc could not assign, sell, or otherwise dispose1992 Tax Ct. Memo LEXIS 231">236 of this note without written approval of the investor. In the offering memorandum, Agbanc stated that: The $ 69,000 purchase price has been fixed by Agbanc and is not subject to negotiations or modification, though appraisal has established the fair market price of such animals used in an embryo program to be significantly above the offering price. * * * Agbanc is of the view that the purchase price reflects each animal's fair market value.An Appraisal prepared by Karney J. Redman (hereinafter Redman), also included therein, represented that each cow in the program was capable of producing an average of $ 65,000 of income per year form the sale of progeny and embryos and, consequently, was worth between $ 75,000 and $ 85,000. He qualified the appraisal, however, by stating that: It is our understanding that each of these cows will be used in a program to generate embryos for transplant. If for some reason a particular cow was not used in such a program, you should be aware that our appraisal would change accordingly.The specific animals offered by Agbanc were selected by TCR based upon the "linear measurement valuation" method developed by Redman. This method1992 Tax Ct. Memo LEXIS 231">237 was developed to aid in the selection of genetically superior animals with emphasis placed on pedigree, confirmation, performance, and past performance. It uses the physical linear measurements of the animal to assess and evaluate the cow. Agbanc represented that the linear measurement valuation method provided the most effective system for selecting genetically superior animals. To each of the investors purchasing a cow, Agbanc offered a 3-year lease agreement with Therriault Creek Ranch (hereinafterTCR), a corporation running a ranch located in Eureka, Montana. TCR was family owned and, at the time of the offering, had conducted a ranching operation for several years. It started a Simmental breeding program and hired Ambanc, paying it $ 17,500, to structure the Agbanc program. TCR agreed to breed the Agbanc cows utilizing embryo transfer technology. The technology of embryo transfer is a process by which a breeder flushes embryos from a genetically superior donor cow, which then are transplanted into other lesser quality recipient cows (surrogates) who carry the calves to term. The purpose is to increase the yield of a genetically superior cow, who normally would produce1992 Tax Ct. Memo LEXIS 231">238 only nine to ten calves in her lifetime. The embryo transfer process entails the superovulation of a donor cow. To increase the number of eggs a cow normally produces, she is injected with a series of hormone shots. At her next heat, approximately 5 days later, she is bred by artificial insemination using semen from a superior bull. Six to eight days later, the fertilized eggs are flushed from her and observed under a microscope to assure normality. If a recipient cow is ready, the embryo can then be implanted in her reproductive tract and she carries the calf to term. If a recipient cow is not immediately available or is not in exactly the same estrous cycle as the donor cow, the embryo can be frozen and later thawed and transferred to a recipient cow. Under the lease, TCR agreed to place the cow in its embryo transfer program, providing the bull semen and all necessary veterinary services. It also agreed to let the cow have a naturally born calf at least once during the lease term. For each cow, it promised to pay the investor an annual rent of $ 14,070 for a period of 3 years. In addition, it agreed to pay a bonus of $ 450 per transferable embryo produced in the second1992 Tax Ct. Memo LEXIS 231">239 and third years of the lease, payable in a lump sum on July 1, 1987. Moreover, the investor was to receive the first natural born calf, if any, and six embryos guaranteed to pass a 90-day pregnancy test. The investor could elect to have the six embryos implanted in recipient cows, but was obligated to compensate TCR for this service. TCR promised to keep records relating to embryo production and provide petitioners with semi-annual reports thereof. Under the lease, the investor agreed to pay TCR $ 1,126 semi-annually for maintaining the cow during the initial year of the lease term. Afterward, if TCR's expenses of maintaining the cows increased, the investor's contribution increased proportionately. If the investor elected to have embryos implanted in recipient cows, he also had to pay $ 900 for each recipient cow. If a calf was born, the investor had to pay $ 300 semiannually for its maintenance. At the end of the lease term, TCR was to "return" the cow to the investor, and, thereafter, TCR was to have no further rights to the animal. At the end of the lease, the investor had the option to either sell the donor cow, natural calf, and the six embryos, or to retain ownership1992 Tax Ct. Memo LEXIS 231">240 of the animals and choose a cattle manager to operate his herd. The investor also had the option of extending TCR's management by executing a cattle management agreement. If the investor chose this option, he agreed to pay, every 6 months, $ 1,126 per cow and $ 300 per calf for feeding and maintenance. He also agreed to pay $ 100 per flush of the donor cow or any female cow and $ 900 each for recipient cows. Further, if TCR sold the donor cow, calves, or embryos, it was entitled to 25 percent of the sales price if the following minimum sales prices were obtained: (1) For the donor cow $ 18,000, net after deduction of selling fees; (2) for embryos $ 2,000, net after deduction of all costs associated therewith; (3) for calves (15 months or older) $ 5,250, net after deduction of cost of recipient cows and selling fees; and (4) for any natural born calf $ 6,000, net after deduction of selling fees. Agbanc was the lease service manager. In such capacity, it agreed to bill and collect lease payments and, on a best efforts basis, market and liquidate the cows and calves on behalf of the investor. In addition, Agbanc agreed to bill and collect the semi-annual maintenance payments due1992 Tax Ct. Memo LEXIS 231">241 from the investor to TCR. All of the investors and TCR were required to send their payments to Agbanc. In the offering memorandum, Agbanc represented that, over the course of the program, it would be profitable. To illustrate this premise, it provided investors with two cash flow projections. Option A assumed that: (1) The investor leases the cow for 3 years, enters into a cattle management with TCR for a fourth year, and sells the cow at the end of the 1-year management agreement; (2) a natural calf is born and sold 15 months later for $ 6,000, net of selling expenses; (3) 6 embryos are implanted in recipient cows and, when the calves are born, they are sold for $ 2,000 each, net of recipient cow expenses and selling expenses; (4) the cow is flushed for the one year covered by the cattle management agreement, and produces eight embryos which are sold for $ 500 each, net of flushing expenses and selling expenses; and (5) the cow is sold after 4 years of ownership for $ 19,500, net of selling expenses. Option B assumed that: (1) The investor leases the cow for 3 years, enters into a cattle management agreement with TCR for the next 2 years, and sells the cow at the end of the 1992 Tax Ct. Memo LEXIS 231">242 2 years' management agreement; (2) a natural calf is born and sold 10 months later for $ 6,000, net of selling expenses; (3) 6 embryos are implanted in recipient cows and, when the calves are born, they are raised for 15 months and then sold for $ 5,100 each, net of recipient cow expenses and selling expenses; (4) the cow is flushed for 2 years during the cattle management agreement and produces 14 embryos which are sold for $ 500 each, net of flushing expenses and selling expenses; and (5) the cow is sold in the fifth year for $ 18,000, net of selling expenses. Using these assumptions, Agbanc projected cash flow as follows: Before TaxBefore TaxPeriodCash FlowCash FlowEndingOption AOption BDec. 83$ (8,026)$ (8,026)Dec. 841 (6,242)(6,242)Dec. 85(242)(692)Dec. 862 8,1332 (7, 467)Dec. 873 17,8413 28,865Dec. 884 18,374Total cash flow $ 11,464$ 24,8121992 Tax Ct. Memo LEXIS 231">243 In addition, the offering memorandum placed considerable emphasis on the tax benefits an investor could expect from the program. The principal tax benefits depicted were the investment tax credit, depreciation deductions, the deductibility of cattle maintenance expenses, and the deduction of interest expense paid pursuant to the promissory note. The following are the projected amounts: Deprec.InterestOperatingYearITCExpenseExpenseExpense1$ 6,900$ 10,350$ 1,126215,180$ 6,1672,627314,4905,0233,077414,4903,7655,852514,4902,3832,70261,126The offering memorandum also represented that an investor would reduce his Federal income tax bill by $ 12,638 for 1983, $ 4,952 for 1984, and $ 2,835 for 1985. However, it cautioned that: This investment may be deemed a "tax shelter" by the Internal Revenue Service thereby subjecting the Purchasers to a significant risk of having their Federal income tax returns audited by that agency. Such an audit could result in assessments with regard to this investment or the Purchasers' other dealings and transactions.Specifically, it warned the investor that the price1992 Tax Ct. Memo LEXIS 231">244 of the cow could be challenged. In this regard it stated: It is quite possible that the Internal Revenue Service will claim that the purchase price of a particular donor cow is inflated and does not actually represent the fair market value of the animal. If the Internal Revenue Service successfully makes such a claim, the anticipated tax benefits of this investment could be eliminated or drastically reduced.Some of the cows sold to investors came from TCR's existing herd. In addition, TCR purchased some of the cows from other Simmental breeders. On November 21, 1983, TCR purchased six cows, for $ 2,500 each, from Fraser Valley Simmental Ranch (hereinafter Fraser Valley). It also purchased, from Alberta Livestock Transplants, Ltd. (hereinafter Alberta), a company located in Calgary, Alberta, Canada, two herds of cows, one of 28 animals at $ 2,500 per cow and the other of 17 animals at $ 3,000 per cow. Although the exact date of the purchases from Alberta cannot be ascertained from the record, 17 of them were shipped across the United States border on January 6, 1984. Alberta declared the value of each cow to the United States Custom Service to be $ 2,500 when they 1992 Tax Ct. Memo LEXIS 231">245 entered the United States. Prior to the sale to the investor, TCR sold the cows in the program to Agbanc for $ 67,000 each, on terms which required a cash downpayment of $ 5,700 and a note for $ 61,300 carrying a 9.6 percent interest rate. The payments Agbanc was required to make under the note to TCR paralleled those of the investor's notes to Agbanc. The note was payable in principal amounts of $ 11,313 on June 30, 1984, $ 12,399 on June 30, 1985, $ 13,588 on June 30, 1986, and $ 24,000 on June 30, 1987. After adding interest, this payment schedule required equal annual payments of $ 17,197 for each of the first 3 years. The Bills of Sale evidencing TCR's sales of petitioners' cows to Agbanc were all dated June 15, 1983. The program was designed so that "money" would move in a circle. In the initial year, for each cow, the investor paid Agbanc $ 6,900, Agbanc paid TCR $ 6,700, and TCR either identified a cow in its existing herd or purchased a cow for a price ranging from $ 1,500 to $ 5,000. For each of the first 3 years of the lease, the investor owed Agbanc a $ 17,684 note payment, Agbanc owed TCR a $ 17,194 note payment, and TCR owed the investor a $ 14,070 lease payment. 1992 Tax Ct. Memo LEXIS 231">246 In addition, the investor owed TCR two semi-annual maintenance payments of $ 1,126 each. All of these "payments" were charged and credited through Agbanc. Each of the investors was charged for the note payment ($ 17,684), and maintenance payments ($ 2,252), and credited with a lease payment ($ 14,070), leaving a balance due to Agbanc of $ 5,866. Agbanc owed TCR a $ 17,197 note payment and the $ 2,252 maintenance payments received from the investors and charged TCR $ 14,070 for the lease payment it had credited to the investors. Therefore, the program envisioned that upon receipt of the investors' cash payment of $ 5,866, Agbanc was to remit $ 5,379 to TCR, leaving Agbanc the balance of $ 487. Under the program, TCR never would have to actually pay anything, its lease payments to the investors being both debited and credited on the Agbanc books. Although Agbanc had not paid its notes to TCR in full, TCR suspended Agbanc's payments, and in turn, Agbanc suspended investor payments pending resolution of Agbanc's and the investor's tax problems. At the time of the suspension, petitioners were delinquent on their note payments to Agbanc, but no collection action had been initiated. 1992 Tax Ct. Memo LEXIS 231">247 Agbanc sued two of its investors (other than petitioners in this action) when their payments became delinquent, but these suits were dismissed for lack of prosecution. One of these investors filed bankruptcy, but Agbanc did not submit a claim in those proceedings. Prior to the commencement of this litigation, Agbanc did not send petitioners any report of the embryos their cows had produced, or what disposition had been made of those embryos (i.e., whether they were implanted in a recipient cow, frozen, or sold). Nor did petitioners request such an accounting. Moreover, none of the petitioners attempted to sell, other than to TCR, any of their embryos or live calves. At the time of trial, TCR had not turned over possession of any cows to any investor. PetitionersTommie N. Rasmussen and Mary Ann RasmussenPetitioner, Tommie N. Rasmussen, is a criminal investigator for the Gila County Attorneys Office and, at the time of trial, had been doing this type of work for 17 years. His wife, Mary Ann Rasmussen, is a social worker for the public schools in Globe, Arizona. Prior to the end of 1983, neither of them had any experience in the cattle industry, nor had either 1992 Tax Ct. Memo LEXIS 231">248 of them ever held any type of agricultural job. The Rasmussens became involved in the Agbanc program through the purchase of a general partnership interest (25 percent) in an Arizona partnership named Futura Investments (hereinafter Futura). They became interested in Agbanc when their financial advisor recommended it to them. Mr. Rasmussen knew that his financial advisor would receive a commission should they become investors. Thereafter, the program was presented to them by John McDonnell, the President and majority shareholder of Agbanc. However, Mr. Rasmussen made no independent effort to check either TCR's or Agbanc's history or reputation, or to validate any of the factual representations made in the offering memorandum. Mr. Rasmussen did submit the offering memorandum to his accountant, who also invested in the program. However, Mr. Rasmussen did not testify as to the content of any advice he received from his accountant with regard to the Agbanc Program, nor was the accountant called to testify at trial. On December 1, 1983, Futura purchased six cows from Agbanc for the total sum of $ 414,000. The Bill of Sale evidencing this purchase was dated May 11, 1984. The cows1992 Tax Ct. Memo LEXIS 231">249 Futura purchased had been acquired by TCR on November 21, 1983, from Fraser Valley at a cost of $ 2,500 each, a total of $ 15,000. Futura paid the $ 41,400 down payment on December 1, 1983, and signed a non-secured promissory note dated July 1, 1983, for $ 372,600. Futura did not submit any financial information to Agbanc at the time it purchased the cows. In 1983, Futura paid Agbanc $ 6,756 for maintenance expenses and an additional $ 5,630 for reasons unexplained in the record. Futura made no payments to Agbanc between January 1984 and February 1986. Sometime after May 30, 1986, Futura sold three live calves to TCR for $ 1,500 each, receiving credit against the note payments it owed Agbanc. Prior to the commencement of this litigation, neither Futura nor the Rasmussen's had received semi-annual reports of, nor inquired about, their cows' flushing and production records from TCR. The Rasmussens paid to or for Futura $ 14,148, $ 9,323, $ 4,109, and $ 3,868, during 1983, 1984, 1985, and 1986, respectively. They ceased making payments to Futura on July 30, 1986. Mr. Rasmussen testified that he believes he is liable for that portion of the Futura note which may remain unpaid1992 Tax Ct. Memo LEXIS 231">250 after receiving the appropriate credits. At the end of 1985, three partners withdrew from Futura. At the time of their withdrawal, all three were in default on their maintenance and note payments. Agbanc refunded to these three partners the amount of cash they had invested in the program. The Rasmussens filed joint Federal income tax returns for 1983 and 1984. On these returns, they deducted partnership losses from their 25 percent interest in Futura of $ 18,326 and $ 13,661 for 1983 and 1984, respectively. In addition, they claimed an investment credit of $ 10,350 in 1983, but because of certain limitations were able to offset only $ 2,107 and $ 2,582 in taxes for 1983 and 1984, respectively. In the notice of deficiency, respondent disallowed the claimed losses and investment credits for both years. She also determined that the Rasmussens should have reported $ 20,771 as their distributive share of income for 1984 from Futura. In addition, respondent determined that the Rasmussens were liable for additions to tax and increased interest for both years under sections 6653(a), 6659, 6661, and 6621(c). Donald B. Horne and Marjorie S. HorneDonald B. Horne worked for 1992 Tax Ct. Memo LEXIS 231">251 the United States Post Office for 44 years until his retirement in 1972. He was Director of the Engineering and Facilities Department at the Dallas, Texas, Regional United States Post Office. His wife, Marjorie S. Horne, was working in the purchasing office of the El Paso, Texas, Public School System when she resigned in 1974. Mrs. Horne was raised on a ranch and spent most of her life on a ranch. However, prior to entering into the Agbanc program, she had little experience actually operating or administering a ranch. The men in her family had taken on these responsibilities. Other than spending summers on his grandfather's ranch, Mr. Horne also had no ranching experience prior to entering the Agbanc program. However, in December 1983, Mrs. Horne's aunt died and Mr. Horne has been managing the "Home Ranch" ever since. Most of the Home Ranch has been leased out. The Hornes became interested in the Agbanc program because Marjorie Horne's son, William Max Young, was executive vice-president and 49 percent owner of Agbanc. Mr. Young has an extensive educational background in animal husbandry and works as a cattle broker and consultant. He left Agbanc's employ toward the end 1992 Tax Ct. Memo LEXIS 231">252 of 1983. He did not testify at trial. On October 7, 1983, the Hornes purchased one cow in the Agbanc program. A Bill of Sale reflecting the sale of the Agbanc cow to them was dated July 1, 1983. They paid Agbanc $ 8,026, which amount included the $ 6,900 down payment and $ 1,126 in maintenance costs for 1983. They also signed a promissory note dated July 1, 1983, for $ 62,100. The Hornes testified that they believed they would have to pay the note from their personal funds if their cow did not produce sufficient income. As part of the Agbanc transaction, the Hornes submitted to agbanc a completed "Confidential Qualification Questionnaire" in which they represented the total size of their net worth and annual income. However, the questionnaire did not ask the Hornes to identify the specific assets they held or liabilities they owed which comprised their net worth, nor were they required to provide any information as to their sources of income. The Hornes paid Agbanc $ 6,994, $ 5,867, and $ 3,540, in 1984, 1985, and 1986, respectively. They ceased making payments on the note on July 1, 1986. Agbanc credited the Hornes for three lease payments from TCR. Prior to their investment1992 Tax Ct. Memo LEXIS 231">253 in Agbanc's program, the Hornes did not check into TCR's or Agbanc's history or reputation. Nor did they inspect their cow, have it appraised, or investigate to determine its fair market value. The Hornes submitted the offering memorandum to their accountant, who advised them that the program was "risky". However, they did not follow up with any type of investigation after receiving such advice. The Horne cow was a heifer raised by TCR, resulting from an embryo transplant which had been made at TCR. After producing a live calf, the Horne cow died on February 3, 1986. Despite this, TCR informed the Hornes on March 24, 1986, that their cow and her calf were "all well and healthy". It is unclear exactly when the Hornes learned that their cow had died, but Mr. Horne thought it was sometime after they filed their 1986 income tax return. In May 1986, they sold the calf back to TCR for a $ 1,200 credit on their Agbanc account. Until the commencement of this litigation, the Hornes never received any embryo production reports from TCR, nor did they inquire as to whether their cow had produced any embryos or whether they were entitled to any compensation for them. The Hornes filed1992 Tax Ct. Memo LEXIS 231">254 joint Federal income tax returns for 1983 and 1984. On Schedule E, they deducted $ 1,126 in maintenance costs and $ 9,833 in depreciation for 1983. For 1984, they reported rents received of $ 14,070, against which they deducted interest of $ 6,167, maintenance costs of $ 3,378 and depreciation of $ 14,421, thereby claiming a net loss of $ 9,896. The Hornes claimed the investment credit of $ 6,900. They did not claim a loss on their cow when it died in 1986. In the notice of deficiency, respondent disallowed all of the deductions claimed by the Hornes (except for $ 1,126 of maintenance expense in 1984), but did not adjust for the rental income they had reported. In addition, respondent determined that the Hornes were liable for the additions to tax and increased interest under sections 6653(a), 6659, 6661, and 6621(c) for both years. Richard Besserman and Rosalie BessermanRichard Besserman is a medical doctor specializing in diseases of the ear, nose, and throat. He has practiced medicine in the Phoenix, Arizona, area for 21 years. Rosalie Besserman is an interior designer. Neither of the Bessermans had any involvement with the cattle industry prior to investing in1992 Tax Ct. Memo LEXIS 231">255 Agbanc. The Bessermans were personal friends of and had prior business dealings with John McDonnell. However, the Agbanc program was sold to Mr. Besserman by a patient who had a financial planning practice. Mr. Besserman purchased one cow for $ 69,000 on December 21, 1983. The Bill of Sale evidencing this transaction was dated April 19, 1984. He signed an Installment Purchase agreement effective July 1, 1983 (which had attached Exhibit A identifying the cow purchased), and a promissory note dated July 1, 1983, for $ 62,100. Mr. Besserman testified that upon signing the note he felt obligated to pay the note. He paid Agbanc $ 4,742 and $ 5,867, in 1984 and 1985, respectively, but made no payments thereafter. There is no evidence that the Bessermans independently checked TCR's or Agbanc's history or reputation prior to investing in the program. Mr. Besserman submitted the "Confidential Qualification Questionnaire" to Agbanc making representations as to the amounts of his net worth and annual income, without specifying the sources of this wealth or income. The Besserman cow was purchased by TCR from Alberta as evidenced by an invoice dated January 6, 1984, for $ 2,500. When1992 Tax Ct. Memo LEXIS 231">256 the cow entered the United States on that date, Alberta declared its value to be $ 2,500. Prior to his purchase, Mr. Besserman did not know the identity of his cow, nor did he have it inspected or appraised. Mr. Besserman never received reports from TCR nor inquired about the embryo production of his cow prior to the commencement of this litigation. The Bessermans filed joint Federal income tax returns in 1983, 1984, and 1985. Although their 1985 return was not filed until October 17, 1985, the Bessermans gave no reason for the delay. On these returns, they reported their Agbanc activity on Schedule F. For 1983, they deducted $ 2,252 in feed purchased and $ 9,832 in depreciation, for a total loss of $ 12,084. For 1984, they reported $ 14,070 as other income, and deducted $ 6,167 in interest, $ 1,126 in feed purchased, $ 14,421 in depreciation, and $ 150 in dues and publications, for a net loss of $ 7,794. For 1985, they reported $ 14,070 as sale of livestock-other income, against which they deducted $ 13,766 in depreciation, $ 1,126 for feed purchased, and $ 5,023 in interest, for a net loss of $ 5,845. In addition, for 1983, the Bessermans claimed and were able to use the1992 Tax Ct. Memo LEXIS 231">257 entire $ 6,900 investment tax credit attributable to their Agbanc investment. In the notice of deficiency, respondent disallowed the losses and the investment credit claimed. Respondent also determined that the Bessermans were liable for additions to tax and increased interest under section 6661 for 1983 (to the extent section 6659 does not apply), under section 6651(a)(1) for 1984, and under sections 6653(a), 6659, and 6621(c) respectively for all 3 years. ExpertsTimothy J. GayPetitioners presented the expert testimony of Timothy J. Gay to support their contention that the fair market value of the program was $ 69,000. Mr. Gay is a certified public accountant, and in his capacity as an auditor, he has audited some agricultural entities. However, he is not an expert at valuing cattle. At the time of trial, he was in charge of securities, litigation support, and bankruptcy services, at Toback & Company, CPA's. To value the program, Mr. Gay relied on the offering memorandum and periodicals published in 1983. He never saw the cows but claimed it was unnecessary to do so because his valuation of the program was based on economic return using projected cash flow as1992 Tax Ct. Memo LEXIS 231">258 it had been included in the offering memorandum, except that, in his projection, he increased embryo sales. He did not investigate the validity of any of the projections included in the offering memorandum because it was his understanding that the projections pertaining to the ability of the cows to produce the income were based on the opinion of experts in Simmental cows. He determined that, in 1983, the value of each cow in the program was $ 73,427. C. K. AllenRespondent's first expert, C. K. Allen, is an associate professor of agriculture at Northwest Missouri State University with a B.S., M.S., and Ph.D., in animal husbandry. Since receiving his doctorate, he has worked primarily in the animal breeding and genetics field. Dr. Allen also has experience in cattle valuation and cattle management. To prepare his report, Dr. Allen inspected petitioners' seven cows. The Horne cow had died. He researched the value of Simmental cattle during the years in issue, looking at the distribution of values as well as the averages. He factored in individual merit, reviewing the cows' weaning weights and pedigree. Dr. Allen concluded that the Agbanc cows were average or a little1992 Tax Ct. Memo LEXIS 231">259 better than average. He found that in 1983, an average full-blood Simmental heifer was worth $ 3,173. He valued the Futura cows from $ 3,400 to $ 4,500, the Horne cow at $ 2,000 to $ 7,000, and the Besserman cow at $ 2,500. It was Dr. Allen's opinion that putting cows into the Agbanc program or any other embryo transplant program did not increase their fair market value. He also stated that leasing cows is not common in the cattle industry and that the "stream of income" approach is not used in the industry to appraise cows. Moreover, because embryo transplant programs generally are so expensive, only superior cows are placed in such programs, and the Agbanc cows did not measure up to that quality standard. While at TCR, Dr. Allen observed that the Agbanc cows were being treated like commercial cattle, not as highly valuable breeding cattle. He stated that "a two or three thousand dollar calf is an expensive calf, * ,and they just weren't being handled that way. They were being handled en masse". Ron DailyRespondent's second expert, Ron Daily, received his B.S. Degree in Animal Science in 1970. He has 15 years' experience in managing cattle operations, 5 years1992 Tax Ct. Memo LEXIS 231">260 conducting agricultural appraisals and 2 years as Executive Secretary of the Texas Angus Association. He is a member of several professional associations, including the International Society of Livestock Appraisers and the American Society of Farm Managers and Rural Appraisers. His appraisal was based on a comparable market analysis, viz a comparison of the subject property with other livestock that have been sold in approximately the same period. He compared cattle of like pedigree, quality of individuals, size, and age. He used sales averages for Simmental cattle during similar time spans. From these factors, he calculated a composite figure to arrive at the fair market value of petitioners' cows. Based upon his investigation and analysis, he found that the average fair market value of petitioners' cows, as of July 1, 1983, was $ 2,719. Mr. Daily noted that the Agbanc program provided that the cows sold to petitioners would be virgin heifers, and that virgin heifers have no production history from which to indicate their ability to produce quality calves. Although sales data sometimes show that the value of a cow increases when it has proven its ability to produce superior1992 Tax Ct. Memo LEXIS 231">261 progeny, this added value is not the result of the increased number of progeny, but rather the quality of the progeny. He concluded that the cost associated with embryo transfers was too high to risk on cows of unknown production. He faulted the cash flows projected under options A and B in the offering memorandum because, among other things, they were based upon each of the cows producing 53 embryos during 2 years of flushing. He felt that 26 embryos per donor per year is extremely high; his involvement with approximately 25 Simmental donors showed that they averaged eight viable transferable embryos per year. The data from other embryo transfer centers also indicate that the number of embryos projected by Agbanc was more than double the industry average. Moreover, by examining TCR's records, he determined that the average success rate for implanted embryos for Agbanc cows was 33 percent. Based on these determinations, he valued the Agbanc embryos at $ 250 to $ 300. Finally, Mr. Daily commented that the sale/leaseback approach customarily is used in appraising real estate and that "no one has ever been able to conduct an income approach appraisal on beef cattle due to the 1992 Tax Ct. Memo LEXIS 231">262 inconsistent production of the animals and the wide range of operation costs associated with the production of progeny". Richard W. ParksRespondent's final expert, Richard W. Parks, received his A.B. from Harvard, and his M.A. in Statistics and Ph.D. in Economics from the University of California, Berkeley. An economist, he analyzed the economic feasibility of the Agbanc program. In discussing the fair market value of the Agbanc cows, Dr. Parks focused on the prices at which they sold: first from Alberta Livestock and Fraser Valley Simmental Ranch to TCR ($ 2,500 - $ 4,000), then from TCR to Agbanc ($ 67,000), and finally from Agbanc to the investors ($ 69,000). He found no indication in the Allen, Daily, or Redman reports, of prices for comparable livestock in the $ 60,000 range; he did find considerable market evidence supporting prices of $ 3,000 to $ 4,000. Consequently, he concluded that neither the TCR to Agbanc sale at $ 67,000 nor the Agbanc to investor sale at $ 69,000 could be regarded as being at a fair market value. Rather, their purpose was to establish an inflated value because it served as the basis on which an investment tax credit and depreciation1992 Tax Ct. Memo LEXIS 231">263 deductions were computed for the investors. Dr. Parks criticized the Redman appraisal of $ 75,000 to $ 85,000 included in the offering memorandum. In it, Redman suggests that the cows selected for the Agbanc program were more valuable than other identical cows not used in the program, and attributed value to the Agbanc cows based on the projected cash flows of the program, ignoring the fact that the cows could be replaced for $ 3,000 to $ 4,000. In Dr. Park's opinion, Redman used an incorrect economic analysis because in competitive markets the price of reproducible goods tends toward the cost of reproducing an equivalent or substitute good. The reason for this tendency is that, if the price is above reproduction cost, competitors will enter the market, produce the good and offer to sell it at a lower price. This process will continue until the market value closely approximates the reproduction cost. Dr. Parks illustrated this principle by comparing two identical cars, each priced at $ 10,000. Despite the fact that the first car may be used as a family car producing no income and the second may be used as a taxicab, generating net income of $ 20,000 per year, the second car1992 Tax Ct. Memo LEXIS 231">264 continues to be worth the same amount as the first. In those cases where the ability to generate income may depend on ownership of a license or medallion, allowing access to a limited market, the resale price might well exceed the $ 10,000 value of the car itself, but the extra value is attributable to the license, not the car. Dr. Parks also noted that one important premise of the concept of a fair market value is that the buyer and seller be "informed". If petitioners had been informed buyers, they would have known that the market price of cows comparable to the Agbanc cows was less than $ 4,000, and, therefore, would have refused to pay more for just the cow alone. Similarly, he found it made no economic sense for TCR to make lease payments whose present value vastly exceeded the prices at which it could (and did) purchase comparable animals. Finally, Dr. Parks pointed out that, in the cash flow projections, most of the cash projected to be received early in the program was covered by the contractual obligations built into the Agbanc program, whereas the larger amounts toward the end of the period were associated with sales prices and bonus payments, items involving substantial1992 Tax Ct. Memo LEXIS 231">265 risk. OPINION The issue we must first decide is whether the Agbanc program had economic substance and business purpose and, therefore, whether the losses and investment credits attributable thereto should be recognized. It is a long-settled rule of law that transactions which have no business purpose or economic substance other than the creation of income tax losses or credits are to be disregarded for tax purposes. Knetsch v. United States, 364 U.S. 361">364 U.S. 361, 364 U.S. 361">366 (1960); Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 293 U.S. 465">469-470 (1935); Killingsworth v. Commissioner, 864 F.2d 1214">864 F.2d 1214, 864 F.2d 1214">1216 (5th Cir. 1989), affg. Glass v. Commissioner, 87 T.C. 1087">87 T.C. 1087 (1986); Boynton v. Commissioner, 649 F.2d 1168">649 F.2d 1168, 649 F.2d 1168">1172 (5th Cir. 1981), affg. 72 T.C. 1147">72 T.C. 1147 (1979). To determine whether economic substance is present, courts analyze the objective realities of the transaction to determine whether what was actually done is what the parties to the transaction purported to do. 293 U.S. 465">Gregory v. Helvering, supra at 469; Killingsworth v. Commissioner, 864 F.2d 1214">864 F.2d at 1216. Therefore, 1992 Tax Ct. Memo LEXIS 231">266 when taxpayers resort to the expedient of drawing up documents to characterize transactions contrary to objective economic realities and which have no economic significance beyond expected tax benefits, the particular form they employed is disregarded for tax purposes. Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 435 U.S. 561">572 (1978); Falsetti v. Commissioner, 85 T.C. 332">85 T.C. 332, 85 T.C. 332">347 (1985). In evaluating the economic reality of a particular transaction, courts typically focus on whether (1) the transaction had "economic substance", and (2) the taxpayer had a nontax business purpose beyond the generation of tax benefits. Sochin v. Commissioner, 843 F.2d 351">843 F.2d 351, 843 F.2d 351">353 (9th Cir. 1988), affg. Brown v. Commissioner, 85 T.C. 968">85 T.C. 968 (1985); Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543">820 F.2d 1543, 820 F.2d 1543">1549 (9th Cir. 1987), affg. T.C. Memo. 1986-23. These elements are precise factors to consider in analyzing whether the transaction had any practical economic effects other than the creation of income tax losses. See, e.g., Neely v. United States, 775 F.2d 1092">775 F.2d 1092, 775 F.2d 1092">1094 (9th Cir. 1985);1992 Tax Ct. Memo LEXIS 231">267 Thompson v. Commissioner, 631 F.2d 642">631 F.2d 642, 631 F.2d 642">646 (9th Cir. 1980), affg. 66 T.C. 1024">66 T.C. 1024 (1976). In this case, we are faced with deciding whether, and to what extent, petitioners are entitled to deductions and credits with regard to their Agbanc transactions. Respondent argues that these transactions should be disregarded for Federal income tax purposes and that petitioners should not be allowed to deduct any losses or be allowed any investment credit because their transactions with Agbanc lack economic substance. Moreover, she maintains that Agbanc is a generic tax shelter and should be analyzed in accordance with Rose v. Commissioner, 88 T.C. 386">88 T.C. 386, 88 T.C. 386">414 (1987), affd. 868 F.2d 851">868 F.2d 851 (6th Cir. 1989). Petitioners claim that the Agbanc program, as formulated and set forth in the offering memorandum, was bona fide and, therefore, they are entitled to the tax benefits flowing therefrom. For petitioners to prevail, we would have to find that the elements of that transaction had "economic substance" and "business purpose". In other words, to allow petitioners the full amount of the losses and investment credits they claimed, 1992 Tax Ct. Memo LEXIS 231">268 we would have to find that: (1) The sales between Agbanc and petitioners and the leases between TCR and petitioners were bona fide transactions; (2) petitioners' promissory notes to Agbanc evidenced genuine indebtedness; and (3) petitioners intended to profit from their investment in the Agbanc program. Validity of Sale and Lease TransactionsClearly the most important factor we must consider in determining whether the Agbanc cattle sales were bona fide transactions is the relationship of the price charged petitioners for the cows and their fair market value. See, e.g., Independent Electric Supply, Inc. v. Commissioner, 781 F.2d 724">781 F.2d 724, 781 F.2d 724">728 (9th Cir. 1986), affg. Lahr v. Commissioner, T.C. Memo. 1984-472; Marine v. Commissioner, 92 T.C. 958">92 T.C. 958, 92 T.C. 958">989 (1989), affd. without published opinion 921 F.2d 280">921 F.2d 280 (9th Cir. 1991); Brannen v. Commissioner, 78 T.C. 471">78 T.C. 471, 78 T.C. 471">508 (1982), affd. 722 F.2d 695">722 F.2d 695 (11th Cir. 1984). Since a normal attribute of a true arm's-length sale is a purchase price approximately equal to fair market value, a big difference between the two amounts strongly indicates1992 Tax Ct. Memo LEXIS 231">269 that the transaction lacks economic substance. 85 T.C. 332">Falsetti v. Commissioner, supra at 351; Thompson v. Commissioner, 66 T.C. 1051-1053. "Fair market value" has been defined as the price upon which a well informed and willing buyer and seller would agree, dealing at arm's length, with neither acting under any compulsion to buy or sell. Drybrough v. Commissioner, 45 T.C. 424">45 T.C. 424, 45 T.C. 424">429 (1966), affd. per curiam 384 F.2d 715">384 F.2d 715 (6th Cir. 1967). The determination of fair market value is a question of fact to be determined from all of the evidence. However, where the property to be valued has been sold in an arm's-length transaction, at or about the valuation date, the most reliable evidence of the fair market value of such property is its sales price. Andrews v. Commissioner, 38 F.2d 55">38 F.2d 55, 38 F.2d 55">56-57 (2d Cir. 1930), affg. 13 B.T.A. 651">13 B.T.A. 651 (1928); Chiu v. Commissioner, 84 T.C. 722">84 T.C. 722, 84 T.C. 722">730 (1985); Flynn v. Commissioner, 35 B.T.A. 1064">35 B.T.A. 1064 (1937). Except for the cow sold to the Hornes (which was born and raised on TCR's ranch), TCR purchased all of the cows1992 Tax Ct. Memo LEXIS 231">270 sold to petitioners from Alberta and Fraser Valley for $ 2,500 per cow near the time petitioners acquired their cows from Agbanc. These cows were then sold to Agbanc for $ 67,000 each and Agbanc resold them to petitioners for $ 69,000 each. Because the sales between Agbanc and TCR were part of a prearranged program, the parties to that sale were not dealing at arm's length, and, therefore, we may properly ignore such sales for valuation purposes. On the other hand, the transactions between TCR and Alberta and Fraser Valley were at arm's length. Therefore, we view the price Alberta and Fraser Valley charged TCR ($ 2,500 - $ 3,000) as the best evidence of the amount at which these cows would change hands between a willing buyer and seller in an arm's-length transaction. Cf. Guggenheim v. Rasquin, 312 U.S. 254">312 U.S. 254, 312 U.S. 254">257-258 (1941). See Colonial Fabrics, Inc. v. Commissioner, 202 F.2d 105">202 F.2d 105, 202 F.2d 105">107 (2d Cir. 1953), affg. a Memorandum Opinion of this Court dated January 22, 1951; Brannen v. Commissioner, 78 T.C. 471">78 T.C. 497; Narver v. Commissioner, 75 T.C. 53">75 T.C. 53, 75 T.C. 53">96-97 (1980), affd. per curiam 670 F.2d 855">670 F.2d 855 (9th Cir. 1982).1992 Tax Ct. Memo LEXIS 231">271 Petitioners argue, however, that in determining whether the sales to petitioners were bona fide transactions, we must value not only the cow, but also determine the value of the "Agbanc program", viz, place a value on those intangible rights added to the cow when it was placed in the Agbanc program. Petitioners identify such intangibles as the value of the lease, the expertise of TCR in the embryo transfer process, the expertise of TCR and Agbanc in marketing cattle, and the economies of scale anticipated from participation in TCR's large scale operations. However, the offering memorandum represented that "Agbanc believes that the $ 69,000 purchase price represents the fair market value of each donor cow". (Emphasis added.) It further represented that the investor would be entitled to an investment credit and depreciation deduction based on that $ 69,000 purchase price. Because investment tax credits are available only on the cost of tangible property (sections 38(a)(2), 46(a) and (c), 48(a)), 4 and depreciation must be based on the cost of tangible property (section 168(a) and (c)), 5 we conclude that, at least for purposes of computing those tax deductions and credits, 1992 Tax Ct. Memo LEXIS 231">272 the offering memorandum must have been referring to the fair market value of the "cow" and not the "program". Moreover, petitioners' argument was propounded by taxpayers in two other cases involving the purported sale of cattle already decided by this Court. Houchins v. Commissioner, 79 T.C. 570">79 T.C. 570 (1982); Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221 (1981).1992 Tax Ct. Memo LEXIS 231">273 In both Houchins and Grodt & McKay Realty, Inc., the taxpayers argued that the value of their investment included certain contract rights associated with the cattle. In these cases, we found the applicable contract rights were valueless. See also Autrey v. United States, 889 F.2d 973">889 F.2d 973 (11th Cir. 1989). However, petitioners argue that the contract rights attached to the cows in the Agbanc program did have value. This value rested primarily in the lease, for it purported to provide an income stream of $ 14,070 per year for 3 years. In fact, petitioners' only expert witness valued the program based on the cash flow projected in the offering memorandum (after increasing the projected amount of embryo sales), which included the annual rents to be realized from the lease. To make such a finding, however, we would have to find that a corporation (TCR), experienced in ranching and in breeding cattle, was willing, in an arm's-length transaction, to pay $ 14,070 per year to rent a cow that it could purchase for $ 2,500. Our common sense rules otherwise. Only when we consider the Agbanc program as a whole does it become apparent why TCR would enter into such1992 Tax Ct. Memo LEXIS 231">274 a lease agreement. TCR was willing to lease a cow for that exorbitant amount of annual rental only because it would never be required to come up with any money to pay such rental; the Agbanc program envisioned that the lease "payments" would be made by bookkeeping entries. Under these circumstances, we find that the leases between TCR and petitioners simply had no economic substance, and, accordingly, we disregard it in our analysis. Petitioners also ask us to value other intangible rights they acquired under the Agbanc program, such as the management and marketing expertise of both TCR and Agbanc. Even if such expertise could be separately evaluated, petitioners did not present any evidence of such value. Moreover, even if they could and had done so, because of the inflated price paid by petitioners for their cows, the economic benefits flowing from the use of such expertise would accrue to TCR; it would not have benefited petitioners. Lastly, petitioners ask us to value their right to board their cattle at TCR, a large ranching operation. However, petitioners had to pay $ 1,126 semi-annually for this right during the initial year. During subsequent years, this semi-annual1992 Tax Ct. Memo LEXIS 231">275 payment was to increase proportionately with TCR's costs. There is no suggestion in the record that this maintenance payment would not cover the value of the right to use TCR's facilities. Accordingly, we find that intangible right also had no value. Our finding that the prices charged TCR by Alberta and Fraser Valley for the cows is the best indication of the fair market value of the cows sold to petitioners by Agbanc is buttressed by the opinions of Dr. Allen and Dr. Parks, respondent's experts. They both were of the opinion that putting the cows into the Agbanc Donor Cow Program or any other embryo transplant program would not have made the cows any more valuable than cows of the same quality not in a transplant program. Moreover, the fair market values of the cows determined by these experts all were within the same "ballpark". Petitioners' expert testified to the value of the Agbanc program; he presented no evidence as to the value of the cows. He valued the program based entirely on the facts and figures portrayed in the offering memorandum, except that he increased embryo sales. He admitted that he is not an expert in the valuation of cattle, and that he did not investigate1992 Tax Ct. Memo LEXIS 231">276 the validity of any of the amounts in the offering memorandum. Without a valid independent investigation of the cash flow projections on which his opinion was based, we give little credence to his valuation. Finally, petitioners claim that the cows chosen were superior breeding animals because they were chosen by using Redman's "linear measurement system". However, because the Agbanc cows were chosen from Alberta and Fraser Valley using such system, any advantage the system may have produced was already reflected in the cost of the cows to TCR. In addition to the wide discrepancy between the fair market value of the cows and the price to the investor in the offering memorandum, there are a number of other factors which also indicate that there was no economic substance to these sales. In 79 T.C. 570">Houchins v. Commissioner, supra at 591, and 77 T.C. 1221">Grodt & McKay Realty, Inc. v. Commissioner, supra at 1237-1238, we identified six factors to be considered in deciding whether a sale was bona fide. See also Cherin v. Commissioner, 89 T.C. 986">89 T.C. 986, 89 T.C. 986">997 (1987); Massengill v. Commissioner, T.C. Memo. 1988-427, affd. 1992 Tax Ct. Memo LEXIS 231">277 876 F.2d 616">876 F.2d 616 (8th Cir. 1989). They are: (1) Whether legal title passes; (2) the manner in which the parties treat the transaction; (3) whether the purchaser acquired any equity in the property; (4) whether the purchaser has any control over the property, and if so, the extent of such control; (5) whether the purchaser bears the risk of loss or damage to the property; and (6) whether the purchaser will receive any benefits from the operation or disposition of the property. The following application of these factors to the Agbanc program also shows the Agbanc sales to be spurious. Petitioners produced bills of sale dated June 15, 1983, evidencing TCR's sale of the cattle to Agbanc, and bills of sale dated July 1, 1983, April 19, 1984, and May 11, 1984, reselling the cattle from Agbanc to petitioners, to establish that petitioners received legal title to the cattle. However, except for the Horne cow, TCR did not own the cows on June 15, 1983, the date it purportedly sold them to Agbanc. Moreover, it is unclear on what date TCR actually identified the individual cows to the contracts, and, in any event, it appears that this was done after the end of 1983. Therefore, 1992 Tax Ct. Memo LEXIS 231">278 we doubt the efficacy of those documents to transfer title to petitioners in 1983. Further, there is considerable evidence that the parties did not treat the transaction as a sale. At the time Agbanc and petitioners documented the transaction, none of the cows had been assigned. Possession of the cows was never transferred to petitioners but remained throughout with TCR and, at all times, TCR treated the cattle as its own. Moreover, although under the lease petitioners purportedly retained an economic interest in the cows' production, TCR neglected to report to petitioners the number of embryos being produced by each cow, and whether TCR was transferring them to recipient cows, freezing them, or selling them. All of these factors show that neither petitioners nor TCR acted as though a sale had been consummated. In addition, as is evident from our discussion of the fair market value of these cows, petitioners never acquired any equity in the cows. The balance on the promissory notes always exceeded such value. The fourth factor is whether petitioners had any control over the property. The documents show that petitioners had complete control and that they had an option as to1992 Tax Ct. Memo LEXIS 231">279 whether they would lease the cow to TCR. However, as a practical matter, no one would enter into the Agbanc program to purchase a cow worth $ 2,500 for $ 69,000, without entering into such lease, as the lease was that part of the transaction which enabled petitioners to "pay" such a high price without having to come up with actual cash. Because the lease was necessary for the transaction to "work", petitioners never had any real choice, and, therefore, TCR always retained control over the possession and management of the cows. With regard to which party bore the risk of loss, the documents indicated that petitioners did. However, again, as a practical matter, TCR bore such risk. This conclusion is poignantly illustrated by the death of the Horne cow. Even though the Horne cow died in February 1986, the Hornes continued to get credit for the annual lease payments. Moreover, neither Agbanc nor TCR demanded payment of its notes from the Hornes, even though there were no future revenues to be derived from the Horne cow. Lastly, we must consider whether petitioners were likely to receive any benefits from the production from or disposition of their cows. Based on our economic 1992 Tax Ct. Memo LEXIS 231">280 analysis included later in this opinion, we find that they would not. In summary, petitioners would have us find that a bona fide sale occurred when a cow TCR originally purchased for $ 2,500 was, within a short time, sold to petitioners for $ 69,000. In addition, they would have us accept as bona fide a lease in which TCR, an experienced ranching operation, promised to pay a $ 14,070 annual rental on a cow it could purchase for $ 2,500. We reject both premises based on the preceding analysis and find that neither the sale of the cattle to petitioners nor their leases with TCR had any economic substance. Structure of FinancingThe presence of deferred debt that is not likely to be paid is an indication of lack of economic substance. Knetsch v. United States, 364 U.S. 361">364 U.S. 361 (1960); Waddell v. Commissioner, 86 T.C. 848">86 T.C. 848, 86 T.C. 848">902 (1986), affd. per curiam 841 F.2d 264">841 F.2d 264 (9th Cir. 1988); Estate of Baron v. Commissioner, 83 T.C. 542">83 T.C. 542, 83 T.C. 542">552-553 (1984), affd. 798 F.2d 65">798 F.2d 65 (2d Cir. 1986). Therefore, where a transaction is not conducted at arm's length by two economically self-interested parties, or 1992 Tax Ct. Memo LEXIS 231">281 where a transaction is based upon "peculiar circumstances" which influence a purchaser to agree to a price in excess of the property's fair market value, we have disregarded indebtedness to the extent it exceeded the fair market value of the purchased asset. See, e.g., Bryant v. Commissioner, 790 F.2d 1463">790 F.2d 1463, 790 F.2d 1463">1466 (9th Cir. 1986), affg. Webber v. Commissioner, T.C. Memo. 1983-633; Odend'hal v. Commissioner, 80 T.C. 588">80 T.C. 588, 80 T.C. 588">604 (1983), affd. and remanded 748 F.2d 908">748 F.2d 908 (4th Cir. 1984); Lemmen v. Commissioner, 77 T.C. 1326">77 T.C. 1326, 77 T.C. 1326">1348 (1981); Roe v. Commissioner, T.C. Memo. 1986-510, affd. without published opinion Young v. Commissioner, 855 F.2d 855">855 F.2d 855 (8th Cir. 1988), affd. without published opinion Sincleair v. Commissioner, 841 F.2d 394">841 F.2d 394 (5th Cir. 1988). We have found that the Agbanc cows were worth considerably less than their sales price to petitioners, and that the annual rent called for in TCR's lease of those cows greatly exceeded any rental which could be considered economically feasible. These inflated amounts were reflected in promissory1992 Tax Ct. Memo LEXIS 231">282 notes in the amount of $ 62,100 per cow. By arranging that the price of the cows be inflated, and then deferring payment of the inflated portion by these notes, Agbanc greatly increased the investment tax credits and depreciation deductions available to petitioners without requiring payment in cash. The offering memorandum represented that these notes would be "paid" by offsetting lease payments, sales of calves, bonus payments for embryos and, lastly, the sale of the cow. Therefore, petitioners knew that, at least for the first 3 years, the principal payments due to TCR on these "recourse" notes would be offset by the lease payments they were owed by TCR. As expected, bookkeeping entries were made on the Agbanc books crediting petitioners for the lease payments and debiting petitioners for the note payments. We considered a similar situation in 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). Under the form of that transaction, a motel was sold to the taxpayer and his partners at an inflated price with the seller financing the transaction. The seller then leased back the motel, such lease calling1992 Tax Ct. Memo LEXIS 231">283 for rental payments approximating the payments due on the purchase price. Bookkeeping entries reflecting payments due under the sales agreement by the buyer to the seller were offset against rentals due under a lease from the seller to the buyer. We declined to award any economic significance to those bookkeeping entries because -- The obligations * * are too contingent and indefinite to constitute indebtedness within the meaning of section 163(a) or cost for the purpose of computing a basis for depreciation under section 167(g). * * Estate of Franklin v. Commissioner, 64 T.C. 752">64 T.C. 771; see also Hager v. Commissioner, 76 T.C. 759">76 T.C. 759, 76 T.C. 759">787-788 (1981). Nevertheless, petitioners argue that we should recognize their indebtedness to Agbanc because their notes were "recourse", and petitioners testified that they believed that they would have to pay these notes with other resources had the annual rent under the lease, and sales of calves, embryos, and their cow, not covered the payments. However, we must examine the substance of such debt and not be guided solely by its form. Waddell v. Commissioner, 86 T.C. 848">86 T.C. 902.1992 Tax Ct. Memo LEXIS 231">284 We have refused to give effect to notes, which appear on their face to be recourse notes, but which were unlikely to ever be enforced because of the circumstances surrounding them. See, e.g., Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 88 T.C. 1086">1122-1124 (1987), affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186">856 F.2d 186 (4th Cir. 1988), affd. sub nom. . Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93 (9th Cir. 1989), affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865">868 F.2d 865 (6th Cir. 1989); Helba v. Commissioner, 87 T.C. 983">87 T.C. 983, 87 T.C. 983">1009-1011 (1986), affd. without published opinion 860 F.2d 1075">860 F.2d 1075 (3d Cir. 1988); Houchins v. Commissioner, 79 T.C. 570">79 T.C. 570, 79 T.C. 570">599-603 (1982). From the outset, neither Agbanc nor petitioners treated their indebtedness as genuine. For instance, one of the first indications that a loan is genuine is the care with which a perspective lender scrutinizes a transaction prior to making the loan to ensure that it will be repaid. Had a third party lender, such as a bank, been1992 Tax Ct. Memo LEXIS 231">285 making unsecured loans as substantial as those purportedly made by Agbanc, it would have required extensive financial information from the borrower, and then the information supplied would have been checked. Yet, the Confidential Qualification Questionnaire included in the offering memorandum only required information as to the total net worth and total income of the investor without revealing its makeup or source. Moreover, although Agbanc received a completed Confidential Qualification Questionnaire from both the Hornes and Bessermans, it did not make any investigation to determine the validity of that information. Agbanc did not even require the completion of a Confidential Qualification Questionnaire from Futura or any of its partners. Certainly, a bona fide lender would have required financial information from Futura about its organization and financial condition (as well as the financial condition of its partners) before advancing $ 372,600 to purchase six cows. Agbanc's failure to take these steps indicates that it had no intention of enforcing collection of these notes. Nevertheless, Agbanc points to the fact that it sued two of its investors (other than petitioners) 1992 Tax Ct. Memo LEXIS 231">286 to prove that it intended that the notes be paid. However, both of these lawsuits were dismissed for failure to prosecute these actions. Moreover, there is no evidence that these notes were paid either before or after the dismissals. Finally, although the notes to Agbanc were "recourse", Agbanc notified petitioners in 1987 that it had suspended payments thereon. John McDonnell testified that he did this because the Internal Revenue Service had disallowed the promised tax benefits to petitioners, thereby putting them in a cash bind. However, the offering memorandum had warned the investors that the projected tax benefits might not stand up under scrutiny. Therefore, the Internal Revenue Service's disallowance was anticipated by the parties prior to petitioners' incurring this indebtedness, yet no provision was inserted in the notes to provide for this contingency. In form, these notes were enforceable regardless of circumstances, and had they been genuine, a lender would have so enforced them. In summary, these Agbanc transactions involved parties which did not deal at arm's length. Petitioners purchased cows at greatly inflated prices. For each cow, they paid $ 6,900 in 1992 Tax Ct. Memo LEXIS 231">287 cash, which cash payment exceeded the fair market value of the asset purchased. In addition, they signed nonsecured "recourse" promissory notes which further inflated the purchase price of their cows, thereby increasing petitioners' investment credits and depreciation. Payments on the notes were made by bookkeeping entries which were offset by highly inflated lease payments. When payments became delinquent, Agbanc made only cursory collection efforts and later suspended payments, even though it purportedly had an enforceable right to collect. Under these circumstances, we conclude that this "indebtedness" was not genuine; it did nothing more than create income tax benefits. Accordingly, it cannot be recognized. See Goldstein v. Commissioner, 364 F.2d 734">364 F.2d 734, 364 F.2d 734">740 (2d Cir. 1966), affg. 44 T.C. 284">44 T.C. 284 (1965). Business PurposeIn order for us to uphold the losses and credits they claimed, petitioners must also show that they had a business purpose other than tax avoidance when entering the Agbanc program. Casebeer v. Commissioner, 909 F.2d 1360">909 F.2d 1360, 909 F.2d 1360">1363 (9th Cir. 1990), affg. in part and revg. in part Larsen v. Commissioner, 89 T.C. 1229">89 T.C. 1229 (1987);1992 Tax Ct. Memo LEXIS 231">288 affg. T. C. Memo. 1987-628, affg. Moore v. Commissioner, T.C. Memo. 1987-626, affg. Stern v. Commissioner, T.C. Memo. 1987-625. This "business purpose" test involves consideration of whether petitioners had an "actual and honest profit objective". Shriver v. Commissioner, 899 F.2d 724">899 F.2d 724, 899 F.2d 724">725-726 (8th Cir. 1990), affg. T.C. Memo. 1987-627; Estate of Thomas v. Commissioner, 84 T.C. 412">84 T.C. 412, 84 T.C. 412">439-440 (1985). In determining whether a taxpayer intended to profit from an activity in which his participation was passive, we must pay particular attention to whether the taxpayer was prudent in acquiring the property and in assigning duties to third parties and to whether the taxpayer monitored the performance of such duties as the enterprise progressed. Flowers v. Commissioner, 80 T.C. 914">80 T.C. 914, 80 T.C. 914">932 (1983). Specifically, this Court has taken into account (in addition to the factors already discussed in this opinion), such factors as: Whether the taxpayer was knowledgeable of the industry, Sutton v. Commissioner, 84 T.C. 210">84 T.C. 210, 84 T.C. 210">224 (1985), affd. per curiam1992 Tax Ct. Memo LEXIS 231">289 788 F.2d 695">788 F.2d 695 (11th Cir. 1986), affd. sub nom. Knowlton v. Commissioner, 791 F.2d 1506">791 F.2d 1506 (11th Cir. 1986); whether he attempted to obtain valid information about the industry or research the feasibility of making a profit in a particular industry, Surloff v. Commissioner, 81 T.C. 210">81 T.C. 210, 81 T.C. 210">234-237 (1983); whether he ultimately relied upon the promoters of the shelter, Estate of Baron v. Commissioner, 83 T.C. 542">83 T.C. 542, 83 T.C. 542">555-556 (1984), affd. 798 F.2d 65">798 F.2d 65 (2d Cir. 1986); whether he negotiated the purchase price, Elliott v. Commissioner, 84 T.C. 227">84 T.C. 227, 84 T.C. 227">238 (1985), affd. without published opinion 782 F.2d 1027">782 F.2d 1027 (3d Cir. 1986); whether there was any evidence of past profitability, Cronin v. Commissioner, T.C. Memo. 1985-83; and whether he spent any appreciable time or effort in monitoring his investment, Horn v. Commissioner, 90 T.C. 908">90 T.C. 908, 90 T.C. 908">936 (1988). Application of these factors to the Agbanc program shows that petitioners did not enter into or engage in the Agbanc transactions with economic profits in mind. For instance, none of the petitioners1992 Tax Ct. Memo LEXIS 231">290 demonstrated any meaningful knowledge of nor made any independent investigation into the overall operations of the cattle industry, the risks encountered in conducting a cattle breeding business, or specifically, whether and how embryo transplant technology could be used profitably in the cattle industry. Nor did they obtain any independent financial information or background information on TCR. Ultimately, they relied almost exclusively upon the Agbanc promoters and their financial advisors, all of whom had a financial stake in having petitioners purchase their cows. Further, no attempt was made by any of the petitioners, or their agents, to negotiate the price of the cow, the terms of the lease agreement, the amount of the promissory notes, the interest rate, payment dates, or duration thereof. In fact, the offering memorandum precluded such negotiations. The absence of arm's-length negotiations is a key indicator of a transaction's lack of economic substance. Helba v. Commissioner, 87 T.C. 983">87 T.C. 983, 87 T.C. 983">1005-1007 (1986), affd. without published opinion 860 F.2d 1075">860 F.2d 1075 (3rd Cir. 1988). Nor have petitioners demonstrated that they had any reasonable1992 Tax Ct. Memo LEXIS 231">291 basis for believing their cows would generate any profits. The offering memorandum contained two calculations entitled "before tax cash flow" which projected, on an annual basis, the amount of cash the investor would receive or have to pay. These projections were made on two sets of assumptions, both of which show that the program ultimately would be profitable. Under both projections, cash flow is significantly negative in the early years. These projections turn positive in later years because they included (per cow) estimated receipts from the sale of a live calf ($ 6,000), sale of six calves, net of recipient and selling costs (at $ 5,100 each totalling $ 30,600), residual value of the cow ($ 19,500 or $ 18,000), and embryo bonus payments and embryo sales (at $ 500 each totaling $ 27,850 or $ 30,850). There is little credible evidence in this record which would substantiate the validity of those cash flow projections. Although there is some vague testimony from the principals involved in organizing, promoting, and operating the Agbanc program to the effect that the cash flow projections were prepared based on assumptions the principals deemed reasonable, their testimony was1992 Tax Ct. Memo LEXIS 231">292 not backed up by any documentary evidence of the arm's-length sales they purportedly based their assumptions on, or expert testimony validating such assumptions. Moreover, the income projections were extremely optimistic as to sales prices and the number of embryos which would be produced. For instance, the resale value of each of petitioners' cows was projected at $ 18,000 and $ 19,500; yet, there is no objective evidence in this record explaining why a cow purchased for $ 2,500 to $ 3,000 would be worth almost $ 20,000, 3, 4, or 5 years later. Moreover, a live calf was projected to command a $ 6,000 price after expenses. Again, none of the evidence explains why the offspring of a cow costing $ 2,500 to $ 3,000 would be worth more than twice as much. Consequently, petitioners have not shown that the Agbanc cows would have produced a profit given the $ 69,000 purchase price. Further, we doubt that petitioners ever believed that the Agbanc program would result in economic profit to them. None of them spent any appreciable amount of time monitoring their investments. None of them received the semi-annual production reports from TCR to which they were entitled under their lease, 1992 Tax Ct. Memo LEXIS 231">293 and none of them requested this information from TCR after they failed to receive the required reports. None of the petitioners received or inquired about any accounting of the amounts which might be due to them from their cows' production, even though, according to the projections, these amounts should have been substantial. Petitioners' almost complete lack of interest confirms that they did not anticipate profits. Finally, we turn our attention to the tax benefits depicted in the offering memorandum and other promotional material. These tax benefits included deductions for depreciation, cattle maintenance, and interest expenses, as well as the investment tax credit. At the time of their investment in the Agbanc program, petitioners knew that they were investing in a program designed to yield substantial tax benefits. The offering memorandum represented that an investor purchasing one Agbanc cow would reduce his Federal income tax bill by $ 12,638 for 1983, $ 4,952 for 1984, and $ 2,835 for 1985. It was not until 1986 that the offering memorandum predicted the investor would have to pay taxes with respect to the Agbanc program, and this tax was premised on receipt of the 1992 Tax Ct. Memo LEXIS 231">294 extraordinarily high prices Agbanc estimated would be received upon sale of the embryos, calves, and upon disposition of the cows. Without realization of these prices, no tax would have been incurred; in fact, additional tax losses might have been claimed. In summary, we have scrutinized the evidence and are convinced that petitioners were not seeking profits when they bought their Agbanc cows. The picture that emerges is one of petitioners who sought, bought, and claimed, substantial tax benefits through the Agbanc program. ConclusionBased on the entire record in this case, we conclude that the Agbanc program was lacking in economic substance and business purpose and, therefore, was a "sham", and should be ignored for tax purposes. We have highlighted in the foregoing analysis those factors which were of primary importance in our coming to this conclusion: (1) Agbanc completely controlled the structure of the program; (2) petitioners had no opportunity to negotiate the price or terms of any of the elements; (3) petitioners knew practically nothing about breeding cattle and did little to enlighten themselves prior to entering into the program; (4) the cows purportedly 1992 Tax Ct. Memo LEXIS 231">295 were sold to petitioners at prices 25 times their cost; (5) the cows were leased for an annual rental almost six times their value; (6) the cows were "paid" for with promissory notes the parties never expected would be collected; and (7) after investing their dollars, petitioners evidenced little interest in the profitability of their cows. Consequently, we hold that the losses and credits claimed by petitioners which are attributable to the Agbanc program are not allowable. See Falsetti v. Commissioner, 85 T.C. 332">85 T.C. 332 (1985). Because of our holding, we need not consider the parties' other arguments. We note, however, that respondent failed to eliminate the lease income from Agbanc reported by the Hornes and the Bessermans when she issued their notices of deficiency. Consequently, our holding that the Agbanc transaction lacked economic substance will require a revised computation of their deficiencies because it eliminates this "income". Additions To TaxNegligenceRespondent determined that all of the petitioners were negligent in claiming their Agbanc losses and investment credits and, therefore, that they were liable for the additions to tax under1992 Tax Ct. Memo LEXIS 231">296 sections 6653(a)(1) and (2). 6Section 6653(a)(1) provides that, if any portion of an underpayment of tax is due to negligence or intentional disregard of rules or regulations, an amount equal to 5 percent of the underpayment is added to the tax. Section 6653(a)(2) provides for an addition to tax equal to 50 percent of the interest on the portion of the underpayment attributable to negligence. Negligence has been defined as the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances . Zmuda v. Commissioner, 731 F.2d 1417">731 F.2d 1417, 731 F.2d 1417">1422 (9th Cir. 1984),1992 Tax Ct. Memo LEXIS 231">297 affg. 79 T.C. 714">79 T.C. 714 (1982); Marcello v. Commissioner, 380 F.2d 499">380 F.2d 499, 380 F.2d 499">506 (5th Cir. 1967), affg. in part and remanding in part 43 T.C. 168">43 T.C. 168 (1964); Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985). Because an addition to tax under section 6653(a) is presumptively correct, the taxpayer bears the burden of establishing that respondent's determination was erroneous.7Betson v. Commissioner, 802 F.2d 365">802 F.2d 365, 802 F.2d 365">372 (9th Cir. 1986), affg. in part and revg. in part T.C. Memo. 1984-264; Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 58 T.C. 757">791-792 (1972); Enoch v. Commissioner, 57 T.C. 781">57 T.C. 781, 57 T.C. 781">802-803 (1972). 1992 Tax Ct. Memo LEXIS 231">298 All of the petitioners deducted losses in connection with their Agbanc transactions. In addition, all claimed an investment credit on the cows purchased based on a $ 69,000 purchase price. In doing this, they relied on the facts and information contained in the offering memorandum and other documents submitted to them by Agbanc, and representations made to them by persons having a connection with Agbanc. None of the petitioners made any significant attempt to consult with any independent person having the type of expertise necessary to evaluate the validity of Agbanc's factual representations. None of the petitioners attempted to check with knowledgeable sources outside the Agbanc circle to independently verify the history, expertise, experience, credibility, reputation, or financial capability of Agbanc, TCR, or any of the other principals. None of the petitioners questioned, to any great degree, the genuineness of this program that promised to directly reduce their Federal income tax liability in the initial year by an amount far greater than their cash outlay during such year. We have held that the failure of a taxpayer to make a meaningful investigation beyond the promotional1992 Tax Ct. Memo LEXIS 231">299 materials supplied by the sales person was not reasonable or in keeping with a reasonably prudent person. LaVerne v. Commissioner, 94 T.C. 637">94 T.C. 637, 94 T.C. 637">652 (1990); F.2d. (9th Cir. 1992), affd. without published opinion sub nom. Cowles v. Commissioner, 949 F.2d 401">949 F.2d 401 (10th Cir. 1991). Moreover, we already have found that from petitioners' point of view the Agbanc program lacked business purpose, and was formulated to provide tax benefits. To maximize these tax benefits, petitioners signed documents which they knew, at the time, misstated the facts. For instance, they signed backdated promissory notes to "create" interest deductions for a period prior to their participation in the program, representing therein that they owed an indebtedness which they knew did not exist on July 1, 1983. In addition, other documents received by petitioners, such as the offering memorandum, should have put petitioners on notice that there were serious questions as to viability of the proffered tax benefits. Yet, before claiming these tax benefits, none of the petitioners bothered to seriously investigate whether there was any basis to the underlying facts represented1992 Tax Ct. Memo LEXIS 231">300 therein or verify whether there existed the authority necessary to support these munificent deductions and credits. Some of the petitioners testified that they consulted with their accountants about the tax benefits promised in the offering memorandum. The Courts have absolved taxpayers from additions to tax for negligence in cases where the taxpayer: (1) Consulted a fully qualified, independent, accountant; (2) fully disclosed the facts to him; and (3) then relied on his advice in good faith. See, e.g., Betson v. Commissioner, 802 F.2d 365">802 F.2d at 372; Leonhart v. Commissioner, 414 F.2d 749">414 F.2d 749 (4th Cir. 1969), affg. per curiam T.C. Memo. 1968-98. However, the record in this case does not adequately disclose the extent and substance of the facts petitioners disclosed to their accountants nor the essence of the advice given to them as a result. See Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93, 864 F.2d 93">96 (9th Cir. 1989), affg. sub nom. 88 T.C. 1086">88 T.C. 1086 (1987). Moreover, petitioners did not call their accountant as a witness to describe the circumstances of such consultation or explain the advice given. Therefore, we may1992 Tax Ct. Memo LEXIS 231">301 properly infer that the testimony of these witnesses would have been unfavorable to petitioners' case. Pollack v. Commissioner, 47 T.C. 92">47 T.C. 92, 47 T.C. 92">108 (1966), affd. 392 F.2d 409">392 F.2d 409 (5th Cir. 1968); Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158">6 T.C. 1158, 6 T.C. 1158">1165 (1946), affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). In summary, petitioners' conduct does not evidence the due care and prudence required by the statute. Therefore, we find that petitioners were negligent, as defined by section 6653(a), and, accordingly, hold that they were liable for the additions to tax under sections 6653(a)(1) and (a)(2). DelinquencyRespondent determined that the Bessermans did not file their Federal income tax return for 1984 within the time prescribed by law and, therefore, that they were liable for the addition to tax under section 6651(a)(1). That section requires an addition to tax in case of failure to file an income tax return on time unless it is shown that such failure is due to reasonable cause and not due to willful neglect. Sec. 6651(a)(1). The burden of establishing reasonable cause rests with petitioner. Rule 142(a); BJR Corporation v. Commissioner, 67 T.C. 111">67 T.C. 111, 67 T.C. 111">131 (1976).1992 Tax Ct. Memo LEXIS 231">302 The record does not disclose any reason for the Bessermans not filing their return on time. Accordingly, they are subject to the addition to tax under section 6651(a)(1). Valuation OverstatementsRespondent also determined that petitioners were subject to the addition to tax under section 6659(a) for all taxable years at issue. Section 6659(a) imposes a graduated addition to tax on an underpayment "attributable to a valuation overstatement". Section 6659(c) provides that there is a valuation overstatement if the value of any property or the adjusted basis of any property claimed on any return is 150 percent or more of the amount determined to be the correct amount of such valuation or adjusted basis, as the case may be. The question of whether the addition to tax under section 6659 applies has been considered by the Fifth and Ninth Circuits (the circuits to which this case is appealable) in Todd v. Commissioner, 862 F.2d 540">862 F.2d 540 (5th Cir. 1988), affg. 89 T.C. 912">89 T.C. 912 (1987), and Gainer v. Commissioner, 893 F.2d 225">893 F.2d 225 (9th Cir. 1990), affg. T.C. Memo. 1988-416. In 862 F.2d 540">Todd v. Commissioner, supra,1992 Tax Ct. Memo LEXIS 231">303 the Fifth Circuit looked to the legislative history of section 6659 to see if it provided for a method of calculating whether a given tax underpayment is attributable to a valuation overstatement. It found that: Such a formula is found * , in the General Explanation of the Economic Recovery Tax Act of 1981, or "blue book," prepared by the staff of the Joint Committee on Taxation. Though not technically legislative history, the Supreme Court relied on a similar blue book in construing part of the Tax Reform Act of 1969, calling the document a "compelling contemporary indication" of the intended effect of the statute. The committee staff explained section 6659's operation as follows: The portion of a tax underpayment that is attributable to a valuation overstatement will be determined after taking into account any other proper adjustments to tax liability. Thus, the underpayment resulting from a valuation overstatement will be determined by comparing the taxpayer's (1) actual tax liability (i.e., the tax liability that results from a proper valuation and which takes into account any proper adjustments) with (2) actual tax liability as reduced by taking into account1992 Tax Ct. Memo LEXIS 231">304 the valuation overstatement. The difference between these two amounts will be the underpayment that is attributable to the valuation overstatement. [Todd v. Commissioner, 862 F.2d 540">862 F.2d at 542-543, fn. refs. omitted.]Subsequently, in Heasley v. Commissioner, 902 F.2d 380">902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo. 1988-408, supplemental opinion T.C. Memo. 1991-189, the Fifth Circuit, using the formula approach, arrived at the same conclusion when all of the deductions and credits related to the tax shelter had been disallowed by respondent, and the taxpayer conceded the disallowance prior to trial. The court explained: Whenever the I.R.S. totally disallows a deduction or credit, the I.R.S. may not penalize the taxpayer for a valuation overstatement included in that deduction or credit. In such a case, the underpayment is not attributable to a valuation overstatement. Instead, it is attributable to claiming an improper deduction or credit. In this case, the Heasleys' actual tax liability does not differ one cent from their tax liability with the valuation overstatement included. In other words, the Heasley's valuation1992 Tax Ct. Memo LEXIS 231">305 overstatement does not change the amount of tax actually owed. * * [Heasley v. Commissioner, 902 F.2d 380">902 F.2d at 383]In considering a particular issue, this Court is constrained to follow the reasoning of the Court of Appeals to which appeal would lie. Coastal Petroleum Refiners, Inc. v. Commissioner, 94 T.C. 685">94 T.C. 685, 94 T.C. 685">687 (1990); Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742, 54 T.C. 742">756-757 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). Pursuant to Todd, Heasley, and Gainer, we hold that the addition to tax under section 6659 does not apply in these cases. Substantial UnderstatementRespondent also determined that, to the extent that section 6659 does not apply, petitioners are liable for the addition to tax under section 6661. That section applies to income tax returns that are due to be filed after December 31, 1982, if the addition to tax will be assessed after October 21, 1986. All of the income tax returns under consideration were filed after December 31, 1982, and any assessment of this addition to tax will be made after this Court renders its decision. Therefore, section 6661 is applicable to all 1992 Tax Ct. Memo LEXIS 231">306 years at issue. Section 6661 provides that a taxpayer whose income tax return contains a substantial understatement of tax may be liable for an addition to tax equal to 25 percent of the underpayment attributable to such understatement. Pallottini v. Commissioner, 90 T.C. 498">90 T.C. 498 (1988). The term "understatement" is expressly defined by section 6661(b)(2) as the excess of the amount of the tax required to be shown on the return over the amount of the tax which is actually shown on the return filed. Further, the term "substantial understatement" is defined in section 6661(b)(1) as an "understatement" which exceeds the greater of 10 percent of the tax required to be shown on the return or $ 5,000. If a "substantial understatement" is present, it triggers the application of the addition to tax provided for in section 6661(a). Woods v. Commissioner, 91 T.C. 88">91 T.C. 88, 91 T.C. 88">95 (1988). In her brief, respondent conceded that if this Court finds that there is no economic substance or business purpose to the Agbanc transaction, the elimination of Agbanc income from the tax computation will decrease the Rasmussens' and Hornes' deficiencies for 1984 to an amount1992 Tax Ct. Memo LEXIS 231">307 less than $ 5,000. Since we have found that the Agbanc program lacked economic substance, it follows then that the Rasmussens and the Hornes are not subject to the addition to tax under section 6661 for 1984. Moreover, respondent determined that the section 6661 addition to tax does not apply to the Bessermans for 1984 and 1985 because their deficiencies for those years are less than $ 5,000. Consequently, the $ 5,000 threshold amount eliminates the issue of the section 6661 addition to tax, except with regard to all petitioners for 1983 and the Hornes for 1984. Further, the amount of the understatement taken into account under section 6661 can be reduced if there is substantial authority for the tax treatment of the item at issue. Sec. 6661(b)(2(B)(i). In the case of "tax shelters", the reduction for substantial authority applies only where the taxpayer reasonably believed that the tax treatment was more likely than not the proper treatment. Sec. 6661(b)(2)(C). A partnership, other entity, investment plan, or other arrangement, whose principal purpose is the avoidance or evasion of Federal income tax is considered a "tax shelter" for section 6661 purposes. Sec. 6661(b)(2)(C)(ii); 1992 Tax Ct. Memo LEXIS 231">308 sec. 1.6661-5(b)(1), Income Tax Regs.As noted earlier, petitioners did not address the additions to tax in their brief. Therefore, they have not argued that their position is supported by substantial authority. Moreover, we know of no such authority inasmuch as we have held that petitioners' participation in the Agbanc program was motivated by the tax benefits offered thereby. Further, we find that petitioners did not believe that the tax treatment they reported on their return was more likely than not the proper treatment. This finding is evidenced most succinctly by the facts surrounding the investment credits claimed by petitioners. These credits were based on purchase prices inflated by notes which were to be largely "paid" by offsetting credits through Agbanc. We are convinced that petitioners understood that the basis on which the investment credit was claimed could have been set by Agbanc at any amount just as long as offsetting lease payments were raised proportionately. Moreover, although petitioners testified at trial that they believed they ultimately would make a profit in the Agbanc program, and that, therefore, it was a bona fide business activity, their actions1992 Tax Ct. Memo LEXIS 231">309 belie their statements. There is no evidence that any of them followed up their investment to ascertain whether it was or could be profitable. None of them knew whether their cow was producing embryos and, if so, the value of the production. The Hornes did not even know that their cow had died until some months later. The only aspect of the program petitioners continued to follow was the viability of the tax benefits. We believe that they were nervous about the claimed benefits because the discussion of the tax aspects of the program in the offering memorandum indicated they may not be upheld under close scrutiny. Horn v. Commissioner, 90 T.C. 908">90 T.C. 908, 90 T.C. 908">942-944 (1988). Consequently, we find that petitioners did not reasonably believe that the treatment of those items in their tax returns would prevail. For this reason and the others stated heretofore, we hold that petitioners are subject to the additions to tax under section 6661 for the applicable years. Increased InterestRespondent also determined that all of the petitioners were subject to the increased rate of interest provided in section 6621(c). 8Section 6621(c) provides for an interest rate1992 Tax Ct. Memo LEXIS 231">310 of 120 percent of the adjusted rate established under section 6621(b) if there is a "substantial underpayment" which is "attributable to 1 or more tax motivated transactions". Stanley Works & Subsidiaries v. Commissioner, 87 T.C. 389">87 T.C. 389, 87 T.C. 389">413-415 (1986). An underpayment is substantial if it exceeds $ 1,000. Sec. 6621(c)(2). The increased rate applies to interest accrued after December 31, 1984, even though the transaction was entered into prior to the date of enactment of section 6621(c). Solowiejczyk v. Commissioner, 85 T.C. 552">85 T.C. 552 (1985), affd. per curiam without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986). The phrase "tax motivated1992 Tax Ct. Memo LEXIS 231">311 transaction" includes sham transactions entered into for tax benefits. Sec. 6621(c)(3)(A)(v); Sheldon v. Commissioner, 94 T.C. 738">94 T.C. 738, 94 T.C. 738">770 (1990); Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086 (1987), affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186">856 F.2d 186 (4th Cir. 1988), affd. without published opinion sub nom. Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93 (9th Cir. 1989), affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865">868 F.2d 865 (6th Cir. 1989). We have found that the Agbanc program lacked business purpose and economic substance and that petitioners entered into such program to obtain its tax benefits. It is therefore a "sham" transaction. McCrary v. Commissioner, 92 T.C. 827">92 T.C. 827, 92 T.C. 827">852-854 (1989). Because sham transactions are tax motivated transactions which fall within the scope of section 6621(c)(3)(A)(v), we hold that petitioners are liable for the increased interest. Based on the foregoing, Decisions will1992 Tax Ct. Memo LEXIS 231">*312 be entered under Rule 155. Footnotes1. Cases of the following petitioners are consolidated herewith: Donald B. Horne and Marjorie S. Horne, docket No. 27744-87, and Richard Besserman and Rosalie Besserman, docket No. 27736-88.↩2. All section references are to the Internal Revenue Code in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩1. 50 percent of the interest due on the deficiency. ↩2. Applies to that portion of the deficiency to which section 6659↩ is not applicable. 3. To be determined.↩1. 50 percent of the interest due on the deficiency. ↩2. Applies to that portion of the deficiency to which section 6659↩ is not applicable. 3. To be determined.↩3. "Purebreds" are Simmental cattle upgraded from other breeds to reflect at least 7/8ths Simmental for cows and 15/16ths Simmental for bulls. "Fullbloods" have 100% Simmental (European) parentage.↩1. For the year ending December 31, 1984, Agbanc projected that the investor would receive rental income of $ 14,070, make a note payment of $ 17,685 and two maintenance payments totalling $ 2,627. This resulted in a negative cash flow of $ 6,242 ($ 17,685 + 2,627 - 14,070). ↩2. For the year ending December 31, 1986, the calculation was as follows: ↩DescriptionOption AOption BLease$ 14,070 $ 14,070 (6) calves sold at 2,000 12,000 (4) embryos sold at 500 2,000 2,000 Less: Debt Service (17,685)(17,685)Operating Expenses (2,252)(5,852)Cash Flow $ 8,133 ($ 7,467) 3. For the year ending December 31, 1987, the calculation was as follows: ↩DescriptionOption AOption BBonus Payment$ 23,850 $ 23,850 Cow sold (Residual value)19,500(6) calves sold at 5,100 30,600 (4) embryos sold at 500 2,000 (7) embryos sold at 500 3,500 Less: Debt Service (26,383)(26,383)Operating Expenses (1,126)(2,702)Cash Flow $ 17,481 $ 28,865 4. For the year ending December 31, 1988, Agbanc projected that the cow would be sold for $ 18,000, three embryos would be sold at 500 each for $ 1,500 and maintenance would cost $ 1,126. This resulted in cash flow of $ 18,374 ($ 18,000 + $ 1,500 - $ 1,126).↩4. Secs. 38(a)(2) and 46(a) allow an investment tax credit based on a percentage of the cost of a "qualified investment". Under sec. 46(c), a "qualified investment" could only be in "sec. 38 property". Sec. 48(a) limits "sec. 38↩ property" to certain tangible property. Therefore, the investment tax credit is available only on tangible property. 5. The availability of accumulated cost recovery system depreciation under sec. 168 is also linked to tangible property. Sec. 168 provides for depreciation on "recovery" property. Sec. 168(c) defines "recovery" property as "tangible property". Thus, the depreciation deduction under section 168↩ is available only on the cost of tangible property.6. The additions to tax for negligence (sec. 6653(a)), valuation overstatements (sec. 6659), and substantial understatement of tax liability (sec. 6661↩), were repealed for income tax returns due to be filed after December 31, 1989, and were replaced with an accuracy related addition under sec. 6662. Omnibus Budget Reconciliation Act of 1989, Pub . L. 101-239, sec. 7721(c), 103 Stat. 2106, 2395.7. Despite their burden to prove that the additions to tax determined by respondent were wrong, petitioners failed to address the correctness of such determinations in either their opening or reply briefs. Therefore, we could construe that these issues were conceded by petitioners. Harris v. Plastics Manufacturing Co., 617 F.2d 438">617 F.2d 438 (5th Cir. 1980); see also Stringer v. Commissioner, 84 T.C. 693">84 T.C. 693, 84 T.C. 693">708 (1985), affd. without published opinion 789 F.2d 917">789 F.2d 917↩ (4th Cir. 1986). However, because the additions to tax were challenged in the petitions and are a substantial part of respondent's determinations, we will address their correctness.8. Prior to the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1511(a), 100 Stat. 2085, 2744, subsection (c) was designated subsection (d). Sec. 6621(c)↩ was repealed as to income tax returns due to be filed after December 31, 1989, by sec. 7721(b) of the Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, 103 Stat. 2106, 2399.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625532/	MARTIN O'CONNOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.O'Connor v. CommissionerDocket No. 96639.United States Board of Tax Appeals40 B.T.A. 489; 1939 BTA LEXIS 846; August 22, 1939, Promulgated 1939 BTA LEXIS 846">846 COMMUNITY PROPERTY. - Profit from sale of United States bonds was taxable to husband where the bonds were his separate property and the gain resulted from a mere increase in market value of the bonds not occasioned by any activity of the community. MURDOCK 40 B.T.A. 489">489 OPINION. MURDOCK: The Commissioner determined a deficiency of $765.82 in the petitioner's income tax for 1936. The only issue for decision is whether the gain from the sale of United States bonds was community property, as the petitioner contends, or was the separate property of the petitioner, as the Commissioner has determined. The case has been submitted upon the pleadings, all of the allegations of fact in the petition having been admitted in the answer. The facts are found as pleaded. The petitioner acquired $326,000 face value of United States bonds as a legatee and devisee of his brother. The brother died on October 20, 1932, at which time the market value of the bonds was $321,775.27. The petitioner sold the bonds during 1936 for $347,026.56 and realized a profit, of which 60 percent, or $15,150.77, is to be taken into account 40 B.T.A. 489">490 in computing net income. The petitioner at all1939 BTA LEXIS 846">847 times material hereto was married and living with his wife in Victoria, Texas. They each reported one-half of the last mentioned amount on their separate returns for 1936. The Commissioner, in determining the deficiency, included the entire amount in the income of the petitioner on the ground that all of the proceeds from the sale were his separate property. The parties agree that the bonds were at all times the separate property of the petitioner. They also agree that the laws of Texas govern the question of whether all of the proceeds from the sale of those bonds were the separate property of the petitioner, or the excess of the amount realized over the value of the bonds when acquired by the petitioner represented community property. The law of Texas provided in 1936 that "all property of the husband, both real and personal, owned or claimed by him before marriage, and that afterwards acquired by gift, devise, or descent, as also the increase of all lands thus acquired, shall be his separate property." Art. 4613, Vernon's Texas Statutes - 1936. It is not argued here that the words "increase of all lands thus acquired" are to be taken literally, as if they referred only to1939 BTA LEXIS 846">848 increase in real estate. On the contrary, the petitioner concedes that mere enhancement in value of separate personal property is "increase in lands" and remains separate property. The point which he would make is that the increase in value becomes community property when it is realized through a sale. While the revenue acts provide that the excess realized over basis is gain, yet it does not appear that the laws of Texas include any similar method for determining that a part of the sale price of separate property is community property. The petitioner has not cited a single authority for concluding that any part of the proceeds from the sale of separate property is community property in the absence of some contribution by the community towards the increase in value. Here the bonds were the separate property of the petitioner. The increase in their value was in no way produced by his efforts or the efforts of the community. Each party has cited a number of authorities to show that the law of Texas favors his view, but upon analysis we conclude that those most nearly in point support the determination of the Commissioner. Cases involving the use of separate property in some1939 BTA LEXIS 846">849 mercantile or other business in which the husband was actively engaged are not in point. The income resulting from the employment of his time and energy is community property. Likewise, interest and rents from separate property are community property. If the proceeds from the sale of separate property are inseparably intermingled with community property, the latter is always favored and the former 40 B.T.A. 489">491 may lose its identity. The case of W. T. Carter, Jr.,36 B.T.A. 853">36 B.T.A. 853, relied upon by the petitioner, is distinguishable for the reasons just mentioned. There the husband acquired some stock in a family corporation in Texas as a gift from his father. Later, he acquired additional stock by (1) purchase with community funds, (2) stock dividends, and (3) gift from his mother. He then sold some of the stock at a profit, which the Board held was community property taxable one-half to each spouse. The Board there said: Where the increase in separate property was spontaneous and independent of assistance from the community, it was separate property, 1939 BTA LEXIS 846">850 Stringfellow v. Sorrells,82 Tex. 277">82 Tex. 277; 18 S.W. 689">18 S.W. 689, but where it involves care, labor, or attention from the members of the community, it is community property, Hayden v. McMillan,23 S.W. 430">23 S.W. 430. In the case at bar, petitioner devoted the major portion of his time to the management and operation of the corporation which issued the stock in controversy. The case of Brand v. Brand,102 S.W.(2d) 210, was apparently another where separate and community funds were commingled. The case of Anita Owens Hoffer,24 B.T.A. 22">24 B.T.A. 22, is directly in point. There the wife had acquired some corporate stock by gift. She sold it at a profit during coverture while living in Texas. The Commissioner contended and the Board held that the gain was her separate property, citing Oscar Chesson,22 B.T.A. 818">22 B.T.A. 818, and G.C.M. 8209, C.B. IX-2, p. 326. There was no indication that that community had contributed in any way to the increase in value. The later Carter case, supra, in no way impinges upon the rule of the Hoffer case. The following is from 1939 BTA LEXIS 846">851 22 B.T.A. 818">Oscar Chesson, supra, which was affirmed, 57 Fed.(2d) 141: The answer to this question depends upon the local law. Stephens v. Stephens,292 S.W. 290">292 S.W. 290, has been accepted as a leading case defining the property rights of husband and wife in royalties from the separate property of the husband. See John O'Neil et al., supra, and Ferguson v. Commissioner of Internal Revenue, 45 Fed.(2d) 573, affirming W. P. Ferguson,20 B.T.A. 130">20 B.T.A. 130, in this regard. The opinion of the Court in the Stephens case included the following reasoning which is especially pertinent to the instant case: The land is separate property. The oil in place is realty capable of distinct ownership, severance and sale. It is a part of the corpus of appellee's sole estate. He conveyed his oil and received, as the principal consideration therefor, one-eighth of the production. No skill, labor or supervision of either of the spouses, and no community property was expended in the sale or production. The oil and the proceeds thereof received by the appellee were neither rent nor profits, within the meaning of the law making1939 BTA LEXIS 846">852 such common property, but the consideration for separate realty. Extracting the oil from beneath the surface depletes and exhausts forever the corpus of his separate property; removing it to the top of the ground changes it from real to personal property, but such change or mutation, and the money received, are definitely traced, and, in our opinion, the fund in controversy belonged to appellee in his sole and separate right. 40 B.T.A. 489">492 See also James R. Parkey,16 B.T.A. 441">16 B.T.A. 441. We follow these decisions in concluding that the income from the royalties here under consideration belongs to the petitioner and should therefore be reported for income tax purposes in its entirety by the petitioner. Since the community contributed in no way to the increase in value of the bonds here in question, and there appears to be no distinction between such increase and the increase in value of real estate, we conclude that the entire proceeds of the sale of the bonds was the separate property of the petitioner under the laws of Texas and the Commissioner did not err in taxing the proper percentage of the gain as his income. Decision will be entered for the respondent.1939 BTA LEXIS 846">853	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625533/	Joyce Purcell, Petitioner v. Commissioner of Internal Revenue, RespondentPurcell v. CommissionerDocket No. 27793-83United States Tax Court86 T.C. 228; 1986 U.S. Tax Ct. LEXIS 150; 86 T.C. No. 16; February 26, 1986, Filed 1986 U.S. Tax Ct. LEXIS 150">150 Decision will be entered under Rule 155. Held: On the facts of record, petitioner is entitled to relief under sec. 6013(e), I.R.C. 1954, with respect to certain items of omitted income and is not entitled to such relief with respect to another item of omitted income. Petitioner is not entitled to relief under sec. 6013(e) for disallowed deductions since not contesting respondent's disallowance of the deductions is not sufficient to establish that the deductions were "grossly erroneous" because they had no basis in fact or law. Alan L. Cates, for the petitioner.Robert P. Crowther, for the respondent. Scott, Judge. SCOTT86 T.C. 228">228 Respondent determined deficiencies in petitioner's income tax for the calendar years 1977 and 1978 in the amounts of $ 82,955.89 and $ 49,749.21, respectively. The issue for decision is whether petitioner is relieved from liability under section 6013(e)1 with respect to the income tax resulting from (1) the inclusion in the income of petitioner and her then husband of (a) dividends resulting from amounts paid by a corporation of which they were stockholders for personal travel and entertainment expenses, and (b) a portion of the sales price of petitioner's stock in another corporation allocated to a covenant not to compete; and (2) the disallowance of claimed bad debt and worthless stock deductions with respect to a third corporation 86 T.C. 228">229 in which both petitioner and her then husband owned stock.1986 U.S. Tax Ct. LEXIS 150">153 FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Petitioner, who resided in Franklin, Tennessee, at the time of the filing of her petition in this case, filed a joint Federal income tax return with her then husband, W. Bruce Purcell, for each of the calendar years 1977 and 1978 with the Director, Internal Revenue Service Center, Memphis, Tennessee. For the calendar year 1977, they filed an amended Federal income tax return on Form 1040X.Petitioner and W. Bruce Purcell were married on July 23, 1952, and were divorced in October 1982. W. Bruce Purcell died, by accidental drowning, in July 1983. During the years 1977 and 1978, both W. Bruce Purcell and petitioner were stockholders and employees of Purcell Enterprises, Inc. This company was run primarily by Mr. Purcell, and petitioner's duties were limited to signing checks on the corporation's bank account when Mr. Purcell was out of town and some typing and clerical work when her services were needed in the office. She did not deal with the corporate customers. The company had an American Express account and each of the officers of the company, including Mr. Purcell, had an American Express Card1986 U.S. Tax Ct. LEXIS 150">154 in his name on this account. Petitioner had a company American Express Card in her name, permitting her to make charges to the account of Purcell Enterprises, Inc.Petitioner occasionally accompanied her husband on trips and at his request charged the cost of the hotel room that she and her husband used and other costs of the trip on the corporate American Express Card issued in her name. Other than the charges made on the card at her husband's request, petitioner made only a few charges on the company American Express Card. Occasionally she made other charges on this card and did not keep a record or diary of the charges she made. Petitioner discussed the use of this card with Mr. Purcell and was told by him that he would take care of the charges she made for personal purposes, because the corporation always owed him money. Petitioner 86 T.C. 228">230 charged a few meals in Nashville to this credit card and charged lodging in Knoxville, where her children were in school, to this credit card. Petitioner also charged a small purchase of foreign currency to this credit card.In February 1974, a corporation, International Demolition & Salvage Co., Inc. (International Demolition), was 1986 U.S. Tax Ct. LEXIS 150">155 formed under the laws of the State of Tennessee. During the years 1977 and 1978, petitioner and W. Bruce Purcell each owned 25 percent of the outstanding stock of International Demolition. Petitioner was the treasurer of International Demolition during 1977 and 1978 and was a corporate director in these years. International Demolition had a sustained history of losses throughout its existence. It was in financial difficulties in 1977 and 1978 and ultimately failed. Petitioner's then husband, W. Bruce Purcell, and other shareholders of International Demolition infused money into the corporation in 1976, 1977, and 1978, which moneys were treated on the corporate books as loans to the corporation.Reese Tires, Inc., was a corporation the stock of which was owned by petitioner and Mr. Ira Reese. As of April 15, 1977, petitioner owned 560 shares of the stock of Reese Tires, Inc., and Mr. Reese owned 480 shares of the stock of that corporation. Under date of April 15, 1977, petitioner, W. Bruce Purcell, and Ira Reese entered into an agreement to sell petitioner's and Mr. Reese's stock in Reese Tires, Inc., to Universal Tire, Inc., a Tennessee corporation. The sales agreement was 1986 U.S. Tax Ct. LEXIS 150">156 negotiated by Mr. Purcell and Mr. Reese. Petitioner did not participate in the negotiation for the sale of the stock of Reese Tires, Inc., to Universal Tire, Inc. However, she did sign the agreement and initialed the agreement in several places where changes were made. One of the changes initialed by petitioner was in a clause agreeing that neither petitioner, Mr. Purcell, nor Mr. Reese would compete with Universal Tire, Inc., in the tire business for a period of 3 years in specified locations. One of the changes made in the agreement by pen, which was initialed by petitioner, was changing 5 years to 3 years in this clause of the agreement.The income tax returns of petitioner and her then husband for the years 1977 and 1978 were prepared by a certified public accountant. Except for certain items of 86 T.C. 228">231 medical expenses and charitable contributions and other types of personal items, none of the information used in the preparation of the returns was furnished to the CPA by petitioner. Most of the information used by the CPA in preparing the joint returns of petitioner and her then husband for the years 1977 and 1978 was obtained by the CPA from a Mr. John H. Moses who was1986 U.S. Tax Ct. LEXIS 150">157 the comptroller of both Purcell Enterprises, Inc., and International Demolition. If the CPA needed additional information or to clarify information he had, generally he would ask a question of the comptroller and if the comptroller could not answer the question, he would attempt to get the information from Mr. Purcell. The CPA very seldom consulted with Mr. Purcell and did not consult at all with petitioner. When the CPA prepared the returns, he was of the opinion that he had sufficient information to prepare the returns correctly. The CPA made no audit of the records of petitioner or Mr. Purcell in preparing their individual income tax returns, but prepared the returns from information furnished to him. Petitioner did not review the returns prepared by the CPA.Petitioner personally guaranteed certain notes of her then husband, W. Bruce Purcell, to banks in Nashville, Tennessee, for loans made to him.Petitioner's primary occupation was as a housewife. She married Mr. Purcell shortly after she graduated from high school. She worked after they were married to assist Mr. Purcell with his college education. When petitioner signed the guarantees of her husband's loans, he told1986 U.S. Tax Ct. LEXIS 150">158 her that his businesses had sufficient assets to pay off these business debts.There were problems in connection with petitioner's marriage during 1977 and 1978. Mr. Purcell was away from home during much of the time in these years and was drinking heavily. He also was seeing the woman whom he married after he and petitioner were divorced in 1982.In the divorce decree, a recitation is made that petitioner and Mr. Purcell had lived apart since 1979. In the divorce decree there was incorporated a property settlement agreement between petitioner and Mr. Purcell. In the property settlement agreement, petitioner received the family home, which was free and clear at the time, and the furnishings of 86 T.C. 228">232 that home. She also received an automobile. The agreement provided for certain cash payments by Mr. Purcell to petitioner over a period of 121 months. Paragraph 7 of the agreement provided as follows:7. That HUSBAND shall keep in full force and effect and pay all necessary premiums for three (3) certain policies of insurance with the New York Life Insurance Company, being Policy Numbers 33-002-776, 36-402-141, and 36-426-995, in the total face amount of Nine Hundred Thousand1986 U.S. Tax Ct. LEXIS 150">159 ($ 900,000.00) Dollars, which policies of insurance are owned by and payable to WIFE as beneficiary to secure this agreement, and further HUSBAND shall keep in full force and effect and pay any and all necessary premiums for a major medical hospitalization insurance program in at least the amount of Fifty Thousand ($ 50,000.00) Dollars and both collision and liability insurance for WIFE in the operation of any vehicle or conveyance of any nature whatsoever in at least the amount of Three Hundred Thousand ($ 300,000.00) Dollars until the death or remarriage of WIFE or for said One Hundred Twenty-One months from July 1, 1982 to July 1, 1992.The property settlement agreement also transferred to petitioner 15 cemetery lots in Woodlawn Memorial Park in Nashville, Tennessee, and Mr. Purcell's interest in 6 parcels of real estate specifically described in the agreement, some of which were owned jointly by Mr. Purcell and others. The agreement provided that Mr. Purcell would execute a note in the amount of $ 121,000 to petitioner to secure the payment of the principal sum of $ 121,000 as periodic alimony in monthly installments of $ 1,000 each for 121 months, beginning on July 1, 1982, 1986 U.S. Tax Ct. LEXIS 150">160 and continuing through July 1, 1992, unless petitioner dies or remarries prior to the date of the last payment. The property settlement agreement also provided for the transfer by Mr. Purcell of certain certificates of stock in the bank of Maryville, Tennessee, to petitioner. The only property granted to Mr. Purcell by the agreement, other than his personal effects which he was to remove from the family residence, was all right, title, and interest which petitioner had in any business interests of Mr. Purcell, including but not limited to Purcell Enterprises, Inc. Mr. Purcell assumed the responsibility and liability for all outstanding debts and bills with respect to his business operations, particularly including indebtedness to the Third National Bank of Nashville, Tennessee, and the Continental National American Insurance & Bonding Co.86 T.C. 228">233 with regard to the bonding of construction contracts in Mr. Purcell's business. Mr. Purcell agreed to hold petitioner harmless with respect to all indebtednesses which he had incurred or which were incurred in connection with his businesses.Respondent in his notice of deficiency increased the reported income of Mr. Purcell and petitioner1986 U.S. Tax Ct. LEXIS 150">161 by $ 17,750 in 1977 and $ 5,298.69 in 1978 as nonbusiness bad debts from Reese Tires, Inc., which were not allowable since it had not been established that they became worthless in 1977 or 1978. For the years 1977 and 1978, respectively, respondent increased petitioner's reported income by $ 144,411.26 and $ 95,185.05 because of disallowance of claimed deductions of bad debts of International Demolition on the ground that the debts did not become worthless in 1977 or 1978 or otherwise represent an allowable deduction, and also increased the reported income by $ 26,904.85 in 1977 by disallowance of a claimed long-term capital loss from worthless stock of International Demolition on the ground that it had not been established that the stock became worthless in that year. Respondent increased the reported income of Mr. Purcell and petitioner by $ 28,258.10 in 1977 and $ 25,575.65 in 1978 with the explanation that the items represented dividends under sections 301 and 316 of the Internal Revenue Code because of benefits received from the permitted use of corporate property without compensation. The explanation of these items showed that in 1977, $ 7,675.08 was from personal use of 1986 U.S. Tax Ct. LEXIS 150">162 aircraft and $ 20,583.02 from payment of personal travel and entertainment expenses and that in 1978, $ 8,681.03 was from personal use of aircraft and $ 16,894.62 from payments by Purcell Enterprises, Inc., of personal travel and entertainment expenses.Respondent in 1977 increased Mr. Purcell's and petitioner's reported income by $ 15,300, explaining that this was the amount of the purchase price of the stock of Reese Tires, Inc., paid by Universal Tire, Inc., for the purchase of a covenant not to compete and therefore should have been shown as ordinary income on the tax return. Respondent made a compensating adjustment in petitioner's 51 percent share of the payment from Universal Tire, Inc., which had been reported as gain from the sale of the stock. In 86 T.C. 228">234 addition, respondent made certain other minor adjustments with respect to interest deductions and a change in the amount of a bad debt loss which have not been placed in issue in this case.Petitioner, at the trial, conceded that the adjustments made by respondent in the deficiency notice were correct for the purpose of this case, stipulating that --petitioner intends to limit her challenge to the adjustments made 1986 U.S. Tax Ct. LEXIS 150">163 by the Commissioner in his notice of deficiency to whether I.R.C. sec. 6013(e), as amended by sec. 424 of the Tax Reform Act of 1984, Pub. L. No. 98-369, 98 Stat. 494, 801-803, affords her relief as an innocent spouse.At the trial, petitioner's counsel stated that petitioner was unable to question the adjustments made by respondent because of lack of knowledge of the transactions.OPINIONSection 6013(e), as amended by the Tax Reform Act of 1984, Pub. L. 98-369, sec. 424(a), 98 Stat. 801-802 (1984-3 C.B. 309-310), 2 provides that a spouse is relieved of liability 86 T.C. 228">235 under regulations prescribed by the Commissioner where a joint return has been made for a taxable year and on that return there is a substantial understatement of tax attributable to grossly erroneous items of one spouse, if the other spouse establishes that in signing the return she did not know, and had no reason to know, that there was such substantial understatement, and taking into account all the facts and circumstances, it is inequitable to hold the other spouse liable for the deficiency in tax for the taxable year attributable to such substantial understatement.1986 U.S. Tax Ct. LEXIS 150">164 Grossly erroneous items are defined to mean "any item of gross income attributable to such spouse which is omitted from gross income" and "any claim of a deduction, credit, or basis by such spouse in an amount for which there is no basis in fact or law." Sec. 6013(e)(2)(A) and (B). Substantial understatement "means any understatement * * which exceeds $ 500." Sec. 6013(e)(3).There is a further provision requiring that the understatement must exceed a specified percentage of the income for the pre-adjustment year of the spouse claiming the benefit of the statute. However, the parties in this case have stipulated facts which clearly show that petitioner's income for the pre-adjustment year was such that this requirement is met.Respondent apparently admits that petitioner has met the requirements of section 6013(e), as amended, with respect to omission of income resulting from the determination of a dividend to petitioner's former husband because of personal use of an aircraft, although he argues generally that petitioner has failed to show that it would be inequitable to hold her liable for the total deficiency in this case. 3 Also, 86 T.C. 228">236 respondent does not claim that the1986 U.S. Tax Ct. LEXIS 150">165 items on which petitioner claims relief as grossly erroneous items were not items of Mr. Purcell. Respondent contends that petitioner either knew, or had reason to know, that Purcell Enterprises, Inc., was paying personal expenses of petitioner and her then husband. Respondent contends that petitioner did in fact know that there had been a covenant not to compete signed with respect to the sale of the stock of Reese Tires, Inc., and that all petitioner has shown with respect to the income allocable to the covenant not to compete is that she did not know the tax effect of such a covenant being part of a contract for the sale of stock.1986 U.S. Tax Ct. LEXIS 150">166 Petitioner takes the position that she did not know, and had no reason to know, of the omission from income of any of the items determined by respondent to have been omitted. Petitioner further takes the position that she did not know, and had no reason to know, of the claimed deductions for bad debts and worthless stock in connection with International Demolition and that the requirement of the item being grossly erroneous is met in that the claimed deductions are in an amount for which there is no basis in fact or law. Her position is that her failure to contest the determination of respondent that the claimed bad debt losses and worthless stock deduction are not allowable is sufficient to show that the deduction items are grossly erroneous.Respondent argues that petitioner knew or certainly had reason to know of the claimed bad debt loss and worthless stock deductions, that these deductions are not grossly erroneous items as defined in section 6013(e)(2)(B) since they did have some basis in fact and law, and in any event petitioner has not established to the contrary. Respondent also argues that it would not be inequitable to hold petitioner liable for the deficiency resulting1986 U.S. Tax Ct. LEXIS 150">167 from the disallowance 86 T.C. 228">237 of these claimed deductions under the facts and circumstances of this case.In our view, petitioner did not know or have reason to know that personal expenses and personal travel were being paid for by Purcell Enterprises, Inc., and therefore did not know, or have reason to know, of the omission of these items from the joint tax returns she filed with her then husband. The record shows that petitioner had an American Express Card of Purcell Enterprises, Inc., which she used to pay travel expenses for herself and her husband when her husband was on a business trip. The record also shows that she used this card for certain personal items. However, the testimony shows that her husband represented to her that amounts charged on the American Express Card of Purcell Enterprises, Inc., had to be justified as company expenses in order to be paid by the company and that any personal expenses which petitioner put on the card were being paid by him personally and not by the company. In fact, the company comptroller testified that charges on the company's American Express Card were required to be justified in order for him to authorize payment by the company, 1986 U.S. Tax Ct. LEXIS 150">168 and in connection with charges involving the Purcells, he looked to Mr. Purcell for justification. Under the circumstances, we conclude that petitioner did not in fact know that the personal charges she put on the Purcell Enterprises, Inc., American Express Card were being paid for by the company rather than by her then husband and did not know that he was charging personal items to the company credit card.In our view, petitioner must have known in connection with the sale of the Reese Tires, Inc., stock that the contract of sale contained a covenant not to compete. Although she did not assist in negotiating the sale, she was the owner of the stock and a signatory to the contract. One of the persons to whom the noncompete provision applied was petitioner and another was her then husband, Mr. Purcell. Not only did petitioner sign the contract, she initialed a change in the years for which the covenant not to compete was effective. Petitioner never specifically testified that she did not read the agreement with respect to the sale of stock that she signed, although she testified that her 86 T.C. 228">238 husband did all the negotiating. In our view, the evidence here does not support1986 U.S. Tax Ct. LEXIS 150">169 lack of knowledge on the part of petitioner with respect to the terms of the contract for the sale of the stock of Reese Tires, Inc. Certainly petitioner did not know the legal effect of the provision with respect to a covenant not to compete. However, the cases are clear that the spouse claiming to be relieved from liability for omission from income of an item must be unaware of the circumstances which give rise to that omission and not merely to the tax consequences of the facts. McCoy v. Commissioner, 57 T.C. 732">57 T.C. 732 (1972); Quinn v. Commissioner, 62 T.C. 223">62 T.C. 223 (1974), affd. 524 F.2d 617">524 F.2d 617 (7th Cir. 1975); Smith v. Commissioner, 70 T.C. 651">70 T.C. 651, 70 T.C. 651">672-673 (1978). As we pointed out in the Smith case, it is immaterial that both spouses were unaware of the tax liability created by the transactions of which they were aware. Here, we do not know whether Mr. Purcell was aware of the tax liability created by a part of the amount paid under the contract for sale of the Reese Tires, Inc., stock being allocable to a covenant not to compete, but it is clear that petitioner did1986 U.S. Tax Ct. LEXIS 150">170 not know the tax consequences of having this provision in the contract. However, this is immaterial since we conclude that the evidence shows that she did know that the noncompete agreement was in the contract.The record is clear that petitioner did know of loans made by her then husband to International Demolition. From the evidence we conclude that she did not examine the returns sufficiently to know that these amounts had been deducted in 1977 and 1978 as worthless debts on the joint returns she filed with her then husband. We also conclude that she did not examine the returns sufficiently to know that there had been a deduction for worthless stock of International Demolition taken as a deduction on the returns. However, petitioner has made no showing as to the circumstances which caused these items to be deducted. The accountant testified that he thought when he prepared the joint returns of petitioner and her then husband that all items in the returns were accurate. Certainly under these circumstances he must have done some investigation of the financial condition of International Demolition. The record shows that this company was in bad financial condition. In our 86 T.C. 228">239 1986 U.S. Tax Ct. LEXIS 150">171 view, petitioner's conceding that respondent's adjustments with respect to the worthless stock and bad debt deductions are correct is not sufficient to establish that the claimed deductions were in an amount for which there was no basis in fact or law. If the statute had intended that a mere concession that respondent was not in error in disallowing a claimed deduction was sufficient to cause the item to be grossly erroneous as having no basis in fact or law, it would have so provided.Prior to the amendment of section 6013(e) by Pub. L. 98-369 in 1984, no relief was granted where the deficiency was because of the disallowance of claimed deductions. Resnick v. Commissioner, 63 T.C. 524">63 T.C. 524 (1975); Allen v. Commissioner, 61 T.C. 125">61 T.C. 125, 61 T.C. 125">132 (1973), affd. on this issue and revd. on another issue 514 F.2d 908">514 F.2d 908, 514 F.2d 908">915 (5th Cir. 1975). In explaining the reason for the change in the law with respect to disallowed deductions made by Pub. L. 98-369, in 1984, the House committee report states that --The Committee believes that the present law rules relieving innocent spouses from liability for tax on a joint1986 U.S. Tax Ct. LEXIS 150">172 return are not sufficiently broad to encompass many cases where the innocent spouse deserves relief. Relief may be desirable, for example, where one spouse claims phony business deductions in order to avoid paying tax and the other spouse has no reason to know that the deductions are phony and may be unaware that there are untaxed profits from the business which the other spouse has squandered. [Supplemental Report of Comm. on Ways and Means, H. Rept. 98-432 (Pt. 2), on H.R. 4170 (Tax Reform Act of 1984), at 1502 (1984).]This report further states with respect to the changes in the bill as follows:Under the bill, the innocent spouse (sec. 6013(e)) rule will 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 the other spouse. Grossly erroneous items include any item of income that is omitted from gross income, regardless of the basis for omission. A claim for deduction or credit will be treated as a grossly erroneous item only if the claim had no basis in law or fact. The bill defines a substantial understatement1986 U.S. Tax Ct. LEXIS 150">173 as any understatement of tax that exceeds $ 500. As under present law, relief may be granted only where it would be inequitable to hold the innocent spouse liable.86 T.C. 228">240 It is clear from the statute itself, and made even clearer by the committee reports, that whereas any omission of income resulting in an understatement of tax in excess of $ 500 is to be considered a grossly erroneous item, only deductions without a basis in fact or law are to be considered grossly erroneous. Therefore, in order to be relieved from tax resulting from a disallowed deduction, it is incumbent on a taxpayer to prove that the claimed deduction not only is not properly allowable but that it has no basis in fact or law. To establish that the deduction is a grossly erroneous item under this definition is part of the burden of a taxpayer claiming to be an innocent spouse.Here, petitioner has made no showing that the bad debt deductions which were disallowed by respondent and the worthless stock deduction that was disallowed had no basis in fact or law. All that has been shown is that she did not contest the adjustments as made by respondent. In fact, the evidence that is in the record with respect1986 U.S. Tax Ct. LEXIS 150">174 to these items indicates that they were not "grossly erroneous" from the standpoint of being "phony" deductions. The record shows that loans had been made by petitioner's husband to International Demolition and that that company was in bad financial condition in 1977 and 1978. The accountant who prepared the joint returns of petitioner and her then husband testified that he thought he had sufficient information to justify the items shown on the returns, and the comptroller of Purcell Enterprises, Inc., who also handled the books of International Demolition, testified that he had furnished information to the accountant.Under the facts of this case, there has been no showing that the claimed deductions had no basis in fact or law. They were not "phony" deductions as referred to in the committee report. We therefore conclude that petitioner is not an innocent spouse with respect to the claimed bad debts and worthless stock deductions.Since respondent has conceded that petitioner is an "innocent spouse" with respect to the constructive dividends received by her husband from the private use of the airplane owned by Purcell Enterprises, Inc., and we have concluded that petitioner 1986 U.S. Tax Ct. LEXIS 150">175 did not know, or have reason to know, of the constructive dividends from the payments by 86 T.C. 228">241 that corporation of personal bills and travel, it is necessary for us to determine whether it would be inequitable to hold petitioner liable for the deficiency in tax attributable to these understatements of income.Whereas the law prior to the 1984 amendment specifically referred to whether the spouse claiming relief from tax significantly benefited from the omissions from income, the present law does not specifically contain this provision. However, even though the present statute does not specifically refer to the other spouse receiving substantial benefits from the omissions or wrongfully claimed deductions, in our view it would not be inequitable to hold the other spouse liable for the deficiency if such substantial benefits were received. Therefore, we deem it necessary to determine whether petitioner received substantial benefits from the omission of the constructive dividends from the income reported on the returns.The record shows no benefit to petitioner from her husband's use of the company plane and only very minor benefits received by petitioner from the payment by Purcell1986 U.S. Tax Ct. LEXIS 150">176 Enterprises, Inc., for a few meals and some lodging she charged to the American Express Card issued in her name. Certainly these benefits were not substantial. The record also shows that under the agreement incident to her divorce from Mr. Purcell, petitioner received most of the property accumulated during the marriage of the parties and, in addition, Mr. Purcell was required to keep insurance policies payable to her in force to ensure periodic payments. Petitioner testified at the trial that the property which she received in the divorce settlement had been acquired by her and Mr. Purcell long before the years here in issue and that prior to the years here in issue, she was actually the owner of the insurance policies which Mr. Purcell was required to keep in effect, and had paid the premiums on these policies. She testified that she did not receive the periodic payments required under the agreement. Although not precisely shown in the record, petitioner apparently did receive the proceeds of the insurance policies upon Mr. Purcell's death. She testified about the requirement she was facing of paying Mr. Purcell's debts which she had guaranteed. 86 T.C. 228">242 Petitioner claims1986 U.S. Tax Ct. LEXIS 150">177 that she did not substantially benefit from the various items of omitted income.Since we have held that petitioner is not entitled to relief under section 6013(e) for the omitted income from the covenant not to compete or from the disallowance of the deductions for bad debts and worthless stock, we need only consider whether it would be inequitable to hold petitioner liable for the tax on the omitted income from constructive dividends. The regulation in effect with respect to the prior law provided, in section 1.6013-5(b), Income Tax Regs., that whether it is inequitable to hold a person liable for the deficiency in tax is to be determined on the basis of all the facts and circumstances. 4 This section of the regulations states that in making the determination, a factor to be considered is whether the person seeking relief significantly benefited, directly or indirectly, "from the items omitted from gross income." This regulation goes on to say that normal support is not to be considered a significant benefit. It further refers to a person seeking relief receiving from his spouse "an inheritance of property or life insurance proceeds which are traceable to items omitted from 1986 U.S. Tax Ct. LEXIS 150">178 gross income by his spouse."1986 U.S. Tax Ct. LEXIS 150">179 Here, the record shows that the property received by petitioner in the divorce proceeding had been acquired in years prior to the years here in issue. Petitioner had paid the insurance premiums prior to her divorce from Mr. Purcell. The omitted income was from personal items paid by Purcell Enterprises, Inc. Clearly, the use of the airplane by Mr. Purcell for personal purposes in no way benefited petitioner, and the Government apparently does not contend 86 T.C. 228">243 to the contrary. Although petitioner may have received some small benefit from the payment of travel and entertainment expenses by the corporation, from her testimony it is reasonably clear that whatever benefit she received was not significant. She only occasionally went on trips with Mr. Purcell and made insignificant charges on her American Express Card which she thought Mr. Purcell was personally paying.Based on the record as a whole, we conclude that petitioner did not significantly benefit from the constructive dividends received by Mr. Purcell from Purcell Enterprises, Inc., because of the payment by that corporation of personal expenses for meals, travel and entertainment for Mr. Purcell and, to some extent, 1986 U.S. Tax Ct. LEXIS 150">180 for petitioner. We therefore conclude that with respect to the entire constructive dividends from Purcell Enterprises, Inc., in each of the years here in issue, petitioner is entitled to relief under section 6013(e).Decision will be entered under Rule 155. Footnotes1. Unless otherwise stated, all statutory references are to the Internal Revenue Code of 1954 as amended and in effect during the years here in issue.↩2. Sec. 6013(e), as amended by the Tax Reform Act of 1984, provides as follows:SEC. 6013(e). Spouse Relieved of Liability in Certain Cases. -- (1) In general. -- Under regulations prescribed by the Secretary, ifd/m (A) a joint return has been made under this section for a taxable year,(B) on such return there is a substantial understatement of tax attributable to grossly erroneous items of one spouse,(C) the other spouse establishes that in signing the return he or she did not know, and had no reason to know, that there was such substantial understatement, and(D) taking into account all the facts and circumstances, it is inequitable to hold the other spouse liable for the deficiency in tax for such taxable year attributable to such substantial understatement,then the other spouse shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent such liability is attributable to such substantial understatement.(2) Grossly erroneous items. -- For purposes of this subsection, the term "grossly erroneous items" means, with respect to any spouse -- (A) any item of gross income attributable to such spouse which is omitted from gross income, and(B) any claim of a deduction, credit, or basis by such spouse in an amount for which there is no basis in fact or law.(3) Substantial understatement. -- For purposes of this subsection, the term "substantial understatement" means any understatement (as defined in section 6661(b)(2)(A)) which exceeds $ 500.(4) Understatement must exceed specified percentage of spouse's income. -- (A) Adjusted gross income of $ 20,000 or less. -- If the spouse's adjusted gross income for the preadjustment year is $ 20,000 or less, this subsection shall apply only if the liability described in paragraph (1) is greater than 10 percent of such adjusted gross income.(B) Adjusted gross income of more than $ 20,000. -- If the spouse's adjusted gross income for the preadjustment year is more than $ 20,000, subparagraph (A) shall be applied by substituting "25 percent" for "10 percent."(C) Preadjustment year. -- For purposes of this paragraph, the term "preadjustment year" means the most recent taxable year of the spouse ending before the date the deficiency notice is mailed.↩3. Respondent in his brief states as follows:"The fourth area of adjustment involves income realized by petitioner's husband from his personal use of an airplane maintained by Purcell Enterprises, Inc. The respondent concedes that the petitioner is an innocent spouse with respect to said income."At the start of the trial the court asked whether it was respondent's view that a determination of innocent spouse status with respect to omitted income items could be made separately from a determination of innocent spouse status with respect to disallowed deduction items. It is respondent's position that the two areas of adjustment, i.e., omitted income and disallowed deductions, may be considered separately in determining whether petitioner is an innocent spouse."Because of these two concessions by respondent, it is clear that respondent agrees with petitioner that under sec. 6013(e)↩, as amended, individual items of income or deductions may be separately considered in determining whether there is a substantial understatement of tax attributable to grossly erroneous items of one spouse. Since petitioner approached her case on an item-by-item basis, we do not consider there to be an issue in this case as to whether different items of income and deduction may be separately considered in determining whether a taxpayer is entitled to any relief as an "innocent spouse."4. Sec. 1.6013-5(b), Income Tax Regs., provides as follows:(b) Inequitable defined↩. Whether it is inequitable to hold a person liable for the deficiency in tax, within the meaning of paragraph (a)(4) of this section, is to be determined on the basis of all the facts and circumstances. In making such a determination a factor to be considered is whether the person seeking relief significantly benefitted, directly or indirectly, from the items omitted from gross income. However, normal support is not a significant "benefit" for purposes of this determination. Evidence of direct or indirect benefit may consist of transfers of property including transfers which may be received several years after the year in which the omitted item of income should have been included in gross income. Thus, for example, if a person seeking relief receives from his spouse an inheritance of property or life insurance proceeds which are traceable to items omitted from gross income by his spouse, that person will be considered to have benefitted from those items. Other factors which may also be taken into account, if the situation warrants, include the fact that the person seeking relief has been deserted by his spouse or the fact that he has been divorced or separated from such spouse.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625535/	IRVING H. BRAIN, JR., and KATHLEEN B. BRAIN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; JAY HEARIN REALTOR, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBrain v. CommissionerDocket Nos. 39472-86; 39565-86United States Tax CourtT.C. Memo 1990-35; 1990 Tax Ct. Memo LEXIS 35; 58 T.C.M. 1249; T.C.M. (RIA) 90035; January 22, 1990John E. Cicero, II, and Terrence F. Pyle, for the petitioners. Monica J. Miller, for the respondent. SWIFTMEMORANDUM FINDINGS OF FACT AND OPINION SWIFT, Judge: In timely notices of deficiency, respondent determined deficiencies in petitioners' Federal income taxes for 1982, 1983, and 1984, additions to tax, and additions to interest as follows: Petitioners Irving and Kathleen BrainDocket No. 39472-86Additions to Tax or Interest, I.R.C. Secs. 1YearDeficiency6653(a)(1)6653(a)(2)66616621(c) 21982$ 19,879.44$ 993.97$ 1,987.94 19839,895.19494.75989.52 *1990 Tax Ct. Memo LEXIS 35">37 Petitioner Jay Hearin Realtor, Inc. Docket No. 39565-86Additions to Tax or Interest, I.R.C. Secs.YearDeficiency6651(a)(1)6653(a)(1)6653(a)(2)6621(c)1983$ 7,188.61-$ 359.43* *19848,089.61$ 373.24404.48 *In these consolidated cases, the primary issues for decision are: (1) Whether the fees in question represent part of the purchase price of the stock in petitioner Jay Hearin Realtor, Inc. ("JHR") so that the fees paid are not deductible by JHR and are taxable as constructive dividends to the stockholder petitioners Irving H. and Kathleen B. Brain; and (2) whether JHR has satisfied the substantiation requirements of section 274(d) with respect to certain business and entertainment expenses. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Petitioners Irving H. and Kathleen B. Brain resided in Tampa, Florida when they filed their petition. Petitioner JHR maintained its principal office in Tampa, Florida1990 Tax Ct. Memo LEXIS 35">38 when it filed its petition. JHR was organized under Florida law in 1948 by Jay L. Hearin. The primary business of JHR was the management of office and warehouse buildings, small shopping centers, and other commercial properties. Due to financial difficulties, in 1962 all of the stock of JHR was sold by Jay L. Hearin and other shareholders of JHR to Thomas and Carolyn Sheehan and another individual for $ 55,000, approximately the amount of JHR's then-existing debt obligations. Thomas Sheehan had worked for JHR since 1952. In 1969, the other individual died, and Mr. Sheehan and his wife purchased the balance of the stock in JHR for $ 20,000. Thereafter until 1978, the Sheehans were the sole stockholders of JHR. From 1974 through 1978, annual gross receipts of JHR ranged from $ 175,000 to $ 263,000. The contracts under which JHR performed management services were subject to termination upon notice from JHR's clients. Most of JHR's largest contracts for management services had been in effect for 10 to 15 years, due primarily to Mr. Sheehan's personal relationship with the clients. In 1976, the Sheehans decided to sell JHR. They sought a selling price of $ 270,000. Initially, 1990 Tax Ct. Memo LEXIS 35">39 the Sheehans represented themselves and JHR in negotiations with prospective buyers. On June 5, 1976, petitioners Irving H. and Kathleen B. Brain made an offer to purchase the stock of JHR and to take over all of JHR's business for $ 270,000. The Brains drafted their initial offer to purchase the stock of JHR without assistance of lawyers or accountants. Prior to the purchase of JHR, Irving Brain as an employee of a bank had some limited experience managing commercial properties. The Brains, however, had no significant experience owning or managing a business. They did not know JHR's clients, and they were not familiar with the properties JHR managed. For these reasons, the Brains' initial offer to purchase the stock of JHR included a provision under which the Sheehans, after the sale of JHR stock to the Brains, would be obligated to provide consulting services to JHR and to the Brains for a period of 12 years without additional compensation, other than reimbursement of expenses. The Brains' offer of June 1976 to purchase the stock of JHR was not accepted. Over the course of the next two years, the Sheehans and the Brains hired lawyers to represent them in their continuing1990 Tax Ct. Memo LEXIS 35">40 negotiations with regard to the sale of JHR and with regard to the obligations to which the Sheehans would be subject after the sale. Various offers and counter offers were proposed under each of which it was generally contemplated that the Sheehans would be obligated to perform consulting services and/or under which they would be subject to covenants not to compete with JHR after the sale. On February 17, 1978, the Sheehans and the Brains finally entered into a written agreement with respect to the sale of JHR to the Brains. The written agreement was reflected in a limited partnership agreement between the Sheehans and the Brains. It called for the contribution by the Brains to the limited partnership of $ 46,000 in cash and a $ 4,000 personal recourse promissory note due on May 1, 1979, bearing interest at 10 percent. In exchange, the Brains would receive approximately a 50 percent ownership interest in the limited partnership. The limited partnership agreement called for the contribution by the Sheehans to the limited partnership of all of the stock of JHR in exchange for which the Sheehans would receive from the partnership $ 46,000 in cash, 3 an assignment from the partnership1990 Tax Ct. Memo LEXIS 35">41 of the Brains' $ 4,000 promissory note, and a 50-percent ownership interest in the limited partnership. Apparently on April 30, 1978, the transaction as described generally above closed. The limited partnership agreement anticipated the execution by the Sheehans and the Brains of the following additional documents: (1) A written sales agreement between the Sheehans and the limited partnership, on the one hand, and the Brains, on the other, under which the entire stock interest in JHR would be transferred to the Brains without further consideration; and (2) the execution of a written consulting agreement between the Sheehans and JHR under which the Sheehans would be available to and would provide consulting services to the Brains in connection with the business of JHR and under which the individual participants in the transaction would be subject to written covenants not to compete with JHR for 12 years. Under the consulting agreement, the Sheehans were to be paid $ 2,690 per month from June 1, 1978, through May 1, 1990. Apparently, neither the sales agreement1990 Tax Ct. Memo LEXIS 35">42 nor the consulting agreement (which was to include the covenants not to compete) was formalized by any written documents other than the descriptions thereof in the limited partnership agreement. The parties, however, considered themselves bound by the terms of the sales agreement and consulting agreement (including the covenants not to compete) and have honored their obligations thereunder from the time the limited partnership agreement was entered into through the time of trial. The Brains have managed the business of JHR as the sole owners. The Sheehans have provided periodic consulting services to JHR and to the Brains concerning the business. Although they moved to New Hampshire sometime after the transfer of ownership of JHR to the Brains, the Sheehans have returned to Florida on average three or four times a year. They have periodically met personally with the Brains and discussed the business of JHR, and they have discussed the business of JHR over the phone. The Sheehans have not entered into any competing business with JHR, and JHR has made the monthly payments of $ 2,690 to the Sheehans. With regard further to the consulting agreement and the covenants not to compete,1990 Tax Ct. Memo LEXIS 35">43 both of these provisions were described in section 6 of the limited partnership agreement, which section was labeled "Contract for Consulting Services." The only consideration provided in the agreement in exchange for the Sheehans' obligations arising under section 6 of the partnership agreement (which as indicated included the description of both the consulting agreement and the covenants not to compete) was the $ 2,690 monthly fee. Section 6 itself provided for the consideration, and, although section 6 referred to the consideration as a "consulting fee," it expressly provided that the covenants not to compete were a "substantial part" of the contractual obligations entitling the Sheehans to the consulting fees. On JHR's corporate Federal income tax returns for its 1983 and 1984 taxable years and subsequent taxable years through the time of trial, the monthly $ 2,690 in consulting fees paid to the Sheehans have been deducted as current business xpenses. On the Sheehans' individual joint Federal income tax returns for 1982 and 1983 and subsequent years through the time of trial, the same monthly fees were reported as ordinary taxable income received by the Sheehans in connection1990 Tax Ct. Memo LEXIS 35">44 with the consulting agreement. On audit, respondent determined that the monthly fees of $ 2,690 paid by JHR to the Sheehans represented part of the Brains' purchase price for the JHR stock. Accordingly, respondent disallowed the current deductions claimed with respect thereto by JHR and treated the fees as payments made by JHR on the Brains' behalf with respect to the Brains' purchase of JHR stock and taxable as constructive dividends to the Brains. Respondent also disallowed certain travel and entertainment expenses of JHR for lack of substantiation. OPINION Monthly FeesIn cases involving an allocation between various assets of consideration received or paid in connection with the sale or purchase of a business, a dispute often arises between the seller and buyer as to the proper allocation, each having a different interest from a tax standpoint in the allocation. In such cases respondent may simply be a stakeholder. See for example Peterson Machine Tool, Inc. v. Commissioner, 79 T.C. 72">79 T.C. 72, 79 T.C. 72">80-81 (1982), affd. F.2d (10th Cir. 1984, 84-2 USTC par. 9885; 54 AFTR 2d 84-5407). In the instant case, however, the sellers and1990 Tax Ct. Memo LEXIS 35">45 buyers treated the monthly fees consistently -- JHR and the Brains treated the fees as deductible ordinary and necessary business expenses to JHR, and the Sheehans reported the fees received each year as ordinary taxable income. This treatment by all participants to the transaction is consistent with petitioners' characterization of the fees as representing JHR's payment for consulting services and for the covenants not to compete, but is inconsistent with respondent's characterization of the fees as representing the payment by JHR, on the Brains' behalf, of part of the purchase price of the JHR stock purchased from the Sheehans. We have held that where a taxpayer seeks to establish a position at variance with specific language of a written agreement, strong proof must be offered in support of such an interpretation. Peterson Machine Tool, Inc. v. Commissioner, 79 T.C. 72">79 T.C. 81. In the context of a dispute over an allocation to a covenant not to compete, we have held that this rule requires taxpayers to show that the covenant not to compete was intended as part of the agreement1990 Tax Ct. Memo LEXIS 35">46 and that the covenant had independent economic significance as a separately bargained-for element of the agreement. Peterson Machine Tool, Inc. v. Commissioner, 79 T.C. 72">79 T.C. 81; Major v. Commissioner, 76 T.C. 239">76 T.C. 239, 76 T.C. 239">247 (1981); Lazisky v. Commissioner, 72 T.C. 495">72 T.C. 495, 72 T.C. 495">502 (1979), affd. on another issue Magnolia Surf, Inc. v. Commissioner, 636 F.2d 11">636 F.2d 11 (11th Cir. 1980). In a number of courts, including the Eleventh Circuit Court of Appeals to which this case would be appealed, parties to a sales agreement will only be allowed to vary from allocations set forth in a sales agreement where they establish proof of mistake, fraud, undue influence, or any other ground that, in an action between the parties to the agreement, would be sufficient to set the agreement aside or to alter its construction. Bradley v. United States, 730 F.2d 718">730 F.2d 718, 730 F.2d 718">720 (11th Cir. 1984); Commissioner v. Danielson, 378 F.2d 771">378 F.2d 771, 378 F.2d 771">775 (3d Cir. 1967), revg. and remanding 44 T.C. 549">44 T.C. 549 (1965). Regardless of which1990 Tax Ct. Memo LEXIS 35">47 of the above rules of proof if any is applied to the facts of this case, petitioners have established that the $ 2,690 in fees paid monthly by JHR to the Sheehans represented payment for the Sheehans' obligations under the consulting agreement to provide consulting services and to avoid competing with JHR, and that the consulting services and the covenants not to compete were an intended part of the agreement having economic significance as separately bargained-for elements of the agreement. As indicated, the adverse parties to the transaction consistently so treated the fees. The Sheehans did so contrary to their own tax position. Mr. Sheehan was a particularly persuasive and credible witness. The new owners of JHR understandably wanted a long-term consulting agreement with Mr. Sheehan to have the benefit of his business acumen and his long-term relationship with the clients of JHR, as well as covenants from Mr. and Mrs. Sheehan that they would not compete with JHR in years subsequent to the transfer of ownership. We also doubt that either the strong proof rule or the rule of 378 F.2d 771">Commissioner v. Danielson, supra, has any application where some aspects of the1990 Tax Ct. Memo LEXIS 35">48 transaction are not clear. In this case, some of the agreements that were to be formalized in separate written form were not so formalized. The documentation, however, that we do have (namely, the description of the consulting agreement in the limited partnership agreement) indicates that the fees in question were to be paid in connection with the consulting agreement and that consulting services as well as the covenants not to compete were part of the consulting agreement. In spite of their failure to formalize in written form some aspects of the overall transaction, the parties to the transaction understood the terms of their agreement. They have generally abided by the agreement, and we perceive no reason to rewrite their agreement or to undo the agreement they appear to have entered into. Respondent emphasizes that the fees in question were to be paid even after the death of the Sheehans (in favor of the estate or heirs of the Sheehans) -- an indication that the fees were not for consulting services or the covenants not to compete. Where, however, consulting services are so valuable1990 Tax Ct. Memo LEXIS 35">49 that the purchaser of a business agrees to pay therefor for a set period of time regardless of the death or disability of the consultant, that feature of the agreement will not justify a different treatment of the fees. Hornaday v. Commissioner, 81 T.C. 830">81 T.C. 830, 81 T.C. 830">839 n.7 (1983); Yelencsics v. Commissioner, 74 T.C. 1513">74 T.C. 1513, 74 T.C. 1513">1525 (1980); Wager v. Commissioner, 52 T.C. 416">52 T.C. 416, 52 T.C. 416">419 (1969). Respondent also argues that other features of the consulting agreement and covenants not to compete compel a decision in his favor. We have considered respondent's arguments and find them unpersuasive. On the facts of this case and particularly in light of the credible testimony offered by the individual participants in the underlying transaction, our decision is for petitioners on this issue. Travel and Entertainment ExpensesPetitioners argue that they are entitled to additional business travel and entertainment expense deductions under section 274 even though they have not satisfied the substantiation requirements of that section with respect to the claimed expenses. Petitioners base their argument on the fact that they satisfied the substantiation1990 Tax Ct. Memo LEXIS 35">50 requirements of section 274(d) with respect to some business travel and entertainment expenses for each year in dispute. Without citing any authority, petitioners argue that once a taxpayer satisfies the section 274(d) substantiation requirements for some expenses, the Court is entitled to use its authority under Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540, 39 F.2d 540">543-544 (2d Cir. 1930), to estimate for the taxpayer additional allowable business travel and entertainment expenses. We disagree. The substantiation requirements of section 274(d) apply to all of a taxpayer's claimed business travel and entertainment expenses. Dowell v. United States, 522 F.2d 708">522 F.2d 708, 522 F.2d 708">712 (5th Cir. 1975). Additions to the TaxThe final issue concerns the additions to tax and interest. Petitioners failed to address the additions to tax. We therefore sustain respondent's determinations under section 6651(a)(1) and section 6653(a)(1) and (2). Rule 142(a). Because of our resolution of the primary issue in this case in favor of petitioners, we conclude that petitioners are not liable1990 Tax Ct. Memo LEXIS 35">51 for additional interest under section 6621(c). Also and for the same reason, we doubt the applicability of the section 6661 addition to tax for substantial understatements of income tax. We reserve ruling on the applicability of that addition to tax until after the parties have attempted to resolve this matter in the context of the Rule 155 computation. Based on our resolution of the above issues, Decisions will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as in effect for the years in issue, and all rule references are to Tax Court Rules of Practice and Procedure. ↩2. In the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1511(c)(1)(A)-(C), 100 Stat. 2744, Congress amended Code section 6621 by, among other things, redesignating subsection (d) as subsection (c).↩. 50 percent of the interest due on the total amounts of the deficiencies. ** 120 percent of the underpayment rate established under section 6621(a)(2). ↩. 50 percent of the interest due on the total amounts of the deficiencies. * 120 percent of the underpayment rate established under section 6621(a)(2).↩3. The agreement does not make completely clear whether the Sheehans were to receive $ 46,000 or $ 26,000 in cash.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625538/	Appeal of CARROLL CHAIN CO.Carroll Chain Co. v. CommissionerDocket No. 104.United States Board of Tax Appeals1 B.T.A. 38; 1924 BTA LEXIS 266; October 30, 1924, decided Submitted October 13, 1924. 1924 BTA LEXIS 266">266 A corporate taxpayer operating its business for a part of its first fiscal year after organization, and sustaining a net loss therefrom, is entitled to deduct such loss from taxable income earned in the succeeding taxable year, under section 204(b) of the Revenue Act of 1921. Mr. G. G. McAllister, Treasurer of Carroll Chain Co., for the taxpayer. John B. Milliken, Esq. (Nelson T. Hartson, Solicitor of Internal Revenue) for the Commissioner. LANSDON 1 B.T.A. 38">38 Before GRAUPNER, STERNHAGEN, and LANSDON. FINDINGS OF FACT. The Commissioner and the taxpayer agree that the following are the facts in this case, which facts are therefore made the findings of fact by the Board: That the amount of the deficiency in question is $365.98; that the Carroll Chain Co. was organized and began business operations in 1 B.T.A. 38">39 November, 1921; that it operated on a fiscal-year basis, so that the first taxable period was from November 1, 1921, to June 30, 1922; that during its first taxable period the taxpayer suffered a net loss in operating its business, and no tax was due at the end of the first taxable period; that the taxpayer filed a return for the fiscal year1924 BTA LEXIS 266">267 July 1, 1922, to June 30, 1923, and attempted to deduct the loss suffered during the first taxable period as an offset against the profits that were made during the fiscal year beginning July 1, 1922, and ending June 30, 1923, in conformity with what it believed to be the provisions of section 204(b) of the Revenue Act of 1921; that if the taxpayer is entitled to such deduction there is no deficiency in tax and conversely if it is not so entitled there is a deficiency in tax for the year July 1, 1922, to June 30, 1923, of $365.98, which is the deficiency asserted in the so-called 60-day letter mailed by the Commissioner to the taxpayer on August 4, 1924, and not on June 30, 1924, as set forth in the petition of the taxpayer. DECISION. The taxpayer is entitled to deduct from its gross income for the fiscal year ended June 30, 1923, the net loss sustained for the fiscal year ended June 30, 1922. The deficiency in tax found by the Commissioner, arising from the disallowance of this item, shall not be assessed. OPINION. LANSDON: There being no controversy over the facts in this case, it remains only for the Board to determine whether the Commissioner erred in disallowing the1924 BTA LEXIS 266">268 loss suffered in business operations by this taxpayer during the period November 1, 1921, to June 30, 1922, as a proper deduction from the taxable income of the taxpayer, resulting from profits earned during the fiscal year July 1, 1922, and ended June 30, 1923. As his reason for such disallowance, the Commissioner asserts that the deductions provided in section 204(b) are to be allowed only when the taxpayer was in operation as a going business concern during the entire 12 months of the preceding fiscal year in which loss was suffered, and relies on the language of the section in question and of section 200 to support his contention. Section 204(b) of the Revenue Act of 1921, authorizing a taxpayer to deduct losses sustained in any taxable year from taxable income earned in a subsequent taxable year or years, was inserted for the purpose of establishing a more equitable basis for computing taxes on income earned in business operations continuing from year to year. It would have been entirely proper for Congress to have made explicit provision for computing the taxes of enterprises operating for only a part of the first year of their existence, had it would have been obviously1924 BTA LEXIS 266">269 unjust for Congress to grant such a beneficial privilege to going concerns and, in the same Act, deny equally necessary relief to newly established enterprises. It is clear either that Congress overlooked the claims of concerns operating for only a part of their first fiscal year or assumed that the term fiscal year, as used in the Act, means the 12-months' period terminating on a specified date entirely without regard as to whether the taxpayer had 1 B.T.A. 38">40 actually and literally operated on each and every business day of such 12-months' period. The Commissioner held that as the Act does not specifically provide that deductions may be made for an operating period of less than one year he must conclude that the Congress did not intend that such deductions should be allowed. It is a rather violent assumption to take it for granted that Congress, designing to impose certain conditions on taxpayers, would so construct the statute that each and every taxpayer could evade the application of such provisions to himself by the performance of a perfectly legal voluntary act; that is, by electing to begin business on the 1st day of any month and to keep his accounts on the basis of a1924 BTA LEXIS 266">270 fiscal year ending 12 months from the date of beginning operations. In the case at bar the taxpayer could have escaped controversy with the Commissioner by electing to keep its accounts on the basis of a fiscal year ended October 31, 1922. It is not reasonable to assume that if Congress had intended the taxpayer should be deprived of the benefit of the provisions of section 204(b) it would have permitted such an easy and obvious method of evading the purpose of the law-making body. The definition of a fiscal year found in section 200 of the Revenue Act of 1921 was intended to define an accounting period. It specifies eleven separate 12-months' periods, any one of which may be elected as the basis of its accounting system by any taxpayer the nature of whose business requires that its books shall not be kept on a calendar-year basis. The 12 months preceding the close of such a period constitute the fiscal year elected by the taxpayer for bookkeeping purposes. The statute does not require the taxpayer to operate its business during the entire 12 months, but does specifically provide that the year may end, and therefore that the books must be closed on the last day of any month1924 BTA LEXIS 266">271 other than December. It is a well-established principle that taxation must be based only on actual facts and not on mere bookkeeping entries. Because the nature of this taxpayer's business required that its books should be closed at the end of the first eight-months' operation does not in any way affect the facts that it lost money during that period, or that such a loss occurred within the fiscal year elected by the taxpayer as the basis of its accounting, or that such fractional fiscal year was its first taxable year. The fact that Congress did not intend to deprive taxpayers operating for only part of their first year of business is indicated by section 226 of the Revenue Act of 1921, which makes express provision for returns covering only a portion of a year under certain circumstances therein set forth. That provision was necessary because of unusual conditions which therefore had to be expressly dealt with by Congress. The condition of the taxpayer in the case at bar was natural and in entire accord with the general provisions of section 204(b) and therefore did not require any specific treatment. It is generally held that laws levying taxes must not be interpreted1924 BTA LEXIS 266">272 by implication. The obvious reason for this doctrine is to prevent either the courts or the administrative agents of the taxing body corporate from levying and collecting taxes not clearly and specifically authorized by the legislature, which in all free countries is the only 1 B.T.A. 38">41 body clothed with such authority. In the case of the , this language is used. The interpretation of statutes levying taxes must not extend beyond their provisions by implication, nor must they be interpreted beyond the clear import of the language used. In case of doubt they are interpreted strongly against the Government and in favor of the taxpayer. As both the Commissioner and the taxpayer rely on an interpretation by implication, the one that the mere bookkeeping definition of a fiscal year bars the deduction authorized in section 204(b) to a taxpayer operating for only a part of a 12-months' period and the other that Congress could not have intended to penalize such taxpayer and failed only by inadvertent omission to provide explicitly for its relief, the Board must follow the rule laid down by the courts, and decide in1924 BTA LEXIS 266">273 favor of the taxpayer.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625539/	MRS. W. A. MITCHELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Mitchell v. CommissionerDocket No. 3177.United States Board of Tax Appeals13 B.T.A. 10; 1928 BTA LEXIS 3331; July 23, 1928, Promulgated 1928 BTA LEXIS 3331">3331 Evidence held insufficient to overcome respondent's determination of a deficiency. J. M. McMillen, Esq., for the petitioner. Benjamin H. Saunders, Esq., for the respondent. GREEN 13 B.T.A. 10">10 In this proceeding the petitioner seeks a redetermination of her income-tax liability for the year 1919, for which the respondent, as set forth in his deficiency letter dated February 7, 1925, determined a deficiency of $1,831.31. The petitioner alleges that the respondent erred in holding that the sale by her of certain interests in the oil, gas and other minerals in, on or under certain real estate for $16,000 cash to W. C. Barnes in the year 1919, resulted in income to her of $16,000. The respondent contends that the property which the petitioner sold was inherited from her mother in 1916, at a time when it apparently had no value as an oil and gas property, and that, therefore, the entire proceeds from the sale in 1919 constituted taxable gain. FINDINGS OF FACT. The petitioner is an individual and resides at Winters, Tex., Mrs. W. A. Mitchell and Fannie Mitchell are the same person. She is the daughter of E. Y. Jennings and Mrs. Modena Jennings, who1928 BTA LEXIS 3331">3332 died in 1916 leaving a will which bequeathed all her personal property to her husband, E. Y. Jennings, and which contained the following provisions regarding the disposition of her real estate: Third, I give to my beloved husband E. Y. Jennings during his natural life, and so long as he may live, all of my real estate and he is hereby given power to sell and dispose of the same, as he may see proper and after his death, the said real estate shall pass to our beloved children, or their descendants, share and share alike, as they would inherit, under the law of descent, and distribution as provided for under the laws of the State of Texas, and in the event the said real estate should be sold, by my beloved husband, during his life, then the proceeds arising therefrom shall descend and pass as the said real estate, as above mentioned. Some of the children of Modena Jennings and E. Y. Jennings, among them the petitioner, contested the probate of the will of Modena Jennings and were successful in the County and District Courts at Breckenridge, Tex. E. Y. Jennings took an appeal to the Court of Civil Appeals at El Paso, Tex., where a decision was rendered on May 15, 1919, reversing1928 BTA LEXIS 3331">3333 the judgments of the County and District Courts and remanding the case for a new trial. 13 B.T.A. 10">11 Four of the children, who had not contested the will of their mother, Modena Jennings, were given property by their father, E. Y. Jennings, prior to the decision of the higher court. After the decision was rendered the petitioner, her husband, and her sister, Mrs. Lacy, went to see E. Y. Jennings for the purpose of urging the latter to give them the equivalent of what he had given the other children who had not contested the will. After two or three hours of pleading, he told them he would quitclaim to them certain property but that they must sign an agreement not to give him any more trouble about the will which was agreed to by the petitioner, Mrs. Lacy, and Mr. Mitchell. A few days later, on June 28, 1919, the petitioner and her husband signed a release (the exact nature of which is not disclosed) and agreed not to further contest the will, and E. Y. Jennings thereupon quitclaimed certain interests in oil and gas royalties to the petitioner and her husband, which interests the petitioner and her husband sold on the same day to W. C. Barnes for $16,000. The quitclaim deed from1928 BTA LEXIS 3331">3334 Jennings to the petitioner and her husband recited a consideration of $1. OPINION. GREEN: This proceeding must be decided adversely to the petitioner on the ground that she has failed in her proof. The error alleged in the amended petition was that: The Commissioner erred in holding that the sale by taxpayer of certain interests in the oil, gas and other minerals in, on or under certain Real estate for $16,000.00 cash to W. C. Barnes in the year 1919, resulted in income to taxpayer of $16,000.00. The petitioner further alleged in the same petition that: The Commissioner considered the $16,000.00 as income on the theory that the property sold had been inherited by taxpayer from her mother and the $16,000.00 represented the increase from the date inherited to the date sold. It is the petitioner's contention that the property which she sold was acquired as a gift from her father on the day she sold it and that she, therefore, realized neither profit nor loss on the sale. But the record is so void of essential facts that we are unable to determine whether or not there is merit to the petitioner's contention. For instance, all that we can find as a fact, other than the1928 BTA LEXIS 3331">3335 respondent's determination that the petitioner inherited the property in question from her mother in 1916, is that after she had pleaded with her father for several hours to give her what he had given some of the other children who had not contested the will, he quitclaimed to her and her husband the property in question, which was sold on the same day to Barnes for $16,000. But who owned the property prior 13 B.T.A. 10">12 to Modena Jennings' death? Was it the separate property of E. Y. Jennings? Was it the separate property of Modena Jennings? Or was it community property? The respondent in his answer admits that E. Y. Jennings quitclaimed to the petitioner and her husband "certain royalty interests in oil, gas and minerals on, in or under certain real estate formerly belonging to Mrs. E. Y. Jennings." The original petition alleged that the "royalty interests" were "on, in or under certain real estate which Mr. and Mrs. E. Y. Jennings owned prior to the death of Mrs. E. Y. Jennings." The amended petition does not allege who was the owner of the property prior to Modena Jennings' decease, but in the brief counsel for petitioner argues as follows: Certainly there is no evidence1928 BTA LEXIS 3331">3336 in the record that this taxpayer inherited any interest whatever in the property deeded to her. Neither is there any evidence that the property transferred to her was ever property owned by Mrs. Jennings prior to her death. The record merely shows that E. Y. Jennings deeded certain royalty interests to his daughter (Mrs. Mitchell) and her husband. There is nothing whatever to show that Mrs. Jennings had an interest in the property at any time or to show that the title to this property was not in E. Y. Jennings, the maker of the deed. As a presumption of law, the party making a transfer is presumed to own the property he transfers. If this presumption is not rebutted it stands as a fact. Where in the record is there any testimony to show that this property transferred to Mr. and Mrs. Mitchell did not belong to E. Y. Jennings? * * The answer to the last question in the above quotation is that the respondent determined the deficiency on the finding that the petitioner inherited the property sold from her mother, and that the presumption of correctness of that determination has not been overcome. We, furthermore, do not know whether the mother's will was ever probated. It1928 BTA LEXIS 3331">3337 is alleged in the petition that the will "was duly probated," but that allegation was denied in the respondent's answer and no proof of probate was offered. The nature of the release which the petitioner and her husband signed and delivered to petitioner's father was not disclosed. Lastly, the record does not show when the leases creating the royalty interests in question were made or by whom made. The evidence, in our opinion, is wholly insufficient to enable us to pass upon the legal effect that such facts might cause. The burden is upon the petitioner to prove by competent evidence that the respondent erred in his determination of the deficiency. . This we believe she has failed to do, and, accordingly, judgment must be for the respondent. In passing we desire merely to mention the , who was also a daughter of Modena Jennings and a sister to the petitioner here. While that case has not been used 13 B.T.A. 10">13 as an authority for the instant decision, the facts there are more complete and on those facts the respondent's determination was sustained. 1928 BTA LEXIS 3331">*3338 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/4625543/	INTER-STATE GROCERY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Inter-State Grocery Co. v. CommissionerDocket No. 88729.United States Board of Tax Appeals39 B.T.A. 182; 1939 BTA LEXIS 1058; January 24, 1939, Promulgated 1939 BTA LEXIS 1058">1058 The limitation on capital losses provided by section 117(d) of the Revenue Act of 1934 held applicable to capital losses sustained by a corporation upon the liquidation of another corporation whose stock it held. White v. United States.305 U.S. 281">305 U.S. 281, and Helvering v. Chester N. Weaver Co.,305 U.S. 293">305 U.S. 293. George B. Lang, Esq., and Milo A. Lang, Esq., for the petitioner. James C. Maddox, Esq., for the respondent. SMITH 39 B.T.A. 182">182 OPINION. SMITH: This proceeding involves a deficiency of $1,502.46 in petitioner's income tax for 1934. The only question in issue is 39 B.T.A. 182">183 whether a loss which the petitioner sustained in 1934 on the liquidation of a subsidiary company is deductible in full, as petitioner contends, or whether it is subject to the limitation on the deduction of capital losses provided for in section 117(d) of the Revenue Act of 1934, as respondent has determined. There is no dispute as to the facts. The petitioner is a Missouri corporation engaged in the wholesale grocery business. About the year 1929 it organized a new company, the Inter-State Grocery Co., of Oklahoma, which1939 BTA LEXIS 1058">1059 began doing business at Perry, Oklahoma. The new company was incorporated under the laws of Oklahoma and petitioner subscribed and paid cash for $21,300 of its $25,000 of capital stock. In 1934 the Oklahoma company was completely liquidated and petitioner sustained a loss on its stock of $12,059.74. In its income tax return for 1934 petitioner claimed the deduction of the full amount of the loss. The respondent has disallowed the deduction of all but $2,000 of the amount claimed on the ground that the loss is a capital loss on which the deduction is limited by section 117 of the Revenue Act of 1934. The applicable provisions of the Revenue Act of 1934 are as follows: SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * * * (f) LOSSES BY CORPORATIONS. - In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise. * * * (j) CAPITAL LOSSES. - Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in section 117(d). SEC. 117. CAPITAL GAINS AND LOSSES. (a) GENERAL RULE. - In the case of a taxpayer, other than1939 BTA LEXIS 1058">1060 a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income: 100 per centum if the capital asset has been held for not more than 1 year; 80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years; 60 per centum if the capital asset has been held for more than 2 years but not for more than 5 years; 40 per centum if the capital asset has been held for more than 5 years but not for more than 10 years; 30 per centum if the capital asset has been held for more than 10 years. * * (d) LIMITATION ON CAPITAL LOSSES. - Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges. If a bank or trust company incorporated under the laws of the United States or of any State or Territory, a substantial part of whose business is the receipt of deposits, sells any bond, debenture, note, or certificate or other evidence of indebtedness issued by any corporation (including 39 B.T.A. 182">184 one issued by a government or political subdivision thereof), with interest1939 BTA LEXIS 1058">1061 coupons or in registered form, any loss resulting from such sale (except such portion of the loss as does not exceed the amount, if any, by which the adjusted basis of such instrument exceeds the par or face value thereof) shall not be subject to the foregoing limitation and shall not be included in determining the applicability of such limitation to other losses. In ; affirming ; and ; reversing , the Supreme Court held that the limitation imposed by section 101 of the Revenue Act of 1928 and section 23(r) of the Revenue Act of 1932, which in all material respects correspond to section 117(d) of the Revenue Act of 1934, applies to losses sustained by a stockholder on the liquidation of a corporation. Petitioner makes the contention that corporations are excluded from the limitation on capital losses imposed by section 117(d) and that under section 23(f) corporations are entitled to the deduction of the1939 BTA LEXIS 1058">1062 full amount of all losses sustained in operations not compensated for by insurance or otherwise. It refers to subdivision (a) of section 117, which provides that in the case of a taxpayer "other than a corporation" certain percentages only of the gain or loss recognized on the sale of a capital asset, depending upon the number of years held, shall be taken into account in computing net income. From this it argues that section 117 was never intended to apply to corporations; that, since corporations are taxable upon the full amount of gain realized from the sale of capital assets regardless of the period for which the assets have been held, it must follow that the full amount of the loss is likewise deductible regardless of the length of time held. It is quite apparent, however, that subdivisions (a) and (d) are entirely independent of each other. The second sentence of subdivision (d), "Limitation on Capital Losses", clearly shows that that subdivision is applicable to losses sustained by a corporation upon the sale of capital assets. If this were not so there would be no point in Congress specifically providing that in the case of certain banks or trust companies the limitation1939 BTA LEXIS 1058">1063 is not to be applied in respect of losses arising from the sale of bonds. We think it clear that subdivision (d) applies to all taxpayers, including corporations. The statute has been so construed by the respondent in article 117-2 of Regulations 86 and we think correctly so construed. The determination of the respondent is sustained. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625544/	NATIONAL ADJUSTING ASSOCIATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.National Adjusting Asso. v. CommissionerDocket No. 53464.United States Board of Tax Appeals32 B.T.A. 314; 1935 BTA LEXIS 968; March 29, 1935, Promulgated 1935 BTA LEXIS 968">968 1. Taxpayer, a collection agency, is entitled to receive certain commissions on collections made by it, and on payments made by debtors directly to clients; it has a record only of commissions earned on collections made by it and on reported payments received by clients directly from debtors; it retains collections made by it on behalf of its clients and does not make settlement therefor until and unless clients report payments received by them from debtors; and, in making an estimate of earned commissions for the purpose of ascertaining taxable income, it fails to take into account the commissions to which it may be entitled on payments made by debtors to clients. Held that the method of accounting employed by taxpayer and its method of estimating its earned commissions do not clearly reflect its income. 2. Where, in such situation, in order to more clearly reflect taxpayer's earned commissions, the Commissioner employed an average percentage based upon preceding five-year totals of collections and of remittances thereof to clients, taxpayer failing to show that such method is erroneous, the method of ascertaining earned commissions used by the Commissioner is approved. 1935 BTA LEXIS 968">969 David Levinson, Esq., for the petitioner. B. M. Coon, Esq., for the respondent. MCMAHON 32 B.T.A. 314">315 This is a proceeding for the redetermination of an asserted deficiency in income tax for the year 1927 in the amount of $6,231.90. The petition alleges the following assignments of error: (a) Respondent does not recognize petitioner's full liability to clients. (b) Respondent refuses to accept petitioner's detailed list of liabilities to clients. (c) Respondent substitutes a percentage method of his own, the basis for which is erroneous. This proceeding was submitted upon the pleadings, a stipulation of facts read into the record, and testimony, from which we make the following findings of fact. FINDINGS OF FACT. Petitioner is a corporation, organized May 7, 1918, under the laws of the State of Illinois, and is engaged in the business of operating a collection agency, the principal office of which is at 173 West Madison Street, Chicago, Illinois. The contracts of petitioner with its clients are in printed form, which has been substantially the same over a period of years. The contracts of petitioner with each client provide, in1935 BTA LEXIS 968">970 substance, that in consideration of the services to be rendered by the petitioner, the client assigns the therein listed claims to the petitioner and appoints it attorney in fact for the collection thereof with full power and authority to settle the same; that the client "will not be required to pay * * * any commissions on any claims unless collection is made"; that the petitioner is to receive out of collections made the following fees: A docket fee of 50 cents for office filing, plus commissions upon the accounts collected as follows: For the first $100, 50 percent; for all above $100, 10 percent; for all amounts collected on outlawed claims, or by partial payments, 50 percent; for claims placed in the hands of its attorney for collection, 50 percent; that the specified commissions are payable to the petitioner regardless of whether payments on the claims are made to petitioner or to the client directly; and that if payments on the listed claims are made to the client, the commission on such payments shall be remitted immediately to the petitioner. Petitioner maintains statistical records consisting of large "master" cards on which are entered as soon as received lists of the1935 BTA LEXIS 968">971 claims sent to it for collection. As collections are made by petitioner for its clients, a record of the collections are entered on the cards. As petitioner receives reports from clients of payments received by clients from debtors directly, such information is recorded on the cards. On the cards are also recorded the commissions to which 32 B.T.A. 314">316 the petitioner is entitled and the amounts sent to clients in settlement of accounts. Petitioner maintains a double-entry bookkeeping system and its transactions relating to collections for its clients and disbursements to its clients of the collections made less commissions due from the clients under the contracts are recorded on its books in the following manner: Collections received on behalf of clients are credited to an account designated "Contracts" and debited to "Cash." When settlements are made with clients, "Cash" is credited with the amount paid to clients, and the same amount is debited to "Contracts." Settlements are made with clients only when petitioner has received from the clients a statement of the amounts collected directly by the clients. However, some of the clients do not notify the petitioner promptly of payments1935 BTA LEXIS 968">972 received from debtors. At the end of each year there is a credit balance in the contracts account, a portion of which represents income while the remainder belongs to clients. In order to reflect in its income tax return that portion of the amount of the credit balance in the contracts account to which petitioner is entitled, the petitioner has for many years (including the year before us) estimated the portion of the credit balance in the contracts account which represents income. The difference between such estimated income and the credit balance in the contracts account represents estimated liabilities to petitioner's clients. The petitioner's estimate of income is a percentage of the year's collections determined shortly after the close of each calendar year by petitioner's accountants for the purpose of preparing a timely income tax return. The percentages, as estimated for the years 1924 to 1927, inclusive, are 71.48, 75, 75, and 70 percent, respectively. Commencing with the year 1924 and every year thereafter, a certified public accountant caused to be made a so-called "physical inventory" of the petitioner's liability to its clients. This embraced an examination of1935 BTA LEXIS 968">973 the individual master cards; the amounts collected by the petitioner from the debtors of clients were reduced by commissions to which the petitioner is entitled thereon; and the balances on all the master cards, 50,000 to 75,000 in number, were then totaled. The grand total for each year was taken by the petitioner and its accountant to represent the so-called "actual liability" of petitioner to its clients. The amounts of the so-called "actual liability" of petitioner to its clients so computed, and the liabilities as estimated, are as follows: YearSo-called actual liabilityEstimated liability1923$109,620.071924$138,329.25146,274.401925180,518.86179,342.411926231,458.67203,779.081927226,334.65220,499.0332 B.T.A. 314">317 This system was arranged for some time in 1924, to take effect as of December 31, 1924, and has been continued to the present time. The percentage estimated and used by petitioner at the end of 1924 to determine its liability to its clients was 28.32 percent, which figure was obtained from a compilation of figures, based upon the experience of two organizations, prepared by the president of petitioner after its1935 BTA LEXIS 968">974 organization. At December 31, 1925, the so-called "physical inventory of liabilities" for 1924 having been completed, a comparison of the "estimated liability" and so-called "actual liability" for 1924 indicated to petitioner and its accountant that the 28.32 percent used for 1924 was too high; and it was therefore reduced to 25 percent for 1925. The same percentage was used for 1926. Upon a comparison of the so-called "actual liability" for 1926 and the 1926 "estimated liability", the petitioner concluded that 25 percent was too low and it was changed to 30 percent for 1927. The respondent, upon audit of petitioner's returns, determined that its method of determining its earned commissions did not clearly reflect its taxable income. In recomputing the tax liability of the petitioner for the years 1924 to 1927, inclusive, the respondent, in order to determine the earned commissions, used an average percentage based upon the total collections and total remittances to clients, of the preceding five years. As the only year before us is the year 1927, we set forth only the method of the calculation made by respondent of the percentage used for 1927 as shown by the statement attached1935 BTA LEXIS 968">975 to the notice of deficiency: YearPaid to clientsCollections from debtors1922$28,909.71$245,187.43192346,122.99275,550.18192430,815.65237,198.36192532,495.48262,257.96192662,660.34348,388.04201,004.161,368,581.97$201,004.16 divided by $1,368,581.97 equals 14.687% average paid to clients. 100% minus 14.687% equals 85.313%.Collections for 1927 $353,913.99 X .85313 equals$301,934.64Reported by taxpayer 353,913.99 X .70 equals247,739.79Increase in commissions earned54,194.85The same method was applied in preceding years and the following percentages were obtained and used to determine what portion of the annual collections represented earned commissions and what portion a liability to clients, as shown by the statement attached to the notice of deficiency. 32 B.T.A. 314">318 YearCollectionsEarned Liability tocommissionclientsPercentPercent1924$237,198.3884.37315.6271925262,257.9685.49314.5071926348,388.0486.51913.481OPINION. MCMAHON: The respondent, upon an audit of petitioner's returns covering a period of years, determined1935 BTA LEXIS 968">976 that the petitioner's method of estimating earned commissions failed to reflect the commissions to which petitioner was entitled on payments made by debtors to clients, particularly in view of the fact that petitioner retained collections made by it until clients reported on payments received from debtors. The respondent, therefore, pursuant to section 212(b) of the Revenue Act of 1926, 1 recomputed the earned commissions by using an average percentage based upon total collections and remittances for a period of five preceding years. 1935 BTA LEXIS 968">977 The petitioner contends that the total of collections received by it in each year, in excess of its commissions thereon, is a liability and remains a liability until settlement is made, or until the expiration of the statute of limitations; and that, therefore, no part thereof, until settlement or expiration of the statutory period, can possibly be included in its gross income. The practice of the petitioner of examining the master cards did not aid in determining the commissions to which petitioner was entitled on both collections made by it and on all payments made by debtors to clients. While payments made by debtors to clients were entered on the cards, such payments and the commissions thereon were entered only if and when the clients reported such payments to the petitioner. Hence, the cards did not disclose the commissions on unreported payments to clients to which the petitioner was entitled. The practice of checking up the master cards, therefore, does not disclose the actual amount of commissions to which petitioner is entitled under its contracts because it fails to disclose the commissions to which the petitioner is entitled on unreported payments made to clients, 1935 BTA LEXIS 968">978 and discloses merely (1) the commissions 32 B.T.A. 314">319 to which it is entitled on collections made by it, and (2) commissions to which it is entitled on reported payments made by debtors to clients. The petitioner does not make settlements with its clients until the amount of its offsetting claims against the clients for commissions on payments made by debtors to clients has been ascertained. Hence collections made by petitioner, less its commission thereon, which ordinarily would be due and payable to clients, are retained by the petitioner until clients make reports of payments received. The earned commission reported by petitioner on its return was estimated by using the following percentages for 1924 to 1927, inclusive: 71.48, 75, 75, and 70 percent, respectively, while the respondent used the following percentages: 84.373, 85.493, 86.519, and 85.313 percent, respectively. There is no evidence to show how, or the method by which, the percentages used by the petitioner were determined or arrived at, except that the first percentage used was based on some figures submitted by petitioner's president and that changes in the percentages were made when the annual check up of the1935 BTA LEXIS 968">979 master cards indicated to petitioner that a change should be made. On the other hand, the percentages used by respondent are based upon the total collections from debtors of clients and remittances from petitioner to clients over a period of five years. They are based on known and actual figures resulting from petitioner's own business experience covering a period of five years. The petitioner adduced no evidence pertaining to the collections ordinarily due clients which petitioner retained each year awaiting reports from clients as to payments received by them. There is no evidence as to the amounts of collections so retained by petitioner, if any, which were never remitted to clients. There is no evidence as to the amount of commissions earned each year by the petitioner on collections made by it, or the amount of commissions earned each year on reported payments made by the debtors directly to clients, both of which were ascertainable from its own records. The petitioner contends that the entire amount collected by it in excess of its commission thereon is a liability and remains a liability until settlement is made or until the expiration of the statutory period of limitations. 1935 BTA LEXIS 968">980 No doubt there were some clients who failed to make reports to petitioner and as to these, according to petitioner's practice, no settlements have been made. Hence, some of these retained collections were probably never remitted to clients. The petitioner has been in existence since 1918. In the meantime claims of clients for collections retained by petitioner have probably been outlawed, but there is no evidence that petitioner included such items in income at any time. The petitioner contends that the respondent's method is inconsistent and erroneous because, while he based his computation of the petitioner's 32 B.T.A. 314">320 liability to its clients on the amount of $109,620.07, the amount which petitioner estimated to be due to its clients as of December 31, 1923, he assumes that there is no further liability to clients for each succeeding year. The petitioner is in error in this respect. The respondent in determining the amount due to clients as of December 31 each year recognized the fact that petitioner is continually incurring and reducing its liability to its clients. Commencing with the amount of $109,620.07, as the amount of liabilities due clients as of January 1, 1924, he1935 BTA LEXIS 968">981 deducted each year the amount remitted to clients and added each year the difference between the amount collected and the amount determined to be earned commissions, or 15.627 percent of the collections in 1924, 14.507 percent of collections in 1925, 13.481 percent of collections in 1926, and 14.687 percent of collections in 1927, with the result that at the end of 1927 the amount due to clients was estimated to be $68,252.64. In our opinion the petitioner has failed to show that respondent's method of computation of petitioner's earned commissions is erroneous. Furthermore, we are convinced, from the evidence presented, that the method of accounting employed by the petitioner and its method of estimating its earned commissions do not clearly reflect its annual income. We must, therefore, approve the respondent's determination. Decision will be entered for the respondent.Footnotes1. (b) The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the 200 or if the taxpayer has no annual accounting period of does not keep books, the net income shall be computed on the basis of the calendar year. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4512655/	IN THE COURT OF APPEALS OF IOWA No. 18-1590 Filed March 4, 2020 STATE OF IOWA, Plaintiff-Appellee, vs. DAVID M. PUTZ, Defendant-Appellant. ________________________________________________________________ Appeal from the Iowa District Court for Jasper County, Terry Rickers, Judge. A defendant appeals his convictions for sponsoring a gathering where controlled substances were used and possession with intent to deliver marijuana. REVERSED AND REMANDED. Martha J. Lucey, State Appellate Defender, and Kerrigan Owens (until withdrawal), law student, for appellant. Thomas J. Miller, Attorney General, and Timothy M. Hau, Assistant Attorney General, for appellee. Heard by Bower, C.J., and Tabor, Mullins, May, and Greer, JJ. 2 TABOR, Judge. Today we must decide if a police officer may enter a third party’s residence without a search warrant based on a verbal request from the Iowa Department of Human Services (DHS) to take custody of a juvenile. The officer’s warrantless entry into the residence of David Putz and Carrie Carre to locate fourteen-year-old D.B. led to a search for drugs and charges against the couple. The district court denied Putz’s motion to suppress and convicted him on a stipulated record. In this appeal, Putz contests his drug convictions by arguing the officer’s entry violated his constitutional rights. Because the State failed to show a recognized exception to the warrant requirement justified that entry, we reverse the suppression ruling and remand for further proceedings consistent with this opinion.1 We reach the same conclusion in State v. Carre, No. 18-1584, 2020 WL ______, at ___ (Iowa Ct. App. Mar. 4, 2020), also filed today. I. Facts and Prior Proceedings We glean the following facts from the suppression hearing and the minutes of testimony. After Putz waived his right to a jury trial, the district court relied on those stipulated minutes to find him guilty of possession of marijuana with intent to deliver and sponsoring a gathering where controlled substances were used. This case did not start as a drug investigation. It started over concerns for the welfare of a juvenile. Those concerns reached Newton Police Officer Andrew Hansen on December 12, 2016, when he fielded a call from D.B.’s sister.2 1Because we reverse on this ground, we need not address Putz’s other issues. 2Our record does not contain any information about the sister’s age, her location, or any context for her concerns. Nor does it contain any information about D.B.’s mother other than she was located in Davenport. 3 According to Officer Hansen’s testimony at the suppression hearing, the sister said D.B.’s mom “was not around. She was in Davenport. [D.B.] was on his own. He was drinking alcohol and going with older males to Sioux City.” Rather than starting an investigation, Officer Hansen advised D.B.’s sister to call the DHS. Two days later, the officer received a call from Jared Lawrence, a DHS child protection worker based in Mahaska County. Lawrence said “he wanted a law enforcement emergency removal done on [D.B.].” Lawrence believed the officer could find D.B. at a Newton residence. Lawrence’s information came from Carre, who notified the DHS that D.B. was at her home. She reportedly told Lawrence D.B. was “skittish” and “she was doing the best she could to keep him at the residence.” Lawrence was prepared to testify that on December 12 he spoke with D.B.’s sister; from that conversation Lawrence understood “[D.B.]’s whereabouts were unknown” and he “had been transient for the past several months.” The next day, Lawrence called the Newton School District to see if D.B. was enrolled (he was not). And after receiving Carre’s call on December 14, Lawrence contacted Newton police to request a “law enforcement removal” of D.B. When asked what a “law enforcement removal” entailed, Officer Hansen said: “There’s a situation where a child is in danger. DHS would like [law enforcement] to pick them up right away, and then DHS will find placement for them in a safe environment.” The officer did not believe he needed a court order for the “emergency law enforcement removal” sought by the DHS. Officer Hansen said Lawrence had spoken with the county attorney’s office and “they would fill out the paperwork the next day.” 4 On the same evening he spoke with Lawrence, Officer Hansen went to find D.B. at the house where Carre and Putz lived. The officer knocked at the front door. He testified “a male between fifteen and eighteen years of age” answered the door.3 The officer testified he did not know it then, but later learned the person who answered the door was D.B.’s eighteen-year-old brother. Officer Hansen recalled asking if D.B. was there. But the occupant walked away without answering. The officer testified: “I advised him I would need to follow him in.” The officer acknowledged he did not have consent to enter the house. Rather, the officer reasoned: “I read the body language of the individual I was speaking with, and I knew something was not right. And he just walked away from me so I went to investigate what was going on.” When asked to elaborate, the Officer Hansen explained, “I was not—I did not feel I needed to run after him. But the situation was odd, and his lack of emotion and lack of acknowledgement was concerning to me so I followed him in.” The officer followed the teenager to the back of the home where a younger male emerged from a bedroom. That younger teenager identified himself as D.B. Officer Hansen told D.B. that he “would need to come with me.” But taking D.B. into custody did not end the officer’s involvement. When the bedroom door opened, the officer smelled “the burnt odor of marijuana.” Then Carre walked out of that bedroom. When the officer asked about the smell, Carre said D.B. “smoked a bowl to calm down.” Based on that admission, Officer Hansen 3 A witness for the defense contradicted the officer’s version of events. A.C., Carre’s daughter, testified she answered the door that evening and “was surprised to see a cop standing there.” 5 asked for consent to search. Carre declined, telling the officer that he “would need a search warrant.” So Officer Hansen sought a search warrant for the entire house. While waiting for the warrant, the officer gathered all the occupants into the living room. Those occupants included Carre, Carre’s two daughters, Putz, D.B., DB.’s brother, and another teenager. Officer Hansen also “did a quick visual search” to “make sure there was nobody else in the residence. During that sweep, he noticed a marijuana pipe in another bedroom. Also before obtaining the warrant, the officer searched toiletry bags that Carre retrieved from the bedroom. The bags contained methamphetamine. The warranted search of the residence revealed additional drug paraphernalia, a glass jar containing eighteen baggies of marijuana, as well as a safe holding two more glass jars containing five and six baggies of a green, leafy substance, a digital scale, and additional plastic bags. Putz told officers the marijuana belonged to him and was for his personal use. The State charged Putz with delivery or possession with intent to deliver methamphetamine, sponsoring a gathering where controlled substances were used, and delivery or possession with intent to deliver marijuana. He moved to suppress the evidence found at his residence. He claimed the officer’s warrantless entry into his home violated his rights under both the Fourth Amendment of the United States Constitution and article I, section 8 of the Iowa Constitution. After the district court denied that motion, the State amended its trial information to add two counts of distributing controlled substances to minors. Putz waived his right to a jury trial, and the State proceeded with a trial on the minutes 6 of testimony for (1) possession with intent to deliver marijuana in violation of Iowa Code section 124.401(1)(B)(7) (2016) and (2) sponsoring a gathering where controlled substances were used in violation of section 124.407. The district court found Putz guilty on those two counts. He now appeals. II. Scope and Standard of Review We review de novo this challenge to the suppression ruling because Putz’s appeal implicates constitutional issues. See State v. Baker, 925 N.W.2d 602, 609 (Iowa 2019). We independently evaluate the totality of the circumstances as shown by the entire record. Id. We defer to the district court’s factual findings, but they do not bind us. Id. III. Analysis Both the Fourth Amendment and article I, section 8 protect against unreasonable searches and seizures.4 Our supreme court has recognized the preference for search warrants. See State v. Angel, 893 N.W.2d 904, 911 (Iowa 2017). That preference is especially strong when defendants challenge a search of their home under the state constitution. See State v. Short, 851 N.W.2d 474, 502 (Iowa 2014) (expressing “little interest in allowing the reasonableness clause to be a generalized trump card to override the warrant clause in the context of home searches”). Putz contends Officer Hansen’s warrantless entry into his home violated his constitutional rights. We address that contention in a two-step analysis: (1) did 4 On appeal, Putz does not urge a different standard for interpreting the state constitutional provision but contends the Iowa Supreme Court may apply the standard more stringently under state than federal case law. See State v. Ochoa, 792 N.W.2d 260, 267 (Iowa 2010). 7 Putz have a reasonable expectation of privacy in the area searched and (2) if so, did the State unreasonably invade that protected interest? See State v. Tyler, 867 N.W.2d 136, 167 (Iowa 2015). Here, no dispute arises that Putz had a reasonable expectation of privacy in the home he shared with Carre. In fact, the “chief evil” the Fourth Amendment and article I, section 8 each strive to address is such a warrantless intrusion into a home. State v. Kern, 831 N.W.2d 149, 164 (Iowa 2013). So we turn to the reasonableness of the invasion of that protected interest. “Subject to a few carefully drawn exceptions, warrantless searches and seizures are per se unreasonable.” State v. Lewis, 675 N.W.2d 516, 522 (Iowa 2004). Courts recognize exceptions to the warrant requirement for searches based on consent, plain view, probable cause coupled with exigent circumstances, searches incident to arrest, and emergency aid. Id. The State bears the burden to prove an exception applies. State v. Watts, 801 N.W.2d 845, 850 (Iowa 2011). In the district court, the State argued three exceptions to the warrant requirement: consent, emergency aid, and probable cause (or its equivalent) plus exigent circumstances. The district court rejected the first two exceptions. First, the State did not show Officer Hansen received permission to enter the home: “The Court does not find that opening a door to a police officer operates as consent for the officer to enter the home.” Second, the court ruled the emergency-aid exception did not apply because the State did not show the risk of imminent danger: Even though Officer Hansen had been dispatched to perform the emergency removal of a minor, the State has failed to show that it was reasonable for Officer Hansen to believe that an emergency existed. At the time he knocked on the front door, he did not know if 8 [D.B.] was still present in the home, or have any knowledge that showed [D.B.] was at risk for death or bodily injury. So the State was left with the warrant exception for probable cause (or its equivalent) coupled with exigent circumstances. The district court latched onto that rationale, recognizing “the State’s strong interest in safely recovering [D.B.]” as a runaway under Iowa Code section 232.19(1)(c) and finding “exigent circumstances necessary” to enter Putz’s residence without a warrant based on Carre’s description of the juvenile as “skittish.” On appeal, the State does not resurrect the consent exception but does reprise its community-caretaking argument rejected by the district court, as well as advocating that entry into Putz’s home was supported by the equivalent of probable cause coupled with exigent circumstances. We will address each of those exceptions in turn. A. Community Caretaking/Emergency Aid The United States Supreme Court recognized the community-caretaking exception to the warrant requirement in Cady v. Dombrowski, holding: “Local police officers . . . engage in what, for want of a better term, may be described as community caretaking functions, totally divorced from the detection, investigation, or acquisition of evidence relating to the violation of a criminal statute.” 413 U.S. 433, 441 (1973). Community-caretaking has three subdivisions: “(1) the emergency aid doctrine, (2) the automobile impoundment/inventory doctrine, and (3) the ‘public servant’ exception.” Tyler, 867 N.W.2d at 170. The emergency-aid and public-servant doctrines are “analytically similar”—though critics brand the public-servant category as “amorphous” and at risk of “swallowing up constitutional 9 restrictions on warrantless searches all together.” See State v. Coffman, 914 N.W.2d 240, 245 (Iowa 2018); id. at 263 (Appel, J., dissenting). In this appeal, the State focuses on the emergency-aid exception, contending “the information available to Hansen would have led a reasonable person to believe emergency action was necessary.” It is true, a police officer may enter a home without a warrant to render emergency assistance. See State v. Emerson, 375 N.W.2d 256, 258–59 (Iowa 1985). But the admissibility of evidence discovered after that entry hinges on this question—would a reasonable person have believed an emergency existed? State v. Carlson, 548 N.W.2d 138, 141 (Iowa 1996); see also Coffman, 914 N.W.2d at 257–58 (holding under Iowa Constitution, the State must also show officer “subjectively intend[ed] to engage in community caretaking”). Framed more broadly, we must ask (1) was Officer Hansen conducting bona fide community-caretaking activity and (2) did the public’s need for that activity outweigh the intrusion on Putz’s privacy interest in his home. See Coffman, 914 N.W.2d at 244–45. The district court found insufficient proof the officer’s warrantless entry was necessary to rescue or render aid to D.B. After all, Officer Hansen did not know if D.B. was actually at the home when he knocked on the door. Neither did Officer Hansen know if the young man who answered the door was D.B. or was about to alert D.B. to the police presence. In fact, he described the person who answered 10 the door as somewhat older than D.B.—fifteen to eighteen years old, rather than D.B.’s fourteen years.5 To counter the district court’s finding, the State cites Carlson, where the police entered the defendant’s home, looking for his girlfriend who was reported missing by her distraught daughters. 548 N.W.2d at 142. That missing woman was trying to end an abusive relationship with Carlson and, uncharacteristically, did not answer calls from her daughters for two days. Id. at 143. Carlson did not answer the officer’s knock at the door, but tire tracks in the snow confirmed he was at home. Id. (accepting reasonable belief that “it seemed highly likely that some terrible harm had befallen her, requiring a rescue”).6 The State compares the missing-person report in Carlson to the DHS concerns for D.B. The State’s comparison is apt on the surface. But digging deeper, the cases bear few similarities. Here, the State offered no evidence D.B. faced any harm inside the Putz-Carre residence. In fact, Carre herself had contacted the DHS to let child protection workers know D.B. was safe at their home. At oral argument, the State pointed only to the risk of D.B. taking flight from Putz’s home, possibly out a back door. 5 Hansen testified he was the only officer at the scene and “did not want that individual running out the back door.” The officer testified while he was not familiar with the Putz residence, it was a “bungalow type house” likely with a “similar layout” to other houses of that style that featured a back door. Despite his familiarity with the bungalow layout—and Carre’s warning that D.B. was “skittish”—Officer Hansen did not take the reasonable step of bringing a second officer to the call in case D.B. tried to slip out the back. 6 The State also cites State v. York, No. 12-0405, 2013 WL 530956, at 5 (Iowa Ct. App. Feb. 12, 2013), in which we approved reliance on the emergency-aid exception when “[a]n intoxicated and suicidal teenager led police to a home where they discovered signs of a forced entry and unresponsive residents.” Unlike D.B.’s situation, the facts in that case justified the officers “in fearing for the juvenile’s life.” 11 “The emergency-aid exception is subject to strict limitations.” Id. at 141. This case does not fall within those narrow constructs. We agree Officer Hansen arrived at the Putz-Carre residence to conduct bona fide caretaking activity— acting on the DHS request to find a teenager whose sister expressed concerns about his welfare. And we appreciate that peace officers must often react to changing circumstances with little time for introspection. See U.S. v. Harris, 747 F.3d 1013, 1017–18 (8th Cir. 2014) (recognizing police may be called to “make a split-second decision in the face of an emergency” to protect the public). But after Officer Hansen knocked on the front door and asked if D.B. was there, the officer switched to investigation mode. He testified the young man’s “lack of acknowledgement was concerning to me so I followed him in.” The officer’s decision to “investigate what was going on” arose from his mere hunch that something was “not right” about the situation. The officer’s “read” of that young man’s “body language” did not provide a reasonable basis to believe D.B. was present, still less that D.B. faced serious harm inside that home requiring the officer’s warrantless entry to render immediate aid. See Kern, 831 N.W.2d at 174 (holding community-caretaking exception did not justify police entry into home where officer’s motivation was to search for evidence of a crime). The lack of imminent danger was also evident from the fact that two days earlier Officer Hansen learned of the sister’s concerns but did not take any action to find fourteen-year-old D.B. Instead, the officer recommended the sister contact DHS workers to “advise them of the situation.” Nothing about the circumstances the officer encountered at Putz’s residence corroborated the corrupting influence of “older males” D.B.’s sister mentioned. The State offered no proof that D.B.’s 12 “transient” situation had reached an emergency status that justified police in making a warrantless entry into a third party’s home. Like the district court, we reject the State’s reliance on the emergency-aid exception. B. Taking Custody of a Runaway Under Exigent Circumstances That rejection leaves us with the State’s remaining argument—that Officer Hansen’s entry into Putz’s home fell under the warrant exception for probable cause coupled with exigent circumstances. The State does not argue Officer Hansen had probable cause to believe a crime was being committed in Putz’s home. Instead, the State argues—and the district court accepted—that the officer had “the equivalent” of probable cause under the child-welfare chapter. Generally, probable cause exists to conduct a search if a reasonably prudent person would believe evidence of a crime might be located at that place. See State v. Nitcher, 720 N.W.2d 547, 554 (Iowa 2006). Exigent circumstances generally involve the danger of violence or injury to police officers or others, the risk of the subject’s escape, or the probability that evidence will be concealed or destroyed if the officer waits for a warrant to act. Id. at 555. To decide if an officer faced an exigency that justified acting without a warrant, we look to the totality of circumstances. See Missouri v. McNeely, 569 U.S. 141, 149 (2013). Although the district court did not believe the State offered sufficient evidence of an emergency for the emergency-aid exception, it nevertheless decided the DHS request that police execute an “emergency removal of a minor” was the “equivalent” of probable cause. As for exigent circumstances, the district court identified Officer Hansen’s reliance on “Carre’s own expression of urgency” 13 when describing D.B.’s restlessness and her attempts to keep the teenager at the house. We start with the probable-cause equivalency. The district court noted this case was “factually unique” because it did not involve a crime but rather “the emergency removal of a minor without any type of court or administrative order.” The court then cited two provisions—Iowa Code sections 232.19 and 232.79—as “scenarios where a police officer may take a minor into custody.” The court decided “the most applicable scenario” was the authorization to seize runaway children. That code section provides: A child may be taken into custody . . . [b]y a peace officer, when the peace officer has reasonable grounds[7] to believe the child has run away from the child’s parents, guardian, or custodian, for the purposes of determining whether the child shall be reunited with the child’s parents, guardian, or custodian, placed in shelter care, or, if the child is a chronic runaway and the county has an approved county runaway treatment plan, placed in a runaway assessment center under section 232.196. Iowa Code § 232.19(1)(c). The district court assumed D.B. had “run away” from his parents because the sister reported his mother was in Davenport and he was in Newton.8 Putz attacks that assumption on appeal. He points out the legislature did not define “runaway” in chapter 232 but did so in the criminal code. The kidnapping chapter defines “a runaway child” as “a person under eighteen years of age who is 7 The State asserts, and we agree, that the standard of “reasonable grounds” is comparable to the “probable cause” requirement. See Kraft v. City of Bettendorf, 359 N.W.2d 466, 469 (Iowa 1984) (equating expression “reasonable ground” in arrest statute to traditional “probable cause”). 8 Carre’s daughter, A.C., testified D.B.’s sister had talked to their family “about how [D.B.] hadn’t been home much and he’d been running away and he’d just been in some trouble and so we were trying to help him out.” 14 voluntarily absent from the person’s home without the consent of the person’s parent, guardian, or custodian.” Id. § 710.8(1)(c). Putz contends the State failed to prove Officer Hansen had reasonable grounds to believe D.B. was a runaway. Putz asserts the record does not show “where D.B.’s home was located, the identity of D.B.’s primary parent, guardian or custodian, who D.B. lived with, or whether on December 14, 2016 D.B. was a runaway.” We agree the State did not establish that the officer had information to show D.B. was voluntarily absent from his home without parental consent. Nothing in this record shows that between the sister’s calls on December 12 and the officer’s warrantless entry on December 14, either the DHS or the police tried to contact D.B.’s mother to check on his status. The State presented no evidence to clarify where D.B. was living; the hearsay relayed from his sister did not make clear whether D.B. left the mother’s new home in Davenport or if the mother moved there without him. The record did show D.B.’s older brother was with him in Newton. The State cannot rely on the runaway-child provision in section 232.19(1)(c) as the equivalence of probable cause that a crime had been committed without proof the officer reasonably believed D.B. had run away from his parents. In the district court, the State also relied on section 232.79(1). That statute allows a peace officer to take a child into custody without a court order or parental consent if “the child is in a circumstance or condition that presents an imminent danger to the child’s life or health” and “[t]here is not enough time to apply for an 15 order under section 232.78.”9 Hansen’s testimony at the suppression hearing points to section 232.79 as the basis for his trip to Putz’s residence. The officer cast the DHS request as an “emergency removal” where “a child is in danger.” But as Putz argues on appeal, the State did not establish D.B. was in “a circumstance or condition” that presented “imminent danger” to his life or health. Id. § 232.79(1)(a). Nor did the State show it did not have enough time to apply for an ex parte order from the juvenile court. See id. § 232.78. On appeal, the State responds it was “immaterial” whether it had time to seek court approval for the removal because the officer was acting as a community caretaker. The State also admits if D.B. was a runaway, it could not have satisfied the requirements under section 232.78(1) because the record lacks evidence of D.B.’s parents’ consent or conduct. We are unconvinced by the State’s circular argument. Because we have already rejected the State’s community-caretaker theory, we cannot conclude section 232.79 provided the officer authority to enter the Putz residence to remove D.B. Returning to the State’s theory that D.B. was a runaway, even if Officer Hansen had reasonable grounds to believe that was true, section 232.19(1)(c) only authorized the officer to apprehend the child. See State v. Ahern, 227 N.W.2d 164, 167 (Iowa 1975) (holding code section “allows a peace officer to take into 9 The juvenile court may enter an ex parte order for the temporary removal of a child when (1) a parent or guardian is (a) absent, (b) refuses to consent to the child’s removal, or (c) there is reasonable cause to believe that a request for consent to remove the child will further endanger the child or cause the parent or guardian to take flight and (2) where it appears that the child’s immediate removal is necessary to avoid imminent danger to the child’s life or health and (3) there is not enough time to file a petition and hold a hearing under section 232.95. See Iowa Code § 232.78(1). 16 immediate custody a runaway child”). It did not separately permit the officer to cross the threshold into a third party’s home to take the juvenile into custody. As the Ahern court cautioned: “Of course, that section may not authorize deprivation of fourth amendment protections.” Id. Even if the State could rely on the runaway-child provision as the equivalent of probable cause, we cannot find exigent circumstances paved the officer’s entry into Putz’s home. The State must advance “specific, articulable grounds” to support a finding of exigent circumstances. Watts, 801 N.W.2d at 851. In the context of entering a home without a warrant to make an arrest, a finding of exigency requires courts to consider these important, but not all-inclusive criteria: (1) a grave offense is involved; (2) the suspect is reasonably believed to be armed; (3) there is probable cause to believe the suspect committed the crime; (4) there is strong reason to believe he is on the premises; (5) there is a strong likelihood of escape if not apprehended; and (6) the entry, though not consented to, is peaceable. State v. Luloff, 325 N.W.2d 103, 105 (Iowa 1982). Here, the State contends “any parent would agree a runaway juvenile is a situation necessitating immediate police action.”10 That contention rings true in the abstract. But here any concrete information from the perspective of D.B.’s parents 10 The State cites two out-of-state cases upholding officers’ warrantless entry into defendants’ home to find runaway juveniles. See State v. Smith, 367 P.3d 260 (Idaho Ct. App. 2016); State v. Sadler, 193 P.3d 1108 (Wash. Ct. App. 2008), declined to follow on other grounds in State v. Sublett, 292 P.3d 715 (Wash. 2012). In both cases, the police had strong evidence the juveniles were being held on the property of suspects who threatened the juveniles with serious harm. Smith, 367 P.3d at 263–64; Sadler, 193 P.3d at 1121. By contrast, Officer Hansen had no information Carre or Putz posed any danger to D.B.’s safety. In fact, he knew Carre had called the DHS to report D.B.’s location. 17 is glaringly absent. The officer had no basis to believe D.B.’s alleged presence at the Putz home required immediate police action. When viewed in its totality, the record here does not support the district court’s finding of exigent circumstances. The district court focused on Carre’s description of D.B. as “skittish” to presume he was a “flight risk.” But as the district court recognized, Officer Hansen did not know if D.B. was still present in the home when he entered the front door. And the officer had no information that D.B. faced imminent danger if he was still inside the home or, conversely, that he faced imminent danger if he left the home. Here, a sister expressed concern her teenaged brother was “on his own” and making bad choices. The officer originally diverted her concerns to DHS. DHS learned from Carre that D.B. was present in her home and that she would try to keep him there. Dispatched to that house, the officer knocked on the door. When an occupant, who appeared to be in his teens answered, the officer did not ask for Carre so that she could confirm D.B.’s presence in her home. Instead, based on that teenager’s body language, the officer felt compelled to walk into the house without consent. That situation did not amount to exigent circumstances. Both the Fourth Amendment and article I, section 8 draw a “firm line at the entrance to the house.” See Watts, 801 N.W.2d at 852 (quoting Payton v. New York, 445 U.S. 573, 590 (1980)). Without exigent circumstances, an officer may not cross that threshold without a warrant. Id. Here, the State failed to show specific, articulable grounds to support a finding of exigent circumstances to justify Officer Hansen’s entry. 18 Because the State did not establish an exception to the warrant requirement justifying the officer’s entry, all evidence discovered in Putz’s home must be suppressed. See Luloff, 325 N.W.2d at 106 (“Information gained during the illegal entry led to the discovery of evidence that formed the basis for the search warrant. The exclusionary rule bars the use of both evidence directly seized in an illegal search and evidence discovered indirectly through the use of evidence or information gained in the illegal search.”). We reverse the suppression ruling and remand for further proceedings consistent with this opinion. REVERSED AND REMANDED. Bower, C.J., and Mullins, J., concur; May, J., concurs specially; and Greer, J., partially dissents. 19 MAY, Judge (specially concurring). I specially concur for the reasons explained in State v. Carre, No. 18-1584, 2020 WL _______ (Iowa Ct. App. Mar. 4, 2020), also filed today. 20 GREER, Judge (concurring in part and dissenting in part). For the reasons explained in my partial dissent in State v. Carre, No. 18- 1564, 2020 WL ____ (Iowa Ct. App. Mar. 4, 2020), also filed today, I respectfully dissent from the majority’s conclusion that the community-caretaking doctrine does not apply here. I would find the officer’s warrantless entry into the home falls under the community-caretaking exception to the warrant requirement and would affirm the district court on that issue.	01-04-2023	03-04-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625554/	Herbert A. Nieman & Co. v. Commissioner.Herbert A. Nieman & Co. v. CommissionerDocket No. 56932.United States Tax CourtT.C. Memo 1960-119; 1960 Tax Ct. Memo LEXIS 169; 19 T.C.M. (CCH) 632; T.C.M. (RIA) 60119; June 8, 1960Harvey W. Peters, Esq., 1308 North Prospect Avenue, Milwaukee, Wis., and William A. Jackson, Esq., for the petitioner. Erving Sodos, Esq., for the respondent. VAN FOSSAN Supplemental Memorandum Opinion VAN FOSSAN, Judge: Petitioner filed a motion requesting a "correction" in our Opinion, 33 T.C. 451">33 T.C. 451, filed December 9, 1959. Specifically, 170 petitioner takes issue with the finding that the breeder foxes were "inventoried," and asks us to find the contrary. Were we to find that the foxes were not inventoried, petitioner would be entitled to an allowance for depreciation in computing its taxable income. Petitioner's motion must be denied for the reasons set forth in our original opinion and amplified herein. The notice of deficiency contained the following paragraph concerning this issue: "The issues raised in your claims for refund requesting deductions in the taxable years 1941 to 1945, inclusive, in the respective amounts of $29,405.92, $28,553.64, $30,370.94, $32,877.00, and $33,949.71 for depreciation on live foxes carried in inventory on your books and records, and alleging that the gains realized upon the sale of skins pelted from foxes previously used for breeding purposes are taxable as long-term capital gains under the provisions of section 117(j) of the Internal Revenue Code of 1939 have been carefully considered. It has been concluded that since the value of the animals upon which you seek to deduct depreciation was taken into the inventories used in computing the gross profit reported on your returns, 171 such animals are not subject to depreciation under the method of accounting used by you and, further, that no timely applications for a change in method of accounting have been filed." The presumption of correctness of respondent's determination is not a matter of evidence but is merely an arbitrary fixation of the procedural posture of the parties to the trial, and such presumption disappears once evidence which would support a contrary finding has been adduced in the trial of a contested issue. We search this record in vain for such evidence. Petitioner's motion states: "There is not a scintilla of evidence respecting 'inventorying' of animals and pelts, other than the fact that these cost figures were 'included under the heading inventories' on 'balance sheets accompanying its Federal income and declared value excess-profits tax returns.'" We agree, and it is therein that petitioner failed. If there was disagreement with respondent's determination, the burden rested upon petitioner to bring forth evidence to show the contrary. Examining petitioner's returns we find that under "Cost of Goods Sold" (Schedule A) for the years in issue, petitioner listed various amounts representing172 inventory at the beginning and at the end of the year of the return. These inventory entries were the totals of the amounts listed in Schedule L under the headings: "Breeding Foxes & Other Foxes," "Fox Pelts," and "Finished Goods Inventory." The "Breeding Foxes & Other Foxes" entry is some evidence that petitioner treated the breeder foxes as part of its livestock inventory. The original cost of the breeder foxes, the pelts of which were sold in the years 1942 to 1945, inclusive, and the amount of sales commissions and selling expenses were deducted from gross income of petitioner as deductions reducing petitioner's ordinary taxable income. It is stipulated that respondent did not question the deduction of the cost of the breeder foxes. We were of the opinion that respondent erred in including in ordinary income the sales price from these pelts and held they were subject to capital gains treatment consistent with section 117(j) of the Internal Revenue Code of 1939. Petitioner argues that taking such deductions is inconsistent with "inventory" treatment of the breeder foxes. See section 29.22(a)-7. Regulations 111. 1173 In following this argument we have carefully examined petitioner's returns for the years in issue but found no evidence that such deductions had in fact been taken. It may be that the cost was included on the line "Other costs per books" (Schedule A). We examined the itemization of this entry in the schedule, but the entries were so general as to prevent the actual tracing of these cost items. If petitioner desired to substantiate this argument, an opportunity was afforded at the hearing to produce the necessary evidence which would indicate that the costs were deducted. Nor do we think that the fact that petitioner took the deduction and respondent acquiesced in this treatment adds weight to petitioner's argument against the finding that breeder foxes were inventoried. We have found that petitioner has not shown that respondent erred in determining that petitioner "inventoried" the breeder foxes. The deduction from gross income for the year of the cost of the breeder foxes sold was erroneous and respondent's acquiescence in this error does not bind this Court. A comparison of the total cost of production of the breeder foxes with the valuation petitioner placed on inventory174 indicates that petitioner used a "cost" method of valuing its inventories. Regulations 111, sec. 29.22(c)-3. The facts do not indicate that petitioner used the "cost or market" or the "farm-price" method. Cf. secs. 29.22(c)-4, 29.22(c)-6, Regulations 111. It could not have been using the "unit-price" method for the years 1941 to 1944 since this method was not proposed and approved by the respondent until 1944. Sec. 29.22(c)-6, Regulations 111, as amended by T.D. 5423, 1945 C.B. 70">1945 C.B. 70. Petitioner was on a "cost" method, and since it does not appear that petitioner requested permission in 1944 to change to the "unit-price" method (or in fact did change), we conclude that petitioner continued to use the "cost" method. See sec. 29.41-2, Regulations 111. Cf. sec. 29.22(c)-6, Regulations 111; Elsie SoRelle, 22 T.C. 459">22 T.C. 459. See, also, Rev. Rul. 60-60, I.R.B. 1960-7, 29. Petitioner argues that the case of Scofield v. Lewis, 251 F. 2d 128 (C.A. 5), is applicable to the facts of this case and inferentially would grant petitioner permission to change its method of accounting. That case applied to a special fact situation dealing with Regulations175 requiring a taxpayer electing the "unit-price" method of valuing his livestock inventory to apply it to all livestock, including breeding animals. The Court of Appeals for the Fifth Circuit held that the Regulations had no basis in the statute and ruled that the taxpayer, who was compelled to value his entire inventory in this manner under the Regulations, could retroactively change his accounting method. Petitioner does not fit within the special facts of that case since it used a "cost" basis of valuation. Cf. Jack Frost, 28 T.C. 1118">28 T.C. 1118; Carter v. Commissioner, 257 F. 2d 595 (C.A. 5). Assuming, arguendo, that petitioner used the "unit-price" method, petitioner has not shown that it was compelled by respondent to include its breeder foxes in the inventory and that the inclusion was other than voluntary. Such a showing is required by the Lewis case, supra. See Carter v. Commissioner, supra; Andrew Little, Jr., 34 T.C. - (May 6, 1960). Petitioner did not argue Lewis on brief, even though it was cited by respondent. Petitioner had ample opportunity in the brief and reply brief to discuss the applicability of that case. Petitioner is not entitled176 to re-argue or re-brief points, which may have been overlooked at the hearing of the case, through the use of a motion for corrections. Petitioner argues that clarification and instructions are required for a Rule 50 computation. Respondent disagrees, and states that the data found in our opinion are entirely adequate. In any event, if the parties cannot agree on the computation, Rule 50(b) provides a means of settling the disagreement, and a motion at this time is untimely and inappropriate. For the reasons to be found in the original opinion and those discussed above, the motion must be denied. Decision will be entered under Rule 50. Footnotes1. Sec. 29.22(a)-7. Gross Income of Farmers. - * * Also live stock acquired for draft, breeding, or dairy purposes and not for sale, may be included in the inventory, instead of being treated as capital assets subject to depreciation, provided such practice is followed consistently by the taxpayer. In case of the sale of any live stock included in an inventory their cost must not be taken as an additional deduction in the return of income, as such deduction will be reflected in the inventory. * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625557/	J. C. MEADE, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, RespondentMeade v. CommissionerDocket No. 21261-86.United States Tax CourtT.C. Memo 1988-108; 1988 Tax Ct. Memo LEXIS 136; 55 T.C.M. (CCH) 377; T.C.M. (RIA) 88108; March 10, 1988. J. Richard Staley, for the petitioner. Monica J. Miller, for the respondent. PAJAKMEMORANDUM FINDINGS OF FACT AND OPINION PAJAK, Special Trial Judge: Respondent determined a deficiency in, and additions to, petitioner's 1982 Federal income tax as follows: Additions to tax under SectionsDeficiency6651(a)(1)6653(a)(1)6653(a)(2)6659 1$ 2,910.87$ 158.84$ 253.75 2 $ 684.00138 * 50 percent of the interest due on the $ 2,280 underpayment of tax due to negligence. After concessions, the issues for decision are: (1) whether petitioner is entitled to any deduction for charitable contributions, allegedly and principally to the Universal Life Church of Modesto, California; (2) whether petitioner is entitled to use the income averaging method of reporting his income under section 1301; (3) whether petitioner is liable for additions to tax under sections 6651(a)(1), 6653(a)(1), and 6653(a)(2); and (4) whether damages should be awarded to the United States under section 6673. FINDINGS OF FACT To the extent stipulated, the facts are so found. Petitioners resided in Goldenrod, Florida, when his petition was filed. Petitioner had lived in Denver, Colorado, before his move to Florida. During 1982, petitioner was employed as a field service engineer by Technicare Corporation. Petitioner was not trained as a minister. He was declared a minister by the Universal Life Church of Modesto, California, (ULC Modesto) on June 6, 1970. Petitioner has no formal training as a minister. He admitted that he had no direct responsibility over any congregation as a Universal139 Life Church (ULC) minister. He attended informal gatherings of four or five friends in his home, the homes of friends, and in parks, to discuss beliefs. He did not perform any baptisms or funerals. Petitioner had a personal checking account at the Sun Bank, Winter Park, Florida, during 1982. Petitioner wrote checks on his personal account payable to the "Universal Life Church, Inc." during 1982 in the total amount of $ 5,671.22. Nine of these checks were endorsed "Universal Life Church, Inc., Modesto, Calif., Acct. No. 700 209 473." This ULC account was not in California but was with the Sun Bank, Winter Park, Florida. We shall refer to this ULC account as the "ULC Florida" account. Six of petitioner's personal checks were endorsed "Universal Life Church, Inc. Acct. No. 712 310" and two such checks were endorsed "Universal Life Church, Inc., Modesto, Calif., Acct. No. 050 877." Examination of these checks shows that they were cleared in Denver, Colorado. We shall refer to these ULC accounts as the "ULC Colorado" accounts. The parties orally stipulated that a $ 200 amount allegedly donated to the ULC was from petitioner's Columbia Savings and Loan Association account in Aurora, 140 Colorado. The withdrawal slip shows that petitioner had an address in that city. There was no evidence that any entity or individual except petitioner had use of this $ 200. One check drawn on petitioner's personal account in the amount of $ 65 was endorsed "Universal Life Church, Inc., . . . Winston-Salem, North Carolina." This apparently was an account used by another ULC "minister' whose name petitioner could not remember. Of the $ 5,671.22 in checks drawn on petitioner's personal Sun Bank checking account, $ 5,119.10 was deposited in the Sun Bank ULC Florida account. Petitioner had signatory authority over this account. He used the funds from this account to pay his rent, electricity, telephone, travel and miscellaneous expenses. Petitioner filed his 1982 Federal income tax return in May 1983. Respondent disallowed petitioner's claimed charitable deduction of $ 6,215.74 for 1982. Respondent determined that petitioner did not establish that he qualified for the income averaging method of computing his tax liability. Respondent also determined the additions to tax set forth above. OPINION In this case petitioner presents yet another unfounded claim to deductions for141 alleged contributions to the ULC. This Court alone has considered over 130 such cases. . The Court of Appeals for the Eleventh Circuit, to which an appeal of this case would lie, has characterized the appeal of such cases as frivolous. , affg. per curiam an unreported opinion of this Court. 3 We agree with the statement in , that like the many preceding ULC cases, petitioner's claims "do not even pass the smell test." It is well established that deductions are a matter of legislative grace, and that a taxpayer must satisfy the specific statutory requirements for the deductions he claims. , affd. without published opinion . A taxpayer bears the burden of proving his entitlement to the deductions he claims. ; Rule 142(a). 142 A charitable contribution or gift is allowed as a deduction under section 170 if it is made to an entity organized and operated exclusively for religious or charitable purposes, provided that none of the net earnings of the organization inure to the benefit of a private individual. 4143 Petitioner drew checks made payable to ULC Modesto. He then deposited the checks in the ULC Florida account in the total amount of $ 5,119.10. Petitioner asserts that the ULC Florida account was a ULC Modesto account. This assertion is unfounded since petitioner failed to show that any gift had been made. The term "charitable contribution" as it is used in section 170 is largely synonymous with the term "gift." A gift is generally defined as a voluntary transfer of property to another without consideration. Petitioner failed to prove that a transfer of funds had been made or that any other person had control over the ULC Florida account. Without a transfer of property to another no gift occurs, because the funds remain under petitioner's dominion and control. . Moreover, the record overwhelmingly establishes that the deposits to the ULC Florida account inured to petitioner's benefit. Section 170(c)(2)(C); ; , affd. without published opinion . Petitioner144 wrote checks on the ULC Florida account to pay his rent, electricity, telephone, travel and miscellaneous expenses. In fact, petitioner admitted at trial that the funds allegedly contributed to the ULC Florida account were used to pay these personal expenses. Petitioner's assertion that the payment of his personal expenses from the funds in the Florida ULC account was deductible as a parsonage allowance is specious. Section 107 provides in pertinent part that "in the case of a minister of the gospel income does not include * * * the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home." Section 107 allows an exclusion from income paid to a minister by a religious organization for money expended on housing. The parsonage allowance exclusion does not allow the exclusion of compensation from other sources. Petitioner deposited his own funds into the ULC Florida account. Petitioner did not receive any compensation from a religious organization. He cannot exclude compensation from other sources under section 107. The remaining checks and the withdrawal slip representing alleged charitable contributions to ULC Modesto or ULC145 Denver accounts and to the ULC North Carolina account are insufficient to substantiate a charitable contribution. Petitioner has not shown that a contribution occurred to an entity organized and operated exclusively for charitable or religious purposes, and that none of the net earnings of the organization inured to the benefit of petitioner or other individuals. The endorsement stamps reading "Universal Life Church, Inc., Modesto, Calif." are insufficient to show that the funds were transferred to a charitable organization and that the net earnings did not inure to the benefit of petitioner or other individuals. While petitioner denied that he had signatory control over the ULC Colorado accounts, in view of the ULC tax avoidance transfers made by petitioner with the ULC Florida account, his uncorroborated denial is simply unbelievable. In answer to a question at trial, petitioner did not deny that he had received funds back from the ULC Colorado accounts. Since petitioner has failed to meet his burden of showing that he made any valid charitable contributions, we uphold respondent's determination on this issue. 5146 In another ULC case, the Court of Appeals for the Eleventh Circuit imposed double costs in favor of respondent and against the taxpayer. We find apposite the following statement of the Eleventh Circuit: We note that other taxpayers have attempted to avoid payment of taxes through claimed contributions to the Universal Life Church and in those cases have attempted the same tactics as the taxpayers here. If there are similar frivolous appeals of other cases, as frivolous as this, we would be inclined to asses attorney's fees in addition to doubling the costs. [, affg. per curiam an unreported opinion of this Court. 6] Respondent also disallowed petitioner's use of the income averaging method of reporting income. Petitioner has the burden of proving that respondent's determination is incorrect. ; Rule 142(a). Since petitioner has failed to introduce any evidence showing he is entitled to use the income averaging147 method, he has not met his burden of proof and respondent's determination is sustained. There is no question that petitioner's 1982 Federal income tax return, due on April 15, 1983, but filed in May 1983, was untimely. Petitioner offered no explanation for the delinquent filing of his return and thus failed to carry his burden of proving that the delinquency was due to reasonable cause and not due to willful neglect. . Petitioner is liable for the addition to tax under section 6651(a). Respondent also determined that petitioner is liable for additions to tax under section 6653(a). Petitioner bears the burden of proving that the underpayment was not due to negligence or intentional disregard of the rules and regulations. Axelrod v. Commissioner, 56, T.C. 248, 258 (1971). Petitioner deliberately understated his tax liability by claiming contribution deductions which were without substance in law or in fact. Petitioner was negligent in claiming these deductions and respondent's determinations are sustained. . Congress has granted this Court148 the authority to award the United States damages up to $ 5,000 whenever it appears to this Court that the proceedings before it have been instituted or maintained by the taxpayer primarily for delay or that the taxpayer's position in such proceedings was frivolous or groundless. Section 6673. This Court has held numerous times that a taxpayer's liability for tax cannot be escaped by establishing a ULC bank account and then paying personal expenses from the funds in that account. ; , affd. without published opinion . Petitioner was informed by respondent about the provisions of section 6673 and that the Court had repeatedly found actions based on ULC contributions to be without merit. Petitioner nevertheless maintained this action and delayed its determination by failing to produce documentary evidence until trial. Petitioner's waste of the Court's time and resources on a case based on grounds previously determined and his failure to cooperate with preparation for trial is a disservice to taxpayers with legitimate issues149 to be determined. We find the proceedings in this case were instituted and maintained primarily for delay and that petitioner's position in this proceeding is frivolous and groundless. Damages will be awarded to the United States in the amount of $ 2,300. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect during the taxable year in question. All rule references are to the Tax Court Rules of Practice and Procedure. ↩2. In his answer, respondent conceded that the section 6659 addition to tax was not applicable in this case and requested that the Court award damages to the United States under section 6673.↩3. This unreported opinion was a Bench Opinion rendered by Judge C. Moxley Featherston on March 3, 1986. ↩4. Section 170(c) provides in pertinent part as follows: SEC. 170(c). CHARITABLE CONTRIBUTION DEFINED. -- For purposes of this section, the term "charitable contribution' means a contribution or gift to or for the use of -- * * (2) A corporation, trust, or community chest, fund, or foundation -- (A) created or organized in the United States or in any possession thereof, or under the law of the United States, any State, the District of Columbia, or any possession of the United States; (B) organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals; (C) no part of the net earnings of which inures to the benefit of any private shareholder or individual; * * * ↩5. Petitioner offered no documentation to support his claim that a $ 37.35 charitable contribution deduction shown on his return represented a payroll deduction for the United Way. Since we found that he was not a believable witness, his unsupported testimony is insufficient to prove this claim. ↩6. As stated in footnote 3, supra,↩ this unreported opinion was a Bench Opinion rendered by Judge C. Moxley Featherston on March 3, 1986.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625559/	ROGER L. WHITESEL AND JOAN H. WHITESEL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWhitesel v. CommissionerDocket No. 12484-81.United States Tax CourtT.C. Memo 1983-9; 1983 Tax Ct. Memo LEXIS 781; 45 T.C.M. (CCH) 474; T.C.M. (RIA) 83009; January 5, 1983. Roger L. Whitesel, for the petitioners. Genevieve K. Murtaugh, for the respondent. KORNER783 MEMORANDUM FINDINGS OF FACT AND OPINION KORNER, Judge: Respondent determined the following deficiencies in income tax and additions to tax against the petitioners: Deficiency in IncomeAdditions toTaxable Year EndingTax and Self-EmploymentTax UnderDecember 31TaxSection 6653(a) 11977$439.64$21.9819781,303.9965.2019792,272.67113.63The issues presented for our decision are: 1. Whether the assessment of any tax or additions to tax against the petitioners for the year 1977 is barred by the applicable statute of limitations, as pleaded by petitioners; 2. whether the income of an organization designated as the "Joan H. Whitesel Family Estate (A Trust)" is properly taxable to petitioners on any one or more of the following grounds: (a) that the income earned from personal services may not properly be assigned to the trust organization, under the principles of ;784 (b) that the formation and operation of said trust organization was a sham transaction, lacking any economic reality, and should be ignored for Federal tax purposes; (c) that the income of said trust organization is taxable to petitioners under the "grantor trust rules" of sections 671 through 678; 3. whether certain alleged expenses incurred by the trust organization in earning its income were properly allowable to petitioners and deductible by them; 24. whether petitioners are liable for self-employment tax with respect to that portion of the trust organization's income which was shown as derived from carrying on a business by the trust organization; 5. whether petitioners are entitled to any investment tax credit pursuant to section 38 for the years 1977 and 1978; 6. whether petitioners785 are liable for additions to tax under section 6653(a) for all three years here in issue. Some of the facts have been stipulated, and such stipulation, together with the attached exhibits, are incorporated herein by this reference. At the time of filing their petition herein, petitioners were residents of Middletown, Ohio. Petitioners' joint Federal income tax return for the year 1977 was filed on April 17, 1978 with the District Director of Internal Revenue at Cincinnati, Ohio. Petitioners' joint returns for the years 1978 and 1979 were filed with the Internal Revenue Service at Covington, Kentucky. Fiduciary income tax returns on Form 1041 for the trust were filed for years 1977, 1978 and 1979 with the Internal Revenue Service Center at Covington, Kentucky. Respondent's statutory notice of deficiency herein was issued on March 27, 1981. By written instrument entitled "Declaration of Trust of This Pure Trust," and under date of November 13, 1974, petitioner Joan H. Whitesel (hereinafter "Joan") purported to establish the "Joan H. Whitesel Family Estate (A Trust)" (hereinafter "the trust"). The record herein establishes the following material facts with respect to the786 organization and operations of the trust: 1. Petitioner Roger L. Whitesel (hereinafter "Roger") and one Bert O. Ferris were designated in the trust instrument as the original trustees. Roger accepted his appointment as a trustee in the trust instrument by acknowledgement before a notary public, but it does not appear that Mr. Ferris did so. During the years 1977, 1978 and 1979 Roger was "executive trustee" of the trust, and was in charge of the regular day-to-day management of the trust. The record does not establish that anyone else was a trustee in this period, although the fiduciary tax returns which were filed for the trust for 1977 and 1979, together with a power of attorney with respect to the 1977 return, were executed by Joan as "trustee." 32. Joan, in her capacity as grantor, purported to assign all her services and income therefrom to the trust, for her life. 3. Under the trust instrument, the trustees were to have787 full powers with respect to all trust property, to the same extent as an individual owner of said property, subject only to the obligation to conduct themselves for the best interest of the trust. Any trustees' minutes granting specific powers to the trustees were to be evidence that such powers were properly granted. The trustees were given unlimited discretion, during the term of the trust, to distribute capital and income in any manner and to any persons whom they chose. Upon dissolution, the assets of the trust were to be distributed to the beneficiaries, not otherwise identified except as those then holding transferable certificates of beneficial interest in the trust. During 1977, 1978 and 1979, petitioners were owners of such certificates. Neither the trustees, the officers of the trust nor beneficial certificate holders were given any beneficial interest in the trust assets. 4. The term of the trust was stated to be 25 years, with the right of the trustees to continue the trust for an additional similar or shorter period. The trustees, however, could terminate the trust at any time and make distribution to the beneficial certificate holders. The trust res was not788 identified in the trust instrument, nor does the record herein show what property, if any, was owned by the trust in the years in issue, nor the provenance of any property as to which income was reported in the trust fiduciary returns. The trust fiduciary returns do not disclose the person or persons who performed the services which generated the "business income" which was reported by the trust in its fiduciary returns for the years in issue. Upon examination of the trust fiduciary returns and petitioners' individual returns for the years 1977 through 1979, respondent determined that the gross business income of the trust, as well as the dividend income, reported by it for all three years, and the capital gains reported by the trust for 1978, were taxable to petitioners on any one or more of the following three grounds: A. That petitioners had improperly assigned to the trust income from personal services performed by themselves; B. that the trust was without economic significance but was created in a sham transaction that should not be recognized for Federal income tax purposes; and/or C. that the powers which petitioners or either of them had under the trust instrument789 were such as to require that the trust income be taxed them under the provisions of section 671 of the Code. Respondent further determined that petitioners were liable for self-employment tax under section 1401 with respect to the gross business income reported by the trust. Respondent further denied claimed investment tax credits under section 38 for the years 1977 and 1978, and asserted additions to tax under section 6653(a) for all years. Addressing the issues in this case in the order stated above: Issue 1.The record shows that petitioners' joint return for the year 1977 was filed on April 17, 1978, and that respondent's statutory notice was issued on March 27, 1981. Such issuance was within the three year statute of limitations provided by section 6501(a), and was therefore timely. Issue 2.Respondent's determination that the trust income was taxable to petitioners was based upon three alternative and somewhat overlapping grounds, as we have set forth. The statutory notice of deficiency is presumed to be correct, even though it is stated on alternative theories, , and petitioners have the burden790 of proof to show that respondent's determinations are in error, both with respect to this issue and with respect to the other issues raised herein. ; Rule 142(a). With respect to the present issue, petitioners failed to carry their burden of proof to show that respondent was in error under any one of his three theories. 4a. Petitioners made no showing in this record that the trust actually carried on the trade or business whose income it reported. Roger introduced in evidence a document, dated in 1976, purporting to be a contract between himself and the trust, and providing that he would "contract his construction skills" to the trust. It is unclear from this document791 whether Roger was to serve as an employee or as an independent contractor under this agreement and we cannot tell whether in fact he performed any services thereunder. There is nothing in the record to show that services were performed for the trust by anyone other than one or both petitioners. b. Pertinent provisions of the trust instrument herein appear to be the same as the trust instrument which was involved in , which we found to be nothing more than a sham because, inter alia, the taxpayer/grantors had total control over the assets and operations of the trust, no one other than themselves had any economic interest in the trust, and no valid reason was shown to exist for the trust other than the desire to avoid individual income taxes. There is nothing in this record to lead us to the conclusion that respondent erred here in arriving at the same conclusion as he (and this Court) did in See also , aff'd . c.The trust instrument in this case also appears to792 be identical in its operative provisions to the trust instruments which we considered in , appeal dismissed 10th Cir. 1980, and , where we held that the trust powers retained or granted by the taxpayers to themselves rendered the trust income taxable to them under the "grantor trust" provisions of the Code (section 671-678). In the instant case, none of the trustees' minutes or trust records were put in evidence, nor anything else that would show that petitioners had anything other than unlimited power over trust corpus and income, including the right to distribute the same to themselves, nor that anyone other than they had any economic interest in the trust. The instant record establishes only that Roger was the "executive trustee" of the trust in the years in question, although there are exhibits in evidence suggesting that Joan purported also to act as a trustee during the period. Given petitioners' failure of proof in showing that there were any independent trustees, or any parties with an interest (adverse or otherwise) in the trust, other than themselves, 793 see section 672, we are unable to hold that petitioners have shown any error in respondent's determination that the trust income herein was properly taxable to them. Sections 674, 675, 677, 678. Compare , affirming a Memorandum Opinion of this Court; ;Issues 3-6.As to all the remaining issues raised by the petition herein, as listed above, there is a complete absence of any evidence in this record through which we could hold that respondent committed any error in his determinations. Roger was petitioners' only witness and his testimony was both brief and devoid of any content with respect to these issues, nor were any exhibits introduced which were material. 5794 Since we hold that petitioners have failed to sustain their burden of proof upon any issue presented herein, Decision will be entered for the respondent.for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect in the years in issue, and all rule references are to the Rules of Practice and Procedure of the Tax Court, except as otherwise noted.↩2. This issue was not raised in the statutory notice of deficiency, nor in petitioners' pleadings. At trial, however, the parties agreed that the deductibility of these expenses was fairly in issue between them, and could be considered by the Court.Pursuant to Rule 41(b), therefore, this issue will be considered as though it had been affirmatively pleaded in the petition herein.↩3. By affidavit attached to their memorandum brief herein, petitioners attempted to show that another person was also a trustee in the 1977-1979 period. Statements on brief and ex parte affidavits are not evidence in this Court. Rule 143(b).↩4. We assume, without deciding, that the trust is valid under applicable state law, as petitioners have represented. Such validity, however, even if true, is not dispositive of the questions presented. State law may determine property rights and the ownership of income, but Federal law will determine how and to whom such income is taxed. ; .↩5. At trial, Roger introduced in evidence a document which he claimed constituted an acceptance by respondent of his 1977 return as being correct. Upon this belief, Roger claims, he filed his 1978 and 1979 returns in the same fashion, and was therefore not negligent nor liable for section 6653(a) additions to tax. Inspection of the document reveals that it was nothing more than a "Notice of Action" by the United States Parole Commission of the Department of Justice, granting Roger a release from prison on parole, conditioned upon Roger filing his income tax return for 1977, which Roger did. There is no indication of acceptance of this return as correct↩ by the Department of Justice, respondent or anyone else, upon which Roger could rely.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625560/	PAN-AMERICAN LIFE INSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Pan-American Life Ins. Co. v. Commissioner (A)Docket No. 84638.United States Board of Tax Appeals38 B.T.A. 1430; 1938 BTA LEXIS 740; December 23, 1938, Promulgated 740 1. Where petitioner, a life insurance company, issued policies of combined life, health, and accident insurance, and some of the policies contained premium waiver benefits in case of total and permanent disability, and others contained both premium waiver benefits and monthly income benefits in case of total and permanent disability, it is held, that a reserve for incurred but not yet accrued disability benefits embracing both premium waiver and monthly income benefits held by petitioner at the beginning and end of the taxable year comes within the term "reserve funds required by law" as that term is used in section 203(a)(2) of the Revenue Act of 1932. 2. Where, under two types of ordinary life policies issued by petitioner, the insured either contracted or later elected to have the insurance paid to the beneficiary in installments rather than a lump sum at death, it is held, that petitioner is not entitled, under section 203(a)(8) of the Revenue Act of 1932, to deduct as interest paid on its indebtedness an amount added in the taxable year as interest to the funds held on deposit under such policies to make payments of future installments due under the terms of the741 policies. Penn Mutual Life Insurance Co. v. Commissioner, 92 Fed.(2d) 962, followed. 3. Where petitioner and the insured have entered into a trust agreement providing that at death the net proceeds of the policy are to be retained by petitioner, improved with interest at 3 1/2 percent, which interest is to be paid to the beneficiary until a designated date, at which time the principal is also to be paid to the beneficiary, it is held, that petitioner is entitled under section 203(a)(8) of the Revenue Act of 1932 to deduct the amount of interest actually paid to the beneficiary during the taxable year. Eugene J. McGivney, Esq., Solomon S. Goldman, Esq., and Edwin J. Prinz, Esq., for the petitioner. Allen T. Akin, Esq., for the respondent. BLACK 1431 This proceeding is for the redetermination of a deficiency in income tax for the taxable year 1933 in the amount of $4,245.10. The issues remaining for decision after certain concessions made by both parties are as follows: (1) Is petitioner entitled under section 203(a)(2) of the Revenue Act of 1932 to deduct from its gross income an amount equal to 3 3/4 per742 centum of the mean of its reserve for incurred but not yet accrued disability benefits held at the beginning and end of the taxable year? 2. Is petitioner entitled under section 203(a)(8) of the Revenue Act of 1932 to deduct from its gross income, as "interest paid or accrued within the taxable year on its indebtedness," the amounts, hereinafter more fully described, of $9,282.31 and $257.88, in connection with certain ordinary life policies, and trust agreements, respectively? The concessions made by petitioner consist simply of the withdrawal and abandonment of certain assignments of error relating to depreciation of furniture and fixtures and to the deductibility of 3 3/4 per centum of the mean of two reserves, namely, a reserve for supplementary contracts and a reserve for policies upon which a surrender value may be demanded. The concessions made by the respondent consist of admissions in his brief that petitioner is entitled under section 203(a)(8) of the Revenue Act of 1932 to deduct from its gross income, as "interest paid or accrued within the taxable year on its indebtedness," the amounts of $4,615.05, $160.98, and $40.28 in connection with certain trust agreements743 and installment certificates other than the policies and trust agreements referred to in issue (2) above. These concessions made by the respondent and petitioner will be given effect under Rule 50. FINDINGS OF FACT. Petitioner is a life insurance company, incorporated under the laws of the State of Louisiana, with its principal office in the city of New Orleans. Its taxable year 1933 is the calendar year 1933. More than 50 per centum of its total reserve funds held during the taxable year were held for the fulfillment of its life insurance and annuity contracts. Among the states in which it transacted business during the taxable year were Louisiana, Oklahoma, Indiana, and Illinois. During the taxable year petitioner issued life insurance policies some of which carried additional provisions relating to certain noncancelable benefits in case the insured became totally and permanently disabled by accident or disease. These noncancelable benefits, for which in each case the insured obligated himself to pay an additional 1432 premium, were of two kinds - (1) waiver of premiums by petitioner in case of total and permanent disability, and (2) both waiver of premiums744 and payment of monthly income by petitioner in case of total and permanent disability. Policies which carried additional provisions relating to waiver of premiums only, in case the insured became totally and permanently disabled, provided in part that: PAN-AMERICAN LIFE INSURANCE COMPANY * * HEREBY AGREES, that upon receipt by the Company * * * of due proof * * * that the Insured has, while said policy * * * are in full force and prior to the anniversary date of said policy nearest to the sixtieth birthday of the Insured, become totally disabled, as the result of bodily injury or disease occurring after the issuance of said policy, so as to be wholly and continuously prevented thereby from engaging in his own or any other business or occupation and from performing any work for compensation or profit * * * and that such disability has already continued uninterruptedly for a period of at least six months (such disability of such duration being deemed to be permanent only for the purpose of determining the commencement of liability hereunder), the Company during the continuance of such disability will waive the payment of each premium under said policy * * * beginning with the745 premium, the due date of which next succeeds the date of commencement of such disability, provided that no premium shall be waived the due date of which is more than one year prior to the date of receipt at the Home Office of the Company of written notice of claim hereunder. * * Notwithstanding that proof of disability may have been accepted by the Company as satisfactory, the Insured shall at any time, on demand from the Company, furnish due proof of the continuance of such disability, but after such disability shall have continued for two full years, the Company will not demand such proof more often than once in each subsequent year. Policies which carried provisions relating to both waiver of premiums and payment of monthly income in case the insured became totally and permanently disabled carry substantially the same provision as above and in addition another provision which reads as follows: 2. Pay to the insured * * * a monthly income of $10 for each $1,000 of face amount of said policy * * * such monthly income to be paid for each completed month of such continuous disability beginning with the fourth such month, provided, however, that in no case shall any monthly746 income be paid for the first three months of disability nor for any fractional part of a month of disability, nor for any period of disability more than one year prior to the date of receipt at the Home Office of the Company of written notice of claim hereunder. * * Notwithstanding that proof of disability may have been accepted by the Company as satisfactory, the Insured shall at any time, on demand from the Company, furnish due proof of the continuance of such disability, but after such disability shall have continued for two full years, the Company will not demand such proof more often than once in each subsequent year. During the taxable year petitioner maintained a reserve for unpaid and unresisted claims incurred under these disability provisions, 1433 which is referred to herein as the "Reserve for Incurred Disability Benefits", in the amounts set forth in the following table: Beginning of yearEnd of yearReserve for premium waiver benefits$93,375.27$113,674.60Reserve for monthly income benefits217,875.64265,240.76Total311,250.91378,915.36The mean of the above reserve amounts to $345,083.13, and 3 3/4 per centum thereof747 equals $12,940.62. The purpose of the reserve for incurred disability benefits is to enable petitioner to pay the benefits which have occurred but which have not yet become due. It is based upon a table which shows the rates of death and recovery from disability. The name of this table is "Hunter's Rates of Termination of Disability on Disabled Lives." The manner of setting up the reserve is to set up the present value of the probable future benefits. This is done by discounting the probable future benefits (either the waiver of premiums or both the waiver of premiums and the payment of a monthly income) at 3 1/2 per centum compound interest, and reducing that amount with the aid of Hunter's table by the probability of the insured living and still being totally and permanently disabled on the premium due date. This manner of setting up the reserve for incurred disability benefits does not differ from the manner in which reserves are set up on noncancelable health and accident insurance policies. The provisions in the policies which carried the noncancelable disability benefits involve life contingencies and differ from provisions of supplemental contracts which involve no life748 contingency. The reserve for incurred disability benefits is set up only in those policies where the insured has sustained total and permanent disability, and the waiver of premiums or both the waiver of premiums and the payment of a monthly income, depending upon the type of policy, is subject in all cases to the continuance of such disability. The amount in the reserve at the beginning and end of the taxable year is reconciled as follows: To the reserve at the beginning of the year, add the present value of probable future benefits on claims incurred during the year, less reserves released on recoveries during the year, plus compound interest at 3 1/2 per centum per annum. The recoveries occur either by the death of the person who is disabled or by his actually recovering from his disability. The reserve for incurred disability benefits held by petitioner at the beginning and end of the taxable year was required by the laws of the States of Oklahoma (secs. 10501 and 10502, Oklahoma Statutes, 1434 1931; title 36, secs. 184 and 185, Oklahoma Statutes Annotated) and Illinois (sec. 10, Acts of 1869 as amended in 1907 and 1919; ch. 73, sec. 331, Illinois Revised Statutes, 749 1935; ch. 73, sec. 221, Smith-Hurd Illinois Annotated Statutes; repealed by Act of 1937, June 29, Laws 1937, p. 696, sec. 453, effective July 1, 1937), two of the states in which petitioner transacted business during the taxable year. The source of the reserve was premium payments and income from the investments thereof. Facts relating to interest question. - (We omit from these findings that part of the stipulation which relates to interest deductions which respondent has conceded in his brief.) Petitioner held deposits under the following forms of supplementary contracts, trust agreements, and installment certificates: Ordinary life monthly income policies in which the policy provides for a lump sum payment at death and for a series of 240 monthly installments; and ordinary life policies, providing for installment settlements selected by the insured, payable over a period of from five to twenty-five years. Petitioner held deposits under both types of policies above mentioned, with respect to which it was stipulated: That the funds held on deposit under such policies on the first day of 1933 was $270,164.83 and that $6,575.56 entered the fund in 1933 and that750 petitioner added interest of $9,282.31 to the said fund in 1933, which interest was computed at 3 1/2% per annum, making the total fund $286,022.70, and paid out of said fund $27,353.31, leaving $258,669.39 in the fund on the last day of 1933 as shown by schedule annexed hereto and made a part hereof and marked Exhibit "G". It was also stipulated that petitioner held deposits under certain trust agreements as follows: * * * (c) Trust Agreements, entered into by the Insured, for the deposit of the proceeds of the policy with petitioner, in which petitioner agrees that the said net proceeds shall bear interest at the rate of 3 1/2% per annum on funds remaining in the Company's possession at the end of each year, under which Agreements the interest was payable to the Beneficiary until a designated date and then the principal sum is payable to the Beneficiary. That form of such Trust Agreement is attached hereto and made a part hereof and marked Exhibit "J." That the fund held on deposit under such Trust Agreements on the first day of 1933 was $14,856.57 and that $12,405.03 entered the fund in 1933 and that petitioner added interest of $257.88 to the said fund in 1933, which751 interest was computed at 3 1/2%, making a total of $27,519.48 and paid out of said fund $202.90, leaving $27,316.58 in the fund on the last day of 1933 as shown by schedule attached hereto and made a part hereof and marked Exhibit "K". * * The exhibits referred to in the stipulation are not copied in these findings of fact, but are incorporated herein by reference. 1435 OPINION. BLACK: The first question for decision is whether petitioner is entitled to deduct from its gross income an amount equal to 3 3/4 per centum of the mean of its reserve for incurred disability benefits held at the beginning and end of the taxable year. The applicable statute is the Revenue Act of 1932, the material provisions of which are set out in the margin. 1752 Petitioner is a "life insurance company" as that term is defined in section 201(a). The policies with respect to which the reserve in question was held were "contracts of combined life, health, and accident insurance." Under all of these policies the insured agreed to pay a certain annual premium in consideration for petitioner agreeing to pay the insured's beneficiary a sum certain upon receipt of due proofs of death of the insured. In some of the policies the insured agreed to pay a small additional premium in consideration for petitioner agreeing to waive the future payment of premiums in case the insured became totally and permanently disabled as the result of bodily injury or disease; and in some of the policies the insured agreed to pay a larger additional premium in consideration for petitioner agreeing not only to waive the future payment of premiums as they became due, but also to pay the insured a stated monthly income in case the insured became totally and permanently disabled as the result of bodily injury or disease. To meet its future unaccrued and contingent obligations under these combined life, health, and accident policies, petitioner set up and held at the beginning753 and end of the taxable year several reserve funds. Its largest reserve was a reserve to meet the purely death claims as and when they matured. This reserve is a part of the reserve for outstanding policies and annuities, reported on line 1, schedule A, of petitioner's income tax return. Another reserve was a reserve to meet its future unaccrued and contingent obligation to waive premiums or to waive 1436 premiums and to pay a monthly income, depending upon the type of policy, in cases of total and permanent disability where the insured had not yet become disabled. This reserve is a part of the reserve for disability and accidental death benefits, reported on line 2 of schedule A of petitioner's return. The statutory per centum of the mean of the two last mentioned reserves was deducted by petitioner and allowed by respondent as "reserve funds required by law", and those reserves are not involved in this proceeding. They constitute the larger part of petitioner's reserves "required by law." Another reserve reported by petitioner on line 3 of schedule A of petitioner's return was for supplementary contracts. This reserve petitioner concedes is a solvency reserve and that754 petitioner is entitled to no deduction by reason thereof. The fourth reserve, which is the one here involved, was set up by petitioner and held to meet its future unaccrued and contingent obligation to waive premiums or to waive premiums and to pay a monthly income, depending upon the type of policy, in cases of total and permanent disability where the insured had already become disabled. This reserve is the reserve for incurred disability benefits, reported by petitioner on line 4 of schedule A in the amounts of $311,250.91 and $378,915.36, respectively, and is subdivided according to the benefits reserved for, as follows: Beginning of yearEnd of yearReserve for premium waiver benefits$93,375.27$113.674.60Reserve for monthly income benefits217,875.64265,240.76Total311,250.91378,915.36This reserve for incurred disability benefits did not include any amount for benefits which had already accrued in favor of the disabled insured. Such latter amounts would represent pure liabilities of petitioner and the reserve set up therefor would be in the nature of a solvency reserve and not a reserve "required by law" as that term is used in755 section 203(a)(2) of the Revenue Act of 1932. Cf. Maryland Casualty Co. v. United States,251 U.S. 342">251 U.S. 342, as modified by United States v. Boston Insurance Co.,269 U.S. 197">269 U.S. 197. It included only amounts held for the payment of benefits which would become due in the future, providing the insured survived and remained disabled. At the time petitioner filed its income tax return for the year 1933 the respondent's regulations (art. 971, Regulations 77) held that the type of reserve here involved was a reserve required by law. The pertinent 1437 provisions of these regulations are set out in the margin. 2 Substantially the same provisions were contained in all of the regulations issued under all of the revenue acts beginning with the Revenue Act of 1921. See article 681 of Regulations 62, 65, and 69, and article 971 of Regulations 74. "Items 7-11 of the liability page of the annual statement" referred to in the regulations are also set out in the margin. 3 These items correspond with lines 1 to 5, respectively, of "Schedule A - Reserve Funds" contained in the blank income tax return for life insurance companies, form 1120 L. Item 10756 of the liability page of the annual statement is the item petitioner relied upon at the time it filed its return as authority for deducting 3 3/4 per centum of the mean of the reserve for incurred disability benefits held at the beginning and end of the taxable year. 757 Shortly after the Court of Claims handed down its decision in Continental Assurance Co. v. United States,8 Fed.Supp. 474, the respondent issued Regulations 86 under the Revenue Act of 1934. Although section 203(a)(2) of the Revenue Act of 1934, so far as material here, was the same as similar provisions in all the prior revenue acts beginning with the Revenue Act of 1921, the respondent in article 203(a)(2)-1 of Regulations 86 omitted all reference to items 7-11 of the liability page of the annual statement for life insurance companies and held, among other things, that the reserve funds required 1438 by law did not include "estimated value of future premiums which have been waived on policies after proof of total and permanent disability." Thereafter, the Supreme Court handed down its decision in Helvering v. Inter-Mountain Life Insurance Co.,294 U.S. 686">294 U.S. 686, in which it cited with approval Continental Assurance Co. v. United States, supra.The respondent then issued Treasury Decision 4615. (Cumulative Internal Revenue Bulletin XIV - 2, p. 310), in which he amended article 681 of Regulations 62, 65, and 69, 758 and article 971 of Regulations 74 and 77, to read the same, so far as material here, as article 203(a)(2)-1 of Regulations 86, supra. Since then the Supreme Court has decided Helvering v. Illinois Life Insurance Co.,299 U.S. 88">299 U.S. 88. The respondent, in support of his contention that the term "reserve funds required by law" in section 203(a)(2), supra, does not include the reserve for incurred disability benefits here in question, relies upon his regulations as amended by T.D. 4615, supra, and the decisions of New York Life Insurance Co. v. Edwards,271 U.S. 109">271 U.S. 109 (point 3), Helvering v. Inter-Mountain Life Insurance Co., supra, and Helvering v. Illinois Life Insurance Co., supra.Although not a conclusive test, it is, nevertheless, a prerequisite to the allowance of any deduction under section 203(a)(2), supra, that the reserve in question be required, as expressed by the respondent in his regulations, either by "express statutory provisions or by the rules and regulations of the State insurance departments when promulgated in the exercise of a power conferred by statute. 759 " Cf. McCoach v. Insurance Co. of North America,244 U.S. 585">244 U.S. 585; Maryland Casualty Co. v. United States, supra;United States v. Boston Insurance Co., supra;New York Life Insurance Co. v. Edwards, supra;Helvering v. Inter-Mountain Life Insurance Co., supra; and Helvering v. Illinois Life Insurance Co., supra.And the respondent concedes in his regulations that a company is permitted to make use of the highest aggregate reserve called for by any state in which it transacts business. Petitioner transacted business in Louisiana, Oklahoma, Indiana, and Illinois. As stated in our findings of fact, the reserve in question was required by the laws of Oklahoma, cf. In re Oklahoma National Life Insurance Co.,68 Okla. 219">68 Okla. 219; 173 Pac. 376, and until July 1, 1937, by the laws of Illinois. The petitioner having met successfully the prerequisite stated in the preceding paragraph, the question at issue, at least as far as premium waiver benefits are concerned, is identically the same as the issue relating to the reserve for incurred disability760 benefits in the recent case of Monarch Life Insurance Co.,38 B.T.A. 716">38 B.T.A. 716. In that case we held that the reserve for incurred disability benefits (apparently involving premium waiver benefits only) was a reserve fund 1439 required by law and that the petitioner there was entitled to deduct from its gross income an amount equal to 3 3/4 per centum of the mean of such a reserve fund held at the beginning and end of the taxable year. It follows that, at least as far as premium waiver benefits are concerned, the instant proceeding is controlled by our holding in Monarch Life Insurance Co., supra. Cf. Equitable Life Assurance Society of the United States (reserve for unpaid and unresisted accident and health claims), 33 B.T.A. 708">33 B.T.A. 708, 711. Regarding that portion of the reserve for incurred disability benefits involving monthly income benefits, we know of no reason why it should be treated any differently from that portion of the reserve involving premium waiver benefits. The policies involving both kinds of benefits are substantially the same, except that in those involving both premium waiver and monthly income benefits the insured761 agrees to pay a larger additional premium than the insured pays in those policies involving premium waiver benefits only. We hold that both portions of the reserve for incurred disability benefits involved herein should be treated alike and that petitioner is entitled to deduct from its gross income the amount of $12,940.62 set out in our findings as representing 3 3/4 per centum of the mean of the reserve for incurred disability benefits held at the beginning and end of the taxable year. Before passing this question, however, we wish to say that we have carefully considered the respondent's contentions and find ourselves unable to concur in the belief that the effect of the holdings in the New York Life case, the Inter-Mountain Life case and the IllinoisLife case is to exclude the present reserve from the classification of "reserve funds required by law" as that phrase is used in section 203(a)(2) of the Revenue Act of 1932. In the New York Life case, supra, the Supreme Court was not satisfied from the evidence that the reserve there involved in point (3) was required by the laws of New York. Neither was there anything to show how the value of the contractual762 benefits under the policies was arrived at. Under those circumstances the Court said: "The company has not shown enough to establish its right to the exemption." The proof lacking in the New York Life case has been supplied in the instant proceeding. The reserve funds involved in the other two cases were in the nature of solvency reserves and were essentially different from the one which we are now considering. For instance, the reserve in the Inter-Mountain case, supra, was against matured, unsurrendered, unpaid coupons, and was not essentially an insurance reserve. Inter-Mountain's liability thereon depended upon no contingency. The insured there at any time could have withdrawn the matured coupons 1440 in cash. Likewise, in the IllinoisLife case, supra, the reserve for survivorship investment funds was not a reserve set aside to mature or liquidate any future unaccrued and contingent claims. IllinoisLife was bound at the end of 20 years to discharge a definite liability consisting of the total contributions to the fund plus the interest it had agreed to pay. The reserve set up to meet this definite liability was in substance nothing more than763 a solvency reserve. Neither do we think the Supreme Court in the Inter-Mountain and IllinoisLife cases intended to construe the phrase "reserve funds required by law" to mean only the reserve funds relating to life insurance. It seems to us that the structure of the act requires a recognition of other reserves. Sec. 201(a), supra, defines the term "life insurance company" as one "engaged in the business of issuing life insurance and annuity contracts (including contracts of combined life, health, and accident insurance), the reserve funds of which held for the fulfillment of such contracts comprise more than 50 per centum of its total reserve funds." In this definition there can be no doubt but that Congress intended the term "reserve funds" to apply to "contracts of combined life, health, and accident insurance" as well as to "life insurance and annuity contracts." Therefore, it would seem to follow that the term "reserve funds" in section 203(a)(2) would also apply to "contracts of combined life, health, and accident insurance," which is the type of policies involved in the instant proceeding. Any other construction of the act would be inconsistent with the764 respondent's allowance of the statutory per centum of the mean of the reserve for disability and accidental death benefits reported on line 2 of schedule A of the return and briefly referred to at the beginning of this opinion. The only difference between that reserve and the one for incurred disability benefits is that in the latter the disability has already taken place. But the insured must survive and remain disabled on each and every anniversary date of the policy before any actual liability accrues against petitioner. Interest question. - As we have already stated, respondent in his brief concedes that petitioner is entitled to deduct the interest items covered by paragraphs (b), (d), and (e) of the stipulation. He contests the deduction of those included in paragraphs (a) and (c) of the stipulation. These latter have been described in our findings of fact. The second question, therefore, for decision falls into two subdivisions - (1) whether petitioner is entitled to deduct $9,282.31 as interest in connection with two types of its ordinary life policies, and (2) whether petitioner is entitled to deduct $257.88 as interest in connection with the type of trust agreements765 referred to in our 1441 findings of fact. The applicable statute is the Revenue Act of 1932, the material provisions of which are set out in the margin. 4 We shall first consider the deductibility of the so-called interest in connection with the two types of petitioner's ordinary life policies. The first type of policy provides for a lump sum payment at death and for a series of 240 monthly installments. A copy of one of these policies is attached to the stipulation. It provides for a lump sum payment of $500 at death and for a series of 240 monthly installments of $50 each, aggregating in all $12,500. The commuted value of this policy is $9,200. The policy contains a provision that at any time before his death the insured may elect to have the commuted value paid at his death in one sum rather than a first payment of $500 followed by a series of 240 monthly installments of $50 each. But766 if no such election is made by the insured, the beneficiary can neither assign nor commute the installments therein provided for. The second type of policy simply provides for one lump sum payment at death unless the insured during his life time shall elect to have the insurance paid to the beneficiary in any one of the equal annual installments from five to twenty-five years provided for in that paragraph of the policy headed "Installment Benefits - Installment Settlements." A copy of one of these policies is also attached to the stipulation. It provides for a lump sum payment at death of $5,000, or for either 5, 10, 15, 20, or 25 equal annual installments, providing the insured so elected during his lifetime. In all of the policies of the second type that are here involved the insured had so elected. Assuming that in the case of the sample policy of this type referred to above the insured had elected to have the insurance paid in 20 equal annual installments, the beneficiary of this policy would receive 20 equal annual installments of $339.90 (5 times $67.98) aggregating in all $6,798, instead of the lump sum of $5,000 payable at death which was originally provided for. As767 in the first type of policy, if the insured in the second type of policy died after electing to have the insurance paid in equal annual installments, the beneficiary could not thereafter either assign or commute the installments therein provided for. Petitioner contends that in the first type of policy the difference between the commuted value of $9,200 and the aggregate payments 1442 of $12,500, or $3,300, and in the second type of policy the difference between the commuted value of $5,000 and the aggregate payments of $6,798 or $1,798, represents interest on its indebtedness which it is entitled to deduct as and when it is paid to the beneficiary. As soon as a policy of either type becomes a death claim, petitioner deposits the commuted value of that policy in a separate fund, which fund on a gradually declining basis is improved with interest at the rate of 3 1/2 per centum per annum so that the commuted value plus the interest will exactly equal the aggregate installments paid to the beneficiary. At the beginning of the taxable year petitioner had on deposit $270,164.83 in connection with about 43 policies embracing both types here under discussion. During the year768 the fund was increased by $6,575.56, due to the death of one of petitioner's policyholders of the first type. Also during the year the fund deposited in connection with the 44 policies was improved with interest in the amount of $9,282.31 and during the year there was paid to beneficiaries a total amount of $27,353.31. It is the $9,282.31 which petitioner contends it is entitled to deduct as interest paid on its indebtedness. It bases this contention partly upon the ground that the only reserve fund for which it has received a deduction under section 203(a)(2) (see footnote No. 1, supra ) is a reserve fund (included in the reserve for outstanding policies and annuities) set up to meet only the commuted value of the policies in question upon the death of the insured. At the time petitioner filed its return it also claimed a deduction under section 203(a)(2) for the statutory percentage of the mean of a reserve for supplementary contracts, reported on line 3 of schedule A of petitioner's return. Included in this reserve were amounts set up to meet the difference between the commuted value and the aggregate payments to be made under the two types of ordinary life policies now769 under discussion. This deduction was disallowed by the respondent upon the ground that the reserve for supplementary contracts did not come within the term "reserve funds required by law" as that term is used in section 203(a)(2). This action on the part of the respondent was originally assigned as error by the petitioner, with an assignment of error in the alternative "that if it is not entitled to a deduction of 3 3/4 percent of the mean of reserve funds on Supplementary Contracts * * * it should be allowed to deduct all interest paid, credited or accrued on the said reserve funds under Sec. 203(a)(8) of the Revenue Act of 1932." At the hearing petitioner withdrew and abandoned its main assignment of error as to the reserve funds on supplementary contracts and relied solely on its alternative assignment of error that it was entitled to a deduction for alleged interest in the above amount of $9,282.31, upon the authority of Great Southern Life Insurance Co.,33 B.T.A. 512">33 B.T.A. 512, issue (b) 1443 (1); affirmed upon other issues, 770 89 Fed.(2d) 54; certiorari denied, 302 U.S. 698">302 U.S. 698. The question here under consideration, we think, is not the same as that we decided in Great Southern Life Insurance Co., supra.The issue referred to by petitioner is issue (b)(1) in the latter case, wherein the taxpayer claimed a deduction from its gross income of the amount disbursed by it as interest on coupons which were theretofore left to accumulate with the company at interest and were surrendered during the taxable year and principal and interest were paid thereon. We held that under such circumstances the interest was deductible. We cited a regulation of the Commissioner which specifically covered the subject and allowed the deduction of interest paid under such circumstances. But we have not that issue in the instant case. One that would be somewhat comparable to it is where the insured dies and the beneficiary voluntarily leaves the proceeds of the policy on deposit with the insurance company and it agrees to pay interest thereon. We held in 771 Penn Mutual Life Insurance Co.,32 B.T.A. 839">32 B.T.A. 839, that in such a case the insurance company is entitled to deduct the guaranteed rate of interest which is paid to the beneficiaries. That sort of interest the Commissioner concedes is deductible. The exact issue now before us was decided unfavorably to the instant petitioner's contentions in Penn Mutual Life Insurance Co., supra (assignment of error No. (1), syllabus No. 2). Our decision in Penn Mutual was affirmed as to all contracts made or options exercised for installment settlements prior to the death of the insured, but was remanded as to all options for installment settlements exercised by the beneficiary after the death of the insured. Penn Mutual Life Insurance Co. v. Commissioner, 92 Fed.(2d) 962, 967, 968. All the contracts or options for installment settlements involved in the two types of ordinary life policies now under consideration were all made or exercised by the insured prior to the death of the insured, and are, therefore, ruled by that part of the Third Circuit's decision wherein it concluded, p. 968: We hold, therefore, that the portion of the respective sums772 of $211,254.60 and $238,640.01, which in fact represents the 3 percent. annual interest included in the installment settlements paid to beneficiaries by the petitioner under the Trust Certificate policy or under an option of the Ordinary Life policy exercised prior to the death of the insured, is not interest on indebtedness within the terms of the statute and cannot be deducted by the petitioner from its gross income. We sustain the ruling of the Board in so far as it relates to such payments. Counsel for petitioner in his briefs recognizes that the decision in Penn Mutual is contrary to the petitioner's contention in the instant proceeding, but contends that the Board and the Circuit Court misapprehended the facts in that case and that the issue there should be distinguished from the issue here. We have considered this contention 1444 of petitioner, but think we should abide by our previous decision as affirmed by the Third Circuit. We hold, therefore, that petitioner is not entitled under section 203(a)(8) of the Revenue Act of 1932 to deduct from its gross income as "interest paid or accrued within the taxable year on its indebtedness" the amount of $9,282.31773 which it added during the taxable year to its deposits held under both types of ordinary life policies here involved. Penn Mutual Life Insurance Co. v. Commissioner, supra. Cf. Penn Mutual Life Insurance Co.,32 B.T.A. 876">32 B.T.A. 876 (part I). Regarding the deductibility of $257.88 as interest in connection with the type of trust agreement attached to the stipulation as exhibit "J", the respondent contends that under Massachusetts Mutual Life Insurance Co. v. United States,288 U.S. 269">288 U.S. 269, no more interest may be allowed as a deduction to a life insurance company than that actually paid during the taxable year; and that in any event no amount is allowable as interest for the reason that petitioner has failed to show that no part of the amount of $257.88 is actually and in fact dividends under that part of the specimen trust agreement reading: * * * and after the first interest year there shall also be added as additional interest thereon each year thereafter, such amount as may be determined by the Directors of the Pan-American Life Insurance Company and apportioned annually from the surplus earnings of the said Company for the preceding774 year. The respondent, however, in effect concedes that if it were not for the above quoted provision of the trust agreement, any interest actually paid under the trust agreements of this type would be deductible under our decision in Great Southern Life Insurance Co., supra.In making the contention relative to the above quoted provision of the trust agreement, we think the respondent has overlooked that part of the trust agreement immediately preceding the above quoted provision which provides that: "The said net proceeds shall bear interest at the rate of 3 1/2% per annum on funds remaining in the Company's possession at the end of each year" and also that part of the stipulation which provides that the amount of $257.88 was computed at 3 1/2 per centum. Whatever effect, if any, the above quoted provision relied upon by the respondent might have in another taxable year, we are satisfied from the record before us that it has no effect whatever in the present taxable year. Since the entire amount of $257.88 in question was computed at 3 1/2 per centum it is clear that this amount did not contain any so-called "additional interest" to be determined by petitioner's775 directors and to be apportioned from petitioner's surplus earnings for the preceding year. It is, therefore, our opinion that petitioner is entitled to deduct as interest that part 1445 of the $257.88 that was actually paid out during the taxable year. The stipulation says that the amount paid out was $202.90. Massachusetts Mutual Life Insurance Co. v. United States, supra;Great Southern Life Insurance Co., supra.We, therefore, hold that in connection with the type of trust agreement attached to the stipulation as exhibit "J" petitioner is entitled under section 203(a)(8) of the Revenue Act of 1932 to deduct $202.90 as interest paid during the taxable year on its indebtedness. Cf. Edith M. Kinnear,20 B.T.A. 718">20 B.T.A. 718. The deficiency should be redetermined in accordance with this report. Decision will be entered under Rule 50.Footnotes1. SEC. 201. TAX ON LIFE INSURANCE COMPANIES. (a) DEFINITION. - When used in this title the term "life insurance company" means an insurance company engaged in the business of issuing life insurance and annuity contracts (including contracts of combined life, health, and accident insurance), the reserve funds of which held for the fulfillment of such contracts comprise more than 50 per centum of its total reserve funds. * * SEC. 203. NET INCOME OF LIFE INSURANCE COMPANIES. (a) GENERAL RULE. - In the case of a life insurance company the term "net income" means the gross income less - * * * (2) RESERVE FUNDS. - An amount equal to 4 per centum of the mean of the reserve funds required by law and held at the beginning and end of the taxable year, except that in the case of any such reserve fund which is computed at a lower interest assumption rate, the rate of 3 3/4 per centum shall be substituted for 4 per centum. * * * ↩2. ART. 971. Tax-exempt interest and reserve funds. - Under paragraphs (1) and (2) of section 203(a), life insurance companies are entitled to deduct from gross income: * * * (2) Four per cent of the mean of the reserve funds required by law and held at the beginning and end of the taxable year, except that in the case of any such reserve fund which is computed at a lower interest assumption rate, the rate of 3 3/4 per cent shall be substituted for 4 per cent. The reserve deduction is based upon the reserves required by express statutory provisions or by the rules and regulations of the State insurance departments when promulgated in the exercise of a power conferred by statute; but such reserves do not include assets required to be held for the ordinary running expenses of the business nor do they include the reserve or net value of risks reinsured in other solvent companies to the extent of the reinsurance. * * * * * * A company is permitted to make use of the highest aggregate reserve called for by any State in which it transacts business, but the reserve must have been actually held as shown by the annual statement. Generally speaking, the following will be considered reserves as contemplated by the law: Items 7-11 of the liability page of the annual statement for life insurance companies * * . ↩3. 7. Net Reserve (i.e. the net present value of all the outstanding policies in force on the 31st day of December, 19 , as computed by the on the following tables of mortality and rates of interest) $ 8. Extra reserve for total and permanent disability benefits, $ , and for additional accidental death benefits, $ , included in life policies $ 9. Present value of amounts not yet due on supplementary contracts not↩ involving life contingencies computed by the $10. Present value of amounts incurred but not yet due for total and permanent disability benefits $11. Liability on policies canceled and not included in "net reserve" upon which a surrender value may be demanded $4. SEC. 203. NET INCOME OF LIFE INSURANCE COMPANIES. (a) GENERAL RULE. - In the case of a life insurance company the term "net income" means the gross income less - * * (8) INTEREST. - All interest paid or accrued within the taxable year on its indebtedness * * *. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477224/	OPINION. Rige, Judge: The tax consequences of this transaction, or series of transactions, depend upon whether they are characterized as a sale or as a “reorganization.” Petitioners contend that we must regard the sequence of events as initially comprising two completely independent transactions. The first would be the sale of their stock in Jack & Heintz, Inc., for cash plus securities of the purchasing corporation, a transaction fully taxable at capital gains rates.. The second transaction, in petitioners’ view, was the statutory merger of Precision’s 1-day-old operating subsidiary, Jack & Heintz, Inc., into itself. Petitioners argue that although this merger may satisfy the formal requirements of section 112 (g) (1) (A) 3 for a reorganization, it is to be considered as separate and distinct from the exchange of the previous day and does not affect the capital gains treatment of that exchange. Respondent’s position is that the agreement to sell executed on March 4, the sale on March 5, and the merger on March 6 were all parts of a single unitary transaction, a plan of reorganization under section 112 (b) (3) ,4 and that the cash received by petitioners constitutes “boot” taxable as ordinary income under section 112 (c).5 After careful consideration of the record herein, we are convinced that petitioners’ exchange of their stock in Jack & Heintz, Inc., on March 5,. 1946, for cash plus preferred stock of Precision constituted a sale of such stock and was not an exchange executed “pursuant to a plan of reorganization.” The cash received by petitioners constituted consideration for their stock and, therefore, could not have the effect of the distribution of a taxable dividend. The basic facts herein are that petitioners, after unsuccessfully attempting to sell their stock in Jack & Heintz, Inc., in an all cash deal, finally settled for approximately $5,000,000 in cash plus 60,000 shares of preferred stock in the corporation which was organized by the purchasing group to make the purchase. Essential to this arrangement was the promise made to petitioners by members of the purchasing group that the preferred stock being paid to petitioners as part of the consideration would shortly thereafter be sold on their behalf together with a public offering of the purchasing corporation’s own preferred stock. Pursuant to the plan conceived by the purchasing group, petitioners caused their corporation to amend its profit-sharing plan and had its board of directors give its approval to the purchasing group’s plan to merge Jack & Heintz, Inc., into Precision. On the day following the exchange of petitioners’ stock in Jack & Heintz, Inc., for cash plus stock in Precision, the former company was merged into the latter. Then, according to the original plan, still another corporation was merged into Precision. This was followed by a public offering of Precision’s common stock through which Precision obtained $8,525,000 of additional capital. However, due to the underwriter’s insistence that the market for preferred stock was too weak at that time, the promoters of Precision were unable to fulfill their oral promise to petitioners that petitioners’ preferred shares in Precision would he included at public offering. Private sales were, therefore, arranged by the promoters of Precision and, on August 30, 1946, petitioners sold all their preferred shares in Precision, except the 10,000 then held in escrow. We think it clear that petitioners did not dispose of their stock in Jack & Heintz, Inc., pursuant to a “plan of reorganization.” The term “reorganization,” as used in section 112, contemplates a readjustment of the corporate structure of an enterprise, and requires that those individuals who are the owners of the enterprise prior to such readjustment continue to maintain a substantial proprietary interest therein. Roebling v. Commissioner, 143 F. 2d 810 (C. A. 3, 1944), affirming a Memorandum Opinion of this Court, entered June 30,1943, certiorari denied 323 U. S. 773 (1944); Southwest Natural Gas Co., 14 T. C. 81 (1950), affd. 189 F. 2d 332 (C. A. 5,1951), certiorari denied 342 U. S. 860 (1951). Kegs. 111, sec. 29.112 (g)-1.6 The terms of the instant plan did not contemplate the petitioners’ maintenance of a proprietary interest in the continuing corporation. The record convinces us that petitioners wished to dispose of their entire interest in Jack & Heintz, Inc. When they were unable to obtain “an all cash deal,” they settled for cash plus preferred stock in the purchasing corporation, but only after obtaining the promise of the promoters of such purchasing corporation that their preferred stock in that corporation would be sold together with a public offering of that corporation’s stock within 30 days. Due to various unforeseen difficulties, the public offering was delayed and, when finally made, the underwriters prevented the sale of petitioners’ stock at that time. However, within a month, private sales were arranged by the purchasing group on petitioners’ behalf and petitioners disposed of all but the 10,000 shares then held in escrow. This was no mere readjustment of corporate structure. The old proprietors were stepping out; they were being paid in cash plus the preferred stock of the purchasing corporation; and most important, the preferred stock which they received was to be held only temporarily until its sale was arranged for by the purchasing group. It is true that petitioners were, according to the terms of sale, required to help effectuate the merger. Thus, they caused Jack & Heintz, Inc., to amend its profit-sharing plan and to approve the merger before the March 5 exchange; they were also required to subsequently vote for the merger of Eisemann into Precision. But these are only conditions of sale imposed by the purchasers upon the sellers and do not change the essential nature of the transaction which was one of “sale” rather than “reorganization.” It does not help us to characterize the March 5 transaction as an “exchange” rather than as a sale for, in a technical sense, every sale may be referred to as an exchange. The essential element which must be shown if this transaction is to be termed a statutory reorganization is that the exchange took place “pursuant to a plan of reorganization” as that phrase is used in section 112 (b) (3), and, as we have stated above, this element is lacking herein. The parties themselves, in their various printed agreements, characterized the March 5 transaction as a sale; and we think this is of some help in establishing their intent to divest themselves of their proprietary interest in Jack & Heintz, Inc., and the continuing corporation. The principal objective of the parties was the purchase and sale of Jack & Heintz, Inc. What the purchasing group did with that corporation subsequently was not important to petitioners. Petitioners were not particularly concerned whether the purchasing group held Jack & Heintz, Inc., as an operating subsidiary or merged it into itself. Having disposed of their stock in Jack & Heintz, Inc., by sale, petitioners are entitled to capital gains treatment on the profits thus realized. Decisions will be entered under Rule 50. SEC. 112. RECOGNITION OF GAIN OR LOSS. (g) Definition of Reorganization. — As used In this section (other than subsection (b) (10) and subsection (1)) and in section 113 (other than subsection (a) (22))— (1) The term “reorganization” means (A) a statutory merger or consolidation. * * * SEC. 112. RECOGNITION OF GAIN OR LOSS. (b) Exchanges Solely in Kind.— *»»♦* (3) Stock foe stock on reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. SEC. 112. RECOGNITION OF GAIN OR LOSS. (c) Gain From Exchanges Not Solely in Kind.— (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5), or within the provisions of subsection (1), of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph or by subsection (1) to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money andi the fair market value of such other property. (2) If a distribution made in pursuance of a plan of reorganization is within the provisions of paragraph (1)- of this subsection but has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be taxed as a gain from the exchange of property. Regulations 111. Seo. 29.112 (g)-l. Purpose and Scope op Exception of Reorganization Exchanges.— Purpose: » * * The purpose of the reorganization provisions of the Internal Revenue Code is to except from the general rule certain specifically described exchanges incident to such readjustments of corporate structures, made in one of the particular ways specified in the Code, as are required by business exigencies, and which effect only a readjustment of continuing interests in property under modified corporate forms. Requisite to a reorganization under the Code are a continuity of the business enterprise under the modified corporate form, and a continuity of interest therein on the part of those persons who were the owners of the enterprise prior to the reorganization. * * *	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625561/	ANDREW B. C. DOHRMANN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Dohrmann v. CommissionerDocket No. 23969.United States Board of Tax Appeals19 B.T.A. 466; 1930 BTA LEXIS 2399; March 31, 1930, Promulgated 2399 Under authority of decision by the Supreme Court in Lucas v. Earl,281 U.S. 111">281 U.S. 111, held that the wife correctly returned her own salary. Ralph W. Smith, Esq., and Homer Tooley, Esq., for the petitioner. Eugene Meacham, Esq., for the respondent. LOVE 466 This proceeding is for the redetermination of deficiencies in income tax for the years 1922 and 1923, in the amounts of $1,176.52 and $3,838.23, respectively. The only error assigned is that the respondent erroneously included in petitioner's taxable income for each of the years 1922 and 1923, the amount of $9,000 received each year by petitioner's wife as salary from the A.B.C. Dohrmann Co. and reported by her as her separate income. FINDINGS OF FACT. The petitioner is an individual with his office at 135 Stockton Street, San Francisco, Calif.During each of the years 1922 and 1923, the petitioner's wife received as salary from the A.B.C. Dohrmann Co. the amount of $9,000 which she reported as income in her separate income-tax returns for those years. During the years 1922 and 1923 the petitioner and his wife had an oral understanding to the effect that2400 the salary she received belonged absolutely to her as her own separate property. The respondent included in petitioner's income for each of the years 1922 and 1923, respectively, the amount of $9,000 received by his wife. OPINION. LOVE: The petitioner contends that his wife's earnings for the years 1922 and 1923 belonged to her as her separate property and were correctly returned by her in the first instance. The respondent contends that under the laws of the State of California such earnings become community property and, under , should be taxed to the husband. It may be well to note that under the laws of the State of California, a wife is competent to contract with her husband. This is not true in some of 467 the States. In , the court said, inter alia:In the absence of a valid agreement to the contrary, it is conceded the earnings of either spouse become community property. As presented by the pleadings, as well as by contentions of both parties at the hearing, the issues raised were: First, an issue of fact as to whether or not there was*2401 an agreement, a contract, between the husband and wife that her salary should be her separate income and not community income under the laws of the State of California. Second, an issue of law as to whether or not, regardless of the issue of fact as to whether there was such a contract, the income was, under the laws of the State of California, community income, and as such, made returnable by the husband under the decision in the case of Since the hearing in the instant case, the Supreme Court has handed down its opinion and decision in the case of . In view of the holdings of the court in the Earl case, it is unnecessary for us to decide either of the issues presented in this case. Under the Earl case, we hold that the salary in question was correctly returned by the wife who earned it. Reviewed by the Board. Judgment will be entered under Rule 50.MURDOCK dissents.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625564/	JAMES B. and DOROTHY B. HODGES, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Hodges v. CommissionerDocket Nos. 24835-85, 25210-85, 13148-86, 20740-86, 21253-86, 22618-86, 43317-86, 16622-87, 20215-87, 32627-87, 39041-87, 5602-88, 14473-88, 25636-88United States Tax CourtT.C. Memo 1992-370; 1992 Tax Ct. Memo LEXIS 394; 63 T.C.M. (CCH) 3198; June 29, 1992, Filed 394 Decisions will be entered under Rule 155 in the following cases: docket No. 24835-85; docket Nos. 25210-85 and 14473-88; docket No. 20740-86; docket No. 21253-86; docket No. 22618-86; docket No. 16622-87; docket Nos. 20215-87 and 25636-88; docket No. 5602-88, and docket No. 13148-86. Orders will be issued restoring the following cases to the general docket for disposition of remaining issues: docket No. 43317-86; and docket Nos. 32627-87 and 39041-87. Jack Elon Hildreth, Jr., for petitioners in docket Nos. 24835-85, 25210-85, and 14473-88. Steven L. Staker, for petitioners in docket Nos. 13148-86, 20740-86, 21253-86, 22618-86, 43317-86, 16622-87, 20215-87, 32627-87, 39041-87, 5602-88, and 25636-88. Sherri L. Feuer, for respondent. DAWSONDAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: These cases were assigned to Special Trial Judge James M. Gussis pursuant to the provisions of section 7443A(b)(4) and Rules 180, 181, and 183. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. The Court agrees with and adopts the opinion395 of the Special Trial Judge, which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE GUSSIS, Special Trial Judge: Respondent determined deficiencies, increased interest, and additions to tax in these cases as follows: James B. and Dorothy B. HodgesDocket No. 24835-85Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6651(a)(1)6653(a)(1)6653(a)(2)1981$ 28,135.00applicable$ 1,263.05$ 2,400.8050% of theinterest dueon $ 28,135.00In docket No. 24835-85 respondent has conceded the addition to tax under section 6651(a)(1). A. Gordon Keyes, Jr. and Barbara J. KeyesDocket No. 22618-86Increased Interest and Additions to TaxSec.Sec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)6653(a)(1)6653(a)(2)6661(a)1979$ 3,514.00applicable$ 175.70------ 19828,542.00applicable--$ 427.1050% of the1 $ 854.20interest dueon $ 8,542.00396 Charles H. Merrill and Bernadette R. MerrillDocket No. 16622-87Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)(1)6653(a)(2)66591983$ 3,754.00applicable$ 187.7050% of the$ 1,126.20interest dueon $ 3,754.00Stanley M. Riffe and Phyllis W. RiffeDocket No. 20740-86Additions to TaxSec.Sec.YearDeficiency6653(a)(1)6653(a)(2)1982$ 13,358.00$ 668.0050% of theinterest dueon $ 13,358.00By amended answer for docket No. 20740-86, respondent asserted increased interest and an addition to tax under sections 6621(c) and 6661(a). Wilbur L. Rigmaiden and Patricia R. RigmaidenDocket No. 5602-88Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)(1)6653(a)(2)6661(a)1981$ 6,726.00applicable$ 336.3050% of the-- interest dueon $ 6,726.0019825,774.00applicable288.7050% of the$ 1,443.50interest dueon $ 5,774.00Per T. Ron and Sonja RonDocket No. 20215-87Increased Interestand Additions to TaxSec.Sec.Sec.YearDeficiency6621(c)6653(a)6653(a)(1)1980$ 1,387.00-- $ 69.35-- 198319,865.00applicable-- $ 993.25397 Increased Interestand Additions to TaxSec.Sec.Sec.Year6653(a)(2)66596661(a)1980------ 198350% of the--$ 4,966.25interest dueon $ 19,865.00Per T. Ron and Sonja RonDocket No. 25636-88Increased Interestand Additions to TaxSec.Sec.YearDeficiency6621(c)6653(a)(1)1981$ 20,720.89applicable$1,036.04198229,855.00applicable1,492.75Increased Interestand Additions to TaxSec.Sec.Sec.Year6653(a)(2)66596661(a)198150% of the$ 6,216.26--interest dueon $ 20,720.89198250% of the8,942.10--interest dueon $ 29,807.00By amended answer for docket No. 20215-87, respondent asserted increased interest under section 6621(c) for 1980. By amended answer for docket No. 25636-88, respondent asserted an addition to tax under section 6661(a) for 1982. John W. RutlandDocket No. 25510-85Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)(1)6653(a)(2)66591981$ 2,245.00applicable$ 112.2550% of the$ 673.50interest dueon $ 2,245.00John W. RutlandDocket No. 14473-88Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)(1)6653(a)(2)66591984$ 1,705.00applicable$ 85.0050% of the$ 512.00interest dueon $ 1,705.00398 Richard F. Standfest and Lucinda D. StandfestDocket No. 43317-86Increased Interestand Additions to TaxSec.Sec.Sec.YearDeficiency6621(c)6653(a)6653(a)(1)1979$ 4,033.00-- $ 202.00-- 19808,114.00-- 406.00-- 19812,710.00-- -- $ 136.00198237,963.00applicable-- 1,898.00198321,425.00applicable-- 1,071.00Increased Interestand Additions to TaxSec.Sec.Year6653(a)(2)66611979----1980----1981----198250% of the$ 3,796.00interest dueon $ 37,963.00198350% of the2,143.00interest dueon $ 21,425.00By amended answer for docket No. 43317-87, respondent asserted an addition to tax under section 6653(a)(2) for 1981 and increased interest under section 6621(c) for 1979 and 1980. By amended answer, respondent claimed an increased rate for the section 6661(a) addition from 10 percent to 25 percent for the years 1982 and 1983. Jolinda A. TraughDocket No. 13148-86Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)(1)6653(a)(2)6661(a)1981$ 9,732.00applicable$ 487.0050% of the-- interest dueon $ 9,732.00198211,955.00applicable598.0050% of the$ 1,196.00interest dueon $ 11,955.0019839,118.00applicable456.0050% of the912.00interest dueon $ 9,118.00399 By amended answer for docket No. 13148-86, respondent claimed an increased rate for the section 6661(a) addition from 10 percent to 25 percent for the years 1982 and 1983. Clione M. VeselyDocket No. 21253-86Increased Interest and Additions to TaxSec.Sec.Sec.YearDeficiency6621(c)6653(a)(1)6653(a)(2)1982$ 2,998.00applicable$ 150.0050% of theinterest dueon $ 2,998.0019834,613.00applicable231.0050% of theinterest dueon $ 4,613.00James F. Wann, Jr. and Lavonne M. WannDocket No. 39041-87Increased Interest andAdditions to TaxSec.Sec.Sec.YearDeficiency6621(c)6651(a)(1)6653(a)(1)1981$ 14,898.22applicable$ 3,129.00$ 824.66Increased Interest andAdditions to TaxSec.Sec.Sec.Year6653(a)(2)66596661(a)198150% of the$ 4,124.00--interest dueon $ 14,898.22James F. Wann, Jr. and Lavonne M. WannDocket No. 32627-87Increased Interest andAdditions to TaxSec.Sec.Sec.YearDeficiency6621(c)6651(a)(1)6653(a)(1)1982$ 17,064.00applicable$ 3,364.00$ 853.20198312,589.95applicable2,595.73695.10400 James F. Wann, Jr. and Lavonne M. WannDocket No. 32627-87Increased Interest andAdditions to TaxSec.Sec.Sec.Year6653(a)(2)66596661(a)198250% of the--$ 3,613.75interest dueon $ 17,064.00198350% of the--2,641.00interest dueon $ 12,589.95Respondent has now conceded that the addition to tax under section 6659 is inapplicable in these cases. In docket Nos. 32627-87 and 39041-87, petitioners James F. Wann, Jr. and Lavonne M. Wann have conceded the deductions pertaining to Oil Recovery Systems for the years 1981, 1982, and 1983. Petitioner James F. Wann, Jr. has also conceded the innocent spouse issue raised under section 6013(e) in these cases. After concessions, the issues for decision are: (1) Whether petitioners are entitled to deductions for development expenses under section 616 or exploration expenses under section 617 with respect to investments in certain gold mining programs; (2) whether petitioners Hodges and Rutland are entitled to loss deductions under section 165; (3) whether petitioners are liable for increased interest under section 6621(c); (4) whether petitioners are liable for the additions to tax for negligence401 under section 6653(a)(1) and (2); and (5) whether petitioners are liable for the additions to tax under section 6661(a) for substantial understatements of Federal income tax liability. Certain issues remaining in docket Nos. 39041-87 and 32627-87 (James F. Wann, Jr. and Lavonne M. Wann), and in docket No. 43317-86 (Richard F. Standfest and Lucinda D. Standfest) will be addressed in subsequent proceedings. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioner James B. Hodges is a marine engineer with a business degree from the University of Southern California. In 1981, Mr. Hodges was engaged in real estate development activities. James B. and Dorothy B. Hodges resided in San Clemente, California, when their petition was filed. Petitioner A. Gordon Keyes, Jr. was a crane operator in 1982. A. Gordon Keyes, Jr. and Barbara J. Keyes resided in Fontana, California, when their petition was filed. Petitioner Charles H. Merrill grew up on a farm and was a warehouse worker during the taxable year. Charles H. Merrill and Bernadette R. Merrill resided in Running402 Springs, California, and Riverside, California, respectively, when their petition was filed. Petitioner Stanley M. Riffe is an engineer and was a program manager for an aerospace company during the taxable year 1982. Stanley M. Riffe and Phyllis W. Riffe resided in Tucson, Arizona, when their petition was filed. Petitioner Wilbur L. Rigmaiden has two years of college education and was an insurance salesman during the taxable years here involved. Wilbur L. Rigmaiden and Patricia R. Rigmaiden resided in Newport Beach, California, when their petition was filed. Petitioner Per T. Ron is a licensed civil and structural engineer in California. Per T. Ron and Sonja Ron resided in Riverside, California, when their petitions were filed. Petitioner John W. Rutland has two years of junior college education and was an aerospace engineer during the taxable years here involved. John W. Rutland resided in Long Beach, California, when his petition was filed. Richard F. Standfest and Lucinda D. Standfest resided in Sunnymead, California, when their petition was filed. Petitioner Jolinda A. Traugh has a doctoral degree and was a professor of biochemistry at the University of California at403 Riverside during the taxable years. Jolinda A. Traugh resided in Riverside, California, when her petition was filed. Petitioner Clione M. Vesely was a registered nurse during the taxable years involved. Clione M. Vesely resided in Montrose, California, when her petition was filed. Petitioner Lavonne M. Wann was a tax preparer during the taxable years involved. James F. Wann, Jr. and Lavonne M. Wann resided in Riverside, California, when their petition was filed. During the period here involved International Recovery, Inc. (International), was engaged in several programs involving gold mines. Generally, investors were offered units in one or more of three mining programs promoted by International: The Reward Brown Monster mine program (hereinafter the Reward Brown program), the Cassill mine program (Cassill program), and the Tiedeman mine program (Tiedeman program). Generally, investors purchase mineral aggregate or ore from a particular mine and were required to make a payment in the form of cash and a promissory note to cover the mining expenses purportedly incurred in mining the aggregate. Investors then claimed the total mining expenses (cash plus note) as mining development404 deductions on Schedule C of their respective tax returns. Gold deposits in the Reward Brown mine were concentrations of gold that formed in a quartz rock vein. Mining this type of deposit required underground tunneling. Placer deposits are essentially buried stream or river beds where rock and gravel containing gold settled after it was eroded and washed away from gold-bearing land formations. Successive layers of sediment or volcanic deposit then covered this alluvium to varying depths. Gold deposits in the Cassill and Tiedeman mines were of this type. The placer deposits in the Tiedeman mine were close enough to the surface and were amenable to strip mining. In the Cassill mine, the placer deposits were much deeper and required tunneling in much the same manner as for the Reward Brown vein. A proven or measured body of ore is one that has been systematically drilled or measured by physical workings which block out three or four dimensions and systematically sampled and assayed and, considering both the tonnage and quality aspects of the ore body, determined to be economically feasible to mine. Probable ore is ore that generally occurs in the periphery of proven ore and 405 has not been determined as exactly as proven ore. Potential ore is a geological estimate of the potential of a particular property. Each of the mines involved in the International programs is a consolidation of contiguous claims of various acreage. Individuals obtained their claims--exclusive rights to develop and mine designated parcels of public land--by registering and recording with the Government. The mines here involved were composed of both patented and unpatented claims. A patented claim usually required proof that a specific amount of ore existed which could be mined profitably at the time of patenting. An unpatented claim was one where no such proof was made. International, a California corporation, was formed in 1981 by Don C. Como (Como). Como had no prior mining experience. Como was engaged primarily in educational film production prior to the inception of the International programs. Theodore Youngquist was hired as mining engineer for the Reward Brown mining property and, later, for the Cassill mining property. He was terminated in 1983. Mervin Lovenberg was retained by International as a consulting geologist. Reward Brown Mines ProgramInternational's406 first mining program involved the Reward Brown mines, located near Lone Pine, California. Claims for both the Reward Brown mine, formerly known as the Hirsch mine, and the Brown Monster mine were patented in the 1880s. A number of other claims also comprise the mines. These mines are adjacent to or above an underground vein system in a mountain which was sheared along a geologic fault. Together they are known as the Reward Brown Monster group (Reward Brown mine). Mine owners or their lessees have worked the Reward Brown mine at various times since its discovery. At times during an approximate 30-year period before International began activities related to the Reward Brown mine, one Dr. Walter Wilson or his family held varying degrees of ownership in the mine. In 1980, the Reward Brown mine was transferred to Mr. W. Valentine (Valentine). Valentine transferred the Reward Brown mine to his partnership, Missouri Mines, which later became Missouri Mines, Inc. (Missouri Mines). By agreement dated May 18, 1981, Missouri Mines leased the Reward Brown mine to International for a renewable annual term (Reward Brown lease). Como executed the lease for International. The Reward Brown407 lease provided for renewal as long as International mined at least 100 tons per day. The lease required no rent or royalty for the first 9 months, but starting with the 10th month, a royalty of 10 percent of net production after smelting or $ 3,500 as a minimum monthly payment was required. The Reward Brown lease required International to pay Missouri Mines $ 50 for each unit that International sold, and International agreed "to fund up to $ 750,000 to establish an operating organization" at the mine. The Reward Brown lease stated that International anticipated selling 1,000 to 2,000 units to "individual purchasers, based on a structure that will enable purchasers to shelter their 1981 income". On the same day that the Reward Brown lease was signed, Valentine and International entered into a 1-year "Operating Agreement" which required Valentine to "establish an operating organization to supervise the development of the mining properties". Valentine was to be paid $ 100,000. This operating agreement was never put into effect. The Reward Brown program was described in a "Confidential Private Placement Memorandum" (the Reward Brown brochure) issued by International in 1981. The408 Reward Brown brochure described the program as an opportunity to purchase mineral aggregate on a tonnage basis in the property to be mined, gave the history and location of the property, and identified the individuals involved in the program. One Reward Brown brochure stated that 500 units of mineral aggregate were offered for sale. This brochure stated that "accompanying geology and engineering reports" had found evidence of 200,000 tons of ore in one pocket containing .8 ounces of gold and 22 ounces of silver per ton. The total tonnage was estimated to exceed 700,000 tons. A second brochure offered 750 units of mineral aggregate. This brochure stated that "a current geology and engineering report" had found evidence of 200,000 tons of aggregate in one pocket containing .8 ounces of gold and 22 ounces of silver per ton, with a potential of 500,000 tons of aggregate. The total tonnage in this second brochure was estimated to exceed 1,300,000 tons of mineral aggregate. The Reward Brown brochure stated that the purchaser of the mineral aggregate would receive the following benefits: PROJECTED POTENTIAL RETURN ON CASH--800% in addition to recapture of initial cash. * TAX-FREE409 INCOME--It is the opinion of our tax consultants that until gold bullion is sold and converted to dollars it is not taxable. TAX ADVANTAGES--500% leveraged purchase. * LEGAL REPRESENTATION--International Recovery, Inc., retains a distinguished California attorney to answer your legal questions. Also included in the package is an Attorney's opinion letter. * NOT A LIMITED PARTNERSHIP--This is a Schedule C deduction. * HISTORICAL MINE--Located in California and available to visit. This mine was previously closed due to high recovery cost with gold at only $ 35.00 an ounce. * VERIFICATION OF CLAIMS--Recent geology and assay reports; documented claim rights. * SIMPLICITY--All financial and legal requirements will be fulfilled by a group with over seven successful years of experience in tax-advantageous business ventures. The Reward Brown brochure also included an engineering report which evaluated the Reward Brown claims as containing three major veins and one with a pocket of approximately 200,000 tons of gold-silver ore that should average .8 ounces of gold and 22 ounces of silver per ton and that drilling would establish a minimum of 700,000 tons of gold-silver410 ore that would average .40 ounces of gold per ton. The Reward Brown brochure explained the tax benefits of the program. A purchaser could acquire 1400 tons of mineral aggregate (one unit) for $ 250. If the purchaser decided to execute a mining agreement with International, he paid $ 10,000 to International upon signing and executing a promissory note for $ 40,000 in favor of Lloyd's Insurance Limited in Nassau, Bahamas, to have the unit mined. The Reward Brown brochure indicated that the purported mining costs were fully deductible in the initial year, as demonstrated by sample Federal income tax return (Schedule C) included on the brochure. The Reward Brown brochure also included a computation of the estimated income potential for one unit of mineral aggregate as follows: Estimated Income Potential According to assay reports and engineering surveys, it is believed that a ton of mineral aggregate will have a mineral value of $ 200 in gold. Some of the mineral aggregate might be higher. However, as an overall conservative estimate, the amount of $ 200 per ton shall be used. (This value is based on a market of $ 500 per ounce of gold) EXAMPLE OF ESTIMATED VALUE OF GOLDONE TON OF MINERAL AGGREGATEGold---$ 200.001400 tons at $ 200 per ton$ 280,000.00MINING CONTRACT = $ 50,000(Development Cost)Deduct: Cash Down Payment$ 10,000)Note40,000 Interest (estimated4 years)16,000 $ 66,00066,000.00$ 214,000.00Deduct: Override (royalty 60%)-$ 128,400.00MILLING COST---Deduct-$ 5,920.00(Estimate based on $ 1 a gram on 191 ounces)Estimated Income in Gold Bullion$ 79,680.00Plus Original Cash Down Payment$ 10,000.00Total Estimated Income in Gold$ 89,680.00411 The Reward Brown brochure provided that the funds received, including the funding of the notes, would be used, inter alia, for drilling additional shafts and galleries, acquiring and maintaining buildings, and leasing and purchasing equipment necessary to prepare the property for mining. The anticipated completion date for the programs was November 30, 1982. The Reward Brown brochure included the following documents: A Purchase Agreement, an Addendum to Purchase Agreement, a Processed Aggregate Purchase Agreement, a Mining Agreement, a Mining Agreement-Assignment, and a "Full Recourse Promissory Note". The purchase agreement provided as follows: PURCHASE AGREEMENT This agreement entered into this day of , 1981 by and between Missouri Mines Inc., hereinafter referred to as seller, and , hereinafter referred to as buyer. Whereas, the seller has gold mining properties located in the state of California and the buyer desires to immediately purchase tons of mineral aggregate from said seller and seller agrees to sell said tons of mineral aggregate at the execution of this agreement, subject to the following terms and conditions: 1. The seller 412 will now sell said tons of mineral aggregate to buyer and buyer shall now pay the sum of two hundred fifty dollars ($ 250) for each 1400 tons, to Missouri Mine Inc. upon signing this agreement, and the buyer shall further pay, as the balance of the purchase price, an override (royalty) of 60% of the net total of all gold and silver mined from said tons of mineral aggregate after deducting the mining development cost plus accrued interest thereon. 2. The buyer shall have full and complete ownership rights of all gold and silver in the entire said tons of mineral aggregate and the buyer has the right to mine the said tons of mineral aggregate himself or he may contract with others to mine the said tons of mineral aggregate. You may contract with International Recovery, Inc. by executing the mining agreement. 3. The said override (royalty) can be paid in gold bullion. 4. It is agreed by the seller and the buyer that the override (royalty) shall apply and be calculated on the gold and silver remaining after deducting all development, interest, mining and processing costs. 5. The buyer shall have reasonable access to his property at all times, and he will in turn grant 413 reasonable access to other property owners. 6. It is agreed by both the seller and the buyer that if the buyer contracts with a mining company to mine buyer's mineral aggregate that the buyer will give an assignment to the mining company to deduct the said 60% override (royalty) from the net gold and silver after deduction of all development, interest, mining and processing costs as stated above and said override (royalty) shall be paid in gold and silver bullion. 7. It is agreed by the seller and the buyer that all mining operations of the said tons of mineral aggregate will be completed not later than six years after date herein. 8. Execution hereof by the seller is an acknowledgement and representation relied upon by buyer as a part of the consideration thereof that deposits of ore or other minerals are shown to exist in sufficient quantity and quality to reasonably justify commercial exploitation. Note assay reports. 9. A bill of sale for the said tonnage and date purchased will be furnished to each purchaser. This said particular aggregate is his legal property and will be recorded in the purchaser's name. 10. Buyer agrees to develop the aggregate expeditiously. Buyer414 further agrees to enter into, and commit payment for, an agreement for development and mining with a mining operator prior to November 30, 1981, unless the buyer agrees to expeditiously develop and mine the aggregate personally. In an addendum to the purchase agreement, International/Missouri Mines reserved the right to make substitutions of mineral aggregate. Where the purchaser engaged International as his mining contractor, International would agree under the Processed Aggregate Purchase Agreement to repurchase the mineral aggregate, after processing, for $ 1.50 per ton. Provisions for the payment of mining costs of $ 50,000 per unit ($ 10,000 in cash and $ 40,000 by promissory note) were contained in the Mining Agreement: This agreement entered into this day of 1981 by and between International Recovery, Inc., hereinafter referred to as miner, and hereinafter referred to as principal. Whereas the principal desires the miner to do the mining and development of his tons of mineral aggregate at the Missouri Mine-Reward-Brown Monster, and the miner agrees to perform such mining and development of said tons of mineral aggregate, subject415 to the following terms and conditions: 1. The principal agrees to pay the miner for development the sum of $ as follows: a. The principal agrees to pay the sum of $ at the execution of this agreement as initial payment. b. At the signing of this agreement, the principal agrees to execute a note in favor of Lloyd's Insurance Limited in the amount of $ for financing the balance of the cost of said mining operation. Miner warrants by execution hereof that Lloyd's Insurance Limited is an independent organization with no interest, other than an interest as a creditor, in the mining activity contemplated by this mining agreement. c. The principal agrees that said promissory note shall be due and payable ten years after date of this agreement and that said note shall bear simple interest at the rate of 10% per annum. d. For mining costs, the principal further agrees to pay the miner $ 1.00 (one dollar) per gram of principal's gold extracted * * * 2. The principal requests the miner to deduct from the total of the gold and silver mined, the promissory note in the amount of $ , plus interest for the account of Lloyd's Insurance Limited. * * 416 3. The principal declares that he/she has a 60% override (royalty) agreement with International Recovery Inc. - Missouri Mine, and the principal requests that the miner, after deducting all mining costs * * * shall further deduct 60% of the remainder of said gold and silver for the account of International Recovery Inc. - Missouri Mine as payment of override (royalty). * * * 4. Miner agrees to complete all development work of principal's aggregate within 12 months. * * * 6. The initial phase of mining will not begin until after 150 feet of tunneling has been completed. No aggregate will be processed for purchasers during the initial phase of development. * * * 7. The miner agrees to complete all mining operations not later than six years after date of this agreement. This document in the Reward Brown brochure entitled Mining Agreement--Assignment provided that the purchaser of mineral aggregate could assign to International the right to deduct the amount of the promissory note plus interest and remit the same in gold and silver bullion to the account of Lloyd's Insurance Limited. Mr. Como understood that Lloyd's Insurance Limited (Lloyd's) was a publicly traded417 entity formed in Nassau in 1979. He located Lloyd's through a business associate, one Don Fikes. The promissory notes executed by the purchasers of mineral aggregates provided in most instances that the principal was payable in 10 years, with simple annual interest of 10 percent. Although petitioners in these cases were generally billed for interest due, none of the petitioners paid the interest and no action was taken against any petitioner for nonpayment of the interest. An unspecified number of such notes were never funded. International made payments in excess of $ 1,000,000 to Lloyd's in the period from November 1981 to August 1982. In a note to financial statements prepared in 1984 for International it is stated that International expected to collect approximately $ 40,000,000 from recourse notes signed by principals to Lloyd's. Cassill Mine ProgramInternational's second mining program involved the Cassill mining claims (the Cassill mine) located in El Dorado County, California. The Cassill mine, which was a placer mine, consisted of a number of mining claims which were made by various individuals in the first half of this century. In 1958, one Blanche Cassill418 had placer claims patented. In 1970, the mine was transferred to Robert and Patricia Perona (Peronas). By agreement dated June 22, 1982, the Peronas leased the Cassill mine to International for an initial term ending January 31, 1983, for $ 10,000. The lease was executed for International by one Jack A. Whitley, II (Whitley), an International executive. International had the option to renew the lease for a 2-year term upon payment of $ 90,000. International also had the option to extend the lease for additional terms. By agreement dated July 12, 1982, International agreed to surrender the Cassill mines lease, and by agreement dated July 12, 1982, the Peronas leased the Cassill mine to Cassill Mines, a California corporation. Mr. Whitley executed this lease as president of Cassill Mines. Mr. Whitley had no mining background when he became president of Cassill Mines. The new lease was substantially similar to the lease of June 22, 1982. The initial lease term rental was reduced to $ 250. Under the lease, Cassill Mines agreed to pay the Peronas 10 percent of the adjusted monthly gross income from the mining of the claims. On the same date, Cassill Mines and International 419 entered into a mining licensing agreement which provided in part as follows: 1. CASSILL agrees that it will recommend INTERNATIONAL as the prefered [sic] miner for the Cassill Mining Project. In this connection, INTERNATIONAL shall cause to be prepared a Memorandum Brochure which CASSILL will make available to prospective purchasers of mineral aggregate. 2. CASSILL acknowledges that INTERNATIONAL may enter into separate Standard Mining Agreements with certain of those individuals who have purchased and will purchase units of mineral aggregate from the Claims. The Cassill program was described in private placement memoranda. Except for a few modifications, together with information which necessarily differed between mines (e.g. information regarding the location, physical properties of the mines, offering periods and time schedules), these brochures and their accompanying documents were substantially similar to the Reward Brown brochure and its documents for 1981. However, the Addendum to Purchase Agreement (whereby the mine retained the right to substitute other property for any specific property purchased by an investor) and Purchase Agreement were combined as one document420 in the 1982 and 1983 Cassill brochures. In the 1983 Cassill brochure, the address for Lloyd's Insurance Limited was shown as Grand Turk, Turks and Caicos Islands, B.W.I., while the 1982 address was shown as Nassau, Bahamas. The Cassill private placement memoranda described the program as an opportunity to purchase mineral aggregate on a cubic yard basis. One unit in the Cassill program was comprised of 2,000 cubic yards of mineral aggregate. Each unit sold for $ 300, processing costs were $ 4 per cubic yard, and repurchase of the aggregate under a Processed Aggregate Purchase Agreement was $ .50 per cubic yard. A contract was offered to purchasers for the development and mining of the mineral aggregate at $ 50,000 per unit. The mining agreement required a cash payment of $ 10,000 and a promissory note for the balance of $ 40,000 payable to Lloyd's Insurance Limited. Cassill mines had the right to substitute the purchaser's mining property for other property of the same or better caliber. International was authorized to deduct from the income from the gold and silver mined the principal and interest due on the Lloyd's promissory note, a 60 percent royalty on the gold and silver421 mined, and the milling costs of $ 4 per cubic yard of aggregate. The Cassill private placement memoranda explained that the purchaser of the mineral aggregates would receive the following benefits: PROJECTED POTENTIAL RETURN ON CASH - 700% including recapture of initial cash. TAX-FREE INCOME - It is the opinion of our tax consultants that until gold bullion is sold and converted to dollars it is not taxable. TAX ADVANTAGES - 500% leveraged purchase. LEGAL REPRESENTATION - International Recovery, Inc., retains a distinguished California attorney to answer your legal questions. Also included in the package is an attorney's opinion letter. NOT A LIMITED PARTNERSHIP - This is a Schedule C deduction. HISTORICAL AREA - Located in California and available to visit. The immediate surrounding area produced revenue of over $ 500,000,000 from gold, based on $ 500 per ounce. VERIFICATION OF CLAIMS - Recent geology and assay reports: documented claim rights. SIMPLICITY - All financial and legal requirements will be fulfilled by a group with over seven successful years of experience in tax-advantageous business ventures. Each purchaser was required to select a422 mining contract or to perform the development work or perform such work himself. A tax opinion letter in each brochure concluded that a purchaser's mining development costs were fully deductible in the year of purchase. Each brochure included the following estimated income potential for each cubic yard of mineral aggregate: One cubic yard of mineral aggregate $ 120 2,000 cubic yards at $ 120 per cubic yard . . . $ 240,000 Mining Contract = $ 50,000 (Development Cost) Deduct: Cash Down Payment$ 10,000Note40,000Interest16,000(estimated 4 years)Processing (milling cost)8,000$ 74,00074,000$ 166,000Deduct: Override (60% royalty)99,600 Estimated Income in Gold Bullion66,400 Plus Original Cash Down Payment10,000 Total Estimated Income in Gold$ 76,400The value of $ 120 per cubic yard was based upon "government reports and engineering surveys". One of the Cassill private placement memoranda indicated an offering of 300 units of 2,000 cubic yards of mineral aggregate in the Cassill program. The memorandum anticipated another 100,000 cubic yards of mineral aggregate would be confirmed423 and certified, making it possible to offer an additional 50 units. A second private placement memorandum offered 1,000 units of 2,000 cubic yards of mineral aggregate. This second memorandum also stated that "accompanying geology and engineering reports" had found evidence of 2,000,000 cubic yards of ore. Both memoranda contained a report by geologist Roy C. Austin dated June 1, 1982. Mr. Austin's report stated that field work done on the Cassill claims had shown that there were 500,000 cubic yards of gravel left to be mined. The Cassill private placement memoranda also contained a letter dated July 16, 1982, from geologist Mervin F. Lovenberg to International. Mr. Lovenberg stated in the letter that the Cassill mining claims contained a minimum of 500,000 cubic yards of gold placer deposits documented by the United States Bureau of Land Management. In a program report issued March 1, 1983, with respect to the Cassill mining program, International reported that it had acquired three items of heavy-duty equipment costing in excess of $ 700,000. In July or August 1983, Mr. Whitley withheld several hundred contracts from International because he was concerned whether there was424 sufficient mineral aggregate in the Cassill mine to support the purchasers' contracts. He later released them when he obtained an oral agreement from David Pierce that he would make certain that sufficient aggregate would be made available. By letter to Mr. Lovenberg dated October 3, 1983, Mr. Whitley inquired about the amount of proven mineral aggregate available under the existing lease between Cassill Mines and the Peronas and also inquired about the amount of measured, probable, and inferred mineral aggregate available on adjacent properties. By letter to Mr. Whitley dated October 10, 1983, Mr. Lovenberg advised that there were 500,000 cubic yards of mineral aggregate at the Cassill mine. Mr. Lovenberg also stated that another 500,000 cubic yards was inferred in the Cassill mining claims. Mr. Lovenberg also stated that some 500,000 cubic yards of measured aggregate and some 200,000 cubic yards of indicated ore existed on adjacent property not involved in the Cassill mining claims. By letter to International dated October 27, 1983, Mr. Whitley formally notified International that he would enter no further agreements to sell mineral aggregate from the Cassill mining program. 425 Subsequently, International acquired a lease on the Tiedeman mining claims. Mr. Como proposed to transfer units of mineral aggregate in the Tiedeman mines to cover any shortfall to purchasers in the programs. Prior to November 21, 1983, International sold 70 more units in the Cassill mining program. Mr. Whitley learned of these sales and by letter to International dated November 21, 1983, he revoked International's license to mine the Cassill mining claims. Litigation ensued, and work was continued by International on the Cassill mining program for a limited period. Tiedeman Mine ProgramThe third gold mining program operated by International involved the Tiedeman mine, a placer mine located in El Dorado County, California, some 4 miles south of the Cassill mining claims. Pursuant to a lease agreement dated November 4, 1983, the Tiedeman mine property was leased by International Recovery Development Corporation from one Maurice S. Indursky of New York Stone and Mineral Company. The lease was for a period of 1 year, with an option to renew for additional periods. An employee of International was president of International Recovery Development Corporation. The Tiedeman426 mine consisted of portions of three parcels of patented claims. The Tiedeman mine offering consisted of 1,000 units of mineral aggregate. Pursuant to the private placement memorandum purchasers were offered a 2,000-cubic-yard unit of mineral aggregate in the Tiedeman mine for $ 300 per unit, with an obligation to pay a royalty of 60 percent of the total gold and silver bullion produced from the mineral aggregate after deducting all mineral costs. Purchasers could select a mining contractor from a list which included International. One of the Tiedeman mine private placement memoranda prepared for use in this mining program stated that a purchaser of mineral aggregate would receive the following benefit: PROJECTED POTENTIAL RETURN ON CASH -- 700% including recapture of initial cash. TAX-FREE INCOME -- It is the opinion of our tax consultants that until gold bullion is sold and converted to dollars it is not taxable. TAX ADVANTAGES -- 500% leveraged purchase. LEGAL REPRESENTATION -- International Recovery Inc. retains a distinguished California attorney to answer your legal questions. Also included in the package is an attorney's opinion letter. NOT A LIMITED PARTNERSHIP427 -- This is a Schedule C deduction. HISTORICAL AREA -- Located in California and available to visit. The immediate surrounding area produced revenue of over $ 500,000,000 from gold, based on $ 500 per ounce. VERIFICATION OF CLAIMS -- Recent geology and assay reports: documented claim rights. SIMPLICITY -- All financial and legal requirements will be fulfilled by a group with over seven successful years of experience in tax-advantageous business ventures. One of the private placement memoranda used in the Tiedeman mining program outlined the following estimated income potential to purchasers of a unit of mineral aggregate: ESTIMATED INCOME POTENTIAL Based on geological and engineering reports and 14 core drillings with results completed in 1984, it is believed that a cubic yard of mineral aggregate will have a value in excess of $ 175 in gold, based on .5% gold per cubic yard. Some of the mineral aggregate may be higher. However, as an overall estimate, the amount of $ 175 per cubic yard will be used. (This value is based on the value of gold at $ 350 per ounce.) * * * Deduct:Initial Cost of Aggregate$ 300Cash Down Payment10,000Note (Full Recourse)40,000Interest On Note (10%)16,000(estimated 4 years)Processing & Milling Costs30,000Total Development Costs$ 96,300$ 96,300Gross Income After Principal's DevelopmentCosts Are Paid$ 254,700Deduct: Override (60% of net gold mined)$152,820(Tiedeman's Royalties)Principal's Estimated Income In Gold Bullion$101,880428 Another Tiedeman mine placement memorandum used a value of gold at $ 120 per cubic yard (based upon gold at $ 450 an ounce) in computing the estimated income potential which resulted on projected total estimated income of $ 76,400. One of the Tiedeman mine private placement memoranda stated that "the accompanying geology and engineering reports" found evidence of 2,500,000 cubic yards of aggregate. Another Tiedeman mine private placement memorandum stated that the "accompanying geology and engineering reports" found evidence of 2,500,000 cubic yards of ore. A two-page geological report prepared by geologist R. W. McComas which was included in the Tiedeman mine private placement memoranda, concluded that the potential reserves contained within the bounds of Tiedeman mine property could amount to approximately 2,500,000 cubic yards of placer material. The report also stated that the value of this placer material would be difficult to predict. The report further stated that an average value of .30 ounces per cubic yard of placer material seemed feasible. Finally, the report recommended that an exploratory program be conducted to ascertain the exact location, extent and configuration429 of the subsurface channel. Petitioner John W. Rutland, who previously had acquired an interest in a program called the Alitolia mining program, transferred such interest to the Tiedeman mine promotion in 1984. On August 2, 1984, he made a payment of $ 5,000 to International. Securities and Exchange Commission and Department of Justice ComplaintsOn September 27, 1985, the Securities and Exchange Commission (SEC) filed a complaint against International and Mr. Como in the United States District Court for the Central District of California. International and Mr. Como consented to an order of permanent injunction. The consent decree entered March 1986 provided, in pertinent part, that International would not: (a) Sell any security of International Recovery or any other security, unless a registration statement is in effect with the SEC as to such security or an exemption from registration is applicable; (b) offer to buy or sell any International Recovery or other security through a brochure or otherwise unless a registration statement is in effect or an exemption is applicable; (c) make or obtain money or property by making untrue statements of material facts or omitting 430 necessary material facts concerning: 1. The use of proceeds from the sale of any such security; 2. the quantity of gold and silver available to be mined by the issuer of said security; 3. the prospects for obtaining substantial tax benefits by investing in any such security; and 4. the existence of third party loans to investors buying any such security; (d) employing any device, scheme or artifice to defraud or engaging in any transaction, act, practice or course of business which operates or would operate as a fraud or deceit against any person by distributing materially false or misleading documents, including, among other items, offering memoranda, and engaging in the purchase or sale of any such security in contravention of section 17(a) of the Securities Act of 1933, ch. 38, tit. I, 48 Stat. 74, 84 and of section 10(b) of the Securities Exchange Act of 1934, ch. 404, tit. I, 48 Stat. 881, 891 or Rule 10b-5 thereunder. The Department of Justice also filed a complaint for injunctive relief in the Central District of California against Mr. Como and International. Pursuant to a consent order signed by Mr. Como and International, a final judgment of permanent injunction was 431 entered in January 1986. The final judgment of permanent injunction enjoined Mr. Como and International from: a. Taking any action in furtherance of the organization, promotion, advertising, marketing, or selling of the Tax Shelters; b. Representing that investors in the Tax Shelters will be entitled to deductions for Federal income tax purposes, including deductions for mine development expenditures and from furnishing or distributing materials, and oral or written information, which so indicate; c. Organizing or assisting in the sale of * * * [a] plan * * * in which i. False or fraudulent statements are made with respect to [the] deductibility of mine development expenses; ii. False or fraudulent statements are made with respect to the existence of financing by a third party; iii. False or fraudulent statements are made with respect to the use of funds for mine development; iiii. False or fraudulent statements are made with respect to the expectation of profit in gold mining programs; v. Gross valuation overstatements are made with respect to the value of ore contained in a mining claim * * * Petitioners' Involvement with the ProgramsPetitioner 432 Lavonne M. Wann (Mrs. Wann) executed a purchase agreement dated December 28, 1981, for 1,050 tons of mineral aggregate in the Reward Brown mining program. She also executed additional documents relating to her participation in the Reward Brown mining program. She paid $ 187.50 to Missouri Mines for the mineral aggregate, made a payment of $ 7,500 to International and executed a promissory note payable to Lloyd's for $ 30,000. She executed another purchase agreement dated July 7, 1982, for 3,150 tons of mineral aggregate in the Reward Brown mining program. She paid $ 562.50 to Missouri Mines for the mineral aggregate, executed a 90-day promissory note payable to International in the amount of $ 22,500, and also executed a promissory note payable to Lloyd's in the amount of $ 89,500. Mrs. Wann entered into the July 7, 1982, transaction pursuant to a joint venture agreement of the same date with Marilynn Vesely, Donald D. Fink and Terri Fink, and Charles H. Merrill and Bernadette Merrill. Mrs. Wann's interest in the joint venture was four-ninths, which equaled 1,400 tons (one unit) of mineral aggregate. Mrs. Wann also executed a purchase agreement dated December 13, 1982, for 2,000433 cubic yards of mineral aggregate in the Cassill mining program. She paid $ 300 to Cassill mines for the mineral aggregate, made a payment (on February 4, 1983) to International in the amount of $ 10,116.45 in satisfaction of a 90-day promissory note executed on December 13, 1982, and executed a promissory note payable to Lloyd's in the amount of $ 40,000. Mrs. Wann executed an additional purchase agreement dated May 20, 1983, for 2,000 cubic yards of mineral aggregate in the Cassill mining program. She also received 100 cubic yards of mineral aggregate as a bonus. She paid $ 300 to Cassill mines for mineral aggregate. She also made a payment (by check dated May 20, 1983) of $ 5,125 to International, executed a 90-day note (dated May 20, 1983) payable to International in the amount of $ 4,875, and executed a promissory note payable to Lloyd's in the amount of $ 40,000. Mrs. Wann claimed Schedule C deductions for mining development expenses on her 1981, 1982, and 1983 Federal income tax returns in the respective amounts of $ 37,500, $ 100,000, and $ 50,000. Respondent disallowed the deductions in full. Petitioner James B. Hodges executed a purchase agreement on November 19, 434 1981, for 1,400 tons of mineral aggregate in the Reward Brown mining program. He paid $ 250 to Missouri Mines for the aggregate. He also paid $ 10,000 to International and purportedly executed a promissory note for $ 40,000. Mr. Hodges claimed a Schedule C deduction for mine development costs in the amount of $ 50,000 on his 1981 Federal income tax return. Respondent disallowed the deduction in full. In December 1981, petitioner John W. Rutland purchased 700 tons of mineral aggregate in the Reward Brown mine. He paid $ 125 to Missouri Mines for the aggregate. He also made a payment of $ 5,000 to International by check dated December 19, 1981, and also executed a promissory note payable to Lloyd's in the amount of $ 20,000. Mr. Rutland claimed a Schedule C deduction for mining development costs in the amount of $ 25,000 on his 1981 Federal income tax return with respect to his participation in the Reward Brown mining program. Respondent disallowed the deduction in full. Mr. Rutland claimed an interest expense deduction on Schedule C of his 1984 Federal income return in the amount of $ 5,000. The Schedule C activity was identified as the Tiedeman mining program. The $ 5,000435 interest deduction was the only item appearing on Schedule C. Respondent disallowed the deduction in full. Petitioner A. Gordon Keyes, Jr. executed a purchase agreement on July 7, 1982, for 1,400 tons of mineral aggregate in the Reward Brown mine. He paid $ 250 to Missouri Mines for the mineral aggregate, made a payment of $ 2,000 to International and another payment in the amount of $ 8,240 to International, and executed a promissory note in the amount of $ 40,000 payable to Lloyd's. Mr. Keyes claimed a Schedule C deduction for mining development costs in the amount of $ 50,000 on his 1982 Federal income tax return with respect to his participation in the Reward Brown mining program. Respondent disallowed the deduction in full. In 1983 petitioner Charles H. Merrill purchased a quantity of mineral aggregate in the Tiedeman mine program for $ 150. In connection with this purchase, he also made a payment of $ 5,000 to International and executed a promissory note in the amount of $ 20,000. Mr. Merrill claimed a Schedule C deduction for mining development costs in the amount of $ 25,000 on his 1983 Federal income tax return with respect to his participation in the Tiedeman mining436 program. Respondent disallowed the deduction in full. Petitioner Stanley M. Riffe executed a purchase agreement on July 6, 1982, for 1,400 tons of mineral aggregate in Reward Brown mine, paying $ 250 to Missouri Mines. He also made a down payment to International which included a 90-day note payable to International in the amount of $ 8,320 and a cash payment of $ 2,000. He also executed a promissory note payable to Lloyd's in the amount of $ 40,000. On December 20, 1982, Mr. Riffe executed a purchase agreement for 1,000 cubic yards of mineral aggregate in the Cassill mining program, paying $ 150 to International. He also made a payment to International in the amount of $ 5,000 and executed a promissory note payable to Lloyd's in the amount of $ 20,000. Mr. Riffe claimed a Schedule C deduction for mining development costs on his 1982 return with respect to the Reward Brown mining program ($ 37,500) and the Cassill mining program ($ 25,000) in the total amount of $ 62,500. Respondent disallowed the deductions in full. Petitioner Wilbur L. Rigmaiden executed a purchase agreement on or about December 28, 1981, for 700 tons of mineral aggregate in the Reward Brown mining program. 437 He paid $ 125 to Missouri Mines for the aggregate. He also made a payment of $ 5,000 to International by check dated December 28, 1981, and executed a promissory note payable to Lloyd's in the amount of $ 20,000. Mr. Rigmaiden executed a second purchase agreement dated July 7, 1982, for 700 tons of mineral aggregate in the Reward Brown mine. He paid $ 125 to Missouri Mines for the aggregate. He also agreed to pay the sum of $ 5,000 as an initial payment upon execution of the purchase agreement and to execute a note in favor of Lloyd's in the amount of $ 20,000. Mr. Rigmaiden claimed Schedule C deductions for mining development expenses with respect to the Reward Brown program in the amount of $ 25,000 in each of the taxable years 1981 and 1982. Respondent disallowed the deductions in full. Petitioner Per T. Ron executed a purchase agreement dated December 31, 1981, for 1,750 tons of mineral aggregate in the Reward Brown mining program. He paid $ 312.50 to Missouri Mines for the mineral aggregate. He also made a payment of $ 12,500 to International and executed a promissory note payable to Lloyd's in the amount of $ 50,000. On July 7, 1982, Mr. Ron purchased 1,400 tons of438 mineral aggregate in the Reward Brown mining program. In connection with this transaction, he paid $ 250 to Missouri Mines for the mineral aggregate, paid $ 10,296 to International, and executed a promissory note payable to Lloyd's in the amount of $ 40,000. On December 13, 1982, Mr. Ron purchased 1,000 cubic yards of mineral aggregate in the Cassill mining program. He paid $ 150 to Cassill Mines for the mineral aggregate, made a payment of $ 5,000 to International, and executed a promissory note payable to Lloyd's in the amount of $ 20,000. On February 10, 1983, Mr. Ron purchased 2,000 cubic yards of mineral aggregate in the Cassill mining program. In connection with the transaction, he paid $ 300 to Cassill mines for the mineral aggregate, made payments of $ 10,213.04 to International, and executed a promissory note payable to Lloyd's in the amount of $ 40,000. On May 16, 1983, Mr. Ron purchased 1,000 cubic yards of mining aggregate from Cassill mines. In connection with this transaction, he paid $ 150 to Cassill mines for the mineral aggregate, made payments to International in the amount of $ 5,080, and executed a promissory note payable to Lloyd's in the amount of $ 20,000. 439 On July 18, 1983, Mr. Ron purchased 1,000 cubic yards of mineral aggregate from Cassill mines. In connection with the transaction, he paid $ 150 to Cassill mines for the mineral aggregate, paid $ 5,000 to International, and executed a promissory note payable to Lloyd's in the amount of $ 20,000. Mr. Ron claimed Schedule C deductions for mining development expenses with respect to his participation in the above-described mining programs in the taxable years 1981, 1982, and 1983 in the respective amounts of $ 62,500, $ 75,000, and $ 100,000. Respondent disallowed the deductions in full. Petitioner Richard F. Standfest executed a purchase agreement dated December 11, 1982, for 6,000 cubic yards of mineral aggregate in the Cassill mining program. He paid $ 900 to Cassill mines for mineral aggregate, made a payment of $ 30,000 to International and executed a promissory note payable to Lloyd's in the amount of $ 120,000. Mr. Standfest also executed a purchase agreement dated September 8, 1983, for 3,000 cubic yards of mineral aggregate in the Cassill mining program. He paid $ 450 to Cassill mines for the mineral aggregate, made a payment of $ 15,000 to International and executed440 a promissory note payable to Lloyd's in the amount of $ 60,000. Petitioners Richard F. Standfest and Lucinda D. Standfest claimed Schedule C deductions for mining development expenses on their 1982 and 1983 Federal income tax returns in the respective amounts of $ 150,000 and $ 75,404. Respondent disallowed the deductions in full. Dr. Jolinda A. Traugh executed a purchase agreement dated December 28, 1981, for 1,050 tons of mineral aggregate in the Reward Brown mining program. She made a payment of $ 182.50 to Missouri Mines for the mineral aggregate, made a payment of $ 7,500 to International, and executed a promissory note payable to Lloyd's in the amount of $ 30,000. She also executed a purchase agreement dated July 7, 1982, for 2,100 tons of mineral aggregate in the Reward Brown mining program. She paid $ 375 to Missouri Mines for the mineral aggregate, made a payment of $ 15,000 to International, and executed a promissory note payable to Lloyd's in the amount of $ 60,000. Dr. Traugh claimed Schedule C deductions for mining development expenses with respect to her participation in the above-described mining venture on her 1981 and 1982 Federal income tax returns in the 441 respective amounts of $ 37,500 and $ 75,000. Respondent disallowed the deductions in full. Petitioner Clione M. Vesely and her brother, Donald D. Vesely, executed a purchase agreement dated December 26, 1982, for 1,000 cubic yards of mineral aggregate in the Cassill mining program. She paid $ 75 to Cassill mines for the mineral aggregate, made a payment of $ 2,500 to International and, together with her brother, executed a promissory note payable to Lloyd's in the amount of $ 20,000. She executed another purchase agreement dated May 9, 1983, for 1,500 cubic yards of mineral aggregate from the Cassill mining program. She paid $ 225 to Cassill mines for the mineral aggregate, made payments of $ 5,090 to International, and executed a promissory note payable to Lloyd's in the amount of $ 20,000. Clione M. Vesely claimed Schedule C deductions for mining development costs on her 1982 and 1983 Federal income tax returns in the respective amounts of $ 12,500 and $ 25,000. Respondent disallowed the deductions in full. OPINION During the years at issue, petitioners in these cases claimed mining development expenses purportedly generated from their participation in three gold-mining 442 programs promoted by International: the Reward Brown mining program, the Cassill mining program, and the Tiedeman mining program. Most of the petitioners were involved in the Reward Brown and the Cassill programs. The programs were similarly packaged. For a minimal sum, a participant acquired a unit of mineral aggregate in the particular mine measured either in tonnage or in cubic yards of aggregate. A cash payment would be made to International together with a promissory note in favor of Lloyd's, an off-shore entity, and the total cash payment and the face amount of the note would be claimed in full as a mining development expense in the initial year of participation in the program. Even though the program highlighted the available deductions as mining development expenses, petitioners now belatedly contend, in the alternate, that the amounts claimed on their returns are deductible as mining exploration expenses. Respondent contends that the International mining programs were shams devoid of economic substance and that the transactions were not engaged in with the requisite profit objective, and, hence, the deductions are not allowable under either of the theories propounded443 by petitioners. Petitioners have the burden of proof. Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933). To qualify under section 616(a), the expenditures must have been paid for the development of a mine or other natural resource (other than an oil or gas well) after the existence of ores or minerals in commercially marketable quantities has been disclosed. To qualify under section 617(a), the expenditures must have been paid for the purpose of ascertaining the existence, location, extent or quantity of ore or other mineral before the beginning of the development stage of the mine. However, for the deduction to be allowable under either section 616(a) or 617(a), the activity giving rise to the expenditure must constitute an activity engaged in by petitioners with the actual and honest objective of making a profit. Horn v. Commissioner, 90 T.C. 908">90 T.C. 908, 932-933 (1988); Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 1117 (1987), affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. sub nom. without published opinion Hatheway v. Commissioner, 856 F.2d 186 (4th Cir. 1988), affd. sub444 nom. Skeen v. Commisioner, 864 F.2d 93 (9th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865">868 F.2d 865 (6th Cir. 1939). It is well established that a transaction entered into solely for tax consequences 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), affg. in part and revg. in part 81 T.C. 184">81 T.C. 184 (1983). A transaction will be recognized, however, if it has economic substance. Estate of Thomas v. Commissioner, 84 T.C. 412">84 T.C. 412 (1985). In deciding whether a transaction has any practical economic effect other than the creation of tax benefits, the consideration of both business purpose and economic substance is relevant to the inquiry. Collins v. Commissioner, 857 F.2d 1383 (9th Cir. 1988), affg. Dister v. Commissioner, T.C. Memo. 1987-217; Sochin v. Commissioner, 843 F.2d 351">843 F.2d 351, 354 (9th Cir. 1988),445 affg. Brown v. Commissioner, 85 T.C. 968">85 T.C. 968 (1985). We have examined the voluminous record in searching for the requisite business purpose on the part of the several petitioners here involved, and we conclude that a sufficient business purpose simply did not exist. Initially, we note that many of the petitioners herein learned about the International mining program through Mrs. Wann, who is also a petitioner here, and in large part relied upon her for information about the programs. At the time of the trial Mrs. Wann, a public accountant, did part-time work preparing tax returns and handling audits. She is an enrolled agent authorized to represent clients before the Internal Revenue Service. Mrs. Wann, in past years, had operated a tax service and bookkeeping service. She sold the bookkeeping practice in 1980. In addition, Mrs. Wann has operated rental properties and has invested in stock including mining stock. She also owns an interest in some 40 mining claims in Nevada. She visited the Reward Brown mining property in or about October 1981 and obtained information about the mines from individuals involved with the mining program. She subsequently obtained446 the Reward Brown private placement memorandum. She contacted one David Pierce with respect to the legal opinion he had prepared for the private placement memorandum. There is no evidence to show that she made any serious effort to make an independent verification of the information she obtained about the mining program. She relied largely on the individuals associated with the mining program, including Dr. Como who was president of International Recovery. Mrs. Wann also visited the Cassill mine property at some point in 1982. Mrs. Wann has never paid any interest on the promissory notes payable to Lloyd's. She understood that the notes were payable from the proceeds of any gold that was mined from her mineral aggregate before the due date of the notes. She was aware of the engineering report dated April 20, 1981, evaluating the Reward Brown mining property. The report, which was included as part of the Reward Brown private placement memorandum, indicated the existence of a pocket of some 200,000 tons of gold-silver ore that would average .8 ounces of gold and 22 ounces of silver per ton and that further drilling would contact ore in "appreciable amounts". She also testified447 that, upon inquiry, she was informed by the program's mining engineer that at least 1,500,000 tons of ore existed in the Reward Brown mining property. Although she testified that she discussed the feasibility of the Reward Brown mining program with several individuals, it appears from the record that such individuals included a broker, an attorney, and two certified public accountants. It does not appear that such individuals had backgrounds in mining. In making her Cassill mining program investments, Mrs. Wann relied upon a report prepared by geologist Mervin F. Lovenberg. She was unsure how the notes would be paid if no gold was produced, stating that "I haven't had to cross that bridge." She did not know who held the promissory notes at the time of the trial. She made no effort to verify her title in the mineral aggregate she acquired from Missouri Mines. When she invested in the Cassill mining program toward the end of the year 1982, no gold had been mined there. She testified that, as of the date of the trial, it was her understanding that at least one unit of aggregate had been processed. Most of the petitioners in these cases were friends or relatives of Mrs. Wann. 448 Petitioner James B. Hodges was introduced to the Reward Brown mine program by a business associate who had purchased a unit in the program. Mr. Hodges had no prior experience in mining investments. Nor did he have any previous mining experience. Mr. Hodges reviewed the private placement memorandum with his accountant. He made no effort to have an attorney or a geologist review any of the documents in the placement memorandum. Mr. Hodges visited the mine site before he made his purchase and observed some equipment there. He discovered that all operations were shut down on the occasion of his second visit to the mine site in May or June, 1982. On his third visit to the mine site in September 1982 he observed equipment and machinery in operation. Mr. Hodges was unaware of the location or specifics of the mineral aggregate which he purchased. Mr. Hodges understood that his $ 40,000 note was to be paid from the proceeds of the sale of the mineral aggregate. He had "no idea" as to who would receive the proceeds from the note. He testified that in any event he did not intend to pay the note. Mr. Hodges did not know when his mineral aggregate would be mined. He did not know how449 many units were sold in the Reward Brown mine and stated that it made no difference to him. Petitioner John W. Rutland, who entered the Reward Brown mining program in December 1981, did not visit the Reward Brown mine in that year. He testified that his return preparer reviewed the Reward Brown private placement memorandum. In making his purchase of mineral aggregate in 1981, Mr. Rutland relied primarily on the material included in the private placement memorandum. He testified that he would not pay the promissory note he had executed in favor of Lloyd's unless he received his ore. Mr. Rutland also made other mining investments in 1980, 1982, and 1983 which also provided him with deductions with a ratio of five to one to his cash investment. The 1982 and 1983 investments were with an entity called Alitolia mines, with financing evidenced by notes in favor of an entity called Columbia Financial. In 1984, Mr. Rutland was offered an opportunity to transfer his two units from Alitolia mines to the Tiedeman mining program upon making an "interest payment". Accordingly, Mr. Rutland made a payment of $ 2,500 to International for each of his two units, or a total of $ 5,000, in or450 about August 1984. As a consequence of the transfer of the two units, he received 2,000 cubic yards of mineral aggregate in the Tiedeman mine. Petitioner A. Gordon Keyes, Jr. learned about the Reward Brown mining program from petitioners Wilbur L. and Patricia R. Rigmaiden. He did not visit the mine before making his purchases of mineral aggregate in 1982 but relied upon Mrs. Wann for information about the mining program. He had no prior mining experience. Mr. Keyes' purchase was reviewed by his tax preparer, one Gregory A. Morrison. Although Mr. Keyes testified that his unit in the program would not be substituted for some other unit, the record shows that he executed an addendum to his purchase agreement on July 7, 1982, giving International the right to make a substitution of mining property. Mr. Keyes testified that he had no idea how International intended to use his payments made to International. Although he was billed for interest payments, on the promissory note, he made no interest payments. He testified that he intended to pay the note when "I got my gold". Prior to his purchase of mineral aggregate in the Tiedeman mining program in 1983, petitioner Charles H. 451 Merrill had no mining experience. He never visited the mine in question. His knowledge of the mining transaction was apparently derived from Mrs. Wann, his mother-in-law. Mr. Merrill was completely unfamiliar with the details of the 1983 transaction. He knew nothing about Lloyd's. He has never made any interest payments on his note. Mr. Riffe was not aware of many aspects of the Reward Brown mining program. He did not know the intended recipient of the proceeds of the Lloyd's note. He testified he did not know who held the Lloyd's note at the time of trial. Mr. Riffe was billed for interest on the note but he never made any interest payments. He did not know that his unit in the Reward Brown mine could be substituted for another unit. He did not know what the mining costs per ton were. Mr. Riffe read the Cassill mines private placement memorandum before he made his purchase of mineral aggregate in the Cassill mining program. He also discussed the program with Mrs. Wann. He did not know that his unit in Cassill mines could be substituted for another unit. Mr. Riffe never visited the Cassill mine property. He discussed the Reward Brown mine with an acquaintance, Mrs. 452 Wann. He reviewed the private placement memorandum and discussed the program with Mrs. Wann. He visited the Reward Brown mine in January 1982 and a second time in June 1983. Petitioner Wilbur L. Rigmaiden learned about the Reward Brown mining program from Mrs. Wann. He had no prior mining experience. Apart from his discussions with Mrs. Wann and reading the private placement memorandum, Mr. Rigmaiden made no further inquiries or investigation into the merits of the Reward Brown mining program. He could not identify the seller of the mineral aggregate and did not know the specific units of aggregate that he purchased. Mr. Rigmaiden was not aware that his units could be substituted, even though he had executed agreements to allow such substitution. He did not question the projected mining costs for his mineral aggregate. Mr. Rigmaiden did not pay any interest on the promissory note he executed in connection with his acquisition of mineral aggregate. It was his understanding that the promissory note would be paid from the proceeds of the gold mined from his unit. He testified that he was bound by the note but that he had no intention to pay the note as of the time of the trial, 453 that he would seek legal advice, and that "right now it's hard to say". Petitioner Per T. Ron learned about the Reward Brown mining program from Mrs. Wann. He read the private placement memorandum and discussed the mining program with Mrs. Wann. He also read a general article about the Reward Brown mine which he received from Mrs. Wann. Mr. Ron also visited the Reward Brown mine property at some point. He also visited the Cassill mine property in July 1984, after he acquired his mineral aggregate there. Mr. Ron has never paid any interest on his promissory note. He did not know who held the notes he had executed, and he did not know whether Lloyd's had funded his particular notes. He purportedly intended to pay the notes when gold was mined from his various units of mineral aggregate. He was not aware that his units in the Reward Brown and Cassill mines could be substituted. Petitioner Lucinda D. Standfest testified that she and her husband learned about International in 1982 through Mrs. Wann. She had no prior mining experience and did not visit the Cassill mine property prior to the initial purchase. She read the Cassill mine private placement memorandum prior to making454 her initial purchase. She testified that "We felt by reading it -- we felt that the mine was commercially profitable." No interest payments were made on the notes executed in part of the participation in the Cassill mining program. She testified that she did not know who held the promissory notes at the time of the trial. She did not know that the units of mining aggregate could be substituted. Dr. Jolinda A. Traugh learned about the Reward Brown mining program from one Sue Robinson who was acquainted with Mrs. Wann and had previously made an investment in the Reward Brown mining program. At some time in December 1981, Dr. Traugh obtained a private placement memorandum which she admitted she did not read very carefully. She made no effort to independently investigate the merits of the mining program. She never made interest payments on the promissory notes even though she had been billed on occasion. She did not know what the funds she advanced to International were used for specifically. Petitioner Clione M. Vesely is Mrs. Wann's sister. She never visited the Cassill mining property where she had purchased mineral aggregate in 1982 and 1983, and she made no effort to investigate455 the mining program. She relied for the most part on her sister for information regarding the program. She paid no interest on the promissory notes executed by her. She did not know that the mineral aggregate she purchased could be substituted. She could not recall receiving any assay reports with respect to her units of aggregate. In short, the record demonstrates a complete failure by petitioners to make a proper evaluation of the mining programs and a marked indifference to the profit aspects of the various mining programs in which they took part. Their readiness to accept with no apparent reluctance an obligation of a royalty of 60 percent of the total gold and silver bullion produced from their mineral aggregate, their willingness to purchase a unit of mineral aggregate at some undeterminable location, and their willingness to accept the entire International package without negotiation and without questioning the reasonableness of the projected mining costs or the validity of the estimated income potential from their mineral aggregate belie a business purpose on the part of petitioners in entering these transactions. Since it appears from the record that petitioners had456 little or no prior mining experience, their somewhat casual approach to the economic soundness of their investment strongly suggests that they entered the transactions solely for tax purposes. The focus upon tax benefits heralded in the private placement memoranda describing the mining programs supports this conclusion. Purchasers of mineral aggregates were promised a tax advantage of five to one, and a 6-page tax opinion concluding that the mining development costs were fully deductible in the year in which the purchasers invested in the mining program was included in the private placement memoranda. A schedule showing the deductible development costs keyed to the number of units acquired by a purchaser in a mining program is also featured in the private placement memoranda. Moreover, an analysis of the mining properties as well as the proposed plans to mine the properties is persuasive evidence that the transactions here involved were not realistically conducive to an economic profit. Dr. Charles P. Miller, a consulting geologist in mining geology and mineral exploration, testified as respondent's expert witness. Dr. Miller made a detailed examination of the Reward Brown mine457 and the relevant mining claims and concluded that no economic or commercially marketable mineralization had been delineated on the Reward Brown mining claims and that no development work had been done by International at the Reward Brown mine. During his extended field examination of the Reward Brown mine, Dr. Miller studied outcrops, prepared a map of the existing tunnels on the property to show the extent of mining, and mapped the geology in the tunnel. He also examined available assay results which indicated that the grade of gold in the area to be mined by International was not economic to mine during the period here relevant. Dr. Miller described the ore deposit at the Reward Brown mine as an epithermal gold system and that economic gold values in a vein system of that type would commonly bottom out. The Reward Brown mines have previously been intermittently mined for many years. Dr. Miller testified that "a lot of what had been originally in that vein system has already been mined out". Commercially marketable ore requires proven or measured ore, which is ore that has been defined in three or four dimensions and has been systematically sampled and assayed and determined458 to be economically feasible. Dr. Miller took field samples during his field examination of the Brown Reward mine. The assays on such samples ranged from .002 ounces per ton to .610 ounces per ton. Three samples were from older Brown Reward workings and three samples came from the tunnel into the mine constructed by International. Only one sample indicated more than .1 of an ounce per ton or economically viable to mine. Dr. Miller testified that the estimates of some 200,000 tons of ore that appeared in the Reward Brown placement memorandum were estimates of potential ore and not proven ore. Dr. Miller also made a field examination of the Cassill mine property and examined relevant court records to ascertain the status of patented and unpatented claims. Dr. Miller testified at the trial, that on the basis of his field examination and on the basis of patent records from the Bureau of Land Management made available to him after his report on the Cassill mine program was prepared, that there is no commercially marketable ore at the Cassill mine. Finally, Dr. Miller made a field examination of the Tiedeman mine property and examined court records with respect to the patented claims459 on the property. Based upon his observations on the property and prior geology reports done on the property, Dr. Miller concluded that no commercially marketable ore has been proven or established on the Tiedeman mine property. Dr. Miller noted that although the Tiedeman property had been mined in the past, he was not aware of records that would establish definite grade and tonnage of ore. He further noted that placer deposits are difficult to explore, and proven reserves are verified only after extensive testing. Robert L. Hamilton also testified as respondent's expert witness with respect to the Reward Brown mine program, the Cassill mine program, and the Tiedeman mine program. Mr. Hamilton inspected the Reward Brown mine in December 1982 and examined the tunnel constructed by International which was intended to intersect the vein system of the older mine workings at a higher level. At some later date, International supplied Mr. Hamilton with a plan map displaying the investors' lots with respect to the ore veins on the Reward Brown property. Mr. Hamilton concluded that the map did not reflect the true nature of the vein dips and was misleading. Mr. Hamilton testified that460 he was unable to find any criteria which showed proven ore beyond the ore workings from prior years. He stated in his report on the Reward Brown mine that he was provided no proof of the estimate 200,000 tons of ore averaging .8 ounces of gold per ton as claimed by International in the relevant Reward Brown private placement memorandum. Mr. Hamilton also inspected the Cassill mine property early in 1984. Virtually nothing had been done in the way of development of the property. Some preparation had been made to construct an underground tunnel and some equipment was at the site. Mr. Hamilton inspected the Tiedeman mine property in mid-1985. Some earth-moving equipment was on the site and it appears that a small amount of the gravel had been exposed and that the trammel was in operation. No data was made available to Mr. Hamilton to indicate the existence of any commercially marketable ore body on the Tiedeman mine property. Mr. Hamilton stated in his report that it was quite obvious during his mid-1985 inspection that the mine openings on the Tiedeman mine property had recently been cut and that the plant had seen little use. Mr. Hamilton also stated in his report that, based461 upon his observations of the limited amount of aggregate that had apparently been treated at the time of his visit to site, he was not convinced that the Tiedeman mining program was an on-going operation. Mr. Hamilton testified with respect to the Tiedeman mining property that he was not shown any data which at that time indicated the existence of a commercially marketable ore body. In determining the economic feasibility of these transactions, we have also considered the opinions of petitioners' expert witnesses. We do not find such opinions helpful and, in any event, we are not bound by the opinions proffered by expert witnesses. See Silverman v. Commissioner, 538 F.2d 927">538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo. 1974-285; Chiu v. Commissioner, 84 T.C. 722">84 T.C. 722, 734 (1985). R. W. McComas, a consulting geologist, testified as petitioners' expert witness. Mr. McComas inspected the Tiedeman gold placer mine property in November 1983 for the purpose of determining the potential gold deposit. His geological report dated November 26, 1983, which was included in the Tiedeman mine private placement memorandum, made no determination 462 of the amount of proven ore or the economic value of the ore in the Tiedeman mine. Mr. McComas was retained to conduct and supervise an exploration program on the Tiedeman mine property from May 5, 1984, to May 15, 1984. His purpose was to determine the extent and amount of gold-bearing gravel in the channel existing on the leased property and to determine the economic value of the deposit. Mr. McComas drilled 14 holes, 8 of which penetrated the channel. Assays of the samples ranged from no trace of gold to 1 ounce of gold per ton. In his 1984 report Mr. McComas estimated that 2,750,000 cubic feet of placer material existed in the Tiedeman property channel. However, he also estimated that only 82,500 tons of potential gold-bearing placer material was available. Mr. McComas, using assays from drill hole samples and taking into consideration the value of historic production of placer deposits in the Sierra, estimated a minimum average value of 0.35 ounces of gold per ton in the area that was drilled. Mr. McComas also noted in his 1984 report that accurate values could only be obtained by large tonnage bulk sampling. Dr. Miller testified that the spacing of the drilling program463 conducted by Mr. McComas was not a proper sampling method to estimate the commercially marketable ore in the area. Mr. Kent Ausburn, a geologist, also testified as petitioners' expert witness. Mr. Ausburn testified generally as to the factors that may justify exploration for minerals. He inspected the Reward Brown mine site and examined prior reports dealing with the mineralization in the area. He inspected the tunnel in the side of the mountain, but he testified that he "did not really have time to do any kind of real work underground". He concluded that a viable exploration program was being conducted. He was unable to make any estimate of the ore tonnage revealed as a result of the tunneling work undertaken by International. As to the grade of the gold mineralization Mr. Ausburn relying in large part on assays of prior sampling activities, testified that it averaged a little over .1 ounce per ton. He indicated that the results of such assay were well below ore grade materials. He also indicated that the ore produced for the Reward Brown mine during the earlier periods of its main production was in the range of about .5 ounces per ton. A considerable portion of the earlier464 reports used by Mr. Ausburn on the quality of ore deposits at the Reward Brown mine was based on work done prior to 1940. In his conclusion Mr. Ausburn relied on tonnage figures and ore quality figures contained in the Reward Brown private placement memorandum. We find nothing persuasive in the expert opinion proffered by petitioners' expert witness which would support a finding that the mining programs here at issue offered a realistic profit potential. The lack of any economic validity of the Reward Brown mines is underscored by the testimony of Paul Skinner who had previously mined in the older working at the higher level of the Reward Brown mines. He testified that he stopped mining because it was not economical. He testified that to his knowledge no one seriously mined the property between 1956 and the date it was leased by International. Mr. Skinner had also assayed several hundred samples for International from the Reward Brown property and never found anything that exceeded .1 ounces per ton. With respect to the engineering report in the Reward Brown private placement memorandum estimating a pocket of 200,000 tons of ore that should average .8 ounces of gold per ton, 465 he stated that "It's someone's pipe dream." He also expressed suspicion with respect to the estimate of 200,000 tons of gold-silver ore indicated in the Reward Brown placement memorandum. He also described the estimate that drilling would establish a minimum of 700,000 tons of gold-silver ore that would average in excess of .4 ounces of gold per ton and 10 ounces of silver per ton as "a fantasy". A compilation of assays was done by Mr. Skinner for a former owner of the property from samples taken on the Reward Brown property over a period of some 20 or 30 years in very divergent locations. One sample is from tailings, which are left over from the milling process. His report was included in the Reward Brown placement memorandum and when Mr. Skinner discovered this, he notified Mr. Valentine to remove the report as unauthorized. We also note that although a series of reports issued by International in 1982 and 1983 alleged that a new gold vein had been discovered in the International adit (tunnel) at the Reward Brown mines and that a complicated system of gold bearing veins had been intersected, a subsequent report in early 1984 indicated that the International engineers had been466 premature in reporting that the main vein system had been struck and that the ore did not contain values sufficiently concentrated to warrant refining. The structure of the financing for the contemplated mining costs is also a relevant consideration in determining whether the transactions had economic substance. Here, the bulk of the purported mining costs in each of the three mining programs was to be financed through the execution of promissory notes by the purchasers of mineral aggregate in favor of Lloyd's, an off-shore corporation, and the subsequent funding of such mining costs by Lloyd's. The existence of Lloyd's is shrouded in obscurity. The record is not clear as to the location of the notes as of the time of trial. Moreover, the record is singularly unclear as to the extent of the actual funding provided by Lloyd's. Nor does the record show when, if at all, the notes were funded. None of the petitioners here involved received any gold mined from their aggregates. Moreover, with the exception perhaps of a single unidentified investor in these mining programs, none of the hundreds of investors in such programs obtained any gold. In determining the economic substance467 of the International mining programs, the very structure of the programs suggests the absence of any valid economic substance. International, which was chosen by all the petitioners as mining contractor, had no discernable mining experience. Mr. Como, the president of International and ostensibly the driving force behind the mining program, had a background in documentary films. He had no actual mining background in 1981. Mr. Whitley, the International executive who became president of Cassill mines, had no mining background. Finally, the economic substance of the International mining program promotions is markedly dubious in view of the actions brought against International and Mr. Como in 1985 by the SEC and early in 1986 by the Department of Justice. Pursuant to the SEC action, International and Mr. Como consented to an order of permanent injunction which provided in pertinent part that International would not obtain money or property by making untrue statements or omitting necessary material facts concerning the use of proceeds from the sale of its securities, the quantity of gold and silver available to be mined by the issuer of said securities, the prospects for obtaining468 substantial tax benefits by investing in said securities, and the existence of third party loans to investors buying any such securities. With respect to the Department of Justice action, a final judgment of permanent injunction pursuant to a consent order, enjoined International and Mr. Como from participating in the marketing of tax shelters. In general, the final judgment enjoined International from organizing or assisting in the sale of a plan in which false statements were made with respect to the deductibility of mine development expenses, the existence of third party financing, the use of funds for mine development, and the opportunity for profit in the programs, and in which gross valuation overstatements were made with respect to the value of ore contained in the mining claims. For these reasons and upon consideration of the entire record, we conclude that the International mining transactions here involved were entered into by petitioners solely for tax benefits and were completely lacking in any discernible economic substance. In short, the transactions were a sham. Consequently, they will not be recognized for Federal income tax purposes. We so conclude. In view469 of our conclusion, we need not consider other arguments made by the parties. We therefore hold that the petitioners in these cases are not entitled to the deductions they claimed in the years at issue with respect to their participation in the International mining programs. Respondent is sustained. Nor is there any merit in the argument made by some of the petitioners herein that some portion of the expenditures incurred is deductible under the provisions of section 165(a). Section 165(c), which applies in the case of individual taxpayers, limits losses under section 165(a) to those incurred in a trade or business or profit-motivated transactions and to casualty losses, including theft losses, incurred by such taxpayers. We find nothing in this record which would support a theft loss. In essence, the payments here involved were made to purchase a package of purported tax benefits with the attendant risks. Petitioners took these risks voluntarily and received exactly what they paid for. Under these circumstances, we must conclude that no loss deduction is warranted under section 165(c)(3). Horn v. Commissioner, 90 T.C. 908">90 T.C. 908, 940-941 (1988); see Secoy v. Commissioner, T.C. Memo 1987-286">T.C. Memo. 1987-286,470 affd. without published opinion 869 F.2d 1498">869 F.2d 1498 (9th Cir. 1989). Moreover, since we have concluded that petitioners' activities with respect to the mining programs lacked economic substance, we must reject petitioners' remaining arguments sketchily made under the provisions of sections 165, 167, and 168. In the absence of any proven trade or business or profit-motivated activity engaged in during the period at issue, these statutory provisions simply do not apply. In docket No. 14473-88, petitioner John T. Rutland claimed a deduction of $ 5,000 on Schedule C of his 1984 tax return as interest expense. The business activity was identified as Alitolia Mining, purportedly gold mining. No other information appears on Schedule C. In his petition, Mr. Rutland alleges that he paid $ 5,000 to International for mining and development of his mineral aggregate at the Tiedeman mining program. Mr. Rutland testified that in 1984 he was permitted to switch two blocks of mineral aggregate from Alitolia Mining to the Tiedeman mining program upon making an "interest payment" of $ 5,000. It would appear that this payment was actually intended as a purported mining and development471 expense and, under our holding above, such expenditure is disallowed. In any event, on the basis of this confusing record, we are unable to conclude that this payment was paid on a genuine indebtedness in order to be deductible as interest under section 163(a). See Hager v. Commissioner, 76 T.C. 759">76 T.C. 759, 773 (1981). Thus, whether this enigmatic deduction is labeled as a mine development expense or as interest, the result is the same. We sustain respondent's disallowance of this deduction claimed by Mr. Rutland in 1984. Sections 6653(a) and 6653(a)(1) impose an addition to tax if any part of an underpayment of tax is due to negligence or intentional disregard of rules or regulations. Section 6653(a)(2) provides for an addition to tax in an amount equal to 50 percent of the interest on the portion of the underpayment attributable to negligence. Negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). No useful purpose would be served in discussing separately all of the petitioner-investors here involved. We have fully472 described above the circumstances attendant upon each petitioner's involvement with the International mining programs and we perceive no need to do so again. With minor exceptions the procedures followed by petitioners in entering into the mining programs are markedly similar. For the most part, petitioners demonstrated a studied indifference to the economic plausibility of the gold mining programs with which they became involved. Petitioners generally accepted the packaged programs with little more than the assurances of an accountant, a return preparer, a relative or an acquaintance. There is scant evidence in the record as to the advice, if any, petitioners obtained from these sources. Nor is there anything in the record to establish a good faith reliance upon such advice or that the individuals dispensing such advice were in fact competent to do so. Even though they lacked any prior mining experience, petitioners made no serious effort to inquire into the economic aspects of the gold mining ventures. Given their lack of mining experience, petitioners' purported reliance on the contents of the private placement memoranda is not, standing alone, tantamount to due care. It473 does not appear that they seriously questioned any of the salient features of the mining programs, such as the willingness of an unfamiliar off-shore entity to fund their substantial amounts of mining and development costs with no apparent concern for their credit worthiness. Nor did the absence of any identifiable unit of mineral aggregate, which was the indispensable ingredient of their investment in their particular gold mining program, appear to generate any concern or doubts as to the economic merit of the programs. In short, petitioners' actions show an absence of any diligent and good faith effort to investigate the soundness of the mining programs. The failure of petitioners to make a meaningful investigation beyond the promotional materials supplied by the sales people or to consult independent knowledgeable advisors was not reasonable or in keeping with the standard of the ordinarily prudent person. See LaVerne v. Commissioner, 94 T.C. 637">94 T.C. 637, 652-653 (1990), affd. by unpublished opinion sub nom. Cowles v. Commissioner, 949 F.2d 401">949 F.2d 401 (10th Cir. 1991), affd. without published opinion 956 F.2d 274">956 F.2d 274 (9th Cir. 1992). On474 this record, we conclude that petitioners are liable for the additions to tax under sections 6653(a), 6653(a)(1) and (2). See also Howard v. Commissioner, 931 F.2d 578">931 F.2d 578, 582 (9th Cir. 1991), affg. T.C. Memo 1988-531">T.C. Memo. 1988-531. Respondent determined additions to tax under section 6661(a) which respect to several of the petitioners for the taxable years and in the amounts as stated above in our findings of fact. 2With respect to returns filed after December 31, 1982, section 6661(a) imposes an addition to tax equal to 25 percent of any underpayment of tax attributable to a substantial understatement of income tax. Pallottini v. Commissioner, 90 T.C. 498">90 T.C. 498 (1988). A substantial understatement is one that exceeds the greater of either 10 percent of the tax required to be shown on the return or $ 5,000. Sec. 6661(b)(1). The amount of the understatement may be reduced by an amount for which there was substantial authority for the treatment adopted by taxpayer on his return. Sec. 6661(b)(2)(B)(i). This reduction is not available in the case of a tax shelter unless in addition the taxpayer reasonably believed that the claimed tax treatment475 was "more likely than not" the proper tax treatment. Sec. 6661(b)(2)(C)(i)(II). For this purpose, section 6661(b)(2)(C)(ii) defines a tax shelter as any partnership or other entity or investment plan or arrangement the principal purpose of which is the avoidance or evasion of Federal income tax. Here we have found on the basis of the entire record that the International mining programs were shams without any economic substance. Claims based upon unreal or economic sham476 transactions are not recognizable for tax purposes. Knetsch v. United States, 364, U.S. 361, 369 (1960); Horn v. Commissioner, 90 T.C. 908">90 T.C. 908, 943 (1988). In view of the substantial tax benefits promised to purchasers of mineral aggregates in the mining programs, and the complete absence of any economic feasibility in the proposed mining activities, we find that the principal purpose of the programs here at issue was tax avoidance. Hence, the mining programs are considered tax shelters for section 6661 purposes. Sec. 6661(b)(2)(C)(ii); sec. 1.6661-5(b)(1), Income Tax Regs. We know of no authority that would support the positions taken by petitioners inasmuch as we have held that their participation in the mining programs was motivated solely by the tax benefits offered. See sec. 1.6661-3(b), Income Tax Regs. Moreover, we are convinced on this record that petitioners did not believe that the tax treatment on their returns was more likely than not the proper tax treatment. In view of the casual approach taken by petitioners to their supposed gold mining activity, the suspect method of financing, the mining and development costs gained through the device 477 of a promissory note which was henceforth ignored by everyone, the failure to monitor the mining programs except perhaps in some superficial fashion, all belie their professed desire to make a profit. As far as we can determine, they firmly believed only in the viability of their tax benefits. On this record, therefore, we hold that petitioners in the cases enumerated above in footnote 2 are subject to the additions to tax under section 6661(a). Section 6621(c) 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". 3 The increased rate of interest applies to interest accrued after December 31, 1984, even though the transaction was entered into prior to the enactment of the statute. Solowiejczyk v. Commissioner, 85 T.C. 552 (1985), affd. without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986). The term "tax motivated transaction" includes any "sham or fraudulent transaction". Sec. 6621(c)(3)(A)(v). The statutory language encompasses transactions, such as the International mining programs involved in these cases, 478 which are without business purpose and lack any opportunity for profit. Cherin v. Commissioner, 89 T.C. 986">89 T.C. 986, 1000-1001 (1987). Consequently, with respect to the underpayments involved in these cases attributable to the disallowed deductions incurred in connection with the International mining program transactions, the increased rate of interest applies. See sec. 6621(c)(1). Respondent is sustained on this issue. Decisions will be entered under Rule 155 in the following cases: docket No. 24835-85; docket Nos. 25210-85 and 14473-88; docket No. 20740-86; docket No. 21253-86; docket No. 22618-86; docket No. 16622-87; docket Nos. 20215-87 and 25636-88; docket No. 5602-88, and docket No. 13148-86. Orders will be issued restoring the following cases to the general docket for disposition of remaining issues: docket No. 43317-86; and docket Nos. 32627-87 and 39041-87479 . Footnotes1. The following cases were consolidated for trial, briefing, and opinion: A. Gordon Keyes, Jr. and Barbara J. Keyes, docket No. 22618-86; Charles H. Merrill and Bernadette R. Merrill, docket No. 16622-87; Stanley M. Riffe and Phyllis W. Riffe, docket No. 20740-86; Wilbur L. Rigmaiden and Patricia R. Rigmaiden, docket No. 5602-88; Per T. Ron and Sonja Ron, docket Nos. 20215-87 and 25636-88; John W. Rutland, docket Nos. 25210-85 and 14473-88; Richard F. Standfest and Lucinda D. Standfest, docket No. 43317-86; Jolinda A. Traugh, docket No. 13148-86; Clione M. Vesely, docket No. 21253-86; James F. Wann, Jr. and Lavonne M. Wann, docket Nos. 32627-87 and 39041-87.↩1. By Amendment to answer,respondent claimed an increased addition to tax under section 6661(a)↩ from 10 percent to 25 percent (or $ 2,135.50).2. The sec. 6661(a) issue has been raised in the cases involving Jolinda Traugh (1982 and 1983), A. Gordon Keyes, Jr. and Barbara J. Keyes (1982), Richard F. Standfest and Lucinda D. Standfest (1982 and 1983), Per T. Ron and Sonja Ron (1982 and 1983), James F. Wann, Jr. and Lavonne M. Wann (1982 and 1983), Wilbur L. Rigmaiden and Patricia R. Rigmaiden (1982), and Stanley M. Riffe and Phyllis W. Riffe (1982). In those instances where respondent has raised the sec. 6661(a) issue in the amended answer, respondent has the burden of proof. Rule 142(a)↩.3. In those cases where respondent raised the sec. 6621(c) issue by amended answer, respondent has the burden of proof. Rule 142(a)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625565/	FIFTH THIRD UNION TRUST CO., TRUSTEE UNDER THE WILL OF JACOB G. SCHMIDLAPP, DECEASED, TRUST FUND NO. 1340, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. FIFTH THIRD UNION TRUST CO., TRUSTEE OF THE CHARLOTTE R. SCHMIDLAPP FUND, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. FIFTH THIRD UNION TRUST CO., TRUSTEE OF A TRUST FUND UNDER DEED OF TRUST OF JACOB G. SCHMIDLAPP, DESIGNATED FUND NO. 1163, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. EDGAR STARK, EXECUTOR, ESTATE OF JACOB G. SCHMIDLAPP, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Fifth Third Union Trust Co. v. CommissionerDocket Nos. 26127-26130, 36836.United States Board of Tax Appeals20 B.T.A. 88; 1930 BTA LEXIS 2205; June 16, 1930, Promulgated 2205 1. Where respondent determines a tax on the income received by a trustee under a will from property coming into such trustee's hands under the will, but sends a deficiency notice to the executor, who was a different person from the trustee, and the trustee files with the Board a petition from such notice, the proceeding will be dismissed for lack of jurisdiction. 2. Held that the trusts here involved are not exempt from taxation under the provisions of section 231(6) of the Revenue Act of 1921. 3. Held that the petitioners are not entitled to the deductions taken in their returns for income claimed to have been permanently set aside for charitable and educational purposes under the provisions of sections 219(b) and 214(a)(11) of the Revenue Act of 1921. 4. Where petitioner at the time of filing its return contended that its income was either exempt from tax under section 231 of the Revenue Act of 1921, or was deductible under the provisions of sections 219(b) and 214(a)(11), and did not report any tax on the return, held that it is entitled to have the profits on the sale of corporate stock held for profit or investment for a number of years taxed under the2206 provisions of section 206, although not so claimed in its original return. 5. The action of the respondent in disallowing a deduction taken for executor's commission approved for lack of evidence. Benjamin H. Saunders, Esq., and J. L. Lackner, Esq., for the petitioners. Maxwell E. McDowell, Esq., for the respondent. TRAMMELL 89 These proceedings which were consolidated for hearing are for the redetermination of deficiencies as follows: Abbreviated titleDocketNo.YearDeficiencyTrust Fund No. 1340261271922$ 705.27Charlotte R. Schmidlapp fund261281922667.5336836192314,341.83Fund No. 116326129192229.30Estate Jacob G. Schmidlapp26130192288.68192336.26The matters in controversy are (1) whether the Board has jurisdiction of the proceeding in Docket No. 26127, (2) whether the petitioners are exempt from taxation under the provisions of section 231(6) of the Revenue Act of 1921, (3) if the petitioners are not exempt from taxation, then whether their entire income during the years involved has been paid or permanently set aside for charitable or educational purposes2207 and is deductible in accordance with the provisions of section 214(a)(11) and 219(b) of the Revenue Act of 1921, (4) if the Charlotte R. Schmidlapp Fund is not exempt from taxation and its entire net income is not deductible, then whether the respondent erred in not computing the tax on the profit from the sale of certain corporate stock in 1923 under the capital net gain provisions of section 206 of the Revenue Act of 1921 and (5) whether the amount of $5,880.04 taken as a deduction in the 1923 return of the estate for executor's commission is allowable. FINDINGS OF FACT. By a trust agreement dated February 18, 1907, Jacob G. Schmidlapp created a trust fund known as the Charlotte R. Schmidlapp 90 Fund. The Union Savings Bank & Trust Co. of Cincinnati, Ohio (now the Fifth Third Union Trust Co.), which was made trustee, designated this fund as Trust No. 774. The trust agreement is in part as follows: I, Jacob G. Schmidlapp, in consideration of the duties and obligations hereby imposed upon and assumed by The Union Savings Bank and Trust Company, of Cincinnati, Ohio, as Trustee, in memory of my daughter, Charlotte, hereby give, transfer and deliver to said The Union2208 Savings Bank & Trust Company the following personal property, to-wit: Five hundred (500) shares of the Preferred Stock of The National Water Company, Five hundred (500) shares of the Common Stock of The National Water Co., One hundred and seventy-five (175) shares of the Preferred Stock of The American Hominy Company, Five hundred and twenty-five (525) shares of the stock of The North American Company, Fifty thousand ($50,000) Dollars of The Cincinnati, Lawrenceburg and Aurora Electric Railroad Company 5% First Mortgage Bonds, Thirty thousand ($30,000) Dollars of The Havana Electric Railroad Company 5% Consolidated Gold Bonds, To have and to hold the same, with any additions thereto, in trust, for the following uses and purposes; to collect any and all income thereon; to sell and transfer any part or all of said property, at such time and price as, in its judgment, will be to the advantage of said trust estate; to invest and reinvest, from time to time, the proceeds of such sales, or any additions thereto, in such property, real or personal, as, in its discretion, it may deem best, and, generally, to exercise full and absolute power and control over said property, and2209 to pay the net income thereof as herein provided. The net income derived from said property, as herein provided, or any contribution thereto by said Jacob G. Schmidlapp, shall be used in aiding young girls in the preparation for womanhood, by bringing their minds and hearts under the influence of education, relieving their bodies from disease, suffering or constraint, and assisting them to establish themselves in life, and Beginning January 1st., 1908, three thousand ($3,000) dollars per annum of the net income shall be used for such purpose, the balance of the income to be added to the principal. The amount of the income to be applied each year to the purposes of this trust is to be increased at the rate of Five hundred ( $500) dollars per year, until the amount to be used shall reach Six thousand ($6,000) dollars per year, after which the amount of the income to be distributed each year shall not be increased until the amount of the principal fund reaches Four hundred thousand ($400,000) dollars, after which, Ten thousand ($10,000) dollars per year shall be distributed for the purposes of this trust, and thereafter, as the principal fund is increased by One hundred thousand2210 ($100,000) dollars, the amount of the income distributed shall be increased by Twenty-five hundred ($2500) dollars. In each case, all excess of income over the amount distributed shall be added to the principal fund, until the principal fund shall reach the sum of Two million ($2,000,000) dollars, after which the Committee may, at its discretion, distribute the total annual income thereof as herein provided, or it may continue to increase the amount to be distributed at the rate of Twenty-five hundred ($2500.) dollars per year, as the principal fund is increased by One hundred thousand ($100,000) Dollars, adding the surplus income from year to year to the principal fund. 91 A Committee, consisting of five of the Directors of The Union Savings Bank & Trust Company, to be appointed yearly, or as vacancies may occur, by the Board of Directors of said The Union Savings Bank and Trust Company, together with the Mayor of the City of Cincinnati, and the President of the University of said city, shall have control of the distribution of said income. And said Committee and its successors shall adopt such rules and regulations as it may, from time to time, deem necessary to properly2211 govern and carry out the charity herein established. Said Jacob G. Schmidlapp hereby reserves the right, at any time or from time to time, during his life, to change or amend the conditions of this agreement as to the use and disposition of the income derived from said trust fund; such changes or amendments shall be in writing, and shall take effect upon receipt of the same by The Union Savings Bank and Trust Company, as Trustee. * * * The Union Savings Bank & Trust Company, as Trustee, shall not be responsible for any depreciation in any of the securities herein mentioned, or securities or property in which funds derived from the sale thereof may be reinvested by it from time to time in good faith, or for any loss of any kind not occasioned by its own gross negligence or bad faith. Purchasers, corporations and transfer agents are not required to look beyond the authority hereby given to said Trustee, nor to the proper disposition or disposal of the funds, proceeds or property herein referred to. On May 23, 1910, Schmidlapp amended the trust agreement as follows: I, Jacob G. Schmidlapp, in pursuance of the right reserved in the Trust Agreement between myself and The Union2212 Savings Bank and Trust Company, under date of February 18th, 1907, establishing The Charlotte R. Schmidlapp Fund, and in order to render the same more definite and certain, do hereby declare that all salaries, expenses and costs incurred in the distribution of said Fund, and in carrying out the trust established, shall be paid out of the amounts which said agreement specifies shall be set aside each year, to be used for the purposes of said trust. Furthermore, it is my desire, without, however, making it mandatory, that the expenses of administration in any year shall not exceed ten (10) per cent of the amount set aside in that year for distribution. The total net income of this trust fund was $22,527.05 for 1922 and $80,328.61 for 1923. By an agreement dated July 3, 1916, Schmidlapp placed another trust fund in the hands of the Union Savings Bank & Trust Co. of Cincinnati as trustee. The trustee designated this fund as Trust No. 1163. The trust agreement reads in part as follows: This Indenture made this 3rd day of July 1916, between Jacob G. Schmidlapp of Cincinnati, Hamilton County, Ohio, party of the first part hereinafter called the Donor, and The Union Savings Bank2213 and Trust Company, a corporation organized and existing under the laws of the State of Ohio, having its principal place of business at Cincinnati, Ohio, hereinafter called the Trustee, Witnesseth: That the Donor in consideration of the sum of one dollar to him in hand paid by the Trustee, the receipt whereof is hereby acknowledged, and in 92 consideration of the mutual covenants hereinafter set forth, has sold, assigned, transferred and set over and by these presents does sell, assign, transfer and set over unto the Trustee and its successors and assigns the following described property, to wit: Twelve hundred and thirteen (1213) shares of the Capital Stock of the North American Company, of a par value of One hundred ($100.00) dollars per share. TO HAVE AND TO HOLD the same, together with any and all other property that may hereafter be added hereto, unto the Trustee, its successors and assigns. IN TRUST NEVERTHELESS, and for and upon, the following uses and purposes, and subject to the terms, conditions, powers and agreements hereinafter set forth and declared. FIRST: To hold, manage and control, invest and reinvest, the same and any other properties, securities2214 or monies which may be held hereunder as hereinafter provided for, collecting the income thereof and after payment of all charges and expenses of administration of said Trust, to use the net income thereof for educational and charitable purposes as the Trustee by its duly authorized officers, may deem advisable and proper, and pay the same or any part or portion thereof from time to time to such person, persons, charitable organizations, associations, or corporations duly organized for charitable or educational purposes, for relief in sickness, suffering and distress, the care of young children and the aged or the helpless and afflicted, for the promotion of education, to improve living conditions and/or for the good and welfare of State or Nation in emergencies. SECOND: Injudicious charity having a tendency to take from men the incentive of self-support, making of such pensioners on the bounty of others, and desiring as much as possible to avoid such abuse, it is hereby mutuallyagreed that the Trustee or its successors has full power, authority and discretion in the use of the income, and may from time to time withhold all or any portion of said income or accumulate the same and2215 add to the principal fund such portion, portions, or all of said income as it may deem advisable. THIRD: The Trustee may at any time cause to be formed a corporation if it so desires, for the purpose of following the conditions of this Trust, and transfer thereto, all the securities, monies or property held hereunder subject to the Trusts herein expressed, but in case such corporation shall be formed, the Directors from time to time, of The Union Savings Bank and Trust Company, or its successor or successors, shall with such other person or persons if any, as may be required by law, be Trustees or Directors of said Corporation. FOURTH: The Trustee shall at all times, and from time to time, have full power and authority, and entirely in its discretion, by its duly authorized officers, to sell, assign and transfer, exchange, invest or reinvest, any or all of the above mentioned stock, or any other property that at any time may be taken under the terms of this Trust, to convert personal property into real estate and real estate into personal property; and to execute and deliver sufficient assignments, releases or satisfaction of bonds and mortgages or other securities; to sell and2216 convey and or to lease for a term with or withot privilege of purchase, or in perpetuity any real estate at any time held under this Trust, and to execute, acknowledge and deliver good and sufficient deed or deeds of conveyance, or lease or leases therefor, and no purchaser, corporation, transfer agent or person, need look beyond the authority herein given it for power so to act, nor look to the proper application of the purchase money, property or securities, nor look to the proper disposition of the division or 93 disposal of fund or property, nor inquire into the validity, expediency or propriety of any such sale, lease, exchange or assignment. The Trustee is further authorized and empowered to vote in person or by proxy, all shares of stock held hereunder whenever occasion may arise or consent to the reorganization and consolidation of any corporation, or sale to any other corporation or person of the property of any corporation, the stocks, bonds or securities of which are held hereunder, and to do any act with reference to said stocks, bonds or other securities necessary or proper to enable the Trustee to obtain the benefit of any such reorganization, consolidation2217 or sale for such stocks, bonds or other securities so held, and in case any stocks, bonds or other securities shall contain options to holders thereof, to convert the same into other stocks, bonds or securities, or in case the right shall be given to any of the holders of stocks, bonds or securities, to subscribe for additional stocks, bonds or other securities, the Trustee is hereby authorized and empowered to exercise such option and to make any necessary payments therefor, and to hold such securities as investments of such Trust Fund, or to take advantage of any rights in any manner which to it seems for the best interest of the Trust Estate. The Donor expressly reserves to himself the privilege of increasing the principal of the Trust Estate at any time by adding thereto such stocks, bonds, securities, monies or real property as he may elect, and the same are to be held, managed and controlled as provided herein. In case of securities taken or purchased for said Trust Fund at a premium, the Trustee shall not be bound to set aside any part of the income thereof as a sinking fund to retire or absorb such premium, nor be liable for the loss or depreciation of any securities2218 held hereunder, nor be liable or responsible for the loss or depreciation of any fund or securities received, or investments and reinvestments made hereunder, and shall not be liable for any mistake in judgment, or decrease in value of the Trust Property, or for any acts or omissions done or permitted to be done by it in good faith, but shall be liable only for acts or omissions done or permitted to be done by it in bad faith or through its gross negligence. FIFTH: The Donor further expressly reserves to himself the privilege at any time or times during his life, to designate to whom, or for what purpose, and the amount that payments of the income shall be made. SIXTH: Notwithstanding anything to the contrary herein contained, the Donor at any time or times during the continuance of the Trust herein provided for, may, by instrument in writing, executed and acknowledged or proved by him, in the manner required for a deed of real estate (so as to enable such deed to be recorded in the State of Ohio) delivered to the Trustee or its successors, modify or alter in any manner, or revoke in whole or in part, this indenture, and estates and interest in property hereby created and provided2219 for, and in case of such revocation, said instrument shall direct the disposition to be made of the Trust Funds affected by such revocations, and upon delivery of such instrument to the Trustee or its successors, the said instrument shall take effect according to its provisions and the Trustee or its successors shall make and execute all such instruments, if any, and make such conveyances, transfers or deliveries of property as may be necessary or proper in order to carry the same into effect, and no one born or unborn, corporation, association or organization, shall have any right, interest or estate under this indenture. * * * EIGHTH: The Trustee by joining in the execution of this instrument, signifies its acceptance of the Trust hereby created, and covenants and agrees to, 94 and with the Donor, that it will faithfully execute the Trust herein created, according to the best of its skill, knowledge and ability. NINTH: It is mutually agreed that this indenture shall extend to and be obligatory upon the executors, administrators and successors respectively of the parties hereto. The total net income of this trust fund was $12,760.49 for 1922. Schmidlapp died2220 December 18, 1919, leaving a will dated January 12, 1911. Under this will another trust fund was created and the Union Savings Bank & Trust Co. of Cincinnati was made trustee. This fund has been designated Trust No. 1340 by the trustee. The provisions of the will creating this trust fund are as follows: Item One. I direct that my debts be paid by my Executor, hereinafter named. Item Two. Having heretofore provided for my children by a certain Trust agreement with The Union Savings Bank & Trust Co., of Cincinnati, Ohio, as Trustee, bearing date of June 20th, 1905, which Trust Agreement I do hereby confirm and ratify, and having also provided for others of my family, I give, devise and bequeath to my children or child surviving me and their or his heirs and assigns forever, my residence property known as "Kirchheim," situated on Grandin Road, Walnut Hills, Cincinnati, Ohio, together with all the Furniture, Pictures, Books, Bric-a-brac, Silverware, China and all other household goods contained in and used in connection with said residence, and also all of my Carriages, Horses, Harness, Automobiles, Stable and garden tools and equipments, and other belonging used in connection2221 with my said residence, and I direct that no inventory or appraisement be made of the same. Item Three. * * As I have followed this idea and have retained out of my estate, barely enough to produce income sufficient to meet my expenses, including my yearly charities, I hereby give, devise and bequeath to The Union Savings Bank & Trust Co., a corporation organized under the laws of the State of Ohio, and having its principal office in the City of Cincinnati, in said state, all the rest, residue and remainder of my remaining estate, both real and personal, of whatever nature, and wherever situate, to have and to hold the same to it and its successor and assigns forever, in trust, nevertheless, for the following uses and purposes: 1st. To hold, manage and control the same, collecting the income thereof, and paying all charges, taxes, assessments, repairs, insurance premiums and other expenses of administration of said trust. I empower said Trustee to sell the property of said trust, both Real and Personal, or any property at any time held hereunder, or any part or parts thereof, at public or private sale, in such lots or parcels, at such time or times, at such place or places, 2222 or places, for such prices and on such terms, as said Trustee may deem advisable; and to lease the same, or any part thereof, for any term of years or perpetually, with or without privilege of purchase, and with such other covenants and provisions, and upon such rents, as said Trustee may deem advisable; and to make, execute and deliver any and all deeds, conveyances, assignments, transfers and other instruments necessary or proper to carry out any such sales or leases. Receipts signed by said Trustee for all or any portion of any purchase money, shall be good and sufficient discharges for the sums therein stated to have been received, and no purchaser, corporation or transfer Agent, shall be concerned to inquire as to the occasion of any sale, or to see to the 95 application of the proceeds of said sale or purchase money. I further empower said Trustee to invest any and all money which may come into its hands as Trustee, as part of said trust, in such form of property, real or personal, or in improving other property of said trust, as said Trustee may deem fit, and such investments from time to time to vary, alter and transpose at pleasure, converting realty into personalty, 2223 and personalty into realty, as often as said Trustee deem proper, and said Trustee shall not be held responsible for any depreciation in any of the property or securities held hereunder, or in which said funds may be invested, and re-invested by it from time to time, in good faith, or for loss of any kind whatsoever, not occasioned by its own gross negligence or bad faith. 2nd. The net income of said trust estate or of any property at any time held hereunder is to be used for charitable purposes, as the Trustee may deem advisable and proper, and I hereby authorize and direct the Trustee hereunder, to pay the net income of said estate, or any part of portion thereof, from time to time, to such person or persons, charitable organizations or associations, or to corporations duly organized for charitable purposes, as said Trustee may deem advisable, for relief in sickness, suffering and distress, the care of young children, or the helpless and afflicted. Believing as I do that it is every man's duty, as far as it is in his power, to prevent those of his own blood from becoming a charge on the state and a burden to society, I request that the Trustee at all times give preference to2224 any of my brothers and sisters, and the brothers and sisters of my deceased wife, Emelie Balke Schmidlapp, and the children of any of them, and any of my friends whom in the judgment of the Trustee, I would assist if living, and who may at any time be in suffering, sickness or distress, and without the means to provide for themselves in reasonable comfort. 3rd. Injudicious charity tends to take from men, the incentive to self-support, making of such, pensioners on the bounty of others, rather than self-supporting men and women, and desiring as far as possible to avoid such abuse, I hereby give the Trustee, full power, authority and discretion, in the use of the income of said trust estate, to pay out for such charitable purposes, in the relief of suffering and distress, all or any portion of said income, at such time or times as it may deem best, or from time to time to withhold all or any portion of said income, or to accumulate and add to the principal fund, such portion or portions of said income as it may deem advisable. Item Four. Said Trustee may at any time cause to be formed a charitable Corporation, if it so desires, for the purpose of following the conditions of2225 this trust, and transfer thereto, all the property, real and personal, held hereundrer, subject to the trusts herein expressed, but in case such a corporation shall be formed, the Directors of The Union Savings Bank & Trust Co., of Cincinnati, Ohio, or its successor, and the Mayor of the City of Cincinnati, Ohio, from time to time, shall Ex-Officio, together with such other person or persons as may be required by law, be the Trustees or Directors of said Corporation. The total net income of this trust was $24,060.05 for 1922. Edgar Stark, who for the past eleven years has been vice president of the now Fifth Third Union Trust Co., and for 20 years its trust officer, and who was close to Schmidlapp in a business way, was named executor by Schmidlapp in his will. Real property placed in trust under the will vested in the trustee immediately upon Schmidlapp's death and was never under the control of the executor. 96 On account of certain litigation not having been finally determined, the administration of the estate has not been completed by the executor. The executor has not turned over the personal property to the trustee under the will, since administration of the2226 estate has not been completed, but when it is completed he will do so. The income from the personal property is, however, now being turned over to the trustee. No payments for charitable purposes are to be made by the executor from the personal property, but only the necessary administration expenses. The proceeding in Docket No. 26130 arises from the respondent's determination of deficiencies against the executor on income from the property of the estate in his hands. The executor's account is carried on the books of the Fifth Third Union Trust Co. under the designation of Trust No. 1335. The total income of the estate was $31,375.12 for 1922 and $17,332.81 for 1923. Pursuant to the terms of the trust agreement, the distribution of the income from the Charlotte R. Schmidlapp Fund, Trust No. 774, is controlled by a committee. The money available for distribution from this fund is not actually paid over to the committee, but is set aside and carried by the trustee in a "Distribution Fund" and paid out on the requisition of a "director," who is a woman employed by the committee to make investigations for it. The committee meets from time to time and passes on cases to which2227 a distribution of the income is being considered and which have been investigated by the "director." In cases where prompt action is necessary, the committee has instructed the trustee to make payment from the income of the trust fund on the requisition of the "director." The distributions under this trust have in general been made to individuals, such as assisting young women in obtaining an education, in paying hospital bills, and for operations and helping invalids. Disbursements were also made to movements having charitable objects, such as for the benefit of the blind and for institutions for certain cures. Distributions of income of this trust began to be made in 1908 and have continued since then. The Fifth Third Union Trust Co., as trustee, has the sole control of the trust fund created by the trust agreement of July 3, 1916, and designated Trust No. 1163. The executive committee of the board of directors of the Trust Co. sets aside the income from this trust fund and, as applications for assistance to individuals are approved by the committee after having been investigated by an investigator employed by it for that purpose, the income is distributed upon the instructions2228 of the committee. From the creation of this trust until the time Schmidlapp's will became effective, practically all of the distributions made from this trust were made for the 97 benefit of individual cases. Since that time distributions have been made largely along educational lines. However, there are a number of cases in which distributions are being made for the benefit of individual cases. Under this trust large appropriations have been made to the Cincinnati Museum of Fine Arts and for the purpose of endowing a chair of aeronautics at the University of Cincinnati. A distribution was also made to the Palestine Relief Fund, and for two years a subscription was made to the Community Chest. The Fifth Third Union Trust Co., as trustee, has sole control of the trust created by Schmidlapp's will and administers the trust in the same manner as that created by the trust agreement dated July 3, 1916. It was a considerable time after the will became effective that distributions from the income from the trust created by it were made, the first being made in May, 1927, to the American Red Cross for the Mississippi flood relief. A distribution was also made from the income2229 of this trust to the Palestine Relief Fund. Distributions have been made from the income of this trust and the one created on July 3, 1916, to committees organized for such purposes as giving relief to flood sufferers in Kentucky and rebuilding school buildings destroyed there. In addition to he foregoing, a contribution has been made to a boys' home. At the time of the hearing all appropriations for relief in the case of individuals were being made from the income of this fund. On March 15, 1924, an income-tax return was filed by the Fifth Third Union Trust Co., as trustee of the Charlotte R. Schmidlapp Fund, covering the income of that fund for 1923. The total income shown on the return was $83,470.98, against which a deduction of the same amount was taken. The deduction was composed of $3,142.37 as representing salaries of employees, administration expense, etc., and $80,328.61 as representing the amount paid or permanently set aside for charitable or educational purposes. Included in the items of income was an amount of $60,605 representing the profit from the sale in 1923 of certain capital stock of the North American Co. This stock was part of the securities turned2230 over to the trust fund at the time of its creation in 1907 and has been held for profit or reinvestment since that date. On February 8, 1927 the respondent addressed a notice of deficiency to "Mr. Edgar Stark, Executor, Estate of Jacob G. Schmidlapp, deceased, P.O. Box 1462, Cincinnati, Ohio." This notice proposed a deficiency in income tax of $705.27 for 1922. The tax was on income received by the trustee from property received under Schmidlapp's will and not income received by Stark as executor, a separate deficiency notice having been sent Stark with respect to the tax on that income. From this notice of deficiency a petition 98 was filed with the Board on April 7, 1927, by the Fifth Third Union Trust Co., trustee under Schmidlapp's will. The pertinent portions of the petition are: THE FIFTH THIRD UNION TRUST COMPANY, Trustee under the Will of Jacob G. Schmidlapp, deceased, Trust Fund #1340, Petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, Respondent. PETITION The above named petitioner hereby petitions for a redetermination of the deficiency set forth by the Commissioner of Internal Revenue in his notice of deficiency dated February 8, 1927, bearing the2231 Bureau symbols IT:PA; 2 60D RKJ, and as a basis of this proceeding alleges as follows: (1) The petitioner is The Fifth Third Union Trust Company, as Trustee under the will of Jacob G. Schmidlapp, deceased of a fund designated "Trust Fund #1340", with its principal office at Nos. 14-18 West Fourth Street, Cincinnati, Hamilton County, Ohio. At the time of the execution of the said Will, said petitioner Company operated under the name of The Union Savings Bank & Trust Company; its name was subsequently changed, by proceedings had in accordance with the laws of Ohio, to The Union Trust Company, which name has, since the determination of the deficiency by the Commissioner of Internal Revenue, been changed, by proceedings had in accordance with the laws of Ohio, to The Fifth Third Union Trust Company. * * * 5. * * * (a) Under the last will and testament of Jacob G. Schmidlapp, dated, January 12, 1911, all of the Estate, both real and personal of the said Jacob G. Schmidlapp, with the exception of his residence property, is devised and bequeathed to The Union Savings Bank & Trust Company, a corporition, (later known as The Union Trust Company and at the present time as The Fifth2232 Third Union Trust Company), as Trustee, in trust for the uses and purposes set out in said Will * . This petition was verified by Edgar Stark as "Vice-President and Trust Officer of The Fifth Third Union Trust Company, Trustee under the Will of Jacob G. Schmidlapp, deceased, for the fund - known and designated as 'Trust Fund #1340.'" The petition was given Docket No. 26127. OPINION. TRAMMELL: At the hearing counsel for the petitioners moved that the proceeding in Docket No. 26127 be dismissed on the ground that the Board does not have jurisdiction, since the respondent addressed and sent to Edgar Stark, executor of the estate of Jacob G. Schmidlapp, the notice of a deficiency determined against the trustee under Schmidlapp's will. Section 283 (a) of the Revenue Act of 1926 provides in part as follows: 99 If after the enactment of this Act the Commissioner determines that any assessment should be made in respect of any income, war-profits, or excessprofits tax imposed by the * * * Revenue Act of 1921, * * * or by any such Act as amended, the Commissioner is authorized to send by registered mail to the person liable for such tax notice of the amount proposed2233 to be assessed, which notice shall, for the purposes of this Act, be considered a notice under subdivision (a) of section 274 of this Act. The trustee petitioner filed the petition based on the notice sent to the executor. The determination of a deficiency against the trustee and the sending of notice thereof to the executor does not meet the requirement of the Act that notice is to be sent to the person liable for the tax. . Since the proceeding in Docket No. 26127 was not based upon a notice by the respondent to the petitioner as required by the Act we do not have jurisdiction and the proceeding will be dismissed. See ; , and . The respondent does not contend that the Charlotte R. Schmidlapp trust and the one created by the instrument of July 3, 1916, were not for charitable and educational purposes, and that the one created under the will was not for charitable purposes. The manner in which these trusts are administered and the income therefrom distributed is set2234 forth in our findings of fact. The respondent concedes that the bequest in the will establishing the testamentary trust that friends and relatives be given preference does not deprive it of its otherwise charitable character. He also concedes that the trusts established by Schmidlapp are primarily for the public generally rather than for the benefit of needy friends and relatives. The petitioners contend that the trusts are exempt from taxation under the provisions of section 231(6) of the Revenue Act of 1921. That section provides in part as follows: That the following organizations shall be exempt from taxation under this title - (6) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scienific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any privata stockholder or individual. The petitioners urge that the trusts are each a fund or foundation within paragraph 6 of section 231 of the Act. The respondent contends that in the phrase "any community chest, fund or foundation" the word "community" 2235 relates to and modifies the three words "chest," "fund" and "foundation" and describes the manner of creation and not the manner of distribution of the trust. His contention is that a fund or foundation, to be exempt under the provisions 100 of section 231(6), must be one created by community contributions and not by a single individual. In , the question of the deductibility, under section 214(a)(11) of the Revenue Act of 1921, of contributions or gifts to a "community chest, fund or foundation" was considered. There the court said: This brings us to the fundamental question in the case. Were the plaintiff's gifts to or for the use of a "corporation or community chest, fund, or foundation"? If the instrument effectuating the gift be examined, it is at once apparent that, whatever else it does, it certainly creates a trust. Gifts to trusts, eo nomine, are not included in the provisions for deductions in Section 214 of the Act of 1921, nor are they expressly excluded. Is the plaintiff's gift properly described by any term of the clause above quoted? The immediate donee in this case is not a corporation in2236 the ordinary sense. * * It is not a community chest. In my opinion, the word "community" plainly means raised or contributed by a community, and not, for the benefit of a community. Community chests are well known and extensively adopted vehicles of charity. The name implies a method of raising and administering funds for the benefit of all organized charities in a single community. One of the essential ideas involved is that the contributions should be from the whole community or from as many members of it as possible. The aim in every case is to induce every member of the community to contribute according to his means. I can not conceive of the contribution of a single individual being called a community chest and it had not been suggested that the plaintiff's gift here for example can be described as such. Does the word "community" also modify either or both of the words "fund" and "foundation"? The plaintiff's gift is a gift to a fund or a foundation. It is not a gift to a community fund or a community foundation. The plaintiff's position is that the word "community" modifies only the word "chest", and he bases this upon the argument that the word "chest" would be2237 meaningless without the additional descriptive term, which is perfectly true, but it has very little bearing upon the question whether the word "community" also applies to the other two words in the phrase. The defendant's position is that a consideration of all the Revenue Acts since and including the Act of 1917 down to date, clearly indicates that Congress intended to exclude gifts to trusts, and that Congress would simply be nullifying its own scheme and purpose if funds and foundations generally were exempt, because there can scarcely be a charitable fund or foundation which is not a trust. * * A strongly suggestive enactment having a direct bearing upon the question is Section 706 of the Revenue Act of 1928, which retroactively allows a deduction in case of gifts to trusts for charitable purposes, but limits such deductions to cases where such gifts were made during the taxable year of 1923, and were followed in the following year by gifts of substantially the same amount to the same trust. The amount allowed as a deduction is limited to $50,000. Now what possible reason could there be for this provision, unless Congress recognized the fact that the law prior to the2238 inclusion of trusts by the Act of 1924 was not intended to cover trusts? If the words "fund or foundation" meant funds or foundations generally, most trusts could have been placed under these terms, and there would have ben no need for the retroactive provisions for the Act of 1928. The only conclusion 101 that can be drawn is that Congress was legislating retroactively to permit the use of gifts to trusts as deductions, in view of the change of policy of the later acts, at the same time by implication reaffirming its own understanding that the Act of 1921 allowed deduction only in case of community chests, community funds, or community foundations. I therefore conclude that the funds and foundations intended by the phrase being considered are community funds or community foundations, in the sense of being raised or contributed by the community generally * * . (Italics supplied.) We think the construction given by the court to the words "community chest, fund, or foundation" is sound and correct. Since the trusts here being considered were not "raised or contributed to" by the community generally, but were created by one person, Schmidlapp, we are of the opinion2239 that they are not exempt from taxation under the provisions of paragraph (6) of section 231. In the respective petitions in these proceedings it is alleged that the respondent erred in refusing to allow as deductions the following indicated amounts as taken in the returns of the respective petitioners: YearDeductionTrust No. 1340 (testamentary trust)1922$24,060.05Charlotte R. Schmidlapp fund192222,527.05192380,328.61Trust fund No. 1163 (trust created July 3, 1916)192212,760.49Estate of Jacob G. Schmidlapp192231,375.12192317,332.81The petitioners contend that the foregoing respective amounts, which constituted the entire income of each, were allowable deductions under sections 219(b) and 214(a)(11) of the Revenue Act of 1921. Section 219(b) of the Revenue Act of 1921 provides in part as follows: The fiduciary shall be responsible for making the return of income for the estate or trust for which he acts. The net income of the estate or trust shall be computed in the same manner and on the same basis as provided in section 212, except that (in lieu of the deduction authorized by paragraph (11) of subdivision (a) of2240 section 214) there shall also be allowed as a deduction, without limitation, any part of the gross income which, pursuant to the terms of the will or deed creating the trust, is during the taxable year paid or permanently set aside for the purposes and in the manner specified in paragraph (11) of subdivision (a) of section 214. Section 214 provides: (a) That in computing net income there shall be allowed as deductions: * * (11) Contributions or gifts made within the taxable year to or for the use of: (A) The United States, any State, Territory, or any political subdivision thereof, or the District of Columbia, for exclusively public purposes; (B) any corporation, or community chest, fund, or foundation, organized and operated 102 exclusively, for religious, charitable, scientific, literary, or educational purposes, including posts of the American Legion or the women's auxiliary units thereof, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private stockholder or individual * . The position of the petitioners is that all the income of the trusts, whether distributed or set aside for addition2241 to the principal fund of the trusts, is deductible under sections 219 and 214(a)(11) as contributions or gifts to a community chest, fund, or a foundation organized exclusively for charitable or educational purposes. Contributions or gifts made by the trusts to or for the use of any corporation, community chest, fund or foundation as provided in section 214(a)(11) or permanently set aside therefor are deductible, regardless of the exempt status of the petitioner trusts, but we have no evidence that any amounts were during the taxable year paid out by the trustee to or were permanently set aside for the use of any corporation, community chest, fund or foundation organized or operated exclusively for the purposes set out in section 214, unless it be held that the mere accumulation of funds by the trusts themselves comes under that classification. It is contended that the trusts, even though they did not actually pay out funds for such purposes, by actually accumulating such funds, permanently set them aside as that expression is used in the statute for a corporation or community trust fund or foundation, since the trusts themselves were such organizations. We have held above on the2242 question as to the exemption of the trusts that they are not corporations, community chests, funds or foundations, as provided in section 231(6). In our opinion, therefore, there is no merit in the petitioner's contention in this respect. In determining the deficiency in Docket No. 36836 the respondent has subjected to both normal and surtax the profit of $60,605 realized by the Charlotte R. Schmidlapp Fund on the sale in 1923 of certain corporate stock which has been held by the trust for profit or reinvestment since its creation in 1907. The petitioner contends that the tax on this profit should be computed under the capital net gain provision of section 206 of the Revenue Act of 1921. It urges that in filing its return it reported no tax liability because it contended that it was exempt under section 231, or that its entire income was permanently set aside for charitable or educational purposes under sections 219 and 214. The petitioner also urges that in view of this there was no occasion for it to make an election or claim as to the benefits of section 206. The respondent, while not denying that the petitioner is otherwise entitled to the benefits of section 206, contends2243 that, since it did not make an election or request that the profit on the sale of the stock *103 be taxed under that section until the filing of an amended petition shortly before the date of the hearing, it is not now entitled to have its tax computed under that section. The act does not restrict the time of election, and it is our opinion that under the circumstances here presented the capital net gain provision is still available to the petitioner. . It is alleged in the petition in the case of the estate of Jacob G. Schmidlapp that the respondent erred in finding that an amount of $5,880.04 deducted in the 1923 return as executor's commission is not deductible. In his answer the respondent denied this allegation of error. Since no mention is made of this alleged error in the brief of the petitioners, and as no evidence was submitted with respect to it, the respondent's action is sustained. In Docket No. 26127 an order will be entered dismissing the proceeding. In Docket Nos. 26128, 26129, 26130, and 36836, judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625566/	APPEAL OF FR. BERGNER & CO.Fr. Bergner & Co. v. CommissionerDocket No. 5546.United States Board of Tax Appeals4 B.T.A. 460; 1926 BTA LEXIS 2273; July 28, 1926, Decided 2273 Replacement cost of depreciable assets as of March 1, 1913, depreciated from the date of acquisition to that date, can not, in the absence of other evidence, be accepted as the value for depreciation allowances for the taxable years in question. Elmer L. Hatter, C.P.A., for the petitioner. F. O. Graves, Esq., for the Commissioner. MORRIS460 Before MARQUETTE, MORRIS, and GREEN. This is an appeal from the determination of deficiencies in income and profits taxes for the years 1919 and 1920 in the amounts of $527.18 and $384.36, respectively. The only issue presented is the value of the taxpayer's building for purposes of depreciation. FINDINGS OF FACT. 1. The taxpayer is a Delaware corporation with its principal place of business at Baltimore, Md.2. During the years involved the taxpayer owned a building, erected by it during 1905 and 1906, and located at Paca and Cross Streets, Baltimore. The total cost of this building was $90,779.84. The reproduction cost of said building as of March 1, 1913, was $156,534.51. 461 3. The Commissioner allowed depreciation based on cost at the rate of 2 per cent for the taxable2274 years in question. OPINION. MORRIS: The only question presented to us for consideration is the basis for depreciation allowances for the taxable years in question, both parties agreeing that 2 per cent is a reasonable rate. Through the use of the original contractor's records of material and labor used in the erection of the building, the taxpayer has established the March 1, 1913, replacement cost, using material and labor prices on that date. It contends that this cost, depreciated from the date of the completion of the building in 1906 to March 1, 1913, should be taken as the basis for computing its depreciation deductions for the taxable years in question. We have heretofore held that replacement cost as of March 1, 1913, even if properly depreciated, does not necessarily prove the fair market value as of that date. ; ; ; . The deficiencies are $527.18 for 1919 and $384.36 for 1920. Order will be entered*2275 accordingly.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625567/	Estate of Newcomb Carlton, Deceased, Winslow Carlton and The Chase Manhattan Bank (Successor to The Chase National Bank of the City of New York), Executors, Petitioner, v. Commissioner of Internal Revenue, RespondentCarlton v. CommissionerDocket No. 65119United States Tax Court34 T.C. 988; 1960 U.S. Tax Ct. LEXIS 80; September 15, 1960, Filed 80 Decision will be entered under Rule 50. Decedent, in 1930, created a trust to which he conveyed securities and life insurance policies, retaining certain powers and reserving, for life, the income remaining after payment of premiums on the policies. Decedent agreed with beneficiary and beneficiary's wife not to change terms of trust without their consent. Without obtaining such consent decedent thereafter, by letter and subsequently by executed instrument both delivered to the trustee, released all retained powers except the power to appoint a successor trustee to the individual trustee who had resigned, which right had not been exercised at the date of decedent's death, March 12, 1953. The final release of powers by decedent was on December 7, 1943. Decedent paid all premiums on the life insurance policies prior to their transfer to the trust in 1930 and a portion of the premiums thereafter. Held:1. Decedent having prior to his death effectively released all powers over the trust except the appointment of a successor trustee, the trust corpus is not includible in his gross estate under section 811(d)(2), I.R.C. 1939.2. The transfer to the trust occurred in 1930, within81 the meaning of section 811(c)(1)(B), I.R.C. 1939.3. Proceeds of the insurance policies are not includible in decedent's gross estate under section 811(g)(2)(B), I.R.C. 1939, he having no incidents of ownership therein at date of death.4. Proportion of proceeds of the insurance policies applicable to premiums paid by decedent is includible in his gross estate under section 811(g)(2)(A), I.R.C. 1939, since he retained incidents of ownership after January 10, 1941.5. Section 811(g)(2)(A), I.R.C. 1939, as applied to facts herein, is constitutional. Walter E. Beer, Jr., Esq., for the petitioner.Theodore E. Davis, Esq., for the respondent. Scott, Judge. SCOTT 989 OPINION.Respondent determined a deficiency in estate tax in the amount of $ 110,691.35 for the Estate of Newcomb Carlton.The issue for decision is whether the entire proceeds of insurance policies, or any part thereof, and the value of securities transferred in trust by decedent are includible in his gross estate.In his notice of deficiency respondent determined that "the entire proceeds of life insurance policies aggregating $ 239,327.54 on the life of Newcomb Carlton held by and payable to the Chase Manhattan Bank (successor trustee) under agreement of trust dated February 24, 1930, are includible in gross estate83 under the provisions of section 811(c), 811(d), and 811(g) of the Internal Revenue Code of 1939."Respondent further determined that "stock held in the trust of February 24, 1930 is includible in gross estate under the provisions of sections 811(c) and 811(d) of the Internal Revenue Code of 1939, in the value of $ 34,442.50."The facts have been stipulated and are found accordingly.The decedent died on March 12, 1953. The estate tax return was filed with the district director of internal revenue for the Upper Manhattan District of New York.The decedent, on or about February 24, 1930, entered into a trust agreement with Fletcher L. Gill and the Chase National Bank of the City of New York, and pursuant thereto transferred to the trustees 21 insurance policies on his life which had been acquired by him prior to February 24, 1930, 500 shares of stock of the Chase National Bank -- Chase Securities Corporation, and 284 shares of stock of the Bank of Manhattan Trust Company. This instrument was under seal by Newcomb Carlton and Fletcher L. Gill. The decedent paid all premiums on the insurance policies transferred to the trust which became due prior to February 24, 1930, and paid all84 premiums which were ever paid on the Mutual Benefit Life Insurance Company policy No. 442,870.The provisions of the trust agreement included the following: That, during the lifetime of the grantor, the trustees should apply the net income of the trust to the payment of premiums upon the policies of life insurance deposited in the trust, and should pay quarterly to the grantor any balance of the net income not required for the purpose of paying such premiums; that after the death of the grantor, the net income of the entire fund as then constituted 990 should be paid to Winslow Carlton, son of the grantor, during his lifetime, but that upon his reaching the age of 35 years the principal of the trust should be paid over to him, but if Winslow Carlton should die before reaching the age of 35, or predecease the grantor, the principal should be paid as directed by the will of Winslow Carlton; that the grantor intended to part with and grant to the trustees the right to receive all premium dividends on the policies, the right to surrender the same for their respective cash surrender value, to obtain loans on such policies and all other rights and options therein provided for and 85 also all rights in connection with the securities deposited in the trust; in addition to the usual powers of trustees, they could invest and reinvest the principal of the trust in such investments, including preferred and common stock, as the trustees in their discretion might deem for the best interests of the trust estate without being limited to investments authorized by law for trust funds, provided that during the lifetime of the grantor no sales of securities or reinvestments should be made except upon the direction or with the consent and approval of the grantor; the grantor reserved the right to add to the trust estate by depositing additional policies with the trustees made payable to them and/or depositing cash, additional securities or other property with the trustees, all of which should thereupon become subject to the terms of the trust; that the trustees might exercise or dispose of any conversion privileges or subscription rights in connection with the securities comprising the trust estate and might participate in any plan for refunding or adjusting any stocks, bonds, or other securities or enter into any corporate consolidation or reorganization and, subject to the86 direction or with the approval of the grantor during his lifetime, make such contributions or payments in connection with any such matters as the trustees might deem advisable; that the trustees were to determine any question that might arise as to whether interest, dividends, rights, stock dividends, sale and purchase prices, accruals, receipts, and disbursements of any kind received or paid out by the trustees should be treated and accounted for as income or as principal; that the trustees might invade the principal of the trust fund or borrow on any of the insurance policies in case the net income in their hands was insufficient to pay the premiums then due on the policies; and that the grantor might, in case the net income in the hands of the trustees should at any time not be sufficient to pay the premiums then due on the insurance policies, pay to the trustees any amount sufficient to make up such deficiency, and that the trustees should accept and use such payment for such purpose. The grantor specifically reserved during his lifetime the power to change the age at which Winslow Carlton should receive the principal 991 of the trust fund, to appoint a successor trustee87 should a trustee resign, and to remove the trustees with or without cause in his discretion and to appoint a successor trustee or trustees. The trust instrument stated that the trust was irrevocable. The trusts created were to be administered in the State of New York and in all respects governed by the laws of that State.During the period from February 24, 1930, to the date of the decedent's death on March 12, 1953, the trustees or the trustee applied all of the dividends from the securities in the trust and all dividends received on the insurance policies to the payment of the expenses of the trust and to the payment of premiums on the policies. In no calendar year of the trust were the amounts of dividends on the securities and policies in the trust sufficient to pay the expenses of the trust and the premiums on the policies.In the period from February 24, 1930, through August 20, 1936, Newcomb Carlton paid a portion of the premiums on the policies but paid no premiums on these policies after that date. During the period August 20, 1936, through March 12, 1953, Winslow Carlton paid a portion of the premiums on the policies. All premiums on the policies in the trust were paid88 as they became due during the period from February 24, 1930, until March 12, 1953. The total amount of proceeds collected on the insurance policies held in trust on March 12, 1953, was $ 239,327.54 and the total premiums paid on these policies was $ 287,027.59. Decedent paid $ 152,042.24 of the total premiums, the trustees, from the trust income, paid $ 84,557.37, and Winslow Carlton paid $ 50,427.98.On April 30, 1935, Fletcher L. Gill resigned as trustee of said trust. No successor trustee for Fletcher L. Gill was ever appointed.By agreement, under seal, made May 1, 1935, the decedent and Winslow Carlton and Margaret Mary Carlton, the wife of Winslow Carlton, agreed that in consideration of Winslow and Margaret Mary Carlton agreeing to establish out of such funds as they might receive under the trust agreement dated February 24, 1930, or under the will of the decedent, a fund of such sum or sums of money as might be necessary to provide an annual income of $ 1,500, each, for the three sisters and one brother of decedent who might survive decedent, the decedent would not change the terms of the trust agreement or of his will without the consent of Winslow and Margaret Mary Carlton. 89 In a letter dated May 28, 1936, addressed to the Chase National Bank of the City of New York, the decedent stated that he surrendered the right reserved in the trust agreement to change the age at which his son, Winslow Carlton, should be paid the principal of the trust. This letter was delivered to the Chase National Bank of the City of New York.992 On May 29, 1936, Winslow Carlton and Margaret Mary Carlton consented to a change in the will of the decedent and to a correction of the date as originally used as the date of the trust agreement in the agreement of May 1, 1935.On December 7, 1943, the decedent executed, under seal, an instrument stating that he surrendered and relinquished the power and authority reserved to him to direct or consent to the sale of and reinvestment in securities and payments in connection with any reorganizations, consolidations, refundings, or exercise of any conversion privileges or subscription rights and the power to discharge the trustees and appoint successor trustees to trustees so discharged. This instrument was delivered to, and receipt of the document acknowledged by, the Chase National Bank of the City of New York.The decedent was90 born on February 16, 1869, and was a resident of the city, county, and State of New York on March 12, 1953, the date of his death. Decedent was a member of the board of directors of the Chase National Bank of the City of New York from February 21, 1917, to September 22, 1948.Winslow Carlton was born on December 27, 1907, and was over the age of 21 when the trust was created on February 24, 1930. On that date, and at all times thereafter, Winslow Carlton had a will in effect.The trustee distributed the securities in the trust to Winslow Carlton on May 28, 1953, on which date their value was $ 32,050. The securities in the trust at its termination consisted of 500 shares of capital stock of the Chase National Bank of the City of New York and 290 shares of capital stock of the Bank of Manhattan Trust Company. The securities were all either originally transferred to the trustees or received in exchange for, or as stock dividends on, the securities transferred. The date of death value of the securities was $ 34,442.50.Petitioner contends that no part of the trust corpus, including the proceeds of the insurance policies, is includible in the gross estate under the provisions of 91 section 811(c), 811(d), or 811(g)(2)(A) or (B) of the 1939 Code. 192 993 Respondent's first contention is that decedent at the date of his death still retained all powers originally reserved to him by the trust instrument of February 24, 1930, which retained powers were of such a nature as to require the inclusion in the gross estate under section 811(d)(2) of the 1939 Code of the entire trust corpus including the proceeds of the insurance policies, relying on Lober v. United States, 346 U.S. 335">346 U.S. 335 (1953). His position is that the letter dated May 28, 1936, and the instrument executed on December 7, 1943, were ineffectual since Winslow Carlton and his wife did not consent to any alteration of the trust agreement as required by the contract of May 1, 1935.Respondent argues that because of the provision of the agreement 994 of May 1, 1935, between the decedent and his son and daughter-in-law that decedent "will not change the terms of the said trust agreement * * * without the consent" of his son and daughter-in-law, the releases of powers by the decedent subsequent to that date without such consent are void. Respondent does not contend that the agreement of May 1, 1935, was an amendment to the trust instrument93 and petitioner's brief contains no discussion of such an issue. We have, therefore, not considered the questions of whether the agreement of May 1, 1935, was, under New York law, an amendment to the trust instrument, whether the trust should be considered as irrevocable were this agreement to be considered as an amendment thereto, or the effectiveness of the subsequent releases of powers by the decedent if that agreement were construed as an amendment to the trust instrument. Both respondent and petitioner have considered the agreement of May 1, 1935, to be a contract between the decedent and his son and daughter-in-law. Respondent assumes that the releases by the grantor of powers reserved by him in the trust instrument should be construed as changing the terms of the trust in violation of the contract of May 1, 1935. It is unnecessary for us to decide whether this assumption is a valid one, for even were the documents of May 28, 1936, and December 7, 1943, releasing decedent's previously retained powers over the trust considered in violation of the contract of May 1, 1935, they would not thereby become void. There would arise a cause of action under the contract. Tutunjian v. Vetzigian, 299 N.Y. 315">299 N.Y. 315, 87 N.E. 2d 275 (1949).94 Respondent also contends that since the letter of May 28, 1936, was not under seal and was not notarized, it was ineffectual to modify the trust agreement. Had this letter been executed prior to September 1, 1935, the effective date of an amendment of section 342 of the Civil Practice Act of New York, the laws of which govern the trust here being construed, there might be merit to respondent's argument. Under the provisions of section 342 of the Civil Practice Act, as amended, a written instrument made after September 1, 1935, which modifies, varies, or cancels a sealed instrument, executed prior thereto, shall not be deemed invalid or ineffectual because of the absence of the seal thereon. Likewise, this instrument is not invalid or ineffectual because of not being notarized. In re Morgan's Will, 177 N.Y.S. 2d 829 (1958).The letter of May 28, 1936, and the instrument of December 7, 1943, effectively released all power and authority reserved in the trust instrument to the decedent except the power to appoint a trustee to replace the trustee who resigned in 1935. No such trustee was ever appointed. The mere unexercised retention of the right by95 the grantor of a trust to appoint a cotrustee, even though there 995 is no prohibition to appointing himself, does not constitute a power to alter, amend, or revoke so as to require the inclusion of the corpus of the trust in his gross estate under section 811(d)(2) of the Internal Revenue Code of 1939. Estate of C. Dudley Wilson, 13 T.C. 869">13 T.C. 869 (1949) affirmed per curiam 187 F. 2d 145 (1951).Respondent further contends that if, on May 28, 1936, the decedent validly surrendered his power to change the age at which the beneficiary was to be paid the trust principal and on December 7, 1943, validly surrendered his management control and right to remove the trustee, the value of the corpus is includible in his gross estate under section 811(c)(1)(B) of the 1939 Code because the decedent retained for his life the right to the income from the trust property. Section 811(c)(1)(B) of the 1939 Code, as amended by the Technical Changes Act of 1953, applies to tranfers made after March 3, 1931. Relying on Smith v. United States, 139 F. Supp. 305">139 F. Supp. 305 (Ct. Cl., 1956), respondent contends that there96 was not a bona fide transfer effected, for tax purposes, on February 24, 1930, but such transfer occurred on May 28, 1936, or December 7, 1943, when the settlor completely surrendered his powers to alter, amend, or revoke the trust. The present case is distinguishable from Smith v. United States, supra, in that in the Smith case the grantor had reserved, in conjunction with her husband, the power to revoke the trust completely. This power was not released until her husband's death in 1933 at which time the transfer was held to have been effected. In Estate of Robert J. Cuddihy, 32 T.C. 1171">32 T.C. 1171 (1959), this Court stated its disagreement with the construction placed upon the term "transfer" in the Smith case but held that in any event the Smith case was inapplicable to an irrevocable trust created prior to March 4, 1931, wherein powers to alter or amend similar to those reserved in the instant case had not been released until a later date. This Court reaffirmed its holding in the Cuddihy case in Estate of Ellis Branson Ridgway, 33 T.C. 1000">33 T.C. 1000 (1960), on appeal (C.A. 3). We, 97 therefore, conclude that section 811(c)(1)(B) is inapplicable to the transfer by decedent of the securities and insurance policies to the trust since this transfer was made before March 4, 1931.The respondent next contends that the proceeds of the insurance policies are includible in the decedent's gross estate under section 811(g)(2)(B) of the 1939 Code which provides for such inclusion of proceeds of insurance policies receivable by beneficiaries other than the executor where the decedent possessed at his death any incidents of ownership in such policies exercisable either alone or in conjunction with any other person. In support of his position respondent relies upon Estate of Myron Selznick, 15 T.C. 716">15 T.C. 716 (1950), affirmed per curiam 195 F. 2d 735 (C.A. 9, 1952), wherein proceeds 996 of insurance policies were held to be includible in the decedent's gross estate under section 811(g)(2)(B) of the 1939 Code. In the Selznick case the insurance policies were made payable to the trust. In addition to the insurance policies the trust corpus included securities and the income of the trust was payable for life to the98 grantor. The grantor reserved the power to cancel the insurance policies with the consent of any two of three persons, the trustee and two appointees of the grantor whose appointment he could revoke and for whom he could substitute other appointees. The proceeds of the canceled policies were to be added to the trust corpus, the investment of which was controlled by the grantor without being limited to investments approved and permissible by law for trust funds. The combination of rights reserved by the grantor of the trust in the Selznick case was sufficient to permit the grantor during his lifetime to receive income from the investment of proceeds from canceled insurance policies. The right of the grantor to receive the income from the proceeds of the canceled insurance was held to constitute an incident of ownership in the insurance policies under section 811(g)(2)(B). The interests in and controls over the trust which decedent in the instant case retained at the date of his death are not comparable to those retained by the grantor in the Selznick case.Decedent in the instant case retained until the date of his death the right to the income from the trust in excess99 of that needed to pay the premiums on the insurance policies and the right to appoint a cotrustee to replace the trustee who had resigned. Any control that decedent would have acquired over the insurance policies had he appointed himself cotrustee would have been control over the policies jointly with the corporate trustee as trustee only and such control would be solely for the benefit of the trust. Such control as trustee would not constitute incidents of ownership in the insurance policies in decedent except in his capacity as trustee for the benefit of the trust.The trust income was made up of dividends on the insurance policies and securities in the trust. Although decedent, from the inception of the trust in 1930 until the date of his death, had the right to receive the income from the trust in excess of that required to pay the premiums on the insurance policies, there was no such excess income and he, in fact, never received any such income. This right of decedent to receive the trust income in excess of that required to pay the insurance premiums was a right reserved by him as grantor and thus a right for his personal benefit and not a right as trustee. However, the100 right to receive the dividends on the insurance policies which formed a part of the trust income was assigned absolutely to the trustees for the benefit of the trust and could 997 inure to the personal benefit of the grantor only if such income exceeded the premiums on the insurance policies. In Estate of Lena R. Arents, 34 T.C. 274">34 T.C. 274 (1960), the decedent, on June 4, 1932, created an irrevocable trust to which she transferred securities and insurance policies on the life of her husband, which policies had previously been assigned absolutely to her, reserving to herself for life the trust income in excess of that necessary to pay the premiums on the insurance policies. The trustees were directed to use the dividends on the insurance policies to pay the premiums on such policies and if a dividend on a specific policy exceeded the premium on such policy, to use the excess to pay premiums on other policies in the trust. In the Arents case the total income from the trust exceeded the amount necessary to pay the premiums on the insurance policies and the excess was paid to the grantor. We held that the value of the insurance policies at the date101 of death of the grantor of the trust was not includible in her gross estate under the joint resolution of March 3, 1931, which applies to transfers made after March 3, 1931, and before June 7, 1932, since she had not retained for her life the possession or enjoyment of, or the income from, the insurance policies. We there stated:Aside from the dividends earned by the policies which were directed under the trust instrument to be applied to the payment of premiums, the policies were nonproductive. Consequently, the sole income arising from the policies by way of dividends (the amount of which is not shown by the record herein) was reflected by the increase in the overage of excess investment income which the decedent received during her life. The trustee was without power to collect on the policies during the life of the decedent's husband (who has outlived her) or otherwise to dispose of them. A somewhat similar situation existed in Estate of Charles C. Smith, 23 T.C. 367">23 T.C. 367, involving the question whether the decedent was entitled to a marital deduction with respect to amounts paid by him as premiums on life insurance policies which he had transferred102 in trust. The corpus of the trust consisted solely of insurance policies on the life of the settlor-decedent. A provision appeared in the trust instrument entitling the decedent's wife to receive the net income arising from the trust for her life. We there held this provision to be meaningless * The Arents case did not involve insurance under policies upon the life of the decedent so as to require a determination whether the decedent retained incidents of ownership in the policies under section 811(g)(2)(B) of the 1939 Code. However, by analogy, in the instant case the fact that the dividends on the insurance policies constituted a part of the trust income which was retained by decedent for life to the extent not required to pay premiums on such insurance policies is of no greater significance in determining whether decedent retained incidents of ownership in the insurance policies than it was in the Arents case in determining whether decedent therein had retained 998 possession or enjoyment of or income from the insurance policies there involved. Decedent in the instant case was 84 years old when he died and the entire trust income from the insurance dividends103 and securities had never been sufficient in any year to pay the premiums on the insurance policies. The possibility that decedent might have lived long enough that the insurance dividends would exceed the premiums due on the policies in any year is too remote to constitute an "incident of ownership" in the insurance policies. Cf. Commissioner v. Hall's Estate, 153 F. 2d 172 (C.A. 2, 1946), affirming a Memorandum Opinion of this Court.We agree with the petitioner that decedent did not possess at his death any incidents of ownership in the insurance policies transferred to the trust.Respondent argues in the alternative that under the provisions of section 811(g)(2)(A) of the 1939 Code the proceeds of the insurance policies are includible in decedent's gross estate to the extent purchased with premiums paid by him in proportion that the amount so paid by the decedent bears to the total premiums paid for the insurance.Section 811(g)(2)(A) requires the inclusion in the gross estate of proceeds of insurance policies upon the life of decedent receivable by beneficiaries other than the executors to the extent purchased with premiums paid directly or104 indirectly by decedent, even though decedent at the date of his death had no incidents of ownership in such policies. The legislative history of this provision which was incorporated in the Internal Revenue Code of 1939 by section 404(c) of the Revenue Act of 1942 is reviewed in detail in Estate of Ellis Baker, 30 T.C. 776 (1958). It is applicable to estates of decedents dying after the effective date of the Revenue Act of 1942 (Oct. 21, 1942), but in determining the proportion of the proceeds of an insurance policy includible in his gross estate, the premiums paid by decedent on or before January 10, 1941, should be excluded if at no time after that date the decedent possessed an incident of ownership in the policy. For the purposes of section 811(g)(2)(A) it is of no consequence that decedent possessed no incidents of ownership in the insurance policies at the date of his death if he possessed such incidents of ownership after January 10, 1941. Cf. Estate of Louis Solowey, 15 T.C. 188">15 T.C. 188 (1950), affirmed per curiam 189 F. 2d 968 (C.A. 2, 1951), certiorari denied 342 U.S. 850">342 U.S. 850.105 Since decedent did not surrender his management control of the securities forming a part of the corpus of the trust and his right to remove the trustees without cause until after January 10, 1941, the question arises whether these retained powers over the trust, combined with the right to receive the income of the trust in excess 999 of the amount necessary to pay insurance premiums, operated to give decedent incidents of ownership in the insurance policies.Incidents of ownership are not confined to ownership in the technical, legal sense but include the right of the insured or his estate to the economic benefits of the insurance policy and such rights as the power to change the beneficiary, to cancel the policy, and to borrow against its cash surrender value (Regs. 105, sec. 81.25, as amended by T.D. 5239, 1943 C.B. 1081">1943 C.B. 1081). In Commissioner v. Treganowan, 183 F. 2d 288 (C.A. 2, 1950), reversing 13 T.C. 159">13 T.C. 159, followed in Estate of William E. Edmonds, 16 T.C. 110">16 T.C. 110 (1951), the court held an amount, receivable upon the death of a member of the New 106 York Stock Exchange by his widow, in accordance with the provisions of the constitution of the Exchange, to be includible in such decedent's gross estate as insurance payable to beneficiaries other than his executors, even though as a member of the Exchange, he had no right to change the beneficiaries or any interest which he could pledge or upon which he could borrow. The court stated:From both the broad language used and its inclusive interpretation, it is thus clear that such powers as to receive the surrender value of the insurance or to put another in one's place as the insured are incidents of ownership. An Exchange member does have the power to sell his seat, thus divesting his beneficiary of any right to payments, and entitling the purchaser to the same insurance which the seller has had. This power to cancel one's own engagement and substitute another seems to us an incident of ownership within the statutory meaning. * In the instant case decedent, prior to his surrender on December 7, 1943, of powers and authority over the trust to which the insurance policies were assigned, could likewise act in such a manner as to change the value of the insurance policies assigned107 to the trust. Decedent as grantor had reserved the right to direct the investment of the securities in the trust and to receive the income in excess of that necessary to pay the premiums. Decedent, having also reserved the right to discharge the trustees without cause and appoint trustees of his own choosing, was assured of having trustees who would follow his direction as to the investment of the trust funds. Cf. van Beuren v. McLoughlin, 262 F. 2d 315 (C.A. 1, 1959), certiorari denied 359 U.S. 991">359 U.S. 991. The investment of the trust fund was not limited to investments approved by law for trust funds and investments could be made in common stocks. The trustees were to determine any question that might arise as to whether amounts of receipts and disbursements should be treated and accounted for as income or principal. Decedent, had he chosen to do so, prior to December 7, 1943, could have directed that all the securities in the trust fund be sold and the proceeds placed in currently non-income-producing stocks which in his opinion would increase in value or 1000 produce a higher income in some future year. This could108 have required borrowing against the insurance policies to pay the premiums thereon. These powers, reserved in decedent as grantor to handle the trust corpus in a way that might necessitate the use of the loan value of the insurance policies in an effort to increase the future income of the trust for the ultimate benefit of the grantor individually as well as for the trust, while differing in degree, are not distinguishable in principle from the rights reserved by the grantor of the trust in Estate of Myron Selznick, supra, to increase his income from the trust by surrendering the insurance policies for cash and adding such cash to the corpus of the irrevocable trust, the income of which he had retained for life. Decedent saw fit to reserve unto himself as grantor of the trust until December 7, 1943, powers and controls over the trust that could have been exercised in such a manner as to affect the interests of the trust beneficiary in the insurance policies. The fact that decedent did not actually use his reserved powers prior to the surrender thereof in December 1943 is immaterial. The facts in Estate of Myron Selznick, supra,109 show that the grantor of the trust considered therein had never used his reserve power to cancel any of the insurance policies during his lifetime. It is the existence of the right, power, or authority rather than its exercise or the likelihood of its exercise, which is controlling. Adeline S. Davis, 27 T.C. 378">27 T.C. 378, 382 (1956).The proceeds of the insurance policies transferred to the trust are includible in the decedent's gross estate to the extent applicable to premiums paid by decedent, Newcomb Carlton. The payment of premiums by the trustees from the trust income and the payment of premiums by Winslow Carlton are not indirect payments by decedent. Estate of Edmund W. Mudge, 27 T.C. 188">27 T.C. 188 (1956).The petitioner contends that section 811(g)(2)(A) of the Internal Revenue Code of 1939 is unconstitutional as applied to the facts of this case. The recent decision of the Supreme Court in United States v. Manufacturers National Bank of Detroit, 363 U.S. 194">363 U.S. 194 (1960), held section 811(g)(2)(A) of the 1939 Code not to be unconstitutional as applied to premiums paid after January 10, 1941, with110 respect to policies in which decedent retained no incidents of ownership. Upon reasoning analogous to that used by the Supreme Court in the Manufacturers National Bank case, this Court has held section 811(g)(2)(A) constitutional as applied to premiums paid prior to January 10, 1941, where decedent retained incidents of ownership after that date. Estate of Ellis Baker, supra. See also Estate of Clarence H. Loeb, 22">29 T.C. 22 (1957), affd. 261 F. 2d 232 (C.A. 2, 1958). We hold section 811(g)(2)(A) to be constitutional as applied to the facts of this case.1001 Since we have held that the value of the securities is not includible in the gross estate, the question raised by the petitioner concerning the date of valuation of the securities becomes moot.Respondent agrees to the adjustments for administrative expenses and fees as contended for by petitioner and such adjustment should be included in the computation of tax under Rule 50.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; * * (c) Transfers in Contemplation of, or Taking Effect at, Death. -- (1) General Rule. -- To the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise -- * * (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 his death (i) 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 his death.Subparagraph (B) shall not apply to a transfer made before March 4, 1931; nor shall subparagraph (B) apply to a transfer made after March 3, 1931, and before 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 3, 1931 (46 Stat. 1516). * * (d) Revocable Transfers. -- * * (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. * * (g) Proceeds of Life Insurance. -- * * (2) Receivable by other beneficiaries. -- To the extent of the amount receivable by all other beneficiaries as insurance under policies upon the life of the decedent (A) purchased with premiums, or other consideration, paid directly or indirectly by the decedent, in proportion that the amount so paid by the decedent bears to the total premiums paid for the insurance, or (B) with respect to which the decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person. For the purposes of clause (A) of this paragraph, if the decedent transferred, by assignment or otherwise, a policy of insurance, the amount paid directly or indirectly by the decedent shall be reduced by an amount which bears the same ratio to the amount paid directly or indirectly by the decedent as the consideration in money or money's worth received by the decedent for the transfer bears to the value of the policy at the time of the transfer. For the purposes of clause (B) of this paragraph, the term "incident of ownership" does not include a reversionary interest.[As provided by sec. 404(c), 1942 Act, as amended by sec. 503(a), 1950 Act, Code sec. 811(g), as amended, is applicable as follows:(c) Decedents to Which Amendments Applicable. -- The amendments made by subsection (a) shall be applicable only to estates of decedents dying after the date of the enactment of this Act; but in determining the proportion of the premiums or other consideration paid directly or indirectly by the decedent (but not the total premiums paid) the amount so paid by the decedent on or before January 10, 1941, shall be excluded if at no time after such date the decedent possessed an incident of ownership in the policy. * *]↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625568/	George Bradshaw, Petitioner, et al., 1 v. Commissioner of Internal Revenue, RespondentBradshaw v. CommissionerDocket Nos. 20699, 20700, 20701, 20702, 20703, 20704United States Tax Court14 T.C. 162; 1950 U.S. Tax Ct. LEXIS 282; February 3, 1950, Promulgated 282 Decisions will be entered under Rule 50. Purchase rebates, or patronage dividends, issued by cooperative purchasing association in the form of registered redeemable interest-bearing promissory notes payable in any event upon dissolution of the association, held, accruable income to the participating members in the years when issued to them. Maurice R. McMicken, Esq., and Ivan Merrick, Jr., Esq., for the petitioners.William E. Koken, Esq., for the respondent. LeMire, Judge. LeMIRE 163 Income tax deficiencies have been determined against the petitioners for 1944 and 1945, as follows:Petitioner19441945George Bradshaw$ 147.29$ 232.41Mary E. Bradshaw382.29232.40Warren L. Murphy351.94229.38Vera Rose Murphy380.33229.38Clifford M. Schumacher382.32232.41Lydia M. Schumacher382.31232.41283 The proceedings were consolidated for hearing. They all involve the same issue, namely, whether purchase rebates or patronage dividends issued by a cooperative purchasing association in the form of promissory notes of the association were accruable income to the contributing members in the years when the purchases on which they were computed were made or in the years when the notes were issued, or whether, in the circumstances, they were accruable at any time.FINDINGS OF FACT.Some of the facts have been stipulated and are found accordingly.The petitioners are all residents of Seattle, Washington. George Bradshaw, Warren L. Murphy, and Clifford M. Schumacher will be referred to hereinafter as the petitioners. Their wives are parties to these proceedings by reason of the fact that they and petitioners filed separate income tax returns on a community property basis for the years involved, the calendar years 1944 and 1945. The returns were filed with the collector of internal revenue for the district of Washington.During 1944 and 1945 the petitioners were equal partners in the operation of a chain of retail grocery stores located in King and Kitsap Counties, Washington, under 284 the name of Money-Savers Super Markets. The partnership was formed in 1943 as the successor of a corporation known as Money-Savers, Inc., whose stock was all owned by the members of the successor partnership.Both the corporation and the partnership were members of a cooperative purchasing association known as Associated Grocers Co-op. The association, hereinafter sometimes referred to as the Co-op, was 164 organized under the laws of the State of Washington in 1934. Its purpose, as set out in its articles of association, was, in part:1. To unite in a non-profit Cooperative association, persons, firms and corporations engaged in the retail grocery business and in the raising, handling, and selling or otherwise marketing of any agricultural, live-stock, dairy, marine, or other products.2. To procure and purchase for the members thus associated any or all merchandise, products, or other commodities used or useful in the conduct of the business of its members, and to purchase, manufacture, store and deliver the said merchandise, products and commodities.The Co-op had a capitalization at all times here material of $ 300,000, divided into 6,000 shares of stock of a par value285 of $ 50 each. Article V of the articles of association provides, in part:The excess of income arising from monthly dues and any other payments by members, from charges to members for delivery of merchandise in excess of the cost of handling and of the administration of the association, shall first be applied to setting aside adequate reserves for taxes, depreciation, bad debts, inventory losses, and for other contingencies, and not less than ten per cent (10%), nor more than twenty-five per cent (25%) of the remainder shall be apportioned and credited to the statutory reserve fund account, and the then remaining balance shall be apportioned and credited to the members of the association in the proportion that each member's purchases bear to the total purchases of all members during the fiscal period in which the said excess of income was realized, said refund to be paid in cash, credits or notes of the association, payable upon such terms and conditions as the Board of Directors of the association shall, at the time of the issuance of such notes or establishments of such credits determine to be to the best interests of the association.During the taxable years 1944 and 1945 the 286 partnership purchased merchandise from the Co-op for retail sale to its customers in amounts as follows:Jan. 1 to June 30, 1944$ 140,879.25July 1 to Dec. 31, 1944161,049.91Jan. 1 to June 30, 1945133,803.55July 1 to Dec. 31, 1945125,003.48During these years the Co-op issued and delivered to the partnership as purchase rebates or patronage dividends registered redeemable notes, such as referred to in article V above, in the following amounts:Date issuedPeriod of salesAmount3-31-44Last half 1943$ 2,007.559-30-44First half 19443,959.093-31-45Last half 19441,306.709-30-45First half 19452,427.193-31-46Last half 19452,383.05Each of the notes referred to above was issued pursuant to the following provisions of the corporation's bylaws:165 Sec. 14. The Board of Trustees may further provide that all such dividends as described in Section 13 may be paid by the association at the discretion of the Board of Trustees in the registered redeemable notes of the association, such notes to bear interest at the rate determined by the Board, shall be payable upon the liquidation of the association, redeemable upon call of the Board of Trustees287 in such manner as the Board may provide and shall be subordinated to the claims of all secured and general creditors of the association in the event of liquidation. It is intended that this privilege shall be exercised by the Board whenever necessary to maintain the working capital of the association at an efficient point, and the notes so issued shall be redeemed in order of issuance in such manner as the Board may provide when the working capital of the association is, in the opinion of the Board, equal to that required by the necessities of the business. * The notes so issued were credited to the partnership in the books of the Co-op in a separate notes payable account. This account for the period March 31, 1942, to March 31, 1946, shows credits totaling $ 26,495.02, including $ 6,632.93 of notes issued to the predecessor corporation during 1942, and a balance of $ 25,795.02 after a debit of $ 700 representing amounts applied in payment of fourteen additional shares of capital stock issued to the corporation September 30, 1942. Similar notes were issued to other members and credited to their accounts. These accounts showed notes outstanding in the total amounts of $ 288 119,185.29 at September 30, 1942; $ 305,170.27 at September 30, 1943; $ 479.197.30 at September 30, 1944; $ 520,421 at September 30, 1945; and $ 613,434.21 at March 31, 1946. The Co-op also issued to its members other than the partnership dividend notes bearing interest at 4 per cent, of which it had outstanding $ 321,753.82 at March 31, 1942. No new 4 per cent notes were issued after that date and by November 30, 1945, notes outstanding had been reduced to $ 233,599.82.The balance sheets of the Co-op for the years ended September 30, 1943, 1944, and 1945, show the following assets and liabilities:9-30-439-30-449-30-45ASSETSCash$ 16,526.21$ 51,072.32$ 127,310.14Notes and accounts receivable, lessreserve for bad debts498,969.12519,122.50548,045.92Merchandise inventory797,495.83798,366.11904,061.17Merchandise in transit18,696.4575,819.1732,295.07Investments8,842.6510,774.1918,665.19Warehouse sites29,250.0059,552.4061,696.84Buildings and equipment, lessreserve for depreciation356,039.87355,455.19355,961.69Deferred charges2,230.098,754.6614,581.71Total1,728,050.221,878,916.542,062,617.73LIABILITIESAccounts payable383,229.38309,626.85248,160.38Notes payable1,129,814.351,272,781.391,274,545.82Accrued wages, taxes, and interest26,060.1652,076.0354,032.31Federal income taxes16,782.4210,499.589,793.41Paving assessment9,674.68Members' deposits77,000.0089,250.0096,250.00Capital stock15,400.0031,850.00261,450.00Surplus79,763.91103,158.01118,385.81Total1,728,050.221,878,916.542,062,617.73289 166 Neither the partnership nor its corporate predecessor ever entered the notes in question in their books or reported them in their income tax returns. The notes that had been issued to the corporation were distributed to the stockholders when the company was dissolved and have since been held by them individually. None of the notes has ever been redeemed by the Co-op, but the interest on them has been paid promptly each year up to the present time.The partnership kept its books and made its returns on an accrual basis. It filed returns for the calendar years 1944 and 1945 showing distributable income of $ 90,200.87 for 1944 and $ 45,256.51 for 1945. In determining the deficiencies herein the respondent has added to partnership gross income for 1944 and 1945, as income accrued in those years, the full amount of the notes which it received from the Co-op on purchases made during those years.OPINION.In principle, the same question involved here was before us in Harbor Plywood Corporation, 14 T.C. 158">14 T. C. 158, where we held that credit memorandums issued by a cooperative marketing association as rebates or patronage dividends were accruable and 290 taxable to a member reporting on the accrual basis in the years when received, although not paid until a subsequent year. We pointed out that the distributions were made out of earnings already realized by the association which, in reality, belonged at all times to the contributing members. 2Substantially the same facts are present in the instant case. The notes issued to the partnership represented the partnership's proportional part of earnings already realized by the association which, under its articles of incorporation and bylaws, it was required to distribute to the partnership during the taxable years. The Co-op had the right to make the distributions in the form of registered redeemable notes, which it did, if, in the discretion of the trustees, this was necessary291 in order to maintain a sufficient working capital. The amounts represented by the notes issued to the partnership and other members were credited to them and carried as liabilities in the corporation's books. Like the credit memorandums in the Harbor Plywood case, supra, the notes were payable at any time when there was sufficient cash available. There was an uncertainty as to the time when the partnership would receive the cash, but no contingency as to its rights to receive it or as to the amount, such as would have prevented its accrual. See United States v. Safety Car Heating & Lighting Co., 167 297 U.S. 88">297 U.S. 88. The partnership's rights to definite amounts of income became fixed when the notes were issued.The petitioners argue that even if the notes are to be treated as dividends accruable in the taxable years when issued, they would have to be reported at their fair market value, under section 115 (a), Internal Revenue Code, and section 29.115-10, Regulations 111, and that the notes had no fair market value when received by the partnership.In the first place, the notes in question were not dividends, in the ordinary sense, of292 corporate earnings voluntarily distributed to stockholders substantially in proportion to their stockholdings. They were, as described in the stipulation of facts, "a purchase rebate or so-called 'patronage dividend' on the amount of the purchases made * * * by said partnership from the Associated Grocers Co-op." The amounts of distributions were based not on stock ownership, but on the amount of patronage.Furthermore, we can not find from the evidence that the notes were entirely worthless when issued to the partnership, or at any time thereafter. Neither is there any evidence on which we could determine a fair market value of anything less than their face value. The notes bore interest at the rate of 2 per cent per annum, which has been paid regularly when due. The Co-op was in a sound position financially at the time the notes were issued and, for all the evidence shows, has continued so. Its balance sheets for 1943, 1944, and 1945 show that it was solvent and financially able to pay all of its obligations, including the notes in question, during all those years. There is no evidence that it will not still be able to do so if and when it is dissolved and the notes thereby293 become due and payable.It is to be noted that in the notice of deficiency the respondent determined that the patronage dividends in dispute accrued to the partnership during the years when the purchases on which they were computed were made from the Co-op. On that theory, the amount accruable to the partnership was $ 5,265.79 in 1944 and $ 4,810.24 in 1945. In his brief the respondent advances the alternative theory that the patronage dividends are accruable and taxable to the partnership in the years when it received the notes, with the result that the amounts accruable to the partnership are increased from $ 5,265.79 to $ 5,966.64 for 1944 and decreased from $ 4,810.24 to $ 3,733.89 for 1945.We think that the issuance of the notes by the Co-op is what determined the time of the accrual of the income to the patrons. The amounts to be distributed under the Co-op's articles of association were not known until the accounting was made at the end of each half year and the trustees had determined how much of the income was to be set aside for reserves. It was only the remaining balance that was to be "apportioned and credited" to the members. (See 168 article V of the articles*294 of association set out above.) While the members' rights to some undetermined portion of the income may have attached at the time the sales were made, which is the theory on which respondent determined the deficiencies, the amounts could not be ascertained with any reasonable accuracy until they had been determined by the board of directors. We think that as a practical matter the time for the accruals was when the rebates or patronage dividends were determined and credited to the members in the Co-op's books and the notes issued to them.As noted above, a recomputation on this basis may result in an increased tax liability for 1944, but, since the respondent has not moved for any increase in the deficiency determined for either of the years before us, none may be found.Decisions will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Mary E. Bradshaw; Warren L. Murphy; Vera Rose Murphy; Clifford M. Schumacher; and Lydia M. Schumacher.↩2. San Joaquin Valley Poultry Producers' Assn., 136 Fed. (2d) 382; Midland Cooperative Wholesale, 44 B. T. A. 824; United Cooperatives, Inc., 4 T. C. 93↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625570/	John D. Riley and Inez P. Riley, Petitioners, v. Commissioner of Internal Revenue, RespondentRiley v. CommissionerDocket No. 84881United States Tax Court37 T.C. 932; 1962 U.S. Tax Ct. LEXIS 193; February 14, 1962, Filed 193 Decision will be entered under Rule 50. Petitioners and a firm of contractors entered into a contract for the subdivision and development of certain real estate owned by petitioners. Under the provisions of the contract, petitioners were to convey a certain number of the improved lots to the contractors as compensation for the work done. Held, when petitioners conveyed 40 lots to the contractors to compensate them for work done, petitioners realized a taxable gain. Held, further, on the facts, petitioners were in the trade or business of selling real estate and the gain so realized was ordinary income. W. H. Albritton, Esq., for the petitioners.Homer F. Benson, Esq., and Glen W. Gilson II, Esq., for the respondent. Train, Judge. TRAIN932 OPINION.Respondent determined deficiencies in petitioners' income tax as follows:Docket No.YearDeficiency1956$ 2,058.778488119571,257.30The deficiency proposed for 1957 was assessed and paid.The issues remaining for decision are:(1) Whether the petitioners realized taxable gain when they conveyed 40 lots in the Lake Forest Subdivision to pay for work done by a firm of contractors; and(2) If the transaction resulted in the195 realization of taxable gain, whether it was capital gain or ordinary income.All of the facts have been stipulated and are hereby found as stipulated.The petitioners John D. Riley (hereinafter sometimes referred to as John) and Inez P. Riley (hereinafter sometimes referred to as Inez) are husband and wife. Their Federal income tax return for 1956 was filed with the district director of internal revenue, Birmingham, Alabama.In 1941, Inez acquired from her father, Andrew J. Preston, and the Federal Land Bank of New Orleans, an old farm or plantation known as the Knox Farm, which consisted of approximately 563 acres. The farm was made up of a pecan grove, cultivated lands, pasture lands, and swamp lands with an old abandoned millpond. From 1941 through 1945, the farm was operated for agricultural purposes. During that period of time it was difficult to secure farm labor or tenants. In 1944, petitioners began selling part of the farm. In that year 140 acres were sold to one purchaser. In 1945, another 90 acres were sold to a single purchaser.933 On May 28, 1946, approximately 40 acres were subdivided and platted into lots. This property was known as Green Acres. The 196 plat was recorded in the office of the Judge of Probate of Covington County, Alabama. Soon after the plat had been filed, Inez, joined by her husband, John, sold lots Nos. 1, 2, and 3 in block 2 of Green Acres for $ 750 each. Lots 2 and 3 were not paid for, were repossessed and subsequently sold again. Thereafter, petitioners entered into a contract with Lummus Auction Company (hereinafter referred to as Lummus Auction), Atlanta, Georgia, to sell the subdivided property at auction. In order to market the property, it was replatted as Green Acres on May 27, 1947, by dividing the lots in blocks 1 through 9, into 75-front-foot lots (except lots 1, 2, and 3 of block 2 which had already been sold) and by eliminating blocks 10 and 11 (later platted as Lake Forest Subdivision) from the plat entirely. On January 13, 1955, blocks 1, 2, and 3 of Green Acres were replatted and on December 22, 1955, blocks 8 and 9 were replatted.On June 19, 1947, Lummus Auction offered Green Acres, as replatted, for sale at auction. The subdivision (consisting of 94 lots) was sold, but petitioners were distressed at the extremely low prices being bid. They had friends bid in 66 of the 94 lots, at the prevailing197 prices, for the purpose of computing the contract commissions of the auction company and to preserve the lots for subsequent sale at more favorable prices. During the remainder of 1947, two lots were sold out of Green Acres and another portion of the Knox Farm acreage, unplatted, consisting of 5 acres and 8 acres, was sold to individual purchasers.On November 1, 1948, additional acreage of the Knox Farm was subdivided and platted. The plat consisted of three blocks adjoining blocks 4 and 5 of Green Acres. The newly platted lots were designated as Extension of Green Acres Subdivision (hereinafter referred to as Green Acres Extension). This plat was also recorded.During the years 1948 through 1956, the following sales were made:Extension ofKnox FarmYearGreen AcresGreen Acres(sales in acres)(sales in lots)(sales in lots)1948541949113195011None19516None50195211 and a portion of two others127 to one purchaser34 to one purchaser1953None240 to one purchaser19542219553 and part of 4 others2019561 and part of 2 others2934 In addition to the aforementioned sales from the original Knox Farm, sales were198 made from other subdivisions known as the John D. Riley Subdivision and the Valley of Shilo Subdivision. Both of these subdivisions were owned by Inez.There was an area on Knox Farm of approximately 70 acres which contained an old abandoned millpond. There was no existing means of entrance into this area. No lots had been sold out of this platted area, as it was not marketable as a subdivision in its then condition. In 1954, arrangements were begun to make this area marketable as a subdivision. A plat was prepared and the area was known as the Lake Forest Addition to the City of Andalusia, Alabama. Subsequently, block F of the Lake Forest Addition was resubdivided by a plat made on April 12, 1954. On April 24, 1954, petitioners and McDonald, Hooper & DeJarnette (hereinafter referred to as McDonald-Hooper) entered into a written contract for the subdivision, platting, grading, draining, and developing the subdivision. The pertinent parts of the contract are as follows:This agreement made and entered into on this the 24 day of April, 1954, by and between INEZ P. RILEY and JOHN D. RILEY, parties of the first part; and W. B. McDONALD, M. S. HOOPER AND HENRY DeJARNETTE, INDIVIDUALLY199 AND AS PARTNERS, DOING BUSINESS AS McDONALD, HOOPER & DeJARNETTE, a partnership, hereinafter termed parties of the second part;Witnesseth:Whereas, the parties hereto plan to develop a subdivision in the City of Andalusia, Alabama, known as LAKE FOREST,And Whereas, the parties of the second part agree to furnish the services, labor, materials and equipment necessary to make surveys, sub-divide, plat and record said sub-division, and the necessary services, materials, labor and equipment to grade, drain, develop and improve said sub-division and existing dam thereon, in the manner desired by the parties of the first part;And Whereas, the parties of the first part agree to furnish for said development the following described real estate, to-wit: All of the SE 1/4 of NW 1/4 and the SW 1/4 of NW 1/4 of Section 21, T. 4, R. 16 E., lying and situated North of Midway Drive as shown and recorded in Green Acres Addition to the City of Andalusia, Alabama, and containing seventy acres, more or less.Now Therefore, in consideration of the premises, and in further consideration of one dollar, in hand paid each to the other, the receipt whereof is hereby acknowledged, the parties hereto200 agree as follows:1. The parties of the first part agree to;(a) Furnish the land hereinabove described, free of all incumbrances at the agreed value of Twenty-Eight Thousand ($ 28,000.00) Dollars as their share of the development.2. The parties of the second part agree to;(a) Make surveys, sub-divide, plat and record said sub-division for the agreed sum of Eight Hundred and Forty ($ 840.00) Dollars.(b) To furnish all storm drain pipe, and other incidental items of materials at invoice cost (plus freight and taxes, at actual cost).(c) Furnish and construct all 4" concrete aprons for spillways at dam for the price of 33 cents per square foot.935 (d) To furnish the following pieces of construction equipment at the rental rates as shown below (each rental price to include operator & fuel):D-6 or D-7 Angledozer or Bulldozer$ 10.00 per hr.Motor Patrol10.00 per hr.John Deere Tractor & Roller6.00 per hr.Power Shovel10.00 per hr.Dump Trucks2.50 per hr.(e) To furnish all construction labor (other than equipment operators) to clear and grub, laying of pipes and other incidental items required in the development, at the following price:Foreman$ 1.50 per hr. plus 10% for taxes, ins. etc.Semi-skilled$ 1.00 per hr. plus 10% for taxes, ins. etc.Unskilled$ 0.75 per hr. plus 10% for taxes, ins. etc.201 Total of A, B, C, D and E in this paragraph shall not exceed $ 12,000.00, unless hereafter amended in writing between the parties hereto; and the work done shall be as directed by the parties of the first part. It is further agreed that parties of the second part will furnish to the parties of the first part a statement of accrued costs of development each 30 days during the continuance of said work; and work may be terminated by parties of the first part at their discretion, and the value of all work assessed as of that date.3. At the completion of said development or at the termination of work as hereinabove set forth, the total amount due the parties of the second part is to be added to the $ 28,000.00 contribution of the parties of the first part; and from this combined sum the true equity of each is to be ascertained. When said equities are established, the parties hereto will jointly inspect and establish a wholesale value for each and every lot in said sub-division; said values, in their aggregate, to equal the combined total of the $ 28,000.00 due the parties of the first part and the amount due the parties of the second part under this agreement.4. When said values are202 established and lots numbered, the number and value of each lot will be placed on a separate slip of paper, and all of the slips of paper placed in a container in the presence of each of the parties hereto and a party selected by the parties hereto. The parties of the second part will then and there, in the presence of the others, draw from the container a sufficient number of lots (of an aggregate value) equal to the amount due the parties of the second part under this agreement; and the parties of the first part will forthwith execute and deliver a warranty deed to said drawn lots, to the parties of the second part. It being the intention of this agreement to establish a method whereby work done by the parties of the second part can be paid for with a portion of the developed property. [Emphasis supplied.]On May 31, 1955, paragraph 2 of the contract was amended by providing that the cost of the work done by McDonald-Hooper would not exceed $ 14,000.Pursuant to the contract as amended, the work of subdividing, platting, surveying, grading, draining, developing, and improving the property was done by McDonald-Hooper. The work was completed on January 13, 1956. Upon completion203 of the work, the value of the work done by McDonald-Hooper was determined to be $ 14,000. Pursuant to the provisions of the contract, the lots as subdivided were then valued. After the valuation of each of the lots in accordance with the total aggregate value, 40 lots were set aside for and conveyed 936 to McDonald-Hooper and 80 lots were retained by Inez. Of the remaining lots, one was sold in 1956 and two were sold in 1957. The proceeds of such sales were reported as ordinary income in the returns filed for such years.Inez did not have a real estate license. At all times pertinent to the issue under consideration John was a licensed real estate dealer and handled the sales of all parcels of real estate sold by Inez.In the notice of deficiency respondent made the following determination regarding the transaction with McDonald-Hooper:It is determined that you realized ordinary income in the amount of $ 9,333.33 from the transaction whereby you exchanged lots in Lake Forest Subdivision for improvements made to lots in said subdivision which were retained by you, computed as follows:Value of improvements received on lots retained$ 9,333.33Basis of lots exchangedNoneGain$ 9,333.33204 Accordingly, your taxable income is increased in the amount of $ 9,333.33 for the taxable year ended December 31, 1956. Sections 61, 1221 and 1011 of the Internal Revenue Code of 1954.In their Federal income tax return for 1956, petitioners treated the transaction as a sale or exchange of a capital asset held for more than 6 months and reported the gain as capital gain. The following business schedule from petitioners' 1956 return indicates their treatment of other items of income and expense:JOHN D. & INEZ P. RILEYANDALUSIA, ALA.REAL ESTATE, AGENCY"SALES OF LOTS IN DEVELOPED REAL ESTATE SUBDIVISIONS"1956IncomeSales:4 Lots in John D. Riley Subdivision$ 775.004 Lots in Green Acres Subdivision1,900.001 Lot in Lake Forest1,100.0015 Lots in Valley of Shilo4,750.001 Lot on Watson St. -- Misc300.002 Houses repossessed -- Misc2,400.00Total$ 11,225.00Cost of Sales:4 Lots in John D. Riley Subdivision600.004 Lots in Green Acres1,110.241 Lot in Green Acres159.4915 Lots in Valley of Shilo2,135.101 Lot on Watson St250.002 Houses -- Repossessed and sold1,900.00Total6,154.83Gross Profit on Sales$ 5,070.17Appraisals -- Commissions of Land Sales4,543.00Total Gross Income$ 9,613.17Expenses:Commissions paid to others793.00Taxes204.00Appraisals Expenses200.00Interest Paid1,050.00Automobile Expense & travel751.00Rent, Lights, Telephone -- Office837.00Promotion -- Entertainment105.00Accounting Fees50.00Total Expense3,990.00Net Profit for Year$ 5,623.17205 937 Issue 1.Petitioners conveyed 40 lots in the Lake Forest Subdivision to McDonald-Hooper for work done on the subdivision. The issue to be decided is whether petitioners realized a taxable gain.Petitioners contend that the transaction with McDonald-Hooper was merely an addition to capital and a nontaxable event. We see no merit in this contention.Section 1001(a) of the 1954 Code 1 provides that the gain from "the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 1011." Section 1001(b) provides that "The amount realized" is the sum of "any money received plus the fair market value of the property (other than money) received." Literally, where there is a disposition of real estate for services, 2 no property or money is received by the one disposing of the real estate. However, in similar circumstances, it has been held that "money's worth" is received and that such receipt comes within section 1001(b). International F. Corp. v. Commissioner, 135 F. 2d 310 (C.A. 2, 1943), affirming 45 B.T.A. 716">45 B.T.A. 716 (1941); United States v. General Shoe Corporation, 282 F. 2d 9206 (C.A. 6, 1960), certiorari denied 365 U.S. 843">365 U.S. 843 (1961). Since the petitioners received a quid pro quo, the transaction resulted in a closed transaction with a consequent realized gain. By virtue of section 1002, 3 the entire amount of the gain is to be recognized.938 Issue 2.Having decided that petitioners realized a taxable gain, the remaining issue is whether it was ordinary income or capital gain. The answer to this question is dependent207 upon whether the lots conveyed to McDonald-Hooper were held primarily for sale to customers in the ordinary course of petitioners' trade or business or for investment. If the lots were held primarily for sale to customers, then section 1221(1) of the 1954 Code 4 would exclude the lots from the classification of capital assets and the gain would be ordinary income rather than capital gain.The issue is one of fact, D. L. Phillips, 24 T.C. 435">24 T.C. 435 (1955), and there is no one determinative test. The208 many cases that turn on this issue have set forth certain factors to be considered. C. E. Mauldin, 16 T.C. 698 (1951), affd. 195 F. 2d 714 (C.A. 10, 1952). Some of these factors are the taxpayer's purpose in acquiring, holding, and disposing of the property, the activities of the taxpayer, or those acting either with him or on his behalf with respect to the improvement and actual disposition of the property, the frequency and continuity of sales, and the extent of advertising to promote sales or lack of such. But each case rests on its own facts and in most instances it is unlikely that all factors will be applicable or of the same weight that they might have in another factual background. See C. E. Mauldin, supra;Gamble v. Commissioner, 242 F. 2d 586 (C.A. 5, 1957), affirming a Memorandum Opinion of this Court; Consolidated Naval Stores Company v. Fahs, 227 F. 2d 923 (C.A. 5, 1955). While the purpose for the acquisition must be given consideration, intent is subject to change, and the determining factor is the purpose for209 which the property is held at the time of sale or exchange. Carl Marks & Co., 12 T.C. 1196">12 T.C. 1196 (1949); Richards v. Commissioner, infra; Mauldin v. Commissioner, supra; Raymond Bauschard, 31 T.C. 910 (1959), affd. 279 F. 2d 115 (C.A. 6, 1960); Eline Realty Co., 35 T.C. 1 (1960).Petitioners have pointed out that the Knox Farm was owned by Inez and that the sales were always handled by her husband, John. They argue that since she was not conducting any business, the property could not be held primarily for sale to customers in the ordinary course of her trade or business.There is no merit in petitioners' contention. It is an accepted principle of law that one may conduct a business through agents, 939 and, although others may bear the burdens of management, the business is nonetheless his. Walter H. Kaltreider, 28 T.C. 121">28 T.C. 121 (1957), affd. 255 F. 2d 833 (C.A. 3, 1958); Achong v. Commissioner, 246 F. 2d 445 (C.A. 9, 1957), affirming a Memorandum Opinion of this210 Court; Fackler v. Commissioner, 133 F. 2d 509 (C.A. 6, 1943); Snell v. Commissioner, 97 F. 2d 891 (C.A. 5, 1938); Richards v. Commissioner, 81 F. 2d 369 (C.A. 9, 1936). There is no doubt that John was handling Inez' property as her agent; therefore, any activity engaged in by John, relating to her property, can be imputed to her.Petitioners have suggested that they were merely liquidating the Knox Farm. It is true that one may liquidate an asset in the most advantageous way and still obtain capital gains treatment. Galena Oaks Corporation v. Scofield, 218 F. 2d 217, 220 (C.A. 5, 1954). However, petitioners have failed to show that this was what they were doing. Even assuming they had, a taxpayer is no less in the real estate business simply because his objective is to liquidate property than he would be if his objectives were something else, if his activities with respect to the property amount to the conduct of the real estate business. Frieda E. J. Farley, 7 T.C. 198">7 T.C. 198 (1946); Achong v. Commissioner, supra.211 In 1956, the year before us, more than 50 percent of petitioners' income was derived from sales of Inez' property. In their Federal income tax return for 1956, petitioners' business schedule was headed:JOHN D. & INEZ P. RILEYANDALUSIA, ALA.REAL ESTATE, AGENCY"SALES OF LOTS IN DEVELOPED REAL ESTATE SUBDIVISIONS"It is settled that statements of this nature (self-description of business or occupation) constitute evidence of a taxpayer's business. Kaltreider v. Commissioner, 255 F. 2d 833 (C.A. 3, 1958), affirming 28 T.C. 121">28 T.C. 121 (1957); White v. Commissioner, 172 F. 2d 629 (C.A. 5, 1949); Pacific Homes v. United States, 230 F. 2d 755 (C.A. 9, 1956).There were sales in every year from 1944 through 1957. In addition to subdividing and selling lots out of the Knox Farm, there was similar activity in connection with two other subdivisions (Valley of Shilo and John D. Riley Subdivisions) owned by Inez. Just how, when, and under what circumstances these latter two subdivisions were acquired is not shown by the present record. We do know that in 1956, 212 four lots in the John D. Riley Subdivision and 15 lots in Valley of Shilo Subdivision were sold. The extent to which any of this property was advertised or promoted is unknown, but this must weigh against the petitioners since the burden of proof is on 940 them. On the basis of the record before us, we are satisfied that petitioners were carrying on a real estate business.Petitioners contend that even if they were real estate dealers, this does not mean that the transaction under consideration must necessarily be treated as a sale to customers in the ordinary course of business. They contend that they may occupy a dual role; that of dealers and investors. We agree with petitioners' contention as a statement of what the law is. However, the burden of proof is upon the petitioners to show that the property was held for investment.Petitioners' main argument is set forth in the following excerpt from their brief:we are concerned with the conveyance by Petitioners of a portion of the swamp lands and old abandoned mill pond, intended for sale as a subdivision (in connection with the general liquidation of the investment in "Knox Farm"), but which was "not marketable213 as a subdivision in its then condition". The transaction between Petitioners and the Contractors and Engineers was for the very purpose of making the property involved in the transaction marketable as a subdivision. We are still at a loss to understand the Commissioner's idea that property which is not marketable in its then condition, conveyed to Contractors and Engineers in connection with arrangements and work to make it marketable, constitutes a sale or exchange of property "held primarily for sale to customers in the ordinary course of business". * * [Emphasis in original.]We see no merit in petitioners' position. Petitioners seem to be laboring under the misapprehension that marketability "in its then condition" is a touchstone for decision. They have apparently confused their case with cases such as Eline Realty Co., supra, 5215 and Charles E. Mieg, 32 T.C. 1314 (1959). 6 Those cases involved unusual pieces of property that were not capable of subdivision or development and had, possibly, a single potential purchaser. In the instant case, petitioners' only problem was one of having work214 done so the property could then be sold in accordance with their desires. Furthermore, the Lake Forest Subdivision property was admittedly intended for sale. McDonald-Hooper improved and subdivided the property so 941 that it could be sold in lots. The conveyance took place after the work was done and at a time when, even under petitioners' theory, the property was marketable and salable.It is also to be noted that in 1956 other sales from the Lake Forest Subdivision were treated as sales from developed real estate subdivisions. The gain from these sales was reported as ordinary income. Although it is stipulated that petitioners216 do not necessarily agree with this treatment, no satisfactory explanation for this treatment has been given.A simple illustration discloses the fallacy inherent in petitioners' theory. A brick manufacturer, owning its own clay deposits, pays its workers in bricks rather than cash. Under petitioners' theory, this would be either a contribution to capital or the gain would be capital gain on the basis that the clay was not marketable as bricks and the bricks were not sold to customers. Obviously, this is not the law.Merely by showing that additional work was required before the property in question could be sold as a subdivision or that it was exchanged rather than sold fails to satisfy petitioners' burden of proving the property was held for investment. Accordingly,Decision will be entered under Rule 50. Footnotes1. All references are to the Internal Revenue Code of 1954 unless otherwise specified.↩2. The contract dated April 24, 1954, provided that it is "the intention of this agreement to establish a method whereby [the] work done by [McDonald, Hooper & DeJarnette] can be paid for with a portion of the developed property."↩3. SEC. 1002. RECOGNITION OF GAIN OR LOSS.Except as otherwise provided in this subtitle, on the sale or exchange of property the entire amount of the gain or loss, determined under section 1001, shall be recognized.↩4. 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;↩5. Eline Realty Co., 35 T.C. 1">35 T.C. 1↩, involved an odd-shaped lot which was regarded as useless unless the land adjoining it was subdivided at some time in the future. Its limited size and narrow dimensions made subdivision, development, or construction unfeasible. Unable to use the lot for subdivision and development, the taxpayer realized that there would be only one probable use and only a single potential purchaser. The taxpayer's only real hope rested in the possibility that at some future time the owner of the adjoining 22-acre tract would subdivide. We held that although the property of which this lot was a part was acquired for the purpose of subdividing and developing, subsequent events changed the purpose for which it was held from one of sale to one of investment.6. In Charles E. Mieg, 32 T.C. 1314↩, the taxpayer sought to buy certain property for subdivision purposes. Part of the land was located on the back side of a mountain and could not be economically subdivided for resale. The owner of the property insisted on selling all of the property or none of it. The taxpayer purchased all of the property. Subsequently, the mountain property was sold and the question arose as to whether it was held for sale or investment. We held "that the rapid increase in value of such parcels was attributable to the location of a country club nearby, and that the original intention accompanying the venture's acquision of such mountain land was to hold it for an extended period as an investment with the hope that an ultimate enhancement in value would provide the opportunity for profitable disposition."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625571/	CHARLES E. CHASE and MARCIA H. CHASE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentChase v. CommissionerDocket No. 37090-85United States Tax CourtT.C. Memo 1990-139; 1990 Tax Ct. Memo LEXIS 139; 59 T.C.M. (CCH) 116; T.C.M. (RIA) 90139; March 15, 1990139 Ps timely filed their 1981 Federal income tax return bearing address A. In July 1984, Ps moved to address B. In September 1984, and January 1985, Ps respectively mailed the third and fourth installments of their 1984 estimated income tax liability to the Fresno Internal Revenue Service Center. Ps made each remittance by using pre-printed Forms 1040-ES accompanied by their personal check. Ps crossed out address A appearing on the pre-printed Forms 1040-ES and typed in address B. On April 9, 1985, respondent sent a notice of deficiency for 1981 to Ps at address A. The notice was returned to respondent, and placed in respondent's files. Held: The crossing out of address A appearing on Forms 1040-ES in September 1984, and January 1985, and the typing in of address B thereon constituted clear and concise notice of Ps' change of address. Respondent did not mail the notice of deficiency to Ps' last known address (address B). Accordingly, Ps' motion to dismiss for lack of jurisdiction will be granted. Lawrence Brookes, for the petitioners. Debra K. Estrem, for the respondent. JACOBS254 MEMORANDUM FINDINGS OF FACT AND OPINION JACOBS, Judge: This matter is before the Court on cross-motions to dismiss for lack of jurisdiction. Petitioners' motion is premised upon respondent's alleged failure to mail the notice of deficiency to petitioners at their last known address. Alternatively, petitioners contend that as a result of actions taken by respondent which interrupted the delivery of the notice to141 them, either (1) the mailing of the notice should be deemed nullified or (2) they should be granted equitable relief under the reasoning of Wallin v. Commissioner, 744 F.2d 674">744 F.2d 674 (9th Cir. 1984), revg. T.C. Memo 1983-52">T.C. Memo. 1983-52. Respondent asserts that the Court lacks jurisdiction because the petition was not timely filed. Subsequent to the date on which the parties filed opening briefs, petitioners filed a motion for attorney's fees and costs. FINDINGS OF FACT 255 Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioners, husband and wife, timely filed their joint 1981 tax return with the Internal Revenue Service Center in Fresno, California. At the time the return was filed, they lived in Portola Valley, California (Portola Valley address). In July 1984, petitioners moved to Belmont, California (Belmont address), where they resided at the time the petition in this case was filed. At the time of their move, petitioners filed a change of address form with the Postal Service. On September 17, 1984, petitioners mailed to the Fresno Service142 Center the third installment of their 1984 estimated income tax liability using a pre-printed estimated tax payment voucher, Form 1040-ES. They crossed out the Portola Valley address pre-printed on the voucher and typed in the Belmont address. The check accompanying the voucher had petitioners' Belmont address printed upon it. On January 15, 1985, petitioners mailed the fourth installment of their 1984 estimated income tax liability. Again they used a pre-printed Form 1040-ES, and again they crossed out the Portola Valley address and typed in the Belmont address. Petitioner Charles E. Chase, a self-employed attorney, has filed estimated tax vouchers since 1970. In 1975, he notified the IRS of a change in his address by using Form 1040-ES, and based on that prior experience, he believed that the third and fourth quarter 1984 estimated tax vouchers could be used to notify the IRS of a change in petitioners' address. The deficiency and additions to tax in this case relate to the year 1981. Petitioners' 1981 return was selected for audit because of their claimed entitlement to a deduction and an investment credit as a result of their investment in Master Recordings, Ltd., a143 partnership which the IRS perceived to be an abusive tax shelter. The audit of Master Recordings, Ltd. was conducted out of the Cincinnati, Ohio, office of the IRS. In mid-1983, Revenue Agent Charles Tonna (Tonna), was assigned to audit those partners of Master Recordings, Ltd. residing within the San Francisco region, including petitioners. Although the audit of Master Recordings, Ltd. had not been completed, Tonna knew that certain adjustments would be made to the 1981 partnership return which would impact its partners. Armed with this knowledge, he requested a copy of petitioners' 1981 tax return from the Fresno Service Center. On March 20, 1984, after reviewing a transcript of petitioners' account obtained from the Fresno Service Center, Tonna determined petitioners' current address to be the Portola Valley address. In early 1985, he had a letter sent to petitioners notifying them that an examination of Master Recordings, Ltd. was being conducted and that adjustments might be made which could affect their 1981 tax return. The letter was sent to petitioners' Portola Valley address, but forwarded to their Belmont address. The letter contained a request that petitioners extend144 the limitations period by signing an enclosed consent form (Form 872-A). Petitioners failed to respond to this letter. On March 15, 1985, Tonna prepared a notice of deficiency which disallowed the loss and investment tax credit claimed by petitioners in 1981 with respect to their investment in Master Recordings, Ltd. Such notice was processed more expeditiously than usual because of the short time remaining for assessment. In determining petitioners' address for purposes of mailing the notice of deficiency, Tonna relied on the information appearing on the transcript obtained in March 1984; he made no other attempt to determine petitioners' current address. On April 9, 1985, respondent mailed the notice of deficiency by certified mail to petitioners at their Portola Valley address. On April 15, 1985, petitioners filed their 1984 tax return, which showed their Belmont address. As a result of this filing, the IRS changed its records during the third week of June 1985, to reflect petitioners' Belmont address. On April 16, 1985, an employee of the post office affixed to the envelope containing the notice of deficiency (the envelope) a yellow forwarding sticker bearing the Belmont145 address. However, the envelope bearing the forwarding sticker was not forwarded to petitioners at their Belmont address, but rather was returned by the Post Office to the San Francisco IRS District Director's office. Once at the San Francisco District Director's office, the envelope was routed to that District's Support Services Unit where, rather than being deposited in the mail for forwarding, it was opened by IRS personnel and retained. When a notice of deficiency is returned to the IRS, the standard procedure followed by the Support Services Unit is to perform an enmod search as to the taxpayer's current address, and thereafter to re-mail the deficiency notice to such address. This procedure is followed even if the statute of limitations has expired. Here, the enmod search conducted on May 8, 1985, disclosed petitioners' current address to be the 256 Portola Valley address. Accordingly, the returned notice was not re-mailed. Petitioners did not know about the deficiency notice until they received a Notice of Tax Assessment, dated August 19, 1985. Thereafter, on October 3, 1985, they petitioned this Court seeking a redetermination of the deficiency set forth in146 respondent's April 9, 1985, notice of deficiency. Throughout 1984 and 1985, as well as during any period before these years, respondent's Fresno Service Center was not processing address changes from Form 1040-ES. This was the case despite the fact that Form 1040-ES for years before and after 1984, but for some reason not for 1984, contained an instruction directing taxpayers to make any address change directly on the form. At the Court's request, respondent surveyed its various service centers to determine whether any were processing address changes from corrections made on Form 1040-ES. During late 1984 and early 1985, only one of respondent's nine service centers, the Brookhaven Service Center, was making address changes based upon 1040-ES Forms filed by taxpayers. OPINION Motions to DismissTo maintain an action in this Court, there must be a valid notice of deficiency and a timely filed petition. See Pyo v. Commissioner, 83 T.C. 626">83 T.C. 626, 632 (1984); Keeton v. Commissioner, 74 T.C. 377">74 T.C. 377, 379 (1980). In the language of the statute, "if the Secretary determines there is a deficiency * * * he is authorized to send a notice of such deficiency147 to the taxpayer by certified or registered mail." Sec. 6212(a). (All section references are to sections of the Internal Revenue Code in effect for the periods in question, and all Rule references are to the Tax Court Rules of Practice and Procedure.) The mailing of such notice must be to the taxpayer at his last known address. Sec. 6212(b)(1). Once this has occurred, the taxpayer has, under usual circumstances, 90 days within which to file a petition with this Court. Sec. 6213(a). The term "last known address" is not defined in either the Internal Revenue Code or the regulations; we have defined it as "the taxpayer's last permanent address or legal residence known by the Commissioner, or the last known temporary address of a definite duration to which the taxpayer has directed the Commissioner to send all communications during such period." Brown v. Commissioner, 78 T.C. 215">78 T.C. 215, 218 (1982). The focus in determining the taxpayer's last known address is on what respondent knew at the time he issued the notice of deficiency and whether, in light of all the surrounding facts and circumstances, he used an address to which he reasonably believed the taxpayer wanted148 the notice to be sent. Pyo v. Commissioner, supra at 633; Brown v. Commissioner, supra at 218-219; Weinroth v. Commissioner, 74 T.C. 430">74 T.C. 430, 435 (1980); Alta Sierra Vista v. Commissioner, 62 T.C. 367">62 T.C. 367, 374 (1974), affd. without published opinion 538 F.2d 334">538 F.2d 334 (9th Cir. 1976). Respondent must exercise due diligence in ascertaining a taxpayer's last known address. Pvo v. Commissioner, supra. Whether respondent has exercised due diligence in a given case is a factual inquiry, to be determined from all of the surrounding facts and circumstances. McPartlin v. Commissioner, 653 F.2d 1185">653 F.2d 1185 (7th Cir. 1981), revg. an unreported order of this Court; Johnson v. Commissioner, 611 F.2d 1015">611 F.2d 1015, 1019 (5th Cir. 1980), revg. an unreported order of this Court; King v. Commissioner, 88 T.C. 1042">88 T.C. 1042 (1987), affd. 857 F.2d 676">857 F.2d 676 (9th Cir. 1988). In this case, petitioners crossed out the Portola Valley address which was pre-printed on their third and fourth quarter 1984 estimated tax vouchers and inserted their new Belmont address. Such, in our opinion, 149 is a clear and concise indication that petitioners' Portola Valley address was no longer to be used. If petitioners had not intended to inform the IRS of a permanent change of address, i.e., if petitioners had intended the Belmont address to be construed as only temporary and not of a definite duration, they would have run the risk of having future IRS correspondence missent. On the record before us, we cannot impute such fecklessness to petitioners. Petitioners' actions in striking their Portola Valley address and inserting their Belmont address on the 1984 1040-ES Form were deliberate and unambiguous, and consistent with their 1984 income tax return filing on April 15, 1985. Since the deficiency letter was mailed on April 9, 1985, the 1984 return could not have formed the basis for a current address notification vis-a-vis the deficiency notice. See Abeles v. Commissioner91 T.C. 1019">91 T.C. 1019 (1988). Furthermore, petitioner Charles E. Chase had on a previous occasion successfully used the estimated tax voucher as a means by which to notify the IRS of a change in his address. Although petitioners did not use words which explicitly indicated an address change, such150 is not fatal. The affirmative actions taken by petitioners provide implicit meaning from which it can reasonably be inferred that an address change was intended. Thus, considering the 257 totality of facts involved herein, we think petitioners' actions were reasonable. Respondent argues that because estimated tax vouchers are not tax returns, he should not be charged with knowledge of the information contained thereon. This would appear to be somewhat specious, given the fact that the IRS must be charged with the knowledge of the identity of the taxpayer and the amount of estimated tax being remitted. We are mindful of our decision in Monge v. Commissioner, 93 T.C. 22">93 T.C. 22 (1989). In Monge, we held that the mere filing of an extension form, without more, did not constitute clear and concise notice of a new address. We therein stated: Petitioners acknowledge that we have previously held * * that the filing of Forms 4868 and 2688 does not constitute clear and concise notification of a change of address unless the taxpayer specifically indicates on the form that it is a new address. Perhaps the most significant objection to petitioners' position151 is that it would require respondent to record the address shown on every extension request filed with him. The adoption of their position would clearly upset the balance between the administrative burdens imposed on respondent and the interest of taxpayers in obtaining actual notice of respondent's determination. If Mr. Monge had wanted respondent to use the address shown on either Form 4868 or 2688 as his last known address, it would have been a simple matter for him to have so indicated on the form itself. Mr. Monge chose not to do so and thereby failed to clearly and concisely notify respondent of the desired change. Accordingly, we hold that the Forms 4868 and 2688 filed by Mr. Monge for the year 1985 did not provide clear and concise notification to respondent of Mr. Monge's change of address. [Monge v. Commissioner, supra at 32; citations omitted.] Here, petitioners did more than put a new address on the estimated tax vouchers -- they crossed out their pre-printed address and replaced it with a new one. Such affirmative action is the type of indication of a change in address we stated would be needed to assuage the administrative burden of requiring152 respondent to check the address shown on all forms. Further, this case is distinguishable from Monge in that here a cursory inspection of the IRS voucher would have revealed a change of address. For the foregoing reasons, we hold that respondent did not mail the deficiency notice to petitioners at their last known address as contemplated by section 6212(b)(1). As a consequence of this holding for petitioners, we need not address their argument that they should be granted equitable relief under Wallin v. Commissioner, 744 F.2d 674">744 F.2d 674 (9th Cir. 1984), revg. T.C. Memo 1983-52">T.C. Memo. 1983-52. Petitioners' motion to dismiss will be granted, and respondent's motion to dismiss will be denied. Motion for Award of Litigation CostsPursuant to Rule 231(a), a petitioner must wait until after the merits of the case have been resolved before moving for an award of litigation costs. Because it is premature, petitioners' motion for an award of litigation costs will be denied, without prejudice to their right to renew their motion at the appropriate time. To reflect the foregoing, An appropriate order will be entered .	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625572/	Hewlett-Packard Company, Petitioner v. Commissioner of Internal Revenue, RespondentHewlett-Packard Co. v. CommissionerDocket No. 3151-75United States Tax Court67 T.C. 736; 1977 U.S. Tax Ct. LEXIS 159; January 31, 1977, Filed 159 1. Held, petitioner substantially complied with the directions of sec. 1.964-1(c)(3), Income Tax Regs., prescribing the procedure for the election of depreciation accounting methods, and the earnings and profits of three of its controlled foreign subsidiaries for the taxable years ended Oct. 31 of 1967 through 1970, properly reflected adjustments for accelerated depreciation.2. Held, further, petitioner did not satisfy the "minimum overall tax burden" test prescribed by sec. 1.963-4(a), Income Tax Regs., and is not entitled to exclude for its taxable year ended Oct. 31, 1968, the subpart F income of its chain of controlled foreign corporations headed by Hewlett-Packard S.A., Geneva, Switzerland. John B. Jones, Jr., and Michael R. Levy, for the petitioner.Robert E. Casey, for the respondent. Featherston, Judge. FEATHERSTON736 Respondent determined deficiencies in petitioner's Federal income tax as follows: 737 Amount ofTYE Oct. 31 --deficiency1967$ 158,119.011968135,309.011969582,216.031970490,022.34Other issues having been settled by the parties or severed for separate trial, 1 those remaining for decision are as follows:(1) Whether petitioner effectively elected for its taxable years ended October163 31 of 1967 through 1970, a method of accelerated depreciation for computing the earnings and profits of three of its controlled foreign subsidiaries when it filed for its taxable years ended in 1964 through 1967 its "written statement" and related information with the District Director, Internal Revenue Service, rather than with the Director of International Operations, Internal Revenue Service, Washington, D.C. 20225, as directed by section 1.964-1(c)(3)(ii), Income Tax Regs., for those taxable periods.(2) Whether petitioner has satisfied for its taxable year ended October 31, 1968, the "minimum overall tax burden" test prescribed by section 1.963-4(a), Income Tax Regs., so as to be entitled to exclude from gross income for such year the subpart F income of Hewlett-Packard S.A., Geneva, Switzerland, a controlled foreign corporation.164 FINDINGS OF FACTGeneralHewlett-Packard Co. (hereinafter petitioner), a California corporation, had its principal office in Palo Alto, Calif., at the time its petition herein was filed. For its taxable years ended October 31 of 1964, 1965, 1966, and 1967, petitioner filed its Federal income tax returns with the District Director of Internal Revenue, San Francisco, Calif. For its taxable years ended October 31 of 1968, 1969, and 1970, petitioner filed Federal income tax returns with the Internal Revenue Service Center, Ogden, Utah.738 Issue 1. Accelerated Depreciation ElectionDuring the period from sometime prior to its taxable year ended in 1964 through its taxable year ended in 1970, petitioner owned 100 percent of the stock of Hewlett-Packard S.A., Geneva, Switzerland (hereinafter HPSA), which, in turn, owned 100 percent of the stock of two West German companies, Hewlett-Packard GmbH (hereinafter GmbH) and Hewlett-Packard VmbH (hereinafter VmbH). By reason of this ownership, HPSA, GmbH, and VmbH were controlled foreign corporations within the meaning of section 957(a). 2 During the same period referred to above, HPSA, together with its several second-tier subsidiaries165 including GmbH and VmbH, comprised a "chain of controlled foreign corporations," as defined in section 963(c)(2). Petitioner's taxable year ended October 31, 1964, was its first taxable year beginning after December 31, 1962, during which HPSA, GmbH, and VmbH were controlled foreign corporations or for which they were included in a chain election under section 963(c)(2).Commencing with the taxable year ended October 31, 1964, and continuing through the taxable year ended October 31, 1970, the earnings and profits of HPSA, GmbH, and VmbH reflected adjustments for accelerated depreciation.For each of its taxable years ended October 31, 1964, through October 31, 1970, petitioner filed Treasury Forms 2952 (Information166 Return with Respect to Controlled Foreign Corporations) with its Federal income tax return on behalf of HPSA, GmbH, and VmbH. Each such Form 2952 with respect to GmbH and VmbH stated that HPSA owned 100 percent of the respective corporation's stock. Each such Form 2952 with respect to HPSA stated that petitioner owned 100 percent of that subsidiary's stock. For each of its taxable years ended October 31 of 1965 through 1970, petitioner also filed Forms 3646 (Income From Controlled Foreign Corporation) with its Federal income tax return on behalf of HPSA, GmbH, and VmbH. Form 3646 was not in existence at the time petitioner filed its tax return for its taxable year ended October 31, 1964. 739 Attached to and filed with each of petitioner's Federal income tax returns for its taxable years ended October 31, 1964, through October 31, 1970, was a statement of "Investments in Affiliates," which indicated that in each of these years petitioner owned 100 percent of HPSA, which, in turn, owned 100 percent of both GmbH and VmbH.Attached to and made a part of petitioner's Federal income tax return for its taxable year ended October 31, 1964, timely filed on April 15, 1965, with the167 District Director of Internal Revenue, San Francisco, Calif., was a statement entitled "Statements of Consent to Elections under IRS Sections." Paragraphs C and D of that statement are as follows:C. We wish to make a group election under Code Section 963 (minimum distribution rule) for the year ended October 31, 1964. Detailed schedule of the group is attached.D. We also elect that under the provisions of Code Section 964 the earnings and profits and the deficits in earnings of the foreign group (Part C) for the year ended October 31, 1964 were determined according to the rules substantially similar to those applicable to domestic corporations.Also attached to and made a part of that return was a schedule containing a page 3 entitled "Information Required of U.S. Shareholders with income from Controlled Foreign Corporations -- Announcement 64-122 -- Year ended 10/31/64." Immediately above the figures on this page of the schedule appears the caption "Recast of Depr. 1964 Purchases from S.L. to 200% D.B. and Freight and Duty." With respect to HPSA, GmbH, and VmbH, the schedule identifies the amount of straight line depreciation per books of each and the amount of depreciation 168 recast to a 200-percent declining balance. The schedule further shows that petitioner owned, directly or indirectly, 100 percent of the stock of HPSA, GmbH, and VmbH.Attached to and made a part of petitioner's Federal income tax returns for its taxable years ended October 31, 1965, through October 31, 1967, each return timely filed with the District Director of Internal Revenue, San Francisco, Calif., were statements entitled "Statements of Consent to Elections under I.R.S. Sections." Paragraph D of the statement attached to the 1965 return is as follows:We also elect that under the provisions of [Code] section 964 the earnings and profits and the deficits in earnings of the foreign group * * for the 740 year ended October 31, 1965 were determined according to the rules substantially similar to those applicable to domestic corporations; i.e.,1. Accounting methods reflect the provisions of section 446 and the regulations thereunder.2. Inventories in accordance with the provisions of section 471 and 472 and the regulations thereunder.3. Depreciation computed in accordance with section 167 and the regulations thereunder.The statements attached to the returns for the169 taxable years ended in 1966 and 1967 contain identical language with the exception of the applicable dates.With respect to the years ended October 31, 1964, through October 31, 1967, petitioner's tax manager, who was responsible for filing its income tax returns, knew that a written statement was required in order to elect to adopt an accelerated depreciation accounting method for its controlled foreign corporations. However, for those years, he was not aware of the specific provisions of the Treasury regulations regarding such statements and was not aware that such statements were supposed to be filed with the Director of International Operations, Internal Revenue Service (sometimes hereinafter referred to as OIO), separate from its income tax returns. Prior to its taxable year ended October 31, 1964, petitioner's tax manager had never filed any forms with OIO on behalf of petitioner's foreign subsidiaries.In 1968, during the course of an examination of petitioner's returns for the years ended October 31 of 1964 through 1967, an agent brought to the attention of petitioner's tax manager that these required statements should be more elaborate and detailed and should have been 170 filed with OIO in Washington, D.C. With respect to each of its taxable years ended October 31, 1968, through October 31, 1970, petitioner timely filed with OIO, Washington, D.C., a statement in letter form with a subject heading "Statement of Consent to Elections Under I.R.S. Sections." Paragraph B of the statement filed in 1969 for the October 31, 1968, taxable year provides as follows:We also elect that under the provisions of Code Section 964, the earnings and profits (or deficit in earnings and profits) of the foreign group * * for the year ended October 31, 1968 were computed substantially as if such corporations were domestic corporations, i.e. [:]1. Accounting methods reflect the provisions of Section 446 and the regulations thereunder; i.e., taxable income has been computed under the 741 accrual method of accounting. Adjustments for foreign accounting practices have been made to conform to U.S. accounting practices.2. Inventories in accordance with the provisions of Section 471 and 472 and the regulations thereunder; i.e., inventories are valued at cost or market, whichever is lower, and freight and customs duty have been removed from its value.3. Depreciation171 computed in accordance with Section 167 and the regulations thereunder; i.e., new assets with useful life of three or more years, the sum of the years digits method, used assets 150% declining balance method or straight line method. Useful lives and methods are similar to those used by the U.S. parent shareholder.The statements filed in 1970 and 1971 for the taxable years ended October 31 of 1969 and 1970, contain identical language with the exception of the applicable dates. Each of these statements also indicates that petitioner owned, directly or indirectly, 100 percent of the stock of HPSA, GmbH, and VmbH.In its Federal income tax returns with respect to its taxable years ended October 31, 1967, through October 31, 1970, petitioner claimed accelerated depreciation deductions in computing the earnings and profits of HPSA, GmbH, and VmbH, which exceeded straight-line depreciation computations by the following amounts:Taxable year ended Oct. 31 --1967196819691970HPSA$ 20,151$ 18,353$ 19,478$ 19,543GmbH35,04111,47958,961122,409VmbH9,8667,10214,86614,462In his statutory notice of deficiency, respondent disallowed the use of172 accelerated depreciation in computing the earnings and profits of HPSA, GmbH, and VmbH and decreased petitioner's claimed deductions by the above amounts.Issue 2. Minimum Overall Tax Burden TestFor its taxable year ended October 31, 1968, petitioner elected to exclude HPSA's subpart F income from its own income by reason of the receipt of a "minimum distribution" with respect to the consolidated earnings and profits of its chain of controlled foreign corporations, as provided in section 963(a)(2). For purposes of computing the percentage of the earnings and profits of petitioner's chain of controlled foreign 742 corporations required to be distributed as the minimum distribution in accordance with section 963(b), the "effective foreign tax rate," as defined in section 963(d)(2), equaled or exceeded 47.38 percent. 3173 For petitioner's taxable year ended October 31, 1968, 83.3 percent of the days of that period were within the "surcharge period" referred to in section 963(b). The minimum distribution required under section 963(b)(1) for this portion within the surcharge period was zero percent of the earnings and profits of petitioner's chain of controlled foreign corporations because the effective foreign tax rate exceeded 47 percent.For that portion of petitioner's taxable year ended in 1968 which was not within the surcharge period, the minimum distribution required under section 963(b)(3) was zero percent of the earnings and profits of petitioner's chain of controlled foreign corporations because the effective foreign tax rate exceeded 43 percent. Thus, for petitioner's entire taxable year ended October 31, 1968, the applicable minimum distribution requirement of section 963(a)(2), computed in accordance with section 963(b) but without reference to the "minimum overall tax burden" test prescribed by section 1.963-4(a), Income Tax Regs., was zero.In the statutory notice of deficiency for petitioner's taxable year ended October 31, 1968, respondent determined that petitioner was not entitled174 to exclude from its gross income HPSA's subpart F income because petitioner did not satisfy the "minimum overall tax burden" test provided for by section 1.963-4(a), Income Tax Regs.For the purpose of section 1.963-4(a)(1), Income Tax Regs., the "overall United States and foreign income tax," as defined in regulations section 1.963-4(a)(2)(ii), of petitioner's chain of controlled foreign corporations for its taxable year ended October 31, 1968, was $ 3,172,537. The consolidated (pretax) earnings and profits of petitioner's chain of controlled foreign corporations for its taxable year ended October 31, 1968, as referred to in section 1.963-4(a)(1)(i), Income Tax Regs., was $ 7,002,953. 4175 743 OPINIONIssue 1. Accelerated Depreciation ElectionWe hold that petitioner made valid elections to make adjustments for accelerated depreciation in computing the earnings and profits of its foreign subsidiaries for the taxable years ended October 31 of 1964 through 1970. As we view the evidence, petitioner effectively committed itself to employ such method beginning with its return for the taxable year ended October 31, 1964, and continuing through the year ended October 31, 1970, and adequately informed the Internal Revenue Service that it elected to do so. We base our holding on an analysis of the general scheme for taxing the income of controlled foreign corporations, the provisions of the statute, the applicable regulations concerning the adoption and change of accounting methods, and the peculiar facts of this case.The key operative provision of subpart F of Part III, subchapter N, chapter 1, of the Code is section 951, which requires the United States shareholders of a controlled foreign corporation (defined in section 957(a)) to include in their gross income their pro rata shares of such corporation's subpart F income (defined in section 952(a)) for any taxable176 year beginning after December 31, 1962. Section 952(c) limits, in general, a controlled foreign corporation's subpart F income for a taxable year to such corporation's earnings and profits for the taxable year. Therefore, in computing the controlled foreign corporation's subpart F income for any taxable year, it is necessary to determine the foreign corporation's earnings and profits for that year. Section 964(a) provides that:For purposes of this subpart, the earnings and profits of any foreign corporation, and the deficit in earnings and profits of any foreign corporation, for any taxable year shall be determined according to rules 744 substantially similar to those applicable to domestic corporations, under regulations prescribed by the Secretary or his delegate.The regulations under section 964(a) contemplate that the accounting methods employed by controlled foreign corporations will substantially conform with United States accounting practices for purposes of determining such corporations' earnings and profits. In order to effectuate such conformity, the regulations provide for various accounting and tax adjustments through the allowance of elections by the controlling177 domestic shareholders. One of the required adjustments, the one with which we are here concerned, is that depreciation must be computed in accordance with section 167 and the regulations thereunder. Sec. 1.964-1(c)(1)(iii), Income Tax Regs. In general, the controlling domestic shareholders are permitted to make any election which is allowed for domestic corporations. Sec. 1.964-1(c)(1)(iv), Income Tax Regs.Section 1.964-1(c)(2), Income Tax Regs., provides, with respect to a controlled foreign corporation, an exception to the procedural requirements which domestic corporations must satisfy for an election to adopt or change a method of accounting. That subparagraph provides in pertinent part as follows:(2) Adoption of method. For the first taxable year beginning after December 31, 1962, in which the foreign corporation is a controlled foreign corporation (within the meaning of section 957) or for which it is included in a chain or group under section 963(c)(2)(B) or (3)(B) * * there may be adopted or made by such corporation or on its behalf any method of accounting or election allowable under this section notwithstanding that, in previous years, its earnings and profits178 were computed, or its books or financial statements prepared, on a different basis and notwithstanding that such election is required by the Code or regulations to be made in a prior taxable year. * This transitional rule allows a qualifying foreign corporation to change its method of accounting in the first taxable year beginning after December 31, 1962 (hereinafter referred to as first post-1962 taxable year), without first securing the consent of the Commissioner. In other words, the foreign corporation is permitted to start with a clean slate in the first year in which it is covered by these provisions. Thus, any method of depreciation computation permissible under section 167 can be adopted for both new and used assets in the first 745 post-1962 taxable year, regardless of the method used theretofore for previously acquired assets. 5179 Normally, to elect to use one of the accelerated methods of depreciation specified in section 167(b)(2), (3), and (4) for a qualifying asset or group of assets, all a taxpayer has to do is compute the depreciation under the selected method for the taxable year "in which the property may first be depreciated by him." Sec. 1.167(c)-1(c), Income Tax Regs. However, section 1.964-1(c)(3), 6 Income Tax Regs., contemplates two added steps in making a depreciation accounting method election on behalf of a controlled foreign corporation in its first post-1962 taxable year. The first step, and the one on which this issue turns, is that the controlling United States shareholders should file a written statement, jointly executed by those shareholders, with the Director of International Operations, Internal Revenue Service, Washington, D.C. 20225, 7 within 746 180 days of the close of the taxable year of the foreign corporation with respect to which the election is made or the adoption or change of method effected, or before May 1, 1965, whichever is later. This written statement should set forth the name and country of organization of the foreign corporation, the names, addresses, 180 and stock interests of the controlling United States shareholders, the nature of the action taken, the names and addresses of all other United States shareholders notified of the election or adoption or change of method, and such other information as the Commissioner may by forms require. Sec. 1.964-1(c)(3)(ii), Income Tax Regs.The second step is that, before filing this written statement, the controlling United States shareholders should give written notice in a specified form of the election made or the adoption or change of method effected to all other persons known by them to be United States shareholders owning (within the meaning of section 958(a)) stock in the foreign corporation. Sec. 1.964-1(c)(3)(iii), Income Tax Regs. Since petitioner directly or indirectly owned all of the stock of the three foreign corporations here involved, this second step is not applicable in this case.After the first post-1962 taxable year, an election on behalf of the controlled foreign corporation to adopt a method of depreciation accounting different from the one adopted for those assets (both new and used) in that year requires the consent of the Commissioner182 (see section 1.964-1(c)(3)(i)(a), Income Tax Regs.), plus the filing of the written statement described in section 1.964-1(c)(3)(i)(b) and (ii), Income Tax Regs., and the notification of other shareholders under regulations section 1.964-1(c)(3)(i)(c) and (iii).In the instant case, subpart F was first applicable to petitioner for its taxable year ended October 31, 1964. Prior to that taxable year, petitioner had depreciated the assets of HPSA, GmbH, and VmbH on its books on a straight line basis. In its first post-1962 taxable year, petitioner changed from straight line depreciation to the double declining balance method of depreciation with respect to those corporations' depreciable assets on hand at the beginning of the taxable 747 year as well as to assets acquired by them during the taxable year and used the double declining balance method in computing the earnings and profits of those controlled foreign corporations. It is stipulated that commencing with the taxable year ended October 31, 1964, and continuing through the taxable year ended October 31, 1970, the earnings and profits of all three corporations reflected adjustments for accelerated depreciation.Respondent183 contends that petitioner's election for the taxable year ended October 31, 1964, was invalid on the grounds that (1) the "written statement" filed by petitioner was not legally sufficient under section 1.964-1(c), Income Tax Regs., because it did not state in adequate detail what election the taxpayer was making, and (2) the "written statement" required by regulations section 1.964-1(c)(3)(ii) was filed with the District Director of Internal Revenue, San Francisco, Calif., rather than with the OIO in Washington, D.C. Respondent contends that as a result of petitioner's invalid election for the taxable year ended October 31, 1964, petitioner is not entitled to use the accelerated depreciation method of accounting for any assets, new or used, for the taxable years at issue herein. We disagree.As noted above, petitioner was entitled, for purposes of choosing a method of depreciation, to treat previously acquired assets as newly acquired assets in the taxable year ended October 31, 1964. 8 To elect, on behalf of a foreign corporation, to use the accelerated depreciation method for those assets, both new and old, all petitioner had to do was compute depreciation under the selected184 method for this first post-1962 taxable year and fulfill the written statement directions of section 1.964-1(c)(3)(ii), Income Tax Regs.9 Petitioner's return for the taxable year ended October 31, 1964, reflects that petitioner computed depreciation according to the double declining balance method. Thus, whether 748 petitioner validly elected to use the double declining balance method of depreciation for its first post-1962 taxable year depends on whether it complied sufficiently with the "written statement" directions of section 1.964-1(c)(3)(ii), Income Tax Regs.185 It is true that petitioner did not literally comply with the "written statement" portions of the election provisions of section 1.964-1(c)(3), Income Tax Regs. Petitioner filed nothing with OIO, Washington, D.C., for its taxable year ended October 31, 1964. Rather, it attached a "written statement" to, and included other pertinent information elsewhere in, its income tax return for that year which it filed with the District Director of Internal Revenue, San Francisco, Calif.However, literal compliance with the procedural directions in Treasury regulations on making elections, such as the "written statement" and place-of-filing provisions with which we are here concerned, is not always required. Repeatedly this Court has held elections effective where the taxpayer complied with the essential requirements of a regulation even though the taxpayer failed to comply with certain procedural directions therein. Columbia Iron & Metal Co., 61 T.C. 5">61 T.C. 5, 8-10 (1973) (copy of corporate minutes regarding a charitable contribution, filed subsequent to filing of return); Alfred N. Hoffman, 47 T.C. 218">47 T.C. 218, 236-237 (1966), affd. per curiam186 391 F.2d 930">391 F.2d 930 (5th Cir. 1968) (imperfect revocation of a subchapter S election); Fred J. Sperapani, 42 T.C. 308">42 T.C. 308, 330-333 (1964) (failure to follow procedural details in election of a proprietorship to be taxed as a corporation); John P. Reaver, 42 T.C. 72">42 T.C. 72, 80-83 (1964) (election of installment reporting in an amended, rather than original, return); Georgie S. Cary, 41 T.C. 214">41 T.C. 214 (1963) (information required, but furnished after return was filed, for election to treat a stock redemption as a dividend or an exchange). Although there exists no litmus test for determining whether literal compliance with a procedural regulation is called for, this Court in Octavio J. Valdes, 60 T.C. 910">60 T.C. 910, 913 (1973), enumerated as follows certain factors which should be considered: 10187 749 In ascertaining whether a particular provision of a regulation stating how an election is to be made must be literally complied with, it is necessary to examine its purpose, its relationship to other provisions, the terms of the underlying statute, and the consequences of failure to comply with the provision in question. * * As to the legal sufficiency of petitioner's "written statement" filed with its income tax return for the taxable year ended October 31, 1964, quoted in pertinent part in our Findings, petitioner elected in this statement to determine the earnings and profits and the deficits in earnings of the foreign group according to the rules "substantially similar" to those applicable to domestic corporations. See sec. 1.964-1(a), Income Tax Regs. This statement standing alone was insufficient to notify respondent that an election to use accelerated depreciation was made or that petitioner was the sole shareholder of those foreign corporations on behalf of which the election was made. However, this statement, coupled with a schedule attached to the 1964 return, contains all the "written statement" information specified in section 1.964-1(c)(3), Income Tax 188 Regs., quoted in part in footnote 6 above.Page 3 of the schedule attached to the return for the October 31, 1964, taxable year is captioned "Information Required of U.S. Shareholders with income from Controlled Foreign Corporations -- Announcement 64-122 -- Year ended 10/31/64," and it lists the foreign corporations for which the section 964 election was made. Included in the information provided in that schedule are the name and country of organization of HPSA, GmbH, and VmbH, and the stock interest (100 percent) of petitioner in each of those controlled foreign corporations. 11 The schedule prescribes the nature of the action taken as "Recast of Depr. 1964 Purchases from S.L. to 200% D.B. and Freight and Duty." From these entries in the 1964 return, it is clear (1) that petitioner was the sole United States shareholder of HPSA, GmbH, and VmbH, (2) that petitioner treated all assets of the controlled foreign 750 corporations as newly acquired in 1964, and (3) that petitioner elected for its first post-1962 taxable year to adopt the double declining balance method of depreciation. The return was filed within the time limit set for filing the written statement (i.e., "within189 180 days after the close of the taxable year of the foreign corporation with respect to which the election is made * * * or before May 1, 1965, whichever is later"). Sec. 1.964-1(c)(3)(ii), Income Tax Regs.We think the statement and material contained in the schedule referred to above, though not contained in a single document, substantially complied with the applicable regulation and thus were legally sufficient to constitute an election by petitioner. Petitioner obtained no advantage and caused respondent to suffer no inconvenience by failing to consolidate all the written statement data into a single document. Petitioner unequivocally committed itself to the double declining balance method of computing depreciation. If the shoe were on the other foot, respondent's position that petitioner190 had made an election not changeable without permission, sec. 1.964-1(c)(3)(i)(a), Income Tax Regs., would be unassailable.We also think that, in view of the regulatory scheme, the consequences of imprecise compliance, and the peculiar facts of this case, literal compliance as to the place-of-filing direction was not necessary, and petitioner's filing of the statement and schedule with the District Director of Internal Revenue substantially complied with the applicable regulation. See Octavio J. Valdes, supra at 913-914. The purpose of having United States shareholders file a written statement with the OIO is reflected by section 1.964-1(c), Income Tax Regs., viewed in its entirety. Immediately following the recitation of the written statement and shareholder notification directions of subparagraph (3) of that regulation, section 1.964-1(c)(4), 12 Income Tax Regs., explains the effect which 751 the controlling domestic shareholders' election on behalf of a controlled foreign corporation will have on certain United States shareholders. The stated purpose of regulations section 1.964-1(c)(4) is to require that the controlling shareholders' election191 or other action with respect to the computation of the controlled foreign corporation's earnings and profits be consistently reflected to the extent that it bears upon the tax liability of those United States shareholders who received actual notice of the election (or who have failed to provide respondent with the information necessary for their notification).192 To the extent that the controlling United States shareholders are aware of other United States shareholders, respondent places the burden of notification upon the controlling shareholders. Sec. 1.964-1(c)(3)(iii), Income Tax Regs. But in order to assure notification to those other shareholders of whom the controlling shareholders are unaware, section 1.964-1(c)(3)(ii), Income Tax Regs., requires the controlling shareholders to file the written statement (which is to include a list of the shareholders notified of the election) with the OIO. Then, by comparing the names and addresses of the shareholders listed on the written statement to the shareholder list prepared from information on the Forms 959 required also to be filed with the OIO pursuant to section 6046 and the regulations thereunder, 13 the OIO is able to determine who the unnotified shareholders are and to provide them with exactly the same information as the controlling shareholders would have provided under section 1.964-1(c)(3)(iii), Income Tax Regs., had they been aware of such 752 shareholders. Thus, the purpose of filing the written statement with the OIO becomes evident -- to enable that office to give 193 notice of the action taken to persons whose status as United States shareholders is established by the OIO's records but is unknown to the controlling United States shareholders.In the instant case, during the taxable years ended October 31, 1964, through October 31, 1970, petitioner owned, directly or indirectly, 100 percent of the stock of HPSA, GmbH, and VmbH. There were no other shareholders of these controlled foreign corporations to be notified of petitioner's election. 194 The failure to file the written statement with the proper office did not, under these circumstances, cause any prejudice to either party or to the essential purpose of section 1.964-1(c)(3)(ii) of the regulations. See Octavio J. Valdes, 60 T.C. at 913.The responsibility of the Director of International Operations, in the context of this regulatory provision, moreover, is essentially a ministerial or clerical one, and his receipt of the written statements involves no audit functions. 14 Jurisdiction to audit a return filed with the proper District Director by a United States shareholder of a foreign corporation which has subpart F income remains lodged with that District Director. I.R. Manual 1118.4(1); compare I.R. Manual 1113.56, 1113.562, and 1113.563. Therefore, where the controlling shareholders fail to comply with the notice and written statement requirements, the audit function is nonetheless safeguarded by the controlling shareholders' required compliance with the existing statutory rules and regulations which attend such election.195 753 Thus, we think that petitioner, having validly elected to use double declining balance depreciation for its first post-1962 taxable year for newly acquired assets (as well as for the assets treated as newly acquired), was bound in subsequent years to that method for those assets, unless and until it received the consent of the Commissioner to change that method. For the reasons discussed above with respect to its taxable year ended October 31, 1964, we think that petitioner also substantially complied with the regulations in electing to use a method of accelerated depreciation for those assets newly acquired in each of its taxable years ended October 31 of 1965, 1966, and 1967. Therefore, the earnings and profits for 1967 of the three foreign subsidiaries should reflect the methods of depreciation elected for assets acquired in each of the taxable years ended October 31 of 1964, 1965, 1966, and 1967. And, finally, since the "written statement" directions of the regulations were fully complied with for the taxable years ended October 31 of 1968, 1969, and 1970, the sum of the years-digits method of accelerated depreciation for assets placed in service during those years196 may be used in computing the foreign subsidiaries' earnings and profits. 15In concluding that petitioner's failure to file a written statement with the OIO did not nullify its accelerated depreciation election, we do not purport to lay down any general rule which would undermine the regulatory direction that such statements be filed with that office. We confine our holding to the facts of this case. Petitioner's failure to file a written statement literally complying with the directions of the regulations was a mistake, but that mistake was not "to any degree attributable to any willful misconduct" by its officers or employees. Edward F. Dixon, 60 T.C. 802">60 T.C. 802, 805 (1973).197 Petitioner had never filed any forms with the OIO on behalf of its foreign subsidiaries. Although its tax manager knew a written statement was to be filed, he was not aware that such statement was to be filed with the OIO.Indeed, the regulations requiring the written statement to be filed with the OIO became final on October 27, 1964, only 4 754 days before the end of petitioner's first taxable year for which an election was to be made. T.D. 6764, 2 C.B. 260">1964-2 C.B. 260, 265. Form 3646, requiring certain information from controlled corporations, was not in existence when petitioner filed its return for the taxable year ended October 31, 1964. Failure to comply with all the directions of the regulations caused no prejudice to the Internal Revenue Service, and since petitioner owned, directly or indirectly, all the foreign subsidiaries' stock, literal compliance would not have served any useful purpose. As soon as petitioner's tax manager learned during 1968 that written statements were to be filed with the OIO, he thereafter filed them with that office as directed by the regulations. Therefore, we think petitioner made a good-faith effort198 to comply with the applicable regulations. See Bell Fibre Products Corp., 65 T.C. 753">65 T.C. 753, 764-765 (1976).Finally, the regulations do not contemplate that they will be given the harsh literal reading here advocated by respondent. The failure of the controlling United States shareholder to provide notice of an election to a person required to be notified under the regulations does not invalidate the election made "if it is established to the satisfaction of the Commissioner that reasonable cause existed for such failure." Sec. 1.964-1(c)(3)(iii), Income Tax Regs. Further, if failure to take any action within the prescribed time period required in making an election is "shown to the satisfaction of the Commissioner to be due to inadvertence or a reasonable cause," the Commissioner may specify a later date for compliance. Sec. 1.964-1(c)(6), Income Tax Regs. Thus, mere inadvertence is sufficient to excuse a taxpayer's failure to timely take all the steps required for a valid election.Since we have concluded, in the light of the facts of this case, that petitioner's returns and accompanying statements and schedule, filed with the District Director of 199 Internal Revenue, substantially complied with the directions of the regulations, these "escape" provisions are technically inapplicable. However, they serve to demonstrate that reason is to reign in applying the regulations. The written statement and place-of-filing directions are not intended to be traps for the unknowing. Rather, they are intended only to contribute to the effective administration of section 964, and in the 755 circumstances of this case, the form and content of the materials filed with the District Director served that purpose.Issue 2. Minimum Overall Tax Burden TestSection 963 permits a United States corporate shareholder to avoid a tax on its subpart F income where a timely election to take such exclusion was made and where certain prescribed standards of minimum distributions of earnings and profits to that shareholder were met. 16 The purpose of this provision is to relieve the United States shareholder of any tax with respect to the foreign subsidiary's undistributed income in those cases where the combined foreign tax and United States tax (to the extent the latter is paid on distributed income) is not substantially below the United States200 corporate tax rate. S. Rept. No. 1881, 87th Cong., 2d Sess. (1962), 3 C.B. 707">1962-3 C.B. 707, 794. Thus, as the effective foreign tax rate increases, the required minimum distribution of earnings and profits by the foreign subsidiary decreases. S. Rept. No. 1881, supra, 1962-3 C.B. at 794-795; see tables in sec. 963(b). To qualify for this relief, however, a corporation is required under section 963(a) 17 to consent in its election to "all the regulations prescribed by the Secretary or his delegate under this section."201 For its taxable year ended October 31, 1968, petitioner made a timely election under section 963. As reflected in our Findings, the foreign tax rate was sufficient to eliminate the necessity of any distribution in order to meet the minimum distribution requirements of section 963(b). There remains, 756 however, the issue as to whether the "minimum overall tax burden" test prescribed by section 1.963-4(a), Income Tax Regs., to which petitioner consented, has also been met.This separate and additional test prescribed by regulations section 1.963-4(a) is to be met by a chain or group of corporations, as in the case of HPSA and its subsidiaries, GmbH and VmbH. 18 It deals with the problem not covered by the express language of section 963, of a United States corporate shareholder receiving grossly unequal distributions from the members of a chain or group of controlled foreign corporations. The amount of such distributions could be arranged so as to take advantage of the varying foreign tax rates in the foreign countries involved and yet still satisfy the minimum distribution test. Allowance of such a practice would have distorted the balance contemplated by section 963 between202 the percentage of creditable foreign taxes and the percentage of earnings and profits required to be distributed. 19203 The means adopted to solve this problem was to require the actual overall foreign and United States tax burden on the earnings of a chain or group to be 90 percent of the tax which would have been imposed if those earnings and profits had been fully subject to United States taxation. If the overall burden was less than required, the United States shareholder might increase the distributions it received until the minimum 757 overall tax burden was met. Thus, the purpose of the "minimum overall tax burden" test was to insure that the relief granted by the "minimum distribution" provisions of section 963 was not abused by non-pro rata distributions.The regulation (sec. 1.963-4(a)(1)(i)) provides that no exclusion should be allowed unless the overall United States and foreign income tax for the taxable year with respect to which the distribution is made equals or exceeds 90 percent of an amount determined by multiplying the sum of the consolidated earnings and profits and the consolidated foreign income taxes of the chain or group of corporations for the taxable year "by a percentage which equals the sum of the normal tax rate and the surtax rate (determined without regard to204 the surtax exemption) prescribed by section 11 for the taxable year of the shareholder." The issue is narrowed to whether the surcharge imposed by section 51 is added to this percentage for petitioner's taxable year ended October 31, 1968.Petitioner contends that, since the surcharge rate was imposed by section 51 rather than section 11, only the normal tax rate and the surtax rate prescribed by section 11, without regard for the surcharge rate prescribed by section 51(a)(2), is multiplied by the consolidated earnings and profits ($ 7,002,953) of petitioner's chain of controlled foreign corporations. Ninety percent of the resulting amount ($ 3,361,417) is $ 3,025,276. Since this amount is less than the overall United States and foreign income tax ($ 3,172,537), petitioner maintains that it satisfied the test and is entitled to exclude HPSA's subpart F income pursuant to section 963.Respondent contends that, in applying the "minimum overall tax burden" test of regulations section 1.963-4(a)(1)(i), the surcharge rate prescribed by section 51(a)(2) is added to the normal tax rate and the surtax rate prescribed by section 11, and the total is multiplied by the consolidated (pretax) 205 earnings and profits ($ 7,002,953) of petitioner's chain of controlled foreign corporations. 20 The result is $ 3,641,536, and 758 90 percent of this amount is $ 3,277,382. Since this latter amount is greater than the overall United States and foreign income tax ($ 3,172,537), respondent contends that petitioner did not satisfy the test and is not entitled to exclude HPSA's subpart F income pursuant to section 963. We agree with respondent.Section 51, added to the Internal Revenue206 Code by section 102(a) of the Act of June 28, 1968, Pub. L. 90-364, 82 Stat. 251, imposed a surcharge on the income of individuals, estates and trusts, and corporations. Section 51(a)(1)(B) imposed on the income of every corporation a tax computed as a percentage of the adjusted tax (as defined in section 51(b)) in addition to the other taxes imposed by chapter 1 of the Code. For corporations, the surcharge was applicable for taxable years ended after December 31, 1967, and beginning before July 1, 1970. Sec. 51; sec. 1.51-1(c)(2), Income Tax Regs. The stated purpose for the surcharge on the tax liabilities of business corporations was to dampen inflationary pressures and keep the economy under control. H. Rept. No. 91-413 (Part 1), 91st Cong., 1st Sess. (1969), 3 C.B. 200">1969-3 C.B. 200, 309. The section was not expected or intended to be a permanent addition to the Code.When the surcharge was added to the Code in 1968, the "minimum distribution" provisions of section 963 were amended to reflect this original enactment. Sec. 102(b) of Act of June 28, 1968, Pub. L. 90-364, 82 Stat. 255. Subsequently, every time the surcharge was extended, section 963 was amended207 to take into account such extensions. Sec. 5(b) of Act of Aug. 7, 1969, Pub. L. 91-53, 83 Stat. 95; sec. 701(b) of Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 659. Thus, Congress expressly recognized the relationship between section 51 and the "minimum distribution" provisions of section 963.Moreover, section 51(f) laid down the general rule that the surcharge rate, where attributable to another tax-imposing section of chapter 1 of the Code, should be considered as emanating from such other section. That section reads as follows:759 For purposes of this title, to the extent the tax imposed by this section is attributable (under regulations prescribed by the Secretary or his delegate) to a tax imposed by another section of this chapter, such tax shall be deemed to be imposed by such other section.Consistent with section 51(f), section 1.51-1(h)(1), Income Tax Regs., in part as follows, was adopted to provide that --to the extent the tax imposed by section 51 is attributable to a tax imposed by another section of chapter 1 of the Code, such tax shall be deemed to be imposed by such other section. For example, if the only tax (other than the surcharge) imposed208 under chapter 1 of the Code to which a particular corporation is subject is the tax imposed by section 11, then the surcharge imposed on such corporation shall be deemed to be imposed by section 11. * * Thus, section 51(f) and this implementing regulation have the effect of treating the section 51 surcharge as imposed by section 11.Therefore, we do not believe that it can be disputed that Congress fully intended that during the surcharge period, the surcharge rate should apply to section 963 and to any regulations promulgated thereunder. To hold otherwise would allow the erosion of the "minimum distribution" provisions of section 963, which the "minimum overall tax burden" test of the regulations was designed to prevent. No requirements less stringent than those of section 963(b) could be applied if section 1.963-4(a), Income Tax Regs., is to serve its intended purpose.In reaching this conclusion, we are applying the same commonsense interpretation to regulations section 1.963-4(a) as we have applied in the discussion of the accelerated depreciation election issue, above. The objective of this regulation section could not be achieved by reading it in isolation even though, 209 as emphasized by petitioner, it is legislative in character. This section must be read in the light of section 51(f) and its implementing regulation which make it clear that the section 51 surcharge is to be deemed to have been imposed by section 11. While it might have been technically more elegant for the Commissioner to have amended section 1.963-4(a), Income Tax Regs., to refer to the temporary section 51 surcharge while it was in effect, we think it was permissible to achieve the same result by promulgating the general provision of section 1.51-1(h)(1), Income Tax Regs., quoted in pertinent part above.760 Since the surcharge rate imposed by section 51(a)(1)(B) must be added to the normal tax rate and surtax rate imposed by section 11 of chapter 1 of the Internal Revenue Code for that part of petitioner's taxable year within the surcharge period, petitioner failed to satisfy the "minimum overall tax burden" test prescribed by section 1.963-4(a), Income Tax Regs., and is not entitled to exclude from gross income for the taxable year ended October 31, 1968, the subpart F income of HPSA.The parties will be expected to file an appropriate motion in respect of the further210 handling of the severed issue.An appropriate order will be issued. Footnotes1. Prior to the trial of this case, an issue concerning the computation of earnings and profits of certain of petitioner's controlled foreign corporations was severed for separate trial or other disposition pursuant to the Court's order dated June 10, 1976. More specifically, the severed issue concerns the basis for purposes of computing depreciation pursuant to sec. 167, I.R.C. 1954↩, and the regulations thereunder.2. All section references are to the Internal Revenue Code of 1954, as in effect during the taxable years in issue, unless otherwise noted. References to certain Code sections which have been repealed subsequent to the periods herein before the Court are given in the present tense for purposes of this opinion.↩3. If petitioner prevails on the accelerated depreciation election issue, the effective foreign tax rate will be higher than 47.38 percent, but this will have no bearing on the outcome of the minimum overall tax burden test issue.↩4. The parties disagree as to the amount of the earnings and profits of petitioner's chain of controlled foreign corporations for the taxable year ended Oct. 31, 1968. This disagreement is the subject of the accelerated depreciation election issue. However, for the purpose of applying sec. 1.963-4(a)(1)(i), Income Tax Regs.↩, and since the amount in disagreement is not sufficiently large to have a bearing on the outcome of the minimum overall tax burden test issue, the parties have agreed to regard the amount of $ 7,002,953 as the 1968 consolidated earnings and profits figure.5. See Cook, "Problems in computing earnings and profits of a controlled foreign corporation," 25 J. Taxation 48 (July 1966)↩; Weiss, "Application of American Accounting Methods To Foreign Operations: Government Objectives in Setting Up Accounting Requirements," 23d Ann. N.Y.U. Tax Inst. 981 (1965).6. Sec. 1.964-1 Determination of the earnings and profits of a foreign corporation.(c) Tax adjustments -- * * (3) Action on behalf of corporation -- (i) In general. An election shall be deemed made, or an adoption or change in method of accounting deemed effectuated, on behalf of the foreign corporation only if its controlling United States shareholders (as defined in subparagraph (5) of this paragraph) --(a) Satisfy for such corporation any requirements imposed by the Code or applicable regulations with respect to such election or such adoption or change in method, such as the filing of forms, the execution of consents, securing the permission of the Commissioner, or maintaining books and records in a particular manner,(b) File the written statement described in subdivision (ii) of this subparagraph at the time and in the manner prescribed therein, and(c) Provide the written notice required by subdivision (iii) of this subparagraph at the time and in the manner prescribed therein. * *(ii) Written statement↩. The written statement required by subdivision (i) of this subparagraph shall be jointly executed by the controlling United States shareholders, shall be filed with the Director of International Operations, Internal Revenue Service, Washington, D.C., 20225, within 180 days after the close of the taxable year of the foreign corporation with respect to which the election is made or the adoption or change of method effected, or before May 1, 1965, whichever is later, and shall set forth the name and country of organization of the foreign corporation, the names, addresses, and stock interests of the controlling United States shareholders, the nature of the action taken, the names and addresses of all other United States shareholders notified of the election or adoption or change of method, and such other information as the Commissioner may by forms require.7. This requirement of the regulation was amended in 1974 to provide for filing the written statement with the Director of the Internal Revenue Service Center, 11601 Roosevelt Blvd., Philadelphia, Pa. 19155. T.D. 7322, 2 C.B. 216">1974-2 C.B. 216↩, 217.8. Although, for purposes of choosing a method of depreciation, previously acquired assets are treated as new assets in the first post-1962 taxable year, we express no opinion as to the basis from which depreciation is taken on these used assets. This is involved in the severed issue.↩9. Since petitioner was the sole shareholder of HPSA, GmbH, and VmbH at all times material herein, as explained above in the text, the notification requirement of sec. 1.964-1(c)(3)(iii), Income Tax Regs.↩, although referred to in the discussion that follows, is technically not applicable.10. Respondent emphasizes that the regulations here involved are "legislative" in character in the sense that they were adopted pursuant to the specific delegation of authority contained in sec. 964(a), quoted above, and for this reason should be literally observed. The statute involved in each of the cases cited above in the text contains similar authorizations. Yet the Court in each of those cases rejected an argument that the taxpayer was required to comply literally with the procedural directions in the applicable regulation.↩11. This information is also provided in Form 2952 (entitled "Information Return by a Domestic Corporation with Respect to Controlled Foreign Corporations") and the statement of "Investments in Affiliates" filed with the return.↩12. Sec. 1.964-1(c)(4), Income Tax Regs., provides in part as follows:(4) Effect of action by controlling United States shareholders. Any action taken by the controlling United States shareholders on behalf of the foreign corporation pursuant to subparagraph (3) of this paragraph shall be reflected in the computation of the earnings and profits of such corporation under this section to the extent that it bears upon the tax liability of a United States shareholder who either --(i) Was a controlling United States shareholder with respect to the action taken;(ii) Received the written notice provided by subparagraph (3)(iii) of this paragraph;(iii) Failed to file any of the returns required by section 6046 and the regulations thereunder within the period prescribed by section 6046(d); or(iv) Was notified by the Director of International Operations of the action taken --(a) Within 240 days after the close of the taxable years (of the foreign corporation) to which such action first relates, or(b) Within 180 days after the close of the first taxable year in which such shareholder becomes a United States shareholder, or(c) Before July 1, 1965, whichever is latest.Subdiv. (iv) was amended in 1965 by T.D. 6829, 2 C.B. 258">1965-2 C.B. 258↩, but such amendment was merely directory and does not change the thrust of the regulation.13. In 1974, pursuant to T.D. 7322, 2 C.B. 216">1974-2 C.B. 216, 217, previously referred to in n. 7 above, the place of filing Forms 959 was changed from the Director of International Operations (OIO) to the "Internal Revenue Service Center designated in the instructions of the applicable form." Sec. 1.6046-1(j)(2), Income Tax Regs. The instructions of Form 959 designate the Philadelphia Service Center, the same place T.D. 7322↩ requires the written statement to be filed.14. Respondent's brief summarizes the reasons for directing the filing of the written statements with the Director of International Operations as follows:1. To afford the Office of International Operations (OIO), Internal Revenue Service, the opportunity to give notice of the action taken to persons whose status as United States shareholders is established by OIO's records but is unknown to the controlling United States shareholders.2. To assure that a single earnings and profits figure for the controlled foreign corporation would be arrived at rather than different earnings and profits figures for each shareholder of the controlled foreign corporation.3. To provide a central reference point for other shareholders and/or the Internal Revenue Service to determine if and when an election had been made or if an adoption or change of a method of accounting had been effectuated and from which to review and examine the nature and/or the sufficiency of an election made or the adoption or change of a method of accounting effectuated.↩15. Since the issue as to the basis of the depreciated assets was severed for separate trial or settlement, the record contains few details as to the property owned by each of the controlled foreign corporations or as to the property on hand at the beginning of, or acquired during, each of the years before the Court.↩16. Sec. 963 was repealed by sec. 602(a)(1) of Pub. L. 94-12 (Mar. 29, 1975), 89 Stat. 58, effective (sec. 602(f) of Pub. L. 94-12, 89 Stat. 64) for taxable years of foreign corporations beginning after Dec. 31, 1975, and for taxable years of U.S. shareholders within which or with which such taxable years of such foreign corporations end.↩17. SEC. 963. RECEIPT OF MINIMUM DISTRIBUTIONS BY DOMESTIC CORPORATIONS.(a) General Rule. -- In the case of a United States shareholder which is a domestic corporation and which consents to all the regulations prescribed by the Secretary or his delegate under this section prior to the last day prescribed by law for filing its return of the tax imposed by this chapter for the taxable year, no amount shall be included in gross income under section 951(a)(1)(A)(i) for the taxable year with respect to the subpart F income of a controlled foreign corporation, if -- (1) in the case of a controlled foreign corporation described in subsection (c)(1), the United States shareholder receives a minimum distribution of the earnings and profits for the taxable year of such controlled foreign corporation;↩18. This regulation was promulgated under sec. 963(f), which provides in part that the Secretary of the Treasury --shall prescribe such regulations as he may deem necessary to carry out the provisions of this section, including regulations for the determination of the amount of foreign tax credit in the case of distributions with respect to the earnings and profits of two or more foreign corporations.↩19. In its brief, petitioner presents the following example which illustrates the problem of non-pro rata distributions from members of a chain or group of controlled foreign corporations to a U.S. corporate shareholder:"if in 1966 two controlled foreign corporations had equal pre-tax earnings but were subject to effective tax rates of 30 percent and 50 percent respectively, the effective foreign tax rate would have been 40 percent. This rate would have been the basis for determining the minimum distribution under Code section 963(b), in this hypothetical case 37 percent. If the foreign corporation taxed at 50 percent had distributed 75 percent of its earnings, the test would have been satisfied. But the United States would have received no taxes because of the 50 percent foreign tax credit. If the distribution had been pro rata, the United States would have collected tax on the half distributed from the corporation taxed at 30 percent."↩20. For the calendar year 1968, sec. 51(a)(1)(B) imposed a surcharge on corporations equal generally to 10 percent of their tax liability without regard to the surcharge. Sec. 51(a)(2)(A)↩ provided that the surcharge would be allocated for fiscal years according to the number of days falling in the surcharge period. For petitioner's taxable year ended Oct. 31, 1968, 83.3 percent of the days of that fiscal year were within the surcharge period. As a result, the applicable surcharge rate was 4 percent (.48 x .10 x .833 = .039984).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625573/	MILDRED A. WILKINSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWilkinson v. CommissionerDocket No. 25107-91United States Tax CourtT.C. Memo 1993-336; 1993 Tax Ct. Memo LEXIS 337; 66 T.C.M. (CCH) 270; July 29, 1993, Filed 337 Decision will be entered under Rule 155. Mildred A. Wilkinson, pro se, and Susan Huffstutter (specially recognized), for petitioner. For respondent: Wesley F. McNamara. DAWSONDAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: This case was heard by Chief Special Trial Judge Peter J. Panuthos pursuant to the provisions of section 7443A(b)(4) and Rules 180, 181, and 183. 1 The Court agrees with and adopts the Chief Special Trial Judge's opinion, which is set forth below. OPINION OF THE CHIEF SPECIAL TRIAL JUDGE PANUTHOS, Chief Special Trial Judge: Respondent determined a deficiency in petitioner's Federal income tax for the taxable year 1985 in the amount of $ 22,102 and additions to tax pursuant to section 6651(a)(1) in the amount of $ 5,526; section 6653(a)(1) and (2) in the amount of $ 1,105, and 50 percent of the interest 338 due on the deficiency, respectively; and section 6654 in the amount of $ 1,267. 2The issues for decision are: (1) Whether petitioner, under a power of attorney, expended the funds of Thelma D. McCulloch during 1985 for petitioner's benefit and without permission, thereby realizing income in the amount of $ 64,175; (2) whether petitioner is liable for the addition to tax pursuant to section 6651(a)(1) for failure to file a Federal income tax return for the taxable year 1985; (3) whether petitioner is liable for additions to tax for negligence pursuant to section 6653(a)(1) and (2) for failure to report income received; and (4) whether petitioner is liable for the addition to tax pursuant to section 6654 for failure to pay estimated income tax. Respondent determined that petitioner expended the funds of Thelma D. McCulloch (hereinafter McCulloch) for petitioner's benefit and without permission, 339 thereby realizing income which petitioner omitted from her return. According to respondent, McCulloch did not possess the requisite donative intent to qualify these expenditures as gifts. Respondent also determined that petitioner should have filed a Federal income tax return for 1985 and paid the estimated tax for that year. According to petitioner, all of the expenditures in issue were authorized by McCulloch. Petitioner maintains that she received a power of attorney from McCulloch and that the expenditures were carried out by petitioner pursuant to that power for the benefit of McCulloch. Therefore, petitioner argues that she did not receive additional income as determined by respondent. Petitioner also maintains that she was not required to file a Federal income tax return for 1985 because she did not have sufficient income for the year in issue. 3FINDINGS340 OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by reference. Petitioner resided in Otis, Oregon, when she filed the petition herein. McCulloch was an elderly woman who never married and had no immediate relatives. She amassed significant personal wealth during her lifetime, resulting in an estate worth over $ 800,000 at the time of her death. Petitioner is married to Melvin Wilkinson (hereinafter husband). They have five daughters, among whom are Susan Huffstutter, Janie Norton, Melanie Leach, and Nancy Ward. Petitioner suffers from multiple sclerosis, which has disabled her since 1974. Her husband also suffers from injuries sustained in a car accident which occurred in 1980. Both petitioner and her husband have not worked for several years, including the year in issue. They support themselves mainly on monthly Social Security disability payments and rental payments received from property they own. Petitioner was introduced to McCulloch through petitioner's mother, Agnes Schreiber, who lived in the same town as McCulloch and who was also her friend. Petitioner and McCulloch became341 close friends. It was at McCulloch's suggestion that petitioner, in 1978, visited spiritual healers in the Philippines to find a possible cure for ailments she suffered as a result of her multiple sclerosis. In February 1985, while visiting these same spiritual healers in the Philippines, McCulloch became very ill and had to return to the United States. Upon her arrival, she was met by petitioner and her husband and brought to a hospital for examination. McCulloch's attending physician, Dr. John Woo, suggested that she be examined by Dr. Paul Ash (hereinafter Dr. Ash). On February 14, 1985, Dr. Ash diagnosed McCulloch as suffering from terminal brain cancer. Dr. Ash provided assistance to McCulloch until early May 1985. McCulloch's condition rapidly deteriorated soon after her diagnosis. Following the diagnosis, petitioner and her husband began assisting McCulloch through her illness. They attended to her medical needs, which consisted of transporting McCulloch to and from various hospitals for treatment and placing and/or moving McCulloch to various nursing homes. Petitioner and her husband also attended to McCulloch's personal residence, which included the delivery of 342 several household and personal items to various charities in the area as well as disposing of unwanted items. On February 21, 1985, while McCulloch was still in the hospital, she granted petitioner a power of attorney. 4 The February 21, 1985, instrument evincing the power of attorney was presented to McCulloch at the hospital for her signature. The document bears the notation that McCulloch appoints petitioner to "act on my behalf concerning my business affairs, including, but not limited to, deposits and withdrawals from my checking and other accounts held with the First Interstate Bank". 343 Pursuant to the power of attorney, petitioner assumed the management of McCulloch's financial and tax affairs. Petitioner transferred assets held in accounts established in McCulloch's name with First Federal Savings and Loan Association of McMinnville (hereinafter Federal Savings) and Shearson Lehman/American Express (hereinafter Shearson) to joint accounts bearing both petitioner's and McCulloch's names. In addition, petitioner attempted to have most of McCulloch's assets held by various investment firms and banks, including First Interstate Bank of Oregon and Investors Diversified Services (hereinafter First Interstate and IDS, respectively) transferred to a joint account established at Shearson. From April 8, 1985, to May 8, 1985, petitioner wrote checks totaling in excess of $ 64,000. All of the checks were drawn on the joint accounts funded mainly by McCulloch's assets. On or about May 28, 1985, petitioner, her husband, and Agnes Schreiber traveled to the Philippines to visit the spiritual healers. The airfare and living costs associated with the trip were paid for by withdrawals from McCulloch's bank accounts. The particular checks in issue (dated April 8, 1985, through344 May 8, 1985) which respondent claims constitute taxable income to petitioner are as follows: PayeeCheck No.AmountExplanationProvided 1FIRST FEDERAL SAVINGS:Larson Motors101$88.77Car repairThe Furniture Mart103650.00Replace dining setUnknown1053,100.00Pickup given to MelMelanie Leach106200.00Gift from Thelma babysurgeryCash107150.00ThelmaMrs. Janie Norton1081,000.00Gift to JanieLarson Motors12143.61Starter for carUnknown12317.00Agnes Schreiber1241,500.00Money owed by ThelmaMeir & Frank1261,095.00TV for Thelma houseBurrell Auto-Elect.12861.78Ignition on carRandall Ward130800.00Closing cost on house(petitioner'sson-in-law)Mr. Marvin H. Schrom1361,000.00Earnest money for homeSears13914.00Thelma undergarmentsGreg Allen Hunt141300.00Legal advice(petitioner'sson-in-law)First Federal1424,388.00Asian HolidaysSears14765.92Bathrobe ThelmaSHEARSON LEHMAN/AMERICAN EXPRESS:Flaming Med. Center864-013501,200.00Petitioner's medicalbills 2Pacific State Bank864-0135112,308.25Petitioner'smortgage 2F.D. Bank VISA864-013521,584.93Petitioner'sVisa bill 2First Interstate864-013532,801.35Petitioner'sloan 2Meir & Frank864-013542,844.49Petitioner's storeaccount bill 2Agnes Schreiber864-013557,500.00Nancy Ward864-0135610,000.00R.K. Ward864-0135710,000.00TOTAL3 $ 62,715.45345 In the months following petitioner's receipt of the power of attorney, certain individuals and entities expressed concern about the way McCulloch's affairs were being handled. Petitioner and her husband were aware of the inquiries being made. On or about April 15, 1985, Aladine O'Dell (hereinafter O'Dell), McCulloch's second cousin, requested information from Dr. Ash concerning McCulloch's mental and physical capabilities as of the beginning of March 1985. First Interstate, which had held an investment management account for McCulloch since approximately 1977, also made similar inquiries of Dr. Ash. In Dr. Ash's opinion, McCulloch lacked competency to understand her financial affairs from at least March 1, 1985. In early May 1985, based upon Dr. Ash's opinion, O'Dell petitioned the Circuit Court of Oregon, Marion County, to be appointed McCulloch's guardian. First Interstate petitioned the same court to be appointed conservator of McCulloch's estate. Pending the outcome of the conservatorship petition, First Interstate determined that it would not honor the request for transfer of McCulloch's assets. On May 10, 1985, the Circuit Court of Oregon, Marion County, declared McCulloch346 incompetent and granted O'Dell guardianship and appointed First Interstate conservator. Upon being appointed conservator, First Interstate attempted to collect McCulloch's assets which petitioner had placed in the joint accounts and also sought an explanation from petitioner concerning the expenditures. Petitioner did not provide First Interstate with an explanation and refused to turn over most of the assets, claiming that it was against McCulloch's wishes. First Interstate informed other institutions of its conservatorship and requested that such institutions not honor any transactions concerning McCulloch's accounts unless authorized by First Interstate. All powers of attorney granted by McCulloch were revoked by First Interstate on May 15, 1985. McCulloch executed a will dated September 13, 1976, and a codicil thereto dated April 29, 1981. The will and codicil provided that a nonprofit charitable organization, the Oregon Community Foundation (OCF), was to receive a large portion of her estate. This will was revoked by a new will executed on April 9, 1985. Under the new will, petitioner and her husband were to receive a sizable portion (approximately $ 170,000) of McCulloch's347 estate. There was no bequest to OCF. Petitioner was appointed personal representative of the estate under the 1985 will. The record is not clear as to the extent to which petitioner participated in the preparation and execution of the 1985 will. McCulloch died on June 30, 1985. Her will dated April 9, 1985, was submitted for probate by petitioner on July 1, 1985, and, pursuant thereto, petitioner was appointed personal representative of McCulloch's estate. After McCulloch's death, petitioner served a demand on First Interstate for the turnover of any of McCulloch's assets it had collected. First Interstate did not comply with petitioner's request and instead filed a First Accounting and Petition for Instruction with the Circuit Court of Oregon, Yamhill County (hereinafter the probate court). OCF filed a petition on August 6, 1985, with the probate court to contest the April 9, 1985, will and to probate instead the will of September 13, 1976, and its codicil, and to appoint First Interstate as executor of the estate. On September 5, 1985, the Oregon Bank was appointed co-personal representative of the estate. On or about October 30, 1985, petitioner filed her resignation 348 as personal representative of McCulloch's estate. On July 10, 1986, petitioner, on behalf of herself, her husband, her daughters, and her sons-in-law, filed a claim against McCulloch's estate for, among other things, payment for services rendered to McCulloch. The claim was settled with each of the claimants being awarded $ 5,000. During this time, Oregon Bank filed suit against petitioner and her husband (and others) in the probate court seeking an accounting and return of various properties and moneys belonging to McCulloch. In November 1987, petitioner and her husband agreed to a settlement in which they relinquished all claims under the will in exchange for payment by Oregon Bank of $ 46,000 and the receipt of all of McCulloch's tangible personal property being held in storage. Petitioner did not file a Federal income tax return for 1985, nor did she authorize anyone to file on her behalf. Petitioner did not make any estimated income tax payments for 1985. OPINION Respondent determined that petitioner failed to report income for the taxable year 1985. Respondent's determination is presumed to be correct. Petitioner bears the burden of proving it erroneous. Rule 142(a); 349 Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933). Respondent seeks to establish that, as of at least March 1, 1985, McCulloch was incapable of forming donative intent and, therefore, the funds expended by petitioner do not constitute gifts. While McCulloch's mental capacity may be of some relevance here, we believe the more important issue is to determine to what extent petitioner's actions were authorized by the power of attorney. 5State law controls on the issue of the interpretation of the power of attorney. See Estate of Casey v. Commissioner, 948 F.2d 895">948 F.2d 895, 897 (4th Cir. 1991), revg. on another issue T.C. Memo 1989-511">T.C. Memo. 1989-511. Under Oregon law, a power of attorney creates an agency relationship. See Scott v. Hall, 177 Or. 403">177 Or. 403, 407, 163 P.2d 517">163 P.2d 517, 518 (1945);350 Ho v. Presbyterian Church, 116 Or. App. 115">116 Or. App. 115, 120, 840 P.2d 1340">840 P.2d 1340, 1343 (1992). Therefore, the authorities and duties of an attorney in fact are governed by the principles of agency. Scott v. Hall, 177 Or. at 407, 163 P.2d at 518. This includes the prohibitions against an agent's profiting from the agency relationship to the detriment of his or her principal. In conjunction with agency principles, the Court must look to the language of the instrument itself to determine the extent of the agent's authority. The power of attorney permitted petitioner to make deposits and withdrawals from McCulloch's checking and other accounts. The power of attorney does not contain any specific language authorizing petitioner or petitioner's family to personally benefit from payments drawn on McCulloch's accounts. In particular, there is no language authorizing petitioner to make gifts to herself or to her family. This is of particular importance, given petitioner's agency relationship with McCulloch. See Estate of Casey v. Commissioner, supra; In re Burgess, 106 Bankr. 612, 618 (D. Neb. 1989)351 (if the powers of attorney were liberally construed to permit the agent to make gifts to and for the benefit of the agent, the basic purpose of the agency could be frustrated). Rather the power of attorney authorizes petitioner to act on McCulloch's behalf concerning McCulloch's business affairs. We note that almost all of the expenditures in issue were for petitioner's direct benefit or made to persons related to petitioner. The following expenditures relate to personal expenses of petitioner or her husband: PayeeCheck No.Amount Explanation Provided Larson Motors101$ 88.77Petitioner's car repairLarson Motors12143.61Starter for petitioner's carBurrell Auto-Elec.12861.78Petitioner's car repairGreg Allen Hunt141300.00Legal adviceFirst Federal1424,388.00Asian holidayFlaming Med. Center864-013501,200.00Petitioner's & husband'smedical billsPacific State Bank864-0135112,308.25Petitioner's mortgagepaymentF.D Bank VISA864-013521,584.93Petitioner's credit cardpaymentFirst Interstate864-013532,801.35Petitioner's loan paymentMeir & Frank864-013542,844.49Petitioner's account paymentPetitioner failed to present352 sufficient information to explain how any of these expenditures were authorized under the power of attorney or how the expenditures were for the benefit of McCulloch. For example, petitioner stated in a deposition taken in a separate proceeding on September 16, 1985, and stipulated by the parties (hereinafter the deposition), that the $ 300 paid to Greg Allen Hunt, petitioner's son-in-law, was for legal services provided for petitioner and her husband's benefit. Petitioner stated in the deposition that the legal advice did not concern any of McCulloch's affairs. For many of the other expenses, petitioner stated in the deposition that although they were personal expenses, she and her husband reimbursed McCulloch for the moneys they expended. Petitioner claimed that she was able to pay back McCulloch from the funds she received from selling property she owned. However, when questioned further on this sale, petitioner became very defensive and refused to provide further information. Petitioner provided little information at trial concerning these expenditures and/or alleged reimbursements. There is nothing in the record to indicate that McCulloch intended such expenditures as 353 gifts. We find it difficult to believe that, as McCulloch's agent, petitioner was authorized to draw checks for the payment of her own credit card bills, medical bills, mortgage, and such. Petitioner has failed to prove that these expenditures were authorized under the power of attorney and were not solely for petitioner's benefit. Therefore, we hold that petitioner must include the total of these expenditures as income for the taxable year 1985. See James v. United States, 366 U.S. 213">366 U.S. 213 (1961); Solomon v. Commissioner, 732 F.2d 1459">732 F.2d 1459, 1460-1461 (6th Cir. 1984), affg. T.C. Memo 1982-603">T.C. Memo. 1982-603. Other expenditures in question concern the payments made to petitioner or individuals related to petitioner. They are as follows: PayeeCheck No.AmountExplanation Provided Melanie Leach106$ 200Gift from Thelma baby surgeryMrs. Janie Norton1081,000Gift to JanieAgnes Schreiber1241,500Money owed by ThelmaRandall Ward130800Closing cost on houseAgnes Schreiber864-013557,500Nancy Ward864-0135610,000R.K. Ward864-0135710,000Petitioner relied almost exclusively on354 her own testimony to establish the characterization of these expenditures. However, petitioner's testimony is vague and confusing, and more importantly, is contradictory. For example, petitioner stated at the deposition that the check issued to Janie Norton for $ 1,000 (check No. 108) was to be used to raise money for McCulloch. According to petitioner, McCulloch requested her to travel to the Philippines to pay the spiritual healers for service they rendered to McCulloch on her final visit in February 1985. Petitioner stated that she needed approximately $ 40,000 to fulfill McCulloch's request but that she was having difficulty obtaining the funds from McCulloch's account. The plan was to issue the check (as well as other checks) to an individual who would then cash the check and return the funds to petitioner. However, prior to trial, petitioner had noted in a document prepared by her and her husband and presented to respondent that the check written to Janie Norton was intended as a gift by McCulloch. At trial, petitioner presented the same argument about raising money for McCulloch to justify the checks issued to Nancy Ward (check No. 864-01356) and R.K. Ward (check No. 355 864-01357) for $ 10,000 each. However, petitioner no longer argued that the check issued to Janie Norton for $ 1,000 was used for the same purpose. Further inconsistencies concern petitioner's explanation of a check in the amount of $ 200 issued to Melanie Leach (check No. 106) and a check in the amount of $ 1,500 issued to Agnes Schreiber (check No. 124), petitioner's mother. Petitioner stated at the deposition that McCulloch intended the check issued to Melanie Leach to be used to pay Melanie Leach's automobile insurance. However, petitioner indicated in a document prepared by her and her husband, as well as at trial, that McCulloch intended the $ 200 as a gift for Melanie Leach. With respect to the check issued to Agnes Schreiber, petitioner stated at the deposition that the check was part of the plan to raise money for McCulloch. However, at trial petitioner testified that the check was payment for money McCulloch owed Agnes Schreiber. Petitioner provided no evidence concerning the $ 7,500 check issued to Agnes Schreiber. The record does not contain sufficient evidence indicating that McCulloch intended that petitioner expend these funds in this manner when she granted356 the power of attorney. Petitioner's testimony was unreliable as a result of various contradictions. This Court is not required to accept the self-serving testimony given by a party before this Court. Tokarski v. Commissioner, 87 T.C. 74">87 T.C. 74, 77 (1986). Petitioner has not met her burden of proof. We, therefore, hold that petitioner must include the total of the expenditures discussed above in income for the taxable year 1985. See James v. United States, supra; Solomon v. Commissioner, supra.The fact that petitioner directed McCulloch's funds to petitioner's relatives or creditors or other persons for petitioner's benefit, rather than receiving them personally, does not prevent the funds from being gross income to petitioner. United States v. Lippincott, 579 F.2d 551">579 F.2d 551, 552 (10th Cir. 1978); Estate of Geiger v. Commissioner, 352 F.2d 221">352 F.2d 221, 231-232 (8th Cir. 1965), affg. T.C. Memo. 1964-153. The remaining expenditures do not appear to benefit either petitioner or individuals related to petitioner. 357 Instead, most of these expenditures pertain to items purchased for McCulloch's personal use. We find that these expenditures were authorized under the power of attorney and for McCulloch's benefit. Therefore, these amounts are not includable in petitioner's income for the taxable year 1985. The checks in this category are as follows: PayeeCheck No.AmountExplanation ProvidedFurniture Mart103$ 650.00Replacement dining setUnknown1053,100.00Pickup given to MelCash107150.00ThelmaUnknown12317.00Meir & Frank1261,095.00TV for Thelma HouseMr. Marvin Schrom1361,000.00Earnest moneySears14214.00Thelma undergarmentsSears14765.92Bathrobe for ThelmaWe next consider whether petitioner is liable for the additions to tax. Section 6651(a)(1) provides for an addition to tax for failure to file a return unless such failure is due to reasonable cause and not due to willful neglect. Petitioner bears the burden of proving that respondent's determination is erroneous. BJR Corp. v. Commissioner, 67 T.C. 111">67 T.C. 111, 130-131 (1976). Petitioner stated that she did not file a return for 1985 because she believed that she358 did not receive an amount of income requiring such a filing. However, this does not constitute reasonable cause. "In the absence of evidence showing reliance on the advice of competent counsel, mere mistaken belief that no return was required under the statute because of lack of income does not constitute reasonable cause for noncompliance". Heman v. Commissioner, 32 T.C. 479">32 T.C. 479, 490 (1959) affd. 283 F.2d 227">283 F.2d 227 (8th Cir. 1960) (interpreting section 291(a), a predecessor to section 6651(a)); see also Richardson v. Commissioner, T.C. Memo 1991-258">T.C. Memo. 1991-258. Accordingly, we hold that petitioner is liable for the addition to tax under section 6651(a)(1) for the 1985 taxable year. Respondent also determined that petitioner is liable for additions to tax for negligence for the year in issue. Section 6653(a)(1) provides for an addition to tax of 5 percent of the amount of any part of an underpayment of tax which is due to negligence or disregard of the rules or regulations. Section 6653(a)(2) provides for an addition to tax of 50 percent of the interest due on that portion of the underpayment attributable 359 to negligence. When an income tax return is not filed, with no reasonable justification for the failure to file, the section 6653(a)(1) and (2) additions will apply to the full amount of the underpayment. Emmons v. Commissioner, 92 T.C. 342">92 T.C. 342, 347-350 (1989), affd. 898 F.2d 50">898 F.2d 50 (5th Cir. 1990). We hold that petitioner is liable for these additions to tax. We next consider whether petitioner is liable for the additions to tax under section 6654(a) for underpayment of estimated income tax for 1985. Petitioner has the burden of proof on this issue. Rule 142(a). Section 6654(c) imposes a requirement that estimated taxes be paid in installments. If a taxpayer fails to pay a sufficient amount of estimated income taxes, section 6654(a) provides for a mandatory addition to the tax in the absence of exceptions provided for in section 6654(e), which are not applicable here. Grosshandler v. Commissioner, 75 T.C. 1">75 T.C. 1, 20-21 (1980). Petitioner failed to pay the estimated taxes for the year in issue. Respondent's determination on this issue is sustained. To reflect our conclusions with respect to the 360 disputed issues, Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code in effect for the tax year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Respondent determined in the notice of deficiency that petitioner is entitled to a personal exemption in the amount of $ 1,040.↩3. While not argued, we assume that petitioner disputes the estimated tax payment under sec. 6654↩ for the same reasons that she disputes the deficiency.4. Petitioner recorded two additional documents evincing powers of attorney granted by McCulloch dated Mar. 1, 1985, and Mar. 14, 1985. The Mar. 1, 1985, document bears the notation that petitioner is appointed to be McCulloch's "personal representative on behalf of all my personal and business affairs. Before -- during, and after my life." The Mar. 14, 1985, document bears the notation that petitioner is "To act on my behalf concerning my business affairs including but not limited to deposits and withdrawals from my checking and other accounts held with U.S. National Bank of Oregon."↩1. The notations reflected in this column appear in a document provided by petitioner to respondent at the examination level. The document was offered by respondent at trial and was not objected to by petitioner.↩2. Not reflected in the above noted document. However, these expenditures were stipulated by the parties.↩3. The total of expenditures in issue determined in the notice of deficiency is $ 64,175. We are unable to ascertain the cause of this difference. Respondent has not presented evidence concerning the additional amount; therefore, the omitted income will be limited to the amount set forth as the total of the checks in dispute.↩5. We will refer to the power of attorney in the singular, although we recognize that petitioner apparently relies upon three separate powers of attorney.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625574/	ROBERT B. BOWLER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Bowler v. CommissionerDocket Nos. 53242, 64125.United States Board of Tax Appeals31 B.T.A. 594; 1934 BTA LEXIS 1063; November 14, 1934, Promulgated 1063 Trusts were created by the petitioner for the benefit of his wife and three minor children, which were made revocable, with the approval of the grantor, by a majority of a committee of three persons named in the trust instruments, two of whom were not beneficiaries. Held, that the income of the trusts is taxable to the grantor. Spotswood D. Bowers, Esq., for the petitioner. Frank M. Thompson, Esq., for the respondent. SMITH 595 OPINION. SMITH: These proceedings, consolidated for hearing, involve deficiencies in income tax for the years 1926 to 1929, inclusive, as follows: Docket No.YearDeficiency532421926$9,672.80Do192710,052.53Do19289,064.166412519299,748.12In his determination of the deficiencies the respondent has held that the income from four certain trusts created by the petitioner for the benefit of his wife and three minor children is taxable to the petitioner because of the revocability of the trusts under the provisions of each of the trust instruments. The sole issue for our present determination is whether during the taxable years under consideration the income of the several1064 trusts is taxable to the petitioner under section 219(g) and (h) of the Revenue Act of 1926 and sections 166 and 167 of the Revenue Act of 1928. Section 219 of the Revenue Act of 1926 provides, so far as material, as follows: (g) Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of the trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor. (h) Where any part of the income of a trust may, in the discretion of the grantor of the trust, either alone or in conjunction with any person not a beneficiary of the trust, be distributed to the grantor or be held or accumulated for future distribution to him, * * such part of the income of the trust shall be included in computing the net income of the grantor. Sections 166 and 167 of the Revenue Act of 1928 are substantially the same as the above quoted provisions of the 1926 Act. The petitioner created four trusts by separate similar trust instruments, all under date of December 25, 1925, naming1065 as the respective beneficiaries: Trust No. 1, his wife, Gladys Stout Bowler; Trust No. 2, his son, Robert Bonner Bowler, Jr., age 19; Trust No. 3, his daughter, Katherine Wise Bowler, age 17; Trust No. 4, his daughter, Anne Fairchild Pendleton Bowler, age 7. The beneficiaries named were to receive all of the income of their respective trusts. In each of the first three of the above trusts the trustor, the petitioner herein, and the respective beneficiaries were named trustees and in the fourth the trustor and his wife, Gladys 596 Stout Bowler, were named trustees. There is no question raised with respect to the duties and powers of the trustees of any of the trusts. However, in addition to the above mentioned provisions, each of the trust instruments contains a further provision designated "Clause Eighth", naming a "committee" of three persons who are given the power to alter or amend the respective trusts in certain respects as specifically set forth. This provision, as contained in the Gladys Stout Bowler Trust - and except for the persons therein named it is practically the same in each trust instrument - is as follows: CLAUSE EIGHTH: I hereby create in1066 JAMES N. STOUT of said New York, said RICHARD W. HALE, and STANLEY CLARKE of said New York, herein referred to as the Committee, a joint power exercisable at any time or from time to time by any two of said persons by instrument or instruments in writing signed by said two and delivered to any trustee hereunder who may be one of themselves, or in case there be no trustee then in office to a person designated by them to accept such delivery. A. To remove any trustee hereunder. B. To appoint a successor to any trustee who dies, resigns, or is removed except in the cases provided for by Clause Seventh paragraph O hereof. C. To change and alter any of or all the trusts herein set forth and declare new trusts of the property in any way or manner whatsoever; also to terminate or modify the beneficial interest of any person or class of persons and to name or appoint any other persons or classes of persons as beneficiaries whether by way of addition or substitution; also to determine and alter the number of, the power of and the succession among the committee. D. No exercise of this power shall exhaust it. It may, however, be released, extinguished or restricted by a like1067 instrument so signed by any two of the committee and delivered to the trustees as aforesaid. E. Any of the persons in whom this joint power is vested may resign at any time by a signed instrument in writing. In case the number of the foregoing committee in whom this joint power is vested should at any time be less than three then a new person or persons shall be appointed a member or members of this committee by a writing signed by the remaining member or members of the committee and with the same effect as if he or they had been originally named. A majority of the committee may also increase the committee to five and name the additional members, in which case the same provisions for the appointment of successors shall govern and the power shall be executed by three or more of the committee. No personal liability shall attach to any member of the committee for any act or omission to act whatsoever. F. A certificate signed by a majority of the committee certifying to a change in the trustees or committee or any other fact affecting either the trust fund or the duties of the trustees shall be conclusive evidence in favor of any person or corporation which acts relying upon1068 such certificate. G. The power given to the committee has priority over the powers herein given to the trustees but shall not in any case take effect so as to prejudice third parties who take property or otherwise change position in good faith relying upon the exercise or purported exercise of any power by the trustees. H. No exercise of said power shall be valid while I am alive and competent to act until and unless I shall have in writing signified that I have no objection thereto. No exercise shall be valid if such instrument exercising said 597 power has been delivered less than five days before the death of any member of the committee. No exercise affecting the first of said equal shares for my said wife and then for my daughter KATHERINE WISE BOWLER after both are dead; no exercise affecting the second of said equal shares held for my said wife and then for my daughter ANNE FAIRCHILD PENDLETON BOWLER after both are dead, and no exercise affecting the third of said equal shares held for my said wife and then for my said son shall be valid after both are dead. The beneficiaries, the trustees, and the "committees" of the four trusts were as follows: BeneficiariesTrusteesCommitteesJames N. Stout.Trust GladysGladys Stout BowlerRichard W. Hale.No. 1Stout BowlerRobert Bonner BowlerStanley Clarke.Richard W. Hale.TrustRobert BonnerRobert Bonner Bowler, Jr.Katherine Wise Bowler.No. 2Bowler, Jr.Robert Bonner BowlerStanley Clarke.Richard W. Hale.TrustKatherineKatherine Wise BowlerRobert Bonner Bowler.No. 3Wise BowlerRobert Bonner BowlerStanley Clarke.James N. Stout.TrustAnne FairchildRobert Bonner BowlerRichard W. Hale.No. 4Pendleton BowlerGladys Stout BowlerStanley Clarke.1069 By reason of clause eighth of the trust instruments, did the grantor of the trusts, acting alone or in conjunction with any other person not a beneficiary of the trusts, have the power to revest in himself any of the corpus of the trusts or have distributed to himself any of the income of the trusts? In Reinecke v. Smith,289 U.S. 172">289 U.S. 172, the Supreme Court had under consideration a somewhat similar question arising under section 219(g) of the Revenue Act of 1924, which corresponds to the above quoted provisions of the 1926 Act. The Court held that the statute was not unconstitutional as applied to trusts created prior to its enactment and that a trust was revocable within the meaning of the statute when it could be revoked by the settlor acting in conjunction with a corporate trustee. In its opinion the Court said: In approaching the decision of the question before us, it is to borne in mind that the trustee is not a trustee of the power of revocation and owes no duty to the beneficiary to resist alteration or revocation of the trust. Of course he owes a duty to the beneficiary to protect the trust res, faithfully to administer it, and to distribute the income; 1070 but the very fact that he participates in the right of alteration or revocation negatives any fiduciary duty to the beneficiary to refrain from exercising the power. The facts of this case illustrate the point; for it appears the trust in favor of the grantor's wife was substantially modified, to her financial detriment, by the concurrent action of the grantor and the trustees. This case must be viewed, therefore, as if the reserved right of revocation had been vested jointly in the grantor and a stranger to the trust. 598 Decisions of this court declare that, where taxing acts are challenged, we look not to the refinements of title but to the actual command over the property taxed - the actual benefit for which the tax is paid. Corliss v. Bowers, supra, 281 U.S. at page 378, 50 S.Ct. 336, 74 L.Ed. 916; Tyler v. United States,281 U.S. 497">281 U.S. 497, 503, 50 S. Ct. 356">50 S.Ct. 356, 74 L. Ed. 991">74 L.Ed. 991, 69 A.L.R. 758">69 A.L.R. 758; Burnet v. Guggenheim, supra. A settlor who at every moment retains the power to repossess the corpus and enjoy the income has such a measure of control as justifies the imposition of the tax upon him. 1071 Corliss v. Bowers, supra. We think Congress may with reason declare that, where one has placed his property in trust subject to a right of revocation in himself and another, not a beneficiary, he shall be deemed to be in control of the property. We cannot say that this enactment is so arbitrary and capricious as to amount to a deprivation of property without due process of law. As declared by the committee reporting the section in question, a revocable trust amounts, in its practical aspects, to no more than an assignment of income. This court has repeatedly said that such an assignment, where the assignor continued to own the corpus, does not immunize him from taxation upon the income. Burnet v. Leininger,285 U.S. 136">285 U.S. 136, 52 S. Ct. 345">52 S.Ct. 345, 76 L. Ed. 665">76 L.Ed. 665; Lucas v. Earl,281 U.S. 111">281 U.S. 111, 50 S. Ct. 241">50 S.Ct. 241, 74 L. Ed. 731">74 L.Ed. 731. It cannot therefore be successfully urged that, as the legal title was held by the trustees, the income necessarily must for income taxation be deemed to accrue from property of some one other than Douglas Smith. The case is plainly distinguishable from 1072 Hoeper v. Tax Commission,284 U.S. 206">284 U.S. 206, 52 S. Ct. 120">52 S.Ct. 120, 76 L. Ed. 248">76 L.Ed. 248, on which respondents rely, for there the attempt was to tax income arising from property always owned by one other than the taxpayer, who had never had title to or control over either the property or the income from it. The measure of control of corpus and income retained by the grantor was sufficient to justify the attribution of the income of the trust to him. The enactment does not violate the Fifth Amendment. A contrary decision would make evasion of the tax a simple matter. There being no legally significant distinction between the trustee and a stranger to the trust as joint holder with the grantor of a power to revoke, if the contention of the respondents were accepted it would be easy to select a friend or relative as coholder of such a power and so place large amounts of principal and income accruing therefrom beyond the reach of taxation upon the grantor while he retained to all intents and purposes control of both. Congress had power, in order to make the system of income taxation complete and consistent and to prevent facile evasion of the law, to make provision by section 219(g) 1073 for taxation of trust income to the grantor in the circumstances here disclosed. * * * The power to revoke here rested in a committee, subject to the approval of the grantor, instead of in the regularly designated trustees and the grantor acting together as in Reinecke v. Smith, supra. We think, however, that the facts in this respect are not materially different and that the reasoning of the Court in that case applies with equal force to the situation presented in the instant proceedings. The committees in whom the power to revoke was nominally lodged stood in no different relation to the settlor or to the beneficiaries of the trust than did the trustees who had the power in Reinecke v. Smith, supra.If the trustees there were under no duty to the beneficiaries to perpetuate the trusts, neither were the committees 599 here. The committee members had no duties or powers in respect of the trusts except to alter or revoke them, and it is reasonable to suppose that in these matters they would have carried out the wishes of the grantor of the trusts by whom they were selected. The situation here appears to be almost identically that1074 pointed out by the Court in Reinecke v. Smith, supra, as giving rise to an unlawful evasion of the tax. While in the instant case the grantor did not have the affirmative power to alter or revoke the trusts in conjunction with the members of the committees, he did have a veto power over their acts and they could do nothing without his written approval. The statute does not require that the grantor's power to revest title in himself shall be a direct and independent power. On the other hand, it recognizes that the power may rest jointly in the grantor and another or others. See Bromley v. Commissioner, 66 Fed.(2d) 552; affirming 26 B.T.A. 878">26 B.T.A. 878. Whether there is actually such a power reposing in the grantor is a matter to be determined from all of the circumstances surrounding the creation and operation of the trusts. We believe that it would require too limited a construction of the statute and one inconsistent with its manifest purpose to say that the grantor must be at liberty to exercise the power by his own affirmative act rather than through the medium of other persons of his own choosing who may have no interest whatever1075 in the trust other than to carry out his wishes. For all that the evidence shows this was the situation here. We know nothing of Robert W. Hale and Stanley Clarke, who were the majority of each of the committees and who had the power to alter or revoke the trusts with the approval of the grantor. It seems to us, too, that, since the committees could change the form of the trusts only with the consent of the grantor, the power might be said to have rested jointly in the committees and the grantor or that, in the language of the statute, the grantor had the power "in conjunction with" the committees. It is the plain inference to be gained from the above quoted language in the Reinecke v. Smith case that, since it was the intention of Congress in enacting section 219(g) "to make the system of income taxation complete and consistent and to prevent facile evasion of the law", the court will look with disfavor upon a construction of the statute that "would make evasion of the tax a simple matter." Obviously, the instant case offers an example of just such an attempt at evasion. Because of the peculiar facts presented in these proceedings we do not believe that anything1076 would be gained by a discussion of the many prior cases involving the same sections of the statutes but *600 materially dissimilar facts. Indeed, no case that we have been able to find bears a closer resemblance to the instant case, either in point of facts or principle involved, than Reinecke v. Smith, supra, and we think that the question here presented is controlled by the decision of the Court in that case. We therefore hold that the trusts were revocable by the grantor and that the income of all of the trusts is taxable to the grantor, the petitioner herein. 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/4625575/	City of New York, Petitioner v. Commissioner of Internal Revenue, RespondentCity of New York v. CommissionerDocket No. 27960-92BUnited States Tax Court103 T.C. 481; 1994 U.S. Tax Ct. LEXIS 70; 103 T.C. No. 27; October 11, 1994, Filed 70 Decision will be entered for respondent. Petitioner, a municipal corporation of the State of New York, seeks a declaratory judgment that the bonds it proposes to issue will be exempt from taxation under sec. 103(a), I.R.C. Petitioner proposes to use $ 15 million of the $ 100 million bond issuance to finance advances to nongovernmental borrowers for purposes of rehabilitating low-income housing units. The advances will be structured as loans that must be repaid in full by the borrowers, and will bear interest rates below the market rate reflected in the yield on the bonds. Held, petitioner may not use time value of money principles to bifurcate the advances into a loan portion and a grant portion for purposes of applying the private loan financing test of sec. 141(c), I.R.C.Held, further, the $ 15 million principal amount of the advances exceeds the $ 5 million private loan financing test threshold of sec. 141(c), I.R.C.Held, further, the proposed bonds constitute private activity bonds under sec. 141(a), I.R.C., and the interest thereon will not be exempt from taxation under sec. 103(a), I.R.C.James S. Kaplan, Helene Jaffa, Robert Firestone, and Amy F. Nogid71 , for petitioner.Marsha A. Keyes, Rebecca L. Caldwell-Harrigal, and Richard L. Carlisle, for respondent. Hamblen, Chief Judge. HAMBLEN482 OPINIONHamblen, Chief Judge: This is an action for declaratory judgment pursuant to section 7478. 1 Petitioner requested respondent to rule that general obligation bonds (bonds) in the face amount of $ 100 million that petitioner proposes to issue will be obligations described in section 103(a), so that the interest thereon will be excludable from the bondholders' gross income. After administrative review, respondent denied petitioner's request on the grounds that the proposed bonds are private activity bonds within the meaning of section 141(a)(2).All of the jurisdictional requirements for a declaratory judgment action have been satisfied. See Rule 210(c). The burden of proof is72 on petitioner, see Rule 217(c)(2)(A), and our decision is based upon the administrative record and the parties' stipulation of facts. See Rule 217(a). We accept as true those facts represented in the administrative record and the parties' stipulation of facts. See Rule 217(b)(1). Only those facts necessary to our decision are set forth.The issue for decision is whether the proposed bonds are obligations described in section 103(a). Resolution of this 483 issue depends on whether the bonds are private activity bonds under the private loan financing test of section 141(c). For the reasons set forth below, we agree with respondent that the proposed bonds are private activity bonds. Accordingly, we hold that the proposed bonds are not obligations described in section 103(a).BackgroundPetitioner City of New York (hereinafter petitioner or the city) is a municipal corporation of the State of New York. In order to combat the deterioration of much of its housing stock in low and moderate income neighborhoods, petitioner has developed a variety of programs. The six such programs involved in the present case are referred to as the programs. 273 Petitioner proposes to issue bonds with a total face amount of $ 100 million. Petitioner will use $ 15 million of the bond proceeds to finance the programs. Petitioner will apply the remaining $ 85 million to projects that have no private use.The $ 15 million of bond proceeds earmarked for the programs will be advanced by petitioner in the form of loans (advances). No portion of the advances is structured as a grant. Although the specific structure of the advances varies with each program, all the advances share several common characteristics. The advances will be made to homeowners, groups of homeowners, private developers, or court-appointed administrators (collectively, the borrowers), who will use the proceeds to renovate either city-owned or privately owned buildings. All the advances must be repaid to the city over a fixed term (generally 30 years), and bear interest at below-market rates. All advances must be repaid in full by the borrowers, and no portion of the advances will be forgiven. In order to ensure that the purposes of the programs are achieved, borrowers must comply with various city-imposed restrictions on the operation of the buildings, such as rent guidelines. 74 As the foregoing indicates, two relevant financial transactions are contemplated: (1) The city will receive $ 100 million pursuant to the bond issue, and (2) the city will transfer 484 $ 15 million of the bond proceeds to the borrowers pursuant to the advances. Because the bonds will be general obligation bonds, repayment of the bonds will be made from the city's general revenues. The city will be solely responsible for the payments to the bondholders, and the bondholders will not receive any security interest in the borrowers' repayments of the advances to the city or in the buildings being renovated under the programs.The actual yield on the bonds will be determined by a bid process. For purposes of its ruling request, petitioner represented that the yield on the bonds will equal 8.5 percent per annum. In contrast, the interest rate on the outstanding advances will range from 0 to 3 percent per annum. The present value of all the payments that the city will receive from the borrowers in repayment of the advances, discounted at the assumed 8.5-percent yield on the bonds, equals $ 4,789,324, which is less than the $ 15 million principal amount of the advances.Contentions75 of the PartiesSection 103(a)3 provides generally that gross income does not include interest on any State or local bond. The city is a political subdivision of the State of New York, and the proposed bonds will be obligations of the city. Accordingly, the proposed bonds fall within the general rule of section 103(a). See sec. 103(c)(1). Section 103(a), however, is qualified by the exceptions contained in section 103(b).76 In denying petitioner's ruling request, respondent relied on the exception set forth in section 103(b)(1), which provides that the general rule of section 103(a) does not apply to "Any private activity bond which is not a qualified bond (within the meaning of section 141)." 4Section 141(a) defines a "private 485 activity bond" as any bond that is part of an issue that meets either: (1) The private business tests of section 141(b), or (2) the private loan financing test of section 141(c). Respondent contends that the proposed bonds are private activity bonds by reason of the private loan financing test of section 141(c), which provides in relevant part as follows:SEC. 141(c). Private Loan Financing Test. --(1) In general. -- An issue meets the test of this subsection if the amount of the proceeds of the issue which are to be used (directly or indirectly) to make or finance loans * * to persons other than governmental units exceeds the lesser of --(A) 5 percent of such proceeds, or(B) $ 5,000,000.77 The parties agree that the borrowers under the programs are "persons other than governmental units". Accordingly, if the amount of bond proceeds that is used to make or finance loans under the programs exceeds $ 5 million, 5 the bonds will meet the private loan financing test and will constitute private activity bonds, the interest from which will not be excludable from the bondholders' gross income.The parties' disagreement centers on the proper measurement of the amount of bond proceeds that will be used "to make or finance loans" within the meaning of section 141(c). According to respondent, the full $ 15 million of bond proceeds that will be used to fund the advances will be used to make or finance loans to the borrowers, thereby causing the proposed transaction to exceed the78 $ 5 million private loan financing test threshold. Respondent bases her argument on the fact that the advances are structured as loans and the borrowers are required to repay the advances in full over a fixed time period.Petitioner concedes that the advances are structured as loans and that the $ 15 million face amount of the advances exceeds the section 141(c) private loan financing threshold. Petitioner, however, argues that the $ 15 million face amount of the advances is not the proper measurement of the amount of bond proceeds that will be used to "to make or 486 finance loans" under section 141(c). Instead, petitioner contends that the advances, despite being structured in full as loans, consist of two distinct economic components: (1) A loan from the city to the borrowers, and (2) a grant from the city to the borrowers. Petitioner contends that only the amount of the loan component is relevant for purposes of the section 141(c) private loan financing test.Petitioner bases this bifurcation argument on the fact that the city allows the borrowers to repay the advances at interest rates below the market rate reflected in the yield on the bonds. Petitioner argues that79 the loan component of the advances equals the present value of the repayments the borrowers must make on the advances, discounted at the assumed 8.5-percent market rate yield on the bonds. Under this formula, the amount of bond proceeds that will be used to make or finance loans equals $ 4,789,324, which is below the $ 5 million private loan financing test threshold of section 141(c). 6 The remaining $ 10,210,676 ($ 15 million - $ 4,789,324) of the advances, according to petitioner, constitutes a grant from the city to the borrowers that is not subject to the private loan financing test. 780 Discussion1. In GeneralThe present case centers on the proper interpretation of the private loan financing test of section 141(c). Specifically, we must decide whether section 141(c) permits petitioner to use present value discounting methods to calculate the amount of bond proceeds "which are to be used (directly or indirectly) to make or finance loans".As a preliminary matter, we note that this Court has previously addressed the general applicability of time value of money principles under the Code. In Follender v. Commissioner, 89 T.C. 943">89 T.C. 943 (1987), respondent attempted to apply 487 time value of money principles to the calculation of the "borrowed amount" under section 465(b)(2), thereby reducing the amount the taxpayer had "at risk" under the rules of section 465. After observing that "The concept of the time value of money is * * * relatively new to the Code", we concluded that time value of money concepts can be applied only in the presence of a legislative directive to do so. Follender v. Commissioner, supra at 950, 952. Because we found that section 465 "does not allow for present value calculations, 81 expressly or implicitly", we rejected respondent's position. Id. at 952.Petitioner contends that the present case is distinguishable from Follender. Petitioner concedes that, like the statute at issue in Follender, there is no specific statutory language in section 141(c) that supports the use of time value of money principles. Instead, petitioner bases its argument on: (1) The legislative history and statutory purpose of section 141(c); and (2) the use of time value of money concepts in certain other areas of Federal tax law. For the reasons set forth below, we find each of these arguments unpersuasive, and we decline petitioner's invitation to graft time value of money concepts onto the private loan financing test of section 141(c).2. Legislative History and PurposePetitioner contends that the primary purpose of section 141(c) and its predecessor is to restrict "conduit financing" in which public issuers use their ability to issue tax-exempt debt to benefit private persons, rather than legitimate municipal purposes. Petitioner engages in a detailed economic analysis of the below-market nature of the advances, concluding that the82 private borrowers under the advances receive the economic benefit of petitioner's ability to issue tax-exempt debt only to the extent that the borrowers pay down the municipality's debt at the favorable tax-exempt rate (i.e., to the extent of the present value of the repayments of the advances discounted at the anticipated yield on the bonds). Petitioner argues that the difference between the face amount of the advances and the discounted present value of the repayments constitutes an implicit grant by the city in furtherance of the public purpose of providing affordable 488 housing, and is not the type of conduit financing that Congress sought to restrict under section 141(c).Although petitioner's analysis might be an appealing interpretation of the transaction based on economic theory, we do not believe that it is apposite for purposes of the statute before us. As the following analysis demonstrates, Congress enacted detailed statutory provisions to determine when a bond issuance that benefits both private and public interests is entitled to tax-exempt status. While petitioner is correct in asserting that the prevention of conduit financing was a significant concern of83 Congress in enacting these provisions, the method Congress chose to address this problem does not support petitioner's use of time value of money concepts to bifurcate the advances into a loan portion and an implicit grant portion.A. Statutory LanguageAs an initial step in addressing petitioner's argument, we must look to the statutory language of section 141(c). As the Supreme Court observed: "There is, of course, no more persuasive evidence of the purpose of a statute than the words by which the legislature undertook to give expression to its wishes." United States v. American Trucking Associations, Inc., 310 U.S. 534">310 U.S. 534, 543 (1940).Section 141(c) does not contain a specific method for calculating the amount of bond proceeds used "to make or finance loans". Accordingly, we look to the words of the statute as ordinarily understood. See Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, 570-571 (1965); Lenz v. Commissioner, 101 T.C. 260">101 T.C. 260, 265 (1993); Union Pac. Corp. v. Commissioner, 91 T.C. 32">91 T.C. 32, 38 (1988). The term "loan" is commonly defined as the "Delivery by one 84 party to and receipt by another party of sum of money upon agreement, express or implied, to repay it with or without interest." Black's Law Dictionary 936 (6th ed. 1990). This definition is consistent with our prior decisions in other contexts, in which a transaction has been held to be a loan if there is an unconditional obligation to repay a sum certain at a fixed or other maturity date. See Adams v. Commissioner, 58 T.C. 41">58 T.C. 41, 58-59 (1972); New England Tank Indus., Inc. v. Commissioner, 50 T.C. 771">50 T.C. 771, 777 (1968), affd. 413 F.2d 1038">413 F.2d 1038 (1st Cir. 1969).489 Under this general definition, the full $ 15 million of advances constitutes loans. All the advances must be repaid by the borrowers to the city over a fixed term, and no portion of the advances will be forgiven. Moreover, the advances are structured as loans under the detailed written documentation between petitioner and each borrower. The fact that the advances carry a beneficial rate of interest does not, in our opinion, prevent the advances from being loans under the common definition of the term. Accordingly, under the ordinary 85 meaning of the statutory language, the $ 15 million of bond proceeds that is used to fund the advances will exceed the $ 5 million private loan financing threshold of section 141(c).B. Statutory PurposeIt is well established that we may look to the legislative history of a statute where the statute is ambiguous. Texaco Inc. & Subs. v. Commissioner, 101 T.C. 571">101 T.C. 571, 575 (1993); Centel Communications Co. v. Commissioner, 92 T.C. 612">92 T.C. 612, 627-628 (1989), affd. 920 F.2d 1335">920 F.2d 1335 (7th Cir. 1990); U.S. Padding Corp. v. Commissioner, 88 T.C. 177">88 T.C. 177, 184 (1987), affd. 865 F.2d 750">865 F.2d 750 (6th Cir. 1989). Even where the statutory language appears clear, we may seek out any reliable evidence as to legislative purpose. United States v. American Trucking Associations, Inc., supra at 543-544; United States Padding Corp. v. Commissioner, supra at 184; Huntsberry v. Commissioner, 83 T.C. 742">83 T.C. 742, 747-748 (1984). However, where a statute appears clear on its face, we require unequivocal evidence of legislative86 purpose before construing the statute so as to override the plain meaning of the words used therein. Huntsberry v. Commissioner, supra at 747-748.The first limitations on the use of tax-exempt bond proceeds to make personal loans were contained in section 103(o) of the Internal Revenue Code of 1954 (1954 Code), which was enacted by the Deficit Reduction Act of 1984 (DRA 1984), Pub. L. 98-369, sec. 626, 98 Stat. 926. That section denied the tax-exclusion benefits of section 103(a) of the 1954 Code to interest on "private loan bonds". 8 The Senate 490 Finance Committee report states that section 103(o) was enacted because of concern "about the growing use of taxexempt bonds to finance loans for personal expenses of higher education * * and the possible use of tax-exempt bonds to finance other personal loans." S. Rept. 98-169 (Vol. 1), at 706 (1984). The report explained the provisions of the new statute as follows:The bill generally denies tax-exemption for interest on consumer loan bonds, which are defined as obligations five percent or more of the proceeds of which are to be used directly or indirectly to make loans to persons other than87 exempt persons. * * Loans to enable a borrower to finance any tax or governmental assessment of general application for an essential government function are not taken into account. In addition, consumer loan bonds do not include IDBs [Industrial Development Bonds], qualified mortgage bonds and qualified student loan bonds. [Id. at 707.]The Tax Reform Act of 198688 (TRA 1986), Pub. L. 99-514, sec. 1301(b), 100 Stat. 2605, increased the restrictions on private loan financing. These new restrictions were codified as section 141(c). 9 The conference committee report noted that "the [private loan financing] restriction applies to loans to all persons other than governmental units", and observed that the revised statute "retains the present-law exceptions to the private loan restriction for all private activity bonds for which tax-exemption is provided specifically in the Code". H. Conf. Rept. 99-841, at II-692 (1986), 1986-3 C.B. (Vol. 4) 1, 692.As the foregoing committee reports illustrate, Congress was concerned about89 the use of tax-exempt bonds as a conduit to finance personal loans. However, Congress realized that certain loans to private persons further important public purposes and therefore should not jeopardize the tax-exempt status of the bond issue. In striking a balance between these concerns, Congress chose to concentrate the initial inquiry on the identity of the recipient of the loans, rather than the purposes served by the loans. As a result, the private loan 491 financing test of section 141(c)(1) focuses on whether the loan recipients are nongovernmental persons rather than the purposes for which the loan recipients are borrowing the money.The statutory inquiry turns to the purpose of the loan only after it is determined that the private loan financing test of section 141(c)(1) is met, thereby causing the bonds to be private activity bonds under section 141(a)(2). Sections 142 through 147 contain the explicit requirements that must be satisfied in order for a private activity bond to be eligible for tax-exempt status based on the public purpose served. 10 As the TRA 1986 conference committee report makes clear, the exceptions to the private loan restrictions based on 90 the public purpose served apply only when a "tax-exemption is provided specifically in the Code". H. Conf. Rept. 99-841, supra at II-692, 1986-3 C.B. (Vol. 4) at 692.Petitioner's bifurcation argument, which focuses at the outset on the purposes served by the advances, is inconsistent with this two-step statutory approach that Congress enacted to limit conduit financing. Because the borrowers under the proposed transactions are not governmental units, the full amount of the advances falls within the scope of section 141(c)(1), which focuses solely on the identity of the borrower. Moreover, the proposed bonds do not constitute qualified private activity bonds under section 141(e), and therefore are not entitled to tax-exempt status based on the purported91 public purpose served by the advances. To allow petitioner to apply time value of money concepts under section 141(c) to separate the "private" loan portion of the advances from the "public" grant portion of the advances would undermine the specific choices Congress made in deciding which loans that benefit both private and public purposes should be eligible for tax-exempt status.C. Substance Over FormPetitioner also cites the following paragraph from the conference committee report on the Tax Reform Act of 1986:The conferees intend that, as under present law, a loan may arise from the direct lending of bond proceeds or may arise from transactions in 492 which indirect benefits that are the economic equivalent of a loan are conveyed. Thus, the determination of whether a loan is made depends on the substance of a transaction, as opposed to its form. For example, a lease or other contractual arrangement (e.g., a management contract or an output or take-or-pay contract) may in substance constitute a loan, even if on its face such an arrangement does not purport to involve the lending of bond proceeds. However, a lease or other deferred payment arrangement with respect92 to bond-financed property that is not in form a loan of bond proceeds generally is not treated as such unless the arrangement transfers tax ownership to a nongovernmental person. Similarly, an output or management contract with respect to a bond-financed facility generally is not treated as a loan of bond proceeds unless the agreement in substance shifts significant burdens and benefits of ownership to the purchaser or manager of the facility. [H. Conf. Rept. 99-841, supra at II-692, 1986-3 C.B. (Vol. 4) at 692; emphasis added.]Petitioner argues that the reference to substance over form in the committee report applies not only to recharacterize as a loan a transaction that is not structured as such, but also to determine that a portion of a transaction is not a loan even when the full transaction is structured as a loan. As applied to the facts of the present case, petitioner contends that the emphasized language mandates that we ignore the fact that the advances are structured in full as loans and that we look to the purported economic substance of the transaction using time value of money principles.We are not persuaded that the emphasized language, 93 taken in the context of the full quoted paragraph, supports petitioner's contention. A more reasonable interpretation of the paragraph indicates that Congress intended that section 141(c) be broadly construed to capture transactions that are in substance loans, even if they are not structured as loans. The emphasized reference to substance over form underscores Congress' concern, expressed in the first sentence of the excerpt, that section 141(c) be applied to all "transactions in which indirect benefits that are the economic equivalent of a loan are conveyed." The examples given in the quoted paragraph further demonstrate that Congress was concerned with broadening, rather than limiting, the potential scope of section 141(c). When analyzed in this context, the emphasized language supports the extension of section 141(c) to transactions, such as certain leases, management contracts, or take-or-pay contracts, that are disguised as something other than loans. It provides no support for petitioner's use 493 of time value of money concepts to reduce the amount of advances that is subject to the private loan financing test.We note that our interpretation of the conference report94 language is consistent with the prior decisions of this Court holding that a taxpayer generally may not invoke the substance over form principle to disavow the form in which he has structured a transaction. See Estate of Durkin v. Commissioner, 99 T.C. 561">99 T.C. 561, 571-574 (1992); Coleman v. Commissioner, 87 T.C. 178">87 T.C. 178, 201-204 (1986), affd. without published opinion 833 F.2d 303">833 F.2d 303 (3d Cir. 1987). This principle has also been adopted by the Supreme Court, which stated in Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134">417 U.S. 134, 149 (1974):This Court has observed repeatedly that, while a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not, and may not enjoy the benefit of some other route he might have chosen to follow but did not. "To make the taxability of the transaction depend upon the determination whether there existed an alternative form which the statute did not tax would create burden and uncertainty." [Citations omitted.]Similarly, 95 "It would be quite intolerable to pyramid the existing complexities of tax law by a rule that the tax shall be that resulting from the form of transaction taxpayers have chosen or from any other form they might have chosen, whichever is less." Television Indus., Inc. v. Commissioner, 284 F.2d 322">284 F.2d 322, 325 (2d Cir. 1960), affg. 32 T.C. 1297">32 T.C. 1297 (1959).Although this Court in certain circumstances permits a taxpayer to disavow the structure of his transaction upon a showing of "strong proof" that the transaction does not reflect economic reality, see Estate of Durkin v. Commissioner, supra at 572-573; Coleman v. Commissioner, supra at 202-203, petitioner has not met this burden. 11 As discussed above, the advances constitute loans as commonly defined. The city is entitled to an unconditional repayment of the advances over a fixed period. The fact that the interest accruing on the outstanding advances is below the market rate 494 does not, in our opinion, constitute "strong proof" that the loan structure does not reflect economic reality.96 3. Use of Time Value of Money Concepts in Other Areas of Tax LawPetitioner also contends that its use of time value of money principles under section 141(c) is supported by the use of these concepts in purportedly analogous statutes, cases and rulings in other areas of tax law. As specific support for this argument, petitioner cites: (A) Sections 1274 and 7872; (B) the Supreme Court decision in Dickman v. Commissioner, 465 U.S. 330">465 U.S. 330 (1984); and (C) section 141(b)(2), as interpreted by respondent's Notice 87-69, 2 C.B. 378">1987-2 C.B. 378. After analyzing these examples, as well as related cases and rulings cited by petitioner, we find that they do not support the use of time value of money principles under section 141(c).A. Sections 1274 and 7872Petitioner argues that a statutory trend in favor of the application of time value of money concepts existed at the time the predecessor to section 141(c) was enacted, and that this trend should influence our interpretation of section 141(c). In support of this assertion, petitioner notes that the Deficit Reduction Act of 1984 (DRA 1984), Pub. L. 98-369, 98 Stat. 494, which contained97 the predecessor to section 141(c), also enacted sections 1274 and 7872, which specifically incorporate time value of money principles. Section 1274, which is a part of the "original issue discount" rules of the Code, uses present value discounting calculations to determine the imputed principal amount of certain debt instruments issued in exchange for property. Sec. 1274(b). This calculation is necessary in order to determine the amount of imputed interest the debtholder must ratably include in his gross income under section 1272 and the issuer may deduct under section 163(e). Section 7872 applies time value of money principles to determine the gift tax and income tax consequences of certain loans with below-market interest rates.Petitioner does not contend that section 1274 or section 7872 directly applies to the present case. 12 Instead, petitioner 495 argues that "Because of the extensive attention paid by Congress to time value of money issues at the time section 141(c) was enacted, it is not likely that Congress would have intended such principles to be ignored when it extended the private lending limitation of Section 103(o) of the 1954 Code." Petitioner further 98 argues, without citing any specific authority, that the use of time value of money principles under section 1274 and section 7872 creates a "strong presumption that Congress intended to apply these concepts to below-market interest advances under section 141(c), absent compelling evidence to the contrary." Although petitioner correctly notes that Congress enacted several statutory provisions during the early 1980s that specifically incorporate time value of money concepts, we disagree with the conclusion petitioner draws regarding the applicability of this statutory trend to section 141(c).99 As discussed above, this Court has previously addressed the inferences to be drawn from the explicit use of time value of money concepts in certain sections of the Code, including those sections enacted by DRA 1984. In Follender v. Commissioner, 89 T.C. 943">89 T.C. 943, 952 (1987), after noting that "The concept of the time value of money is * * relatively new to the Code," we reasoned that the use of time value of money concepts in specific statutes demonstrates that "Congress has been explicit in the areas it has chosen to require present value calculations." Because the statute at issue in that case, section 465(b)(2), "does not allow for present value calculations, expressly or implicitly", we held that time value of money principles could not be imputed. Id.Following the reasoning set forth in Follender, we find that the explicit use of time value of money principles in certain sections enacted by DRA 1984 (e.g., sections 1274 and 7872), coupled with the absence of any such use in section 141(c), the predecessor of which was also enacted by DRA 1984, belies petitioner's argument that Congress intended to apply time value of money concepts to section100 141(c). Sections 1274 and 7872 illustrate that Congress knows how to incorporate time value of money concepts into a statute when it so 496 desires. Had Congress chosen to apply these concepts to section 141(c), it is reasonable to assume that it would have explicitly included them in the statutory language, as was done in sections 1274 and 7872. Cf. Badaracco v. Commissioner, 464 U.S. 386">464 U.S. 386, 395 (1984) (Supreme Court refused to interpret section 6501(c)(1) as a mere tolling of the period for assessing income tax, reasoning that "When Congress intends only a temporary suspension of the running of a limitations period, it knows how unambiguously to accomplish that result.").B. Dickman v. CommissionerPetitioner also cites the Supreme Court decision in Dickman v. Commissioner, 465 U.S. 330 (1984), for the proposition that time value of money principles must be applied under section 141(c) even in the absence of a specific directive in the statute or legislative history. We disagree with petitioner's broad reading of that case.In Dickman, the Supreme Court held that a father's interest-free demand loans to101 his son and a closely held family corporation resulted in taxable gifts of the reasonable value of the use of the money loaned.13102 Id. at 344. In that case, respondent determined the value of the gifts by multiplying the loan balances outstanding at the end of each calendar quarter by the interest rate payable on underpayments of tax under section 6621. Id. at 332 n.2. The holding in the Dickman case was subsequently incorporated into section 7872.14Contrary to petitioner's contention, the Supreme Court's reasoning in Dickman v. Commissioner, supra, does not mandate a broad, indiscriminate application of time value of money principles across all areas of the Internal Revenue Code. The decision was based on the Court's detailed analysis of the statutory language and legislative purpose underlying 497 the Federal gift tax provisions at issue. See Winter v. United States, 23 Cl. Ct. 758">23 Cl. Ct. 758, 762 (1991), affd. without published opinion 972 F.2d 1355">972 F.2d 1355 (Fed. Cir. 1992) (refusing to apply Dickman time value of money principles to income tax deductions because "the holding in Dickman is grounded squarely on the statutory language of section 2501"). The Court's analysis103 revealed that Congress intended to interpret the gift tax provisions in the broadest and most comprehensive sense in order to reach all transfers of property and property rights having significant value. Dickman v. Commissioner, supra at 334. Moreover, the Court reasoned that to impose the gift tax on interest-free loans would further "one of the major purposes of the federal gift tax statute: protection of the estate tax and the income tax." Id. at 338.The reasoning in Dickman indicates that, absent specific statutory authorization, the use of time value of money principles is appropriate when necessary to effectuate a clearly stated legislative purpose. As discussed in detail above, neither the language of section 141(c) nor its legislative history supports the use of time value of money principles. The committee reports show that Congress was concerned with limiting the amount of loans that can be made to nongovernmental persons. For example, in providing that substance over form should control, the conference committee report highlights Congress' desire that the term "loan" be broadly interpreted, so that 104 a wide variety of transactions that are not structured as loans will nevertheless be subject to the private loan financing test. See H. Conf. Rept. 99-841, at II-692 (1986), 1986-3 C.B. (Vol. 4) 692. In sharp contrast to this stated purpose of broadening the scope of section 141(c), petitioner's use of time value of money concepts would narrow the definition of transactions that would be subject to the private loan financing test.In a related argument, petitioner cites respondent's Rev. Rul. 73-61, 1 C.B. 408">1973-1 C.B. 408. That ruling, involving facts similar to those in Dickman, held that non-interest-bearing loans between a father and his son resulted in taxable gifts. 15 Petitioner contends that respondent's use of time 498 value of money principles in Rev. Rul. 73-61, supra, which was validated by the holding in Dickman v. Commissioner, supra, binds respondent to use those principles in the present case. For the same reasons that we rejected petitioner's argument concerning the applicability of Dickman v. Commissioner, supra, we reject petitioner's 105 argument concerning Rev. Rul. 73-61, supra. Petitioner attempts to blindly apply principles from one area of tax law to another area, without regard to the reasoning underlying those principles. The application of time value of money concepts in the revenue ruling, as well as in Dickman, was based on the specific statutory purposes underlying the gift tax provisions at issue. See Rev. Rul. 73-61, 1973-1 C.B. at 408-409. In contrast, as discussed above, the statutory purposes underlying section 141(c) do not warrant the use of time value of money principles.106 C. Section 141(b)(2) and Notice 87-69As discussed above, a bond constitutes a "private activity bond" if it meets either: (1) The private loan financing test of section 141(c), which is at issue here, or (2) the private business tests of section 141(b). Sec. 141(a). A bond issue meets the private business tests of section 141(b) if it meets both: (1) The private business use test of section 141(b)(1), and (2) either the private security test of section 141(b)(2)(A) or the private payment test of section 141(b)(2)(B). 16 In Notice 87-69, 2 C.B. 378">1987-2 C.B. 378, respondent indicated that 499 time value of money principles are to be used for purposes of applying the private payment test of section 141(b)(2)(B). Although petitioner concedes that the private payment test of section 141(b)(2)(B) does not apply directly to the present case, it contends that the time value of money principles implicit in that test apply, by analogy, to the private loan financing test of section 141(c). We disagree.107 In general, the private payment test of section 141(b)(2)(B) is satisfied if the payment of the principal of, or the interest on, more than 10 percent of the proceeds of a bond issue is, directly or indirectly, derived from payments in respect of property, or borrowed money, used or to be used for a private business use. Sec. 141(b)(2). This test presents a peculiar problem in that it requires a comparison of two different streams of income: (1) The payments of debt service on the bonds and (2) the payments generated by property or borrowed money. These payment streams could have vastly different repayment terms, such as the period of time over which payments are made, the rate of interest on the outstanding balances, and the extent to which the outstanding principal is either amortized over the life of the debt or is payable in a single balloon payment. Without some common method of valuing these two streams, the comparison mandated by section 141(b)(2) would be useless. Notice 87-69, supra, by requiring the comparison of the present values of the two income streams, provides such a method. 17108 The use of time value of money concepts under section 141(b)(2) is consistent with our reasoning in Follender v. Commissioner, 89 T.C. 943">89 T.C. 943, 952 (1987), that such principles should not be applied unless the statute provides for them, either expressly or implicitly. Congress, by statutorily requiring a comparison of potentially different income streams, implicitly sanctioned the use of a method for making the comparison meaningful. As in Dickman v. Commissioner, 465 U.S. 330">465 U.S. 330 (1984), time value of money concepts constitute a permissible tool for effectuating congressional intent.This rationale, however, does not extend to the private loan financing test of section 141(c). As noted several times above, nothing in the statutory structure or legislative history 500 of section 141(c) mandates the use of time value of money principles. Unlike the streams of payments involved in section 141(b)(2)(B), section 141(c) merely requires the comparison of two absolute dollar amounts: (1) The "amount of the proceeds" of the issue that are used to make or finance loans, and (2) the lesser of 5 percent of the proceeds or $ 5 million. 109 Accordingly, the present value discounting principles used in section 141(b)(2)(B) are not necessary to carry out the mathematical test required by section 141(c).For the foregoing reasons, we hold that the advances may not be bifurcated, using time value of money principles, into a loan portion and a grant portion for purposes of the private loan financing test of section 141(c). Because the entire $ 15 million principal amount of the advances constitutes a loan for purposes of the test, the $ 5 million private loan financing test threshold of section 141(c) is exceeded. Accordingly, the bonds constitute private activity bonds under section 141(a)(2), and the interest thereon is not excludable from the bondholders' gross income under section 103(a).As a final observation, we recognize that the proposed transactions were designed to alleviate significant public problems faced by the city. We emphasize that our decision is not intended as a rebuke of the city's efforts to address these important issues and is not based on the underlying merits of the programs. Rather, our holding is a result of a straightforward application of the test provided by section 141(c). Congress, 110 if it desires to do so, has the power to revise the requirements of section 141(c) to permit the adoption of the proposed transactions, either by raising the specific dollar limitation in the private loan financing test or by explicitly incorporating time value of money principles into the test. Alternatively, as petitioner conceded at oral argument, the city could restructure the proposed transactions to explicitly separate the intended grant amount from the loan transaction. Unless and until such changes are made, however, we 501 are bound by the limitations of the existing statutory provisions and the transactional form petitioner has chosen.Decision will be entered for respondent. Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code of 1986 as amended, and Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The six programs involved in the present case are the Urban Homesteading Program, the Article 8A Program, the Vacant Building Program, the Participation Loan Program, the SRO Program For-Profit Developers, and the Article 7A Program.↩3. The relevant part of sec. 103 provides:SEC. 103. INTEREST ON STATE AND LOCAL BONDS(a) Exclusion. -- Except as provided in subsection (b), gross income does not include interest on any State or local bond.(b) Exceptions. -- Subsection (a) shall not apply to --(1) Private activity bond which is not a qualified bond. -- Any private activity bond which is not a qualified bond (within the meaning of section 141). * (c) Definitions. -- For purposes of this section and part IV --(1) State or local bond. -- The term "State or local bond" means an obligation of a state or political subdivision thereof.↩4. Petitioner does not contend that the proposed bonds are "qualified bonds" within the meaning of sec. 141(e). Accordingly, if the bonds are private activity bonds, they fall within the exception of sec. 103(b)(1)↩.5. Because the amount of proposed bond proceeds equals $ 100 million, the private loan financing test threshold equals $ 5 million under both the 5-percent test of sec. 141(c)(1)(A) and the specific dollar limitation of sec. 141(c)(1)(B)↩.6. If the actual yield on the bonds is less than the assumed 8.5-percent rate, it is possible that the present value of the repayments on the advances will exceed $ 5 million. Under such circumstances, the bonds would fail to meet the private loan financing test of sec. 141(c)↩ even if we were to accept petitioner's bifurcation argument.7. Respondent concedes that sec. 141(c)↩ does not prevent municipalities from making grants. Accordingly, were we to accept petitioner's bifurcation theory, the grant portion of the advances would not be counted in calculating whether the private loan financing test threshold is exceeded.8. As originally enacted, sec. 103(o) used the term "consumer loan bond". See Deficit Reduction Act of 1984 (DRA 1984), Pub. L. 98-369, sec. 626, 98 Stat. 926. The Tax Reform Act of 1986, Pub. L. 99-514, sec. 1869, 100 Stat. 2888, changed the term "consumer loan bond" to "private loan bond", retroactive to the effective date of DRA 1984. The term "private loan bond" was defined generally as "any obligation which is issued as part of an issue all or a significant portion of the proceeds of which are reasonably expected to be used directly or indirectly to make or finance loans * * to persons who are not exempt persons". Sec. 103(o), I.R.C. 1954↩.9. As part of the Tax Reform Act of 1986, the tax-exempt interest rules contained in secs. 103 and 103A of the 1954 Code were reorganized, by topic, into 11 separate Code sections (secs. 103 and 141- 150 of the Internal Revenue Code of 1986↩). H. Conf. Rept. 99-841, at II-686 (1986), 1986-3 C.B. (Vol. 4) 1, 686.10. Those bond issues that meet one of the specific statutory exceptions are referred to as "qualified" private activity bonds, and, unlike other private activity bonds, the interest thereon is tax-exempt. See secs. 103(b)(1), 141(e)↩.11. We also note that the reasons for allowing petitioner to disavow the form of its transaction appear less clear in the present declaratory judgment action, since petitioner has not yet carried out the proposed transaction and is therefore in a position to change its structure.↩12. Sec. 1.7872-5(b)(5), Proposed Income Tax Regs., 50 Fed. Reg. 33561 (Aug. 20, 1985), promulgated pursuant to the legislative authority of sec. 7872(h)(1)(C), specifically exempts from the scope of sec. 7872↩ "Loans subsidized by the Federal, State (including the District of Columbia), or Municipal government (or any agency or instrumentality thereof), and which are made available under a program of general application to the public." Petitioner does not challenge the validity of this proposed regulation.13. As petitioner notes in its detailed analysis of the cases leading up to the Supreme Court's decision in Dickman v. Commissioner, 465 U.S. 330">465 U.S. 330 (1984), most courts, including this one, had previously held that interest-free demand loans of the type in Dickman did not result in a taxable gift. See, e.g., Dickman v. Commissioner, T.C. Memo. 1980-575, revd. and remanded 690 F.2d 812">690 F.2d 812 (11th Cir. 1982), affd. 465 U.S. 330">465 U.S. 330 (1984); Crown v. Commissioner, 585 F.2d 234">585 F.2d 234 (7th Cir. 1978), affg. 67 T.C. 1060">67 T.C. 1060↩ (1977).14. The coverage of sec. 7872 extends beyond the holding in Dickman v. Commissioner, supra. Whereas Dickman addressed the gift tax consequences of a below-market demand loan, sec. 7872↩ also covers the gift tax consequences of below-market term loans and certain income tax consequences of below-market loans.15. Whereas Dickman v. Commissioner, supra, involved only the gift tax treatment of demand loans, Rev. Rul. 73-61, 1 C.B. 408">1973-1 C.B. 408, addressed the gift tax treatment of both demand loans and term loans. As in Dickman↩, the ruling valued the gift arising from an interest-free demand loan based on the balance of the loan outstanding at the end of each calendar quarter. The ruling valued the gift arising from an interest-free term loan by determining the discounted present value of the foregone interest at the time the loan was made. Because the advances are repayable over specific periods of time, petitioner relies heavily on the present value discounting method applied to the term loan in the ruling.16. The relevant part of sec. 141(b) provides:SEC. 141(b). Private Business Tests. --(1) Private business use test. -- Except as otherwise provided in this subsection, an issue meets the test of this paragraph if more than 10 percent of the proceeds of the issue are to be used for any private business use.(2) Private security or payment test. -- Except as otherwise provided in this subsection, an issue meets the test of this paragraph if the payment of the principal of, or the interest on, more than 10 percent of the proceeds of such issue is (under the terms of such issue or any underlying arrangement) directly or indirectly --(A) secured by any interest in --(i) property used or to be used for a private business use, or(ii) payments in respect of such property, or(B) to be derived from payments (whether or not to the issuer) in respect of property, or borrowed money, used or to be used for a private business use.↩17. Notice 87-69, 2 C.B. 378">1987-2 C.B. 378, in recognition of the unique necessity of a comparison of income streams under the private payment test, explicitly limits the application of its present value analysis to the private payment test of sec. 141(b)(2)(B). Notice 87-69, 1987-2 C.B. at 379↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4669081/	NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION This opinion shall not "constitute precedent or be binding upon any court." Although it is posted on the internet, this opinion is binding only on the parties in the case and its use in other cases is limited. R. 1:36-3. SUPERIOR COURT OF NEW JERSEY APPELLATE DIVISION DOCKET NO. A-2125-19 THOMAS E. SEELEY and DANIELLE SEELEY, h/w, Plaintiffs-Appellants, v. CAESARS ENTERTAINMENT, CORPORATION d/b/a BALLY'S CASINO, BALLY'S PARKPLACE, INC., d/b/a BALLY'S ATLANTIC CITY and BALLY'S CASINO, Defendants-Respondents. ______________________________ Submitted January 4, 2021 – Decided March 18, 2021 Before Judges Hoffman and Smith. On appeal from the Superior Court of New Jersey, Law Division, Atlantic County, Docket No. L-1904-14. Sacchetta and Falcone, attorneys for appellants (Marc T. Sacchetta, of counsel and on the brief; Randi S. Greenberg, on the brief). Cooper Levenson, PA, attorneys for respondents (Amy E. Rudley and Jennifer B. Barr, on the brief). PER CURIAM Plaintiffs Thomas and Danielle Seeley 1 appeal from the Law Division's January 10, 2020 order granting the summary judgment dismissal of the slip- and-fall premises liability action they filed against defendant Caesars Entertainment Corporation. Because we conclude genuine issues of material fact should have precluded the grant of summary judgment, we reverse and remand for further proceedings. I The motion record, construed in the light most favorable to plaintiff as the non-moving party, Brill v. Guardian Life Ins. Co. of Am., 142 N.J. 520, 523 (1995), reveals the following facts. On October 19, 2011, plaintiff – an attorney – attended a deposition in Atlantic City at Bally's Casino, owned by defendant. During a break, plaintiff and his co-counsel, Theodore Baker, went to a public men's restroom. After Mr. Baker entered and went into a stall, plaintiff walked 1 In this opinion, we refer to Thomas and Danielle Seeley collectively as "plaintiffs," and Thomas Seeley individually as "plaintiff." Plaintiff's wife sues per quod. A-2125-19 2 across the floor and slipped and fell on his back. Plaintiff sustained serious back injuries and later underwent multiple-level lumbar fusion surgery. 2 Neither plaintiff nor Mr. Baker noticed moisture on the floor before the fall. Upon hearing plaintiff fall, Mr. Baker exited the stall and offered assistance to plaintiff; at that point, he also made several observations. He first observed a pattern of moisture covering a "fairly wide area" of plaintiff's back. He then investigated the floor, which felt wet and slippery, and observed "the amount of moisture that would be left if you took a wet towel and rubbed it on the floor, or a mop, or a sponge or something." It appeared to him that the amount of moisture was "consistent . . . as if someone had cleaned [the floor], as if someone had come in and wiped it down." Moreover, the pattern of moisture on the floor was consistent with the pattern on plaintiff's back. Plaintiff and Mr. Baker both assumed the moisture on the floor was water because it was odorless. After hearing oral argument and reviewing the deposition testimony of plaintiff and Mr. Baker, the motion judge issued an oral decision. The judge found there was moisture on the floor, but concluded that Mr. Baker's testimony regarding its source was "speculative at best" and that "the circumstantial 2 Plaintiffs filed this action in 2013; however, all proceedings in the case were stayed in 2015, after defendants filed for bankruptcy. In 2019, the bankruptcy court entered an order granting plaintiffs leave to proceed with this action. A-2125-19 3 inference that [the moisture on the floor was created by defendants was not] appropriate under these circumstances [of a public bathroom]." Accordingly, the judge found plaintiff raised no genuine issues of material fact and granted defendants' motion. This appeal followed, with plaintiffs raising the following argument: POINT I MR. BAKER’S TESTIMONY AS TO THE APPEARANCE OF THE LIQUID ON THE FLOOR AND THE PATTERN ON MR. SEELEY’S JACKET WAS SUFFICIENT TO CREATE A JURY QUESTION ON THE ISSUE OF DEFENDANTS’ LIABILITY FOR PLAINTIFF’S FALL. THEREFORE, THE SUMMARY JUDGMENT SHOULD BE REVERSED. II On appeal, we review summary judgment orders de novo. Templo Fuente De Vida Corp. v. Nat'l Union Fire Ins. Co., 224 N.J. 189, 199 (2016). We "review the competent evidential materials submitted by the parties to identify whether there are genuine issues of material fact and, if not, whether the moving party is entitled to summary judgment as a matter of law." Bhagat v. Bhagat, 217 N.J. 22, 38 (2014) (citing Brill, 142 N.J. at 540; R. 4:46-2(c)). To establish a prima facie case of negligence, a plaintiff must set forth evidence that: 1) defendant owed him a duty of care; 2) defendant breached that A-2125-19 4 duty; and 3) defendants' breach of duty proximately caused plaintiff's damages. D'Alessandro v. Hartzel, 422 N.J. Super. 575, 579 (App. Div. 2011). "Under common law of premises liability, a landowner owes increasing care depending on whether the visitor is a trespasser, licensee or social guest or business invitee." Sussman v. Mermer, 373 N.J. Super. 501, 504 (2004). For summary judgment, defendants conceded plaintiff was a business invitee. "Business owners owe to invitees a duty of reasonable or due care to provide a safe environment for doing that which is within the scope of the invitation." Nisivoccia v. Glass Gardens, Inc., 175 N.J. 559, 563 (2003). "The duty of due care to a business invitee includes an affirmative duty to inspect the premises and 'requires a business owner to discover and eliminate dangerous conditions, to maintain the premises in safe condition, and to avoid creating conditions that would render the premises unsafe.'" Troupe v. Burlington Coat Factory Warehouse Corp., 443 N.J. Super. 596, 601 (App. Div. 2016) (quoting Nisivoccia, 175 N.J. at 563). Business owners are generally not liable for injuries caused by defects on the premises of which they had no actual or constructive notice and no reasonable opportunity to discover. Nisivoccia, 175 N.J. at 563. "Ordinarily, an injured plaintiff . . . must prove . . . the defendant[s] had actual or constructive A-2125-19 5 knowledge of the dangerous condition that caused the accident." Ibid. However, notice is not required if the injured plaintiff can establish that the defendants created the dangerous condition. Craggan v. Ikea USA, 332 N.J. Super. 53, 61 (App. Div. 2000). Applying these principles and viewing the facts in the light most favorable to plaintiff, Brill, 142 N.J. at 523, we conclude the motion judge erred in finding Mr. Baker's testimony did not raise genuine issues of material fact. Mr. Baker testified that the area of the restroom floor felt "wet" and "slippery" and appeared to be covered in "the amount of moisture left if you took a wet towel and rubbed it on the floor, or a mop, or a sponge or something." On this point, we note the motion judge accepted that the restroom was "certainly cleaned by the agents or employees of the casino."3 Based on this evidence, if the testimony of plaintiff and Mr. Baker is accepted as credible, a reasonable jury could legitimately infer that one of defendants' employees responsible for cleaning the restroom created the wet and slippery condition that caused plaintiff's fall and resulting injury. See Smith v. First National Stores, 94 N.J. Super. 462, 466 (App. Div. 1967) (finding the plaintiff was not required to show 3 Although casino patrons use these restrooms too, the record contains no basis to suggest the condition that caused plaintiff's fall was created by a mop-carrying casino patron. A-2125-19 6 notice of the slippery condition on a stairway because of the justifiable inference that the supermarket created the dangerous condition). Reversed and remanded for further proceedings consistent with this opinion. We do not retain jurisdiction. A-2125-19 7	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4669083/	NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION This opinion shall not "constitute precedent or be binding upon any court ." Although it is posted on the internet, this opinion is binding only on the parties in the case and its use in other cases is limited. R. 1:36-3. SUPERIOR COURT OF NEW JERSEY APPELLATE DIVISION DOCKET NOS. A-3199-18 A-3926-18 STATE OF NEW JERSEY, Plaintiff-Respondent, v. WAYNE E. MEYERS, Defendant-Appellant. _______________________ Submitted February 8, 2021 – Decided March 18, 2021 Before Judges Currier and Gooden Brown. On appeal from the Superior Court of New Jersey, Law Division, Mercer County, Indictment Nos. 01-09-1212, 01-11-1544, 17-09-0163. Joseph E. Krakora, Public Defender, attorney for appellant (Suzannah Brown, Designated Counsel, on the briefs). Gurbir S. Grewal, Attorney General, attorney for respondent (Sarah D. Brigham, Deputy Attorney General, of counsel and on the briefs). PER CURIAM In these back-to-back appeals, which we consolidate solely for purposes of issuing a single opinion, in a post-conviction relief (PCR) application, defendant challenged the legality of a 2002 probationary sentence imposed after he entered negotiated guilty pleas to second-degree drug related offenses that subsequently rendered him statutorily ineligible for drug court on a 2017 indictment charging him with additional drug related offenses. In an order entered on June 25, 2018, which was amended on October 24, 2018, the PCR court rejected defendant's petition and denied his application to withdraw the 2002 guilty pleas. In Docket No. A-3926-18, defendant appeals from the October 24 order, raising the following point for our consideration: POINT I THE PCR COURT ERRED IN DENYING [DEFENDANT'S] APPLICATION TO WITHDRAW HIS GUILTY PLEAS BASED ON THE ILLEGALITY OF THE PLEA AGREEMENT AND ILLEGAL SENTENCE IMPOSED. After the 2017 indictment was returned, defendant applied for and was rejected from drug court because the 2002 convictions rendered him statutorily ineligible pursuant to N.J.S.A. 2C:35-14(a)(6). In a June 25, 2018 order, the trial court denied defendant's motion to appeal his drug court denial. Defendant ultimately entered a negotiated guilty plea to a second-degree drug distribution A-3199-18 2 charge contained in the 2017 indictment, and the resulting prison sentence, which was imposed in accordance with the terms of the plea agreement, was memorialized in a July 5, 2018 judgment of conviction (JOC). In Docket No. A-3199-18, defendant appeals his drug court denial as well as the sentence imposed under the 2017 indictment raising the following points for our consideration: POINT I THE LOWER COURT ERRED IN DENYING [DEFENDANT'S] MOTION TO APPEAL DRUG COURT DENIAL BECAUSE IT WAS A PATENT ABUSE OF DISCRETION TO REJECT HIM BASED ON CONVICTIONS FOR WHICH HE RECEIVED AN ILLEGAL PLEA AGREEMENT AND SENTENCE. POINT II [DEFENDANT'S] SENTENCE WAS MANIFESTLY EXCESSIVE AND BASED UPON IMPROPER FINDING AND WEIGHING OF AGGRAVATING AND MITIGATING FACTORS. (NOT RAISED BELOW) For the reasons that follow, we affirm in both appeals. I. By way of background, on September 18, 2001, defendant was charged in Indictment No. 01-09-1212 with third-degree possession of a controlled A-3199-18 3 dangerous substance (CDS), N.J.S.A. 2C:35-10(a)(1) (count one); third-degree possession of CDS with intent to distribute, N.J.S.A. 2C:35-5(a)(1), (b)(3) (count two); third-degree possession of CDS with intent to distribute within 1000 feet of school property, N.J.S.A. 2C:35-7 (count three); and second-degree possession of CDS with intent to distribute within 500 feet of a public facility, N.J.S.A. 2C:35-7.1 (count four). The charges stemmed from police seizing heroin from defendant's person on May 20, 2001, after observing him engaging in drug dealing activities. About two months later, on November 15, 2001, defendant was charged in Indictment No. 01-11-1544 with third-degree possession of CDS, N.J.S.A. 2C:35-10(a)(1) (count one); second-degree possession of CDS with intent to distribute, N.J.S.A. 2C:35-5(a)(1), (b)(2) (count two); second-degree possession of CDS with intent to distribute within 500 feet of a public facility, N.J.S.A. 2C:35-7.1 (count three); third-degree aggravated assault, N.J.S.A. 2C:12- 1(b)(5)(a) (count four); and third-degree resisting arrest, N.J.S.A. 2C:29- 2(a)(3)(a) (count five). Those charges stemmed from police seizing crack/cocaine which defendant discarded on August 10, 2001, when he fled from police officers who had observed him engage in a hand to hand drug transaction. A-3199-18 4 Although defendant was accepted into drug court, he withdrew his application and, on July 23, 2002, entered negotiated guilty pleas to counts three and four of Indictment No. 01-09-1212 and counts two and five of Indictment No. 01-11-1544. Under the terms of the plea agreement, the State agreed to recommend an aggregate sentence of five years' probation, conditioned upon successful completion of a long-term in-patient drug treatment program, and dismissal of the remaining counts of the 2001 indictments. Because the plea agreement recommended a probationary disposition for second-degree offenses, the judge accepted defendant's guilty pleas conditioned upon her "review [of the] presentence report." The judge noted that if the presentence report convinced her that the agreement was "in the interests of justice," then she would sentence defendant accordingly. Otherwise, she would allow defendant to withdraw his guilty pleas and proceed "as if it was never entered." At the sentencing hearing conducted on October 4, 2002, upon reviewing the presentence report, the judge sentenced defendant in accordance with the plea agreement. After the judge confirmed that defendant had no prior indictable convictions, had "a limited employment history[,]" "attribute[d his criminal] conduct to ongoing drug use," and was enrolled in "a[n] in[-]patient" drug treatment program, the judge made the following findings: A-3199-18 5 Aggravating factors: I find that given your addiction and the pattern and lifestyle that you have adopted, that there is a risk that you will commit another offense. I've also considered the need for deterring you and others from violating the law. And the imposition of a fine and penalty without imposing a term of imprisonment would be perceived by you or others as merely part of the cost of doing business. On the mitigating side, I have considered that this is your first upper-court conviction, but that you have a juvenile record so I've given that minimum weight. I also find that if you successfully complete the [drug treatment p]rogram, there is some likelihood . . . that you will respond affirmatively to probationary treatment. Accordingly, I find that the aggravating factors outweigh the mitigating factors, although not substantially. . . . [I]t is normally my philosophy to allow defendants with a drug problem to have an opportunity to address it, and I will give you that opportunity. But I have to tell you, that the offenses to which you've entered guilty pleas are serious offenses . . . . [S]o I want to tell you right at the outset that if you violate any of the terms of probation, . . . you can be charged with violating probation. And if you're found guilty of that, you can then be sentenced to the maximum term for these offenses. And you've pled guilty to a couple of second-degree offenses, which carry a maximum term of ten years. See N.J.S.A. 2C:44-1(a)(3), (9), (11); N.J.S.A. 2C:44-1(b)(7), (10). A-3199-18 6 In 2005, defendant violated his probation and, on September 16, 2005, was sentenced to continued probation conditioned upon serving eight months in the county jail. The following year, defendant was arrested on new drug charges, which were subsequently charged in Indictment No. 06-11-1105. The new charges resulted in another violation of probation (VOP) on the 2001 indictments. In February 2007, after being accepted into drug court, defendant pled guilty to third-degree possession of CDS with intent to distribute within 1000 feet of a school zone under Indictment No. 06-11-1105, and was found guilty of the VOP for the 2001 indictments. On February 23, 2007, defendant was sentenced to an eighteen-month term of special probation in drug court on the VOP and a concurrent five-year term of special probation in drug court on the school zone charge, both conditioned on serving six months in the county jail. On June 28, 2013, defendant completed his sentence and graduated from drug court. Four years later, on September 29, 2017, defendant was charged in Indictment No. 17-09-0163 with second-degree distribution of CDS, N.J.S.A. 2C:35-5(a)(1), (b)(2), and 2C:35-5(c) (count two); second-degree conspiracy to distribute CDS, N.J.S.A. 2C:5-2, 2C:35-5(a)(1), (b)(1), and 2C:35-5(c) (count three); third-degree distribution of CDS within 1000 feet of school property, A-3199-18 7 N.J.S.A. 2C:35-7 (count four); second-degree distribution of CDS within 500 feet of a public facility, N.J.S.A. 2C:35-7.1 (count five); and third-degree possession of CDS, N.J.S.A. 2C:35-10(a)(1) (count six). Thereafter, defendant submitted an application for entry into drug court. On February 5, 2018, the trial court entered an order denying defendant's admission because he was "statutorily ineligible for [d]rug [c]ourt pursuant to N.J.S.A. 2C:35-14(a)(6)"1 based on his prior convictions under the 2001 indictments. On March 5, 2018, defendant filed a PCR application challenging the second-degree convictions under the 2001 indictments that now rendered him statutorily ineligible for drug court. Defendant argued that the probationary sentence imposed on his second-degree drug charges was illegal because the sentencing judge failed to make the requisite findings to overcome the presumption of incarceration applicable to second-degree offenses. Defendant also argued that he was denied effective assistance of counsel because his attorney failed to advise him that his guilty pleas could bar him from drug court in the future. 1 Under N.J.S.A. 2C:35-14(a)(6), a person is ineligible for drug court if he has "been previously convicted on two or more separate occasions of crimes of the first or second degree," other than designated offenses that do not apply here. A-3199-18 8 On June 15, 2018, following oral argument, the PCR judge denied defendant's application to vacate the second-degree convictions or withdraw his corresponding guilty pleas. In an oral opinion, the judge first addressed defendant's contention that "his sentence [was] unlawful because the sentencing court's findings [did] not support the imposition of a probationary term" and did not overcome the presumption of incarceration for second-degree offenses. See N.J.S.A. 2C:44-1(d) (requiring the imposition of a sentence of imprisonment upon conviction for "a crime of the first or second degree . . . unless, having regard to the character and condition of the defendant, [the court] is of the opinion that the defendant's imprisonment would be a serious injustice which overrides the need to deter such conduct by others"). The PCR judge acknowledged that despite finding that the "aggravating factors predominated" over the "mitigating factors," the sentencing co urt nonetheless "sentenced . . . defendant to probation." However, the PCR judge determined that because defendant's claim for vacating his sentence rested on "the sentencing court's findings[] concerning aggravating and mitigating factors" and the "balancing of [the] factors," "[s]uch a challenge . . . should have been made on direct appeal" and was "not cognizable as a claim for post- conviction relief." A-3199-18 9 In that regard, the judge relied on State v. Flores, 228 N.J. Super. 586, 595 (App. Div. 1988), where we explained that [w]hile an "illegal" sentence is correctable at any time, . . . this limited exception to the general rule should be confined to cases in which the quantum of the sentence imposed is beyond the maximum provided by law or where the term set by the court is not authorized by any statutory provision. In contrast, we determined in Flores that "questions concerning the adequacy of the sentencing court's findings and the sufficiency of the weighing process employed should be addressed only by way of direct appeal." Ibid. The PCR judge concluded that because the sentence did not "fall[] outside of the maximum term," it was not illegal and, under Flores, should have been addressed on direct appeal. Next, the judge rejected defendant's ineffective assistance of counsel (IAC) claim, finding defendant failed to show that either counsel's performance was deficient under the standard set forth in Strickland v. Washington, 466 U.S. 668, 687 (1984), and adopted by our Supreme Court in State v. Fritz, 105 N.J. 42, 49-53 (1987), or that he was prejudiced as required under the second prong of the Strickland/Fritz test. The judge determined "defense counsel's performance was hardly deficient" as "it [was] hard to imagine a more favorable outcome for . . . defendant short of a dismissal." The judge also rejected A-3199-18 10 defendant's claim "that defense counsel had a duty to warn him of the consequences" of his plea in relation to drug court. In support, the judge pointed out that defendant failed to "identif[y] any case law that impose[d] an affirmative duty to apprise the defendant of the impact of his plea on any future eligibility for [d]rug [c]ourt" and noted that "courts have held that there is no constitutional requirement to explain the . . . possible or even potential enhancement consequences of future abhorrent conduct."2 See State v. Wilkerson, 321 N.J. Super. 219, 227 (App. Div. 1999) (concluding that defense counsel's failure to advise his client "of possible or even potential enhancement consequences of future aberrant conduct is not [IAC]"). Turning to the prejudice prong, the judge explained that "defendant has failed to articulate or establish a reasonable probability he would have rejected the plea offer for a probationary sentence and gone to trial." The judge pointed out that given the number and severity of the charges, "the risks of going to trial were significant." Thus, the judge found it was "incredible to believe . . . defendant would have rejected a probationary offer simply to keep his options 2 The judge noted an exception to this rule for "enhanced penalties for second or subsequent convictions" for "DWI offenses, motor vehicle thefts, . . . and penalties for driving while suspended," none of which applied here. See e.g. State v. Patel, 239 N.J. 424 (2019); State v. Gaitan, 209 N.J. 339, 381 (2012); State v. Laurick, 120 N.J. 1 (1990). A-3199-18 11 open for [d]rug [c]ourt just in case he accrued a future criminal conviction." See State v. DiFrisco, 137 N.J. 434, 457 (1994) (holding that in order to establish the Strickland prejudice prong to set aside a guilty plea based on IAC, a defendant must show "that there is a reasonable probability that, but for counsel's errors, [the defendant] would not have pled guilty and would have insisted on going to trial") (alteration in original) (quoting Hill v. Lockhart, 474 U.S. 52, 59 (1985)); see also State v. Maldon, 422 N.J. Super. 475, 486 (App. Div. 2011) ("'[T]o obtain relief on this type of claim, a [defendant] must convince the court that a decision to reject the plea bargain'" and "insist on going to trial" would have been "'rational under the circumstances'" and, "in fact, that he probably would have done so[.]" (quoting Padilla v. Kentucky, 559 U.S. 356, 372 (2010) (alteration in original))). Finally, the judge analyzed defendant's motion to withdraw his guilty pleas under the four factors enunciated in State v. Slater, 198 N.J. 145, 157-58 (2009), namely, "(1) whether the defendant has asserted a colorable claim of innocence; (2) the nature and strength of defendant's reasons for withdrawal; (3) the existence of a plea bargain; and (4) whether withdrawal would result in unfair prejudice to the State or unfair advantage to the accused." In denying defendant's post-sentence plea withdrawal motion, the judge concluded "[t]his A-3199-18 12 [was] not a case of manifest injustice." See id. at 158 ("post-sentence motions are subject to the 'manifest injustice' standard in Rule 3:21-1"). The judge explained: First, [defendant] has not presented a colorable claim of innocence, second, the nature and strength of defendant's [reasons] for withdrawing are not entitled to significant weight, . . . defendant has already served the sentence, and . . . defendant is pressing this PCR simply to become eligible for [d]rug [c]ourt and circumvent the statutory bar. In other words, he regrets the . . . . [c]ollateral consequences of his plea. Thus he has not identified any compelling, . . . fair or just reasons for withdraw[al] . . . . Third, this is a plea agreement which certainly tilts in favor of the State but this factor alone is not significant. Finally, the unfair prejudice to the State is apparent as defendant pled guilty to this charge over [fifteen] years ago. To put it mildly, it would be exceptionally difficult for the State to prosecute this case. The judge noted further that because defendant "was admitted into [d]rug [c]ourt on separate charges in 2007," and thereby previously "received the benefit of [d]rug [c]ourt," a "denial of a second opportunity . . . does not constitute a denial of fundamental fairness or result in any form of injustice." A-3199-18 13 The judge entered a memorializing order on June 25, 2018. 3 On the same date, the judge entered an order denying "[d]efendant's motion to appeal his drug court denial" based on the court's rejection of defendant's PCR challenge and affirmation that the 2002 convictions rendered him statutorily ineligible. Defendant ultimately entered a negotiated guilty plea to count two of Indictment No. 17-09-0163, charging him with second-degree distribution of CDS stemming from him selling more than one-half ounce of cocaine in 2016 to a confidential informant. On June 29, 2018, defendant was sentenced in accordance with the plea agreement to a prison term of seven years and two months, with a forty-three month period of parole ineligibility. A conforming judgment of conviction was entered on July 5, 2018, and these appeals followed. II. In both appeals, defendant argues the PCR judge "erred in denying [his] PCR [application] because he established that his conviction[s] should be set aside based on the illegal sentence provided for in the plea agreement and imposed by the sentencing court." Defendant reiterates his contention that "[he] should have been permitted to withdraw his guilty pleas" because "the 3 The order was amended on October 24, 2018, to correct the indictment numbers. A-3199-18 14 sentencing court did not impose a sentence of imprisonment as was presumptively required for second degree crimes under N.J.S.A. 2C:44-1(d)" and "[t]here was no legal basis for the court to impose a probationary sentence." According to defendant, had the PCR judge ruled correctly and permitted defendant to vacate "his guilty pleas . . . on the two second[-]degree charges," he would have been "eligible for drug court" under the 2017 indictment. Thus, defendant's inter-related arguments in both appeals center on the propriety of the judge's decision denying his PCR application. 4 In State v. Thomas, we reiterated that: Illegal sentences are "(1) those that exceed the penalties authorized by statute for a particular offense and (2) those that are not in accordance with the law, or stated differently, those that include a disposition that is not authorized by our criminal code." "In other words, even sentences that disregard controlling case law or rest on an abuse of discretion by the sentencing court are legal so long as they impose penalties authorized by statute for a particular offense and include a disposition that is authorized by law." [459 N.J. Super. 426, 434 (App. Div. 2019) (first quoting State v. Schubert, 212 N.J. 295, 308 (2012); then quoting State v. Hyland, 238 N.J. 135, 146 (2019)).] 4 Defendant does not appear to dispute that if his 2002 convictions stand, he is statutorily ineligible for drug court for the 2017 indictment. A-3199-18 15 In Thomas, the State sought to appeal the imposition of a probationary sentence on a defendant convicted of third-degree aggravated assault stemming from a domestic violence incident. Id. at 430. Although the sentencing judge found aggravating factor fifteen based on the fact that "[t]he offense involved an act of domestic violence . . . and the defendant committed at least one act of domestic violence on more than one occasion," N.J.S.A. 2C:44-1(a)(15), the judge rejected the State's reliance on "the statutory presumption of incarceration" contained in N.J.S.A. 2C:44-1(d) to support its position that a sentence of imprisonment was statutorily mandated. Thomas, 459 N.J. Super at 431. We noted that "N.J.S.A. 2C:44-1(d) imposes a presumption of incarceration when a defendant is convicted of a third-degree crime and the trial court finds aggravating factor fifteen applies," and that the presumption could only "be overcome if the trial judge finds, after considering the defendant's 'character and condition,'" that "incarceration would cause a 'serious injustice which overrides the need to deter such conduct by others.'" Id. at 434-35. We also acknowledged that a "'[s]erious injustice' is generally difficult for a defendant to prove and a defendant must show he or she is 'so idiosyncratic that A-3199-18 16 incarceration . . . for the purposes of general deterrence is not warranted. '" Id. at 435 (quoting State v. Jarbath, 114 N.J. 394, 408-09 (1989)). However, in Thomas, we rejected the State's characterization of the sentence as "illegal" based on its contention that "defendant failed to show he was 'idiosyncratic'" as well as its position that "the judge applied inappropriate facts" and failed to "adequately explain" why incarceration would cause defendant a "serious injustice." Ibid. We concluded that "[e]ven if the court's reasoning was inadequate, that deficiency did not render the sentence illegal " because "sentences authorized by law but premised on an abuse of discretion are not illegal . . . ." Ibid. (quoting Hyland, 238 N.J. at 147). See also State v. Balfour, 135 N.J. 30, 41 (1994) ("[T]he presence of a guilty plea and a plea agreement can be an important factor to be weighed in the sentencing decisions" and "when properly justified by the circumstances, . . . does not demonstrate a trial court's abuse of its sentencing discretion."). Likewise, here, we agree with the PCR judge and reject defendant's contention that the plea agreement and resulting sentence were illegal. Because N.J.S.A. 2C:44-1(d) authorizes the imposition of a probationary sentence on a second-degree offense if the statutory criteria are met, the disposition is clearly authorized by law. Further, as in Thomas, even if the sentencing court's A-3199-18 17 reasoning in imposing the probationary sentence was inadequate, "that deficiency did not render the sentence illegal." 459 N.J. Super. at 435. "A finding to the contrary would conflate sentence illegality with judicial abuse of discretion, and undermine [our Supreme] Court's consistently narrow construct of which sentences it deems illegal." Hyland, 238 N.J. at 147. Thus, because our "jurisprudence makes clear that sentences authorized by law but premised on an abuse of discretion are not illegal," ibid., we find that the 2002 sentence was not illegal and agree with the PCR judge that defendant's claim is "not cognizable as a claim for post-conviction relief." 5 In the alternative, defendant argues that his bargained-for Brimage6 sentence7 should be "modified" because it "shocks the conscience." Defendant 5 Defendant does not expressly argue that the PCR judge erred in rejecting his claim based on IAC or in denying his post-sentence motion to withdraw his 2002 guilty pleas under Slater. However, in the interest of completeness, we affirm those decisions for the sound reasons expressed by the judge. Nonetheless, we note that failure to advance an argument effectively waives that argument on appeal. See N.J. Dep't of Envtl. Prot. v. Alloway Twp., 438 N.J. Super. 501, 505 n.2 (App. Div. 2015) ("An issue that is not briefed is deemed waived upon appeal."). 6 State v. Brimage, 153 N.J. 1 (1998). 7 The State "bargained away its right to seek a mandatory extended term [under N.J.S.A. 2C:43-6(f)] as a part of its negotiated plea agreement with defendant." State v. Courtney, 243 N.J. 77, 88-89 (2020). A-3199-18 18 asserts the judge's finding of aggravating factors "lacked the necessary qualitative analysis," and his failure to find mitigating factor eleven "due to the hardship of a lengthy prison sentence on his dependents" was error. We review sentences "in accordance with a deferential standard," State v. Fuentes, 217 N.J. 57, 70 (2014), and acknowledge "that appellate courts should not 'substitute their judgment for those of our sentencing courts.'" State v. Cuff, 239 N.J. 321, 347 (2019) (quoting State v. Case, 220 N.J. 49, 65 (2014)). Thus, we will affirm the sentence unless (1) the sentencing guidelines were violated; (2) the aggravating and mitigating factors found by the sentencing court were not based upon competent and credible evidence in the record; or (3) "the application of the guidelines to the facts of [the] case makes the sentence clearly unreasonable so as to shock the judicial conscience." [Fuentes, 217 N.J. at 70 (alteration in original) (quoting State v. Roth, 95 N.J. 334, 364-65 (1984)).] "While the sentence imposed must be a lawful one, the court's decision to impose a sentence in accordance with the plea agreement should be given great respect, since a 'presumption of reasonableness . . . attaches to criminal sentences imposed on plea bargain defendants.'" State v. S.C., 289 N.J. Super. 61, 71 (App. Div. 1996) (quoting State v. Sainz, 107 N.J. 283, 294 (1987)). See A-3199-18 19 also Fuentes, 217 N.J. at 70-71 ("A sentence imposed pursuant to a plea agreement is presumed to be reasonable . . . ."). Here, the judge found aggravating factors three, six, and nine based on defendant's prior criminal record, particularly his prior drug related convictions and his prior failed attempt at drug treatment. See N.J.S.A. 2C:44-1(a)(3) ("[t]he risk that . . . defendant will commit another offense"); N.J.S.A. 2C:44-1(a)(6) ("[t]he extent of . . . defendant's prior criminal record and the seriousness of the offenses of which he has been convicted"); N.J.S.A. 2C:44-1(a)(9) ("[t]he need for deterring . . . defendant and others from violating the law"). The judge also determined there were no mitigating factors, rejecting defendant's proffer of mitigating factor eleven. See N.J.S.A. 2C:44-1(b)(11) ("[t]he imprisonment of the defendant would entail excessive hardship to the defendant or the defendant's dependents"). In that regard, the judge acknowledged that defendant had "four children" ranging "in age from [fifteen] to six," and that the mother of three of the children was deceased. The judge noted that those three children were "residing with [defendant's] mother" and "the fourth child [was] in the custody of the child's mother." However, according to the judge, while it was "a very unfortunate situation," it did not justify finding mitigating factor eleven given the existence A-3199-18 20 of "a support arrearage of a bit more than [$2000]" and defendant's assertion that "part of the reason for the drug sales was that he needed to support the children." Notwithstanding the overwhelming aggravating factors and dearth of mitigating factors, the judge determined that "[t]he negotiated sentence" was "within the authorized range," "fair," and "in the interest of justice ," and sentenced defendant accordingly. Applying our deferential standard of review, we are satisfied that the judge's findings are amply supported by the record, that the sentence comports with the guidelines, and that the sentence does not reflect an abuse of discretion or shock our judicial conscience. Affirmed. A-3199-18 21	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4625545/	Cleveland-Sandusky Brewing Corp., Petitioner, v. Commissioner of Internal Revenue, RespondentCleveland-Sandusky Brewing Corp. v. CommissionerDocket No. 63466United States Tax Court30 T.C. 539; 1958 U.S. Tax Ct. LEXIS 167; June 9, 1958, Filed 1958 U.S. Tax Ct. LEXIS 167">167 Decision will be entered under Rule 50. 1. Petitioner, in 1925, filed an additional claim for obsolescence of its buildings and other properties for the year 1919, due to national prohibition legislation, in the amount of $ 808,087.87. At the time this claim was filed, the year 1918 had been closed. Petitioner's claim was based upon an alleged total obsolescence for the 1918-1919 period in the amount of $ 1,798,542.94. A settlement was reached, based upon a total obsolescence of $ 1,434,131.98 for the 1918-1919 period. It was agreed that 45 per cent of this amount, or $ 645,359.39, was allocable to 1919, and on this basis the year was closed. Held, that 55 per cent, $ 788,772.59, of the total obsolescence amount which formed the basis of the settlement, was allowable obsolescence for the year 1918 and that consequently the adjusted basis of certain buildings owned by petitioner in the fiscal years 1949 and 1950 was zero.2. In May 1898, petitioner acquired land consisting of four parcels in the same area at a cost of $ 32,820.25. Petitioner sold portions of this land in 1922, 1933, and 1937, and in each instance credited the sales price against the cost of the land. 1958 U.S. Tax Ct. LEXIS 167">168 In 1950 the petitioner, after allocating the original cost of the total property over the entire original acreage, sold 0.2164 acres (to which petitioner allocated a basis of $ 4,354.57) and claimed a loss from such sale. Held, petitioner failed to establish that it was entitled to an adjusted basis greater than that allowed it by respondent.3. Held, a cabin cruiser owned by the petitioner in the fiscal years 1949 and 1950 was used exclusively for business purposes and the entire cost of operation of the cruiser is deductible as an ordinary and necessary business expense. Edward C. Crouch, Esq., for the petitioner.L. Robert Leisner, Esq., for the respondent. Mulroney, Judge. MULRONEY 30 T.C. 539">539 The respondent determined deficiencies in petitioner's income tax in the amount of $ 106.81 for the fiscal year1958 U.S. Tax Ct. LEXIS 167">169 ended March 31, 1949, and in the amount of $ 12,835.97 for the fiscal year ended March 31, 1950. The issues are (1) whether the basis of certain property held by the petitioner in these years should be adjusted, for the purposes of computing depreciation and gain or loss from the sale of such property, for obsolescence in 1918 due to national prohibition legislation; (2) whether petitioner is entitled to a higher basis with respect to a 1950 sale of land than the basis allowed by the respondent; and (3) whether a cabin cruiser owned by the petitioner 30 T.C. 539">540 was used exclusively for business purposes during the fiscal years 1949 and 1950.FINDINGS OF FACT.The Cleveland & Sandusky Brewing Company (by change of name, subject taxpayer), hereinafter called the petitioner, was organized under the laws of Ohio on February 8, 1898. It filed its income tax returns for the fiscal years 1949 and 1950 with the then collector of internal revenue for the eighteenth district of Ohio.In May 1898 the petitioner purchased the brewing plants and properties of 9 breweries -- 8 located in Cleveland, Ohio, and 1 located in Sandusky, Ohio. In 1902 the Schlather Brewery in Cleveland was purchased; 1958 U.S. Tax Ct. LEXIS 167">170 in 1904 the Lorain Brewery, in Lorain, Ohio, was purchased; and in 1907 the Fishel Brewery in Cleveland was purchased. Ten of these breweries, including the Schlather Brewery, were in operation on January 31, 1918, the date when national prohibition legislation affecting all brewery properties was passed. This legislation was to become effective on or before January 16, 1920, depending upon the dates in the interim when State legislatures would make prohibition effective in the various States. The legislature of the State of Ohio made prohibition effective in Ohio on June 1, 1919, and after that date the petitioner was prohibited from brewing and selling alcoholic beverages.In its return for the calendar year 1918 the petitioner claimed a deduction of $ 531,914.82 for obsolescence to buildings, equipment, and other properties as a result of prohibition. In its return for the calendar year 1919 the petitioner claimed a deduction of $ 108,407.37 for obsolescence to buildings, equipment, and other properties as a result of prohibition, making a total of $ 640,322.19 claimed as an obsolescence deduction for the 2 years. Petitioner's returns for 1918 and 1919 were examined by revenue1958 U.S. Tax Ct. LEXIS 167">171 agents and in a report of the respondent under date of August 18, 1922, the total obsolescence of $ 640,322.19 was reapportioned between the 2 years, with $ 440,221.51 being allocated to 1918 instead of $ 531,914.82, and with the 1919 obsolescence being increased by $ 91,693.31.A further examination of the petitioner's returns for 1918 and 1919 was made and in a report dated March 3, 1924, the petitioner was granted an additional allowance for obsolescence of goodwill in the amount of $ 200,277.83 for the year 1918. A certificate of overassessment was issued for the year 1918 and the year was closed. In October 1925, the petitioner protested the assessment for 1919 as set forth in the report of March 3, 1924, and filed a claim for additional obsolescence for the year 1919 in the sum of $ 808,087.87. This matter was appealed by the petitioner to the Board of Tax Appeals. The case (Docket No. 34448) was settled in 1933, based upon a statement prepared 30 T.C. 539">541 by the Bureau of Internal Revenue dated September 25, 1933. The respondent, in the statement, concluded that there was a total obsolescence of petitioner's property for the 1918-1919 period due to prohibition in the amount1958 U.S. Tax Ct. LEXIS 167">172 of $ 1,434,131.98, and that 45 per cent of this amount, or $ 645,359.39, was applicable to the year 1919. A certificate of overassessment was issued on November 21, 1933, based upon the computations in the respondent's statement of September 25, 1933, and the year 1919 was closed. The petitioner entered on its books and records the obsolescence allowed in the statement of September 25, 1933, for the year 1919, but no additional obsolescence to buildings, machinery, or other property was entered by the petitioner on its books for the year 1918.Petitioner, in its returns for the fiscal years 1949 and 1950, claimed depreciation deductions for the Schlather Brewery buildings in the amounts of $ 3,259.47 and $ 1,679.74, respectively, computed upon a depreciated basis of these buildings, on April 1, 1948, in the amount of $ 39,935.40. In fiscal year 1950 these buildings were sold and the petitioner reported a gain of $ 18,382.34 from such sale, based upon an adjusted basis for the buildings of $ 35,296.19. Respondent, in his notice of deficiency, determined that additional obsolescence to petitioner's properties was allowed or allowable for the year 1918 in the amount of $ 788,772.591958 U.S. Tax Ct. LEXIS 167">173 and that the depreciated basis of the Schlather Brewery buildings owned by petitioner (or its subsidiary) on April 1, 1948, was zero. Respondent disallowed the depreciation claimed by the petitioner on said buildings during the fiscal years 1949 and 1950 and determined that the gain on the sale of such buildings and property during the fiscal year 1950 was $ 53,678.53.Paragraph 11 of the stipulation provides as follows:At the time the petitioner purchased the properties of nine breweries in May, 1898, the petitioner acquired the land of the Cleveland Brewery Company located at Ansel Road and Hough Avenue in Cleveland, Ohio at a cost of $ 32,820.25. This land consisted of four parcels, as follows:LocationAcreageMain Brewery Site -- North Side Ansel Rd1.085Old Stables Site -- South Side Ansel Rd.430Northwest corner, Ansel Rd. and Hough Ave.054Triangle parcel, Ansel and Hough Intersection.062Total1.631In 1922 the Triangle parcel was sold for $ 21,500.00, and the sale price was credited against the cost of the land. In 1933, .042 acres of the main brewery site was disposed of for a consideration of $ 5,000.00, which was credited against the 1958 U.S. Tax Ct. LEXIS 167">174 cost of the land. In 1937, the old stables site was disposed of for taxes, leaving a balance of 1.097 acres of the Cleveland Brewery land owned by the petitioner at the beginning of its taxable year April 1, 1949-March 31, 1950. During said taxable year, the petitioner sold .2164 acres of the main brewery site for $ 2,719.34. The petitioner, in reporting this sale on its return, allocated 30 T.C. 539">542 the original cost of the total property ($ 32,820.25) over the entire acreage (1. 631) and claimed an adjusted basis for the .2164 acres sold of $ 4,354.57, and further claimed a loss of $ 1,635.23. The petitioner allocated the original cost of the land, without taking into account recoveries from prior sales which were credited against cost. The respondent determined that the petitioner had credited recoveries on prior sales against the original cost and only the balance of original cost unrecovered could be allocated over the land remaining to be sold in 1950 and thereafter.During the fiscal years ending March 31, 1949 and 1950, the petitioner owned a cabin cruiser. During the fiscal year 1949 the petitioner expended $ 5,079.83 in the operation of this cruiser, which it claimed 1958 U.S. Tax Ct. LEXIS 167">175 as a deduction for that year, and petitioner also claimed a depreciation deduction on the cruiser in the amount of $ 1,642.27. The respondent disallowed $ 2,579.83 of the expense deduction. In the fiscal year 1950 the petitioner expended $ 2,116.86 in the operation of the cruiser, which it claimed as a deduction for that year, and petitioner also claimed a depreciation deduction on the cruiser in the amount of $ 1,642.27. The respondent disallowed $ 1,116.86 of the expense deduction.The cabin cruiser owned by the petitioner in the fiscal years 1949 and 1950 was used exclusively for business purposes and all the expenses of operation were ordinary and necessary business expenses.OPINION.In the stipulation filed in this case it is stated: "Petitioner and respondent concede that the only issue involved in this proceeding relative to depreciation and gain on the sale of the Schlather property is whether or not additional obsolescence was allowed or allowable for the year 1918 in the amount of $ 788,772.59."Section 113 (b) (1) (B) of the Internal Revenue Code of 1939 provides that adjustment shall in all cases be made to the basis of property in respect of any period since February1958 U.S. Tax Ct. LEXIS 167">176 28, 1913, for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent allowed but not less than the amount allowable. The statute is clear that an adjustment must be made for the amount of obsolescence "allowable," whether or not such amount was ever claimed by the taxpayer. See Virginian Hotel Corporation of Lynchburg v. Helvering, 319 U.S. 523">319 U.S. 523.It is admitted that petitioner, a brewery engaged in the business of brewing ale and beer, suffered obsolescence to its buildings, equipment, and other properties when the Eighteenth Amendment to the Constitution of the United States became effective. Both parties realized the proper method of taking the obsolescence was by spreading the total obsolescence, caused by prohibition legislation, over the entire period from January 31, 1918, when it was known that prohibition would become effective, and ending June 1, 1919, the date it did become effective in Ohio. In its 1918 and 1919 income tax returns 30 T.C. 539">543 petitioner claimed total obsolescence because of national prohibition in the sum of $ 640,322.19, which it apportioned between the years 1918 and 1919 in the amounts 1958 U.S. Tax Ct. LEXIS 167">177 of $ 531,914.82 for 1918 and $ 108,407.37 for the year 1919. In 1922 these returns were examined by respondent's agents and respondent made no change in the total amount of obsolescence claimed in these two returns for the 1918-1919 period ($ 640,322.19) but he reapportioned the amounts as between the years, allocating 11/16, or $ 440,221.51 to the year 1918, instead of $ 531,914.82, and the balance, or 5/16 to 1919. Subsequently, in 1924, respondent granted to the petitioner an additional allowance for obsolescence of goodwill for the year 1918 and a certificate of overassessment was issued and the year 1918 was closed.We come now to the evidence which, respondent argues, shows that an additional amount of obsolescence was allowable for the year 1918. In 1925, when the year 1919 was still open, petitioner filed a claim for additional obsolescence for the year 1919. In this claim it apparently claimed a total obsolescence of $ 1,798,542.94 for the years 1918 and 1919, allocating $ 990,455.07 to 1918 and $ 808,087.87 to 1919. This is shown by certain exhibits in evidence consisting of a letter from petitioner's attorney in 1933 in which reference is made to an appraisal report1958 U.S. Tax Ct. LEXIS 167">178 of the American Appraisal Company filed with the Commissioner at a prior date. This appraisal report, which petitioner filed with respondent to substantiate its claim for additional obsolescence in 1919 in the sum of $ 808,087.87, shows the appraisal company's computation of total obsolescence for the 1918-1919 period in the sum of $ 1,798,542.94 and the appraisal company's allocation of $ 990,455.07 to the year 1918, and the balance, or $ 808,087.87, to the year 1919.The dispute was finally settled in 1933 when the respondent determined that the total obsolescence for the 1918-1919 period was $ 1,434,131.98 and allocated $ 645,359.39 to 1919. The obvious implication was that the balance, or $ 788,772.59, was allocated to 1918. On this basis, the year 1919 was closed. The fact that petitioner did not enter the latter amount on its books for 1918 is immaterial. When the settlement was reached in 1933, the year 1918 was closed, and the fact that the petitioner did not feel compelled to make an entry of obsolescence for the closed year cannot eliminate the fact that such amount was allowable for that year. Both the respondent and the petitioner were aware of the necessity for 1958 U.S. Tax Ct. LEXIS 167">179 allocating the total obsolescence over the years 1918 and 1919. The 2 years, consequently, were linked in any determination of the proper allocation of total obsolescence. Petitioner accepted the total obsolescence determined by the respondent for the purpose of closing the year 1919.It is difficult to understand how the petitioner can accept the 1919 portion of the total obsolescence figure as correct and then object to the 1918 portion of the total figure. It is also significant that in its 30 T.C. 539">544 own application for additional obsolescence the petitioner claimed a much larger figure for the year 1918 than the one finally determined by the respondent. We hold that the amount of $ 788,772.59 was "allowable" obsolescence for the year 1918.The next issue involves the correct adjusted basis of land sold by petitioner in the fiscal year 1950. In the trial of this case counsel for petitioner stated that all of the evidence with respect to this issue was contained in the stipulation of facts, with the exception of petitioner's income tax returns for 1922 and 1933. These returns were produced by respondent and admitted in evidence.In our Findings of Fact we have quoted paragraph1958 U.S. Tax Ct. LEXIS 167">180 11 of the stipulation which contains all of the stipulated facts applicable to this issue. The stipulation shows that petitioner in 1898 purchased land in Cleveland at a cost of $ 32,820.25. This land consisted of four parcels which were the main brewery site (1.085 acres on the north side of Ansel Road), the old stables site (0.430 acres on the south side of Ansel Road), the northwest corner of Ansel Road and Hough Avenue (0.054 acres), and the triangle parcel (0.062 acres at the Ansel and Hough intersection). In 1922 petitioner sold the triangle parcel for $ 21,500; in 1933, 0.042 acres of the main brewery site were disposed of for $ 5,000 and in 1937 the old stables site was disposed of for taxes, leaving a balance of 1.097 acres of this land owned by the petitioner at the beginning of the fiscal year 1950. In each instance the sales price of the parcels sold was credited against the cost of the land and no gain was reported on such sales. In the fiscal year 1950 the petitioner sold 0.2164 acres of the main brewery site for $ 2,719.34. In reporting this sale petitioner first determined a cost basis for each parcel by dividing the total cost of the four parcels by the original1958 U.S. Tax Ct. LEXIS 167">181 acreage in each separate parcel. In this manner petitioner determined the cost basis for the main brewery site parcel. Petitioner then determined the cost basis for the land sold from this parcel by dividing the above cost basis in the main brewery site parcel by the acreage sold. By this method petitioner arrived at a basis for the land sold of $ 4,354.57 and petitioner claimed a loss from the sale in the amount of $ 1,635.23. Respondent determined that only the unrecovered balance of the original cost of the land should be allocated over the remaining land and on this assumption determined that the petitioner realized a gain in the fiscal year 1950.There is here no question of concealment or misrepresentation in the prior years and consequently there is no room for any argument of technical estoppel. Respondent argues that the petitioner in the prior years elected a particular method of treating the proceeds from the sales and is, therefore, bound to continue. We are unaware of any such opportunity, under the applicable statutes and regulations, for any election given to the petitioner. Pancoast Hotel Co., 2 T.C. 362. 30 T.C. 539">545 Nor do we think1958 U.S. Tax Ct. LEXIS 167">182 that the petitioner, under these facts, is bound by any duty of consistency. American Light & Traction Co., 42 B. T. A. 1121, affd. 125 F.2d 365. We think it is clear that the proper treatment, when the first sale was made in 1922, would have been to allocate the total cost among the four parcels on the basis of the separate cost of each or on the basis of the fair market value of each parcel if a lump sum were paid for the four and thus arrive at a basis for each separate parcel to be used in the computation of gain or loss. William T. Piper, 5 T.C. 1104.However, there is insufficient information in the record to permit us to make the necessary allocation among the parcels. As we pointed out above, the established rule is that such allocation of the original lump-sum cost must be made on the basis of the fair market value of each of the parcels. We are not given this information. We gather from the stipulation and from the brief that these parcels were located at the intersection of Hough Avenue and Ansel Road in Cleveland. We cannot assume that the fair market value of these separate1958 U.S. Tax Ct. LEXIS 167">183 parcels, situated on different sides of the streets, was so similar that an allocation could be made, as petitioner concludes, merely on the basis of acreage. Petitioner's brief states that at the time of purchase these parcels were improved by buildings which were subsequently torn down by the petitioner. Obviously, if a correct allocation were to be made, the total basis must be allocated between the land and the depreciable improvements. As far as we can tell, this was never done. In view of the paucity of the evidence, we consider it impossible to make the necessary allocation of the original cost basis among the several parcels of land. Respondent gave the land sold in 1950 a cost basis of $ 1,246.76. Petitioner's evidence is insufficient to show it had a higher basis. We affirm the respondent.One reason for the lack of evidence on this point is indicated by petitioner's desire to have the 1922 and 1930 income tax returns added to the stipulated facts. They show petitioner had net losses those years and it probably received no tax benefit from its erroneous treatment of its prior sales from three of the parcels. Petitioner's entire argument on this issue is that because1958 U.S. Tax Ct. LEXIS 167">184 it received no tax benefit, because of its erroneous treatment of the prior sales, it should have the right to report the 1950 sale correctly. Whether or not petitioner received a tax benefit in the years it incorrectly reported its prior sales, is immaterial. We agree it had the right to report its 1950 sale correctly but, as pointed out earlier, the evidence is insufficient upon which to make a determination of cost basis.During the fiscal years 1949 and 1950 the petitioner owned a cabin cruiser. In the fiscal year 1949 petitioner claimed a deduction of $ 5,079.83 under section 23 (a) of the Internal Revenue Code of 193930 T.C. 539">546 for the operation of this cruiser and also claimed a depreciation deduction of $ 1,642.27. Respondent disallowed $ 2,579.83 of the deduction for operational expenses. In the fiscal year 1950 the petitioner claimed a deduction of $ 2,116.86 for the operation of the cruiser and also claimed a depreciation deduction of $ 1,642.27. Respondent disallowed $ 1,116.86 of the deduction for operational expenses. We think that the petitioner has carried its burden of proving that the cruiser was used entirely for business purposes. Marshman, the president1958 U.S. Tax Ct. LEXIS 167">185 of the petitioner during the years 1949 and 1950, testified that the cruiser was used solely to hold sales meetings and to entertain customers and distributors. It was especially necessary to own a cruiser for these purposes since the petitioner's plant was located in a slum area where it was not feasible to conduct the sales meetings or to meet with distributors and customers. Marshman's testimony was that there was a constant need to generate goodwill in the business of distributing beer and to persuade distributors to push the petitioner's product. The cruiser was used for these purposes. Marshman testified that "we had ten salesmen in the city and 2500 accounts. One salesman would have 200, one 280, and so forth. He was assigned the boat to entertain one week or one weekend and Wednesday they always entertained take out store owners because they closed on that day." Marshman also testified that the cruiser was "used only for corporate purposes, business purposes, entertaining, a place for meetings of the distributors * . Customarily on weekends they took a group of distributors or take out people or large dealers fishing down to the islands if the weather permitted." 1958 U.S. Tax Ct. LEXIS 167">186 We are convinced that the cruiser was used solely for business purposes and consequently hold that the respondent erred in disallowing a portion of the operational expense deduction claimed by the petitioner under section 23 (a).Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625547/	L. E. Allen v. Commissioner. Charles Kauderer v. Commissioner.Allen v. CommissionerDocket Nos. 6049, 6094.United States Tax Court1946 Tax Ct. Memo LEXIS 164; 5 T.C.M. 486; T.C.M. (RIA) 46137; June 13, 19461946 Tax Ct. Memo LEXIS 164">164 John W. Piester, Esq., for petitioner, L. E. Allen. J. Lee Boothe, C.P.A., 1053 Book Bldg., Detroit 26, Mich., for petitioner, Charles Kauderer. Cecil H. Haas, Esq., for the respondent. HILL Memorandum Findings of Fact and Opinion HILL, Judge: These proceedings involve income tax deficiencies for the calendar year 1941 in the following amounts: Docket No. 6049$6,405.32Docket No. 60942,566.59Since the proceedings present common issues of fact and law, it was agreed by counsel that they would be determined on one record and for the same reason they have been consolidated for consideration and opinion. The controversies hinge upon a determination of the portion of partnership income which is taxable to each of the petitioners herein. A stipulation of facts with exhibits attached was filed in each case and oral and documentary evidence was submitted at the hearing. Findings of Fact L. E. Allen is an individual residing in Crosse Pointe Park, Michigan, and Charles Kauderer is an individual residing in Detroit, Michigan. The income tax return of each of these individuals for the calendar year 1941 was filed with the collector of internal1946 Tax Ct. Memo LEXIS 164">165 revenue for the district of Michigan at Detroit. Allen's return was prepared on the accrual basis and Kauderer's return was prepared on the cash basis. On June 3, 1941, Allen and Kauderer executed articles of co-partnership of Allen-Kauderer Engineering Company. The partnership thus formed was established to carry on engineering services and production and it was specified, inter alia, that each of the parties would advance one-half of the capital needed to carry on the business, would receive one-half of the net profits after payment of expenses and would share one-half of the business losses. The partnership agreement further provided that books of account should be kept at the place of business and that each partner should have free access to same at all times. On the 31st day of June and the 31st day of December in each year following the formation of the partnership, a general account was to be taken and the respective shares of profits were to be credited to the accounts of the partners. It was provided that upon 60-days notice in writing either partner might withdraw from the business, at which time the partnership should be terminated and an accounting rendered. The partnership1946 Tax Ct. Memo LEXIS 164">166 employed one Warren as accountant. He kept the books of the partnership and prepared the partnership return of income for 1941 and each partner's individual income tax return for that year. It was mutually decided in August 1941 that the partnership would be terminated about September 1, 1941, and that the partner making the highest bid for the other's interest was to become sole owner of the business. Kauderer was not interested in continuing the business and it was therefore concluded that Allen would purchase his interest. A profit and loss statement for the period of the partnership operation was prepared as of August 31, 1941, and showed a profit attributable to the interest of each partner in the amount of $6,105.49. At this date the capital investment of each of the partners was $13,000. Allen did not have the money available, however, to effect dissolution and payment as of September 1 but it was understood that the deal would be closed as soon as he could acquire sufficient capital. Subsequently, capital contributions were made by each partner to enable the partnership to continue operations and as of September 19, 1941, Allen's capital investment in the business was1946 Tax Ct. Memo LEXIS 164">167 $24,500 and that of Kauderer was $15,500. A memorandum signed by each partner showed the respective investments in the business as of October 16, 1941, as $43,000 for Allen and $15,500 for Kauderer. A postscript to this memorandum likewise signed by each partner was as follows: The above unballanced [sic] cash investment is due to a settlement agreed on by both parties as to a proposed disolving [sic] of partnership which has not been carried out to date. On November 3, 1941, Allen and Kauderer executed a typed agreement of dissolution of the company. This agreement referred to the agreement of co-partnership dated June 3, 1941, recited that the parties had mutually agreed to dissolve the co-partnership and waived the 60-day notice required by the partnership agreement, and stated that Allen was to be the sole owner of the company's assets thereafter and was to assume its liabilities. Other pertinent portions of the dissolution agreement are as follows: 4. The party of the first part agrees on the date hereof to pay to the party of the second part the sum of Fifteen Thousand Five Hundred Dollars representing the investment of the party of the second part in and to said business1946 Tax Ct. Memo LEXIS 164">168 and the additional sum of Eight Thousand Nine Hundred ($8,900.00) Dollars in cash representing the estimated profits of the partnership. 5. The party of the second part agrees to execute any Bills of Sale or other instruments that may be necessary to transfer to the party of the first part all his right, title and interest in and to said co-partnership. 6. It is further agreed that on and after the date hereof each of the parties hereto are freed from any obligation to the other created by the original Agreement of Co-Partnership dated June 3rd, 1941. This document had been typed for execution in September 1941 and "November" was substituted in ink for "September" wherever the date of dissolution appeared. In paragraph 4 the typewritten words and figures "Six Thousand ($6,000.00)" were marked out and "Eight Thousand Nine Hundred ($8,900.00)" written in in substitution therefor. In accordance with the dissolution agreement Allen made payments to Kauderer as follows: November 3, 1941, $15,500; January 30, 1942, $5,000; February 28, 1942, $3,900. On the partnership return of income of Allen-Kauderer Engineering Company for the period beginning June 1, 1941 and ending October 31, 1941, ordinary1946 Tax Ct. Memo LEXIS 164">169 net income was reported in the amount of $26,911.14. Under Schedule J of that return, one-half of that income, or $13,455.57, was attributed to the interest of each partner. Respondent has adjusted the partnership ordinary net income to $30,212.29, which adjustment has been agreed to by each of the petitioners. On his individual income tax return for the calendar year 1941 Allen reported $13,455.57 as income from the partnership. In addition to other adjustments to Allen's net income, his income from the partnership was increased by $7,856.72. As thus adjusted Allen's taxable income from the partnership is $21,312.29, or the total adjusted net income of the partnership less $8,900. On his individual income tax return for the calendar year 1941 Kauderer reported as income from the partnership $13,455.57. Under item 16, "Other deductions authorized by law", $4,555.57 was entered. This deduction was explained on the return as follows: Computation of Loss on Sale of Partnership Investment in Allen-Kauderer Engineering Company. Cash Investment June 1, to October 31,1941$15,500.0050% of Partnership Profits13,455.57$28,955.57Less - Sale Price to L. E. Allen24,400.00$ 4,555.571946 Tax Ct. Memo LEXIS 164">170 In addition to another uncontested adjustment respondent increased Kauderer's partnership income to $15,106.14, or one-half of the adjusted partnership ordinary net income, and disallowed the loss deduction. Allen's distributive share of the partnership ordinary net income was $21,312.29 and Kauderer's distributive share was $8,900. Opinion The ordinary net income of the Allen-Kauderer partnership from its formation on June 3, 1941, to its dissolution on November 3, 1941, was $30,212.29. In each of these proceedings we are first called upon to determine the petitioner's distributive share of such income. Petitioner Allen contends that the June 3 agreement is determinative in its provision that each partner is to receive 50 per cent of the partnership net profits, or $15,106.14. The dissolution agreement is regarded by Allen as effecting a purchase by him of Kauderer's interest which, it is argued, is nevertheless a purchase because a later determination of partnership profits revealed that he had bought for $8,900 an interest worth over $15,000. Allen also contends that he realized no taxable gain on the purchase. At the hearing Allen offered no oral evidence in his own behalf1946 Tax Ct. Memo LEXIS 164">171 and since it was agreed that both cases would be considered on one record he objects to the inclusion in the record of the testimony offered by Kauderer and the respondent on the ground that the terms of the dissolution agreement have been integrated in the formal writing signed by both parties and as thus set out may not be varied by oral evidence. Respondent contends in the Allen case that the petitioners entered into a new partnership agreement on or about September 1, 1941, which changed the proft sharing ratios and that under this new agreement Allen's distributive share of the partnership profits is $21,312.29, or the total ordinary net income less $8,900. Petitioner Kauderer's position apparently is that the partnership was terminated as of approximately September 1, 1941, and that the $8,900 received by him represented his one-half of the profits as of that date plus "the difference paid by Allen as part of the plan to retire petitioner." Kauderer regards September and October as a settlement period during which the business was treated as belonging to Allen. In this case, respondent contends that the only partnership agreement was that of June 3, that the partnership was1946 Tax Ct. Memo LEXIS 164">172 not dissolved until November 3, and that Kauderer's distributive share of the partnership income was $15,106.14, or 50 per cent, even though he received only $8,900. Kauderer testified in his own behalf and Allen testified on behalf of respondent. We do not doubt that Allen purchased the interest of Kauderer but we think it is clear that the purchase price agreed upon was the amount of the latter's investment plus his distributive share of the profits. As his share of the profits Kauderer actually received $8,900, but it is the distributive rather than the distributed share of profits which is taxable to a partner. See . A taxpayer may not escape taxation upon profits which he has earned by turning his back upon them or by assigning them to another. Cf. ; . However, partners may alter their existing agreement as to distributive shares of future profits and such a new agreement is determinative for tax purposes. . The controlling inquiry here, therefore, is whether the $8,900 was actually1946 Tax Ct. Memo LEXIS 164">173 Kauderer's distributive share. The instrument embodying the dissolution agreement was composed and typed to take effect about September 1, 1941. If it had been executed as of that date the amounts inserted in paragraph 4 thereof would have been computed in accordance with the June 3 agreement and Kauderer's share of the profits would have been determined as of the execution date in the amount shown by the profit and loss statement prepared as of August 31, 1941, or $6,105.49. The amount "$6,000" was actually typed into the dissolution agreement and later stricken out. Kauderer shared in the profits earned after that time, however, for the amount due him was increased to $8,900. He also contributed an additional $2,500 in capital. We think, therefore, that Kauderer's right to partnership profits was not terminated as of September 1. While the evidence is conflicting as to the method by which the additional $2,794.51 in profit was computed, it is all to the effect that the figure was an estimate. The difficulty lies in determining from this unsatisfactory record whether it was an estimate of 50 per cent of the profits as of November 3, 1941, or as of some earlier date, or whether1946 Tax Ct. Memo LEXIS 164">174 it was intended to represent a different precentage of the profits. When questioned with respect to the October 16 memorandum, petitioner Allen testified: A. Well, I believe the purpose of this was the fact that the decision that I would purchase Mr. Kauderer's share of the business had been agreed mutually between us. That had all been agreed upon. In order to further the interests of the company and let us go ahead and proceed and take care of the necessary capital, I put in additional capital. Otherwise, we would have been… could not have operated. Q. Had the final dissolution agreement - the terms of the final dissolution agreement - been agreed upon? A. It had been agreed we would dissolve, and the amount and everything. But, as Mr. Kauderer brought out in his testimony, it wasn't until later that the actual deal was closed although it was previously all agreed upon. The only reasonable interpretation of these statements seems to be that the $8,900 figure had been agreed upon prior to October 16, 1941, even though it was not known as of what date the partnership would formally cease to exist. The postscript to the October 16 memorandum makes this increasingly clear. 1946 Tax Ct. Memo LEXIS 164">175 We are also irresistibly persuaded by the record that shortly after September 1 the petitioners came to regard the business as belonging solely to Allen with the formal dissolution of the partnership being delayed only by his inability to settle. In view of this and since it would have been contrary to normal business sense for Kauderer to sell for $8,900 a 50 per cent interest in future profits of the concern for an indefinite period in addition to 50 per cent of the accumulated profits, we conclude that it was understood by him and Allen that he was not entitled to future profits and that the $8,900 was based on an estimate of profits earned by the partnership as of a date prior to October 16. When we also note that after September 19 Kauderer contributed no more capital to the enterprise although Allen invested an additional $18,500, it seems apparent that by agreement between the partners prior to October 16 Allen was to bear 100 per cent of the contribution burden and was to receive 100 per cent of the profits. We conclude, therefore, that Kauderer had no right to partnership profits accruing subsequent to the date of that agreement and is not taxable on any portion thereof. 1946 Tax Ct. Memo LEXIS 164">176 The record contains no statement, however, as to the amount of such profits and we have yet to determine each partner's distributive share of profits earned prior to the date of the new agreement. Allen testified as follows with respect to his offer to Kauderer: A. We mutually figured and estimated what we thought the profits were, and I arrived at the eighty-nine hundred figure, and that was my offer to him for his share of the business. When asked whether the $8,900 amount was computed according to the partnership agreement, Kauderer testified: A. No, because there was no real proportion there. Mr. Allen had a little more capital investment at that time; in fact, quite a bit more. Q. Was there any discussion concerning the capital? A. Oh, yes, he was entitled to a little more profit. Q. Well, just what was said? A. Well, just about along that line, that on account of the unbalanced capital investment he was entitled to so much more profits than I was, which I agreed to. Kauderer was then unable to state the proportion of partnership profits which his additional $2,794.51 of profits were to represent but we note the record contains no evidence in contradiction of1946 Tax Ct. Memo LEXIS 164">177 his statement that the equal sharing of profits was abandoned in favor of a new proportion based upon the capital contribution of each partner. It appears, however, that this new proportion was agreed to with respect to profits which had been earned from September 1 to the date of the new agreement. We are, therefore, brought to this point. (1) Until September 1, 1941, Kauderer and Allen each had a 50 per cent distributive share which at that date was $6,105.49 in amount. (2) Settlement was delayed and no new agreement was made until some unknown date prior to October 16, at which time earned profits were estimated and $2,794.51 was added to Kauderer's $6,105.49 share as an unknown but less than 50 per cent proportion of profits accrued from September 1 to that date. (3) From that date Kauderer had no distributive share of future partnership profits. If it were established in the record that the new proportions had been agreed to at September 1 then we clearly should hold that Kauderer's distributive share was $8,900 and that Allen's share was the remainder of the partnership ordinary net income. The only apparent objection here to such a holding is that the new agreement was an1946 Tax Ct. Memo LEXIS 164">178 attempt by Kauderer to assign to Allen a portion of profits which he had earned. We do not regard the objection as insurmountable under the peculiar facts here. After the partners had departed from their original agreement by unbalancing their respective capital contributions, they drifted along without any clear understanding as to the effect of that departure upon the profit sharing ratios. Where the later distribution agreement made under such circumstances is based upon capital contribution the objection has no standing for in such a case the taxpayer's effort is not to assign to another income which he has earned but it is to determine what income he has earned. We have considered the oral evidence offered at the hearing because we think its effect is merely to explain how certain terms of the written dissolution agreement were arrived at and because we see no variance between our conclusions and the provisions of the written instrument. The oral evidence does show an alteration of the original partnership agreement but the parol evidence rule does not prohibit a showing that an oral agreement different from the written original was subsequently entered into by the parties. 1946 Tax Ct. Memo LEXIS 164">179 9 Wigmore on Evidence, § 2441. We hold that petitioner Allen's distributive share of the partnership ordinary net income was $21,312.29 and that petitioner Kauderer's distributive share was $8,900. These conclusions render it unnecessary to consider the remaining contentions of the parties. As to Docket No. 6049, decision will be entered for respondent. As to Docket No. 6094, decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625548/	MODERN INVENTIONS CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Modern Inventions Corp. v. CommissionerDocket No. 25377.United States Board of Tax Appeals16 B.T.A. 1267; 1929 BTA LEXIS 2415; June 29, 1929, Promulgated 1929 BTA LEXIS 2415">2415 The value of patent rights paid in to the petitioner corporation for shares of stock in 1920 determined for depreciation purposes. Maxwell Shmerler, C.P.A., for the petitioner. P. M. Clark, Esq., for the respondent. SMITH 16 B.T.A. 1267">1267 This is a proceeding for the redetermination of a deficiency in income tax for 1922 in the amount of $569.09. The petitioner alleges that in the determination of the deficiency the Commissioner allowed no depreciation for patents for the calendar year 1922, and also failed to allow the deduction from gross income of a loss sustained in the calendar year 1921. Petitioner further alleges that consideration was not given to a waiver of the right to file a petition with the United States Board of Tax Appeals, consenting to a deficiency for the calendar year 1922, filed by the petitioner on request of the Commissioner and acknowledged by him. FINDINGS OF FACT. The petitioner is a New York corporation, organized in December, 1920, with a capital stock of $50,000, divided into 500 shares of a par value of $100 each. Of this stock 100 shares were sold at par for cash and 400 shares in the purchase of certain patent1929 BTA LEXIS 2415">2416 rights. Letters were granted to Henry Lasko on September 28, 1920. This patent was on an invention relating to a stamping machine known as a "nameograph." On September 30, 1920, the same inventor made application for a patent on an improvement of the machine, such application bearing Serial No. 413,774. The rights in the patent and the patent application were assigned by the inventor to Ludwig Lasko, and in turn assigned by him to the petitioner on January 22, 1921. The incorporators of the petitioner were Ludwig Lasko, Charles J. Ball, Jr., and Max Sherover. The 500 shares of stock of the corporation were to be issued to the incorporators in equal amounts. Sherover and Ball were to pay to the corporation $5,000 cash and Lasko $500 in addition to the assignment by the latter of certain rights in the patent and patent application above referred to. The invention upon which Letters were issued involved the idea of applying electrically heated devices and impressing these heated devices into hard rubber with a mechanism that would propel the object on which the stamping were done one step forward each time that the die was returned to1929 BTA LEXIS 2415">2417 its original position. The machine operated in much the same manner as a 16 B.T.A. 1267">1268 typewriter. It was designated to imprint upon fountain pens the name of the seller or the name of the purchaser. The application for a patent was for improvements and refinements upon the machine covered by Letters . The patent was placed upon the petitioner's books of account as having a value of $40,000. This was based largely upon an estimate of the value made by a person who made a model for the machine and who was to superintend the production of it. His estimate of the value was $75,000. This estimate seemed to the incorporators to be in excess of the fair market value and the value placed on the books was accordingly reduced to $40,000. The petitioner produced a few machines for sale in 1921. On December 31, 1921, the petitioner charged as depreciation on patent rights $2,525.74. The result of operation for 1921, as shown by its books of account, was an operating deficit of $2,164.67. In 1922 a new machine, called an "engravograph," was patented, which did the same work as was done by the petitioner's machine and which practically superseded the nameograph. 1929 BTA LEXIS 2415">2418 The engravograph operated upon an entirely different principle from the nameograph. At December 31, 1922, the petitioner charged off depreciation in the amount of $6,948.90. Of this amount the respondent disallowed the deduction of $6,773.50 in determining the deficiency for 1922. The cash value of the patent rights acquired by the petitioner in exchange for shares of stock was $4,500. On December 6, 1926, Max Sherover, as president-secretary of the petitioner, filed with the Commissioner a "Waiver of right to file a petition with the United States Board of Tax Appeals" which provided as follows: The undersigned taxpayer hereby waives the right to file a petition with the U.S. Board of Tax Appeals under Section 274(a) of the Revenue Act of 1926 and consents to the assessment and collection of a deficiency in tax for the year 1922 aggregating $548.18 subject to a credit of $270.58 (12 1/2% of $2,164.67, loss per 1921 return in error not deducted on 1922 return from profits of 1922). The deficiency notice upon which the petition filed with this Board is predicated is dated December 26, 1927, and shows a deficiency in tax for 1922 of $846.69. OPINION. SMITH: The three1929 BTA LEXIS 2415">2419 allegations of error contained in the petition filed in this proceeding have been set forth above. The petitioner contends that the patent rights acquired by it in exchange for shares of stock had a value at the date of acquisition of $40,000. We think that this is not proven by the evidence. Apparently, the rights in the patent were owned at the date of the organization of the corporation by Ludwig Lasko. He received one-third of the shares of stock of the corporation for $500 cash, plus his assignment of certain rights 16 B.T.A. 1267">1269 in the patent owned by him. Ball and Sherover received a like amount of stock of the corporation for $5,000 cash. It appears to us therefore that these transactions show an agreed cash value of the patent rights turned in to the corporation by Lasko of $4,500. We therefore determine that the cash value of the patent rights paid into the corporation was $4,500. From the record we can not determine whether the petitioner had a net loss for 1921. The books of account show an operating deficit for 1921 of $2,164.67 but this was after the deduction from gross income of depreciation on patent rights in the amount of $2,525.74. This deduction for1929 BTA LEXIS 2415">*2420 exhaustion of patent rights was apparently predicated upon a cash value of the patents at the time acquired by the corporation of $40,000, which we have found to be greatly in excess of the true value. We therefore question whether the petitioner had a net loss for 1921 within the meaning of section 204 of the Revenue Act of 1921. The deficiency due from the taxpayer for 1922 should be recomputed upon this basis. The so-called waiver of right to file a petition with the United States Board of Tax Appeals was predicated upon the proposition that the Commissioner would determine a deficiency for 1922 of $548.18, subject to a credit of $270.58. This was not accepted by the Commissioner. It did not bind the Commissioner to find such a deficiency, and has no bearing upon the determination of the deficiency by this Board. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625549/	E. E. Hassen and B. B. Hassen, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentHassen v. CommissionerDocket Nos. 1544-68, 3686-68, 3687-68, 4030-68, 4066-68, 4182-68United States Tax Court63 T.C. 175; 1974 U.S. Tax Ct. LEXIS 25; November 13, 1974, Filed 1974 U.S. Tax Ct. LEXIS 25">25 Decisions will be entered under Rule 155. 1. As a consequence of the individual petitioners' default on a note which was secured by a trust deed pledging their real property community asset, Pacific, the holder of the note, foreclosed, and at the trustee's sale on May 31, 1961, purchased the property for the outstanding balance of the note. A few days prior to the trustee's sale, an officer of Pacific stated to one of petitioners that if Pacific bought in the property petitioner or his designate would be given the first right to purchase it for the outstanding balance of the note and foreclosure costs. On June 5, 1961, U.L.C., petitioners' closely held family corporation, entered into a binding escrow agreement with Pacific to purchase the property for the outstanding balance of the note and foreclosure costs. On Aug. 30, 1961, Pacific sold the property to U.L.C. Held, there was an indirect sale between each of petitioners and U.L.C. under sec. 267(a)(1), I.R.C. 1954, and therefore petitioners are prohibited from deducting their loss which resulted from the foreclosure sale. McWilliams v. Commissioner, 331 U.S. 694">331 U.S. 694 (1947), as interpreted by James H. Merritt, Sr., 47 T.C. 519">47 T.C. 519 (1967), 1974 U.S. Tax Ct. LEXIS 25">26 affd. 400 F.2d 417">400 F.2d 417 (C.A. 5, 1968), followed.2. Vinemore Co., an accrual basis taxpayer, operated Civic Center Hospital and incurred certain expenses for renting the hospital premises during its fiscal year ending Aug. 31, 1964. Held, amount of rental expense deductible under sec. 162(a)(3) determined. Richard K. Seltzer and Robert E. Weiner, for the petitioners.Richard H. Gannon, for the respondent. Scott, Judge. SCOTT 63 T.C. 175">176 Respondent determined deficiencies in petitioners' Federal income tax and additions thereto under sections 6651(a) and 6653(a), I.R.C. 1954, 2 as follows:PetitionerDocket No.YearE.E. Hassen and B.B. Hassen1544-681965 Erwin E. Hassen and Birdie B.3686-681959 Hassen1961 1962 Erwin E. Hassen and Birdie B.4030-681963 HassenVinemore Co., Inc.3687-68FY ending 8/31/624066-68FY ending 8/31/63FY ending 8/31/64Towne Avenue Hospital &4182-681962 Sanitarium1963 Addition to taxDeficiencySec. 6651(a)Sec. 6653(a)E.E. Hassen and B.B. Hassen$ 4,764.00Erwin E. Hassen and Birdie B.73,177.85$ 3,658.89Hassen2,156.85107.84189,795.659,489.78Erwin E. Hassen and Birdie B.24,859.681,242.98HassenVinemore Co., Inc.69,601.0517,114.50855.7331,539.171,576.96Towne Avenue Hospital &10,000.00$ 500.00500.00Sanitarium11,259.07562.95562.951974 U.S. Tax Ct. LEXIS 25">27 Some of the issues raised by the pleadings have been disposed of by agreement of the parties, leaving for our decision the following:(1) Whether section 267(a)(1) prohibits the deduction by petitioners Erwin E. and Birdie B. Hassen of a loss on the foreclosure during 1961 upon real property which was a community asset where the property was purchased at the trustee's sale by the foreclosing party and pursuant to a prior agreement transferred to a corporation owned by petitioners and members of their immediate family.(2) Whether petitioner Vinemore Co., Inc., is entitled to deduct for its fiscal year ending August 31, 1964, rental payments for Civic Center Hospital in the amount of $ 48,000.63 T.C. 175">177 FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.At the time of the filing of their petitions in this case E. E. (E. E.) and B. B. (B. B.) Hassen, husband and wife, were residents of Los Angeles County, Calif. They filed joint Federal income tax returns for the calendar years 1959 through 1963 with the office of the district director of internal revenue at Los Angeles.Vinemore 1974 U.S. Tax Ct. LEXIS 25">28 Co., Inc. (Vinemore), was a California corporation. At the time it filed its petitions in this case, it had its principal office in Los Angeles, Calif. It filed Federal corporate income tax returns for the period October 17, 1957, through August 31, 1958, and for its fiscal years ending August 31, 1959, through August 31, 1964, with the office of the district director of internal revenue at Los Angeles.Towne Avenue Hospital & Sanitarium (Towne) was a California corporation. At the time it filed its petition in this case, its principal office was in Los Angeles, Calif. It filed Federal corporate income tax returns for the calendar years 1962 and 1963 and filed an amended return for the calendar year 1963 with the office of the district director of internal revenue at Los Angeles.U.L.C. Corp. (U.L.C.) and B.J.S. Corp. (B.J.S.) were California corporations.Vinemore utilized an accrual basis of accounting while Towne, U.L.C., B.J.S., and E. E. and B. B. utilized the cash basis at all times here material.All the shares of stock of each of the above corporations, Vinemore, Towne, U.L.C., and B.J.S., were owned at all times here material by E. E. and B. B., their daughters, their brothers, 1974 U.S. Tax Ct. LEXIS 25">29 and their sisters.Issue 1On March 18, 1955, E. E. and B. B. purchased Golden State Hospital (Golden State), for $ 975,000. Although this property was a community asset, B. B. was the nominal owner of Golden State. Subsequent to 1955, E. E. borrowed moneys from his sister, Betty Stein, and B. B. as the nominal owner executed a note and trust deed pledging Golden State to secure the loan. In 1958, Betty Stein transferred the note and trust deed to Pacific 63 T.C. 175">178 Thrift & Loan Co. (Pacific Thrift) as an accommodation to E. E. in connection with his sale in 1958 of shares of stock of Pacific Thrift. Since 1958 E. E. has not owned any interest in Pacific Thrift.Commencing in 1960 Pacific Thrift exerted pressure on E. E. and B. B. to make payments on the note which was in default and threatened foreclosure. In November 1960, Pacific Thrift served a notice of foreclosure upon E. E. and B. B. pursuant to State law. E. E., who had been seeking financing to cure the default, was able to obtain several extensions. In May 1961, Pacific Thrift was forced to foreclose by virtue of the pressure exerted on it by the California Corporations Commission. The trustee's sale took place on May 31, 1961, 1974 U.S. Tax Ct. LEXIS 25">30 and Pacific Thrift was the only bidder, purchasing Golden State for $ 46,300 which amount was equal to the outstanding balance of the note. Pacific Thrift acquired legal title to Golden State as of May 31, 1961. E. E. and B. B. Hassen's adjusted basis in Golden State was $ 524,125.44 at the time of the trustee's sale.During a discussion between E. E. and Mr. Beidner, an officer of Pacific Thrift, a few days prior to May 31, 1961, Mr. Beidner stated that if E. E. did not cure the default and it became necessary to foreclose, and if Pacific Thrift bought Golden State at the trustee's sale, Pacific Thrift would give E. E. or an entity specified by him the first right to purchase Golden State from Pacific Thrift for the amount outstanding on the defaulted note plus foreclosure costs. This right to purchase was contingent upon E. E.'s ability to borrow the purchase price within 90 days of the trustee's sale.On June 5, 1961, U.L.C. and Pacific Thrift entered into an escrow agreement obligating U.L.C. to purchase Golden State 3 unless it was unable to obtain financing. The purchase price was $ 70,000, which amount equaled the amount outstanding on the defaulted note and the costs incurred 1974 U.S. Tax Ct. LEXIS 25">31 by Pacific Thrift on the foreclosure. On August 30, 1961, the sale was consummated and Pacific Thrift conveyed the legal title of Golden State by grant deed to U.L.C.Petitioners E. E. and B. B. in their return for the calendar year 1961 noted that they had sustained a loss on the foreclosure of 63 T.C. 175">179 Golden State during that year but did not claim a loss as the amount of the loss was uncertain at that time due to "pending litigation." In their return for the calendar year 1962 petitioners did claim a "depreciation or operating loss on Golden State" of $ 431,382.60. Respondent disallowed this claimed deduction in its entirety with the explanation that "a foreclosure loss, depreciation or operating loss on Golden State Hospital claimed in your 1962 return in the amount of $ 431,382.60 (and subsequently claimed in a protest to be a foreclosure loss of $ 524,125.53 in 1961) is not allowable because it has not been established that you are entitled to deduct such amount."Issue 1974 U.S. Tax Ct. LEXIS 25">32 2In early 1963 E. E. negotiated a sublease of the premises at 1925 Trinity Street known as American Hospital from the lessee, Trinity Washington Services, Inc. (Trinity), which was owned by George Finerman. The rental payments were to be at the rate of $ 4,000 per month but Trinity required an initial advance payment of $ 12,000 for 3 months' rent. In satisfaction of this requirement, E. E. drew a check, dated April 26, 1963, payable to Trinity in the amount of $ 12,000 on an account of U.L.C. This check had the notation that it was for "Rent for months July, August and September 1963 for premises of American Hospital as per lease agreement" and was endorsed by Trinity. This check was given by E. E. in the presence of E. E.'s brother, Nathan Hassen (Nathan), to George Finerman, representing Trinity.In July 1963 the hospital opened under the name of Civic Center Hospital (C.C.) with Nathan as its administrator. C.C. was operated on behalf of Vinemore by the 1925 Corp., a newly formed corporation, to which Trinity had assigned its city license.E. E. maintained a clinic nearby at 1900 Trinity.C.C. had two checking accounts to which receipts of the hospital would be deposited. Nathan 1974 U.S. Tax Ct. LEXIS 25">33 and C.C.'s accountant were authorized to draw upon these accounts. As the administrator of C.C., Nathan's duties included paying its operating expenses and on two occasions he drew a check in the amount of $ 4,000 against a C.C. account to pay the monthly rent. Nathan considered that this account belonged to Vinemore.C.C. was financially unsuccessful and to meet its expenses it had to seek additional capital from E. E. and his controlled 63 T.C. 175">180 corporation, U.L.C. Either E. E. or U.L.C. would furnish moneys directly to C.C., which would then pay its expenses, or indirectly by paying C.C.'s expenses. E. E. gave four separate checks to Finerman, each of which was to pay for a month's rent of C.C. On C.C.'s books of account there were entries for accounts payable to U.L.C. C.C. ceased to operate in December 1965.C.C. and Golden State are located on separate premises. Vinemore had not claimed any deductions for rental expenses in any of its returns for its fiscal years 1957 through 1963.Vinemore on its return for its fiscal year 1964 reported total income of $ 290,593 composed of gross receipts of $ 154,465, interest income of $ 135,500, and royalties of $ 628. It claimed total deductions 1974 U.S. Tax Ct. LEXIS 25">34 of $ 313,681 of which $ 54,179 was designated as salaries and wages, $ 52,330 as rent, and $ 114,984 as "other deductions," which amount was itemized as follows:Item 26, other deductionsAmountDrugs, medical supplies, X-ray, laboratory$ 34,126Food and kitchen supplies11,112Auto expense3,789Legal and audit2,910Management expense24,900Linen, laundry, housekeeping6,405Employees' health and welfare1,564Insurance2,342Telephone4,817Utilities7,378Stationery, postage, office supplies1,728Miscellaneous expense13,913Total other deductions114,984Respondent in his notice of deficiency determined that Vinemore had a net profit from the operation of C.C. in its fiscal year 1964 with the following explanation:It is determined that a net profit of $ 2,778.51 was sustained during taxable year ended Aug. 31, 1964, from operations of Civic Center Hospital rather than a loss of $ 21,366.00 as claimed on the return. Taxable income is, therefore, increased by $ 24,144.51, computed as follows: 63 T.C. 175">181 Per revised profitand loss statementsubmitted byPer returncorporation's accountantGross receipts$ 154,465 $ 214,921.80Deductions:Bad debtsNone 10,125.80Salaries and wages (nursing andoperating room)54,179 51,085.86Repairs2,679 1Taxes3,624 7,219.86Depreciation365 172.96Drugs, medical supplies, X-ray andlaboratory (also emergency room andmedical records)34,126 44,840.23Food and kitchen supplies (dietary)11,112 18,446.68Auto expense3,789 3,789.00Legal and audit2,910 2,910.00Management or administrative expense24,900 48,540.79Linen, laundry, and housekeeping6,405 1Employees' health and welfare1,564 1,724.39Insurance2,342 4,304.68Telephone4,817 1Utilities7,378 1Stationery, postage, and office supplies1,728 Miscellaneous expense (contractual andadministrative allowances and interest)13,913 8,179.99HousekeepingNone 7,681.33MaintenanceNone 3,121.72Total deductions175,831 212,143.29Net profit (loss)(21,366)2,778.51Net increase in taxable income24,144.511974 U.S. Tax Ct. LEXIS 25">35 The following statement appeared under item (d) in this notice of deficiency to Vinemore for its fiscal year 1964:The deduction of $ 52,330.00 claimed in taxable year ended August 31, 1964, for rental of Golden State Hospital is allowed to the extent paid, or $ 12,333.35; the balance of $ 39,996.65 represents an accrual for which there is no evidence of liability, or an accrual which was not paid within two and one-half months after the close of the taxable year, and is unallowable under the provisions of section 267 of the Internal Revenue Code of 1954.63 T.C. 175">182 OPINIONIssue 1Section 267 provides for the disallowance of deductions for losses from sales or exchanges of property between certain related parties. 41974 U.S. Tax Ct. LEXIS 25">36 1974 U.S. Tax Ct. LEXIS 25">37 The parties agree that petitioners E. E. and B. B. sustained a loss in the amount of $ 477,825.44 as a consequence of the foreclosure sale of Golden State, their community asset. The issue between the parties is whether this otherwise allowable deduction for a loss is precluded by section 267(a)(1).Petitioners contend that section 267(a)(1) is not applicable as their loss resulted from the sale of Golden State to Pacific Thrift which is not a person with the relationship to them designated under the statute, relying on McCarty v. Cripe, 201 F.2d 679 (C.A. 7, 1953); McNeill v. Commissioner, 251 F.2d 863 (C.A. 4, 1958), reversing 27 T.C. 899">27 T.C. 899 (1957). Further, they argue that the subsequent sale of Golden State from Pacific Thrift to U.L.C. was a separate and independent sale, unrelated to the prior sale between petitioners and Pacific Thrift, relying on Commissioner v. Gordon, 391 U.S. 83">391 U.S. 83 (1968); American Bantam Car Co., 11 T.C. 397">11 T.C. 397 (1948), affirmed per curiam 177 F.2d 513 (C.A. 3, 1949), certiorari denied 339 U.S. 920">339 U.S. 920 (1950). Petitioners 63 T.C. 175">183 emphasize that Pacific Thrift, an independent third party, owned and controlled Golden State for 5 days between May 31 and June 5, 1961, and distinguish Merritt v. Commissioner, 400 F.2d 417">400 F.2d 417 (C.A. 5, 1968), affirming 47 T.C. 519">47 T.C. 519 (1967), on the ground that it involved a singular sale between persons designated under the statute.Respondent contends that in substance 1974 U.S. Tax Ct. LEXIS 25">38 there was a sale between petitioners and U.L.C., each of whom was a member of the specified group under the statute, and that the loss arising from the sale is disallowed under section 267(a)(1). Respondent contends that no economic loss actually occurred by virtue of the prearranged disposition of Golden State by Pacific Thrift, relying on McWilliams v. Commissioner, 331 U.S. 694">331 U.S. 694 (1947), and 400 F.2d 417">Merritt v. Commissioner, supra.Under California law a husband and wife each has a vested "present, existing and equal" interest in their community property although such property is managed by the husband. Cal.Civ.Code secs. 161a, 172, 172a (West 1954). Where both husband and wife have vested interests in community property which is sold, each is considered as a seller in determining whether the relationship designated under section 267(b) exists. Daniel M. Ebberts, 51 T.C. 49">51 T.C. 49, 51 T.C. 49">55 (1968); cf. Arizona Publishing Co., 9 T.C. 85">9 T.C. 85 (1947). Petitioners concede on brief that each of them individually owned, directly or indirectly, more than 50 percent in value of the outstanding stock of U.L.C. and that the requisite relationship existed between each of them and U.L.C. under section 267(b)(2) and 1974 U.S. Tax Ct. LEXIS 25">39 the stipulated facts support this concession by petitioners. Respondent does not contend that there was a "direct" sale from petitioners to U.L.C., apparently recognizing the validity of the foreclosure sale at which Pacific Thrift purchased Golden State. Respondent's position is that there was a sale of the property "indirectly," between each of petitioners and U.L.C. within the meaning of section 267(a)(1).The Supreme Court in 331 U.S. 694">McWilliams v. Commissioner, supra, thoroughly considered the scope of an indirect sale within the meaning of section 24(b)(1)(A), I.R.C. 1939, the predecessor of section 267(a)(1). In McWilliams the taxpayer-husband, who managed both his own and his taxpayer-wife's separate estate, ordered his broker to sell certain shares of stock for the account of one of them and to buy the same number of shares of the same stock for the other, at as nearly the same price as possible. The 63 T.C. 175">184 orders were contemporaneously executed on the stock exchange. The selling spouse sold to someone other than the buying spouse and the buying spouse bought from someone other than the selling spouse. Each of the taxpayers filed a separate Federal income tax return and deducted the 1974 U.S. Tax Ct. LEXIS 25">40 losses arising from the sales of their respective shares of stock. Although the Supreme Court realized that the losses arose from sales "between" persons other than those specified in the statute, it nonetheless held that the sales were indirect sales between persons designated by the statute and accordingly the resulting losses were disallowed.The Supreme Court in McWilliams interpreted the underlying congressional purpose of section 24(b) of the 1939 Code, which contained provisions substantially the same as those of section 267(a)(1), to effectively determine the finality of an intragroup transfer of property and to absolutely prohibit the allowance of losses on any direct or indirect sales, bona fide or otherwise, between certain specified groups which have nearly the same economic interests unless there was such a break in the group's continuity of investment that it caused the seller to realize an economic loss. Consequently, if there is a shift of property between those economically related persons designated under section 267(b), then, regardless of the motive for and manner in which the intragroup transfer is accomplished, the resulting loss is disallowed under section 267(a)(1)1974 U.S. Tax Ct. LEXIS 25">41 unless there occurs a definite break in the continuity of the related group's economic interest in the transferred property so that the seller undoubtedly realizes a genuine substantive economic loss.In McWilliams, where one spouse sold property and, through a prearrangement, the other spouse who was related to the seller under the statute contemporaneously purchased like property both in kind and amount and at nearly the same price, the Supreme Court concluded that, irrespective of the mechanics of the transaction, the spouses' economic interest as a whole in the transferred property had not for practical purposes been relinquished nor even diminished but retained uninterrupted and, in this economic sense, their sustained losses were not realized. Under these circumstances the Supreme Court held the sales of the shares of stock by the husband and wife were each an indirect sale between persons specified under the statute within the meaning of the forerunner of section 267(a)(1) and the resulting losses were disallowed pursuant thereto.63 T.C. 175">185 We note that in McWilliams the Supreme Court recognized a period of time between the sale of property by one party and the purchase of the same or 1974 U.S. Tax Ct. LEXIS 25">42 like property by another party who is related to the former party under the statute may under some circumstances be sufficient to break the continuity of the related economic group's investment and to result in the realization of an economic loss by the selling party, thereby negating an indirect sale between the related parties and making the disallowance provision inapplicable. See also United States v. Norton, 250 F.2d 902, 908-909 (C.A. 5, 1958).The Supreme Court in 331 U.S. 694">McWilliams v. Commissioner, supra at 699-701, enunciated the following principles with respect to the forerunner of section 267(a)(1) which illuminate the circumstances in which a sale will be considered an "indirect" sale between persons related within the meaning of section 267(a)(1):Section 24(b) states an absolute prohibition -- not a presumption -- against the allowance of losses on any sales between the members of certain designated groups. The one common characteristic of these groups is that their members, although distinct legal entities, generally have a near-identity of economic interests [fn. omitted]. It is a fair inference that even legally genuine intragroup transfers were not thought to result, usually, 1974 U.S. Tax Ct. LEXIS 25">43 in economically genuine realizations of loss, and accordingly that Congress did not deem them to be appropriate occasions for the allowance of deductions. * We conclude that the purpose of section 24(b) was to put an end to the right of taxpayers to choose, by intra-family transfers and other designated devices, their own time for realizing tax losses on investments which, for most practical purposes, are continued uninterrupted.We are clear as to this purpose, too, that its effectuation obviously had to be made independent of the manner in which an intra-group transfer was accomplished. Congress, with such purpose in mind, could not have intended to include within the scope of section 24(b) only simple transfers made directly or through a dummy, or to exclude transfers of securities effected through the medium of the Stock Exchange, unless it wanted to leave a loop-hole almost as large as the one it had set out to close.[Emphasis supplied.]Each of petitioners sold Golden State and a related entity under section 267(b), U.L.C., purchased it. Whether this set of circumstances may constitute an "indirect" sale between each of petitioners and U.L.C. within the meaning of section 267(a)(1)1974 U.S. Tax Ct. LEXIS 25">44 depends on whether the purchase by U.L.C. was so related to the sale by each of petitioners of their interest in Golden State that 63 T.C. 175">186 the economic interest of each of the specified groups, one consisting of E.E. and U.L.C. and the other of B.B. and U.L.C., continued for most practical purposes uninterrupted so that neither group's sustained loss was a realized loss in the economic sense. Under the facts here present there is not such a severance of the economic interest of either group in the property transferred as to result in the economic realization of the loss incurred by E.E. or B.B. and accordingly we conclude that the sale of each of petitioner's interest in Golden State to U.L.C. was an "indirect" sale between each of the designated groups within the meaning of section 267(a)(1) and the losses of E.E. and B.B. are disallowed thereunder. 51974 U.S. Tax Ct. LEXIS 25">45 Under the facts of the instant case Golden State was purchased by Pacific Thrift on May 31, 1961, and, in accordance with its previous understanding with E.E., giving to him or an entity specified by him the right to purchase Golden State for an amount equal to the outstanding balance on the defaulted note and the foreclosure costs, Pacific Thrift entered into an escrow agreement with U.L.C. on June 5, 1961, on the same terms as those of the understanding and conveyed the property to U.L.C. on August 30, 1961. Even if we assume that Pacific Thrift, an independent legal entity, had absolute control over Golden State for a period of 5 days on the basis that the understanding between it and E.E. was unenforceable, 61974 U.S. Tax Ct. LEXIS 25">47 petitioners did not part with their economic interest in the property transferred so that they would realize an economic loss inasmuch as Pacific Thrift was willing at all times after the foreclosure sale to reconvey Golden State to E.E. or his designate and did in fact reconvey the property to U.L.C. pursuant to an escrow agreement 1974 U.S. Tax Ct. LEXIS 25">46 entered into shortly 63 T.C. 175">187 after the foreclosure sale, the terms of which were identical to those of the oral understanding. The sale by petitioners and the purchase by U.L.C., even if considered two independent transactions, were nonetheless so related to one another by virtue of the prearranged plan that petitioners did not realize an economic loss. At the time of the foreclosure sale petitioners did not anticipate that they would lose their economic interest in Golden State but rather contemplated by virtue of the prearranged understanding that they would retain their interest. Their reasonable expectations were subsequently fulfilled; consequently, their economic wealth was not reduced but merely relocated and their purported losses were not genuine losses in the economic sense but wholly illusory ones. 250 F.2d 902">United States v. Norton, supra at 907-908; Robert Boehm, 28 T.C. 407">28 T.C. 407, 28 T.C. 407">410-411 (1957), affirmed per curiam 255 F.2d 684 (C.A. 2, 1958); John B. Shethar, 28 T.C. 1222">28 T.C. 1222, 28 T.C. 1222">1226 (1957). See Merritt v. Commissioner, 400 F.2d 417">400 F.2d 417, 400 F.2d 417">420-421 (C.A. 5, 1968), affirming 47 T.C. 519">47 T.C. 519 (1967); 51 T.C. 49">Daniel M. Ebberts, supra at 55-56.Petitioners' argument that there was not an "indirect" sale between each of them and U.L.C. relies principally on McNeill v. Commissioner, supra, and McCarty v. Cripe, supra. The Court of Appeals for the Fourth Circuit in the McNeill case stated that the taxpayer's land was seized by Pennsylvania tax authorities for nonpayment of taxes and after the taxpayer's right of redemption had expired and more than 6 years had elapsed the land was sold 1974 U.S. Tax Ct. LEXIS 25">48 to the taxpayer's controlled corporation. The Fourth Circuit, reversing this Court, held on this basis that there was not an indirect sale between the taxpayer and his controlled corporation under the provisions of the predecessor of section 267(a)(1). However, under the facts in McNeill there was not any arrangement whereby the taxpayer or his controlled corporation could reasonably expect to retain the investment in the land. In that case there was lacking that nexus between the sale by the taxpayer and the purchase by his controlled corporation which exists in the instant case to show the existence of an indirect sale. In McCarty, the taxpayer's land was sold at public auction in satisfaction of tax and improvement liens to the highest of 25 bidders who paid for it with funds furnished him by the taxpayer and conveyed the land to the taxpayer's controlled corporation. The Court of Appeals for the Seventh Circuit held that there was not an indirect sale between the taxpayer and his controlled corporation 63 T.C. 175">188 under the provision of the predecessor of section 267(a)(1). The sale by the taxpayer and the purchase by the corporation were not considered related as there was no indication 1974 U.S. Tax Ct. LEXIS 25">49 that there was a prearrangement between the taxpayer and his corporation or anyone else which would have enabled the taxpayer to maintain his investment in the land and as there was a public sale with spirited bidding among a number of persons. These two cases are distinguishable from the instant case on their facts since in neither of those cases was there a prearrangement whereby the taxpayer was to retain his investment whereas in the instant case petitioners did have a prearrangement to retain their investment in Golden State. Here there was only one bidder at the trustee's sale of Golden State.If the McNeill and McCarty cases are not interpreted to turn on the lack of any prearrangement whereby the taxpayer was to retain his interest, then they are clearly contrary to the holding of the Supreme Court in McWilliams. In that case the Supreme Court rejected the argument that two prearranged bona fide sales, the first to an unrelated party, resulted in no indirect sale "between" two related parties in construing language of the provisions of section 24(b) of the 1939 Code substantially the same as that of section 267(a)(1). The construction of section 267(a)(1) in accordance with 1974 U.S. Tax Ct. LEXIS 25">50 petitioners' contention would read out of it any indirect sales, a result obviously contrary to the intent of Congress which enacted a statute making express reference to sales "directly" or "indirectly." Also, see our statement in James H. Merritt, Sr., 47 T.C. 519">47 T.C. 519, 47 T.C. 519">528 (1967), affd. 400 F.2d 417">400 F.2d 417 (C.A. 5, 1968), that in our view the appeals courts in the McNeill and McCarty cases failed accurately to interpret the McWilliams case and the statement by the Fifth Circuit in 400 F.2d 417">Merritt v. Commissioner, supra at 420, that in its view the decision of the Fourth Circuit in the McNeill case was in error.Petitioners urge that an indirect sale between each of them and U.L.C. did not occur as upon the initial sale to Pacific Thrift, there was not a binding commitment to make the subsequent sale to U.L.C., relying on 391 U.S. 83">Commissioner v. Gordon, supra, wherein the Supreme Court, in interpreting the divestiture of control requirements of section 355(a)(1)(D), stated that "Absent other specific directions from Congress, Code provisions must be interpreted so as to conform to the basic premise of annual tax accounting." Even if we assume petitioners properly labeled the commitment 63 T.C. 175">189 of Pacific Thrift as 1974 U.S. Tax Ct. LEXIS 25">51 "not binding," we do not understand how there has been any violation of this basic tenet of taxation under the facts of this case. Here the sale and the purchase by U.L.C. were in the same year. In any event, in our view, section 267(a)(1) does not necessitate that there be a determination of the allowance or nonallowance of a loss deduction based only on the situation at the close of a taxpayer's taxable year. To so hold would permit a sale by one related taxpayer such as was made in the McWilliams case a day or so before the close of a taxpayer's taxable year and a purchase by a related taxpayer a day or so after the beginning of that taxpayer's new taxable year, in effect permitting a loophole which would be a boon for the knowledgeable and a pitfall for the unwary. In McWilliams, the Supreme Court recognized that an indirect sale between specified parties within the meaning of the predecessor provision of section 267(a)(1) may occur although there is a lapse of a period of time between one party's sale and the other's purchase. The fact that the lapse of time extends beyond the close of the selling party's taxable year is of no consequence in determining whether there has been 1974 U.S. Tax Ct. LEXIS 25">52 an indirect sale between designated parties.Petitioners argue that the sale by each of them and the purchase by U.L.C. was not an indirect sale as there was no agreement at the time of the trustee's sale binding Pacific Thrift to transfer Golden State to U.L.C., relying on 11 T.C. 397">American Bantam Car Co., supra. In American Bantam Car Co., we stated as follows at page 405:In determining whether a series of steps are to be treated as a single indivisible transaction or should retain their separate entity, the courts use a variety of tests. Paul, Selected Studies in Federal Taxation, 2d series, pp. 200-254. Among the factors considered are the intent of the parties, the time element, and the pragmatic test of the ultimate result. An important test is that of mutual interdependence. Were the steps so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series?Using these tests we held that the transfer of assets to a corporation controlled by the transferors and the previously contemplated subsequent sale of the corporation's preferred stock by the transferors were not interdependent steps of a single transaction, so that 1974 U.S. Tax Ct. LEXIS 25">53 the transferors had control after the transfer under the provisions of the 1939 Code which are now contained in section 351(a), as the sale of the preferred stock was merely an 63 T.C. 175">190 adjunct to the principal objective of the organization of a new corporation. In our view for an "indirect" sale to occur within the meaning of section 267(a)(1), it is not necessary that there be a single integrated transaction which transfers property between specified persons. To require that the several steps, which are taken with respect to the transfer of property between specified persons, must be considered as parts of a single integrated transaction for there to be an "indirect" sale would in effect limit the disallowance provisions of the statute only to "direct" sales. In McWilliams the Supreme Court held that there was an "indirect" sale even though the several steps involved were not considered as part of a single undivided transaction as the property sold by one party was not the identical property bought by the related party and the sale and purchase were not mutually dependent on one another.The essentials of an "indirect" sale within the meaning of section 267(a)(1) are that the sale by one 1974 U.S. Tax Ct. LEXIS 25">54 person and the purchase by another specified under the statute are so related to one another that the seller does not realize a genuine economic loss. In determining whether there is in fact such an economic loss, the intent of the parties, the time element, the ultimate result, and the mutual interdependence of the steps taken as well as the selling price, the fair market value, and the near-identity of terms of the sale and purchase are among the factors to be considered. However, it is not essential that the sale and purchase be considered a single transaction for there to be an "indirect" sale within the meaning of section 267(a)(1).Finally, we note that while a taxpayer can dispose of his property whenever he so desires, thus controlling the time of his gain or loss on the sale, such a capacity or lack thereof is not material in the determination of whether section 267(a)(1) is applicable. 47 T.C. 519">James H. Merritt, Sr., supra at 528; Thomas Zacek, 8 T.C. 1056">8 T.C. 1056, 8 T.C. 1056">1057 (1947).We hold that respondent properly disallowed the loss claimed by E.E. and B.B. on the foreclosure sale of Golden State.Issue 2This issue is purely factual. It is stipulated that Vinemore keeps its books and reports 1974 U.S. Tax Ct. LEXIS 25">55 its income on an accrual basis of accounting. The evidence shows that Vinemore was in fact the operator of C.C. even though 1925 Corp. performed the functions 63 T.C. 175">191 of the hospital operation on its behalf. On the basis of these facts, it is clear that under section 162(a)(3) allowing an accrual basis taxpayer a deduction for rentals or other payments it is obligated to make as a condition to its continued use or possession of property for the purposes of its trade or business, Vinemore is entitled to deduct the $ 4,000 a month rental of the C.C. hospital unless it has been allowed this deduction under another category in the computation of its taxable income or it was not the entity liable for the payment of this rent.Petitioners take the position that Vinemore has met its burden of proof of showing that it did not deduct on its tax return the rental paid to C.C. and that it was liable for the entire $ 48,000 of rental due from C.C. under the lease.Respondent takes the position that the evidence is insufficient to show that Vinemore was liable for the payment of rent for C.C. and if it were so liable, that it had not been allowed the rental deduction in the computation of its taxable 1974 U.S. Tax Ct. LEXIS 25">56 income in the deficiency notice.The record is clear that the only amount which Vinemore deducted as rent on its tax return for its fiscal year ended August 31, 1964, was the $ 52,330 which respondent in his notice of deficiency referred to as the rental for Golden State. Vinemore concedes that it is not entitled to the disallowed portion of this claimed deduction for rental of Golden State. However, even though respondent considered the $ 52,330 of rent claimed as a deduction by Vinemore to be for rent of Golden State, the evidence is not clear that this claimed deduction for rent was actually for rental of Golden State. There is nothing in the record to indicate that Vinemore had any connection with Golden State, and the indication from the record is that it did not. U.L.C. owned Golden State and the indication in the record is that U.L.C. was the operator of Golden State. While the record shows that the initial $ 12,000 paid for the first 3 months' rent of C.C. was on a check drawn on U.L.C.'s bank account by E.E., the evidence in the record, though not completely clear, is sufficient to show that this was either an advance or a contribution to Vinemore by either U.L.C. or E.E. 1974 U.S. Tax Ct. LEXIS 25">57 The record also shows that C.C. on its books of account had entries showing accounts payable to U.L.C. and that the administrator of C.C. considered the C.C. income and bank account to belong to Vinemore and the obligations of C.C. to be those of Vinemore since Vinemore was 63 T.C. 175">192 the operator of C.C. That his assumption that Vinemore was responsible for C.C.'s obligations and was the owner of C.C.'s income was correct, is borne out by the fact that respondent in his notice of deficiency considered C.C.'s income to be that of Vinemore and allowed Vinemore deductions for the operating expenses of C.C. Although salaries for the operation of C.C. were reported in the same manner on Vinemore's return as was the $ 52,330 of rental, respondent allowed the salaries deduction but disallowed the rental deduction except to the extent he considered it paid partially on the basis that it was rental due to U.L.C., a related taxpayer.Under these facts we do not consider it sufficiently clear that the $ 52,330 which Vinemore deducted not to be rental of the C.C. hospital to sustain petitioners' contention that Vinemore did not deduct any rental for the C.C. hospital on its return. However, all but 1974 U.S. Tax Ct. LEXIS 25">58 $ 12,333.35 of this claimed rental deduction by Vinemore was disallowed by respondent, one reason for the disallowance being respondent's conclusion that this deduction was for unpaid rental due by Vinemore to U.L.C. It may well be that the moneys that paid the C.C. rental came to Vinemore as loans from U.L.C. and that in the U.L.C. account on the books of C.C., the advances by U.L.C. for payment of rent on the C.C. premises were shown as an amount due U.L.C. for rent. The record is not clear enough on this point to reach a conclusion.However, it is clear that Vinemore was not obligated for and did not pay any rental on Golden State and that it was obligated for the $ 4,000 a month rental of the C.C. hospital. Even though a separate set of books was kept for C.C., those books showed the income and obligations of Vinemore. Even if the books of C.C. were sufficiently confusing as to indicate that rental was due by Vinemore to U.L.C., the record establishes this not to be a fact. The $ 4,000 a month rental of C.C. was due to Trinity, an entity totally unrelated to either Vinemore or U.L.C.On the basis of the facts in this record we conclude that it is proper for Vinemore to accrue 1974 U.S. Tax Ct. LEXIS 25">59 and deduct $ 48,000 of rental expense for rental of C.C. during its fiscal year ended August 31, 1964, but that the record is insufficient to show that the $ 12,333.35 which respondent allowed to Vinemore as a rental deduction is not in fact part of the $ 48,000 of accrued rent of the C.C. premises. We therefore conclude on the basis of this record 63 T.C. 175">193 that Vinemore is entitled to an additional deduction of $ 35,666.65 as rental expense.Decisions will be entered under Rule 155. Footnotes1. Cases of the following petitioners are consolidated herewith: Erwin E. Hassen and Birdie B. Hassen, docket Nos. 3686-68 and 4030-68; Vinemore Company, Inc., docket Nos. 3687-68 and 4066-68; and Towne Avenue Hospital & Sanitarium, docket No. 4182-68.↩2. All references are to the Internal Revenue Code of 1954, as amended, unless otherwise specified.↩3. Although the parties' stipulation refers to U.L.C.'s obligation to purchase "Pacific Thrift," the stipulation as a whole and the briefs of the parties make it clear that U.L.C.'s obligation was to purchase "Golden State."↩1. Revised amounts for these items are included under housekeeping and maintenance expenses. Rent expense is shown as a separate adjustment, item (d).↩4. SEC. 267. LOSSES, EXPENSES, AND INTEREST WITH RESPECT TO TRANSACTIONS BETWEEN RELATED TAXPAYERS.(a) Deductions Disallowed. -- No deduction shall be allowed -- (1) Losses. -- In respect of losses from sales or exchanges of property (other than losses in cases of distributions in corporate liquidations), directly or indirectly, between persons specified within any one of the paragraphs of subsection (b). * (b) Relationships. -- The persons referred to in subsection (a) are: * (2) An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; * (c) Constructive Ownership of Stock. -- For purposes of determining, in applying subsection (b), the ownership of stock -- * (2) An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family; * (4) The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants; and(5) * * stock constructively owned by an individual by reason of the application of paragraph (2) or (3) shall not be treated as owned by him for the purpose of again applying either of such paragraphs in order to make another the constructive owner of such stock.5. There is nothing in this record to indicate why U.L.C. was the entity designated to purchase the property or that E.E. and B.B. could not personally have borrowed the funds to pay the note before the foreclosure sale or to either redeem or repurchase the property after that sale. The facts on this issue are fully stipulated and the only reference to E.E.'s efforts to borrow funds is that E.E. "who had been seeking financing to cure the default, was able to obtain several extensions."6. However on this record it may well be that the agreement was enforceable. Under California law an oral agreement for the sale of real property that is within the statute of frauds (Cal.Civ. Code sec. 1624 (West 1954)) is not void but voidable and may be taken out of the operation of the statute by a written memorandum executed subsequently, even though it fails to mention the precedent oral agreement. Ayoob v. Ayoob, 74 Cal. App. 2d 236">74 Cal. App. 2d 236, 168 P.2d 462, 466-467 (3d Dist. Ct. App. 1946); Potter v. Bland, 136 Cal. App. 2d 125, 288 P.2d 569, 573(1st Dist. Ct. App. 1955).It also appears that E.E. and B.B. had the right to redeem Golden State under Cal. Civ. Pro. Code sec. 725a↩ (West 1955). The record as to the foreclosure sale is certainly insufficient for us to conclude that they did not have such a right of redemption.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625551/	Vernon Keith Graves and Theodora Graves, Petitioners v. Commissioner of Internal Revenue, Respondent; Harold J. Graves and Beulah F. Graves, Petitioners v. Commissioner of Internal Revenue, RespondentGraves v. CommissionerDocket Nos. 3644-65, 3645-65United States Tax Court48 T.C. 7; 1967 U.S. Tax Ct. LEXIS 122; April 10, 1967, Filed 1967 U.S. Tax Ct. LEXIS 122">122 Decisions will be entered under Rule 50. On Sept. 1, 1959, the petitioners acquired two buildings in Chicago from a corporation in which they were stockholders and they immediately leased the buildings back to the corporation. Subsequently, in two separate audits of the returns of Harold J. and Beulah F. Graves, one audit covering the years 1959 and 1960 in connection with a net operating loss carryback to 1957 and the other audit covering the year 1961 in connection with a net operating loss carryback to 1958, the revenue agents, except for two adjustments in 1959 not pertinent here, made no changes in the income for the years examined. There was no examination made, in the course of the audits, of the useful lives attributed to the two buildings and their components by petitioners for depreciation purposes. Held, under these facts, the useful lives of the buildings and components were not "accepted on audit by the Internal Revenue Service under presently established procedures for examining depreciation" within the meaning of sec. 3.05 of Rev. Proc. 62-21 (Part II), and, consequently, respondent is not precluded from adjusting the useful lives1967 U.S. Tax Ct. LEXIS 122">123 of these assets for depreciation purposes in the years 1961, 1962, and 1963. Held, further, the useful life of each of the two buildings was 38 years as of Sept. 1, 1959, and the useful life of the components of said buildings as of that date was 28 years. William H. Kinsey, for the petitioners.Merritt S. Yoelin, for the respondent. Mulroney, 1967 U.S. Tax Ct. LEXIS 122">124 Judge. MULRONEY 48 T.C. 7">8 Respondent determined the following income tax deficiencies:DocketPetitionerYearDeficiencyNo.3644-65Vernon Keith Graves and Theodora Graves1960$ 1,063.0119612,233.111962706.0319632,263.653645-65Harold J. Graves and Beulah F. Graves19589,189.171961418.7919621,274.4119634,434.60The issue in these consolidated cases is whether respondent correctly determined the useful lives as of September 1, 1959, of certain buildings located in Chicago, Ill., and the components of such buildings. The year 1960 in docket No. 3644-65 is involved solely because of the elimination of a net operating loss carryback from 1963 due to respondent's adjustments made in petitioners' income for 1963, and the year 1958 in docket No. 3645-65 is involved solely because of the elimination of a net operating loss carryback from 1961 due to respondent's adjustments made in petitioners' income for 1961.FINDINGS OF FACTSome of the facts were stipulated and they are so found.Vernon Keith Graves and his wife, Theodora, are residents of Oregon. They filed joint income tax returns for the years 1960, 1961, 1962, 1967 U.S. Tax Ct. LEXIS 122">125 and 1963 with the district director of internal revenue for the district of Oregon. Harold J. Graves and his wife, Beulah, are residents of Oregon. They filed joint income tax returns for 1958, 1961, 1962, and 48 T.C. 7">9 1963 with the district director of internal revenue for the district of Oregon.Sawyers, Inc., is a manufacturer of stereoscopic slides, viewers and other photographic equipment, and it is also engaged in research along these lines. Sawyers, Inc., maintains its home office and manufacturing complex in Progress, Oreg. Harold Graves was associated with Sawyers, Inc., for 34 years. He was president of the corporation and a member of its board of directors from about 1931 to 1957.In 1951, Sawyers, Inc., purchased land at 3500 N. Kostner Avenue, Chicago, Ill., containing 23,043 square feet for $ 17,722.38 1 and in 1952, constructed a single story structure for $ 158,579.61. A second floor was added during 1954 at a cost of $ 95,870.13. The first and second floors contained a total of 28,500 square feet. On November 28, 1958, Sawyers, Inc., purchased the adjoining land and building at 3512 N. Kostner Avenue from Bell & Howell Corp. for a total purchase price of $ 1967 U.S. Tax Ct. LEXIS 122">126 366,375, which was allocated $ 342,524 to the building and $ 23,851 to the land. The two-story building at 3512 N. Kostner Avenue was constructed in 1952 and contained a total of 41,020 square feet. Sawyers, Inc., used the Chicago property as a distribution center, a sales office, and for research and development.Sawyers, Inc., used the following useful lives for the purpose of computing depreciation of the buildings at 3500 and 3512 N. Kostner Avenue:DepreciationLocationUseful lifecommenced3500 N. Kostner Avenue40 yearsOct. 1, 19523500 N. Kostner Avenue (2d floor addition)38 yearsOct. 1, 19543512 N. Kostner Avenue34 yearsJan. 1, 1959The corporation did not separate the components from the buildings for the purpose of computing depreciation.As of August 31, 1959, the book value of the Chicago property 1967 U.S. Tax Ct. LEXIS 122">127 owned by Sawyers, Inc., was as follows:Buildings3500 N. Kostner Avenue (orig. bldg.)$ 131,160.483500 N. Kostner Avenue (2d floor addition)83,465.973512 N. Kostner Avenue335,807.84550,434.29Land3500 N. Kostner Avenue$ 17,772.383512 N. Kostner Avenue23,851.0041,623.38592,057.6748 T.C. 7">10 On September 1, 1959, the following stockholders of Sawyers, Inc., acquired the Chicago property from the corporation in return for stock in Sawyers, Inc., having a value of $ 592,057.67:UndividedpercentageStockholderownershipHarold J. Graves36.90Beulah F. Graves36.90Vernon Keith Graves10.81Theodora J. Graves.62Robert Graves10.81Juanita M. Graves.62Rex Graves3.34100.00The above stockholders are hereinafter called the owners.After acquiring the Chicago property the owners leased the property back to Sawyers, Inc., under a written lease for a 5-year term starting on September 1, 1959, and ending August 31, 1964, at a monthly rental of $ 3,000. The lease contained a renewal option which Sawyers, Inc., exercised thereby extending the lease term for the 5-year period starting September 1, 1964, and ending1967 U.S. Tax Ct. LEXIS 122">128 August 31, 1969, at a monthly rental of $ 3,750. Under an instrument dated December 28, 1964, the owners, for a stated consideration of $ 15,000, granted to Sawyers, Inc., an option to lease the Chicago property for another term of 5 years starting on September 1, 1969, and ending August 31, 1974, at an annual rental of $ 45,000.Under the terms of the lease the lessee was obligated to pay for insurance coverage of various types and to maintain the leased premises, including heating and air-conditioning systems, interior wiring and plumbing, and drain pipes to sewers or septic tanks in good order and repair during the entire term of the lease at the lessee's own cost.For the purpose of computing the annual depreciation deduction on the Chicago property, the owners assigned a 25-year life to the two buildings and a 5-year life to heating, electrical, and plumbing components of each building. A total depreciation deduction of $ 39,387.51 was computed on their tax returns by the owners of the Chicago property for each of the years 1960, 1961, 1962, and 1963 as follows:AssetCostUseful lifeDepreciationYearsBldg. -- 3500 N. Kostner$ 91,651.8225$ 3,666.00Heating, etc., components39,508.6657,902.002d floor addition65,566.89252,622.69Heating, etc., components17,899.0853,579.00Bldg. -- 3512 N. Kostner284,648.342511,385.93Heating, etc., components51,159.50510,231.89550,434.2939,387.511967 U.S. Tax Ct. LEXIS 122">129 48 T.C. 7">11 A depreciation schedule showing the above computation was attached to the income tax returns filed by petitioners (as well as the other owners of the Chicago property) for the years 1960 through 1963. In each of those years, the total depreciation of $ 39,387.51 was subtracted from the $ 36,000 received as annual rental of the Chicago property under the lease to show a net loss of $ 3,387.51 each year in connection with the Chicago property. This net rental loss of $ 3,387.51 from the Chicago property was then allocated to the various owners in each of the years 1960 through 1963 on the basis of their undivided interests in the Chicago property.Respondent determined in his statutory notices of deficiency that the two buildings at 3500 and 3512 N. Kostner Avenue in Chicago each had a useful life of 45 years and that the components in each of the buildings had a useful life of 25 years. Accordingly, respondent disallowed a portion of the depreciation claimed by petitioners in computing their rental income from the Chicago property in each of the years 1961, 1962, and 1963.On June 26, 1961, Harold J. and Beulah F. Graves filed an application for tentative carryback adjustment1967 U.S. Tax Ct. LEXIS 122">130 showing a 1960 net operating loss of $ 12,855.97 carried back to 1957, generating a claimed 1957 refund of $ 6,207.02. The 1957 refund was allowed on July 27, 1961, in the amount of $ 6,207.02, plus interest of $ 182.72. A revenue agent was then assigned to audit the relevant years and on June 18, 1962, he issued a report involving the years 1957, 1959, and 1960 which, after adjustments, allowed additional refunds of $ 1,583.66 and $ 500 for the years 1957 and 1959, respectively. The audit report showed two adjustments for 1959 involving (1) a mine expense deduction and (2) the amount of a capital loss. The audit report contained the words "no change" as to all items of income for 1960.On or about October 26, 1962, Harold J. and Beulah F. Graves filed a claim for refund of their 1958 taxes in the amount of $ 9,251.09, resulting from the carryback of a 1961 net operating loss. A revenue agent was assigned to audit the relevant years and on May 24, 1963, he issued a report concerning the years 1958 and 1961 allowing a refund of $ 9,189.17, plus interest, for 1958. The audit report contained the words "no change" as to all items of income for 1961.OPINIONImmediately before the1967 U.S. Tax Ct. LEXIS 122">131 start of the trial the petitioners amended their petitions to allege that the respondent is precluded by Rev. Proc. 62-21 from disturbing the depreciation deductions claimed by them on the Chicago property for the years 1961, 1962, and 1963. Petitioners argue that in the prior audits of the returns of Harold J. and Beulah F. Graves for the years 1959, 1960, and 1961 the class lives assigned to 48 T.C. 7">12 the two buildings in Chicago, as well as the components of such buildings, were accepted by the revenue agents within the meaning of section 3.05 of Part II of Rev. Proc. 62-21 and that consequently, under the terms of that subsection, the class lives of such assets may not be disturbed now by respondent.Rev. Proc. 62-21, which was put into effect in July 1962, and was not made retroactive, represents a basic reform in the standards and procedures to be followed in determining depreciation for tax purposes. Replacing the old Bulletin "F" guidelines for depreciable lives, the Revenue Procedure supplies new guideline lives for broad classes of assets which, generally, will permit a more rapid depreciation1967 U.S. Tax Ct. LEXIS 122">132 of assets. A key feature of the Revenue Procedure is that it provides an objective test, the reserve ratio test, to determine the appropriateness of the depreciation taken by a taxpayer. The reserve ratio test is an objective technique for establishing that a taxpayer's retirement and replacement practices for a guideline class of assets are consistent with the class life he is using.The Revenue Procedure is a comprehensive plan designed to put the new depreciation policies into practice and it must be viewed as a whole. Part I of the Revenue Procedure provides guideline lives for broad classes of assets, Part II contains a detailed description of procedures to be followed in examining depreciation deductions, and Part III contains the reserve ratio table and the adjustment table for class lives. Section 2 of Part II sets forth the procedures to be followed where the class life used by the taxpayer is equal to or longer than the guideline life for a guideline class, while section 3 of Part II states the procedure to be followed where the class life used by a taxpayer is shorter than the guideline life for a guideline class.Section 3.01 of Part II provides that where the class1967 U.S. Tax Ct. LEXIS 122">133 life is shorter than the prescribed guideline life for a guideline class the depreciation deduction claimed by the taxpayer for the assets in that class will not be disturbed if the conditions of subsection .02, .03, .04, or .05 of section 3 are met. Section 3.01 also states that "Subsection .05 sets forth the applicable rules for taxable years subsequent to a year for which the class life was examined and accepted by the Internal Revenue Service." Section 3.05 provides, in part, as follows:.05 Subsequent use of class life previously justified. -- Where the class life used by a taxpayer was examined by the Internal Revenue Service and was accepted by reason of subsection .02, .03, or .04 of this section, or where such class life was accepted on audit by the Internal Revenue Service under presently established procedures for examining depreciation (whether before or after the effective date of this Revenue Procedure), the depreciation deduction claimed by the taxpayer for the assets in that class in any subsequent taxable year based on that class life will not be disturbed if the taxpayer's retirement and replacement practices for that class are consistent with the class1967 U.S. Tax Ct. LEXIS 122">134 life being used. This 48 T.C. 7">13 consistency may be demonstrated either by the reserve ratio test set forth in section 5 of this Part or by all the facts and circumstances.Section 3.05 then goes on to state that the "previously justified" class life will not be questioned during a period of 3 years in order to give taxpayers an opportunity to conform their retirement and replacement practices with the class life being used.It is obvious that a class life will be considered "accepted on audit" under the above rules only where such class life has been specifically examined and accepted. This is made abundantly clear in one of the interpretive questions and answers that accompanies the new Revenue Procedure, where the phrase "accepted on audit" as used in section 3.05 is explained as covering "all situations in which the audit report shows adjustments to depreciation or contains comments that the depreciation deduction was examined but not adjusted, or where other specific evidence indicates that the depreciation deduction was examined." 21967 U.S. Tax Ct. LEXIS 122">135 The two audit reports, one covering the years 1957, 1959, and 1960 and one covering the years 1958 and 1961, are in evidence and neither one contains the slightest comment or any other "specific evidence" that the depreciation deductions on the Chicago property (acquired in September 1959), as shown on the returns of Harold J. and Beulah F. Graves were examined. The 1959 and 1960 returns were examined after the taxpayer had filed an application for a tentative carryback to 1957 of a 1960 net operating loss and a refund for 1957 had been allowed. The audit report simply shows two minor adjustments for 1959 and no changes as to 1960. Similarly, the 1961 return was examined after taxpayers filed a claim for refund of 1958 taxes resulting from the carryback of a 1961 net operating loss. The audit report indicated no change and a refund for 1958 was allowed.Moreover, the buildings being depreciated were located in Chicago, while the audits were performed in Portland, Oreg. There is no evidence that the two revenue agents who performed the audits ever requested a collateral investigation of the Chicago property. Both revenue agents were present at the trial and one testified briefly1967 U.S. Tax Ct. LEXIS 122">136 for respondent but was asked no question about his audit. The burden was on petitioner to prove the Chicago property life was "accepted on audit." Respondent might well have a duty to make the agents who made the audits available for petitioner, which he admittedly did in this case, and petitioner was free to put them on the stand but respondent had no burden to prove the agents did not specifically examine and accept the depreciation deduction. The respondent's failure to have the agents testify with respect to the audits does not mean petitioners can indulge in the presumption that if respondent had called on them to testify with 48 T.C. 7">14 respect to the audits their testimony would have been adverse to respondent.We do not believe, on this record, that petitioners have brought themselves within section 3.05 of Rev. Proc. 62-21 or within any of its other provisions so as to preclude the respondent from adjusting the useful life for depreciation purposes of the Chicago property for the years before us. Nor is respondent so precluded by any revenue rulings issued prior to Rev. Proc. 62-21.Respondent contends on brief that as1967 U.S. Tax Ct. LEXIS 122">137 of September 1, 1959, the two buildings in Chicago each had a useful life of 38 years and the heating, electrical, and plumbing components of such buildings had a useful life of 28 years. Petitioners depreciated the buildings over a 25-year life and the components over a 5-year life. As indicated in our Findings of Fact, Sawyers, Inc., constructed a one-story building at 3500 N. Kostner Avenue in Chicago in 1952, added a second story in 1954, and acquired the building on the adjoining property in November 1958. Sawyers, Inc., was a manufacturer of photographic equipment and used the Chicago property as a distribution center, a sales office, and for research and development. The corporation depreciated the original building over a useful life of 40 years, the second floor addition, 38 years, and the building on the adjoining property, 34 years.When the Chicago property was transferred to petitioners and other stockholders of the corporation in September 1959, the useful life of the property for depreciation purposes was abruptly lowered, with useful lives of 25 years assigned to the two buildings, and (for the first time) the components of the buildings were separately depreciated1967 U.S. Tax Ct. LEXIS 122">138 over a useful life of 5 years. The reason for this tailoring of the useful lives of the assets is not hard to find. The Chicago property was immediately leased back to Sawyers, Inc., for a 5-year term at an annual rental of $ 36,000. The annual depreciation deduction of the buildings and components was, not too surprisingly, $ 39,387.51.Respondent's witness stated that, in his opinion, the useful life of the two buildings as of September 1, 1959 (when the property was transferred by the corporation to the petitioners and other stockholders), was 38 years and the useful life of the components was 28 years. The witness examined the property and based his opinion not only upon its physical condition but also upon such factors as the location of the property, accessibility to public transportation, facilities within the structures, availability of a labor force, zoning, and the future potential of the property.Petitioners' witness testified that he agreed with much of the testimony of respondent's witness and, in fact, admitted on redirect examination that he had no quarrel with the determination as to useful lives made by respondent's witness. It would seem, at this juncture, 1967 U.S. Tax Ct. LEXIS 122">139 48 T.C. 7">15 that a dispute no longer existed as to the useful lives of the buildings and components for depreciation purposes under section 167 of the 1954 Code. However, petitioners' witness seems to rely upon a unique definition of economic useful life to justify a 25-year life for the buildings and a somewhat shorter life for the components. He stated this definition to be as follows: "Economic useful life of a building is when it gets to a point where it will not yield a return on the value of the land equivalent to pay a return on the value of the land, that is, economic usefulness is over and that is the economic life." This definition also seems to involve such things as "market reaction," "recapture rates" and the "highest and best use of a parcel of land."It is obvious that petitioners are under a misconception as to the meaning of useful life for depreciation purposes under the Code. In Massey Motors, Inc. v. United States, 364 U.S. 92">364 U.S. 92 (1960), the Supreme Court stated that "it is the primary purpose of depreciation accounting to further the integrity of periodic income statements by making a meaningful allocation of the cost entailed in1967 U.S. Tax Ct. LEXIS 122">*140 the use (excluding maintenance expense) of the asset to the periods to which it contributes." The Supreme Court, in the Massey case, also alluded to the statement in United States v. Ludey, 274 U.S. 295">274 U.S. 295, 274 U.S. 295">301 (1927) that "'The theory underlying this allowance for depreciation is that by using up the plant, a gradual sale is made of it.'" Petitioners' definition is far afield from these recognized concepts of the nature of depreciation for tax purposes which gear the depreciation allowance to recovery of cost over the useful life of the asset in a taxpayer's business.We find, and so hold, that the useful life of each of the two buildings as of September 1, 1959, was 38 years and that the useful life of the components of the buildings was 28 years.Decisions will be entered under Rule 50. Footnotes1. There is an unexplained discrepancy in the stipulation in the cost of the land (Stip. No. 5) and the book value of the Chicago property as of August 31, 1959 (Stip. No. 7).↩2. See question 49, at 1962-2 C.B. 477↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625580/	Joy L. Zubrod, Sr. v. Commissioner.Zubrod v. CommissionerDocket No. 640-66.United States Tax CourtT.C. Memo 1967-204; 1967 Tax Ct. Memo LEXIS 57; 26 T.C.M. 1010; T.C.M. (RIA) 67204; October 19, 1967Joy L. Zubrod, Sr., pro se, 165 Brighton Blvd., Zanesville, Ohio. Clarence E. Barnes, for the respondent. TANNENWALDMemorandum Findings of Fact and Opinion TANNENWALD, Judge: Respondent determined a deficiency in petitioner's income tax for 1963 in the amount of $299.58. Because of concessions by petitioner, only two issues remain for our consideration: (1) Is petitioner an "employee," or is he an independent contractor subject to the self-employment income tax? (2) May1967 Tax Ct. Memo LEXIS 57">58 petitioner deduct certain travel expenses incurred as a result of his wife accompanying him on a business trip as a driver for his car? General Findings of Fact Joy L. Zubrod resided in Zanesville, Ohio, at the time of filing his petition herein. Petitioner and his wife, Thelma K. Zubrod, filed their joint Federal income tax return for 1963 and an amended return for 1963 with the district director of internal revenue, Cincinnati, Ohio. 1Issue No. 1 - Findings of Fact Petitioner was hired by Savings and Loan Publications (hereinafter referred to as "Publications") in August 1962 to sell advertising space in certain magazines. Publications publishes and distributes a monthly magazine containing articles of interest for homeowners and other consumers. Many of the articles contain ideas for home improvements and for building and buying of homes. The magazine is published under various titles such as "Ideas for Better Living." Distribution is handled under one-year contracts with various banks and savings and loan associations. The sponsoring bank or savings1967 Tax Ct. Memo LEXIS 57">59 and loan association is given free advertising space in the magazine, paying only for mailing or other distribution costs. The sponsor will normally mail copies of the magazine to its customers. Additional circulation is provided by placing copies in the bank or savings and loan lobby and in waiting rooms, such as in doctors' offices. The agreement between Publications and the sponsoring institution gives the latter exclusive distribution rights in its locality for the magazine. Publications' publishing costs and profits are derived from the sale of space to local advertisers. Petitioner's job, as one of seven space salesmen in 1963, was to secure this local advertising. His duties did not include securing the initial contract with the sponsor, although he did obtain the sponsor's signature on renewal contracts. Once the initial contract with the sponsor was secured, one of the space salesmen would then be assigned to secure the advertising. A space salesman was assigned specific sponsoring institutions as his accounts rather than a geographical territory. Normally, once a particular account was assigned to a space salesman, that account was his for succeeding years. However, Publications1967 Tax Ct. Memo LEXIS 57">60 reserved the right to take an account away from a space salesman. When petitioner was first hired by Publications, he was instructed by one of the officers of Publications as to his duties and was furnished a detailed book of procedure, further describing his duties and offering certain suggestions on how to approach prospective advertisers. Publications made clear to its space salesmen that it was important for it to know where they were located at all times. Petitioner was to notify Publications promptly of where he was staying in each town and of any change of address. He was also supposed to send a current copy of the local telephone directory to Publications' office in Columbus by parcel post. Petitioner was specifically instructed that he was to contact the sponsoring institution before attempting to sell any advertisements. This call was intended to enable him to obtain suggestions from the sponsor as to prospective advertisers. Petitioner carried a letter from Publications to the sponsor requesting aid in obtaining advertisers. The letter stated in part: Our representative will be completely at your disposal while he is in your community. He will do all of the necessary1967 Tax Ct. Memo LEXIS 57">61 contact work. All he needs from you, in order to be completely successful, is a small amount of assistance in the form of friendly guidance. Our representative will be instructed to call on no one without first securing your full approval for each firm or individual whom you consider as friendly to your organization and eligible to receive an invitation to be represented as an advertiser in your magazine. After petitioner contacted the sponsor, he proceeded to contact prospective advertisers. Although, due to the nature of his work, petitioner had no set hours, he did have press deadlines to meet, and thus was not entirely free to proceed at his leisure. Petitioner was instructed to use the forms provided by Publications for the contracts with the advertisers. Petitioner was not authorized to change any of the terms of those contracts. Publications placed certain restrictions on whom petitioner could accept as an advertiser. If an advertiser from a prior year had been delinquent in paying his bills to Publications, petitioner was not permitted to renew the contract unless the balance due from the prior year was paid immediately. Because beauty shops had proved to be particularly1967 Tax Ct. Memo LEXIS 57">62 bad credit risks, petitioner was not authorized to accept advertisements from them, except to renew contracts with certain acceptable beauty shops. Petitioner was also instructed to obtain the approval of the sponsoring institution prior to calling on any prospective advertiser. Petitioner was further instructed not to promise an advertiser an "exclusive," e.g., he could not promise one lumberyard that none of its competitors would be accepted as advertisers. After all the advertising space had been sold and before leaving town, petitioner was required to pay a final call on the sponsor, to go over the list of advertisers. In addition to securing advertisers, a space salesman was directed to try to collect delinquent accounts. Space salesmen were required to report to the home office of Publications on a regular basis, either in person or by phone. Space salesmen were authorized to make all telephone calls to the home office on a collect basis. Publications did not furnish its space salesmen with a personal office. Petitioner was not hired for a specific length of time. He could leave his job at any time and could be dismissed by Publications at any time. When petitioner was1967 Tax Ct. Memo LEXIS 57">63 first hired by Publications, no formal contract was entered into. However, it was understood that petitioner's compensation would be in the form of commissions at specified rates. Petitioner was given a $150-per-week drawing account for traveling expenses as an advance against commissions. The commission was due upon return of the advertising contracts to Publications. The commissions were not reduced to reflect unpaid accounts. On June 1, 1963, petitioner and Publications signed the following agreement in connection with the drawing account: April 6, 1963 DRAWING ACCOUNT AGREEMENT I understand and agree that my sales connection with Savings and Loan Publications and/or Financial Publications is in the capacity of an Independent Contractor relationship - and that I will receive no salary or wages. I further understand that my income will be in the form of commissions in full payment for advertising contracts processed by me and that no federal, city or state tax, in any form, or social security tax, will be withheld from my commissions. I further understand that if any money is advanced to me by way of a DRAWING ACCOUNT, to be used for travelling and incidental expense purposes, 1967 Tax Ct. Memo LEXIS 57">64 my earned commissions will first be used to offset the amount advanced and that I will, upon termination of my association with Savings and Loan Publications and/or Financial Publications, and/or their heirs and assigns, immediately repay the balance due (the excess, if any, of withdrawals less commissions earned) on said DRAWING ACCOUNT to Savings and Loan Publications. /s/ Joy LeRoy Zubrod, Sr. / Independent Contractor 165 Brighton Blvd. / Address ZanesvilleOhio / City State On behalf of Savings and Loan Publications, and in consideration of the promises hereinabove made by said Independent Contractor, I agree upon the termination of the association of said Independent Contractor with Savings and Loan Publications, and/or Financial Publications, etc., that I will immediately pay any plusbalance due (the excess, if any, of commissions earned, less withdrawals) on said DRAWING ACCOUNT to said Independent Contractor, his heirs and assigns. SAVINGS AND LOAN PUBLICATIONS By: /s/ Donald A. King / Managing Partner Petitioner paid all his traveling expenses and had no income from Publications except his commissions (including the drawing account). At no time did Publications1967 Tax Ct. Memo LEXIS 57">65 withhold any state or Federal taxes, or insurance, or retirement from petitioner's income. Petitioner's original Federal income tax return for 1963 showed $54.98 due as selfemployment tax. An amended return, dated August 3, 1964, showed a self-employment tax income of less than $400, so that no self-employment tax was due Respondent redetermined petitioner's self-employment income on the ground that petitioner was an independent contractor. Petitioner now contends that he was an employee of Publications and that therefore no self-employment tax is due for 1963 with respect to commissions paid him by Publications. Issue No. 1 - Ultimate Finding of Fact Petitioner was an employee of Publications. Issue No. 1 - Opinion The first issue herein is whether petitioner is subject to the tax on self-employment income. Under section 1402(c)2 and (d), he is not subject to that tax on earnings received as an "employee" as defined under the Federal Insurance Contributions Act. That Act is set forth in Subtitle C, Chapter 21, of the Internal Revenue Code. Section 3121(d)3 relates the definition1967 Tax Ct. Memo LEXIS 57">66 of "employee" to the rules of common law and to certain other types of employment which might not be covered by such definition. 1967 Tax Ct. Memo LEXIS 57">67 There has been no suggestion herein that petitioner falls within one of the specific types of employees set forth in section 3121(d). Rather, the question is simply whether petitioner had the status of an employee of Publications "under the usual common law rules applicable in determining the employer-employee relationship." Though there are certain guidelines to deciding whether an individual is an employee of an independent contractor, each case must be decided on its own facts. Labels used by the parties are not of critical significance. United States v. Silk, 331 U.S. 704">331 U.S. 704, 331 U.S. 704">716 (1947). The elements to be considered are the "degrees of control, opportunities for profit or loss, investment in facilities, permanency of relation and skill required." 331 U.S. 704">United States v. Silk, supra at p. 716; see also Enochs v. Williams Packing & Navigation Co., 370 U.S. 1">370 U.S. 1, 370 U.S. 1">3 (1962). That the degree of control is the most important element is clearly revealed by the action of Congress in rejecting the "economic reality" test alleged to have been established by 331 U.S. 704">United States v. Silk, supra.1967 Tax Ct. Memo LEXIS 57">68 H. J. Res. 296, ch. 468, 62 Stat. 438; see United States v. Thorson, 282 F.2d 157 (C.A. 1, 1960); Ringling Bros.-Barnum & Bailey Combined Shows v. Higgins, 189 F.2d 865 (C.A. 2, 1951); Bonney Motor Express, Incorporated v. United States, 206 F. Supp. 22">206 F. Supp. 22 (E.D. Va. 1962); S. Rept. No. 1255, to accompany H. J. Res. 296, 206 F. Supp. 22">supra, 80th Cong., 2d Sess., 1948-2 U.S. Code Cong. Serv. 1752-1775. We have set forth the details of petitioner's relationship with Publications in our findings of fact and will not repeat them here. We are satisfied that Publications retained and exercised sufficient control over petitioner (either directly or through the sponsoring institution as its instrument for that purpose) to make him an "employee" within the common law meaning of that term. Two officers of Publications testified for respondent. Although some of their testimony tended to support respondent's position, even they admitted that petitioner was not entirely free to do as he pleased and that Publications controlled the scope of petitioner's activities in various ways. Moreover, the manual of procedure describing the duties and responsibility of a space1967 Tax Ct. Memo LEXIS 57">69 salesman contained detailed limitations on his right to decide how to carry out his job. Publications informed the sponsoring institution that its representative, i.e., petitioner, would follow whatever instructions the sponsor prescribed. The sponsor, not petitioner, had the final say over whom could be invited to advertise in the magazine, subject only to Publications' right to veto poor credit risks. We note also that petitioner was entitled to his commissions whether or not the advertisers paid Publications for the space. That a space salesman could in a general way determine his hours of work, that he paid his own expenses, that he was paid on a commission basis, and that his employment was at will are not in and of themselves determinative. Cf. 331 U.S. 704">United States v. Silk, supra. On the basis of the entire record, we conclude that petitioner was an employee of Publications and therefore was not subject to the self-employment tax. Issue No. 2 - Findings of Fact To the extent relevant, the findings of fact under Issue No. 1 are incorporated herein. On September 29, 1963, petitioner1967 Tax Ct. Memo LEXIS 57">70 embarked on a business trip to four New York cities, Olean, Elmira, Auburn, and Oswego. He expected to be gone about six weeks and, in fact, did not return until November 10, 1963. Normally, petitioner's business trips were of substantially shorter duration. Petitioner had his wife accompany him on the aforementioned extended business trip to do the highway driving, purportedly because of fractures and neck whiplash suffered by petitioner in an automobile accident in 1955, the continued complications therefrom, and his doctor's advice. His wife had never accompanied him on any other business trips. The expenses deducted by petitioner on his tax return included both his own and his wife's food and motel expenses on this trip. Respondent determined that $162 of the food and $83.43 of the motel expenses were allocable to Thelma and disallowed these items. Issue No. 2 - Ultimate Finding of Fact The traveling expenses allocable to Thelma are a personal expense and are therefore not deductible. Issue No. 2 - Opinion Petitioner testified that he continued to be plagued by injuries resulting from an automobile accident in 1955 and that when he was about to depart on an unusually1967 Tax Ct. Memo LEXIS 57">71 long trip, his doctor advised him to take his wife along to drive his car. He asks us to allow him to deduct his wife's food and motel expenses from that trip. Respondent does not dispute the expenditure of the sums as indicated. Rather, he asks us to find petitioner's testimony unbelievable. Respondent points to the fact that petitioner offered no corroborative evidence as to his injuries or their relationship to the decision to have his wife drive and to minor inconsistencies between petitioner's testimony and data recorded in petitioner's dairy. We see no need to evaluate the credibility of petitioner's testimony because, even assuming the truth of his assertions, his wife's expenses are not deductible. The sums expended for her food and lodging are deductible as a business expense only if she accompanied petitioner for business reasons; that her presence on her husband's business trip may have been necessary for the medical reasons constitutes a personal and not a business purpose. Wm. E. Reisner, 34 T.C. 1122">34 T.C. 1122 (1960); cf. Alex Silverman, 28 T.C. 1061">28 T.C. 1061 (1957),1967 Tax Ct. Memo LEXIS 57">*72 affd. 253 F.2d 849 (C.A. 8, 1958). Petitioner made no claim in his return or during these proceedings that his wife's traveling expenses should be deductible as a medical expense. See 34 T.C. 1122">Wm. E. Reisner, supra at p. 1131; cf. Donnelly v. Commissioner, 262 F.2d 411 (C.A. 2, 1959), affirming 28 T.C. 1278">28 T.C. 1278 (1957); Walter E. Buck, 47 T.C. 113">47 T.C. 113 (i966). Thus, the traveling expenses of Thelma are of a personal nature and therefore not deductible. 4Decision will be entered under Rule 50. Footnotes1. The deficiency notice was issued to both petitioner and his wife but only petitioner filed a timely petition.↩2. All references are to the Internal Revenue Code of 1954 unless otherwise specified. ↩3. SEC. 3121. DEFINITIONS. (d) Employee. - For purposes of this chapter, the term "employee" means - (1) any officer of a corporation; or (2) any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee; or (3) any individual (other than an individual who is an employee under paragraph (1) or (2)) who performs services for remuneration for any person - (A) as an agent-driver or commission-driver engaged in distributing meat products, vegetable products, fruit products, bakery products, beverages (other than milk), or laundry or drycleaning services, for his principal; (B) as a full-time life insurance salesman; (C) as a home worker performing work, according to specifications furnished by the person for whom the services are performed, on materials or goods furnished by such person which are required to be returned to such person or a person designated by him; or (D) as a traveling or city salesman, other than as an agent-driver or commission-driver, engaged upon a full-time basis in the solicitation on behalf of, and the transmission to, his principal (except for side-line sales activities on behalf of some other person) of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments for merchandise for resale or supplies for use in their business operations; if the contract of service contemplates that substantially all of such services are to be performed personally by such individual; except that an individual shall not be included in the term "employee" under the provisions of this paragraph if such individual has a substantial investment in facilities used in connection with the performance of such services (other than in facilities for transportation), or if the services are in the nature of a single transaction not part of a continuing relationship with the person for whom the services are performed.↩4. We note also that, to the extent of $100 of respondent's disallowance, petitioner's expenses for food while traveling would not be deductible on any basis. Petitioner based his claim exclusively on his diary, which reveals only $1,287.60 for food as against $1,387.60 deducted on the return.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625581/	EDWIN B. COX, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Cox v. CommissionerDocket No. 89292.United States Board of Tax Appeals38 B.T.A. 865; 1938 BTA LEXIS 816; October 13, 1938, Promulgated 1938 BTA LEXIS 816">816 1. Petitioner transferred $100,000 to a trust, the income to be paid to his son for life, portions of the corpus to be paid to the son when he attained certain ages and the remainder to be paid to transferor's wife or others. Held, that the transfer was not of a future interest in property and petitioner, in computing his gift tax, properly excluded $5,000 from the amount transferred under section 504(b), Revenue Act of 1932. Commissioner v. Wells, 88 Fed.(2d) 339. 2. During the taxable period referred to in the preceding paragraph, petitioner transferred another $100,000 to his wife in trust for his son. Held, the fact that the son is the beneficiary under each of the trusts does not preclude the exclusion of $5,000 from the amount transferred to each of the trusts in computing the gift tax, each trust being an entity capable of and actually receiving the property transferred. Charles H. Garnett, Esq., for the petitioner. S. B. Anderson, Esq., and Frank T. Horner, Esq., for the respondent. MELLOTT38 B.T.A. 865">866 OPINION. MELLOTT: The Commissioner determined a deficiency in gift tax for the calendar year 19351938 BTA LEXIS 816">817 in the amount of $600. The proceeding was submitted upon an agreed statement of facts, all of which we find to be as stipulated. Petitioner, a resident of Ardmore, Oklahoma, duly filed a gift tax return for the calendar year 1935, reporting total gifts made during that year of $200,000 and net gifts made during the preceding year of $77,791.38. The $200,000 consisted of two gifts of $100,000 each made to trusts. Accordingly petitioner excluded $5,000 from each, under section 504(b) of the Revenue Act of 1932, 1 or a total of $10,000, and computed a tax of $18,634.05, which he paid. It is stipulated that "The sole question for determination * * is whether the petitioner is entitled to the exclusion or exemption of $5,000 from each of said gifts in the computation of his gift tax liability." Respondent filed no brief. The deficiency1938 BTA LEXIS 816">818 was determined upon the theory that the transfer of $100,000 to the Guaranty Trust Co. of New York in trust was a transfer of a "future interest in property" and hence not excludable under section 504(b), supra; but in his amended answer the respondent makes the additional contention that only $5,000 may be deducted because of the fact that petitioner's son was the beneficiary under each of the two trusts. The trust instruments are incorporated in the agreed statement of facts and have been examined by us. For present purposes, however, it will be sufficient to quote the stipulation. (3) On November 15, 1935, the petitioner made a transfer of $100,000.00 to the Guaranty Trust Company of New York as trustee in trust for the benefit of the beneficiaries named in and subject to the terms, provisions, and conditions of, a declaration of trust executed by him in the making of such transfer. 38 B.T.A. 865">867 Petitioner's son, Edwin Lochridge Cox, was one of the beneficiaries named in the declaration of trust, and upon conditions of survivorship and the attainment of certain ages therein stated, was to receive certain distributions from the income and from the corpus of the trust. * 1938 BTA LEXIS 816">819 * (4) On December 14, 1935, the petitioner made a transfer to Elizabeth L. Cox, his wife, as trustee in trust for his son, Edwin L. Cox, of the sum of $100,000.00. This transfer was made by a declaration of trust in writing and was wholly without any restrictions upon the administration of the trust fund by the trustee, but provided for distributions therefrom at certain specified dates, and the termination of the trust on January 1, 1950. * * * The transfer to the Guaranty Trust Co. of New York was not one of a future interest in property. The donor "divested himself of all vestige of title, and no future act on his part could modify or abrogate his act." , affirming . Inasmuch as the statute imposes the tax upon the donor, the quality of the estate conveyed by him is determinative rather than the estate received by any particular beneficiary, ; but even if the gift be considered from the standpoint of the donee, it was one of a present interest in property, the trust being an entity capable of and in fact actually1938 BTA LEXIS 816">820 receiving the property transferred. ; cf. ; . Respondent's contention that the petitioner's son was the beneficiary under each trust, if important, is only partially true. Under the transfer made to petitioner's wife the son, Edwin L. Cox, was the sole beneficiary; but not so under the other trust. The instrument creating it provided that the son should receive the income for his life if he attained the age of 21 years. If he attained the age of 32 years then he was to receive 25 percent of the corpus. If he attained the age of 45 years then he was to receive 33 1/3 percent of the corpus then on hand. It will be noted that the maximum amount of corpus which he could ever receive was only 50 percent of the amount transferred to the trust company by petitioner. Petitioner's wife had a possibility of becoming a beneficiary if she outlived the son, but if not then the son's lineal descendants, if any, were to receive the remainder, otherwise it was to go to Russell Eugene Cox. So while it is true that the son was a beneficiary1938 BTA LEXIS 816">821 under each trust, it can not be said that he was the sole beneficiary. But even if the son were the sole beneficiary under each trust, we are of the opinion that the $5,000 exclusion should be allowed as to each. The trusts were separate entities. As the court pointed out in , "They were no different from persons, for the Act so states." Sec. 1111(a)(1). In , we held that the fact that two beneficiaries 38 B.T.A. 865">868 were in existence at the time the transfer in trust was made did not entitle the donor to two exclusions of $5,000 each. This was on the theory that the trust was the donee. To the same effect also see (on appeal, 8th C.C.A.). The District Court reached a different conclusion in ; but inasmuch as trusts, though abstractions, long have been, and usually are, treated for income tax purposes as entities having separate existence, cf. 1938 BTA LEXIS 816">822 , and inasmuch as we were affirmed in , we prefer to follow our earlier decisions rather than While the precise question now being considered has not been decided, it seems to be a necessary corollary to our earlier decisions that a $5,000 exclusion may be made from each transfer in trust, though the beneficiary be the same. Congress anticipated this holding - though the fact that it did so has comparatively little significance - when it amended section 504(b) in 1938 and provided that the exclusion should not apply to gifts in trust. See Report No. 1567, Committee on Finance, 75th Cong., 3d sess. 2 The reports of the Congressional Committees in connection with the enactment of the Gift Tax Law in 1932 have also been examined; but, as the court pointed out in , "the enactment is neither ambiguous nor doubtful in its expressions," so the reports furnish little aid. 1938 BTA LEXIS 816">823 The respondent erred in denying the exclusion of $5,000 from the transfer in trust made by petitioner to the Guaranty Trust Co. of New York. It follows that the deficiency determined by him can not be approved. Reviewed by the Board. Judgment will be entered for the petitioner.DISNEYDISNEY, dissenting: I can not concur in the finding that Edwin Lochridge Cox was only one of the beneficiaries under the trust set up on November 15, 1935. The trust instrument provided, in short, that he should have the income throughout his life and by the age of 45 one-half of the corpus, and that at his death and that of his 38 B.T.A. 865">869 mother, the trust should cease and the remainder of the corpus should be paid to his lineal descendants, if any, per stirpes; that if no lineal descendants survive him, or if any survive him and die before his mother, the trust should continue through her lifetime to pay her the income and that then the trust should cease, the corpus to be vested in Russell Eugene Cox or his distributees. Under this state of facts, the mother, in any event, would take only the income for her life, perhaps only a portion thereof, and only in the contingency1938 BTA LEXIS 816">824 of surviving Edwin Lochridge Cox and any lineal descendants surviving him. Such remote contingency does not, in my opinion, make her a beneficiary under the trust within the intent of the statute, and I conclude that he was beneficiary in two successive trusts. Moreover, in so far as the majority opinion assumes two successive trusts to the same beneficiary and holds, nevertheless, that there should be allowed two deductions of $5,000 each, I can not concur. The object intended by the statute is too plain, I think, to allow it to be stultified by a plurality of trustees under which arrangement, with trusts of $5,000 each, the gift for tax purposes could be diminished to zero. I do not think that , or , furnish authority herein, for in both cases the question as to who was donee was not met. In , quoting section 1111 of the Revenue Act of 1932, defining "person" as including "trust," the statement is made that the donees were trusts. The question was as to future interest, and taken as a whole the case is1938 BTA LEXIS 816">825 to the effect that there was transfer, taxable under the statute, because the tax is on transfer and not receipt. Definitions based upon inductive reasoning are often pitfalls for unwary thought when applied to particular situations. I think this is a situation where "A word * * * may vary greatly in color and content according to the circumstances and the time in which it is used." . It is well recognized that definitions "are to be understood by looking at the subject-matter * * * and the object of the Legislature * * ." . In spite of the definition of the word "person" as including "trust" in section 1111, the statute as a whole shows that the definition can not be consistently applied. Thus section 142, requiring specially a return by a fiduciary for a trust, and section 16 , providing a particular imposition of a tax upon trusts, seem unnecessary, if the word person is in every instance to include "trust." 1938 BTA LEXIS 816">826 , says: * * * The word "person" like any other words, has no fixed and rigid signification, but has different meanings dependent upon contemporary conditions, 38 B.T.A. 865">870 the connection in which it is used, and the result intended to be accomplished. * * It has been held, in a consideration of perpetuities, that beneficiary, and not trustee, is donee and first taker. , (357). The word trustee itself discloses that another is the person primarily involved. I believe that section 504(b) requires a construction of the word person in its usual sense. . The fact that in , as well as other cases the tax was based upon the transfer to the trust is justified by the words of the statute, which imposes the tax upon the transfer, with emphasis upon that fact. There was transfer, and not in futuro.As said in 1938 BTA LEXIS 816">827 , the same conclusion could have been reached in , by finding that the donees were the cestuis que trust. , holds each of several beneficiaries under a single trust to be donees requiring exclusion of $5,000. Considering the light given upon the intent of the Congress by the Senate Committee Report as to section 501 of the Revenue Act of 1932, 1 it seems to me plain that within the purview of section 504(b) the donee is the beneficiary under a trust. Cases like , and , involving a transfer in trust for several persons do not, I think, answer the question here propounded, as to the application of section 504(b) to successive trusts in the same year for the same beneficiary; for there was in those cases one transfer, within the object of section 501. Here there are two, to the same person. The fact that section 504(b) was amended by section 505(a) of the Revenue Act of 1938 to exclude gifts in trust, along with gifts of future1938 BTA LEXIS 816">828 interests in property, is, I believe, indicative of the intent to clarify the earlier statute and that, being subject to erroneous interpretation, it should be clarified. (1374, 1375); ; certiorari denied, . I think petitioner here has erroneously interpreted its meaning. I dissent. 1938 BTA LEXIS 816">829 OPPER agrees with this dissent. Footnotes1. SEC. 504. NET GIFTS. * * (b) GIFTS LESS THAN $5,000. - In the case of gifts (other than of future interests in property) made to any person by the donor during the calendar year, the first $5,000 of such gifts to such person shall not, for the purposes of subsection (a), be included in the total amount of gifts made during such year. ↩2. SEC. 503. * * * The Committee is also proposing an amendment by which the exclusion would not apply to gifts in trust. The Board of Tax Appeals and several Federal courts have held, with respect to gifts in trust, that the trust entites were the donees and on that account the gifts were of present and not of future interests. The statute, as thus construed, affords ready means of tax avoidance, since a donee may create any number of trusts in the same year in favor of the same beneficiaries with a $5,000 exclusion applying to each trust, whereas the gifts, if made otherwise than in trust, would in no case be subject to more than a single exclusion of $5,000. * * * ↩1. The words "transfer * * * by gift" and "whether * * * direct or indirect" are designed to cover and comprehend all transactions (subject to certain express conditions and limitations) whereby and to the extent (sec. 503) that property or a property right is donatively passed to or conferred upon another, regardless of the means or the device employed in its accomplishment. For example, * * * (3) a transfer of property to B where there is imposed upon B the obligation of paying a commensurate annuity to C would be a gift to C; * * * (7) where A creates a revocable trust naming B as beneficiary, a gift to B of the corpus is effected when A relinquishes the power to revoke or the power is otherwise terminated in B's favor (the income payments to B in the interim being gifts from A in the calendar years when received.) ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625582/	JOHN K. SEXTON and MARJORIE LEE SEXTON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSexton v. CommissionerDocket No. 17024-79.United States Tax CourtT.C. Memo 1984-360; 1984 Tax Ct. Memo LEXIS 311; 48 T.C.M. 512; T.C.M. (RIA) 84360; July 16, 1984. Pollard White, for the petitioners. Robert B. Nadler and John L. Hopkins, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent1984 Tax Ct. Memo LEXIS 311">312 determined deficiencies in petitioners' Federal income tax for the calendar years 1976 and 1977 in the amounts of $14,823.58 and $1,025.81, respectively. The only issue for decision is whether petitioners are entitled to a nonbusiness bad debt deduction in 1976 under section 1661 with respect to transfers of funds previously made to relatives. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners, husband and wife, who resided in Hopkinsville, Kentucky, at the time of the filing of the petition in this case, filed a joint Federal income tax return for the calendar year 1976 with the office of the Director, Internal Revenue Services Center, Memphis, Tennessee. In early 1973, John K. Sexton (petitioner) agreed to loan his son, John D. Sexton, a maximum of $45,000 provided the son and the son's wife signed a promissory note. The son planned to use the fund to buy thoroughbred race horses for resale. On February 5, 1973, John D. Sexton and his wife, Bonnie G. Sexton, executed a1984 Tax Ct. Memo LEXIS 311">313 promissory note in the amount of $45,000 payable on demand to petitioner with interest at the rate of 7 percent per year. Petitioner did not loan any funds to his son and daughter-in-law prior to or immediately following receipt of the promissory note. Petitioner agreed to co-sign loans that his son planned to obtain from various banks up to the amount of $45,000 and in case of a default by his son, he agreed to satisfy the obligations to that extent. On April 25, 1973, petitioners co-signed a $20,000 promissory note of John D. and Bonnie Sexton to the Chesterfield Bank in Chesterfield, Missouri. The note provided for interest at 8 percent per annum. On June 22, 1973, John D. and Bonnie Sexton paid the Chesterfield Bank the amount of $20,000 together with accrued interest in satisfaction of their indebtedness to the bank. On June 26, 1973, John D. and Bonnie Sexton borrowed $30,000 from the Chesterfield Bank and petitioner co-signed the note. The amount of $30,800 (including a finance charge of $800) was payable to the Chesterfield Bank on October 26, 1973. On November 8, 1973, John D. Sexton paid the Chesterfield Bank only the interest of $800 due on the $30,000 loan. By1984 Tax Ct. Memo LEXIS 311">314 letter dated November 8, 1973, the bank informed John D. Sexton that the $800 interest payment did not cover the total interest due on the loan because additional interest had accrued on the $30,000 since the due date of October 26, 1973. By letter dated November 23, 1973, the Chesterfield Bank informed John D. Sexton that the $30,000 loan remained unpaid and requested him to contact the bank to make arrangements to pay the loan. The bank sent a copy of this letter to petitioner. On December 21, 1973, John D. Sexton telephoned his father from California and asked to borrow an additional $10,000 for a short period of time. That day, petitioner sent his son a check for $10,000. John D. Sexton sent his father a check for $10,000 dated December 26, 1973, drawn on a bank in Kansas, but payment of the check was refused by the bank on which it was drawn because of insufficient funds. In early 1974, shortly after the check was not honored, petitioner gave John D. Sexton a check for $3,500 and cash in the amount of $1,500. Early in January 1974, the president of the Chesterfield Bank called petitioner to request payment of the $30,000 note petitioner had co-signed with his son. On1984 Tax Ct. Memo LEXIS 311">315 January 7, 1974, petitioner paid the Chesterfield Bank the amount of $30,486.67 in satisfaction of his son's $30,000 indebtedness plus interest due to the bank. In 1975, John D. Sexton was employed for approximately one year by W. Jeff Hammond Moving and Storage, Inc. (Hammond Moving), which was owned by Larry Larimore, John D. Sexton's father-in-law. In 1975, petitioner purchased the Henderson-Moorefield Lumber Co., Inc. (Henderson-Moorefield), in Hopkinsville, Kentucky, and began to employ his son in the business in July 1976. John D. Sexton's wage and tax statement (Form W-2) from Henderson-Moorefield states that he earned $5,516.87 in 1976. In 1976, John D. Sexton's wife, Bonnie Sexton, was also employed by Henderson-Moorefield, petitioner's company. During 1976, she earned $11,202.37 from her father-in-law's company according to her Form W-2. During 1976, Bonnie Sexton was also employed by Hammond Moving, her father's business. According to her Form W-2 from Hammond Moving, she earned $1,400 in 1976. On their 1976 Federal income tax return, John D. and Bonnie Sexton reported a total of $18,132.44 in wage income. In addition, on this return they reported income of $11,480.151984 Tax Ct. Memo LEXIS 311">316 as dividends received from Hammond Moving, the company owned by Bonnie Sexton's father. They also reported interest income of $127.89. In 1976, John D. and Bonnie Sexton sold their home for $28,000 and purchased a new home for $48,200.19. They obtained a bank mortgage of $47,000 to finance the purchase of the new residence. In 1976, John D. and Bonnie Sexton had no children and suffered from no physical disabilities. Bonnie Sexton had a baccalaureate degree in interior decorating. John D. Sexton was 31 years old in 1976 and needed only 3 hours to qualify for his baccalaureate degree in agriculture at the University of Missouri, Columbia, Missouri. On June 10, 1974, petitioner's brother-in-law, F. Donald Clarkson, and his wife, Eileen K. Clarkson, executed a promissory note in the amount of $4,500 at 7 percent interest per year payable to petitioner. Mr. Clarkson, a professional golfer, operated a sporting goods store and borrowed the $4,500 from petitioner to pay sales tax owed to the Internal Revenue Service. In 1976, Mr. Clarkson, who was in his early 50's, was employed as a golf professional at the Old Warson Country Club, St. Louis, Missouri, and worked in his sporting1984 Tax Ct. Memo LEXIS 311">317 goods store in the evenings. Mrs. Clarkson worked in her husband's sporting goods store during the day. Both Mr. and Mrs. Clarkson had graduated from high school and neither of them suffered from physical disabilities. At no time did petitioners initiate judicial proceedings against, or file liens against, or serve written demand for repayment of the money lent to John D. and Bonnie Sexton and F. Donald and Eileen K. Clarkson. Petitioner never sought the advice of an attorney or an accountant with respect to collection of the amounts loaned to his son and brother-in-law. He did not engage the services of a collection agency to collect the debts. Neither petitioner's son nor his brother-in-law have been declared bankrupt. Petitioners, on their Federal income tax return for 1976, claimed a nonbusiness bad debt deduction of $49,500. This amount was arrived at by adding the $45,000 amount of the promissory note signed by petitioner's son and daughter-in-law in 1973 to the $4,500 amount of the promissory note signed by petitioner's brother-in-law and sister-in-law in 1974. Respondent disallowed petitioners' claimed deduction with the explanation that "nonbusiness bad debts in1984 Tax Ct. Memo LEXIS 311">318 the amount of $49,500 shown on your 1976 return are not allowable pursuant to Section 166 of the Internal Revenue Code."2OPINION Section 166(d)3 provides that where a nonbusiness bad debt becomes worthless within a taxable year, the loss therefrom to a taxpayer other than a corporation shall be considered as a short-term capital loss. To qualify for a deduction for worthless nonbusiness debts under section 166(d)(1), a taxpayer must show that he and the alleged debtor intended1984 Tax Ct. Memo LEXIS 311">319 to create a debtor-creditor relationship, that a genuine debt in fact existed, and that the debt became worthless within the taxable year in which the deduction is claimed. Section 1-166-1(c), Income Tax Regs.4Andrew v. Commissioner,54 T.C. 239">54 T.C. 239, 54 T.C. 239">245 (1970). 1984 Tax Ct. Memo LEXIS 311">320 While the parties agree that petitioner had bona fide nonbusiness debts in the amount of approximately $44,500, respondent takes the position that neither the amount owed to petitioner by his son nor the amount owed to him by his brother-in-law became worthless in 1976. To qualify for deductions for nonbusiness worthless debts under section 166(d)(1), a taxpayer must show that the debt has become totally worthless. No deduction is "allowed for a nonbusiness debt which is recoverable in part during the taxable year." Section 1.166-5(a)(2), Income Tax Regs.51984 Tax Ct. Memo LEXIS 311">321 In this case, petitioner has failed to prove that either the $40,000 nonbusiness debt of his son or the $4,500 nonbusiness debt of his brother-in-law became totally worthless in 1976. Whether or not a debt has become worthless is a question of fact which depends primarily upon the reasonable probability of the debt's ultimate collection. The Court must look at the financial condition of the debtor when determining the worthlessness of the debt. Section 1.166-2(a), Income Tax Regs.6 A showing that the debt is worthless and uncollectible and that legal action to enforce payment would probably not result in the satisfaction of execution on a judgment is sufficient evidence of the worthlessness of the debt. Section 1.166-2(a), Income Tax Regs.1984 Tax Ct. Memo LEXIS 311">322 We find that neither of petitioner's bona fide nonbusiness debts in the total amount of approximately $44,500 became totally worthless in 1976. The evidence shows that at least a portion of these debts was recoverable in 1976. Whether a debt has become worthless within a particular year is a question of fact, Perry v. Commissioner, 22 T.C.. 968, 973 (1954), to be determined on the basis of objective factors, not on the taxpayer's subjective judgment as to the worthlessness of the debt. Fox v. Commissioner,50 T.C. 813">50 T.C. 813, 50 T.C. 813">823 (1968), affd. in an unreported opinion (9th Cir. 1970, 25 AFTR 2d 70-891, 70-1 USPC par. 9373). Determining whether a debt has become worthless is not accomplished by a stereotyped legal test, but requires an examination of all circumstances. Dallmeyer v. Commissioner,14 T.C. 1282">14 T.C. 1282, 14 T.C. 1282">1291 (1950). After an examination of the facts in this case, we conclude that petitioner had a significant hope for the recovery of at least a portion of the amounts loaned to his son and could have recovered some or all of the amounts loaned to his brother-in-law. Petitioner must establish total worthlessness in1984 Tax Ct. Memo LEXIS 311">323 connection with each loan in order to sustain the bad debt deduction. Petitioner argues that the $40,486.67 he lent his son was worthless in 1976 and points to the financial difficulties experienced by John D. and Bonnie Sexton from 1973 through 1982 to support his position. This Court is concerned solely with the financial standing of the debtors in 1976 when the bad debt deduction was claimed by petitioner. As stated by this Court in Pierson v. Commissioner,27 T.C. 330">27 T.C. 330, 27 T.C. 330">338 (1956), affd. 253 F.2d 928">253 F.2d 928 (3d Cir. 1958), "a nonbusiness bad debt is not deductible unless it becomes totally worthless within the taxable year." The regulations also require that in order to obtain a bad debt deduction a taxpayer must show that a nonbusiness debt became wholly worthless within the taxable year in which the deduction is claimed. Section 1.166-5(a)(2), Income Tax Regs. The fact that the debts involved in this case might have become worthless after 1976 is not relevant for our purposes. See Redman v. Commissioner,155 F.2d 319">155 F.2d 319 (1st Cir. 1946), affirming a Memorandum Opinion of this Court. Thus, we will confine our consideration of the debtors' 1984 Tax Ct. Memo LEXIS 311">324 financial conditions to the year 1976. In determining whether a debt is worthless, this Court has considered such factors as the debtor's age, health, earning capacity, educational status, and income. 7 Mere proof of a debtor's financial difficulties will not sustain a bad debt deduction. 8In 1976, John D. and Bonnie G. Sexton were solvent and both were employed. John D. Sexton and his wife both worked for petitioner's lumber company. He earned $5,516.87 from his father's company from July through December 1976. She earned $11,202.37 from her father-in-law's company in 1976. Petitioner made no attempt in 1976 or any other year to collect any of the indebtedness from his son and daughter-in-law out of wages they earned from his lumber business. Bonnie Sexton also worked in 1976 in her father's moving and storage business and earned $1,400. On their Federal income tax return for 1976, John D. 1984 Tax Ct. Memo LEXIS 311">325 and Bonnie Sexton reported a total of $18,132.44 in wage income. In addition, they reported dividend income of $11,480.15 and interest income of $127.89 in 1976. Their adjusted gross income for 1976 was $25,670.13. From this evidence, it appears that they could have sent petitioner some money that year to satisfy at least a portion of the indebtedness. Petitioners argue that John and Bonnie Sextion did not receive dividends in the amount of $11,480.15 in 1976 from Hammond Moving, the company owned by Bonnie Sexton's father. On their 1976 Federal income tax return, however, John D. and Bonnie Sexton reported the $11,480.15 dividend as income. Although petitioner contends that his son and daughter-in-law did not receive the dividend, an amended return was not filed in order to exclude the dividend from their 1976 income tax return. We are not persuaded by petitioners' argument that John D. and Bonnie Sexton failed to receive the dividend in the amount of $11,480.15. There is no evidence in the record concerning this dividend other than the fact that it was reported on John D. and Bonnie Sexton's 1976 tax return. 9 This record indicates that the $11,480.15 dividend should be1984 Tax Ct. Memo LEXIS 311">326 included. However, there is sufficient evidence in this record to show that some payment could have made to petitioner from their other funds. In 1976, John D. and Bonnie Sexton had no children and suffered from no physical disabilities that would have presented them with extraordinary expenses. John D. Sexton was 31 years old in 1976. In 1976, John D. and Bonnie Sexton sold their residence for $28,800 and bought a new home for $48,200.19. John D. and Bonnie Sexton Obtained a $47,000 mortgage loan from the bank and were the only signers of the mortgage note. The fact that the bank extended credit in the amount of $47,000 to the debtors in 1976 indicates that petitioner's conclusion that the loans to his son were totally worthless in that year is invalid. Although a bona fide debtor-creditor relationship existed between petitioner and his brother-in-law, F. Donald Clarkson, in 1976, the record does not reveal any facts to support petitioner's conclusion that1984 Tax Ct. Memo LEXIS 311">327 the $4,500 loan to the Clarksons was uncollectible in that year. In 1976, Mr. Clarkson was employed as a golf professional at a country club and he and his wife both worked in their sporting goods store. He worked in the evenings, while she worked during the day. The record shows that in 1978 or 1979 the Clarksons experienced some financial difficulties. However, there is no showing of any such problems in 1976. In 1976, the Clarksons suffered from no physical difficulties that would present extraordinary expenses or would prevent them from being employed. In 1976, the Clarksons were not bankrupt and petitioner made no attempt to collect from the Clarksons the money owed to him. We find that petitioner has failed to sustain his burden of proving that the nonbusiness debts became totally worthless in 1976. Petitioner made no effort to collect the amounts loaned to his relatives even though it is apparent from this record that at least some of the money could have been recovered in 1976. As this Court stated in 50 T.C. 813">Fox v. Commissioner,supra at 822, the "Mere belief that a debt is bad is insufficient to support a deduction for worthlessness." It is incumbent1984 Tax Ct. Memo LEXIS 311">*328 upon petitioner to show objective facts which illustrate the worthlessness of the debt in 1976. 50 T.C. 813">Fox v. Commissioner,supra at 822-823. We hold that petitioners have failed to sustain their 1976 claimed nonbusiness bad debt deductions. Decision will be entered for the respondent.Footnotes1. Unless otherwise stated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years here in issue.↩2. Petitioners, in their brief, state that they contend that the $40,486.67 which petitioner loaned to his son by paying his son's note plus interest and advancing him $10,000 in cash became worthless in 1976 as did the $4,500 loan to petitioner's brother-in-law. Respondent does not contend that the $40,486.67 and the $4,500 were not loans, but contends that petitioner has not shown that the amounts became worthless in 1976. Respondent took the position that the $5,000 given by petitioner to his won in early 1974 was not a loan and we conclude from petitioners' brief that they now concede that this $5,000 was not a loan to petitioner's son. Petitioner in effect so testified.↩3. Sec. 166(d) provides as follows: (d) Nonbusiness Debts.-- (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 worth-less 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. ↩4. Sec. 1.166-1(c), Income Tax Regs., provides in pertinent part: (c) Bona fide Debt required. Only a bona fide debt qualifies for purposes of section 166↩. A bona fide debt is a debt which arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money.5. Sec. 1.166-5(a)(2), Income Tax Regs., provides: (2) If, in the case of a taxpayer other than a corporation, a nonbusiness debt becomes wholly worthless within the taxable year, the loss resulting therefrom shall be treated as a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977). Such a loss is subject to the limitations provided in section 1211, relating to the limitation on capital losses, and section 1212, relating to the capital loss carryover, and in the regulations under those sections. A loss on a nonbusiness debt shall be treated as sustained only if and when the debt has become totally worthless, and no deduction shall be allowed for a nonbusiness debt which is recoverable in part during the taxable year.↩6. Sec. 1.166-2(a), Income Tax Regs., provides: (a) General rule. In determining whether a debt is worthless in whole or in part the district director will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor. (b) Legal action not required. Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of these facts will be sufficient evidence of the worthlessness of the debt for purposes of the deduction under section 166↩.7. See Yara Engineering Corp. v. Commissioner,T.C. Memo. 1963-283, affd. per curiam 344 F.2d 113">344 F.2d 113↩ (3d Cir. 1965). 8. See Clemens v. Commissioner,T.C. Memo. 1969-235, affd. per curiam 453 F.2d 869">453 F.2d 869↩ (9th Cir. 1971).9. There is some testimony with respect to a dividend reported on John D. and Bonnie Sexton's 1977 Federal income tax return. We do not consider this testimony relevant to the dividend reported on their 1976 return.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625583/	PAUL S. MOSESIAN AND DIANE M. MOSESIAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMosesian v. CommissionerDocket No. 30023-87United States Tax CourtT.C. Memo 1990-415; 1990 Tax Ct. Memo LEXIS 432; 60 T.C.M. 419; T.C.M. (RIA) 90415; August 6, 1990, Filed Decision will be entered for the respondent. Paul S. Mosesian and Diane M. Mosesian, pro se. Steven R. Guest and Edward G. Langer, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION This case was heard by Special Trial Judge Peter J. Panuthos pursuant to the provisions of section 7443A of the Code. 1 The Court agrees with and adopts the Special Trial Judge's opinion, which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE PANUTHOS, Special Trial Judge: Respondent determined deficiencies in petitioners' Federal income tax, additions to tax, and additional interest as follows: Additions to Tax and InterestSec.Sec.Sec.Sec.Sec.YearDeficiency6653(a)6653(a)(1)6653(a)(2)665966211978$ 18,788.00$ 939----$ 805*1990 Tax Ct. Memo LEXIS 432">433 197913,300.00665----3,990198010,060.00503----3,018198126,283.00--$ 1,3147,884198242,164.07--2,10812,649*198356,980.84--2,84917,094*The issues for decision are: (1) whether petitioners are entitled to investment credits and deductions for depreciation arising out of petitioner Paul S. Mosesian's investment in two wind turbines, or, in the alternative, whether the amounts claimed are subject to recapture; (2) whether petitioners are entitled to a theft loss as a result of petitioner Paul S. Mosesian's investment in the wind turbines; (3) whether respondent properly disallowed $ 16,472 of charitable contributions claimed on petitioners' 1983 Federal income tax return; (4) whether petitioners are liable for additions to tax under section 6653(a) for negligence or intentional disregard of rules or regulations; (5) whether petitioners are subject to the 30-percent addition to tax under section 6659, or, in the alternative, to the addition to tax under section 6661; and (6) whether petitioners are liable for additional interest under section 6621(c). FINDINGS OF FACT Some of the facts have been stipulated and are so found. Petitioners were residents of Fresno, California, at the time of filing of their petition. Petitioners were married in July 1982. References to petitioner 1990 Tax Ct. Memo LEXIS 432">434 in the singular are to Paul S. Mosesian. Petitioner is a lawyer who has practiced in the Fresno, California, area since 1964. He has been involved in many different businesses, including farming and agriculture, real estate, land development, real estate appraisal, horse racing, raisin salvaging, and rental of real estate. Free-Wing Turbine Corporation (FWTC) was incorporated in Utah in 1980 for the purpose of developing and promoting wind-driven turbines to generate electrical power. Laird B. Gogins (Gogins), the president of FWTC, designed a so-called "free-wing" wind turbine. Trans Power Manufacturing, Inc. (Trans Power), was incorporated in Utah in 1981. The stated purpose of the corporation was to build, operate, and sell wind machines that would produce electricity for sale to California public utilities. Trans Power was formed by Ben Helsten (Helsten) who, prior to becoming involved in the wind energy business, sold insurance. Trans Power acquired from Gogins the right to build and develop the free-wing wind turbine invented by him. During the summer of 1981, Trans Power began construction of a wind turbine based on the design of Gogins in Corona, California. The Corona 1990 Tax Ct. Memo LEXIS 432">435 wind turbine took approximately 6 months to construct, but it was never connected to a power grid. The wind turbines eventually produced, promoted, and sold by Trans Power were Trans Power's modification of Gogins's design, which was a new concept in wind turbines. The Trans Power wind turbine consists of two towers about 200 feet apart. Each tower has a large pulley wheel near the top of the tower and another wheel at the bottom of the tower. Cables are stretched from one wheel on a tower to a corresponding wheel on the other tower, and fabric sails are stretched from the top cable to the bottom cable. When the wind blows, the sails move the cables. The moving cables turn the wheels on the tower and power a generator, which produces electricity. The major components of the wind turbine include two concrete foundations, two towers, four wheels, six gin poles, two cables, sails, a generator, and metering equipment. FWTC began offering the wind turbines for sale in 1981, with Helsten as the company's selling agent. Helsten, who received commissions from the sale of the wind turbines, sold three or four wind turbines for FWTC. Helsten subsequently acquired from FWTC the rights to 1990 Tax Ct. Memo LEXIS 432">436 sell the wind turbines, which he sold through his corporation, Trans Power. The 1981 investment prospectus prepared for potential purchasers of the wind turbines stated that the machines were new and commercially untested and had never been operated. The 1981 prospectus included a sample purchase agreement and a summary of the sales transaction. The prospectus stated that the seller anticipated that a wind turbine would be operational on site approximately 60 to 90 days after execution of a purchase agreement. According to the prospectus, the purchase price of a wind turbine was to be paid 25 percent in cash, with the remainder to be paid by a nonrecourse promissory note. The prospectus stated that wind turbines would be sold only to those individuals with a net worth in excess of $ 100,000 and who expected that some portion of their income would be subject to tax in the 50 percent or higher tax bracket during the year of purchase. The "Projections" section of the 1981 prospectus contained cash flow projections based on a purchase price of $ 200,000 for a wind turbine. First-year income from a wind turbine was projected to be $ 61,000 and total depreciation was projected to be $ 1990 Tax Ct. Memo LEXIS 432">437 224,611. The 1981 prospectus stated that the projections should be treated as speculation and that they should not be relied on by prospective purchasers of wind turbines. The projections were prepared by Gogins and his engineering group and were based on his original design, not the modified design of Trans Power on which the wind turbines were actually based. The 1981 prospectus contained a discussion of the tax consequences of purchasing a wind turbine and, as an appendix, a tax opinion prepared by attorney Harry Winderman. The opinion discussed basis, investment credit, and limitations on deductions, including section 465 and section 183. The prospectus stated that neither the seller nor seller's agent assumed any responsibility for the tax consequences of purchasing a wind turbine and urged the purchaser to consult a tax advisor with respect to the tax implications of the purchase of a wind turbine. Furthermore, the prospectus stated that the tax benefits of a wind turbine investment were "not free from doubt," and that the benefits might be "reduced or entirely eliminated" if the Internal Revenue Service prevailed on a position contradictory to those outlined in the opinion 1990 Tax Ct. Memo LEXIS 432">438 supplied by tax counsel. The 1982 prospectus was similar in content to the 1981 prospectus. The 1982 prospectus stated, as did the 1981 prospectus, that the wind turbine had never been operational. During 1981, Trans Power and Helsten sold more than 20 wind turbines to be erected at Oak Creek Wind Park in Tehachapi, California. In 1982, Trans Power and Helsten sold more than 20 wind turbines to be located at Cabezon Wind Park in Palm Springs, California. Trans Power and Helsten sold approximately 10 wind turbines in 1983 to be erected in the future at Cabezon Wind Park. In November 1981, Trans Power entered into a ground lease agreement with Oak Creek Energy Systems, Inc. (Oak Creek), for the lease of land at Tehachapi, California, on which wind turbines would be operated. On December 29, 1981, Trans Power was granted a building permit to construct ten wind turbines at Tehachapi. The permit allowed construction of the machines for data collection and testing purposes only. As of December 31, 1981, only one turbine had been erected at Tehachapi, and this was a test machine. As of late October 1982, only a single wind turbine was completely erected at Tehachapi, and it was not operational 1990 Tax Ct. Memo LEXIS 432">439 at that time. During the years 1981 through 1983, Trans Power was paid a total of $ 200 by Oak Creek for power generated by Trans Power turbines located at Tehachapi. Only three wind turbines were ever connected to a power grid, however, and nothing in the record indicates that Oak Creek had an agreement with any utility to sell energy produced by Trans Power or FWTC wind turbines. Aztec Energy Corporation (Aztec) was formed by Robert Paul (Paul) in 1982. The stated purpose of Aztec was to locate sites for, to acquire permits for, and to construct, wind energy farms. Aztec was not in the business of selling wind turbines. In the fall of 1982, Paul met with Helsten, and the two agreed that Paul would try to find sites upon which to erect Trans Power's wind turbines. In December 1982, Aztec acquired property in Cabazon and commenced development of a wind park site on that property. Aztec's offices were approximately 12 miles from the site, which Paul visited almost daily. Paul was employed by Helsten from late December 1982 through March or April 1983 to supervise the construction of Trans Power's wind turbines at Cabazon. Trans Power began construction of its wind turbines at the 1990 Tax Ct. Memo LEXIS 432">440 Cabazon site during the second week of December 1982. As of December 31, 1982, no wind turbine was fully erected and capable of producing electricity at the Cabazon site. Ultimately, only two wind turbines were completely erected at the Cabazon site. On December 27, 1982, Aztec entered into a wind park power purchase and sales agreement with Southern California Edison Company (SCE). The agreement permitted Aztec to sell to SCE power generated at the wind park at Cabazon. SCE constructed a substation at the Cabazon site in the summer or fall of 1983. No Trans Power wind turbine at Cabazon was ever connected to a power grid operated by SCE or any other utility, and Aztec never received any payments from SCE for electricity produced by any Trans Power wind turbine located at the Cabazon site. In March 1983, Trans Power ceased its construction of wind turbines at Cabazon, and Aztec discontinued operation of the wind park in November 1984. Several fundamental problems were inherent in the design of the wind turbines. First, the "wings" or "blades" of the turbine were not capable of moving the cables at sufficient speed to generate the power claimed in the prospectus. Second, the machines 1990 Tax Ct. Memo LEXIS 432">441 were too low to the ground (40-foot height). Wind shear near the ground would prevent them from operating at sufficient speed. Most importantly, the wind turbines could not operate continuously in the absence of a full-time attendant, which made them impossible to operate profitably. Finally, the performance of the wind turbines was greatly exaggerated in the prospectus; they were simply incapable of generating enough power to make them economical. The Trans Power wind turbines at Tehachapi and Cabazon were unreliable and incapable of operating for more than a day or two at a time without breaking down. The wind turbines never operated on a sustained basis or generated more than an insignificant amount of electricity. No more than three of the wind turbines were ever connected to a power grid to enable electricity generated by them to be sold to a utility. The fair market value of a wind turbine was no more than its salvage value of $ 3,000. Petitioner received a copy of the Trans Power 1981 prospectus from Helsten in October 1981. Also in October 1981, petitioner met John Shelburne (Shelburne), who participated in the sales on behalf of Trans Power. Shelburne provided petitioner 1990 Tax Ct. Memo LEXIS 432">442 with additional written material touting the tax benefits of a wind turbine purchase. The materials stated that a tax write-off of better than five-to-one would be possible for 1981, and a write-off of better than four-to-one was possible for 1982. Petitioner had never invested in wind energy equipment prior to his involvement with Trans Power, and he did not obtain an independent appraisal or evaluation of Trans Power's equipment prior to investing. Petitioner executed an agreement dated December 15, 1981, for the purchase of a wind turbine from Trans Power to be erected at Tehachapi (the Tehachapi wind turbine). The total purchase price of the wind turbine was $ 208,000, in addition to which petitioner was obligated to pay a $ 5,000 management fee and a $ 2,000 land lease payment. The purchase price was to be paid as follows: $ 48,000 in cash upon execution of the purchase agreement; a recourse note in the amount of $ 4,000; and the balance in the form of a nonrecourse promissory note. Petitioner executed a nonnegotiable, nonrecourse promissory note dated December 15, 1981, payable to Trans Power in the amount of $ 150,000, to be paid in 15 annual payments of principal and interest. 1990 Tax Ct. Memo LEXIS 432">443 The note bore an interest rate of 12 percent annually and was secured only by petitioner's interest in the Tehachapi wind turbine. Petitioner's total payments on this note did not exceed $ 800. Also in December 1981, petitioner executed a recourse promissory note payable to Trans Power in the amount of $ 4,000 to be paid in 15 annual installments of principal and interest at 12 percent. On December 29, 1981, petitioner wrote a check payable to Trans Power in the amount of $ 48,000. The check bears the notation "Down Payment Wind Electric System Includes $ 2,600.00 of sales tax." Petitioner wrote two other checks dated December 29, 1981, one in the amount of $ 5,000 bearing the notation "Management fee" and the other in the amount of $ 2,000 bearing the notation "Lease payment." Nothing in the record explains the discrepancy between the contract price and the total amount of the notes and checks from petitioner to Trans Power. Petitioner received a letter from Shelburne on December 24, 1981, which stated in part: As we discussed over the telephone, if you decide you want a machine, we want you to know your machine would be started this year but would not actually be completed until 1990 Tax Ct. Memo LEXIS 432">444 the middle of January. We would be able to have a Capacity Rent Check which would indicate 1981 income for your machine. If you would care to pursue a purchase on this basis, we would be very happy to cooperate with you to the fullest extent. In mid-February 1982, petitioner received a check dated February 10, 1982, in the amount of $ 240 designated as a capacity payment for the period ended December 31, 1981, with respect to the Tehachapi wind turbine. Petitioner reported the $ 240 as income on his 1981 Federal income tax return. Petitioner executed an agreement dated December 2, 1982, for the purchase of a wind turbine to be erected at Cabazon (the Cabazon wind turbine). The purchase agreement had not been executed, however, as of December 13, 1982. The purchase price of the Cabazon wind turbine was $ 208,000 and was to be paid as follows: $ 53,000 in cash upon execution of the purchase agreement, with the balance to be paid by a nonrecourse promissory note. In December 1982, petitioner executed a nonrecourse promissory note payable to Trans Power in the amount of $ 155,000, to be paid in 15 equal annual installments with interest at the rate of 9 percent. The note was secured 1990 Tax Ct. Memo LEXIS 432">445 only by petitioner's interest in the Cabazon wind turbine. No payments were ever made by petitioner on the promissory note. On petitioner's 1981, 1982, and 1983 Federal income tax returns, he claimed net losses with respect to the Tehachapi wind turbine of $ 33,710, $ 46,540, and $ 44,730, respectively. He also claimed an investment credit with respect to the Tehachapi machine on his 1981 return, only a portion ($ 11,481) of which he was able to use, and a business energy credit, none of which he was able to use. The unused credits were carried back to petitioner's taxable years 1978, 1979, and 1980, for which years petitioner received refunds of Federal income tax paid in the amounts of $ 18,788, $ 13,300, and $ 10,060, respectively, for a total of $ 42,148. Thus, within months of his cash outlay in December 1981, petitioner had recouped the amount actually paid by him with respect to the Tehachapi wind turbine. On his 1982 and 1983 Federal income tax returns, petitioner claimed net losses with respect to the Cabazon wind turbine of $ 36,200 and $ 45,760, respectively. On his 1982 Federal income tax return, petitioner claimed an investment credit and a business energy investment 1990 Tax Ct. Memo LEXIS 432">446 credit based on his investment in the Cabazon machine. Petitioner used all of the investment credit in 1982, which reduced his Federal income tax liability from $ 30,118 to $ 0. Petitioner's Federal income tax liability for 1983 was reduced by $ 15,082 due to carryover of unused 1982 investment credit and business energy investment credit attributable to the Cabazon wind turbine. OPINION The first issue for decision is whether petitioner properly claimed loss deductions and investment credits with respect to his investment in the Tehachapi and Cabazon wind turbines for the taxable years 1981 and 1982. Petitioner bears the burden of proving his entitlement to the claimed deductions and credits. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Economic SubstanceIn numerous cases, this Court has held that transactions entered into by taxpayers that lacked economic substance are to be disregarded for tax purposes. See, e.g., Rybak v. Commissioner, 91 T.C. 524">91 T.C. 524 (1988); Cherin v. Commissioner, 89 T.C. 986">89 T.C. 986 (1987); and Rose v. Commissioner, 88 T.C. 386">88 T.C. 386 (1987), affd. 868 F.2d 851">868 F.2d 851 (6th Cir. 1989). The mere fact that a transaction generates tax benefits for its investors does not necessarily 1990 Tax Ct. Memo LEXIS 432">447 mean that the transaction lacks economic substance. Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 435 U.S. 561">581 (1978).If a transaction is entered into solely for tax benefits and without any other purpose, however, the form of the transaction will be disregarded and the tax benefits denied. Gefen v. Commissioner, 87 T.C. 1471">87 T.C. 1471, 87 T.C. 1471">1490 (1986). Respondent's primary argument in this case is that the transaction involving the wind turbines lacked economic substance. A transaction has economic substance if it offers a reasonable opportunity for economic profit. Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89">752 F.2d 89 (4th Cir. 1985), affg. in part and revg. in part 81 T.C. 184">81 T.C. 184 (1983).The economic substance test is an objective test. On the facts of this case, we hold that respondent properly disallowed the claimed deductions and credits because petitioner's investment in the two wind turbines lacked economic substance. We find that the investment was without economic substance, for tax purposes, because petitioner was motivated by no purpose other than obtaining tax benefits, and no reasonable possibility of making a profit existed. 752 F.2d 89">Rice's Toyota World, Inc. v. Commissioner, supra at 91. At trial, 1990 Tax Ct. Memo LEXIS 432">448 petitioner presented no expert testimony on the issue of the fair market value of a wind turbine. Helsten testified that a wind turbine cost in excess of $ 100,000 to construct. Dr. Robert E. Wilson, a professor of engineering and the author of numerous articles on the engineering aspects of wind turbines, testified on behalf of respondent. We found Dr. Wilson to be a credible, highly qualified witness. Although agreeing that it would cost over $ 100,000 to construct one of the wind turbines, Dr. Wilson outlined numerous conceptual problems with the design of the wind turbines, all of which negatively affected their fair market value. Despite the cost to construct a wind turbine, the conceptual problems with the design and the need for a full-time attendant meant that the wind turbines could never have profitably generated electricity. The purchase price of the wind turbines, $ 208,000 each, greatly exceeded their cost of construction and greatly exceeded their fair market value, which we have found to be no more than their salvage value, or approximately $ 3,000. Seventy-five percent of the purchase price of each wind turbine was paid with nonrecourse debt. If the purchase price 1990 Tax Ct. Memo LEXIS 432">449 of an asset purchased with nonrecourse debt greatly exceeds the value of the asset, the nonrecourse debt is not bona fide and will not be recognized for tax purposes because the purchaser is not making a capital investment in the unpaid portion of the purchase price. Estate of Franklin v. Commissioner, 544 F.2d 1045">544 F.2d 1045, 544 F.2d 1045">1048-1049 (9th Cir. 1976), affg. 64 T.C. 752">64 T.C. 752 (1975). Only $ 800 was paid on the $ 150,000 note given by petitioner as part of the purchase price of the Tehachapi wind turbine, and no payment was ever made on the $ 155,000 note given as part of the purchase price of the Cabazon wind turbine. The nonrecourse debt served only to increase the purchase price of the wind turbines and generate increased tax credits and deductions. The illusory nature of the financing convinces us that petitioner's investment in the wind turbines was without economic substance and that the cash portion of the selling price was simply paid for tax benefits. The existence of a highly inflated purchase price based upon deferred debt that is not likely to be paid is an indication of a lack of economic substance. Gilbert v. Commissioner, T.C. Memo. 1987-165, affd. without published opinion. The 1990 Tax Ct. Memo LEXIS 432">450 Trans Power wind turbines were never fully operational, could never have operated profitably, and were not capable of functioning as promoted. Of the more than 50 wind turbines sold to investors, perhaps three ever produced electricity for sale to a utility. All of this leads us to the conclusion that Trans Power was in the business of selling tax deductions and credits and was not engaged in a business the objective of which was to make a profit for its investors. The promotional materials received by petitioner from Shelburne were devoted almost exclusively to the tax benefits of the scheme. Petitioner must have known that the wind turbines would not be placed in service in the years in which they were purportedly purchased, and the tax benefits of the transactions obviously overrode any questions of the profitability of the investment in the machines. It is clear from the record that the purpose of petitioner's involvement in the wind turbine investments was to obtain tax deductions and that the investments were devoid of any economic substance. We sustain respondent's determinations regarding the claimed losses and investment tax credits. Since we have held that the investments 1990 Tax Ct. Memo LEXIS 432">451 were without economic substance, we need not address respondent's alternative arguments. Theft Loss DeductionSection 165 allows as a deduction any theft loss sustained during the taxable year and not compensated for by insurance or otherwise. Under section 165(e), a theft loss is "sustained during the taxable year in which the taxpayer discovers such loss." Petitioners presented no proof at trial to support a theft loss deduction under section 165(e). Petitioners bear the burden of proof on this issue. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Petitioners seem to argue on brief that sustaining respondent's determinations in this case requires us to find that a theft loss necessarily occurred in the taxable years in which they made cash outlays for the wind turbines. Petitioners have not only failed to prove the year or years in which a theft loss was discovered by them, they have failed to present any evidence that they were defrauded. Rather, the record before us indicates that they were willing purchasers of the wind turbines and are simply dissatisfied because they will not realize expected tax benefits. Respondent is thus sustained on this issue. Charitable Contributions Deduction1990 Tax Ct. Memo LEXIS 432">452 Petitioners alleged in their petition that respondent improperly disallowed $ 16,472 of charitable contributions for 1983. No evidence was presented on this issue at trial, and the issue was not addressed in petitioners' briefs. Accordingly, petitioners have failed to carry their burden of proof on this issue, and respondent's determination as to the charitable contributions deduction will be sustained. Additions to Tax1. Section 6653(a)Section 6653(a) provides for an addition to tax "if any part of any underpayment * * * is due to negligence or intentional disregard of rules and regulations." We sustain the determination of respondent that petitioners are liable for an addition to tax for negligence for each of the years in issue. Petitioners claimed substantial credits and deductions with respect to a dubious investment after little or no investigation of the merits of the wind turbines. Petitioner was not an engineer, nor did he consult with anyone with knowledge in the field of wind energy. See Beck v. Commissioner, 85 T.C. 557">85 T.C. 557, 85 T.C. 557">577 (1985); Elliott v. Commissioner, 84 T.C. 227">84 T.C. 227, 84 T.C. 227">240 (1985), affd. without published opinion 782 F.2d 1027">782 F.2d 1027 (3d Cir. 1986). Petitioners claimed an 1990 Tax Ct. Memo LEXIS 432">453 inflated basis in the wind turbines for depreciation and credits on their 1981 and 1982 tax returns, when minimal investigation would have revealed that the purchase price of the machines was inflated and that petitioners were not entitled to the deductions and credits. Petitioner's primary investigation of the investment was his own cash-flow analysis, but he simply discounted projections in the prospectus, which explicitly stated that the information should not be relied on by prospective investors. Furthermore, the prospectus specifically noted that the tax benefits of the investment "are not free from doubt" and might be "reduced or entirely eliminated." Petitioners' conduct and omissions thus justify the additions to tax for negligence. 2. Section 6659Section 6659 imposes a graduated addition to tax on an underpayment "attributable to a valuation overstatement." Section 6659(c) provides that: there is a valuation overstatement if the value of any property, or the adjusted basis of any property, claimed on any return is 150 percent or more of the amount determined to be the correct amount of such valuation or adjusted basis (as the case may be). A valuation overstatement of 1990 Tax Ct. Memo LEXIS 432">454 more than 250 percent of the correct valuation or adjusted basis results in the imposition of a 30-percent addition to tax. Sec. 6659(b). On the returns at issue in this case, petitioners reported adjusted bases in the Tehachapi wind turbine and the Cabazon wind turbine of $ 213,000 and 208,000, respectively. We have found that the transactions involving the wind turbines were devoid of economic substance and are to be disregarded for tax purposes. Collins v. Commissioner, 857 F.2d 1383">857 F.2d 1383, 857 F.2d 1383">1385 (9th Cir. 1988), affg. a Memorandum Opinion of this Court; Sochin v. Commissioner, 843 F.2d 351">843 F.2d 351, 843 F.2d 351">353 (9th Cir. 1988), affg. Brown v. Commissioner, 85 T.C. 968">85 T.C. 968 (1985).Accordingly, petitioners have no "adjusted basis" for purposes of depreciation, the investment credit, or the business energy investment credit. The correct adjusted basis in the wind turbines is therefore zero. See Zirker v. Commissioner, 87 T.C. 970">87 T.C. 970, 87 T.C. 970">978 (1986).Petitioners' valuation overstatement is thus more than 250 percent of the correct valuation and they are liable for the addition to tax under section 6659(b) in the amount of 30 percent of the underpayment attributable to the valuation overstatement. See Roach v. Commissioner, T.C. Memo. 1989-586.1990 Tax Ct. Memo LEXIS 432">455 3. Section 6661Section 6661 is applicable only to the amount by which the understatement exceeds the amount of the underpayment attributable to a valuation overstatement as determined under section 6659. Sec. 6661(b)(3); Sec. 1.6661-2(f), Income Tax Regs. As a result of our holding above with respect to the addition to tax under section 6659, further discussion of section 6661 is unnecessary. 4. Section 6621(c)Section 6621(c) provides for interest at the rate of 120 percent of the normal rate (under section 6601) with respect to any substantial underpayment attributable to a tax-motivated transaction. The term "tax-motivated transaction" includes any valuation overstatement. Sec. 6621(c)(3)(A)(i). Petitioners are therefore liable for additional interest as determined by respondent. Decision will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code as amended and in effect for the years at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩. 120 percent of the interest accruing after Dec. 31, 1984, on the entire underpayment of tax.. 50 percent of the interest due on the amount of the deficiency.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625584/	THOMAS M. CRUMPTON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCrumpton v. CommissionerDocket No. 28429-90.United States Tax CourtT.C. Memo 1992-117; 1992 Tax Ct. Memo LEXIS 138; 63 T.C.M. 2200; T.C.M. (RIA) 92117; February 26, 1992, Filed 1992 Tax Ct. Memo LEXIS 138">138 Decision will be entered for respondent William Randolph Klein, for petitioner. Charles A. Baer, for respondent. GUSSISGUSSISMEMORANDUM OPINION GUSSIS, Special Trial Judge: This case was assigned for trial pursuant to the provisions of section 7443A(b)(3) and Rules 180, 181, and 182. All section references are to the Internal Revenue Code in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. Respondent determined a deficiency in petitioner's income tax for 1988 in the amount of $ 4,858 and an addition to tax under section 6653(a)(1) of $ 242.90. The issues presented are: (1) Whether petitioner is entitled to deduct certain employee business expenses in 1988; (2) whether petitioner's fishing activity was an activity engaged in for profit within the meaning of section 183 and if so, whether petitioner is entitled to deduct claimed Schedule C losses of $ 10,828 generated by this activity and; (3) whether petitioner is liable for the addition to tax based on negligence. Some of the facts were stipulated and they are so found. The stipulation of facts and attached exhibits are incorporated1992 Tax Ct. Memo LEXIS 138">139 by this reference. Petitioner was a resident of Bradenton, Florida; when the petition herein was filed. In 1988, petitioner was employed full time by Enterprise Fleets, Inc. (EFI). During the period here involved, EFI had a company policy of reimbursing its employees for any legitimate expense incurred for EFI, without limit or ceiling, upon submission of the proper expense reports. In 1988 petitioner incurred employee business expenditures in excess of $ 14,000 for which he did not seek reimbursement. These expenditures include such items as vehicle expenses ($ 6,336), parking fees and tolls ($ 1,320), travel and lodging ($ 1,040), phone costs ($ 690), stationery ($ 490), office rent and utilities ($ 2,600), meals and entertainment ($ 2,680), and business publications ($ 320). Petitioner claimed these deductions on his 1988 return as employee business expenses which were disallowed by respondent. In 1988 petitioner owned a 1987 Chris Craft Sea Hawk which was 21 feet 6 inches long and was powered by a 200-horsepower Johnson outboard motor. In 1988 petitioner began a charter fishing activity under the name of Captain Tom's Fishing Fleet. On Schedule C of his 1988 return, petitioner1992 Tax Ct. Memo LEXIS 138">140 claimed a loss of $ 10,828 with respect to the charter fishing activity which was disallowed by respondent. Petitioner bears the burden of proving that respondent's determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Section 162(a) allows deductions for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". In the instant case, petitioner contends that the employee business deductions claimed on his 1988 return fall within the ambit of section 162(a). However, it is established that a trade or business deduction is not allowable to the extent that the employee is entitled to reimbursement from his employer. Orvis v. Commissioner, 788 F.2d 1406">788 F.2d 1406, 788 F.2d 1406">1408 (9th Cir. 1986), affg. T.C. Memo. 1984-533; Lucas v. Commissioner, 79 T.C. 1">79 T.C. 1, 79 T.C. 1">7 (1982). In the instant case, it is stipulated that EFI would have reimbursed petitioner for any legitimate business expenses he incurred on its behalf. In view of EFI's reimbursement policy, we must conclude that petitioner is not entitled to the employee business deductions claimed1992 Tax Ct. Memo LEXIS 138">141 on his 1988 return. Nor are we persuaded that some incidental expenditures incurred by petitioner in the pursuit of his employment would not be covered by the employer's reimbursement policy and hence would be deductible as employee business expenses. Initially, the stipulation unequivocally states that the employer would have reimbursed petitioner for any legitimate expense incurred for EFI, without limit or ceiling. Moreover, petitioner's vague and unsatisfactory testimony fails to provide the necessary substantiation with respect to the purported incidental expenses. Respondent is sustained on this issue. Petitioner also claimed a $ 10,828 deduction on his 1988 Federal return for a loss he sustained in operating Captain Tom's Fishing Fleet. The deductibility of this loss turns on whether petitioner's fishing activities were engaged in for profit as required by section 183. Section 183(a) provides that if an activity is not engaged in for profit, no deduction attributable to such activity shall be allowed except as otherwise provided in section 183(b). In determining whether an activity is one engaged in for profit, petitioners must prove an "actual and honest objective 1992 Tax Ct. Memo LEXIS 138">142 of making a profit." Dreicer v. Commissioner, 78 T.C. 642">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). The regulations set forth a number of factors for consideration when making a profit objective determination. They are: (1) The manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on the activity; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation. Sec. 1.183-2(b), Income Tax Regs. No single factor, nor the existence of a majority of the factors, is controlling; rather, "the facts and circumstances of the case in issue remain the primary test." Abramson v. Commissioner, 86 T.C. 360">86 T.C. 360, 86 T.C. 360">371 (1986); sec. 1.183-2(b), Income Tax Regs. Greater weight is to be given to the objective1992 Tax Ct. Memo LEXIS 138">143 facts than to the taxpayer's mere statement of his intent. Beck v. Commissioner, 85 T.C. 557">85 T.C. 557, 85 T.C. 557">570 (1985). It is apparent from the facts and circumstances of the present case that petitioner did not engage in his charter fishing activities in 1988 with the requisite profit objective. Petitioner carried on his fishing activities in a haphazard and casual manner. The only record petitioner kept regarding his charter fishing activity was a spiral notebook which he could not locate at the time of trial. There is no indication in the record that the missing notebook did in fact constitute an appropriate business record. There is little indication in the record to show that petitioner made any serious effort to make an informed business judgment on the economic prospects for the venture. Although petitioner did obtain a Coast Guard license, his preliminary investigation of the charter fishing business was superficial. There is no evidence that petitioner realistically sought any professional advice with respect to the commercial merits of his venture. If petitioner was indeed interested in making a profit one would assume he would have investigated the business1992 Tax Ct. Memo LEXIS 138">144 in greater depth, especially since he had no prior experience in the business. As for the time petitioner was able to devote to the business, the record indicates it was insubstantial. During the time in issue petitioner not only worked full time for EFI but also worked as a bartender at night and on weekends. The record gives no indication that petitioner employed anyone to help him manage the charter fishing activity. The record does indicate that petitioner enjoyed boating activities. The Chris Craft yacht petitioner owned in 1988 was the third boat owned by him. Petitioner stated at trial that he entered the charter fishing business because he thought it would be enjoyable and fairly easy. He admitted he used the boat for personal reasons. While deriving enjoyment from the particular activity at issue is not conclusive as to whether the activity is engaged in for profit, it is a factor to be considered. See sec. 1.183-2(b)(9), Income Tax Regs. His advertising was limited to inserts in the yellow pages and advertising leaflets which he left at various restaurants and tackle shops in the area. His knowledge as to the suitable fishing areas in the vicinity seemed haphazard1992 Tax Ct. Memo LEXIS 138">145 in nature. In short, we find his pursuit of his charter fishing venture decidedly desultory in nature. Upon consideration of all the facts and circumstances we find petitioner did not engage in his fishing activities with an actual and honest objective of making a profit. Accordingly, respondent properly disallowed the losses attributable to the activity for the year at issue. Our conclusion that the charter fishing activity was not engaged in for profit is dispositive of this issue, and consequently we need not address the section 274(d) substantiation arguments made by respondent. The final issue for resolution is whether respondent is liable for the addition to tax based on negligence. Under section 6653(a)(1), if any part of an underpayment is due to negligence or disregard of rules or regulations, an addition to tax is added to the tax due. Negligence as used in section 6653(a)(1) has been defined as a lack of due care or the failure to do what a reasonable and ordinarily prudent person would do in the same circumstances. Crocker v. Commissioner, 92 T.C. 899">92 T.C. 899, 92 T.C. 899">916 (1989). Petitioner failed to keep adequate records. The various deductions claimed by1992 Tax Ct. Memo LEXIS 138">*146 him suggest an absence of any effort to differentiate between personal expenditures and those expenditures which were related to his purported business activities. He admittedly claimed a rental expense for his boat in 1988 which was never incurred. We have considered the record and conclude that petitioner is liable for the additions to tax under the provisions of section 6653(a) in 1988. Respondent is sustained on this issue. Decision will be entered for respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625585/	M. J. LAPUTKA AND SONS, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentM. J. Laputka & Sons, Inc. v. CommissionerDocket Nos. 8093-72, 4050-73.United States Tax CourtT.C. Memo 1981-730; 1981 Tax Ct. Memo LEXIS 10; 43 T.C.M. 177; T.C.M. (RIA) 81730; December 28, 1981. John F. Kennedy and Theodore R. Laputka, for the petitioner. Richard N. Weinstein and Crombie J. D. Garrett, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge1981 Tax Ct. Memo LEXIS 10">12 : These cases were tried before former Special Trial Judge Murray H. Falk pursuant to Rule 180, Tax Court Rules of Practice and Procedure. His report was filed with the Clerk of the Court on June 26, 1981, and was served on the parties. Petitioners filed no exceptions to the report, but respondent did file exceptions on August 10, 1981 and the cases were reassigned, pursuant to Rule 182(d) on September 22, 1981. In particular, respondent has objected to the finding and conclusion of the Special Trial Judge that the petitioner's failure to report income for the taxable year 1966 was without an intent to evade tax and, therefore, was not fraudulent within the meaning of section 6653(b), Internal Revenue Code of 1954. After careful consideration of respondent's exceptions and the evidence presented, the Special Trial Judge's report is adopted, as set forth below, without modification with respect to the addition to tax under section 6653(b) for 1966 because fraud for that year has not been proved by clear and convincing evidence. REPORT OF THE SPECIAL TRIAL JUDGE 1981 Tax Ct. Memo LEXIS 10">13 FALK, Special Trial Judge: Respondent determined the following deficiencies and additions to tax in respect of petitioner's Federal income taxes for the taxable years specified: TaxableAddition to Tax UnderDocketYearDeficiencySec. 6653(b) 1Sec. 6653(a)8093-721962$ 49,286.36$ 24,643.18196362,547.2531,273.63196454,501.9527,250.984050-73196561,773.0030,886.50196636,997.1418,498.5719676,411.503,205.75196817,024.158,512.0819691,988.66$ 99.43These cases were consolidated for trial, briefing and opinion. The issues presented for decision are: (1) The amount, if any, by which petitioner failed to report its income for each of the years in question; (2) whether (and, if so, to what extent) petitioner is entitled to certain deductions in excess of the amounts allowed by respondent for each of the years in issue; (3) whether petitioner is liable for the 50 percent addition to tax for fraud under section 6653(b) for each of the years 1962 through 1968, inclusive;1981 Tax Ct. Memo LEXIS 10">14 (4) whether petitioner is liable for the 5 percent addition to tax for negligence or intentional disregard of rules and regulations under section 6653(a) for 1969; and (5) whether petitioner filed a false or fraudulent return with intent to evade tax for each of the taxable years 1962 through 1966, inclusive, with the result that the statute of limitation does not bar the assessment of a deficiency for each of those years. FINDINGS OF FACT Many of the facts have been stipulated. They and the exhibits referred to therein are incorporated herein by this reference. At the time its petitions herein were filed, petitioner's principal place of business was located in Hazelton, Pennsylvania. Petitioner is a corporation organized under the laws of Pennsylvania. Its taxable year is the calendar year. It filed its federal corporation income tax returns for the years in issue with the District Director of Internal Revenue, Philadelphia, Pennsylvania, on the dates set forth in the following table: YearDate filed19622 3/18/6319632 3/18/6419642 3/18/65196510/14/6619663 6/28/6719676/14/6819686/11/6919694/13/701981 Tax Ct. Memo LEXIS 10">15 Petitioner and respondent executed written agreements pursuant to the provisions of section 6501(c)(4) effectively to extend the periods of limitation upon assessments of the taxes due for the years 1965 and 1966 to December 31, 1970, and for the years 1967, 1968, and 1969 to June 30, 1973. A notice of deficiencies for the years 1962, 1963, and 1964 was mailed on September 14, 1972, and for the taxable years 1965 through 1969, inclusive, on March 27, 1973. Assessment of a deficiency for each of the years 1962 through 1966, inclusive, is barred by the statute of limitations unless petitioner's return for such year was false or fraudulent with the intent to evade tax. (See sec. 6501(c)(1).) Michael Laputka (hereinafter referred to as Michael) began an insurance brokerage business in about 1930 as a sole proprietor. His son George Laputka (hereinafter referred to as George) joined the business in 1931 and from 1933 until its incorporation in 1950 the agency was operated as a partnership between Michael and George under the name "M. J. Laputka and Son." Theodore Laputka (hereinafter reerred to as Ted), another of Michael's sons, started to work for the agency in the 1930s. Upon1981 Tax Ct. Memo LEXIS 10">16 the formation of petitioner in 1950, 1,000 shares of its capital stock were issued; 395 to Michael, 395 to George, 100 to Ted, and 110 to T. R. Laputka Trust (which shares were to be voted by Michael). From 1950 until Michael's death in 1964, Michael was president of the corporation, Ted was vicepresident, and George was its secretary and treasurer. In November of 1954, Michael, George, and Ted executed an agreement whereby Michael agreed to sell most of his shares of petitioner's capital stock to George and Ted in consideration of certain monthly payments to be made by them. The written agreement recited that Michael would retain 10 shares for his lifetime. Voting power was to be vested equally between George and Ted. The agreement also recited that Michael would be entilted, during his lifetime, to 40 percent of the renewal commissions with respect to insurance previously written by him for Lackawanna Casualty Insurance Company and Old Republic Insurance Company (hereinafter referred to as Lackawanna and Old Republic, respectively). In 1960, petitioner's stock book was changed to reflect a stock ownership of 600 shares by George and his wife and 400 shares by Ted and his1981 Tax Ct. Memo LEXIS 10">17 wife, the latter subject to a voting trust in respect of 110 shares to be voted by Michael. Notwithstanding the agreement and modifications, Michael continued to dominate the operations of petitioner's business until about 1962. He often intermingled petitioner's funds with funds in his personal bank accounts, depositing or redepositing money into petitioner's account when and as needed. No formal directors' meetings were held. Routine matters were handled by George and Michael and important decisions were made upon consultation with Ted. Michael and George depended for their livelihoods upon the income they derived from the business of petitioner, whereas Ted was also engaged in an active law practice. In about 1962, Michael went into semi-retirement. George began to conduct the day-to-day operations of petitioner's business, although Michael still played a prominent role in making decisions regarding the business. Michael died in November, 1964, whereupon George became petitioner's president and chief operating officer and Ted became its treasurer. In spite of the November, 1954, agreement that Michael would be entitled to 40 percent of the Lackawanna and Old Republic1981 Tax Ct. Memo LEXIS 10">18 renewal commissions during his lifetime, Lackawanna, with petitioner's concurrence, contineud to make its checks payable to "M. J. Laputka" for the full amount of renewal commissions due from it. Those checks were negotiated by Michael or for his benefit during the years in question until his death in 1964. Old Republic's checks for the full amount of its renewal commisions were made payable to petitioner or to "M. J. Laputka & Sons Insurance" and were cashed by Michael or for his benefit during that same period. After Michael's death, the proceeds of most of the Lackawanna and Old Republic renewal commission checks (still being made payable as described above) were given by George of Ted to Michael's widow. The amounts thus paid by Lackawanna and Old Republic during the calendar years 1962 through 1967, inclusive, were as follows: YearLackawannaOld Republic1962$ 5,192.11$ 1,246.1219635,701.57924.2519644,777.23631.6419655,248.21701.3619665,143.33720.3619671,239.73123.07Those payments were not recorded on petitioner's books of account and were not reported on its federal income tax returns. Under the 1954 agreement and1981 Tax Ct. Memo LEXIS 10">19 modifications made to it, the right to receive these renewal commissions never became an asset of petitioner. George had graduated from high school and attended several institutes and seminars on insurance and bonding. Otherwise, he received no formal higher education. Ted graduated from the Boston University school of business administration in 1941 and the Dickinson school of law in 1948. Ted's law practice consumed the majority of his time. He started his law practice at a desk in petitioner's office and, later, when he formed a law firm with several other attorneys, his law office was adjacent to petitioner's office and they shared common entrances. Ted served as legal counsel for petitioner and for petitioner's largest group of accounts, the Correale companies. 4 Ted's major contribution to the insurance agency was to bring in new accounts. However, inasmuch as he was physically close to petitioner's office, he made himself available to petitioner's employees to answer routine questions and to sign papers. He occasionally opened petitioner's mail. Ted helped to set up petitioner's bookkeeping system and exercised some supervision over the keeping of its books. He was1981 Tax Ct. Memo LEXIS 10">20 aware of petitioner's income and expenditures as shown on its books. In the early 1960s, he spent approximately 30% of his time in petitioner's insurance operation.Ted had the use of an automobile owned by petitioner.He was on friendly terms with George and had a good relationship with Michael. He knew that George owned a vacation home at the seashore, a 33 foot boat, and that he purchased a Cadillac automobile every 2 or 3 years. Mary Petro, George's widowed mother-in-law, worked in petitioner's office a few days a week, three or four hours per day, in 1962, 1963, and 1964. She assisted the regular staff in filing, preparing mailings, and answering the telephone. She was compensated at the rate of1981 Tax Ct. Memo LEXIS 10">21 $ 25 a week for each week she worked, and her services were worth the amount paid. At all times relevant hereto, petitioner kept its financial books and records on the cash basis of accounting. The books of account were handled by office employees of petitioner under the supervision of George and Ted. The bookkeeping system was set up primarily by George and Ted and consisted of accounts receivable cards, account current ledger cards, a cash receipts journal, a cash receipts book, and bookkeeping proof sheets produced by a Burroughs machine, as well as several bank accounts. 5 It did not keep a set of double entry books and did not employ an accountant until late 1965 or early 1966. It kept no records of the nature of its travel and entertainment expenses in any of the years in issue and made no allocation between the business and personal use of its automobiles. Mail delivered to petitioner's place of business was generally placed unopened on George's desk. He opened the mail and delivered1981 Tax Ct. Memo LEXIS 10">22 checks to petitioner's employees to be recorded in the daily cash receipts book. When a premium check was recorded by an employee in the cash receipts book, an amount equal to petitioner's normal 20 percent commission was computed and entered in petitioner's books as "net commission." Ted occasionally opened the mail if George was not in the office. George kept aside some checks from the Correale companies and contingent commission checks which he chose to go unrecorded on petitioner's books. Both George and Ted understood the bookkeeping systems and had continual access to the books of account. Each year, petitioner's federal income tax return was prepared in draft form from the office records by Clara Tomko, an employee of petitioner. She added the "net commission" column in the cash receipts book and recorded that figure as gross receipts on petitioner's federal income tax return form (Form 1120). The return was then reviewed, approved, and signed. Ted signed petitioner's 1963 and 1969 returns. George signed the returns for 1962 and for 1964 through 1968, inclusive. Petitioner placed insurance for the Correale companies through several insurance carriers. During most1981 Tax Ct. Memo LEXIS 10">23 of the taxable years involved herein, George was solely responsible for the Correale companies' accounts. The Correale companies were overbilled for their insurance coverage in each of the years 1962, 1963, 1964, 1965, and 1966. 6 Bills sent to the Correale companies, on petitioner's invoices, were often as much as twice the actual cost of the insurance coverage to which they related. The Correale companies were also billed for premiums on some expired and canceled insurance policies placed through petitioner. George admits that this scheme was practiced from 1962 into 1965. The invoices in inflated amounts and for expired and canceled policies were paid by the Correale companies with checks made payable to petitioner. The checks were sometimes deposited into petitioner's accounts. On other occasions, George, in order to avoid making the usual records of such transactions, cashed the checks, sometimes depositing a part of the check proceeds to petitioner's accounts and, at other times, depositing none of the proceeds to petitioner's account.Respondent determined that the1981 Tax Ct. Memo LEXIS 10">24 amounts paid by the Correale companies in such excess premiums (that is, the amounts over the actual cost of the insurance policies and the normal commission, and the entire amounts billed for expired and canceled policies) during the calendar years 1962 through 1966 were as follows: YearAmount1962$ 85,344.041963108,394.63196493,792.53196599,929.19196634,483.74Those payments were not recorded on petitioner's books of account and were not reported on its federal income tax returns. Petitioner's failure to report this income was due to its fraud in the year 1962 through 1965, inclusive.The amounts of contingent commissions paid to petitioner in the years at issue which George and Michael appropriated for their own personal benefit were as follows: YearAmount1962$ 10,598.57196313,127.84196412,932.4719653,874.441966458.3919671,294.54196857.76Those payments were not recorded on petitioner's books of account and were not reported on its federal income tax returns. When an insured canceled a policy, the insurance carrier returned the unearned premium to petitioner, which forwarded it to the insured. 1981 Tax Ct. Memo LEXIS 10">25 Petitioner reported the returned premiums as returns and allowances, reducing its gross profits by the full amount thereof, whereas it had included only its commissions -- not the full amount of the premiums -- in gross receipts. In late 1965, both George and Ted became aware that the Correale companies' federal income tax returns were being audited by government agents and that insurance policies placed by petitioner for the Correale companies were being reviewed in connection with that audit. The Internal Revenue Service notified petitioner a short time later that an audit of its tax returns was being conducted. Sometime late in 1965 or early in 1966, petitioner retained a public accountant, Anthony F. Scelza, to review petitioner's books and records. He advised petitioner to file amended federal income tax returns for the taxable years 1962, 1963, and 1964. Scelza prepared amended returns for those years. He also prepared petitioner's income tax returns for 1965 through 1968 as they became due from the records which George presented to him. In preparing petitioner's federal income tax return for 1968, Scelza neglected to report capital gains realized by petitioner in that1981 Tax Ct. Memo LEXIS 10">26 year in the sum of $ 20,743.24. Information sufficient to report that income had been given to Scelza by petitioner. Petitioner claims that it had an offsetting capital loss for $ 10,000 which it had invested in Utrolon Corporation, $ 15,000 in Gerald Products, $ 1,500 in Joe Woodring & Co., and $ 9,000 in Comerila, which investments became worthless in 1967 or 1968. In his adjustments to petitioner's gross income, respondent included the above-mentioned excess premiums paid by the Correale companies in 1962 through 1966, inclusive; contingent commissions petitioner received in 1962 through 1968, inclusive; capital gains realized by petitioner in 1968; and payments made for renewal commissions by Lackawanna and Old Republic in 1962 through 1967, inclusive. Respondent determined that 20 percent of the returned premiums properly qualified as a reduction of gross profits and disallowed 80 percent of the reduction in gross profits for each of the years 1962 through 1968, inclusive. Respondent determined that petitioner's claimed deductions for (1) brokers' commissions, (2) salaries, and (3) travel, entertainment, and sales promotion expenses were to be disallowed in the years and1981 Tax Ct. Memo LEXIS 10">27 amounts set forth in the following table: Travel, Entertainment,and Sales PromotionYearCommissionsSalariesExpenses1962$ 1,040.001,665.1319632,000.001,965.951964144.164,155.901965$ 8,820.4017,642.322,138.2119664,496.4520,578.915,197.5419672,360.8218,595.078,293.6319681,895.528,268.8419692,278.34Other adjustments made in the notices of deficiencies were not contested at the trial or on brief and our redetermination of them is deemed to have been waived by petitioner. Petitioner deducted as brokers' commissions not only amounts actually paid to licensed brokers, but the amounts of discounts given to petitioner's employees, Ted's law office employees, and others, for personal insurance policies written for them. Respondent disallowed the deduction claimed by petitioner for brokers' commissions, in its entirety, on the grounds that it could not be determined how much of the deduction represented deductible commissions to licensed brokers. Petitioner did not pay dividends in any of the years at issue. Respondent disallowed as unreasonable and excessive deductions for compensation1981 Tax Ct. Memo LEXIS 10">28 paid to Mary Petro for the taxable years 1962 through 1964 and to George and Ted for the years 1965 through 1967, inclusive. The compensation paid to them in the years indicated was as follows: YearMary PetroGeorgeTed1962$ 1,040.00$ 12,786.82$ 7,681.5719632,000.0015,449.828,172.061964144.16(Not available)196527,860.1412,782.18196627,853.3516,775.56196731,110.8212,484.25Respondent disallowed the entire amount claimed for salaries paid to Mary Petro in 1962, 1963, and 1964 on the ground that she did not perform any services for petitioner. Respondent determined that a reasonable salary for George for 1965, 1966, and 1967, was $ 15,000, $ 15,500, and $ 16,000, respectively, and that reasonable compensation for Ted for those years was $ 8,000, $ 8,500, and $ 9,000, respectively. Respondent disallowed the excess. Reasonable compensation for George for 1965, 1966, and 1967 was $ 16,500, $ 17,000, and $ 17,500, respectively, and for Ted for those years was $ 9,000, $ 9,500, and $ 10,000, respectively. Respondent disallowed the full amount claimed by petitioner as deductions for travel, entertainment and1981 Tax Ct. Memo LEXIS 10">29 sales promotion expenses on the grounds that petitioner failed properly to substantiate such expenses and because petitioner did not allocate them between personal and business expenditures. Fred Correale and George Laputka were indicted in 1970 on several counts of willfully and knowingly aiding and assisting in the preparation of false and fraudulent income tax returns (i.e., the tax returns of the Correale companies) in violation of section 7206(2). George was also indicted on several counts for attempting to evade and defeat petitioner's income taxes, in violation of section 7201. George pleaded guilty to those charges insofar as they related to the taxable year 1963 and was fined and imprisoned. Petitioner reported taxable income and respondent determined adjustments thereto and taxable income for the years and in the amounts set forth in the following table: Taxable IncomeYearPer Return1962$ 1,331.51 19632,367.45 19645,299.47 1965( 3,036.70)196621,374.70 1967(11,381.63)1968( 2,189.08)19698.39 Respondent's AdjustmentsAdditionalAdditionalTaxable IncomeIncome orDisallowedDeductionsDeterminedYearGross ProfitDeductionsAllowedby Respondent1962$ 102,380.84$ 4,269.96$ 1,855.76$ 106,126.5819637 122,668.507,820.91370.67132,486.191964112,133.878,819.57634.78125,618.131965115,132.7532,126.531,739.10142,483.48196643,914.1535,639.12500.00100,427.9719675,694.8434,610.872,025.1326,898.95196837,459.1921,545.991,246.2755,569.8319691,702.617,039.75524.708,226.051981 Tax Ct. Memo LEXIS 10">30 Respondent also determined that part of the underpayment of tax for each of the years 1962 through 1968, inclusive, was due to fraud and that part of the underpayment for 1969 was due to negligence and intentional disregard of the rules. A part of the underpayment of tax required to be shown on each of petitioner's returns for 1962 through 1965, inclusive, was due to fraud. In this proceeding, petitioner claims that it is entitled to a capital loss deduction of $ 35,500 for 1968, not previously claimed by it, due to the worthlessness of its investments in Utrolon, Gerald Products, Joe Woodring & Co., and Comerila. OPINION Issue 1. Unreported IncomePetitioner concedes that it failed to report some of its income during the taxable years involved. It admittedly failed to report capital gains from the sale of stock in 1968. It also concedes its failure to report certain commissions, including contingent commissions, as income for the taxable years 1962 through 1968. 1981 Tax Ct. Memo LEXIS 10">31 Petitioner argues that the remaining adjustments to gross income and gross profit are not proper in that they do not reflect additional income to it. a. Payments by Correale Companies. Petitioner asserts that the payments of excess and fictitious premiums by the Correale companies cannot be considered income to it because it did not authorize the overbilling and did not receive the fruits of those transactions. Petitioner argues, alternatively, that, if we find the premiums to be income to it, it is entitled to an offsetting embezzlement loss deduction under section 165. A corporation is taxable on monies it receives from transactions authorized by it or within the scope of its corporate activities, or where it has command over the monies received. Union Stock Farms v. Commissioner, 265 F.2d 712">265 F.2d 712 (9th Cir. 1959). The payments in issue here were made in response to or supported by petitioner's invoices. They were in the form of checks mailed to petitioner's office and payable to "M. J. Laputka & Sons." All or a portion of the proceeds were often deposited in petitioner's bank accounts and expended by it for corporate purposes. All of this was accomplished1981 Tax Ct. Memo LEXIS 10">32 by or through petitioner's chief operating officer, to all outward appearances acting on petitioner's behalf. The transactions giving rise to this income are properly to be treated as having been authorized by petitioner and the income as having been received by it. It is axiomatic that a corporation can act only through its officers and other agents. Asphalt Industries, Inc. v. Commissioner, 384 F.2d 229">384 F.2d 229, 384 F.2d 229">231 (3rd Cir. 1967). Petitioner relies upon Sherin v. Commissioner, 13 T.C. 221">13 T.C. 221 (1949), and All Americas Trading Corp. v. Commissioner, 29 T.C. 908">29 T.C. 908 (1958). In Sherin, the deficiency was asserted as to certain payments by customers to the corporate-petitioner's president for silk goods at prices over the OPA ceiling price. Such funds were used for the president's personal benefit. In All Americas Trading Corp., the deficiency was asserted as to certain "kickbacks" received by the president. In both cases, we held that the payments were not income to the corporations. Petitioner points to the nature of the transactions in those cases as being beyond the usual, lawful business operation of those corporations. Petitioner1981 Tax Ct. Memo LEXIS 10">33 claims that, since Michael and George's scheme was also illicit, the monies received should not be characterized as income to petitioner, but, rather, as income only to Michael and George, individually. The factual patterns in the cases cited by petitioner are, however, significantly distinguishable from the facts of this case. In All Americas Trading Corp., the president, one Avirgan, was, during the years in issue, a minority shareholder at first and then merely a salaried employee. His main function was that of purchasing agent. The majority shareholder, Tandeter, "directed and controlled the corporate operations, giving complete instructions to Avirgan on how to conduct the business of [the corporation.]" 29 T.C. 908">29 T.C. 910. Suppliers of the corporation had an oral arrangement with Avirgan personally whereby Avirgan received kickbacks on purchases made. The payments were not made to or through the corporation nor upon the corporation's invoices. We held that the monies received were received by Avirgan under a claim of right and not on behalf of the corporation. 29 T.C. 908">29 T.C. 913. We distinguished the numerous cases where money received by virtue1981 Tax Ct. Memo LEXIS 10">34 of such a scheme was held to be income to the corporation 8 and concluded: Avirgan was only a minority shareholder, although he was entitled to 50 per cent of the profits, until June 21, 1950, after which date he held no beneficial title to any stock. He was only the nominal president of petitioner, although having the power to sign checks binding the petitioner. He was in reality only a purchasing agent, with Tandeter in actual control of the petitioner. Avirgan cannot be regarded as acting for the corporation in receiving the kickbacks. * * * [29 T.C. 908">29 T.C. 913.] In Sherin, the petitioner-corporation operated a manufacturing and sales business. Messrs. Berger and Sherin were equal shareholders. Berger was president and in complete charge of the sales operations, working out of the corporate offices in New York City. Sherin, the secretary-treasurer, managed1981 Tax Ct. Memo LEXIS 10">35 the production operation at the Elmira, New York, plant.Berger made a secret arrangement to receive kickbacks from buyers in the form of an excess amount over the OPA ceiling prices.Sherin knew nothing of the plan. All funds were payable to Berger, individually. The president was not a majority or controlling shareholder and his actions could not be characterized as those of the corporation. We held that the corporation had not authorized the illicit payments and therefore there was no income to the corporation. The corporation in Sherin never received any benefit from the transaction."Command over the income," we said, "is a primary test of taxability." 13 T.C. 221">13 T.C. 229. Both before and after Michael's death, George owned a 60 percent equity interest in the corporation. It is abundantly clear from the record that Michael and George -- and after Michael's death, George -- dominated the affairs of petitioner. On all the evidence here, this income was clearly solicited by and paid to the corporate petitioner. Petitioner seeks to avoid the conclusion we reach here on the basis that, since Ted had 50 percent voting power and was not involved in any illegal activity, 1981 Tax Ct. Memo LEXIS 10">36 Michael and George could not bind the corporation by their actions. We do not accept petitioner's argument that Ted was an independent, innocent shareholder. 9 He allowed himself to be dominated by his father and by his brother with regard to petitioner's business, and we believe that he was negligent, if not consciously indifferent, in not inquiring sooner into the financial affairs of the corporation; e.g., before the Internal Revenue Service audit appeared imminent. Ted's law office was adjacent to the insurance office. He not only had access to the books and records of petitioner, but he spent time in the insurance office and was sufficiently knowledgeable of the operation to answer employees' questions. He reviewed the books and records when he approved the draft corporate tax returns. He knew that the books showed that petitioner was operating either at a loss or with only a small profit margin. He knew that George's salary in 1962 and 1963 was approximately $ 12,700 and $ 15,400, respectively (although higher in the later years). Yet, he also knew that the company had invested in numerous business ventures, that the company had bought cars for himself and for George,1981 Tax Ct. Memo LEXIS 10">37 that George owned a seashore home as well as his personal residence and a 33-foot boat, and that George purchased a Cadillac automobile every two or three years. Although Ted was not involved in the illicit scheme, we believe that he had reason to be suspicious prior to the Internal Revenue Service audit.We conclude that the acts of the dominant shareholders here are to be imputed to the corporation, and that petitioner participated in and authorized the overbilling scheme. The monies received benefited petitioner in part and petitioner had command over that income. We hold that respondent properly included the sums generated from the overbilling scheme in petitioner's income. Petitioner attacks respondent's determination of the amount of income realized through the overbilling scheme in each taxable year. Respondent's determination is presumptively correct. See Holland v. United States, 348 U.S. 121">348 U.S. 121 (1954); rehearing denied 348 U.S. 932">348 U.S. 932 (1955); Valetti v. Commissioner, 260 F.2d 185">260 F.2d 185 (3d Cir. 1958); Moriarty v. Commissioner, 18 T.C. 327">18 T.C. 327 (1952),1981 Tax Ct. Memo LEXIS 10">38 affd. per curiam 208 F.2d 43">208 F.2d 43 (D.C. Cir. 1953). The method used by respondent is deemed reasonable unless the taxpayer can show that it is arbitrary. Helvering v. Taylor, 293 U.S. 507">293 U.S. 507 (1935). Petitioner's accountant testified that, due to the lack of any coherent bookkeepting system in the early 1960s, it was almost impossible for him to reconstruct the correct amount of income to be entered on the amended tax returns. The revenue agent spent much time studying whatever records were available from petitioner and from the Correale companies. We cannot say that the method respondent used to determine the deficiencies was arbitrary or unreasonable. Petitioner has not sustained its burden of showing that the amount of additional income from the Correale companies is incorrect in any of the years at issue. We do not conclude, as petitioner would have us do, that it is entitled to an offsetting embezzlement loss deduction.Petitioner argues that if the monies are includable as its income, it is entitled to an embezzlement loss deduction pursuant to section 165 for each taxable year in which funds were misappropriated by George or Michael. Respondent1981 Tax Ct. Memo LEXIS 10">39 argues that there was no embezzlement. He contends that, inasmuch as the shareholders who misappropriated the money also dominated the corporation, it would be anomalous to say that there was the requisite intent to embezzle. They would be taking money from themselves, and this does not constitute embezzlement. Ruidoso Racing Association, Inc. v. Commissioner, 476 F.2d 502">476 F.2d 502 (10th Cir. 1973); Federbush v. Commissioner, 34 T.C. 740">34 T.C. 740 (1960), affd. per curiam 325 F.2d 1">325 F.2d 1 (1963). We agree with respondent. The major question is one of intent. In 34 T.C. 740">Federbush, supra at 750, we stated: Not only does the record indicate that the Federbush brothers had no intent to steal from the corporation, but rather, we think it reveals that they were interested primarily in reducing their taxes which was a more rewarding objective best accomplished through bypassing the corporate books with the corporate income. In this manner they would, if not detected, lighten the tax burden at both the corporate and shareholder level. * * As in Federbush, we have not disregarded the corporate entity. Rather, we have determined that there was1981 Tax Ct. Memo LEXIS 10">40 no intent to embezzle. The money diverted by George and Michael and used by them for their personal benefit is more accurately described as disguised dividends to them. In any event, no deduction would be allowable for the years in which the alleged embezzlement took place. Normally, a theft loss otherwise qualifying for deduction is deductible in the year in which the loss is sustained. Sec. 1.165-1(d)(3), Income Tax Regs. However, if in that year there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, then no loss is permitted until the taxable year in which it can be ascertained with reasonable certainty whether or not such reimbursement will be received. Ramsay Scarlett & Co. v. Commissioner, 61 T.C. 795">61 T.C. 795, 61 T.C. 795">811 (1974), affd. 521 F.2d 786">521 F.2d 786 (4th Cir. 1975). Ted never instituted a stockholder's derivative suit or other proceeding on behalf of petitioner against his brother for restitution, but it appears probable that such a proceeding would have been successful. b. Commissions from Lackawanna and Old Republic. Certain checks for renewal commissions on Lackawanna and Old Republic insurance1981 Tax Ct. Memo LEXIS 10">41 written by Michael prior to petitioner's incorporation were mailed regularly by Lackawanna and Old Republic to petitioner's corporate office. The checks were made payable to "M. J. Laputka," even after Michael's death although it appears that the companies were aware of the fact of his death. We are persuaded on the basis of all the evidence that, as a matter of fact, the persons involved at the time of petitioner's incorporation and at all other times relevant hereto intended that the amounts paid by these two companies were to remain the property of Michael. The right to receive those renewal commissions from Lackawanna and Old Republic simply never became an asset of petitioner. The fact that the renewal commission checks were mailed to petitioner's office is not determinative. The office staff was not responsible for, and, indeed, there was little need for more than minimal clerical work as to those renewal checks. We hold that such renewal checks, pursuant to the agreement of the persons involved and the oral modifications thereto, are not includable in petitioner's income. Petitioner received income in addition to that which it reported on its returns in the amounts1981 Tax Ct. Memo LEXIS 10">42 determined by respondent, for each of the years 1962 through 1966 from the Correale companies, for each of the years 1962 through 1968 in contingent commissions, and in 1968 from capital gains. The amounts paid by Lackawanna and Old Republic as renewal commissions were not income to petitioner. Issue 2. Deductions and Returns and Allowancesa. Compensation of Officers and Employees. Section 162(a)(1) allows as a deduction "a reasonable allowance for salaries or other compensation for personal services actually rendered" when such allowances are "ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." In order to be deductible, compensation must be paid purely for services and be reasonable in amount. Sec. 1.162-7(a), Income Tax Regs.; Electric and Neon, Inc. v. Commissioner, 56 T.C. 1324">56 T.C. 1324, 56 T.C. 1324">1340 (1971), affd. without opinion 496 F.2d 876">496 F.2d 876 (5th Cir. 1974); Nor-Cal Adjusters v. Commissioner, 503 F.2d 359">503 F.2d 359, 503 F.2d 359">362 (9th Cir. 1974), affg. a Memorandum Opinion of this Court; Klamath Medical Service Bureau v. Commissioner, 29 T.C. 339">29 T.C. 339, 29 T.C. 339">347 (1957), affd. 261 F.2d 842">261 F.2d 842 (9th Cir. 1958),1981 Tax Ct. Memo LEXIS 10">43 cert. denied 359 U.S. 966">359 U.S. 966 (1959). Whether the payments were intended as compensation for services rather than a distribution of profits is a question of fact which must be decided on the basis of the particular facts and circumstances of the case. Paula Construction Co. v. Commissioner, 58 T.C. 1055">58 T.C. 1055, 58 T.C. 1055">1059 (1972), affd. without opinion 474 F.2d 1345">474 F.2d 1345 (5th Cir. 1973). The question of the reasonableness of the compensation is also a factual question. Charles Schneider & Co., Inc. v. Commissioner, 500 F.2d 148">500 F.2d 148, 500 F.2d 148">151 (8th Cir. 1974), cert. denied 420 U.S. 908">420 U.S. 908 (1975), affg. a Memorandum Opinion of this Court; Levenson & Klein, Inc. v. Commissioner, 67 T.C. 694">67 T.C. 694, 67 T.C. 694">711 (1977); Pepsi-Cola Bottling Co. of Salina, Inc. v. Commissioner, 61 T.C. 564">61 T.C. 564, 61 T.C. 564">567 (1974), affd. 528 F.2d 176">528 F.2d 176 (10th Cir. 1975). The cases contain a lengthy litany of factors relevant in determining whether amounts are paid purely for services and represent reasonable compensation, see Mayson Mfg. Co. v. Commissioner, 178 F.2d 115">178 F.2d 115, 178 F.2d 115">119 (6th Cir. 1949); Miles-Conley Co. v. Commissioner, 173 F.2d 958">173 F.2d 958 (4th Cir. 1949);1981 Tax Ct. Memo LEXIS 10">44 Irby Construction Company v. United States, 154 Ct. Cl. 342">154 Ct. Cl. 342, 290 F.2d 824">290 F.2d 824 (1961); Home Interiors and Gifts, Inc. v. Commissioner, 73 T.C. 1142">73 T.C. 1142 (1980), and no single factor is determinative, 178 F.2d 115">Mayson Mfg. Co. v. Commissioner, supra; 73 T.C. 1142">Home Interiors and Gifts, Inc. v. Commissioner, supra at 1156. Thus, petitioner's failure to pay dividends is but one factor to be considered. See Laure v. Commissioner, 70 T.C. 1087">70 T.C. 1087 (1978); 67 T.C. 694">Levenson & Klein, Inc. v. Commissioner, supra.However, when the case involves a closely held corporation with the controlling shareholders setting their own level of compensation as employees the reasonableness of the compensation is subject to close scrutiny. Perlmutter v. Commissioner, 44 T.C. 382">44 T.C. 382, 44 T.C. 382">401 (1965), affd. 373 F.2d 45">373 F.2d 45 (10th Cir. 1967). Respondent's determination that the disputed payments are not deductible is presumed to be correct and petitioner bears the burden of proving that determination erroneous. Botany Worsted Mills v. United States, 278 U.S. 282">278 U.S. 282, 278 U.S. 282">292 (1929); Rule 142(a), Tax Court Rules1981 Tax Ct. Memo LEXIS 10">45 of Practice and Procedure.The amounts paid to George and Ted as salaries for the years 1962-1967 were as follows: YearGeorgeTedTotal1962$ 12,786.48$ 7,681.57$ 21,921.20196315,449.828,172.0623,621.881964(Not available)20,256.11196527,860.1412,782.1840,642.32196627,853.3516,775.5644,578.91196731,110.8212,484.2543,595.07In issue here is the reasonableness of the salaries for George and Ted for the years 1965, 1966, and 1967, and the salary paid to Mary Petro in the amounts of $ 1,040, $ 2,000, and $ 144.16, respectively.Beginning with 1965, there was a sharp rise in George's and Ted's salaries with no great correlative change in the amount or character of the services they provided. Petitioner introduced testimony by Ted and George to the effect that their salaries were in fact reasonable. Petitioner, citing Roth Office Equipment Co. v. Gallagher, 172 F.2d 452">172 F.2d 452 (6th Cir. 1949), contends that, inasmuch as respondent did not offer evidence to rebut these statements, the issue should be decided in favor of the petitioner. However, Roth Office Equipment Co. is controlling only where1981 Tax Ct. Memo LEXIS 10">46 the taxpayer introduces "unimpeached, uncontradicted testimony from well-qualified, impartial witnesses" sustaining its contention. 172 F.2d 452">172 F.2d at 455. [Emphasis added.] While respondent did not introduce expert evidence as to what would have constituted reasonable compensation in this instance, Roth Office Equipment Co. does not contemplate the type of self-serving testimony introduced by petitioner here. The absence of persuasive evidence to justify the increases in George and Ted's salaries makes it a close question whether petitioner has carried its burden of proof to any extent. See Heil Beauty Supplies v. Commissioner, 199 F.2d 193">199 F.2d 193 (8th Cir. 1952). Nevertheless, we believe that George and Ted were each entitled to some increase in salary between 1963 and 1965 in light of the additional duties and responsibilities which they had after Michael's semi-retirement in 1962 and his death in 1964.Thus, on all the evidence, we have found, and therefore hold, that reasonable compensation for George for 1965, 1966, and 1967, was $ 16,500, $ 17,000, and $ 17,500, respectively, and for Ted for those years was $ 9,000, $ 9,500, and $ 10,000. 1981 Tax Ct. Memo LEXIS 10">47 Respondent erred with respect to the disallowance of the deductions for salaries paid to Mary Petro. The petitioner's office manager, Clara Tomko, a credible witness, testified that, contrary to respondent's position, Mary Petro did, indeed, work in petitioner's office a few days a week for three or four hours per day during 1962, 1963, and 1964. She assisted the regular staff in filing, preparing mailings, and answering the telephone, and we find that the $ 25.00 per week salary paid to her was not unreasonable. b. Travel. Entertainment and Sales Promotion Expense. Petitioner deducted certain amounts for each of the years 1962 through 1969 for travel, entertainment and sales promotion expenses. Petitioner presented no evidence whatever regarding the nature of any trip or activity, the parties involved, or specific amounts expended. No receipts were produced. Petitioner's accountant testified that he made an allocation between personal and business expenditures based on what he felt was reasonable. In order for deductions to be allowed for such expenditures, the taxpayer must establish that they were ordinary and necessary, and that they were proximately related to1981 Tax Ct. Memo LEXIS 10">48 its trade or business. Sanford v. Commissioner, 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). Further, for taxable years after 1962 the taxpayer must present evidence that each item was actually expended in the amount claimed. Section 274 was added to the Code by section 4 of the Revenue Act of 1962, 76 Stat. 974, applicable to years after 1962, to curb the widespread abuse of the travel and entertainment deduction, H. Rept. 1447, 1962-3 C.B. 423, and to add stringent objective substantiation requirements to the existing law. To meet the requirements of section 274, a taxpayer must substantiate. 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, * * (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons entertained, [or] using the facility * * .[Sec. 274(d)(3).] Ted testified merely that petitioner incurred some expenses for entertainment.Otherwise, petitioner presented no evidence1981 Tax Ct. Memo LEXIS 10">49 as to the business purpose of the entertainment or of the amounts expended. Self-serving and vague testimony is not enough to satisfy the substantiation requirements of 274(d). Ashby v. Commissioner, 50 T.C. 409">50 T.C. 409 (1968). 101981 Tax Ct. Memo LEXIS 10">50 Nor is such testimony sufficient to substantiate deductions claimed for 1962 and previous years, prior to the effective date of section 274. In similar circumstances, we said in Hearn v. Commissioner, 36 T.C. 672">36 T.C. 672, 36 T.C. 672">673-674 (1961), affd. 309 F.2d 431">309 F.2d 431 (9th Cir. 1962), cert. denied 373 U.S. 909">373 U.S. 909 (1963): Petitioner appeared as a witness on his own behalf. * * he presented no records or proof with respect to the contested items other than his own testimony. Although we do not suggest that sworn testimony itself may not be suitable proof in appropriate cases, the testimony here was so general and of such summary and conclusory character that, in our opinion, petitioner has wholly failed to carry the burden of proof, not only as to the making of the expenditures in question * * * but also as to the necessary proximate relationship between the alleged expenditures and his business. Petitioner appeared to us to be an experienced and sophisticated lawyer; and we do not feel that we should indulge in conjecture to fill the gaps in his proof. The expenses in question are of such nature as to afford considerable opportunity for abuse, and it1981 Tax Ct. Memo LEXIS 10">51 is not too much to ask of a taxpayer seeking the benefit of such deductions that he offer not only reasonably satisfying proof that the expenses were in fact incurred but also that they bore a proximate relationship to the conduct of his business. * * Ted was unable to corroborate any travel, entertainment, and sales promotion expense in detail, not only because of the lapse of time between the alleged expenses and the time of trial, but because the corporation only haphazadly made records of such expenditures, if any. We sustain respondent's determination as to the disallowance of travel, entertainment and sales promotion expenses claimed for each of the years at issue. c. Brokers' Commissions. Petitioner wrote insurance policies for its employees and for Ted's law office employees and others not employed by petitioner. Petitioner gave these individuals discounts on the insurance. For accounting purposes, such discounts were shown on petitioner's books as brokers' commissions in addition to actual commissions paid to licensed brokers. Inasmuch as petitioner reported as income the 20 percent commission to which it was normally entitled, brokers' commissions and discounts1981 Tax Ct. Memo LEXIS 10">52 which reduced that percentage were proper offsets against that income. 11 We hold that the "brokers' commissions" were properly deducted from income and that, accordingly, respondent erred in making this adjustment. d. Return Premiums. Petitioner deducted the full amount of premiums returned by the insurance carriers when a policy was canceled. The return premium was forwarded to the insured. Petitioner, however, did not report the full amount of premiums received as income. Rather, it reported only the 20 percent commission to which it was normally entitled. In light of petitioner's method of reporting gross receipts, we sustain respondent's disallowance as returns and allowances of returned premiums in excess of 20 percent thereof. e. Worthlessness of stock. Petitioner contends that certain of its stock investments became worthless during the taxable year 1967 or 1968 for which no deduction was claimed on its returns. Section 165 permits a deduction for worthless securities. Such a loss is deductible in the year in which the1981 Tax Ct. Memo LEXIS 10">53 stock becomes totally worthless. Sec. 1.165-5, Income Tax Regs. However, the taxpayer must establish the cost basis of such stocks and that, in fact, the stocks became totally worthless in the taxable year in which the loss is claimed. Zarnow v. Commissioner, 48 T.C. 213">48 T.C. 213, 48 T.C. 213">217 (1967). Worthlessness of stock is a question of fact, and the conclusion that stock became worthless in the taxable year claimed may not be based only on the subjective belief or opinion of the taxpayer, but must be based on objective evidence. Boehm v. Commissioner, 326 U.S. 287">326 U.S. 287 (1945). The taxpayer need not be an "incorrigible optimist," however, and prove that recoupment would be impossible. United States v. White Dental Co., 274 U.S. 398">274 U.S. 398, 274 U.S. 398">403 (1927). Petitioner presented oral testimony of its accountant that he had prepared a schedule of stock acquisitions and losses for the petitioner. The information, including cost basis of the stocks, was gained from conversations with George. Petitioner also submitted into evidence a letter from a referee in bankruptcy informing Utrolon Corporation (one of the corporations whose stock is in issue) that it had been1981 Tax Ct. Memo LEXIS 10">54 placed in involuntary bankruptcy. No other evidence was introduced as to the worthlessness of any stock or what was the proper year in which to take these deductions. We find the evidence insufficient to sustain petitioner's burden of proof on this issue. Even if we were to conclude that the evidence of involuntary bankruptcy of Utolon was sufficient to establish worthlessness of its stock, the evidence regarding its cost basis, as with the cost basis of each of the other claimed investments, is unsatisfactory.The testimony in this regard was conclusory, self-serving, and contradictory, and we are unable to say that the wholly unsupported statements of George to his accountant as to the cost basis of the stocks can be considered at all reliable. We therefore hold that petitioner has failed to establish its entitlement to such deductions in whole or any part. Issue 3. Additions to Tax Under Section 6653(b) for 1962 through 1968Respondent determined that petitioner's failure to report income with respect to each of the years 1962 through 1968, inclusive, from the excess billing scheme, contingent commissions, and gain from the sale of stock was done with an intent to1981 Tax Ct. Memo LEXIS 10">55 evade tax and, therefore, fraudulent within the meaning of section 6653(b). 12 Petitioner contends that no part of any underpayment was due to fraud, or, in the alternative, that the fraud committed by its officers and shareholders should not be imputed to it. The addition to tax for fraud is imposed pursuant to section 6653(b) if any part of any underpayment of tax is due to fraud. The measure of the penalty to be assessed is 50 percent of the entire underpayment; the difference between the correct tax due and the tax shown on petitioner's return filed for each of the years at issue. Levinson v. United States, 496 F.2d 651">496 F.2d 651 (3rd Cir. 1974), cert. denied 419 U.S. 1040">419 U.S. 1040 (1974). In order to prevail, respondent must show by clear and convincing evidence that at least a part of the deficiency was due to fraud. Sec. 7454(a); Rule 142(b), Tax Court Rules of Practice and Procedure; Valetti v. Commissioner, 260 F.2d 185">260 F.2d 185 (3rd Cir. 1958); Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85 (1970).1981 Tax Ct. Memo LEXIS 10">56 Our determination on the issue of fraud affects not only petitioner's liability for additions to tax under section 6653(b), but, also, its total liability for deficiencies asserted for the years 1962 through 1966, inclusive. Without such a finding, the statute of limitations prevents the Commissioner from asserting a deficiency as to those years. The issue of fraud is a factual question to be determined by consideration of the entire record. 13Mensik v. Commissioner, 328 F.2d 147">328 F.2d 147, 328 F.2d 147">150 (7th Cir. 1964), cert. denied 379 U.S. 827">379 U.S. 827 (1964); Otsuki v. Commissioner, 53 T.C. 96">53 T.C. 96, 53 T.C. 96">105-106 (1969). To establish fraud, respondent must show that the taxpayer intended to evade taxes which it knew or believed it owed, by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. Stoltzfus v. United States, 398 F.2d 1002">398 F.2d 1002, 398 F.2d 1002">1004 (3rd Cir. 1968), cert. denied 393 U.S. 1020">393 U.S. 1020 (1969); Webb v. Commissioner, 394 F.2d 366">394 F.2d 366, 394 F.2d 366">377 (5th Cir. 1968), affg. a Memorandum Opinion of this Court. The critical question is whether the requisite intent is present, and this must be affirmatively1981 Tax Ct. Memo LEXIS 10">57 established by the Commissioner. 260 F.2d 185">Valetti v. Commissioner, supra; Drieborg v. Commissioner, 225 F.2d 216">225 F.2d 216 (6th Cir. 1955); Pigman v. Commissioner, 31 T.C. 356">31 T.C. 356 (1958). Fraud will not be imputed or implied and mere suspicion of fraud is insufficient. Estate of Mazzoni v. Commissioner, 451 F.2d 197">451 F.2d 197 (3rd Cir. 1971), affg. a Memorandum Opinion of this Court. And this precludes a finding of fraud based simply on petitioner's failure to carry its burden of proof that it did not have unreported income as determined by respondent. Nevertheless, inasmuch as fraud can seldom be established by direct proof, it may be based upon circumstantial evidence and reasonable inferences drawn from the evidence. See 451 F.2d 197">Estate of Mazzoni v. Commissioner, supra; 398 F.2d 1002">Stoltzfus v. United States, supra; Schwarzkopf v. Commissioner, 246 F.2d 731">246 F.2d 731, 246 F.2d 731">734 (3rd Cir. 1957), affg. a Memorandum Opinion of this Court. We have kept these1981 Tax Ct. Memo LEXIS 10">58 admonitions carefully in mind in arriving at our conclusions. Fraudulent intent can seldom be established by a single act. Rather, we must review the taxpayer's entire course of conduct and draw reasonable and appropriate inferences therefrom. Helvering v. Mitchell, 303 U.S. 391">303 U.S. 391 (1938); Gano v. Commissioner, 19 B.T.A. 518">19 B.T.A. 518 (1930). Indicia of fraud include: A substantial understatement of income and a pattern of such understatement over several years; failure to keep any, or adequate, books and records, particularly where the taxpayer is an intelligent and experienced businessperson; extensive dealings in cash; destruction or alteration of financial records; and failure to turn over to an accountant all information necessary to prepare accurate income tax returns. 14 A plea of quality is also indicative of fraud, but not conclusive on the issue. See American Lithofold Corp. v. Commissioner, 55 T.C. 904">55 T.C. 904, 55 T.C. 904">924 (1971). The omission from income in 1968 of gain from the sale of stock was due1981 Tax Ct. Memo LEXIS 10">59 to a mistake on the part of Anthony Scelza, petitioner's accountant. In credible testimony, he stated that all of the information had been supplied to him, that it appeared on his worksheet, but that it was inadvertently left out of the submitted copy of the tax return. There was no fraudulent intent on petitioner's part in respect of this omission and we have not considered it further in making our determination as to the issue of fraud. We have carefully considered the evidence presented as to the possible fraudulent underpayment of taxes attributable to the overbilling scheme and commission income and we conclude that fraud has been proved by clear and convincing evidence for each of the taxable years 1962 through 1965, inclusive, in this connection. George's admission that he engaged in the overbilling scheme at least through the beginning of 1965 is highly indicative of the fraud alleged for those years. Coupled with George's guilty plea to a criminal indictment for fraud, 15 and the other circumstantial evidence presented by the respondent, we are convinced that the underpayment of tax for each of those years was done with intent to evade tax. The bookkeeping system of1981 Tax Ct. Memo LEXIS 10">60 the corporation in the early 1960s was haphazard at best, despite the fact that George, Michael, and Ted were experienced in business. Incoming mail was placed unopened on George's desk. He opened the mail and then gave checks to the employees to be recorded in the daily cash receipts book.George kept aside some checks from the Correale companies which he chose to go unrecorded on petitioner's books. He knew that those corporate receipts went unrecorded in petitioner's books of account and that they went unreported when petitioner's tax returns were prepared from the books. George cashed or deposited only a part of the proceeds of many of those checks. He was able to do so without his personal endorsement, because he was a director of the bank and had special permission to cash checks endorsed only by "M.J. Laputka & Sons." Such a practice was not allowed for other customers of the bank; that is, all corporate checks with only a corporate endorsement normally had to be deposited in full in the corporate account. George did so in order to avoid making the usual records of these transactions. Although petitioner retained an accountant early in 1966, George was less than candid1981 Tax Ct. Memo LEXIS 10">61 with him and failed to present him with all of the information regarding income properly includable in gross income, including the contingent commissions and the nature and full extent of the overbilling scheme. All of these were done with intent to conceal the true amount of petitioner's income. We hold that the addition to tax for fraud was properly asserted for each of the taxable years 1962 through 1965, inclusive. The record does not justify a finding of fraud for any of the taxable years 1966 through 1968. 16 Respondent alleges that the overbilling scheme continued through 1966. Respondent proferred as evidence of the extent of the overbilling scheme only extra-judicial summaries and charts prepared by the revenue agent. At no time was the actual evidence presented at the hearing. 17 These extra-judicial summaries were the foundation of respondent's case. Such extrajudicial summaries are not an adequate substitute for the evidence itself. They constitute inadmissible hearsay. United States v. Morse, 491 F.2d 149">491 F.2d 149 (1st Cir. 1974). 18 Notwithstanding the other, circumstantial indicia1981 Tax Ct. Memo LEXIS 10">62 of fraud, absent this evidence we do not believe that respondent has proved his case to the necessary degree in respect of these years. We do not believe that the fraud penalty for the years 1966-1968 can be sustained on account of the omission from income of certain commissions. Mere suspicion of fraud is not enough. Indeed, proof by a slight preponderance of the evidence is not enough. 260 F.2d 185">Valetti v. Commissioner, supra at 188. In these later years, Ted became more active in the daily operation of the business because of the audit by the Internal Revenue Service. The independent accountant prepared the tax returns as they became due, and was in the process of straightening out the financial books and records of the earlier years. There is, in addition, a dramatic drop in the years 1966 through 1968 in the amounts omitted from income attributable to commissions. While there is no express doctrine of de minimus with respect to the fraud penalty, the fact that relatively small amounts of income went unreported bears on the question of intent. See Klise v. Commissioner, 10 B.T.A. 1234">10 B.T.A. 1234 (1928). It seems to us that it is unlikely that such omissions1981 Tax Ct. Memo LEXIS 10">63 were the product of an intent to evade taxes. It is not clear in this instance where the line begins and ends between fraud and negligence, but we are not permitted to sustain a fraud penalty on less than clear and convincing evidence. 260 F.2d 185">Valetti v. Commissioner, supra.The record must contain some convincing affirmative indication of the requires specific intent. Cirillo v. Commissioner, 314 F.2d 478">314 F.2d 478, 314 F.2d 478">482 (3rd Cir. 1963). 1981 Tax Ct. Memo LEXIS 10">64 In the case of a corporation, the fraudulent activities of an officer or shareholder may be attributed to the corporation if: (1) The wrongdoer so dominates the corporation that it is, in reality, a creature of his will, his alter ego or (2) the agent was acting "in behalf of, and not against interests of, the corporation." 19Asphalt Industries, Inc. v. Commissioner, 384 F.2d 229">384 F.2d 229, 384 F.2d 229">233-234 (3rd Cir. 1967); Ruidoso Racing Association, Inc. v. Commissioner, 476 F.2d 502">476 F.2d 502, 476 F.2d 502">506 (10th Cir. 1973). Petitioner here relies heavily on Asphalt Industries, Inc. There, two shareholders each owned 50 percent of the stock in the petitioner-corporation. Anderson was president and devoted full time to the day-to-day operations of the business. Schwoebel was engaged in another business and only spent ten percent of his time in the corporation's affairs. Anderson consulted Schwoebel on important corporate decisions.The two were not related in any way. Each year an independent auditing firm reviewed the books and prepared the corporate income tax returns. It was not until after Anderson's death that Schwoebel learned that the former had been diverting substantial1981 Tax Ct. Memo LEXIS 10">65 amounts of corporate income for his personal use. Schwoebel immediately notified the Internal Revenue Service of the scheme and he caused the corporation to bring suit against Anderson's estate for the corporate income which had been embezzled. The Third Circuit refused to apply principles of agency to impute the Anderson's fraud to the corporation. The court characterized Schwoebel as an independent investor who, absent from the daily operation of the business, had justifiably relied on the independent audits of the books. The decision rests heavily on the court's conclusion that Schwoebel was an innocent stockholder, 384 F.2d 229">384 F.2d at 235, who was damaged financially by the other shareholder's fraud. It was reluctant to impute fraud to the corporate entity and thereby cause him further financial injury. Petitioner's reliance on this case is misguided. We have already discussed in depth and dismissed the notion that Ted was in any way an innocent shareholder and believe that Asphalt Industries, Inc. is properly distinguishable on this basis. 1981 Tax Ct. Memo LEXIS 10">66 We conclude that the fraud of George and Michael is attributable to petitioner. They dominated the corporation to the point where it was a creature of their will. 20 Ted acquiesced in this domination. We hold that petitioner is liable for additions to tax under section 6653(b) for underpayments of tax due to fraud for the years 1962, 1963, 1964, and 1965. Issue 4. Addition to Tax Under Section 6653(a) for 1969Respondent determined that the underpayment of tax in 1969 was due to petitioner's negligence and intentional disregard of internal revenue rules and regulations and has asserted a 5% addition to tax pursuant to section 6653(a). This penalty is properly assessed against the taxpayer's entire tax deficiency1981 Tax Ct. Memo LEXIS 10">67 and not just against that part of it due to negligently unreported income. Abrams v. United States, 449 F.2d 662">449 F.2d 662 (2d Cir. 1971). As pointed out under Issue 2, above, the deduction for brokers' commissions was not improper, given petitioner's method of reporting income. However, petitioner deducted amounts for travel and entertainment as well as automobile expenses solely on the basis of what may have been allocable to the business. The petitioner did not keep the usual records with regard to these expenses. It appears that some personal expenses may knowingly have been deducted. 21 A taxpayer will not be liable for a negligence penalty merely because he failed to keep a detailed report on travel and entertainment expenses sufficient to comply with the strict requirements of section 274, Robinson v. Commissioner, 51 T.C. 520">51 T.C. 520 (1968), affd. per curiam 422 F.2d 873">422 F.2d 873 (9th Cir. 1970), but he is required to substantiate his expenses enough to show that he wasn't negligent in claiming the deductions. The burden is on the taxpayer to prove that the negligence penalty has been imposed in error. Alicia Ruth, Inc. v. Commissioner, 421 F.2d 1393">421 F.2d 1393 (5th Cir. 1970),1981 Tax Ct. Memo LEXIS 10">68 affg. per curiam a Memorandum Opinion of this Court. Petitioner has not offered any proof that it is not liable for the addition to tax and, on this basis, the negligence penalty for 1969 must be sustained. Issue 5. Statute of LimitationsThe petitioner and the respondent timely executed written agreements pursuant to the provisions of Code section 6501(c)(4), which effectively extended the period of assessments of tax due for the taxable years 1965 and 1966 to December 31, 1970 and for the taxable years 1967, 1968, and 1969 to June 30, 1973. Respondent sent deficiency notices to petitioner for 1962, 1963, and 1964 on September 14, 1972 and for 1965, 1966, 1967, 1968, and 1969 on March 27, 1973. Petitioner argues that deficiencies for the years 1962, 1963, 1964, 1965, and 1966 are barred by the statute of limitations. This question is answered by1981 Tax Ct. Memo LEXIS 10">69 our finding that the petitioner is liable for the fraud penalty for the years 1962, 1963, 1964, and 1965, but not for 1966. Code section 6501(c)(1) provides: "In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, * * , at any time." Assessments for the years 1962, 1963, 1964, and 1965 are not barred by the statute of limitations, but the assessment for 1966 is not permissible. In view of the foregoing, Decision will be entered under Rule 155. Footnotes. This report is prepared pursuant to Rule 182(b), Rules of Practice and Procedure of the United States Tax Court.↩1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Amended returns for 1962, 1963, and 1964 were submitted in 1966. The notice of deficiencies and this proceeding are nevertheless based on the original returns. ↩3. Amended return.↩4. The Correale companies are a group of coal mining and related corporations apparently controlled by one Fred Correale. The specific companies referred to as the Correale companies are: Archer Coals, Inc.; Beechwood Transportation Company; Correale Construction Company; Correale Mining Corporation; Diamond Supply Company; Honeybrook Coal Sales Company; Honeybrook Mines, Inc.; Honeybrook Water Company; Lion Coal Company; Necho Coal Company; and Shenadoah Mining Company.↩5. Some of these books and office records were delivered to Anthony Scelza, a public accountant, in 1966 and were lost in a fire which destroyed Scelza's office on December 17, 1967.↩6. This overbilling scheme may have been practiced before 1962, but those years are not before us.↩7. This amount represents the difference between income not recorded on petitioner's books ($ 128,148.29) less the excess of the amount reported over the amount appearing on its books ($ 5,479.79).↩8. See Drybrough v. Commissioner, 238 F.2d 735">238 F.2d 735 (6th Cir. 1956); Currier v. United States, 166 F.2d 346">166 F.2d 346 (1st Cir. 1948); Estate of Simmons v. Commissioner, 26 T.C. 409">26 T.C. 409 (1956); United Dressed Beef Co. v. Commissioner, 23 T.C. 879">23 T.C. 879↩ (1955).9. See Sherin v. Commissioner, 13 T.C. 221">13 T.C. 221, 13 T.C. 221">229↩ (1949).10. In the absence of adequate records to substantiate each element of an expense, a taxpayer may alternatively establish such element: (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. If such element is * * * the cost, time, place, or date of an expenditure, the corroborative evidence shall be direct evidence, such as a statement in writing or the oral testimony of persons entertained or other witness setting forth detailed information about such element, or the documentary evidence described in subparagraph (2) of this paragraph. If such element is either the business relationship to the taxpayer of persons entertained or the business purposes of an expenditure, the corroborative evidence may be circumstantial evidence. [Sec. 1.274-5(c)(3), Income Tax Regs.↩ Emphasis supplied.]11. Because respondent conceded the issue, we need not consider whether "net commissions" was a proper way to report income.↩12. Section 6653: (b) FRAUD.--If any part of any underpayment * * * is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment.↩13. Respondent concedes that George's conviction for criminal tax fraud does not collaterally estop petitioner from litigating its liability for fraud.↩14. See Costello v. Commissioner, T.C. Memo. 1976-399; Haddad v. Commissioner, T.C. Memo. 1960-112↩.15. George's plea of guilty was for the taxable year 1963.↩16. It is well settled that fraud must be proved by clear and convincing evidence for each taxable year where fraud has been asserted. Est. of Stein v. Commissioner, 25 T.C. 940">25 T.C. 940 (1956), affd. per curiam 250 F.2d 798">250 F.2d 798 (2d Cir. 1958); Gleis v. Commissioner, 24 T.C. 941">24 T.C. 941 (1955), affd. per curiam 245 F.2d 237">245 F.2d 237↩ (6th Cir. 1957). 17. The revenue agent compared the books and records of petitioner with those of the Correale companies for the years 1965 and 1966. For 1965, he prepared several summaries which, he testified, indicated the correlation between specific invoices prepared by George with checks and accompanying vouchers drawn by the Correale companies in payment of these invoices. The summaries also indicated the amount, if any, actually paid over to the insurance carriers for these "policies." The information on the summaries was gleaned from print-out sheets from the petitioner's Burroughs machine, account current ledger cards, and monthly folders compiled in the regular course of petitioner's business which contained duplicate invoices and expired policies. For 1966, similar summaries were prepared; however, the print-out sheets were not available for that year. ↩18. This same evidence is admissible to show how the respondent computed the deficiency asserted in the statutory notice. That determination need not be based solely upon admissible evidence. Delsanter v. Commissioner, 28 T.C. 845">28 T.C. 845, 28 T.C. 845">858 (1957); Rosano v. Commissioner, 46 T.C. 681">46 T.C. 681, 46 T.C. 681">687 (1966); Suarez v. Commissioner, 58 T.C. 792">58 T.C. 792, 58 T.C. 792">817↩ (1972) (concurring opinion).19. See generally Federbush v. Commissioner, 34 T.C. 740">34 T.C. 740 (1960), affd. per curiam 325 F.2d 1">325 F.2d 1 (2d Cir. 1963); United Dressed Beef Co. v. Commissioner, 23 T.C. 879">23 T.C. 879 (1955); Ace Tool & Eng., Inc. v. Commissioner, 22 T.C. 833">22 T.C. 833↩ (1954).20. We conclude also that the dominant shareholders acted in behalf of, and not against the interests of the corporation and that the corporation benefited from the fraud. The corporation had access to some of the money to pay its bills and it had access to the money which it otherwise would have paid in income taxes if all of its income were reported. Ruidoso Racing Association, Inc. v. Commissioner, 476 F.2d 502">476 F.2d 502↩ (10th Cir. 1973).21. See also Tomsykoski v. Commissioner, T.C. Memo. 1974-105 (taxpayer failed to substantiate deductions and took personal expenses as business deductions); Newsom v. Commissioner, T.C. Memo. 1974-265↩ (taxpayer took spurious dependency exemptions and claimed head of household status).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625586/	O. J. ERICKSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Erickson v. CommissionerDocket No. 8972.United States Board of Tax Appeals9 B.T.A. 363; 1927 BTA LEXIS 2610; November 26, 1927, Promulgated 1927 BTA LEXIS 2610">2610 1. The petitioner and his wife were divorced prior to December 21, 1920, and thereafter they lived apart and he contributed nothing to the support of the wife and minor children. Held that he was entitled to a personal exemption of $1,000 only. 2. The petitioner filed his return for the year 1920 on March 15, 1921. The deficiency notice was mailed October 21, 1925. Held that the statute of limitations had not run. R. W. Parliman, Jr., for the petitioner. W. F. Gibbs, Esq., for the respondent. GREEN 9 B.T.A. 363">364 In this proceeding the petitioner seeks a redetermination of his income tax for the year 1920 for which the respondent has determined a deficiency in the amount of $112. FINDINGS OF FACT. The petitioner was married and lived with and supported his wife and two dependent children from January 1, 1920, to December 21, 1920, at which date his wife obtained a decree of absolute divorce. On December 24, the wife and the two children left the home of the petitioner and he has not contributed to their support since that date. The petitioner filed his return for the year 1920 on March 15, 1921. On his return he claimed an1927 BTA LEXIS 2610">2611 exemption in the amount of $2,400. The respondent allowed him an exemption of $1,000. The letter notifying the petitioner of the deficiency involved herein was mailed on October 21, 1925. OPINION. GREEN: The petitioner contends that, inasmuch as article 305 of Regulations 65 provides that the exemption to which a married person living with husband or wife is entitled, will be prorated according to the period during which the taxpayer occupies such status, he is entitled to have article 305 of Regulations 45 similarly construed even though it contains no comparable provision. It is sufficient to say that this provision of Regulations 65 is in accordance with the provisions of section 216(f)(2) of the Revenue Act of 1924, where for the first time the statute made provision for prorating the exemption in case of change of status. Section 216 of the Revenue Act of 1918, insofar as is here material, reads as follows: That for the purpose of the normal tax only there shall be allowed the following credits: * * (c) In the case of a single person, a personal exemption of $1,000, or in the case of the head of a family or a married person living with husband or wife, a personal1927 BTA LEXIS 2610">2612 exemption of $2,000. A husband and wife living together shall receive but one personal exemption of $2,000 against their aggregate net income; and in case they make separate returns, the personal exemption of $2,000 may be taken by either or divided between them. Article 305 of Regulations 45 reads, in part, as follows: The status of the taxpayer on the last day of his taxable year determines his right to an additional exemption and to a credit for dependents. * * But an unmarried individual or a married individual not living with husband or wife, who during the taxable year has ceased to be the head of a family or to have dependents, is entitled only to the personal exemption of $1,000 allowed a single person. 9 B.T.A. 363">365 Article 305 does not differ materially from the previous regulations and rulings of the Commissioner and represents the established practice of the Bureau under the Revenue Act of 1913 and subsequent acts up to and including the Revenue Act of 1921. We regard the regulation as a reasonable construction of section 216(c) and we see no merit in the petitioner's contention. We accordingly hold that the respondent's action in allowing the petitioner a1927 BTA LEXIS 2610">2613 credit of only $1,000 is correct. The petitioner further contends that the statute of limitations has run. It is provided by section 277(a)(3) of the Revenue Act of 1926, that taxes imposed by the Revenue Act of 1918 shall be assessed within five years, and by section 277(b) that such period shall be extended by the time for which the running of the statute is suspended. Section 274(a) of the same Act suspends the statute pending a final determination of a proceeding before this Board. We accordingly affirm the Commissioner in this respect. Judgment will be entered for the respondent.Considered by STERNHAGEN and ARUNDELL.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625589/	Estate of Dick W. Paul, Deceased, the Florida National Bank of Jacksonville, Florida, Administrator, Petitioner, v. Commissioner of Internal Revenue, RespondentPaul v. CommissionerDocket Nos. 12891, 12892United States Tax Court11 T.C. 148; 1948 U.S. Tax Ct. LEXIS 114; August 5, 1948, Promulgated 1948 U.S. Tax Ct. LEXIS 114">114 Decisions will be entered under Rule 50. On June 12, 1944, the date of decedent's death, certain bonds were located in a safe deposit box rented in the name of decedent and another party. Pursuant to a court order dated October 6, 1944, these bonds were impounded pending settlement of their ownership. Held, that petitioner had not the requisite control or command of the bonds to constitute its being in constructive receipt of the accrued interest on the bonds and possessed no election or option, the exercise of which would have enabled it to collect such interest. S. Wayne Cahoon, for the petitioner.Newman A. Townsend, Jr., Esq., for the respondent. Arundell, Judge. ARUNDELL11 T.C. 148">149 These cases, consolidated for trial and decision, involve deficiencies totaling $ 232.92 in individual Federal income and victory tax for the taxable1948 U.S. Tax Ct. LEXIS 114">115 year 1943 and in income tax of $ 115.57 for the period June 12 to December 31, 1944, covering the period immediately subsequent to decedent's death.The following issues before the Court involve the respondent's treatment of certain income items in his determination of deficiencies: (1) Did the respondent properly increase the decedent's income in 1942 by the sum of $ 2,335.93 as "other income"? (2) Did the respondent properly increase the decedent's income subject to surtax by the sums of $ 314.27 and $ 123 in 1942 and 1943, respectively? (3) Did the petitioner constructively receive interest income of $ 502.50 during the period June 12 to December 31, 1944, from certain bonds, title to which was in dispute?The proceedings in Docket No. 12891 were dismissed, in so far as they contested a deficiency determined for the period January 1 to June 12, 1944, by an order of this Court dated March 5, 1947, for failure to properly prosecute. A deficiency for that period was determined in the amount of $ 429.FINDINGS OF FACT.The Florida National Bank of Jacksonville, the petitioner herein, is the administrator of the estate of Dick W. Paul, who died on June 12, 1944.During 1942, 1943, 1948 U.S. Tax Ct. LEXIS 114">116 and until June 12, 1944, Paul, hereinafter referred to as decedent, was a resident of St. Petersburg, Florida. Income tax returns for the calendar years 1942 and 1943 were filed by Paul. Returns for the taxable periods January 1 to June 12, 1944, and June 12 to December 31, 1944, were filed by the petitioner as administrator. All of these returns were filed with the collector of internal revenue for the district of Florida, Jacksonville, Florida.Decedent was beneficiary of three trusts from which he received income during 1942 in the sum of $ 2,335.93. No "income from fiduciaries" was disclosed by the decedent on his 1942 tax return. On his 1942 tax return he reported $ 3,296.43 as "income from dividends." He maintained during this year a trading account with a stockbroker and bought and sold stocks and bonds.In 1942 and 1943 decedent received income from U. S. bonds, subject to surtax only, in the sums of $ 314.27 and $ 123, respectively.At the time of Paul's death, the following bonds were located in a safe deposit box at the First National Bank of Tampa, Florida, which box was rented in the name of the decedent and "Mrs. Margaret M. Shepard" (now Mrs. Margaret S. Weaver). 1948 U.S. Tax Ct. LEXIS 114">117 3 $ 1,000 bonds of Maine Central R. R. Co.11 T.C. 148">150 3 $ 1,000 bonds of Cleveland, Cincinnati, Chicago & St. Louis R. R. Co.5 $ 1,000 bonds of Atlantic Coast Line R. R. Co.3 $ 1,000 bonds of Pittsburgh & West Virginia Railway Co.5 $ 1,000 bonds of Southern Railway Co.5 $ 1,000 bonds of Illinois Central R. R. Co.After decedent's death, a controversy arose between the petitioner and Mrs. Weaver and Susie A. Moffatt relative to the ownership of the bonds. Mrs. Weaver claimed the bonds listed above, with the exception of the Maine Central Railroad bonds, and those were claimed by Miss Moffatt. Both claims were adverse to that of the petitioner as administrator of decedent's estate.By stipulation and pursuant to an order of Jack F. White, Judge, County Court of Pinellas County, Florida, in Probate, dated October 6, 1944, the safe deposit box at the First National Bank of Tampa was opened by counsel for petitioner and counsel for Mrs. Weaver and the contents of the box, including the bonds listed above, were removed to a safe deposit box at the Florida National Bank of St. Petersburg, Florida, for convenience and safekeeping pending settlement of ownership. The court 1948 U.S. Tax Ct. LEXIS 114">118 order directed that the contents were to be kept "separate and apart from any of the assets of the said Dick Willard Paul until the further orders of this Court and to remain in said box until an adjudication of the rights of said parties * " and "that the contents of said box shall maintain the same status as if they were still in The First National Bank of Tampa, and said box shall not be opened or tampered with in any way by either of said parties without the consent of both of said parties or without the consent of this Court * ." The bonds remained in this safe deposit box, which is maintained jointly by the petitioner and Mrs. Weaver, from the date of the order until the date upon which this case was heard. From June 12 until December 31, 1944, interest in the sum of $ 502.50 accrued on these bonds, which interest was not reported by petitioner as income of decedent's estate in its income tax return for this period. The interest coupons for this period are still on the bonds and petitioner has made no effort to actually collect such interest.On June 5, 1947, an action was instituted by the petitioner in the Circuit Court of the Sixth Judicial Circuit, Pinellas County, 1948 U.S. Tax Ct. LEXIS 114">119 Florida, in Chancery, in which the court was asked to enter a declaratory decree determining the ownership of the bonds and other assets which were alleged to have been the property of the decedent at the time of his death. A final order has not been entered and the case is still pending.OPINION.The first issue for determination is whether the respondent was correct in increasing decedent's income in 1942 by the 11 T.C. 148">151 amount of $ 2,335.93 received by him in that year as beneficiary of three trusts.It is contended by the petitioner that such income was erroneously reported by the decedent on his 1942 return under the column "dividends," instead of, as it should have been, under "fiduciary income." On the basis of that explanation alone petitioner assigns as error respondent's increase of decedent's income for 1942 in the amount received from these trusts, alleging that increasing decedent's income in that amount results in his being taxed twice on the same income item.The record does not divulge what amounts decedent received as dividend income in 1942, but it does show that he bought and sold stocks through a broker in that year. That no evidence could be produced to show1948 U.S. Tax Ct. LEXIS 114">120 the dividends received in that year was conceded by petitioner at the trial. Without some affirmative showing which would support petitioner's contention that such trust income was erroneously reported as dividend income, we have no alternative other than to sustain respondent's determination.The failure by petitioner to substantiate its assignments of error also disposes of the second issue herein. Following the objection in its petition to respondent's including interest of $ 314.27 in 1942 and $ 123 in 1943, as subject to surtax only, no evidence relative to this issue was produced at the hearing and there was no discussion of this issue in petitioner's brief. In view of petitioner's failure to meet the burden of proving the Commissioner's determination invalid, these issues must be resolved in favor of the respondent. Helvering v. Taylor, 293 U.S. 507">293 U.S. 507; Hague Estate v. Commissioner, 132 Fed. (2d) 775.The final issue involved herein concerns the question of whether petitioner possessed such control over the bonds which had been impounded by court order pending the determination of a dispute of ownership 1948 U.S. Tax Ct. LEXIS 114">121 between petitioner and other parties, as to constitute petitioner's being in constructive receipt of the interest accrued thereon from June 12 to December 31, 1944.The standards for determining the taxability of income from assets not in the possession of the taxpayer are treated in Treasury Regulations 111, section 29.42-2. 1 For a taxpayer to be in constructive receipt of income from assets not reduced to his possession, such income must be credited or set apart and made available to him so that it may be drawn upon at any time. There can be no substantial limitation 11 T.C. 148">152 or restriction as to the time or manner of payment or condition upon which payment is to be made. Applying these principles to the facts in the instant case, it is our opinion that petitioner possessed no control over, or established right in, the impounded bonds and was effectively barred by the court order from collecting the interest on the bonds until such time as the ownership dispute might be settled in its favor.1948 U.S. Tax Ct. LEXIS 114">122 The order of the County Court of Pinellas County, Florida, in preserving certain assets alleged to have been part of decedent's estate, including the bonds in question, is determinative of the issue of "constructive receipt." It stated (1) that the bonds are to remain "separate and apart from any of the assets * * until the further orders of this Court"; (2) that the bonds are "to remain in said box until an adjudication of the rights of said parties * * "; and (3) that "said box should not be opened or tampered with in any way * * without the consent of both of said parties or without the consent of this Court * * ."We can not agree with respondent that this language accorded petitioner an "election" or "option" to collect the interest on these bonds, subject to a contingent liability to Mrs. Weaver and Miss Moffatt if the ownership dispute was decided in their favor. The order directed that the box was not to be opened or tampered with without the consent of both parties, or the consent of the court. These conditions certainly could not have been dissolved merely by petitioner's exercise of an option or election, as the order clearly imposed the obligation of obtaining 1948 U.S. Tax Ct. LEXIS 114">123 the adverse party's consent or the consent of the court. It is impossible for us to believe that the county court, in view of its order restricting access to the box, would have allowed petitioner, without further proceedings, to remove the coupons and collect the interest.The definition of taxable income has been stated as income that is subject to a man's unfettered command and that he is free to enjoy at his own option, whether he sees fit to enjoy it or not. Corliss v. Bowers, 281 U.S. 376">281 U.S. 376. As it is our conclusion that petitioner's command over decedent's bonds was not sufficient to sustain respondent's determination that it constructively received as income the interest thereon, petitioner's tax liability on this issue must await the disposition of the suit instituted and now pending for the purpose of settling the question of ownership.In view of the fact that in Docket No. 12891 the taxable years 1942 and 1943 are involved, effect should be given to the forgiveness features of the Current Tax Payment Act of 1943 in the recomputation of petitioner's tax liability.Decisions will be entered under Rule 50. Footnotes1. Sec. 29.42-2. Income Not Reduced to Possession. -- Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case the income must be credited or set apart to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and must be made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition. * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625590/	ROY D. CROUCH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Crouch v. CommissionerDocket No. 4211-74United States Tax CourtT.C. Memo 1977-60; 1977 Tax Ct. Memo LEXIS 381; 36 T.C.M. 263; T.C.M. (RIA) 770060; March 10, 1977, Filed Roy D. Crouch, pro se. Lowell F. Raeder, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Chief Judge: This case was assigned to and heard by Special Trial Judge Lehman C. Aarons pursuant to the provisions of section 7456(c) of the Internal Revenue Code and General Order No. 5 of this Court. 1 The Court agrees with and adopts Special Trial Judge Aarons' report which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE1977 Tax Ct. Memo LEXIS 381">382 AARONS, Special Trial Judge: Respondent determined a deficiency in petitioner's federal income tax for 1972 in the amount of $923.19. The sole issue is the propriety of petitioner's claimed deduction under section 162 of the Code 2 of travel expense which was disallowed by respondent on the asserted grounds that petitioner's employment "was indefinite in nature and no part of the claimed deduction is allowable in connection with the transportation of tools." FINDING OF FACT Petitioner filed his 1972 return with the District Director of Internal Revenue in Newark, New Jersey. Petitioner resided at Hammonton, New Jersey, at the time of filing his petition. Petitioner is an electrician and has been a member of Local 592, I.B.E.W., Vineland, New Jersey, since 1969. Late in 1968, construction of a nuclear power plant at Salem, New Jersey, was commenced. Such construction was still going on at the time of the trial of this case. Petitioner commenced employment at the Salem project in September, 1971; he worked exclusively at the Salem project during 1972; and except for a layoff of approximately 3 months in 1976, he continuously worked at the Salem project to the time of the trial. The distance from Hammonton, where petitioner and his family resided, to Salem is about 58 miles. Petitioner travelled the round trip 5 days per week in his 1966 Newport Chrysler, which petitioner described as a small car. Public transportation did not offer petitioner a practical alternative way of getting to and from Salem. Petitioner carried his tools in the trunk of his car, the tools consisting of such items as chain wrenches, heavy pipe wrenches, hammers and chisels and filling two boxes measuring respectively, 32" x 10" x 10" and 24" x 12" x 12". These boxes practically filled the trunk space in petitioner's car. There were some co-workers at the Salem project who lived in the vicinity of petitioner's home who went to Salem via car pool. Petitioner's testimony (which was nonspecific in nature) was that these co-workers were unwilling to share a car pool with him because of his tool-carrying. The amount expended by petitioner for such transportation in 1972 was $2,687.40. OPINION It is clear that the cost of commuting to a taxpayer's place of work, regardless of the distance travelled, is a nondeductible personal expense. William L. Heuer, Jr.,32 T.C. 947">32 T.C. 947 (1959), affd. per curiam 283 F.2d 865">283 F.2d 865 (5th Cir. 1960). But as stated by this Court in Eugene G. Feistman,63 T.C. 129">63 T.C. 129, 63 T.C. 129">135 (1974): Where a commuter incurs additional expenses because he has to transport his "tools" to work such additional costs may be deductible as a business expense under section 162. Fausner v. Commissioner,413 U.S. at 839; Harold Gilberg,55 T.C. 611">55 T.C. 611; Robert A. Hitt,55 T.C. 628">55 T.C. 628. It is not enough, however, that the taxpayer demonstrate that he carried tools to work. He must also prove that the same commuting expense would not have been incurred had he not been required to carry the tools. Although petitioner's testimony was forthright and candid, it fell short of persuading the Court that petitioner's commuting expenses would not have been incurred had he not been required to carry his tools. His testimony as to the availability of car pools, as to efforts he might have made to participate in such a pool, as to the cost differential between "car-pooling" and using his own "small car" lacked specificity, and we are unable to conclude that petitioner was serious in his efforts to arrange a car pool in 1972, or that his tool-carrying engendered costs in addition to his normal commuting expense. Assuming, without deciding, that petitioner's commuting expenses might possibly have been deductible had his Salem employment been temporary in nature (cf. Lawrence W. Norwood,66 T.C. 467">66 T.C. 467 (1976), and see Rev. Rul. 75-380, 1975-2 C.B. 59), it is our view that such employment was indefinite rather than temporary. As stated in Truman C. Tucker,55 T.C. 783">55 T.C. 783, 55 T.C. 783">786 (1971), and in many other judicial opinions, employment is considered temporary if it "can be expected to last for only a short period of time." And as set forth in 66 T.C. 467">Lawrence W. Norwood,supra at p. 469Even if it is known that a particular job may or will terminate at some future date, that job is not temporary if it is expected to last for a substantial or indefinite period of time. Ford v. Commissioner,227 F.2d 297">227 F.2d 297 (4th Cir. 1955), affg. T.C. Memo. 1954-209; Lloyd G. Jones,54 T.C. 734">54 T.C. 734 (1970), affd. 444 F.2d 508">444 F.2d 508 (5th Cir. 1971); Leo C. Cockrell,38 T.C. 470">38 T.C. 470 (1962), affd. 321 F.2d 504">321 F.2d 504 (8th Cir. 1963). * * The stipulated facts afford us no basis for determining that petitioner's Salem employment was other than indefinite in nature. We accordingly have no alternative but to sustain respondent's determination. * * In accordance with the foregoing, Decision will be entered for the respondent.1977 Tax Ct. Memo LEXIS 381">383 Footnotes1. Pursuant to General Order No. 5 the post-trial procedures set forth in Rule 182 of this Court's Rules of Practice and Procedure are not applicable to this case.↩2. Statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625653/	PAUL P. DORAMAN and ETHEL M. DORAMAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDoraman v. CommissionerDocket No. 23503-83.United States Tax CourtT.C. Memo 1986-203; 1986 Tax Ct. Memo LEXIS 405; 51 T.C.M. (CCH) 1035; T.C.M. (RIA) 86203; May 20, 1986. Paul P. Doraman, pro se. Cheryl Choy-Weller, for the respondent. PARRMEMORANDUM OPINION PARR, Judge: Respondent determined deficiencies in petitioners' Federal income tax liabilities and additions to tax against petitioner Paul P. Doraman, as follows: Additions to TaxYearDeficienciesI.R.C. Section 6653(b) 11973$3,535.59$4,045.4019743,502.711,751.3619753,631.043,334.20406 After concessions, the issue remaining for decision is the proper computation of the addition to tax for fraud under section 6653(b). This case was submitted without trial pursuant to Rule 122, Tax Court Rules of Practice and Procedure. The facts have been stipulated and are so found. At the time of filing the petition in this case, petitioners resided in Goshen, N.Y.Petitioners filed their 1973 Federal income tax return on April 28, 1975. No extension had been granted by respondent regarding the filing of this return, and it was not filed timely. The amount shown on the return as total income taxes due was $4,555.21. Payments consisting of income taxes withheld, estimated tax payments, and excess FICA tax withheld totalled $5,748.04. A refund of $1,192.83 was claimed on the return and credited on petitioners' estimated tax for 1974 as directed by petitioners. Petitioners timely filed their income tax return for the year 1974. The amount shown as income taxes due was $4,720.88. Income taxes withheld, estimated tax payments, and excess FICA tax407 withheld totalled $6,620.28, resulting in a refund of $1,899.40 which was again credited on petitioners' estimated tax for 1975 pursuant to their instructions. Petitioners' 1975 Federal income tax return was filed late, on April 24, 1976, without any extensions having been granted. The amount shown on the return as income taxes due was $3,178.40. Income taxes withheld, estimated tax payments, and excess FICA tax withheld totalled $5,337.23. 2 Pursuant to petitioners' instructions on the return, $158.83 of the refund due was paid to them, and the remaining $2,000 was credited on their estimated tax for the next taxable year. Respondent determined that the correct tax liabilities of petitioners for the years at issue were $8,090.80 for 1973, $8,223.59 for 1974, and $6,668.40 for 1975. Respondent further determined that at least part of the underpayment of tax was due to fraud on the408 part of Mr. Doraman ("petitioner") and, as to him alone, determined additions to tax for fraud under section 6653(b). Petitioner concedes that the deficiencies determined by respondent are correct, and that part of the underpayments were due to fraud. He also concedes that the statute of limitations does not bar the assessment and collection of the deficiencies in tax and additions to tax, and that his income tax returns for the years 1973 and 1975 were not filed timely. 3 He takes exception, however, to respondent's method of computing the fraud addition. 409 Respondent calculated the fraud addition as follows: 197319741975Total corrected$8,090.80$8,223.59$6,668.40income tax liabilityLess total tax shownon return4,720.88Underpayment of tax$8,090.80$3,502.71$6,668.4050% of underpayment4,045.40$1,751.36$3,334.20Petitioner proposes an alternative method of computation which takes into account his withholding and estimated tax payments, as follows: 197319741975Corrected income tax$8,090.80$8,223.59$6,668.40liabilityLess withholding andestimated tax payments 45,748.045,427.454,516.53Additional taxes due$2,342.76$2,796.14$2,151.8750% of underpayment$1,171.38$1,398.07$1,075.94Petitioner's method is incorrect under the statute. Respondent properly computed the fraud addition as410 set forth in section 6653(b). In pertinent part, that section provides as follows: (1) In General.--If any part of an underpayment (as defined in subsection (c)) of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. Section 6653(c) defined "underpayment" of tax. In pertinent part, it reads: (1) Income, Estate, Gift, and Certain Excise Taxes.--In the case of a tax to which section 6211 * * is applicable, a deficiency as defined in that section (except that, for this purpose, the tax shown on a return referred to in section 6211(a)(1)(A) shall be taken into account only if such return was filed on or before the last day prescribed for the filing of such return, determined with regard to any extension of time for such filing), * * * Section 6211, to which section 6653(c)(1) refers, defines a deficiency, generally, as the amount by which the tax due exceeds the amount shown as tax on the taxpayer's return plus any amounts previously assessed (or collected without assessment) as a deficiency. The statute thus provides for computing the fraud addition in the manner followed by respondent. 411 The addition is 50 percent of the underpayment. Sec. 6653(b)(1). The underpayment is the tax required to be shown on petitioner's returns (in this case, $8,090.80 for 1973, $8,223.59 for 1974, and $6,668.40 for 1975), less the amount actually shown as tax on the returns. Sec. 6211(a)(1). The latter amount would be $4,555.21, $4,720.88, and $3,037.36 for 1973, 1974, and 1975, respectively. However, because petitioner's 1973 and 1975 returns were filed late, for those years the amounts shown as tax on his returns are not taken into account. Sec. 6653(c)(1). The fraud addition is thus 50 percent of $8,090.80 for 1973; 50 percent of $3,502.71 ($8,223.59 minus $4,720.88) for 1974; and 50 percent of $6,668.40 for 1975. Respondent's calculations are correct. A number of cases have dealt with the computation of the fraud addition, and have made clear that where a return is filed late, the underpayment on which the addition is computed is the total corrected tax liability, without any reduction for the tax shown on the late return. See Cirillo v. Commissioner,314 F.2d 478">314 F.2d 478 (3d Cir. 1963), affg. as to this issue a Memorandum Opinion of this Court; Stewart v. Commissioner,66 T.C. 54">66 T.C. 54 (1976);412 Breman v. Commissioner,66 T.C. 61">66 T.C. 61 (1976); Bennett v. Commissioner,30 T.C. 114">30 T.C. 114 (1958); Prejean v. Commissioner,T.C. Memo. 1983-31; Baylor v. Commissioner,T.C. Memo. 1977-253. It is also clear that a taxpayer's withholding and estimated tax payments are not taken into account in determining the amount of tax due or the amount of tax shown on the return. Sec. 6211(b). Such amounts are thus not considered in computing the fraud addition. Secs. 6653(b)(1) and (c)(1); Cirillo v. Commissioner,supra at 484; Tomlinson v. Lefkowitz,334 F.2d 262">334 F.2d 262, 267 (5th Cir. 1964), cert. denied 379 U.S. 962">379 U.S. 962 (1964). We therefore reject petitioner's computation of the fraud addition in favor of respondent's. Accordingly, Decision will be entered for respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years at issue.↩2. The total payments of $5,337.23 reported on petitioners' 1975 income tax return reflected estimated tax payments of $820.70. There is no explanation for the discrepancy between this figure and the $1,899.40 claimed refund from 1974 which petitioners requested credited on their 1975 return.↩3. Petitioner raised the statute of limitations issue in his petition. In his reply, he denied respondent's allegation that he had filed his 1973 and 1975 returns late. At trial, petitioner raised neither of these issues and agreed with respondent that calculation of the fraud addition was the only issue for decision. We therefore deem those issues conceded by petitioner. With regard to the statute of limitations issue, however, we note that under sec. 6501(c)(1), the Commissioner has an unlimited time period in which to assess and collect taxes due where a taxpayer's return is fraudulent. Where a joint return is filed, but only one spouse is liable for the fraud, sec. 6501(c)(1) nevertheless lifts the normal statute of limitations as to the deficiency due from both spouses. Ballard v. Commissioner,740 F.2d 659">740 F.2d 659 (8th Cir. 1984), affg. on this issue a Memorandum Opinion of this Court; Vannaman v. Commissioner,54 T.C. 1011">54 T.C. 1011↩ (1970).4. The amount of payments claimed by petitioner in this computation for 1973 includes estimated tax payments of $149.88 which were credited from his 1972 return. Petitioner's calculation for 1974 and 1975, however, disregards the credit from the prior year's claimed refund, and includes only actual calendar year withholdings.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4512642/	IN THE COURT OF APPEALS OF IOWA No. 18-0958 Filed March 4, 2020 STATE OF IOWA, Plaintiff-Appellee, vs. MELANIE ANNE HOLMAN, Defendant-Appellant. ________________________________________________________________ Appeal from the Iowa District Court for Polk County, Jeanie K. Vaudt, Judge. Melanie Anne Holman appeals her conviction for operating while intoxicated, third or subsequent offense. AFFIRMED. Thomas M. McIntee, Waterloo, for appellant. Thomas J. Miller, Attorney General, and Louis S. Sloven, Assistant Attorney General, for appellee. Considered by Bower, C.J., Mullins, J., and Carr, S.J.* *Senior judge assigned by order pursuant to Iowa Code section 602.9206 (2020). 2 CARR, Senior Judge. This case began when Officer Trevor McGraw stopped a vehicle after observing one of its brake lights was out. During the stop, Officer McGraw observed that Melanie Anne Holman, the driver, showed signs she was under the influence of alcohol; he noticed the odor of an alcoholic beverage emanating from Holman and her eyes were bloodshot and watery. Holman admitted she had consumed shots of whiskey, and Officer McGraw administered field sobriety tests. Based on her performance and a preliminary breath test that showed Holman’s blood alcohol concentration (BAC) was .122, Officer McGraw arrested Holman. After transporting Holman to the jail, Officer McGraw read an implied consent advisory and asked her to take a breath test. The officer offered Holman the chance to make phone calls before deciding whether to take the breath test. Holman consented to the breath test, which showed a BAC of .107. The State charged Holman with operating while intoxicated, third or subsequent offense, and a jury found her guilty. On direct appeal from her conviction, Holman contends she received ineffective assistance of counsel.1 We review this claim de novo. See Lamasters v. State, 821 N.W.2d 856, 862 (Iowa 2012). To succeed, Holman must show counsel breached a duty and prejudice resulted. See State v. Graves, 668 N.W.2d 860, 869 (Iowa 2003). Counsel breaches a duty if counsel’s performance is not objectively reasonable. See State v. Ortiz, 905 N.W.2d 174, 183 (Iowa 2017). 1 Although Iowa Code section 814.7 (2020) prohibits us from considering ineffective-assistance-of-counsel claims on direct appeal, it does not apply to cases pending on July 1, 2019. See State v. Macke, 933 N.W.2d 226, 235 (Iowa 2019). Holman filed her appeal in 2018. 3 Holman first argues that counsel breached a duty by failing to move to suppress the results of the breath test and statements she made after her arrest. She claims that Officer McGraw violated her rights under Miranda v. Arizona, 384 U.S. 436, 479 (1966), because during transportation to the jail, she said she wanted an attorney present with her. But our supreme court has already determined that Miranda rights do not apply to a request to submit to chemical testing under implied consent procedures. See Swenumson v. Iowa Dep’t of Pub. Safety, 210 N.W.2d 660, 663 (Iowa 1973). And Officer McGraw never denied Holman the opportunity to contact an attorney. Instead, Holman repeatedly told the officer that she did not need to call an attorney and had made her decision about testing. Even in the face of Holman’s insistence that she had no intention of contacting an attorney, Officer McGraw provided Holman with a phone to ensure her the opportunity to make phone calls. Eventually, Holman used her phone to call her former spouse, who did not answer, before reaching her daughter and having a brief conversation. When Officer McGraw asked if he prevented Holman from calling anyone, Holman did not hesitate in answering, “No.” On this record, counsel had no duty to move to suppress the results of Holman’s breath test on this basis because there is no reasonable probability that the court would have granted the motion. See State v. Dudley, 766 N.W.2d 606, 620 (Iowa 2009) (stating “counsel has no duty to raise issues that have no merit”). We next reject Holman’s claim that her trial counsel was ineffective in failing to move to suppress statements she made after requesting counsel. The record does not disclose that Officer McGraw testified regarding any incriminating statements Holman made. Only part of the video from the patrol car and the jail 4 was shown at trial. Because nothing in the record shows that any incriminating statements were shared with the jury, Holman was not prejudiced by any failure of counsel to move to suppress them. The State only prosecuted Holman under Iowa Code section 321J.2(1)(b) (2016), which requires that the State prove she operated a motor vehicle while having a BAC of .08 or more. Any incriminating statements would not prejudice Holman because the State did not prosecute her under the operating-under-the-influence alternative. We also reject Holman’s claim that she did not voluntarily submit to the breath test, her signature on the implied consent advisory notwithstanding. Holman cites State v. Pettijohn, 899 N.W.2d 1, 24 (Iowa 2017), for the proposition that the search-incident-to-arrest exception does not apply to breath tests under the Iowa Constitution. She advances that consent, implied under Iowa Code section 321J.6, is involuntary. She seeks to extend Pettijohn from its context under our boating-while-intoxicated statutes to our implied consent laws for motor vehicles. But our supreme court expressly disclaimed any conclusion that its holding in Pettijohn renders the statutory scheme governing implied consent to testing invalid. 899 N.W.2d at 38 (“[T]his decision only applies to the statutory scheme for operating a boat while under the influence and not to the statutory scheme for operating a motor vehicle while under the influence.”); see also id. at 39 (Cady, J., concurring specially) (distinguishing our implied consent laws for boating from our implied consent laws for operating motor vehicles). Finally, Holman contends her trial counsel was ineffective by failing to challenge the sufficiency of the evidence showing she was under the influence of alcohol. As noted above, the State only prosecuted Holman for operating a motor 5 vehicle with an alcohol concentration of .08 or more. She was not charged with the under-the-influence alternative. Counsel had no duty to challenge the evidence showing she was under the influence. AFFIRMED.	01-04-2023	03-04-2020
https://www.courtlistener.com/api/rest/v3/opinions/4669084/	NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION SUPERIOR COURT OF NEW JERSEY APPELLATE DIVISION DOCKET NO. A-5163-18 STATE OF NEW JERSEY, Plaintiff-Respondent, APPROVED FOR PUBLICATION March 18, 2021 v. APPELLATE DIVISION VALERIE WILLIAMS, Defendant-Appellant. _______________________ Submitted December 15, 2020 – Decided March 18, 2021 Before Judges Gilson, Moynihan and Gummer. On appeal from the Superior Court of New Jersey, Law Division, Morris County, Municipal Appeal No. 17-036. Marshall Dennehey Warner Coleman & Goggin, attorneys for appellant (Ryan T. Gannon, on the briefs). Feintuch, Porwich & Feintuch, attorneys for respondent (Philip Feintuch, on the brief). The opinion of the court was delivered by MOYNIHAN, J.A.D. Following a trial de novo in the Law Division, defendant Valerie Williams appeals from her conviction for violating a municipal ordinance that prohibits the unnecessary obstruction of any street in the Borough of Victory Gardens. The undisputed facts adduced at trial evidence that she used black paint to cover white lines painted on a paved surface by the municipality and painted a new exterior white line. She describes that paved area as a "parking bay" she claims is part of her property; the State claims it is part of a public street. On appeal, she argues: [POINT I] THERE WAS REVERSIBLE ERROR THAT REQUIRES [DEFENDANT'S] CONVICTION TO BE OVERTURNED OR ALTERNATIVELY REMANDED FOR A NEW TRIAL. [(A)] The municipal court improperly excluded [defendant's] ability to present evidence of ownership of the parking bay where she painted[.] [(B)] The prosecution failed to meet its burden of demonstrating that [defendant] "obstructed" a public street[.] [POINT II] THE FINES IMPOSED VIOLATE STATE V. NEWMAN[1] AND THE MUNICIPAL CODE[.] 1 132 N.J. 159 (1993). A-5163-18 2 Our review of the Law Division's final decision after a trial de novo is typically "limited to determining whether there is sufficient credible evidence present in the record to support the findings of the Law Division judge, not the municipal court," State v. Clarksburg Inn, 375 N.J. Super. 624, 639 (App. Div. 2005), requiring "'consideration of the proofs as a whole,' and not merely those offered by the defendant," State v. Kuropchak, 221 N.J. 368, 383 (2015) (quoting State v. Johnson, 42 N.J. 146, 162 (1964)). Under that standard, we disregard "[a]ny error or omission . . . unless it is of such a nature as to have been clearly capable of producing an unjust result[.]" R. 2:10-2; see also Kuropchak, 221 N.J. at 383. We nevertheless review the Law Division's interpretation of the law de novo without according any special deference to the court's interpretation of "the legal consequences that flow from established facts." Manalapan Realty, L.P. v. Twp. Comm. of Manalapan, 140 N.J. 366, 378 (1995); see also Kuropchak, 221 N.J. at 383. The proofs did not establish that defendant violated the ordinance; we therefore reverse. The Borough issued a summons charging defendant with violating Chapter III, Section 3-7.29 of the Borough's Municipal Code that provides, in pertinent part: "No person shall unnecessarily obstruct any . . . street, or public place in the Borough with any kind of vehicle, boxes, lumber, wood, or any other thing[.]" The Law Division convicted defendant, reasoning that A-5163-18 3 painting over the white lines constituted an obstruction of the street within the meaning of "or any other thing[.]" We disagree. "The established rules of statutory construction govern the interpretatio n of a municipal ordinance." Twp. of Pennsauken v. Schad, 160 N.J. 156, 170 (1999). "The first step of statutory construction requires an examination of the language of the ordinance. The meaning derived from that language controls if it is clear and unambiguous." Ibid. (citations omitted). Such is the case here. The portions of Chapter III of the Borough ordinances provided in the record contain several sections of definitions, but those sections, including those specific to Section 3-7, do not define "obstruct." We must therefore "read and construe[]" the words "with their context" and, "unless another or different meaning" is specified, give them "their generally accepted meaning, according to the approved usage of the language." N.J.S.A. 1:1 -1; see also In re Plan for the Abolition of the Council on Affordable Hous., 214 N.J. 444, 467-68 (2013); Pub. Serv. Elec. & Gas Co. v. Twp. of Woodbridge, 73 N.J. 474, 478 (1977). Ingrained in all the common definitions of "obstruct" is the physical impediment of passage along a course. Black's Law Dictionary defines it as "[t]o block or stop up (a road, passageway, etc.); to close up or close off, esp[ecially] by obstacle[.]" Black's Law Dictionary 1246 (10th ed. 2014). The A-5163-18 4 Oxford Universal Dictionary's several definitions include: "To block, close up, or fill (a way or passage) with obstacles or impediments; to render impassable or difficult of passage." The Oxford Universal Dictionary 1353 (3d ed. 1964). Webster defines the term as "to block or close up with an obstacle or obstacles, as a road . . .; make difficult to pass." Webster's Encyclopedic Unabridged Dictionary of the English Language 995 (1989). In a statute similar to the Borough ordinance, persons who "purposely or recklessly obstruct[] any highway or other public passage" without "having . . . legal privilege to do so" commit "a petty disorderly persons offense." N.J.S.A. 2C:33-7(a). "'Obstructs' means renders impassable without unreasonable inconvenience or hazard." Ibid. We agree with certain Law Division holdings requiring an actual blockage as a necessary element of that offense. Before her tenure in the Appellate Division and subsequent appointment to our Supreme Court, then-Judge Virginia A. Long, assigned to the Criminal Part in Union County, found a defendant not guilty of violating N.J.S.A. 2C:33-7 after determining "obstruction [was] simply not an issue" where [t]he only testimony about obstruction from the [arresting] officer was his admission that access to the unemployment office was not obstructed at all, but that his concern was with people having to walk on the gravel which was not, to him, "proper access." This testimony, taken in light of an uncontroverted diagram offered by defendants to show other available means of access to the unemployment office, falls far A-5163-18 5 short of what would be necessary to establish an obstruction under the statute. [State v. Greenberg, 179 N.J. Super. 565, 571 (Law Div. 1980).] In contrast, a defendant who "barred the use of the" doorway to a medical clinic that performed abortions, "rendering it impassable to employees and visitors," was found guilty of violating N.J.S.A. 2C:33-7(a). State v. Wishnatsky, 258 N.J. Super. 67, 82 (Law Div. 1990). The plain language of the Victory Gardens ordinance requires a physical blockage before a person can be held accountable for "unnecessarily obstruct[ing] . . . [a] street." Indeed, Section 3-7.29 specifies examples of items that constitute such blockage: "any kind of vehicle, boxes, lumber, wood, or any other thing[.]" (Emphasis added.) In context, therefore, the mere act of repainting the lines or painting a new line—assuming the paved portion was a street—did not obstruct the street in violation of the ordinance. There is no evidence defendant obstructed the street by parking her car in the repainted area. Nor is there any evidence the area was otherwise rendered impassable by defendant's act. Even if the term "obstruct" is ambiguous—which we do not determine or suggest—we must strictly construe the ordinance and narrowly interpret its terms "[b]ecause municipal court proceedings to prosecute violations of A-5163-18 6 ordinances are essentially criminal in nature." Schad, 160 N.J. at 171. All courts "should also be guided by the rule of lenity, resolving any ambiguities in the ordinance in favor of a defendant charged with a violation thereof." Ibid. Viewed through that narrowly focused lens, defendant did not obstruct the street. We do not imply defendant did not commit some violation of another ordinance or a statute. We reverse because the prosecution did not establish a violation of the charged ordinance. Our determination renders it unnecessary to address defendant's claim that she was precluded from offering into evidence what she described as a "building permit" to prove she owned the paved area. We would have determined that argument to be without sufficient merit to warrant discussio n, see R. 2:11-3(e)(2), because, contrary to defendant's contention, she was not precluded from introducing the evidence. As her second counsel 2 admitted to the Law Division, that evidence "was not presented at the [municipal court] hearing" and there was no evidence presented to establish defendant's ownership rights. Our review of the record reveals there was no effort to 2 Defendant was represented by a different attorney during the municipal court trial. A-5163-18 7 authenticate the "building permit" or any other documentary proof that would have supported defendant's claim of ownership. Our decision also renders moot defendant's arguments regarding the fine and restitution. 3 We do agree with her position that neither the municipal court nor the Law Division complied with N.J.S.A. 2C:44-2(c). Courts are required to "take into account the financial resources of the defendant and the nature of the burden that its payment will impose" when "determining the amount and method of payment of a fine." N.J.S.A. 2C:44-2(c)(1); see also Newman, 132 N.J. at 169-70. When "determining the amount and method of payment of restitution," courts are likewise required to "take into account all financial resources of the defendant, including the defendant’s likely future earnings, and shall set the amount of restitution so as to provide the victim with the fullest compensation for loss that is consistent with the defendant’s ability to pay." N.J.S.A. 2C:44-2(c)(2); see also Newman, 132 N.J. at 169-70. Although courts have considerable discretion in imposing monetary sanctions, they must comply with the statutory safeguards. Newman, 132 N.J. at 169-70. 3 The municipal court imposed the maximum fine of $1,250, $33 in court costs and $4,229.33 in restitution, totaling $5,512.33. The Law Division resentenced defendant and imposed a fine of $1,250, court costs of $33 and restitution of $900. In her merits brief, defendant refers to the restitution imposed as an "additional fine." A-5163-18 8 Reversed. A-5163-18 9	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4669085/	NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION This opinion shall not "constitute precedent or be binding upon any court ." Although it is posted on the internet, this opinion is binding only on the parties in the case and its use in other cases is limited. R. 1:36-3. SUPERIOR COURT OF NEW JERSEY APPELLATE DIVISION DOCKET NO. A-1408-19 STATE OF NEW JERSEY, Plaintiff-Respondent, v. RAMONA P. MERCADO- VASQUEZ, a/k/a RAMONA P. MERCADO, and RAMONA P. VASQUEZ, Defendant-Appellant. _______________________ Submitted February 10, 2021 – Decided March 18, 2021 Before Judges Geiger and Mitterhoff. On appeal from the Superior Court of New Jersey, Law Division, Bergen County, Indictment No. 14-12-1883. Joseph E. Krakora, Public Defender, attorney for appellant (Kimmo Abbasi, Designated Counsel, on the brief). Mark Musella, Bergen County Prosecutor, attorney for respondent (William P. Miller, Assistant Prosecutor, of counsel; Catherine A. Foddai, Legal Assistant, on the brief). PER CURIAM Defendant Ramona P. Mercado-Vasquez appeals from a September 25, 2019 order denying her petition for post-conviction relief (PCR) without an evidentiary hearing. On appeal, defendant argues her trial counsel was ineffective for (1) failing to request a Spanish interpreter throughout the court proceedings; (2) pressuring her to plead guilty; (3) misrepresenting her sentencing exposure; and (4) not providing her with full discovery. We affirm, substantially for the reasons set forth in Judge Gary Wilcox's twenty-three-page written opinion. We add only the following comments. We discern the following facts from the record. Defendant befriended codefendant Jorge Valencia, the superintendent of her building, who informed her and other codefendants that a resident, F.D.,1 had money and jewelry in his apartment. Valencia valued these items at $5 million. In September 2013, all defendants formulated a plan to steal the items from F.D.'s apartment and split the proceeds. Defendant agreed with the plan to go into F.D.'s apartment in the middle of the night while he was sleeping, threaten him with a gun,2 and steal 1 We refer to the victims by their initials to protect their privacy. 2 A few days before the robbery, Valencia brought the gun he had stolen from F.D. to defendant's apartment. A-1408-19 2 the items. She also agreed to the plan to summon M.C., the doorman of the building, to F.D.'s apartment and restrain him while the codefendants disposed of the building's surveillance footage. Defendant's role was to wait in her apartment to receive the stolen goods. Defendant never renounced the plan. In fact, a test run was conducted where defendant propped the side door of the building open using a magazine. On November 26, 2013, defendant and her codefendants carried out the plan. Valencia brought the items back to defendant's apartment in a book bag and a green case. Valencia put the items in the electrical panel of defendant's jacuzzi tub. Defendant later moved the stolen goods from the tub and hid them among her child's clothes. Defendant also put some of the items in the laundry room and others inside a closet. On December 12, 2014, a Bergen County grand jury returned a fifteen - count indictment against defendant. Defendant subsequently pled guilty to first- degree armed robbery, N.J.S.A. 2C:2-6 and N.J.S.A. 2C:15-1, and second- degree conspiracy to commit kidnapping, N.J.S.A. 2C:5-2 and N.J.S.A. 2C:13- 1(b). The judge sentenced defendant, pursuant to the plea agreement, to fourteen years' imprisonment for the armed robbery conviction, and a concurrent eight- A-1408-19 3 year term for conspiracy to commit kidnapping.3 Each sentence was subject to the No Early Release Act N.J.S.A. 2C:43-7.2 and Graves Act, N.J.S.A. 2C:43- 6. On September 4, 2018, defendant filed a pro se petition for PCR. On March 27, 2019, defendant filed a supplemental certification. Thereafter, defendant was appointed counsel, who filed a brief in support of her petition. On September 25, 2019, Judge Wilcox issued an order and written decision denying defendant's petition. On appeal, defendant raises the following argument for our consideration: THE PCR COURT ERRED IN DENYING DEFENDANT AN EVIDENTIARY HEARING DESPITE THE FACT SHE DEMONSTRATED A [PRIMA FACIE] CASE OF [] INEFFECTIVE ASSISTANCE [OF] COUNSEL AS DEFENSE COUNSEL'S CONDUCT WAS DEFICIENT FOR NUMEROUS REASONS. We review a PCR court's denial of a petition without an evidentiary hearing de novo. State v. Jackson, 454 N.J. Super. 284, 291 (App. Div. 2018) (citing State v. Harris, 181 N.J. 391, 421 (2004)); see also State v. Blake, 444 3 Thereafter, defendant filed a direct appeal challenging only her sentence on our excessive sentence calendar. R. 2:9-11. On May 24, 2016, we affirmed defendant's sentence as it was "not manifestly excessive or unduly punitive and [did] not constitute an abuse of discretion." We remanded for articulation of the aggravating and mitigating factors considered by the judge. A-1408-19 4 N.J. Super. 285, 294 (App. Div. 2016). To establish a prima facie claim of ineffective assistance of counsel, a defendant must satisfy the two-pronged test enumerated in Strickland v. Washington, 466 U.S. 668, 687 (1984), which our Supreme Court adopted in State v. Fritz, 105 N.J. 42, 58 (1987). To satisfy the first prong of the Strickland standard, a defendant must establish that his counsel "made errors so serious that counsel was not functioning as the 'counsel' guaranteed the defendant by the Sixth Amendment." 466 U.S. at 687. The defendant must rebut the "strong presumption that counsel's conduct [fell] within the wide range of reasonable professional assistance[. . . .]" Id. at 689. Thus, this court must consider whether counsel's "representation fell below an objective standard of reasonableness." Id. at 688. To satisfy the second Strickland prong, a defendant "must show that the deficient performance prejudiced the defense." Id. at 687. In other words, a defendant must establish "a reasonable probability that, but for counsel's unprofessional errors, the result of the proceeding would have been different. " Id. at 694. To satisfy the second prong of the Strickland standard where a defendant seeks to set aside a conviction based on a guilty plea, he or she must show that "had he [or she] been properly advised, it would have been rational for him [or her] to decline the plea offer and insist on going to trial" under the A-1408-19 5 circumstances. State v. Maldon, 422 N.J. Super. 475, 486 (App. Div. 2011) (citing Padilla v. Kentucky, 559 U.S. 356, 372 (2010)). That determination must be "based on evidence, not speculation." Ibid. Our Supreme Court has made clear that the "error committed must be so serious as to undermine the court's confidence in the jury's verdict or result reached." State v. Chew, 179 N.J. 186, 204 (2004) (citing Strickland, 466 U.S. at 694). "With respect to both prongs of the Strickland test, a defendant asserting ineffective assistance of counsel on PCR bears the burden of proving his or her right to relief by a preponderance of the evidence." State v. Gaitan, 209 N.J. 339, 350 (2012) (citing State v. Echols, 199 N.J. 344, 357 (2009); State v. Goodwin, 173 N.J. 583, 593 (2002)). A failure to satisfy either prong of the Strickland standard requires the denial of a PCR petition. Fritz, 105 N.J. at 52 (quoting Strickland, 466 U.S. at 687). A defendant must "do more than make bald assertions that he was denied the effective assistance of counsel" to establish a prima facie claim entitling her to an evidentiary hearing. State v. Cummings, 321 N.J. Super. 154, 170 (App. Div. 1999). In support of her petition for PCR, defendant certifies that she does not speak English proficiently and could not understand the complex legal terms used during the proceedings. Defendant argues that her trial counsel's failure to A-1408-19 6 obtain an interpreter constituted ineffective assistance of counsel and, at a minimum, entitled her to an evidentiary hearing. We find this contention to be without merit as it is contradicted by the record. It is well-settled that "a defendant who is unable to speak and understand English has a right to have his trial proceedings translated so as to permit him to participate effectively in his own defense." State v. Kounelis, 258 N.J. Super. 420, 427 (App. Div. 1992) (citing United States ex rel. Negron v. New York, 434 F.2d 386, 389 (2d Cir. 1970)); see also State v. Linares, 192 N.J. Super. 391, 393 (Law Div. 1983) ("[A] defendant in a criminal case has the right to the assistance of an interpreter so that he [or she] can understand the nature of the ongoing proceedings."). "The constitutional right to a defense interpreter may not be waived by mere acquiescence or nonverbal conduct on the part of the accused." Kounelis, 258 N.J. Super. at 427-28. At the plea hearing, the judge asked defendant whether she needed the aid of an interpreter, as well as whether she was able to read and write in English: [Court:] Ms. Mercado, do you [] need the benefit of a Spanish interpreter? [Defendant:] No. [Court:] Are you completely comfortable in English? [Defendant:] Yes. A-1408-19 7 [Court:] Do you read and write English? [Defendant:] Yes. Later, the judge again inquired: "[d]o you read and write in English?" Defendant replied, "[y]es." Beyond this, defendant testified at length at the sentencing hearing: [Defendant:] Yes. I know what happened was awful and terrible. And I want to apologize to [F.D.] I'm really sorry for what happened. I never wanted any of you or anybody to get hurt. Everyone I hurt, my son, my family. I wish I could change things up and – and go back and never let this to happen. I'm sorry. And I wish I could change things, Judge, and – and maybe let them know that (indiscernible) know what Valencia was planning to do. And mentally, emotionally at that moment I was going though a trauma, wasn't doing well. I feel like I was in a tough situation, because I don't – I don't want to talk on my baby father. We've been together for so many years. I don't want him – I don't want to hurt him. I don't want to him – [Defense Counsel:] Take a second. Catch your breath. Take a second. You're okay. [Defendant:] Your Honor, from my heart, I want you to take a consideration with me and my son, and take my apologies. I know what happened was terrible. I can never be part of it. I should say something. I let something like that happen. I'm really sorry. I would like to have a second chance to be with my son and my mother. A-1408-19 8 The foregoing testimony belies defendant's contention that she did not have a firm grasp of the English language. Any argument that her trial counsel was ineffective in failing to request and utilize an interpreter has no merit. Next, defendant claims that her trial counsel pressured her into pleading guilty. Defendant's plea colloquy, however, convinces us that her trial counsel did not pressure or coerce her in any manner: [Court:] Okay. Did anyone force you or pressure you in any way to do this? [Defendant:] No. [Court:] Have you had sufficient time to make this decision? [Defendant:] Yes. [Court:] Are you comfortable with the decision you've made? [Defendant:] Yes. [Court:] Have any promises been made that are not in writing here? Are there any side agreements that I'm not aware of? [Defendant:] No. [Court:] Have you had sufficient time to discuss your decision with your attorney? [Defendant:] Yes. A-1408-19 9 [Court:] Are you satisfied with all the advice you've received from your attorney? Defendant: Yes. Clearly, defendant's assertion that trial counsel pressured her to plead guilty is nothing more than a bald assertion that is contradicted by the record. Next, defendant contends that trial counsel misinformed her that she would be sentenced to no more than ten years. A defendant's Sixth Amendment right to a fair trial extends to the plea-bargaining process and "an attorney's gross misadvice of sentencing exposure . . . constitutes remediable ineffective assistance." State v. Taccetta, 351 N.J. Super. 196, 200 (App. Div. 2002). Here, the prosecutor accurately communicated the nature of the plea and the recommended sentence: Your Honor, at this time I'm pleased to report that it's my understanding that today [defendant], here with counsel, has agreed to retract her previously entered plea of not guilty and enter pleas of guilty to Counts [Three] and [Five] of the indictment[,] Your Honor[,] previously referred to. Count [Three] relates to an armed robbery in the first[-]degree. And Count [Five] relate[s] to the conspiracy to kidnap in the second[- ]degree. Your Honor, in exchange for a truthful plea and a factual basis supporting these offenses, as well as a factual basis supporting the actions of her co- defendants, in commission of these crimes, the state will at the time of sentencing recommend the following: A-1408-19 10 That [defendant] receive a maximum [fourteen] years [in] New Jersey State Prison on Count [Three], and that sentence . . . run concurrent to a maximum [eight] years in New Jersey State Prison on Count [Five]. [(emphasis added)]. Defendant was present in court when the plea terms were set forth on the record. There is no evidence she objected at that time, nor did she seek to withdraw her plea. Moreover, the New Jersey Judiciary Plea Form, which defendant initialed and signed, indicated the recommended sentence of fourteen years. There is no evidence, aside from defendant's bald assertions, that she was ever promised a sentence of no more than ten years. Finally, defendant asserts her trial counsel failed to provide her with full discovery. More specifically, defendant claims that defense counsel failed to inform her of F.D.'s medical records, which ultimately supported the judge's determination that aggravating factor two, "that the victim . . . was particularly vulnerable[,]" N.J.S.A. 2C:44-1(a)(2), applied. We conclude, as did Judge Wilcox, that defendant's trial counsel strategically argued that because defendant was not in the apartment at the time of the offense, no physical harm was contemplated by her and, therefore, aggravating factor two did not apply to her. Strategic choices by counsel "will not serve to ground a constitutional claim of inadequacy . . . ." Fritz, 105 N.J. A-1408-19 11 at 54. In any event, defendant failed to convince us, in her certification or otherwise, that but for her counsel's failure to obtain these records, she would have rejected the plea offer and proceeded to trial. See Maldon, 422 N.J. Super. at 486. In that regard, Judge Wilcox correctly noted defendant was confronted with a thirty-year sentence on the two counts of the indictment that she ultimately pled guilty to. The plea was thus extremely favorable, and in light of the overwhelming evidence against her, it is unlikely that defendant would have rejected the plea offer and proceeded to trial. Affirmed. A-1408-19 12	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4669087/	NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION This opinion shall not "constitute precedent or be binding upon any court ." Although it is posted on the internet, this opinion is binding only on the parties in the case and its use in other cases is limited. R. 1:36-3. SUPERIOR COURT OF NEW JERSEY APPELLATE DIVISION DOCKET NO. A-0955-19 STATE OF NEW JERSEY, Plaintiff-Respondent, v. JARED A. HENRY, Defendant-Appellant. _______________________ Argued February 24, 2021 – Decided March 18, 2021 Before Judges Ostrer, Vernoia and Enright. On appeal from the Superior Court of New Jersey, Law Division, Ocean County, Accusation No. 12-02-0460. James H. Maynard argued the cause for appellant (Maynard Law Office, LLC, attorneys; James H. Maynard, on the briefs). Shiraz Deen, Assistant Prosecutor, argued the cause for respondent (Bradley D. Billhimer, Ocean County Prosecutor, attorney; Samuel Marzarella, Chief Appellate Attorney, of counsel; Shiraz Deen, on the brief). PER CURIAM Defendant Jared Henry appeals from an October 8, 2019 order denying his second post-conviction relief (PCR) petition. We affirm. On November 16, 2010, defendant was charged with third-degree distribution of obscene materials to a person under the age of eighteen, N.J.S.A. 2C:24-3(b), and second-degree attempted sexual assault, N.J.S.A. 2C:14- 2(c)(4). He pled guilty to third-degree endangering the welfare of a child, N.J.S.A. 2C:24-4(a), in exchange for a recommended sentence of parole supervision for life (PSL) and compliance with the requirements of Megan's Law, N.J.S.A. 2C:7-1 to -23. On September 28, 2012, defendant physically appeared before, and was sentenced by, Judge Rochelle Gizinski, in accordance with the plea agreement. He did not file a direct appeal from his conviction or sentence. On May 30, 2013, counsel for defendant filed defendant's first PCR petition, alleging plea counsel misinformed defendant about the consequences of PSL. In his petition, defendant referenced the judgment of conviction (JOC) "entered by [the trial court] on September 28, 2012." Defendant also annexed to his 2013 petition "[t]he transcript of defendant's sentencing hearing and judgment of conviction . . . as Exhibits F [and] G respectively." The PCR judge A-0955-19 2 denied the petition on March 10, 2014. Defendant did not appeal from this PCR denial. In 2018, defendant moved to withdraw his guilty plea, alleging his JOC was invalid. However, several months later, he withdrew that motion. On July 18, 2019, defendant filed a second petition for PCR, renewing the argument from his first PCR petition that plea counsel was ineffective by misinforming him about the consequences of PSL. Additionally, he contended no valid JOC regarding his September 28, 2012 sentence had been entered in accordance with Rule 3:21-5. The PCR judge disagreed, and denied defendant's second PCR petition as time barred under Rule 3:22-12(a), finding it was filed more than one year after the March 10, 2014 denial of his first PCR petition. The judge noted that in defendant's first PCR petition, he "certified to the court he was the subject of a valid judgment of conviction which he was then collaterally attacking due to allegations of ineffective assistance of counsel. He failed to raise any claim . . . at that time of an invalid JOC." Moreover, the judge observed that "[a]ll versions of the JOC contained in petitioner's appendix have the following sentence on page three thereof: 'This Judgment of Conviction was signed by the A-0955-19 3 Honorable Wendel E. Daniels, P.J.Cr.P., on behalf of the sentencing judge, Rochelle Gizinski, J.S.C.'" On appeal, defendant raises the following arguments: POINT I THE COURT HAD JURISDICTION TO CONVERT, OR OTHERWISE TREAT PETITIONER’S PCR AS, A MOTION TO WITHDRAW HIS GUILTY PLEA [NOT RAISED BELOW] AND FURTHER HAD JURISDICTION TO HEAR AND DECIDE PETITIONER’S PETITION. A. The PCR Court Was Empowered to Decide the Validity of the Judgment of Conviction Recorded by the Court Clerk and Take Appropriate Action Regarding Treating Petitioner's PCR Petition as a Motion to Withdraw His Guilty Plea. B. Petitioner's Application to the Court Was Judiciable as No Valid Judgment of Conviction Had Been Entered by the Clerk and Consequently, None of the Time Bars for Direct Appeals or Collateral Attacks on a Conviction Applied. C. Petitioner’s Assertion that an Unsigned JOC Means the Sentence Has Not Yet Been Formally or Legally Imposed Does Not "Vitiate" the Sentence Ordered by Judge Gizinski. POINT II NO LEGALLY VALID, ENFORCEABLE JUDGMENT OF CONVICTION HAS BEEN EXECUTED IN THIS MATTER. A-0955-19 4 A. JOC#1 – Unsigned, Undated, Received from the File of Prior Counsel. B. JOC#2 – Unsigned, Undated, Received from the Office of the Clerk of the Court. C. JOC#4 – Unsigned, Undated, Received from the New Jersey State Parole Board. D. JOC#5 – Signed by Judge Daniels, but Dated [Two] Weeks Prior to Mr. Henry's Sentencing Date, Obtained from the File of Mr. Henry's Prior PCR Attorney. E. JOC#3 – Signed by Judge Daniels, but with the Signature Date Overwritten by Hand, Obtained from the "Indictment File" of the Judge’s Records. POINT III THE FIVE-YEAR PERIOD DURING WHICH A PETITIONER MUST FILE AN INITIAL PCR DOES NOT BEGIN UNTIL THE JUDGMENT OF CONVICTION IS SIGNED AND ENTERED BY THE CLERK. We need not address defendant's substantive arguments because we agree with the PCR judge that defendant's second petition is time barred under Rule 3:22-12(a)(2). Where a PCR court does not conduct an evidentiary hearing, we "conduct a de novo review of both the factual findings and legal conclusions of the PCR court." State v. Blake, 444 N.J. Super. 285, 294 (App. Div. 2016) (quoting State A-0955-19 5 v. Harris, 181 N.J. 391, 421 (2004)). "[S]econd or subsequent petition[s] for post-conviction relief shall be dismissed unless . . . [they are] timely under Rule 3:22-12(a)(2)[.]" State v. Jackson, 454 N.J. Super. 284, 291 (App. Div. 2018) (fourth alteration in original) (quoting R. 3:22-4(b)). Rule 3:22-12(a)(2) imposes strict time limits on the filing of a second PCR petition, requiring a defendant to file within one year of the latest of three defined events: the date a new constitutional right is recognized by the United States Supreme Court or our Supreme Court and is retroactive to cases on collateral review; the date the factual predicate for the claim is first discovered, if through reasonable diligence it could not have been discovered earlier; and the date of the denial of a prior PCR petition where it is claimed prior PCR counsel was ineffective. Rule 3:22-12(a)(2)(A)-(C). Significantly, the time bar for second or subsequent petitions for PCR is not contingent on the entry of a JOC. Here, defendant's underlying claim is that his plea counsel was ineffective by failing to fully explain the consequences of PSL. He asserted that factual claim when he filed his first PCR petition in 2013, and therefore his second PCR petition, which was filed in 2019, is untimely under Rule 3:22-12(a)(2)(b). That factual claim also is barred under Rule 3:22-5. Even if we broadly read A-0955-19 6 defendant's second PCR petition as alleging his first PCR counsel was ineffective by failing to challenge the validity of the JOC, the second PCR petition is untimely under Rule 3:22-12(a)(2)(c) because it was filed more than a year after the 2014 dismissal of the first PCR petition. Finally, Rule 3:22- 12(a)(2)(a) is inapplicable because defendant does not rely on a new constitutional right. The time bar under Rule 3:22-12(a)(2) may not be ignored or relaxed. Jackson, 454 N.J. Super. at 292-94; see also R. 1:3-4(c) ("Neither the parties nor the court may . . . enlarge the time specified by . . . R. 3:22-12."). Because defendant's second PCR petition was filed more than five years after the March 10, 2014 denial of his first petition, the latter petition was properly denied as time barred. Additionally, since defendant's second PCR petition was properly time barred, an evidentiary hearing on his application was not required. See State v. Brewster, 429 N.J. Super. 387, 401 (App. Div. 2013) ("If the court perceives that holding an evidentiary hearing will not aid the court's analysis of whether the defendant is entitled to post-conviction relief, . . . then an evidentiary hearing need not be granted." (omission in original) (quoting State v. Marshall, 148 N.J. 89, 158 (1997))). The remainder of defendant's arguments lack sufficient merit to warrant discussion in a written opinion. R. 2:11-3(e)(2). A-0955-19 7 Affirmed. A-0955-19 8	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4625650/	G. S. PATTERSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Patterson v. CommissionerDocket No. 12345.United States Board of Tax Appeals16 B.T.A. 716; 1929 BTA LEXIS 2535; May 27, 1929, Promulgated 1929 BTA LEXIS 2535">2535 1. JURISDICTION - FRAUD. - Where the deficiency notice contains a statement "Deficiency asserted" but states no amount of deficiency for a given year, and further claims a fraud penalty for such year, the Board has jurisdiction to determine the tax liability and the liability for the fraud penalty. Gutterman Strauss Co.,1 B.T.A. 243">1 B.T.A. 243. 2. FRAUD - EVIDENCE - BOARD WILL REJECT PATENTLY INCOMPETENT EVIDENCE OF FRAUD. - Respondent's offer in evidence of documents purporting to be revenue agents' reports and memoranda prepared in the Bureau of Internal Revenue, are rejected as incompetent to establish fraud. 3. EVIDENCE. - Offer in evidence of document purporting to be report of an investigating agent of the Commissioner upon a partner of the petitioner, and mentioning the petitioner only incidentally, rejected as incompetent, irrelevant and immaterial. Arthur C. Gunther, Esq., and S. K. Bernstein, C.P.A., for the petitioner. Harold Allen, Esq., for the respondent. LOVE 16 B.T.A. 716">717 OPINION. LOVE: This proceeding results from the respondent's determination of deficiencies in income tax for the years 1920 to 1923, inclusive, 1929 BTA LEXIS 2535">2536 and the assertion of fraud penalties for the years 1919 to 1923, inclusive, in amounts as follows: YearDeficiencyPenaltyTotal1919Assessed.$226.28$226.281920$2,625.721,312.863,938.5819211,796.04892.022,694.061922443.71221.86665.571923685.16342.581,027.745,550.633,041.608,592.23The proceeding was originally set for hearing on May 17, 1928. Successive continuances were granted to June 20, 1928, September 19, 1928, October 23, 1928, and November 26, 1928. These continuances, with one exception, were granted when the Board was advised that the parties were negotiating a settlement. The respondent never objected to them. October 12, 1928, the petitioner filed an application for an order to take certain depositions. At that time the appeal was set for hearing on October 23, 1928. The application was denied by order of October 18, 1928, because it had not been filed at least 30 days prior to the hearing date as required by Rule 46(i) of the Board's rules of practice. By order of October 23, 1928, the appeal was continued to November 26, 1928. November 5, 1928, the petitioner again filed a deposition application1929 BTA LEXIS 2535">2537 which was denied by order of November 10, 1928, in accordance with Rule 46(i), supra.The proceeding came on for hearing on the merits on November 26, 1928. There was no appearance for the petitioner. Since upon the record redetermination of the deficiencies in tax for the years 1920 to 1923, inclusive, is wholly dependent upon our determination of issues of fact, and the petitioner, having the burden of proof, has offered no evidence in support thereof, the deficiencies in tax determined by the respondent for each of the years mentioned are approved. ; Wm A. Pringle16 B.T.A. 716">718 et al., ; ; . It may be pointed out that no question of limitation has been raised. The deficiency letter was mailed to the petitioner December 28, 1925, under the provisions of section 274(a) of the Revenue Act of 1924 and the appeal was filed February 26, 1926, under the same section. No subsequent legislation has affected the Board's jurisdiction. As relating to the year1929 BTA LEXIS 2535">2538 1919, the deficiency letter shows only a penalty for that year. Despite the fact that the Commissioner's notice of determination sets forth no amount as a tax for the year 1919, but only a fraud penalty for that year, the Board has jurisdiction to redetermine the matter. . To sustain the respondent's burden of proof in respect of the fraud penalties, as required by section 907(a) of the Revenue Act of 1924, as amended by section 601 of the Revenue Act of 1928, counsel offered in evidence and the Board tentatively accepted the following described documents, to wit: A document purporting to be a revenue agent's report on G. S. Patterson's business, dated September 24, 1924; another such report dated April 30, 1925; another dated December 22, 1927; another report on the partnership of Johns & Patterson, dated September 24, 1924; another report dated April 15, 1924; another report of an agent, Special Intelligence Unit, relative to Rector Johns; and another report prepared in the Special Adjustment Section, all of which reports were in the nature of ex parte statements; they were not identified by their several authors, 1929 BTA LEXIS 2535">2539 nor otherwise qualified as admissible evidence. No witness testified as to the matters herein set forth. Neither petitioner nor his counsel was present to object, but we do not believe we are authorized, on the issue of fraud, to receive and consider such documents as competent evidence; hence, the same is rejected. In compliance with request made at the hearing by counsel for respondent, his exception to the ruling rejecting such evidence is now allowed and noted. The petitioner, in his petition, denies under oath that his returns were fraudulent. The burden of proving fraud was upon the respondent. While we realize the difficulties faced by the respondent in sustaining that burden under the circumstances herein involved, we do not feel warranted in accepting, as evidence of fraud, documents so patently incompetent as the reports now under discussion. The documents discussed being all that the respondent offered to sustain his burden of proof relative to fraud, the record is now without any evidence upon that issue. We are unable, therefore, 16 B.T.A. 716">719 to find that the petitioner's returns for the years 1919 to 1923, inclusive, or any of them, were fraudulent within the1929 BTA LEXIS 2535">*2540 purview of the statute. The fraud penalties imposed by the respondent for each of the years herein involved are therefore disallowed. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625601/	JEROLD NORMAN FENTON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentFenton v. CommissionerDocket No. 11561-81.United States Tax CourtT.C. Memo 1983-410; 1983 Tax Ct. Memo LEXIS 375; 46 T.C.M. 762; T.C.M. (RIA) 83410; July 18, 1983. 1983 Tax Ct. Memo LEXIS 375">375 In 1975, petitioner purchased a new principal residence and properly took a $1,248 credit pursuant to sec. 44, I.R.C. 1954, on his return for that year. In 1976, petitioner sold his residence and acquired a new residence the use of which did not originate with him. Held, petitioner must recapture the previously taken credit on his 1978 return. Sec. 44(d)(1). Jerold Norman Fenton, pro se. John F. Dean, for the respondent. STERRETTMEMORANDUM FINDINGS1983 Tax Ct. Memo LEXIS 375">377 OF FACT AND OPINION STERRETT, Judge: By statutory notice dated February 27, 1981, respondent determined a deficiency in petitioner's Federal income tax for the taxable year 1978 in the amount of $1,248. The sole issue to be decided is whether the new principal residence credit taken by petitioner on his 1975 return should be recaptured in the year 1978. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioner Jerold Norman Fenton resided in Sykesville, Maryland at the time of filing the petition herein. He filed his 1978 Federal income tax return with the Internal Revenue Service Center, Andover, Maine. On June 20, 1975, petitioner purchased a new residence in GaithersburgMaryland at a cost of $24,950. On his Federal income tax return for that year, petitioner, pursuant to section 44, I.R.C. 1954, claimed a credit in the amount of $1,248 for the purchase of a principal residence. In the year 1976, petitioner was transferred by his employer to a jobsite in Bath, Maine. Due to such transfer, petitioner sold at a loss his residence in Maryland1983 Tax Ct. Memo LEXIS 375">378 on September 13, 1976. On November 3, 1976, petitioner bought a previously occupied residence in Bath, Maine which remained his principal residence through September 1980. In his notice of deficiency respondent determined that petitioner must recapture in 1978 the new principal residence credit taken on his 1975 return. OPINION Section 44(a) allows, in the case of an individual, a tax credit equal to 5 percent of the purchase price of a new principal residence that is purchased or constructed by the taxpayer during the taxable year. Section 44(c)(1) defines the term "new principal residence" as a principal residence "the original use of which commences with the taxpayer." On his 1975 return, petitioner properly took a tax credit of $1,248 pursuant to the provisions of section 44. In 1976, petitioner sold the principal residence with respect to which he took the section 44 credit and shortly thereafter purchased a home in Bath, Maine. The Maine residence had been previously occupied at the time petitioner purchased it.Section 44(d)(1) requires a taxpayer to recapture any tax credit taken with respect to the purchase of a new principal residence if such residence is disposed1983 Tax Ct. Memo LEXIS 375">379 of within 36 months after the date on which it was acquired. The taxpayer need not recapture the previously taken tax credit if the residence is disposed of as a result of the death of the owner, casualty loss, involuntary conversion, or a disposition pursuant to a settlement in a divorce or legal separation proceeding where the other spouse retains the residence as principal residence. See section 44(d)(3). Additionally, no recapture is required where a second new principal residence is purchased or constructed within 18 months of the disposition of the original residence. See sec. 44(d)(2) and sec. 1034(a). 1 In order to avoid the recapture provision of section 44(d)(1) by way of the section 44(d)(2) exception, it is necessary for the taxpayer to purchase or construct a new principal residence as defined in section 44(c)(1). In the instant case, the residence that petitioner purchased in Maine in 1976 was not a "new principal residence" as that term is defined in section1983 Tax Ct. Memo LEXIS 375">380 44(c)(1). Therefore, petitioner does not qualify for the recapture exception of section 44(d)(2). 2At trial, petitioner contended that he was misled by respondent's instructions accompanying the Form 5405 for claiming the credit. Petitioner claims that the instructions did not make it clear that the use of the second residence had to originate with the taxpayer in order to avoid recapture. He argues that he is entitled to rely upon his interpretation of the instructions accompanying this form and therefore should not be required to recapture the credit. We believe that petitioner's reporting stance was one that was taken in complete good faith. However, we need not address the question of whether petitioner's reading of the instructions and of other related matter was reasonable, for the law if clear that erroneous legal advice rendered by an IRS agent or in an informal IRS publication is not binding on respondent and certainly1983 Tax Ct. Memo LEXIS 375">381 not on this Court. Dixon v. United States,381 U.S. 68">381 U.S. 68, 381 U.S. 68">72-73 (1965); Automobile Club of Michigan v. Commissioner,353 U.S. 180">353 U.S. 180, 353 U.S. 180">183 (1957); Smith v. Commissioner, 80 T.C. (1983); Zimmerman v. Commissioner,71 T.C. 367">71 T.C. 367, 71 T.C. 367">371 (1978), affd. without published opinion 614 F.2d 1294">614 F.2d 1294 (2d Cir. 1979). Therefore, because we find that petitioner did not repurchase a "new principal residence" within 18 months after the disposition of his previous residence, we hold that he must recapture the section 44 credit taken with respect to that prior residence. Accordingly, Decision will be entered for the respondent.Footnotes1. Respondent determined that 1978 was the proper year for recapture since it cannot be determined whether the sec. 44(d)(2)↩ exception applies until 18 months after the disposition of the first residence.2. Neither does petitioner qualify for the exceptions contained in sec. 44(d)(3). Moving from one residence to another as a result of a job transfer does not constitute an involuntary conversion for purposes of sec. 44(d)(3)(B)↩. See sec. 1033(a).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625602/	Dale M. Caselton v. Commissioner.Caselton v. CommissionerDocket No. 78477.United States Tax CourtT.C. Memo 1960-233; 1960 Tax Ct. Memo LEXIS 55; 19 T.C.M. 1310; T.C.M. (RIA) 60233; October 31, 1960Dale M. Caselton, 1220 Eastridge Drive, Lincoln, Neb., pro se. Richard J. Shipley, Esq., for the respondent. MULRONEY Memorandum Opinion MULRONEY, Judge: The respondent determined a deficiency in petitioner's income tax for 1957 in the amount of $155. The only question in the case is whether petitioner is entitled in 1957 to a dependency exemption under section 151, Internal Revenue Code of 1954, 1 by providing over half the support of his minor daughter by a prior marriage. Petitioner, a resident of Lincoln, Nebraska, filed a joint Federal income tax return with his present wife, Edna I. Caselton, 1960 Tax Ct. Memo LEXIS 55">56 for the year 1957 with the district director of internal revenue at Omaha, Nebraska. Petitioner claimed a dependency exemption in the 1957 joint return for his four minor children by a prior marriage. Respondent determined that he was not entitled to an exemption for Teresa, one of the four children. Respondent contends that petitioner has not established the total cost of Teresa's support in 1957 and that consequently the petitioner has not met his burden of showing that he provided over half of the support for her in that year in order to be entitled to the dependency exemption under sections 151 and 152. We agree with the respondent. Petitioner appeared pro se at the trial and he alone testified. There is no other evidence. Petitioner was divorced in October 1956 and during 1957 the four children lived with their mother and visited the petitioner at various times throughout the year. Under the divorce decree the petitioner was ordered to pay support for the children in the amount of $200 a month. Petitioner testified that in 1957 he paid $2,425 to his former wife for such support. He also testified that he spent additional amounts of $568 and $414 for the children's support, 1960 Tax Ct. Memo LEXIS 55">57 although apart from his testimony there is nothing in the record to verify these additional amounts or to indicate the nature of the expenditures. There is no evidence to establish the total cost of Teresa's support in 1957, and there is no evidence to even show the total cost of support for all four children. All that we are told is that the petitioner paid these amounts for all four of the children, ranging from 12 to 5 years of age in 1957. Teresa was the youngest. The record shows that petitioner's former wife claimed a dependency exemption for Teresa in 1957, but for none of the other children, and that she was required to make child-care expenditures for Teresa in that year. Petitioner attempted to show, through his testimony alone, what his former wife could conceivably have expended on the four children in 1957. He testified that "She could have made a maximum of $3,000" in 1957 and that it would be impossible for his former wife to pay more for the children's support than he did. The testimony is filled with conjectures and mere opinions of the petitioner. Such opinions and conjectures are not sufficient to establish the total cost of support for the four children, let alone1960 Tax Ct. Memo LEXIS 55">*58 to establish the total cost of support for Teresa in 1957. We hold that petitioner has not shown that he provided over half of Teresa's support in 1957, and therefore is not entitled to a dependency exemption for her in 1957. Sections 151, 152. Decision will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625603/	ROY E. KNOEDLER and NELLIE D. KNOEDLER, ET AL. 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Knoedler v. CommissionerDocket Nos. 3031-72, 4996-72 & 4997-72United States Tax CourtT.C. Memo 1974-85; 1974 Tax Ct. Memo LEXIS 235; 33 T.C.M. 443; T.C.M. (RIA) 74085; April 8, 1974, Filed. 1974 Tax Ct. Memo LEXIS 235">235 The petitioners advanced funds to their wholly-owned corporation by which they were employed. Held: The dominant motivation of these employee-stockholders in making loans to their corporation was not to protect their status as salaried employees and therefore such loans were not proximately related to their trade or business as employees. Losses suffered by them in connection with said loans resulted from nonbusiness bad debts, deductible only as short-term capital losses under sec. 166(d) of the 1954 Code. Michael J. Messina, For the Petitioners. George T. Morse, III for the Respondent. STERRETTMEMORANDUM FINDINGS OF FACT AND OPINION STERRETT, Judge: The respondent determined deficiencies in the petitioners' federal income tax as follows: PetitionerDocket No.YearDeficiency Roy E. and Nellie D. Knoedler3031-721965$2,885.0019661,892.0019682,585.91Estate of Fred E. Knoedler, Deceased, Robert L. Knoedler, Executor4996-721965806.4319661,409.25Robert L. and Helen B. Knoedler4997-7219652,210.7219662,280.7519671,444.961968994.78The sole issue presented for our determination is whether the petitioners, who were both stockholders and employees of Knoedler Manufacturers, Inc., are entitled 1974 Tax Ct. Memo LEXIS 235">236 to business or nonbusiness bad debt deductions under the provisions of section 166 2 for loans which they made to that corporation and which became worthless in 1968. 3 OPINION All of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference. Roy E. Knoedler and Nellie D. Knoedler are husband and wife who, at the time of the filing of the petition herein, maintained their residence in Overland Park, Kansas. They filed their joint federal income tax returns for the calendar years 1965 and 1966 with the district director of internal 1974 Tax Ct. Memo LEXIS 235">237 revenue at Chicago, Illinois and for the calendar year 1968 with the Internal Revenue Service Midwest Region. Robert L. Knoedler, Executor of the Estate of Fred E. Knoedler and a petitioner individually herein, was a resident of Streator, Illinois at the time of the filing of the petition herein. Fred E. Knoedler filed a joint federal income tax return with his wife Eula M. Knoedler, who died on June 2, 1965, for the calendar year 1965 and an individual federal income tax return for the calendar year 1966 with the district director of internal revenue at Chicago, Illinois. Robert L. Knoedler and Helen B. Knoedler are husband and wife who, at the time of the filing of the petition herein, maintained their residence in Streator, Illinois. They filed their joint federal income tax returns for the calendar years 1965, 1966 and 1967 with the district director of internal revenue at Chicago, Illinois and for the calendar year 1968 with the Internal Revenue Service Midwest Region. On or about July 1, 1946, Fred E. Knoedler, age 53, Robert L. Knoedler, age 25 and Roy E. Knoedler, age 30 (hereinafter referred to as Fred, Robert and Roy or as the petitioners) formed a partnership to be 1974 Tax Ct. Memo LEXIS 235">238 known as Knoedler Manufacturers, with its principal office in Streator, Illinois. The initial capital of the partnership consisted of cash contributions of $8,178 and $645 made by Fred and Robert, respectively. 4Knoedler Manufacturers was initially engaged only in the manufacture and sale of operator seats for farm tractors. During 1948, a decision was made to incorporate the partnership. As a result of this decision, the partnership was incorporated on October 7, 1948 under the laws of the State of Illinois and became known as Knoedler Manufacturers, Inc. (hereinafter Manufacturers). By the time of incorporation, the partnership had expanded from its initial capital contribution of $8,823 to equity of $326,018.75. 1974 Tax Ct. Memo LEXIS 235">239 The newly formed corporation received assets valued at $100,000 as capital contributions and it issued 1,000 shares of no par common stock to the petitioners and their wives in the following amounts: Fred E. Knoedler220 sharesEula M. Knoedler180 sharesRobert L. Knoedler180 sharesHelen B. Knoedler120 sharesRoy E. Knoedler160 sharesNellie D. Knoedler140 sharesAt all times during which Fred, Robert and Roy owned sotck in Manufacturers, they occupied the following salaried positions as corporate officers: Fred, president; Robert, vice president; and Roy, secretary-treasurer. At no time did Nellie D., Eula M. or Helen B. Knoedler participate in the active conduct of the business of Manufacturers. Following its incorporation, Manufacturers added the following product lines, either purchased from other companies or developed by Manufacturers itself, to its initial line of tractor seats, some of which were successful and were continued and others which were not: YearProduct Line 1949Tractor platform1950Safety device for mechanical corn pickers1952Oats harvesting device1953New design tractor seat1956Oat huller and grain cracker device; Auger wagon1957Elevator lineDuring the corporation's 1974 Tax Ct. Memo LEXIS 235">240 fiscal year ending May 31, 1951 During the corporation's fiscal year ending May 31, 1951, the petitioners made initial loans to the corporation in the aggregate amount of $109,790. During this same year, the corporation's inventories increased from $83,050.59 to $190,067.84 although total assets increased only from $384,370.50 to $437,682.96. During the corporation's 1952, 1953 and 1954 fiscal years the loan balances aggregated $116,790.00, $117,893.43 and $110,790.00, respectively. During these latter three years, inventories increased by approximately $66,000 while total assets increased by around $60,000. The petitioners were owed the following balances on loans made to Manufacturers at the end of the corporation's fiscal years 1955 through 1959: YearFredRobertRoyTotal 1955$25,000.00$25,000.00$25,000.00$ 75,000.00195677,632.0553,632.0735,632.07166,896.19195783,832.0853,632. 0735,362.07173,096.22 195887,832.0853,632.0735,632.07177,096.22 195987,832.0853,632.0735,632.07177,096.22The loan balances from 1959 to 1968 remained at approximately the same figures. During Manufacturers' 1959 fiscal year, 1974 Tax Ct. Memo LEXIS 235">241 a $200,000 loan was negotiated with the Small Business Administration. Manufacturers' net income or loss and shareholders' equity (including the initial capital contribution of $100,000) for the fiscal years ending May 31, 1949 to 1959 was as follows: YearIncome or (Loss)Shareholders' Equity 1949$111,102.36$ 211,102.36195051,343.54262,445.90195126,940.97289,386.87195227,324.11316,710.98195310,293.47327,004.451954( 17,064.51)309.939.941955( 8,691.43)301,248.511956( 70,997.18)230,251.33195732,671.97262,923.30195838,077.30301,000.601959( 12,176.04)288,824.56 The petitioners received the following compensation from Manufacturers and income from other sources and paid the following federal income taxes for their taxable years 1949 through 1959 5: Fred E. Knoedler YearSalary from ManufacturersOther IncomeTax Liability 1949$18,149.99$1,721.02$3,909.56195017,820.571,460.193,869.58195122,457.531,387.396,033.5219 5220,100.641,493.665,681.84195318,241.301,630.105,027.14195417,472.221,962.804,339.90195520,631.682 ,165.335,506.8619569,999.603,083.772,273.68195716,093.543,296.403,580.42195817,323.283,606.314,440.0619599,492.23-1,271.46Robert L. KnoedlerYearSalary from ManufacturersOther IncomeTax Liability1949$18,149.99$ 513.40$ 3,215.14195017,820.57571.153,259.94195122,457.531,187.955,487.74195220,100.641,32 0.065,159.86195318,241.311,456.504,505.18195417,472.221,387.533,757.92195520,631.67996.244,677.4919 569,999.602,808.422,046.09195717,324.38-3,297.31195817,323.281,966.514,086.53195912,999.78-2,251.94Roy E. KnoedlerYearSalary from ManufacturersOther IncomeTax Liability1949$18,149.90$1,280.77$ 3,100.92195017,820.571,214.823,108.06195122,457.531,445.555,148.08195220,100.641,444.404,751.12195318,241 .311,444.404,081.14195417,472.221,284.283,366.96195520,631.67194.083,996.7619569,999.602,055.101,560.03195716,158.06-2,550.98195816,920.281,425.282,950.68195912,999.78-1,783.941974 Tax Ct. Memo LEXIS 235">242 On November 26, 1968, a contract of sale was entered into between Manufacturers and Streator Dependable Manufacturing Co., Inc. (Streator) whereby Streator was to acquire all of the capital stock of Manufacturers held by petitioners (including their wives). As part of this contract of sale, the petitioners agreed to be compensated only partially for the loans they made to Manufacturers and to release the corporation from any further obligation to them on these loans. At the time the stock of Manufacturers was sold on November 26, 1968, the petitioners were owed the following amounts as a result of loans to the corporation: Fred E. Knoedler$75,013.35Robert L. Knoedler51,091.48Roy E. Knoedler40,818.48The amounts of the outstanding loans to stockholders that became worthless during the calendar year 1968 are as follows: 1974 Tax Ct. Memo LEXIS 235">243 Fred E. Knoedler6 $59,701.63Robert L. Knoedler40,665.58Roy E. Knoedler7 29,306.19On their federal income tax returns for the calendar year 1968, the petitioners Fred E. Knoedler, Robert L. and Helen B. Knoedler, and Roy E. and Nellie D. Knoedler claimed $59,013.35, $40,665.58, and $40,818.00, respectively, as deductions from ordinary income resulting from bad debts arising out of their respective loans to Manufacturers. The petitioners Roy E. and Nellie D. Knoedler, Fred E. Knoedler, and Robert L. and Helen B. Knoedler filed applications for tentative carryback adjustments with the Internal Revenue Service in 1969 to carryback their net operating losses for 1968 to the taxable years 1965 and 1966, 1965 and 1966, and 1965, 1966 and 1967, respectively. The Internal Revenue Service 1974 Tax Ct. Memo LEXIS 235">244 granted the applications and issued refund checks to the petitioners. In his notice of deficiency to Roy E. and Nellie D. Knoedler, the respondent determined that these petitioners' loss claimed for the taxable year 1968 in the amount of $40,818 was a capital loss rather than an ordinary loss since it was determined not to be a business bad debt and that consequently no net operating loss was sustained in 1968 and no carryback was allowable for 1965 or 1966. In his notice of deficiency to Fred E. Knoedler and to Robert L. and Helen B. Knoedler, the respondent determined that these petitioners' losses claimed for the taxable year 1968 in the amounts of $59,013.35 and $40,665.58, respectively, were not allowable as ordinary losses since they were not business bad debts and furthermore were not allowable as nonbusiness bad debt deductions in that year since the loans were not totally worthless in 1968. Accordingly, the respondent determined that the tentative carryback adjustments were erroneously allowed. The sole issue presented requires our determination as to whether the petitioners are entitled to business bad debt deductions as provided in section 166(a) 8 or to nonbusiness 1974 Tax Ct. Memo LEXIS 235">245 bad debt deductions as provided in section 166(d) 91974 Tax Ct. Memo LEXIS 235">246 for loans which they made to Manufacturers, a corporation in which they were both stockholders and employees. The resolution of this issue depends upon the character of the bad debts, whether they are business or nonbusiness in nature. This issue presents a question of fact to be determined in light of all the facts and circumstances in each particular case. Oddee Smith, 55 T.C. 260">55 T.C. 260, 55 T.C. 260">267 (1970), remanded for consideration in light of Generes at 457 F.2d 797">457 F.2d 797 (C.A. 5, 1972); opinion on remand 60 T.C. 316">60 T.C. 316 (1973); Stuart M. Sales, 37 T.C. 576">37 T.C. 576, 37 T.C. 576">580 (1961); section 1.166-5(b), Income Tax Regs.Section 1.166-5(b), Income Tax Regs., provides that for tax purposes the character of a bad debt is determined by the relationship which the debt bears to the taxpayer's trade or business. If the debt bears a proximate relationship to a trade or business of the taxpayer, at the time of making the loans or at the time of worthlessness of the debt, it qualifies as a business bad debt. United States v. Generes, 405 U.S. 93">405 U.S. 93 (1972) at 96; 55 T.C. 260">Oddee Smith, supra at 55 T.C. 260">55 T.C. 260, 55 T.C. 260">267; I. Hal Millsap, Jr., 46 T.C. 751">46 T.C. 751, 46 T.C. 751">754, fn. 3 (1966), affd. 387 F.2d 420">387 F.2d 420 (C.A. 8, 1968); section 1.166-5(b), Income Tax Regs.1974 Tax Ct. Memo LEXIS 235">247 The respondent does not contest the characterization of the loans as debt (rather than contributions to capital), nor does he contend that the loans are unrelated to the petitioners' trade or business as employees of Manufacturers. Rather he contends that there is no proximate relationship between the loans and the petitioners' trade or business as employees. The petitioners, on the other hand, contend that the requiste relationship is present. The parties are in agreement that the proper measure for determining whether a bad debt has a prxoimate relationship to a taxpayer's trade or business is that of dominant motivation. 405 U.S. 93">United States v. Generes, supra at 103. In consideration of the issue at hand, it is the petitioners' dual status as stockholders and employees which presents the difficulty in determining motivation. Here, the petitioners' interest as stockholders is an investment or nonbusiness interest while their status as salaried employees is a business interest. 405 U.S. 93">United States v. Generes, supra at 100-101. It must be clear from the record that the primary and dominant reason for making the loans was business related rather than investment related; an equally balanced relationship 1974 Tax Ct. Memo LEXIS 235">248 between the two interests, much less a mere significant business related motivation, is not enough. 55 T.C. 260">Oddee Smith, supra at 60 T.C. 316">60 T.C. 316, 60 T.C. 316">318-319. In the instant case we cannot say that the petitioners' dominant and primary motive was the protection of their employee status and their salaries derived therefrom. As the petitioners point out in attempting to distinguish the instant case from Generes, their salaries from Manufacturers were their principal sources of income and they were fulltime employees of Manufacturers, neither of which was the case in Generes. However, such facts alone do not convince us that the petitioners' dominant motivation in making the loans was business related especially in light of the fact that a cautious approach is dictated when considering deductions for business bad debts. 405 U.S. 93">United States v. Generes, supra at 102; Whipple v. Commissioner, 373 U.S. 193">373 U.S. 193, 373 U.S. 193">202, 373 U.S. 193">204 (1963). In addition to the facts that their salaries constituted their principal source of income and that they were employed full time by Manufacturers, the petitioners assert that a comparison of their salaries to their investment in Manufacturers supports their claim that the loans were business 1974 Tax Ct. Memo LEXIS 235">249 related. On incorporation of Manufacturers in 1948, the petitioners' investment totalled $100,000, $40,000 by Fred E. and Eula M. Knoedler, $30,000 by Robert L. and Helen B. Knoedler, and $30,000 by Roy E. and Nellie D. Knoedler. 10 Between 1949 and 1959, the petitioners' pre-tax compensation averaged over $17,000 annually, or approximately $52,000 in total each year, and their after-tax compensation averaged just under $14,000 annually or approximately $41,500 in total each year. In light of other factors to be mentioned below, we do not think this comparison, either on a cumulative or individual basis, is either favorable or unfavorable to the petitioners' position. We do not believe that a mechanical comparison of salary and original investment is the only factor to 1974 Tax Ct. Memo LEXIS 235">250 consider in determining whether the loans in question were investment or business related. Rather we should consider the inferences to be drawn from all the facts and circumstances. Hogue v. Commissioner, 459 F.2d 932">459 F.2d 932, 459 F.2d 932">938 (C.A. 10, 1972), affirming a Memorandum Opinion of this Court; and Miles Production Company v. Commissioner, 457 F.2d 1150">457 F.2d 1150, 457 F.2d 1150">1155 (C.A. 5, 1972), affirming a Memorandum Opinion of this Court. In addition to their original investment of $100,000 the petitioners stood to lose the earnings retained in the business by Manufacturers, a substantial amount in itself at all times. 111974 Tax Ct. Memo LEXIS 235">251 In the fiscal year ending May 31, 1956, when the total loan balance went from $75,000 to $166,896.19, an increase of $91,896.19, the petitioners' total salaries amount to only $29,998.80. At this time, just prior to the additional loan of $91,896.19, the petitioners' interest in Manufacturers must also include the $75,000 outstanding loan balance, as the petitioners also stood to lose this latter amount if Manufacturers went under. We think the evidence in the instant case supports the inference that the financing of corporate expansion in existing product lines and into new product lines was provided partly through shareholder loans. In the fiscal year 1951, when the first loans of $109,790 were made, Manufacturers' inventories rose from $83,050.59 to $190,067.84. While we realize that total assets rose only by approximately $53,000 that year and while we cannot say that the loans were used directly to increase inventories, we think that the loans were connected with the business expansion of Manufacturers and thus from the petitioners' standpoint as stockholder-employees, were investment related rather than business related. The petitioners contend that because Manufacturers sustained an overall operating loss during the fiscal years 1951 through 1956 and because Manufacturers' sales and total assets did not increase substantially during that same period, we should conclude that in making the loans in question the petitioners were concerned about their continued employment and the protection 1974 Tax Ct. Memo LEXIS 235">252 of their salaries. While the record may show some reason for the petitioners to be concerned about their employment, we do not think it shows that such concern was their dominant motivation. The following statement from 373 U.S. 193">Whipple v. Commissioner, supra at 202, is of importance in the instant case: * * * Even if the taxpayer demonstrates an independent trade or business of his own, care must be taken to distinguish bad debt losses arising from his own business and those actually arising from activities peculiar to an investor concerned with, and participating in, the conudct of the corporate business. We do not think the petitioners have demonstrated that their dominant motivation in making the loans to their corporation was business related and thus we conclude that the loans in question were not proximately related to the petitioners' trade or business as employees. Accordingly, the petitioners are not entitled to business bad debt deductions under the provisions of section 166(a) but must resort to the provisions of section 166(d) for any allowable deduction. Because we believe the facts of the instant case fall within the provisions of section 166(d) and support a deduction thereunder, 1974 Tax Ct. Memo LEXIS 235">253 the petitioners are entitled to short-term capital losses for the amounts stipulated as worthless in 1968. Decisions will be entered under Rule 155. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Estate of Fred E. Knoedler, Deceased, Robert L. Knoedler, Executor, docket No. 4996-72; and Robert L. Knoedler and Helen B. Knoedler, docket No. 4997-72. ↩2. All Code references herein are to the Internal Revenue Code of 1954, as amended and as applicable to the taxable year involved, unless otherwise indicated. ↩3. The resolution of this issue also determines whether the losses should be carried back under the provisions of sec. 172 from 1968 to the prior tax years involved herein. In the case of Robert L. and Helen B. Knoedler, for the taxable year 1968, the allowable medical and dental expense deduction will be controlled by the adjusted gross income, which in turn depends on the decision reached herein. ↩4. We note in passing that the partnership agreement stated that the partners of Knoedler Manufacturers included not only Fred E. Knoedler, Robert L. Knoedler and Roy E. Knoedler but also their wives, Eula M., Helen B., and Nellie D. Knoedler, respectively. The capital contribution of these partners was stated in the partnership agreement to total $19,121.97. The apparent inconsistencies between the partnership agreement and the stipulation of facts were not explained. ↩. Increased loan balance represents accrued interest loaned to the corporation. ↩5. The schedules of the petitioners' compensation based on Manufacturers' fiscal year ending May 31 is different from the above schedules based on the petitioners' calendar year reporting, except that the amounts of compensation during Manufacturers' 1954, 1955 and 1956 fiscal years are the same as those reported for the petitioners' 1954, 1955 and 1956 calendar years. ↩6. The respondent concedes that this amount, rather than the $59,013.35 claimed on the 1968 return, is the correct part of the loan balance of Fred E. Knoedler which became worthless in 1968. ↩7. The petitioners Roy E. and Nellie D. Knoedler concede that this amount, rather than the $40,818.00 claimed on their 1968 return, is the correct part of the loan balance to Roy E. Knoedler which became worthless in 1968. ↩8. 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. ↩9. SEC. 166. Bad Debts. (d) NONBUSINESS DEBTS. - (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. ↩10. We note that the petitioners' wives owned part of the stock of Manufacturers, but we do not think and the petitioners have not argued that the salary versus investment comparison should be made in instant case only with regard to Fred E., Robert L. and Roy E. Knoedler's interests in the corporation. The husbands' concern with and interest in their wives' investment should be as great as in their own investment. ↩11. Although Manufacturers' net worth as stated on its balance sheet does not necessarily reflect true valve and is only evidentiary in value (Cf. Doyle v. Mitchell Bros. Co., 247 U.S. 179">247 U.S. 179, 247 U.S. 179">187 (1918); and Art Metal Construction Co., 4 B.T.A. 493">4 B.T.A. 493, 4 B.T.A. 493">498↩ (1926)), we think it is a valuable consideration in the instant case.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625605/	Joe K. Swisher and Dorothy M. Swisher, Petitioners, v. Commissioner of Internal Revenue, RespondentSwisher v. CommissionerDocket No. 69508United States Tax Court33 T.C. 506; 1959 U.S. Tax Ct. LEXIS 12; December 16, 1959, Filed 1959 U.S. Tax Ct. LEXIS 12">12 Decision will be entered for the respondent. In 1949 the petitioner was awarded a bonus, payable in installments over a 5-year period, by his employer, General Motors Corporation. In 1950 he terminated his employment with that company and thereafter operated an automobile dealership. He continued to receive installment payments of the bonus through 1954. Held, that the installment payment received in 1954 constituted gross income derived from the petitioner's trade or business and is, therefore, not to be offset by deductions not attributable to his trade or business in computing a net operating loss for 1954, to be carried back to 1952, under section 172(d)(4) of the Internal Revenue Code of 1954. Charles H. Rehm, Esq.,1959 U.S. Tax Ct. LEXIS 12">13 for the petitioners.Leonard A. Hammes, Jr., Esq., for the respondent. Atkins, Judge. ATKINS33 T.C. 506">506 The respondent determined a deficiency in income tax of the petitioners for the year 1952 in the amount of $ 438.50.The question presented is whether, in computing, under section 172 of the Internal Revenue Code of 1954, a net operating loss for 1954 which may be carried back to 1952, the respondent correctly held that an amount of $ 2,000 received by petitioner during 1954 as an installment payment under the General Motors Corporation bonus plan is income attributable to the petitioner's trade or business.FINDINGS OF FACT.Some of the facts are stipulated and are incorporated herein by this reference.33 T.C. 506">507 The petitioners are husband and wife who reside in Fredericktown, Missouri. They filed joint Federal income tax returns for the taxable years 1952 and 1954 with the district director of internal revenue in St. Louis, Missouri. Dorothy M. Swisher is a party to this proceeding only because she and her husband filed joint returns, and hereinafter Joe K. Swisher will be referred to as the petitioner.For approximately 23 years, prior to January 15, 1950, the petitioner1959 U.S. Tax Ct. LEXIS 12">14 was employed in various positions by the General Motors Corporation. During the year 1949 the petitioner was the zone manager in Chicago, Illinois, for the Chevrolet Division of General Motors Corporation, and prior to that he was the national sales promotion manager for Chevrolet. While so employed by General Motors petitioner was eligible for bonuses from his employer. In some years the petitioner received a bonus while in others he did not. In 1949 petitioner was awarded a bonus of $ 10,000, which, commencing in 1950, he received in yearly installments of $ 2,000 per year. The last installment was received in January 1954.On January 15, 1950, petitioner terminated his employment as zone manager for Chevrolet in Chicago, Illinois, and became a Chevrolet and Oldsmobile dealer in Fredericktown, Missouri.The General Motors bonus plan under which the bonus to petitioner was paid provides in part as follows:1. The purpose of this plan is to provide incentive and reward to employes who contribute to the success of the enterprise by their invention, ability, industry, loyalty or exceptional service, through making them participants in that success. * ** * * 4. Full power1959 U.S. Tax Ct. LEXIS 12">15 and authority to construe, interpret and administer this plan shall be vested in the Bonus and Salary Committee as from time to time constituted pursuant to the By-Laws of the Corporation. Decisions of the Committee shall be final, conclusive and binding upon all parties, including the Corporation, the stockholders and the employes, provided, however, that the Committee shall rely upon and be bound by the amount of net earnings, the amount of net capital, the maximum amount which may be credited to the bonus reserve, the total amount available in the reserve, and the value of stock for award purposes, all as reported by the independent public accountants.* * * Upon final determination of bonus awards by the Committee, each award of $ 1,000 or less (cash or stock of equivalent award value) shall be paid at the time of award. Each award of more than $ 1,000 shall be paid in annual instalments of 20% or $ 1,000, whichever is greater, the first such instalment at the time of award, and the remaining instalments in January of each succeeding year (until the full amount of the award is paid) if earned out by the beneficiary by continuing service with the Corporation, at the rate of1959 U.S. Tax Ct. LEXIS 12">16 1/12th of the amount of the first instalment for each complete month of service beginning with January of the year of the determination.* * * 33 T.C. 506">508 7(b). With respect to bonus awards which become payable partly or wholly in cash, the amount of cash payable at the time of award shall be paid forthwith to the beneficiaries. The remaining cash shall be retained by the Corporation (without liability for interest) pending its being earned out by and paid to the beneficiaries at the times specified.* * * 8(a). A beneficiary whose employment terminates by dismissal for cause, of which the Bonus and Salary Committee shall be the sole judge, shall lose any right to earn out his unearned bonus awards.A beneficiary who voluntarily terminates his employment shall have no right to earn out his unearned bonus awards, unless and to the extent the Bonus and Salary Committee, in its sole discretion, decides otherwise. In the event of such decision, the beneficiary may earn out his unearned bonus awards, provided that and for so long as such beneficiary, to the satisfaction of the Bonus and Salary Committee, refrains from engaging directly or indirectly in activities competitive with1959 U.S. Tax Ct. LEXIS 12">17 the activities of General Motors and from acting or conducting himself in a manner inimical or in any way contrary to the best interests of General Motors.* * * 9. If a beneficiary dies, his unpaid and undelivered bonus awards and dividend equivalents shall be paid and delivered to his legal representatives or to the persons entitled thereto as determined by a court of competent jurisdiction, at such times and in such manner as if the beneficiary were living.In his return for the year 1954 the petitioner included the $ 2,000 in income. Such return shows the following:Gross income:Income from interest$ 78.10 Loss from business(2,820.94)Net long-term capital gain249.27 Bonus -- General Motors Corp.2,000.00 Adjusted gross income(493.57)Deductions:Contributions$ 488.00Interest1,200.59Taxes259.60Total deductions1,948.19 Net income(2,441.76)Exemptions1,800.00 Taxable incomeNone The petitioner, in computing a net operating loss for 1954 which he claims as a proper deduction for 1952, treated the $ 2,000 payment under the General Motors bonus plan as nonbusiness income and therefore1959 U.S. Tax Ct. LEXIS 12">18 claimed that he was entitled to take into consideration nonbusiness deductions of $ 1,948.19. In the notice of deficiency the respondent determined that the nonbusiness deductions were in a lesser amount than claimed and further determined:33 T.C. 506">509 It is held that the amount, $ 2,000.00, received by Joe Swisher in the year 1954 as an installment payment under the General Motors Bonus Plan, represents business income and, therefore, may not be offset against nonbusiness deductions in computing the net operating loss carry-back to the year 1952.OPINION.The question presented is whether the $ 2,000 bonus payment received by petitioner in 1954 is to be considered as gross income not derived by the petitioner from his trade or business for purposes of determining, under section 172(d)(4) of the Internal Revenue Code of 1954, the extent to which deductions not attributable to his trade or business may be taken into account in computing his net operating loss for 1954 to be carried back to 1952. Section 172(d)(4) limits the amount of nonbusiness deductions to the amount of the gross income which is not derived from the trade or business. Pertinent provisions of section 172 and the1959 U.S. Tax Ct. LEXIS 12">19 regulations thereunder are set forth in the margin. 11959 U.S. Tax Ct. LEXIS 12">20 It is now well settled, not only by the regulations, but by decisions of this and other courts, that for the purposes of this section an employee is engaged in a trade or business and that the salary and wages received by him are derived from the operation of that business. Anders I. Lagreide, 23 T.C. 508">23 T.C. 508; and Elmer E. Batzell, 30 T.C. 648">30 T.C. 648, affd. (C.A. 4) 266 F.2d 371. However, the petitioner contends that the bonus which he received is not to be considered as wages or salary, 33 T.C. 506">510 and that even if it were so considered, it should not be considered business income for the year 1954 since it related to employment which ceased in 1950. In short, he contends that the only business carried on by him in 1954 was that of conducting an automobile dealership. He, therefore, contends that this bonus is, for present purposes, nonbusiness income and that consequently since it is in excess of the nonbusiness deductions which he claims, such nonbusiness expenses should be taken into consideration in computing the net operating loss pursuant to the terms of the statute.We have set forth in some detail1959 U.S. Tax Ct. LEXIS 12">21 in the Findings of Fact the provisions of the General Motors Corporation bonus plan. Since the petitioner did continue to receive the installments under the bonus awarded to him in 1949, necessarily the bonus and salary committee must have decided that the petitioner had complied with all conditions necessary to "earn out his unearned bonus awards" within the meaning of the plan. Whether his operation of a General Motors dealership after leaving the employ of General Motors entered into the decision of the committee, or whether, as testified by the petitioner, all he had to do to "earn out" the bonus was to merely refrain from activities competitive with or inimical to General Motors, we consider immaterial for present purposes. We are satisfied that the bonus award was a part of compensation paid to him by General Motors. We think it is immaterial whether it be considered that his services as an employee of General Motors extended through the year 1954, or whether it be considered that the bonus constituted deferred compensation for services performed in prior years. In either event, we think, the income must be considered as income attributable to the petitioner's trade or 1959 U.S. Tax Ct. LEXIS 12">22 business within the meaning of the statute. In our opinion income may be considered as income from the taxpayer's trade or business even though such business was not carried on in the year in question, so long as it is derived from a business which the petitioner had carried on in the past. In this connection see Walter G. Morley, 8 T.C. 904">8 T.C. 904, where we took the position that for purposes of section 122(d)(5) of the Internal Revenue Code of 1939 (which corresponds to section 172(d)(4) of the 1954 Code), a loss sustained in one year may be considered as a loss from the operation of a business regularly carried on by the petitioner, where such business had been conducted in prior years, even though not carried on in the year in question.Since, within the meaning of section 172(d)(4), the $ 2,000 bonus installment received in 1954 is not to be considered as "gross income not derived from such trade or business," it may not be offset by the petitioner's nonbusiness deductions for that year in computing his net operating loss.Decision will be entered for the respondent. Footnotes1. Section 172 of the 1954 Code, as it existed in the year 1954, provides in part as follows:(b) Net Operating Loss Carrybacks and Carryovers. -- (1) Years to which loss may be carried. -- A net operating loss for any taxable year ending after December 31, 1953, shall be -- (A) a net operating loss carryback to each of the 2 taxable years preceding the taxable year of such loss, and* * * (c) Net Operating Loss Defined. -- For purposes of this section, the term "net operating loss" means (for any taxable year ending after December 31, 1953) the excess of the deductions allowed by this chapter over the gross income. Such excess shall be computed with the modifications specified in subsection (d).(d) Modifications. -- The modifications referred to in this section are as follows: * * (4) Nonbusiness deductions of taxpayers other than corporations. -- In the case of a taxpayer other than a corporation, the deductions allowable by this chapter which are not attributable to a taxpayer's trade or business shall be allowed only to the extent of the amount of the gross income not derived from such trade or business. * Sec. 1.172-3, Income Tax Regs. ( 26 C.F.R. 1.172-3), provides in part as follows:(a) * ** * * *(3) Nonbusiness deductions -- (i) Ordinary deductions. -- Ordinary nonbusiness deductions shall be taken into account without regard to the amount of business deductions and shall be allowed in full to the extent, but not in excess, of that amount which is the sum of the ordinary nonbusiness gross income and the excess of nonbusiness capital gains over nonbusiness capital losses. See paragraph (c)(3) of this section. For purposes of section 172↩, nonbusiness deductions and income are those deductions and that income which are not attributable to, or derived from, a taxpayer's trade or business. Wages and salary constitute income attributable to the taxpayer's trade or business for such purposes.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625606/	LORD & BUSHNELL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Lord & Bushnell Co. v. CommissionerDocket Nos. 10597, 12124.United States Board of Tax Appeals7 B.T.A. 86; 1927 BTA LEXIS 3265; May 25, 1927, Promulgated 1927 BTA LEXIS 3265">3265 1. AMENDMENT OF PETITION. - The petition in Docket No. 10597 stated that it was an appeal from the determination of deficiencies for the years 1917 and 1918. It plainly referred to a deficiency letter dated November 10, 1925, which asserted deficiencies for the years 1918 and 1919, recited the amounts of such deficiencies, and the whole context was such that no one was likely to be misled and, in fact, the respondent was not misled by the recital of the year 1917 in place of the year 1919. Held, that the motion to amended the petition was properly granted as a matter of course and that the Board acquired jurisdiction of the deficiency for the year 1919. 2. INVESTED CAPITAL. - The cost of petitioner's plant and equipment as shown by the evidence determined for the purposes of invested capital. 3. DEPRECIATION. - Petitioner's plant and equipment was situated upon land held under an indeterminate lease from 1911 to August 1, 1917, and thereafter, under the terms of a lease expiring on April 30, 1932. The deduction for exhaustion, wear and tear of those portions of the plant and equipment having a probable useful life running beyond April 30, 1932, should be computed on1927 BTA LEXIS 3265">3266 the basis of such probable life up to August 1, 1917, and upon the unextinguished balance the depreciation deduction should be computed upon the basis of the term of the lease. Other items of plant and equipment having a probable useful life ending prior to the term of the lease, should be the basis of an exhaustion deduction in proportion to the period of their useful life. William W. Thompson, C.P.A., C. E. Burrows, Esq., and D. J. Greenburg, Esq., for the petitioner. John W. Fisher, Esq., for the respondent. TRUSSELL 7 B.T.A. 86">87 These two proceedings, consolidated for the purpose of hearing and redetermination, are from the Commissioner's statutory deficiency notices dated November 10, 1925, and January 14, 1926, asserting deficiencies in income and profits taxes in the amounts of $52,517.80 for the years 1918 and 1919, and $410.62 for the year 1921, respectively. The petitioner alleges that the Commissioner erred in his determination (1) of the March 1, 1913, value of the petitioner's lumberyard and equipment for the purpose of depreciation and as to the rates of depreciation; (2) of the petitioner's invested capital for the years 1918 and1927 BTA LEXIS 3265">3267 1919, and (3) in not allowing as to the years 1918 and 1919 special assessment under sections 327 and 328 of the Revenue Act of 1918. The Commissioner asserts that the Board is without jurisdiction as to the year 1919 for the reason that no appeal as to that year has been taken within 60 days from the date of mailing of the statutory deficiency notice. FINDINGS OF FACT. The petitioner is an Illinois corporation having its principal place of business at Chicago. It was incorporated in 1883, and since that time has been engaged in buying and selling lumber. The Commissioner's deficiency letter dated November 10, 1925, asserts a deficiency in income and profits taxes for the years 1918 and 1919 in the amount of $52,517.80. On January 4, 1926, the petitioner filed an appeal, Docket No. 10597, from that determination by the Commissioner and alleged that the deficiency letter was 7 B.T.A. 86">88 dated November 10, 1925, and asserted a deficiency of $52,517.80, and that the years involved were 1917 and 1918. The Commissioner's answer, filed on February 12, 1926, admits and denies the allegations of the petition as to the years 1918 and 1919, and denies as irrelevant and immaterial1927 BTA LEXIS 3265">3268 what action the Commissioner took as to the year 1917. On April 3, 1926, the petitioner submitted to the Board an amended petition not complete in itself but merely a correction of its original petition so that the years involved would be 1918 and 1919. No action was taken on this amended petition until the hearing on the merits was had, at which time leave was granted the petitioner to file the said amended petition. The Commissioner objected to the filing of the amended petition on the ground that as to the year 1919 no appeal has been filed within 60 days from the mailing of the deficiency letter and that the Board is without jurisdiction as to that year. Prior to the year 1912 the petitioner's lumberyard had been located at Twenty-second and Center Avenue, Chicago, but its lease for those premises having expired, it was necessary for the petitioner to vacate. During the years 1911 and 1912 the petitioner constructed a new lumberyard at 2424 Laflin Street, Chicago, its present place of business. An entire new plant was erected and was completed in the spring of 1912. In constructing the new lumberyard the swampy ground upon which it was built was filled in and graded, 1927 BTA LEXIS 3265">3269 about three-quarters of a mile of railroad track was laid and there was erected one inclosed and one open dock; a reenforced concrete 2 1/2-story mill building, 66 by 153 feet; and brick-and-reenforced-concrete two-story-and-basement office building, 33 by 56 feet, with modern improvements; a brick-and-concrete barn, 31 by 47 feet; and brick-and-concrete garage, 22 by 29 feet; a brick lunch-room building, 33 by 45 feet; 4 one-story lumber sheds respectively 99 by 233 feet, 52 by 233 feet, 76 by 168 feet, and 19 by 92 feet, each constructed of wood, with tar-and-gravel roofing and plank siding, and upon a foundation of concrete piers. All of the buildings had tar-and-gravel roofing; concrete paving, and plank roads. In 1912 new machinery was installed and some new equipment. One small machine and some equipment was removed from the old lumberyard. The petitioner used its own labor and materials for filling and grading the yard, grading and laying the railroad track, building a portion of the docks and building the plank roads. The docks. buildings, and concrete paving were constructed by contractors, but the petitioner supplied all lumber used at wholesale cost. The plank1927 BTA LEXIS 3265">3270 roads were constructed by filling with cinders, laying down oak and maple stringers covered with 3-inch maple planks. A total of 1,136,000 board feet of lumber, at an average cost of $20 7 B.T.A. 86">89 per thousand feet, was used in constructing the plank roads, representing a cost of $22,720 exclusive of labor, but only $11,116.58 was charged to capital account on petitioner's books. Upon examination of petitioner's accounts kept during the years 1911 and 1912 it was found that the cost to the petitioner of the quantity of lumber used in constructing these plank roads, and the labor employed in such construction, was $25,300.75. The docks were constructed by the Great Lakes Dredge & Dock Co. under a contract which specified that the petitioner deliver at the dock sites a certain quantity of lumber at cost to it at its yard. The petitioner supplied all the lumber used in the docks except the piles, supplied much heavier battens than were called for by the contract, and billed the dock company for only that amount of lumber called for by the contract, although much additional lumber was used. The lumber which the petitioner supplied for the docks cost it approximately $27 per thousand1927 BTA LEXIS 3265">3271 feet, whereas the retail price was approximately 50 per cent more. The contract price for the construction of the docks was $28,105.88, which was entered upon the capital account of the petitioner's books as the cost of the docks, although the dock company did only a part of the actual construction work, the balance having been done by the petitioner with its own labor and materials. Upon examination of petitioner's books kept during the years 1911 and 1912, it was found that labor and material furnished by the petitioner in the construction of these docks over and above the amount billed to the contractor had cost the petitioner $13,045.33, and that the total cost of the docks as completed in 1912 was $41,151.21. The buildings, lumber sheds and the concrete paving were constructed by contractors and the petitioner billed to the contractors, at cost to it, only that amount of lumber called for by the contracts, although additional lumber was used. The petitioner charged $40,741.48, the contract price, to capital account as the total cost of the construction of the buildings. Upon examination of the petitioner's books kept during the years 1911 and 1912, it was found that the1927 BTA LEXIS 3265">3272 petitioner had furnished toward the construction of these buildings labor and material costing $4,286.42 which had not been billed to the contractor, and that the total cost of these buildings when completed in 1912 was $45,027.90. In ascertaining the additional capital cost of each of the foregoing classes of construction the petitioner used the same labor and material costs as shown by its books of account kept during the years 1911 and 1912. When, in 1912, the petitioner had completed its new yards, it charged to capital account for machinery, equipment, and properties not hereinabove mentioned, the total sum of $38,891.06. Upon 7 B.T.A. 86">90 examination of its books of account kept during 1911 and 1912, it was found that there had been charged to expense capital items with respect to properties, machinery and equipment in an aggregate of $10,529.39, making a total of machinery, equipment, and miscellaneous property with an aggregate cost in 1912 of $49,420.45. The ground upon which the new lumberyard was erected was, and is now, owned by Frederick B. Bolles, who was until 1917 the principal stockholder and the active manager of the petitioner. The petitioner had no lease1927 BTA LEXIS 3265">3273 to the property at any time prior to August, 1917. In the fall of 1917 Bolles sold his stock to John Claney and Claney's brothers and retired from the business. On August 1, 1917, Bolles entered into a lease with the petitioner which provides, among other things not material to this proceeding, that upon the termination of the lease on April 30, 1932, all the buildings and permanent improvements on the premises shall be a part of the freehold and the property of the lessor. There is no provision for a renewal of the lease. The cost of petitioner's plant, properties, and equipment, itemized in accordance with the evidence, the normal rates of depreciation applicable to each item, and the rates of depreciation applicable to those items having a normal life running beyond the termination of the lease, are as follows: CostNormal ratesDepreciation - Rates to amortize remaining value over life of lease from Aug. 1, 1917, to Apr. 30, 1932Per centPer centConstruction$45,027.9036.78Machine foundations1,054.2036.78Heating system1,032.4456.78Plank roads25,300.7510Plumbing1,433.0156.78Paving7,267.1256.78Docks41,151.21106.78Electric lighting system1,598.7756.78General machinery15,998.3210Motors4,799.3010Power transmission738.6910Power feed wiring1,715.8210Exhaust and blower system1,392.3710Fire apparatus39.0010Trucks and scales123.6910Signs525.0010Railroad tracks3,272.3036.78Horses3,699.3010Wagons1,764.0010Harness and stable equipment142.3010Office furniture and fixtures987.5910Office machines31.0010Miscellaneous equipment1,806.1333 1/3Total160,900.211927 BTA LEXIS 3265">3274 7 B.T.A. 86">91 There is no dispute as to the additions and improvements made to the petitioner's assets subsequent to March 1, 1913. The Commissioner used the book value of the capital assets for the purposes of invested capital and depreciation and has applied, during the years here in question, rates of depreciation without regard to the lease for the premises occupied by the petitioner. The Commissioner found that a computation of excess and warprofits taxes under the provisions of section 328 of the Revenue Act of 1918 would afford the petitioner no relief. OPINION. TRUSSELL: The original petition in Docket No. 10597 recited that the years under consideration were 1917 and 1918. The context in which these figures were used with references to the deficiency letter, and a copy of the deficiency letter attached to the petition. all made it plain that the years for which the petitioner was appealing to this Board were the years 1918 and 1919. This is so appearent that to our mind no one reading the petition and the deficiency letter could have been misled on account of the recital of the years in question. It is plain from the respondent's answer that the respondent was1927 BTA LEXIS 3265">3275 in no way misled by the erroneous recital. We are, therefore, of the opinion and have held, that the petitioner's request to amend the petition should have been, as it was at the trial, granted as a matter of course, and that the Board acquired jurisdiction of the deficiency for the year 1919 by virtue of the original petition. The record of this case contains convincing evidence that the petitioner's capital accounts so far as they involved the construction of its new lumberyards and properties in the years 1911 and 1912, were incomplete and that much of the material and labor which then went into permanent improvements was incorrectly charged to expense. In so far as the evidence has identified these charges to expense they have been restored to capital account as recited in the findings of fact. The record contains much testimony offered to prove a March 1, 1913, value of plant and equipment. A retrospective appraisal showing a detailed and valued inventory was received and the testimony of four capable men having experience as builders and appraisers was also received. This testimony varied according to the witnesses in total valuations ranging from $250,000 to more than1927 BTA LEXIS 3265">3276 $270,000, and, while we may not doubt that all of this testimony was offered in good faith, we can not overlook the fact that these properties were acquired one and two years prior to March 1, 1913, 7 B.T.A. 86">92 and that the spread between the proven cost and the values testified to by the witnesses is so great that it relieves the opinion testimony of much of the weight that it might otherwise have had. We are of the opinion that the corrected costs as set forth in the findings of fact are the substantial equivalent of the March 1, 1913, value. No testimony was introduced in support of petitioner's claim for relief under section 328 of the Revenue Act of 1918. The deficiencies must therefore be determined without resort to the provisions of that section. The deficiencies may be redetermined in accordance with the foregoing findings of fact and opinion on 15 days' notice, pursuant to Rule 50, and judgment will be entered accordingly.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625607/	MARTHA H. EGLY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEgly v. CommissionerDocket No. 29753-85.United States Tax CourtT.C. Memo 1988-223; 1988 Tax Ct. Memo LEXIS 251; 55 T.C.M. 877; T.C.M. (RIA) 88223; May 18, 19881988 Tax Ct. Memo LEXIS 251">251 Stock owned by P became worthless during the year, but P kept few, if any, records with respect to capital contributions to corporations controlled by her. On the basis of testimony and checks in evidence, Held: P has established her entitlement to a loss on worthless stock. Held further: P's basis determined by making an approximation thereof. P also reported NOL and ITC carryforwards on her tax return, much of which were not usable because P's reported income was zero. The notice of deficiency disallowed a large deduction for worthless stock, but did not mention specifically that the NOLs and ITCs were disallowed. The amount of the deficiency, however, was computed without allowing any ITC or any of the deduction for the excess NOLs not used originally on the return. Held: P has the burden to prove her entitlement to the excess NOLs and ITCs, and she fails to meet that burden. Louis T. M. Conti and W. Lee Autman, Jr., for the petitioner. Eugene J. Wien, James C. Fee, Jr., and Lisa Primavera-Femia, for the respondent. WELLSMEMORANDUM FINDINGS OF FACT AND OPINION WELLS, Judge: Respondent determined a deficiency in petitioner's 1977 Federal income tax in the amount of $ 1,133,913. 1988 Tax Ct. Memo LEXIS 251">252 The issues for decision are (1) whether petitioner is entitled to a deduction for a loss on worthless stock and if so, in what amount, and (2) if not, or if the loss is in an amount less than $ 2,970,000, whether petitioner is entitled to carryforwards and carrybacks of investment tax credits and net operating losses. FINDINGS OF FACT Some of the facts have been stipulated; the stipulations of facts and attached exhibits are incorporated herein by this reference. Petitioner resided in Philadelphia, Pennsylvania when she filed her petition in this case. Shortly after his marriage to petitioner, petitioner's first husband, 11988 Tax Ct. Memo LEXIS 251">253 Otto Henze, founded Penn Fishing Tackle Manufacturing Company ("Penn Fishing") in the early 1930's. After the death of Otto Henze in 1949, the stock in Penn Fishing was owned 1/3 by petitioner and 2/3 by a trust for the benefit of the Henze children. Petitioner was named president of Penn Fishing in the early 1950's and remained in that office until 1963. At that time, her son, Herbert Henze, took over the presidency of Penn Fishing, and petitioner became chairperson of Penn Fishing's Board of Directors. Penn Fishing manufactures and distributes rods, reels, and other accessories used in sport fishing. Under the guidance of the Henze family, Penn Fishing has been and still is one of the leading companies in the sport fishing industry, concentrating mostly in salt water and big game tackle. As Herbert Henze noted, "When you see a man who catches a big shark, he probably used a Penn reel." Petitioner was chairperson of Penn Fishing until 1977, at which time she sold all her Penn Fishing stock to the corporation and resigned from any positions she had as an officer or director of Penn Fishing. 2 Petitioner realized $ 3,000,000 from the sale of her Penn Fishing stock. Her basis in the stock, which she had acquired upon her husband's death in 1949, was $ 30,000. She therefore reported a long term capital gain on her 1977 income tax return in the amount of $ 2,970,000. Respondent does not dispute the treatment of the sale of the Penn Fishing stock on petitioner's tax return. The terms upon which petitioner sold her Penn Fishing stock were 1988 Tax Ct. Memo LEXIS 251">254 as follows: (1) petitioner's debts to Penn Fishing in the approximate amount of $ 742,000 were forgiven; (2) petitioner received a check in the amount of $ 258,000 from Penn Fishing; (3) Penn Fishing assumed petitioner's bank loan from Philadelphia National Bank in the amount of $ 1 million; and (4) Penn Fishing issued to petitioner a $ 1 million note which was payable to her in ten equal yearly installments. 3Michael Manchester became acquainted with petitioner and her children in 1960 when he was hired by Penn Fishing to perform private investigatory services. Shortly thereafter, petitioner and Mr. Manchester became constant companions and, after a few years, began living together. Petitioner and Mr. Manchester never married because of the fact that Mr. Manchester was married to someone else; he never obtained a divorce on account of religious restrictions. Mr. Manchester and petitioner were still living together in her house at the time of trial. In the course of his private detective and claims investigation business in Philadelphia, Mr. Manchester became aware of Rad-O-Lite, Inc. ("Erie"). Erie was incorporated in 1988 Tax Ct. Memo LEXIS 251">255 1957, had its principal place of business in Erie, Pennsylvania, and engaged in designing, manufacturing, installing, and leasing traffic signals and burglar and fire protection systems. On November 9, 1960, Mr. Manchester paid Erie $ 25,000 for an exclusive franchise to distribute Erie's burglar and fire protection systems in the areas of Philadelphia and Atlantic City, New Jersey. By way of check dated November 6, 1960, petitioner had paid Mr. Manchester the $ 25,000 he needed to acquire the franchise. Petitioner's payment to Mr. Manchester was evidenced by an Agreement in which petitioner agreed to lend the $ 25,000 to Mr. Manchester in exchange for payment, in lieu of interest, of one half of the net profit after taxes which Mr. Manchester would derive from the franchise. The agreement provided that Mr. Manchester agreed to repay the $ 25,000 to petitioner within 30 months from the date of the agreement. No repayment of the loan ever was made by Mr. Manchester. Shortly thereafter, on January 24, 1961, two agreements were entered into by Mr. Manchester and Erie, and a third agreement was entered into by petitioner, Mr. Manchester, Erie, and certain of Erie's stockholders. The 1988 Tax Ct. Memo LEXIS 251">256 effects of the agreements were as follows: Mr. Manchester's Erie franchise was expanded; petitioner and Mr. Manchester each received 2,500 shares of stock in exchange for Mr. Manchester's assignment to Erie of a burglar protection device invented by him -- the Rad-O-Phone; and petitioner, Mr. Manchester, and three other individuals (who were friends and relatives of petitioner) were issued an additional total of 50,800 Erie shares in exchange for payments by petitioner to Erie in the sum of $ 63,500. On July 19, 1961, petitioner and Mr. Manchester loaned Erie $ 200,000. The loan was secured by the assignment to petitioner and Mr. Manchester of Erie's accounts receivable and five of its patents. In addition, the loan agreement granted petitioner and Mr. Manchester the right "to form a corporation known as Rad-O-Lite, Inc. of Philadelphia." Petitioner individually provided the $ 200,000 that was loaned to Erie. Rad-O-Lite of Philadelphia, Inc. ("ROLP"), was incorporated on February 8, 1962, for the purpose of manufacturing, selling, leasing, and installing burglar alarm systems and traffic control systems. The initial incorporators were petitioner, Mr. Manchester, and Vincent P. Haley. 1988 Tax Ct. Memo LEXIS 251">257 Petitioner was president of ROLP, and Mr. Manchester was vice president. Petitioner and Mr. Manchester each were issued 2,500 shares of ROLP stock. In exchange for the ROLP stock, Mr. Manchester transferred his Erie franchise to ROLP, and Mr. Manchester and petitioner transferred to ROLP their interests in the $ 200,000 Erie loan and the Erie assets securing the loan. Mr. Manchester and petitioner, however, did not transfer any of their Erie stock to ROLP. Erie continually had financial difficulties and a need for additional capital, so on March 13, 1962, petitioner, Mr. Manchester, and ROLP loaned Erie an additional $ 152,000, which was secured by Erie's accounts receivable and inventory and a pledge of 45,000 shares of Erie stock from three Erie shareholders. Later in 1962, ROLP and its shareholders demanded payment of that $ 152,000 loan. Instead of the loan being repaid, however, an agreement was reached under which petitioner, Mr. Manchester, and ROLP purchased an additional 100,000 shares of Erie stock (15,000 of which were already in their possession pursuant to the March 13 pledge) from a principle shareholder in Erie in exchange for $ 40,000. 41988 Tax Ct. Memo LEXIS 251">258 After several unprofitable years, Erie eventually filed forms with the Commonwealth of Pennsylvania to acknowledge that it went out of existence on June 30, 1965. In 1966 the assets of Erie were sold at a sheriff's sale. At about that time, ROLP 51988 Tax Ct. Memo LEXIS 251">259 acquired the patents securing the $ 200,000 loans; the patents, however, were transferred pursuant to the security interest arising out of the loan agreement, not through the sheriff's sale. Petitioner never received any cash repayments of her loans to Erie or on her investment in Erie stock. On petitioner's 1970 individual income tax return, she reported a $ 25,000 ordinary loss from property identified as "Rad-O-Lite, Inc. - Sec. 1244 Prop." The 1970 return reported that the property was acquired in 1962, was sold in December 1970, had a cost basis of $ 26,000, and was sold at a gross sales price of $ 1,000. Subsequent to the initial incorporation of ROLP, in which petitioner and Mr. Manchester each were issued 2,500 shares of stock, it is unclear how the ownership of the ROLP shares was divided between the two shareholders. As of July 1971, however, ROLP represented, in its election to be taxed under subchapter S of 1988 Tax Ct. Memo LEXIS 251">260 the Code, 6 that its stock was owned as follows: petitioner -- 4,675 shares (93.5 percent); Mr. Manchester -- 325 shares (6.5 percent). The subchapter S election stated that Mr. Manchester had acquired his 325 ROLP shares in 1970. The stock ownership did not change until sometime in 1976 or 1977, when petitioner became the owner of 100 percent of the ROLP shares according to the ROLP corporate income tax return filed for the year ending June 30, 1977. ROLP's subchapter S election was first in effect for the fiscal year beginning July 1, 1971. ROLP filed tax returns as a subchapter S corporation for three years. ROLP filed income tax returns as a corporation taxed under subchapter C for the fiscal years ending June 30, 1975, June 30, 1976 and June 30, 1977. ROLP also had filed returns as a corporation taxed under subchapter C for the early years of its existence in the 1960's. As is shown by its corporate income tax returns, ROLP was never a profitable corporation. 1988 Tax Ct. Memo LEXIS 251">261 ROLP's tax returns reported gross receipts and net losses as follows: Year EndingGross ReceiptsReported Net Loss12/31/62$ 13,905.88 $ 52,309.02 12/31/63Not Available39,527.1112/31/6423,043.29128.1212/31/6546,552.09212.1312/31/662,517.501,697.587 6/30/72 6,779.0098,272.006/30/73-0- 63,410.006/30/74200,424.00189,713.006/30/75359,067.0014,445.006/30/76205,786.0088,219.006/30/7743,704.00125,860.00 During the three years that ROLP was a subchapter S corporation, ROLP's corporate returns and petitioner's individual returns reported petitioner's share (93.5 percent) of ROLP's flow through losses of $ 91,884, $ 59,288, and $ 177,382. 81988 Tax Ct. Memo LEXIS 251">262 ROLP was in constant need of additional cash infusions, most of which came from petitioner. Petitioner alone was not able to provide all the financing needed by ROLP. Additional infusions of capital into ROLP were provided either in the form of direct payments from Penn Fishing, which petitioner authorized, or in the form of loans from banks and other lenders made to petitioner or made to ROLP directly and guaranteed by petitioner. Philadelphia National Bank ("PNB") was the primary lender during the 1970's. As security for the PNB loan, petitioner was required to pledge her stock in Penn Fishing as collateral, that stock being her only significant asset. From time to time, petitioner also pledged her home as security for smaller loans. ROLP's tax returns reported outstanding 1988 Tax Ct. Memo LEXIS 251">263 loans payable to shareholders as follows: DateLoans Outstanding12/31/62$ 170,033.2312/31/63283,592.70 12/31/64290,048.32 12/31/65290,348.54 12/31/66306,627.11 9 6/30/75 575,602.00 6/30/76444,202.00 6/30/77643,904.00 On July 9, 1963, Alert Alarm Corporation ("Alert") was incorporated for the purpose of dealing in burglar alarm systems. The record does not indicate the identity of the initial incorporator(s) of Alert; however, petitioner's son Walter Henze ("Walter") acquired 100 percent of the outstanding stock of Alert (500 shares) on January 15, 1964. In 1968 Walter transferred the Alert shares to ROLP. In exchange for the transfer of the Alert stock, Mr. Manchester paid Walter $ 10,000 and Mr. Manchester and ROLP acknowledged that they were indebted to Walter in the principal amount of $ 125,000 on account of money lent by Walter and used for the benefit of ROLP or 1988 Tax Ct. Memo LEXIS 251">264 Alert. Alert's corporate tax returns for the years 1971 through 1980 reflect the ownership of the Alert stock as follows: 1967-12/7512/75-12/28/80After 12/28/80Petitioner500 shares300 shares--Mr. Manchester-- 20010 500 shares The business carried on by Alert after its incorporation was, in effect, the alarm business formerly carried on by ROLP. Alert was formed to allow ROLP to concentrate on its traffic control business. After petitioner gained control of Alert, Alert's offices were at the same location as those of ROLP, and employees of either corporation from time to time performed services 1988 Tax Ct. Memo LEXIS 251">265 for the other corporation. Expenses of each company were paid out of the bank accounts of both companies, as well as with personal checks from petitioner and Mr. Manchester. The personal checks were payable directly to the vendor or payable to Mr. Manchester or to "Cash," in which case Mr. Manchester or another employee cashed the check at the bank and took the cash directly to the vendor. It did not matter to petitioner which entity paid the bills as long as the bills were paid. The funds of Mr. Manchester, petitioner, ROLP, and Alert were commingled freely. To aid the accountants who prepared the tax returns, however, Mr. Manchester went through the checkbooks and the paid bills and identified the corporation to which each payment was attributable. On the balance sheets filed with its income tax returns, Alert reported loans from shareholders in the following amounts: DateShareholder Loans Payable12/31/75$ 618,124 12/31/76728,615 12/31/77843,222 12/31/781,179,972 12/31/791,251,911 Mr. Manchester was the operating officer for ROLP from its inception; he also became the operating officer for Alert in 1967 or 1968, and remained so throughout the relevant years. The corporations, 1988 Tax Ct. Memo LEXIS 251">266 especially ROLP, consumed all of his time and energy. He lived an extremely modest lifestyle. His only indulgence was cigars; he smoked Webster Fancy Tail cigars. There was nothing extravagent in his clothing, except for a felt hat that he "sported" at one time. Other than that, he "lived a life of near penury." The automobiles he drove were all "cast offs or broken down cars." Mr. Manchester's income during the ROLP years totalled approximately $ 12,000 to $ 13,000 per year. Except for what little money he used for his frugal living expenses, Mr. Manchester put virtually all of his funds into the operations of ROLP. In fact, before he moved in with petitioner, he had been living in a backroom in the ROLP warehouse which was described as a "pig sty." On February 21, 1979, Mr. Manchester was convicted under Federal law of participation in the activities of a racketeering enterprise, conspiracy to participate in a racketeering enterprise, mail fraud, and subscription to a false corporate income tax return of ROLP for the fiscal year ended June 30, 1975. ROLP also was convicted of conspiracy to engage in racketeering. 11 The convictions were a result of a Federal grand jury criminal 1988 Tax Ct. Memo LEXIS 251">267 investigation into bid rigging in the traffic control field and payments of bribes to Pennsylvania Department of Transportation officials. Mr. Manchester's conviction was based upon payments made through ROLP (with his knowledge) to officials in the pursuit of traffic system business for ROLP. 12 The grand jury investigation into ROLP had begun in late 1976 1988 Tax Ct. Memo LEXIS 251">268 or early 1977. The fact that ROLP was being investigated was well publicized; there were major newspaper articles discussing the matter. ROLP's customers and vendors were aware of the grand jury investigation. The attendant publicly interfered with ROLP's sales to customers. A mail watch of ROLP began, and agents of the U.S. Attorney's Office made direct inquiries of customers and business acquaintainces of ROLP, petitioner, and Mr. Manchester. ROLP's sales decreased, and the business was even more strapped for cash than in prior years. ROLP's vendors and suppliers would not deliver goods to ROLP without being paid in cash upon delivery. As ROLP's sales declined and its financial position deteriorated, PNB began pressing petitioner and Penn Fishing for repayment of the loans outstanding to it. Finally, late in 1977, petitioner and Mr. Manchester decided that ROLP should discontinue operations. As noted above, Penn Fishing relieved petitioner of her debt obligations to both PNB and Penn Fishing, transferred cash to her, and executed a promissory note payable to her in exchange for her transfer to Penn Fishing of all her Penn Fishing stock. Much of the cash petitioner received 1988 Tax Ct. Memo LEXIS 251">269 from the sale of her Penn Fishing stock was used to pay off creditors of ROLP. 13Petitioner and Mr. Manchester attempted to dissolve ROLP in December 1977 with the help of the accountant then representing petitioner and ROLP, Robert Kohn. Mr. Kohn prepared two reports for the Commonwealth of Pennsylvania. One was an Out of Existence Affidavit for ROLP which asserted that ROLP ceased to transact business on or about December 31, 1977. On March 18, 1978, Mr. Kohn also prepared a Distribution of Assets in Dissolution (the "Distribution report") which asserted that ROLP was dissolved on December 31, 1977, and that its assets were distributed to petitioner on that date. The Commonwealth of Pennsylvania received notice of ROLP's cessation of business, as evidenced by the following letter from the state's Department of Revenue Bureau of Accounts Settlement: We acknowledge receipt of a statement stating [ROLP] ceased doing business as of December 31, 1977. This Bureau has no record of receiving tax reports for the years [sic] ending December 31, 1964, December 31, 1965, and December 31, 1988 Tax Ct. Memo LEXIS 251">270 1966. In order to effect final settlement on this account and to remove the estimated settlements, please forward tax reports for the respective years to the attention of the undersigned.Apparently, petitioner and Mr. Kohn never bothered to file the outstanding state tax reports because, as of the date of trial, the Secretary of the Commonwealth of Pennsylvania certified that ROLP remained "a presently subsisting corporation" insofar as the state was concerned. On March 14, 1978, ROLP filed an application for and received an extension of the date for which to file its short period final Federal income tax return for the period from July 1, 1977, through December 31, 1977. On June 15, 1978, ROLP filed an application for and received from respondent an additional extension of time to file its final return. The second application contained a statement that the "U.S. District Attorney's Office and Grand Jury" had ROLP's books and records and, therefore, the corporation did not have sufficient data to file a final return. No final Federal income tax return ever was filed for ROLP. The latest ROLP balance sheet in the record is the one prepared for the last Federal income tax return filed 1988 Tax Ct. Memo LEXIS 251">271 by ROLP. The balance sheet was prepared by Mr. Kohn and showed that ROLP's financial position as of June 30, 1977, was as follows: Accounts Receivable$ 2,226 Inventory (Estimated)364,089Prepaid Interest675Buildings and Equipment (net ofaccumulated depreciation) 14,880Total Assets$ 381,870Accounts Payable$ 35,500 Short Term Mortgages & Notes Payable45,540 Loans from Shareholders (Estimated)643,904 Loans Payable260,885 Capital Stock1,000 Retained Earnings (Estimated)(604,959)Total Liabilities and Equity$ 381,870 Although the documents prepared by Mr. Kohn assert that ROLP's assets were distributed upon dissolution to petitioner on December 31, 1977, petitioner never took possession of any of the assets. 14 The Distribution report listed petitioner as receiving inventory in an "amount" of $ 350,000 and three trucks and a station wagon whose "amounts" totalled $ 10,000. Mr. Kohn had prepared that report based on the approximate book value of the assets. The value of the final inventory was provided to Mr. Kohn by ROLP's chief engineer, whose based the valuation only on his estimate of the costs that had been incurred to manufacture the traffic equipment. 15 A significant portion 1988 Tax Ct. Memo LEXIS 251">272 of the costs included in that inventory were salary and wage expenses for engineering, maintenance, and installation personnel, i.e., expenses for tooling the equipment to specifications of ROLP and its customers. ROLP's tax returns treated such salaries and wages as a cost of inventoriable goods rather than as a current deduction. In fact, the last two ROLP Federal tax returns reported such inventoried salary expenses in the total amount of $ 183,556 and costs of goods sold in the total amount of $ 292,538 for the two years. Those returns also reported inventories as of June 1976 and June 1977 in the respective amounts of $ 315,800 and $ 364,089, amounts which approximate the $ 350,000 reported on the Distribution report as the December 1977 inventory. The $ 350,000 value given for ROLP's final inventory, however, far exceeded the fair market value of the inventory. After ROLP ceased operations, the bulk of the inventory assets remained where they were, in the warehouse used 1988 Tax Ct. Memo LEXIS 251">273 by ROLP, until at least 1981 or 1982. The ROLP inventory remained unused because of changes in the middle of the 1970's in the equipment used in the traffic signal industry. 16 Those changes caused the Rad-O-Lite, a patented device which was ROLP's primary stock-in-trade, to become obsolete. As of the early 1970's, the technology in the industry was such that emergency vehicles used devices which utilized radio signals to switch and control stoplights at intersections. The Rad-O-Lite was such a device. Approval from the Federal Communication Commission ("FCC") was required before the radio-activated equipment could be installed at any intersection. An additional disadvantage of the radio-activated devices was their use of a multi-directional radio signal. By their very nature, such signals sometimes interfere with traffic patterns on parallel streets by triggering traffic lights on those streets. By the middle 1970's, however, a high intensity optical emitter was developed in the industry whereby the control device in the emergency vehicles would saturate the intersection with light, which in turn would activate the circuitry that switched the stoplights. The light-activated equipment 1988 Tax Ct. Memo LEXIS 251">274 did not require FCC approval and did not affect the stoplights on other streets. The patented Rad-O-Lite was a "one green, three red" device, i.e., a system whereby an emergency vehicle could trigger stoplights at an intersection so that the direction in which the emergency vehicle was heading would have a green light and all other directions at the intersection would have red lights. Such a system was described as a "preemptor." When a stoplight receives the signal from a preemptor, the preemptor overrides the signal's switch control system and the stoplight for the oncoming emergency vehicle immediately becomes green, regardless of the present phase of the signals at the intersection. Traffic heading in directions 1988 Tax Ct. Memo LEXIS 251">275 other than that of the emergency vehicle suddenly will see a red light, rather than seeing the stoplight progress through the normal yellow-red sequence. A preemption system also requires physical modification of the internal controller of the stoplight. During the middle 1970's preemptors came to be far less in demand because of the development and marketing of a priority control system described as a "phase selector." A phase selector is unlike a preemptor in that an emergency vehicle using a preemptor has total control of the lights at the intersection, whereas a vehicle using a phase selector only has the ability to accelerate the light switching sequence. A phase selector works much like a "Walk" button which a pedestrian pushes to cross a street; it simply accelerates the normal switching sequence. Unlike a preemptor system, a phase selector system is external, leaving the internal mechanism of the stoplights untouched. The use of a phase selector promotes safety much better than does the use of a preemptor. The preemptor's sudden change of the light for the streets intersecting the path of the emergency vehicle might tend to surprise or confuse drivers travelling on those 1988 Tax Ct. Memo LEXIS 251">276 streets, thus increasing the chance of a collision. With the use of a phase selector, however, such surprise and confusion is much less likely because the stoplight progresses through a normal cycle before the emergency vehicle arrives at the intersection. A patent for a phase selector system using a high intensity optical emitter was issued to the Minnesota Mining and Manufacturing Company ("3M") on August 6, 1974. By 1975 3M had begun to market such a phase selector; however, the phase selector was not yet usable in all locations because it did not comport with provisions in some states, e.g., New York, which required that an intersection under priority control show one green light and three red lights. As noted above, the phase selector is a device which does not affect the internal workings of the stoplight controller, so it did not have the ability to put the stoplight into an abnormal sequence and thus could not provide a one green-three red sequence if the stoplight was not already so sequenced. As traffic officials came to appreciate the safety advantages of phase selection, however, traffic control provisions changed to accommodate the new phase selection technology. 1988 Tax Ct. Memo LEXIS 251">277 The availability of phase selection (at least from 3M) in conjunction with its comportment with traffic control provisions caused preemptor equipment including the preemptor equipment that ROLP had in inventory, to become generally obsolete. ROLP first considered the feasibility of designing and marketing a phase selector as early as 1975. As of June 1976, ROLP had prepared a five page advertising document which gave a brief description of the features and specifications of a model ROLP phase selector. The advertising document also included drawings of the front and back of the ROLP phase selector, as well as a simple schematic of the phase selector. When the advertising document was prepared in 1976, however, ROLP had not yet developed a marketable phase selector. The extend of ROLP's expertise in phase selection was that ROLP's two engineers, when they were not otherwise engaged in work for Alert or on repair and maintenance of preemptors, experimented from time to time with the development of a phase selector in 1976 and 1977. Shortly after the decision was made to discontinue ROLP's operations, Pre-Emption Devices, Inc. ("PDI") was incorporated on January 30, 1978. PDI began 1988 Tax Ct. Memo LEXIS 251">278 operations on or about April 1, 1978, and the initial shareholders were petitioner (80 shares) and Mr. Manchester (20 shares). 17 PDI's principal line of business was the development, manufacture, and sale of phase selectors. 181988 Tax Ct. Memo LEXIS 251">279 PDI operated from the same office and plant space as had ROLP. To the extent that PDI had need of any of the former inventory of ROLP, which remained stored in the building now used by PDI, the PDI employees would use the former ROLP inventory. The trucks which were "distributed" to petitioner by ROLP were not used by PDI. 19 Most, if not all, of the former employees of ROLP became employees of PDI. After 1977, PDI continued to use a distinctive triangular logo that ROLP had used on its equipment and stationery, and PDI's phone number was listed beside the heading "Rad-O-Lite by Pre Emption Devices, Inc." Alert also continued to advertise in the telephone directory yellow pages using the ROLP name and logo. PDI's first Federal income tax return was filed for the period ending on December 31, 1978. On its 1978 tax return, PDI reported no assets or liabilities at the beginning of the year because the 1978 return was PDI's "initial return." PDI's first three tax returns reported inventory and loans from shareholders in the following amounts: DateInventoryLoans Payable to Shareholders12/31/78$ 15,532$ 50,000 12/31/7955,447 341,331 12/31/8065,640 433,543 PDI reported gross receipts, costs of sales, and taxable income or loss on its first three tax returns as follows: Year EndGross ReceiptsCost of SalesTaxable Income (Loss)12/31/78$ 119,018$ 68,755$ 9,625 12/31/7997,455 48,728 (185,293) 12/31/80116,195 61,198 (83,607) OPINION 1988 Tax Ct. Memo LEXIS 251">280 The primary issue in this case is whether petitioner is entitled to a long-term capital loss for 1977 on account of her investment in ROLP. In support of her case, petitioner first asserts that her stock in ROLP became worthless during 1977. Respondent counters that the stock still had value by the end of 1977 or, in the alternative, that the stock became worthless in a year before 1977. Petitioner next asserts that even if the ROLP stock did not become worthless in 1977, there was a complete liquidation of ROLP during 1977, so she is entitled to a resulting loss under section 331. Respondent retorts that no liquidation and final distribution of ROLP's assets occurred in 1977. Respondent also argues that even if there were any liquidation and distribution of assets in 1977, it should not be accorded independent significance because the transaction merely was an integral step in a plan of reorganizing ROLP as PDI; as such, any loss may not be recognized on account of the provisions of sections 368 and 354. Respondent also makes the general argument that even if petitioner may recognize a capital loss, she has not shown that her basis in ROLP, if not zero, was greater than any 1988 Tax Ct. Memo LEXIS 251">281 amount she realized from distributions of ROLP's assets. Respondent asserts that any of his grounds is sufficient to support a decision in his favor. Petitioner offers an additional issue for consideration if we should find either that she is not entitled to recognize a loss or that her loss from ROLP was less than $ 2,970,000, the amount of her 1977 capital gain from Penn Fishing. Specifically, petitioner alleges that she is entitled to carrybacks and carryforwards of NOLs and ITCs that would reduce her 1977 taxable income. Respondent also disputes this final assertion and contends that petitioner is entitled to no NOL deduction or ITC because she has not proved her entitlement to any such carryforwards or carrybacks for 1977. Petitioner has the burden to prove that respondent's determinations in the notice of deficiency are incorrect. Rule 142(a); Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). We agree with petitioner that the ROLP stock became worthless in 1977; however, we do not agree that petitioner has shown that she is entitled to a deduction large enough to offset in full her capital gain from the Penn Fishing stock. 201988 Tax Ct. Memo LEXIS 251">282 The parties do not dispute the applicable law with respect to the deductibility of a loss for worthless stock. Section 165(g)(1) provides that if a security which is a capital asset becomes worthless during the taxable year, the resulting loss is treated as the sale or exchange of a capital asset. Respondent readily concedes that petitioner's ROLP stock is a security for purposes of section 165(g) and that the stock was a capital asset. 211988 Tax Ct. Memo LEXIS 251">283 What respondent contests, however, is whether the ROLP stock became worthless. A loss from a worthless security is deductible for the year in which the security becomes wholly worthless. Sec. 1.165-5(c), Income Tax Regs.; Scifo v. Commissioner,68 T.C. 714">68 T.C. 714, 68 T.C. 714">725-726 (1977); Aagaard v. Commissioner,56 T.C. 191">56 T.C. 191, 56 T.C. 191">209 (1971). A mere shrinkage in the value of the stock owned by the taxpayer, even though extensive, does not give rise to a deduction if the stock has any recognizable value on the date claimed as the date of the loss. Sec. 1.165-4(a), Income Tax Regs.; Scifo v. Commissioner,68 T.C. 714">68 T.C. 725. This is a factual matter as to which petitioner has the burden of proof, not only as to whether the securities became worthless at all, but also as to whether they became worthless during the year in issue. Boehm v. Commissioner,326 U.S. 287">326 U.S. 287, 326 U.S. 287">294 (1945); 68 T.C. 714">Scifo v. Commissioner, supra.22 Our duty is to draw whatever inferences and conclusions are reasonable from the facts before us. 326 U.S. 287">Boehm v. Commissioner, supra.Petitioner has the burden of proof that the ROLP stock ceased to have both liquidating value (an excess of assets over liabilities) 1988 Tax Ct. Memo LEXIS 251">284 and potential value (a reasonable expectation that the assets would exceed liabilities in the future) in 1977. Steadman v. Commissioner,50 T.C. 369">50 T.C. 369, 50 T.C. 369">376 (1968), affd. 424 F.2d 1">424 F.2d 1 (6th Cir. 1970), cert. denied 400 U.S. 869">400 U.S. 869 (1970). Generally this burden of proving potential value is met by showing an identifiable event in the corporate life. Steadman v. Commissioner,50 T.C. 369">50 T.C. 376-377. As we stated in Morton v. Commissioner,38 B.T.A. 1270">38 B.T.A. 1270, 38 B.T.A. 1270">1278-1279 (1938), affd. 112 F.2d 320">112 F.2d 320 (7th Cir. 1940): it is apparent that a loss by reason of the worthlessness of stock must be deducted in the year in which the stock becomes worthless and the loss is sustained, that stock may not be considered as worthless even when having no liquidating value if there is a reasonable hope and expectation that it will become valuable at some future time, and that such hope and expectation may be foreclosed by the happening of certain events such as the bankruptcy, cessation from doing business, or liquidation of the corporation, or the appointment of a receiver for it. Such events are called "identifiable" in that they are likely to be immediately known by everyone having an interest by way of stockholdings 1988 Tax Ct. Memo LEXIS 251">285 or otherwise in the affairs of the corporation; but, regardless of the adjective used to describe the, they are important for tax purposes because they limit or destroy the potential value of stock. The ultimate value of stock, and conversely its worthlessness, will depend not only on it current liquidating value, but also on what value it may acquire in the future through the foreseeable operations of the corporation. Both factors of value must be wiped out before we can definitely fix the loss. If the assets of the corporation exceed its liabilities, the stock has a liquidating value. If its assets are less than its liabilities but there is a reasonable hope and expectation that the assets will exceed the liabilities of the corporation in the future, its stock, while having no liquidating value, has a potential value and can not be said to be worthless. The loss of potential value, it its exists, can be established ordinarily with satisfaction only by some "identifiable event" in the corporation's life which puts an end to such hope and expectation. The first issue is whether ROLP had liquidating value at the end of 1977. We first look at the last balance sheet available for 1988 Tax Ct. Memo LEXIS 251">286 ROLP -- the June 30, 1977, balance sheet in the 1977 tax return. At that date, ROLP's assets were reported to have a book value of $ 381,870, of which $ 364,089 represented an estimated amount of inventory. ROLP's liabilities were reported to be $ 985,829, an amount far in excess of the value given for the assets. The loans from shareholders, however, are more properly considered as equity in ROLP. See footnote 21, supra.Excluding the loans from shareholders, ROLP's liabilities were $ 341,925, or approximately $ 40,000 less than the book value of total assets. If the inventory value were reduced by 11 percent, ROLP would have lacked any net worth on its balance sheet. See Ansley v. Commissioner,217 F.2d 252">217 F.2d 252, 217 F.2d 252">256 (3d Cir. 1954). We have seen no indication that any phase selection equipment was included in ROLP's inventory. Indeed, the record as a whole indicates to us that ROLP did not sell any phase selectors and never entered into any agreements to sell or install phase selectors. As of 1977, any parts or equipment owned by ROLP that were usable in phase selectors therefore would not have had significant value. ROLP's preemptor equipment had become obsolete by 1977 and clearly 1988 Tax Ct. Memo LEXIS 251">287 was worth much less than the amount listed as the inventory value on the balance sheet. We thus find that the actual value of the inventory was significantly less than the book value at which it was reported on the balance sheet; certainly, the inventory's fair market value was less than 89 percent of its listed cost. See Ansley v. Commissioner,217 F.2d 252">217 F.2d at 256-257 (even though no appraisal was in evidence, the Court held that a corporation's inventory had decreased significantly in value, based solely upon the testimony of witnesses familiar with the market value of the inventory). In addition, as ROLP continued to make few, if any, sales and lose money during the second half of 1977 (after the date of the balance sheet), the negative worth of the corporation only would have grown greater. In short, we therefore find that ROLP had no liquidating value as of December 1977. A similar analysis of ROLP for 1976 might show that ROLP also may not have had liquidating value in 1976. Although it is a necessary element, a loss of liquidating value alone does not show that a stock has become worthless. 23 Petitioner also must show that an identifiable event has occurred to terminate any 1988 Tax Ct. Memo LEXIS 251">288 hope or expectation of potential value of the stock. Austin Co. v. Commissioner,71 T.C. 955">71 T.C. 955, 71 T.C. 955">970 (1979); Morton v. Commissioner,38 B.T.A. 1270">38 B.T.A. at 1278. The continuation of ROLP's operations from 1976 into 1977 is a strong indication that, in spite of the history of operating losses, the stock was not worthless at the end of 1976. Bullard v. United States,146 F.2d 386">146 F.2d 386, 146 F.2d 386">388 (2d Cir. 1944); Hull's Estate v. Commissioner,124 F.2d 503">124 F.2d 503, 124 F.2d 503">504 (2d Cir. 1942), affg. a Memorandum Opinion of this Court. There is no evidence that would point to any year before 1977 as a year in which ROLP's future prospects became any more dismal than in 1977. 24 We therefore find that ROLP still possessed potential value as of the end of 1976. There are, however, several events occurring in 1977 which would indicate that the ROLP stock became worthless in 1977. First, the testimony of Herbert Henze and the other witnesses indicates that Penn Fishing finally had become impatient with petitioner's constant borrowings and advances of funds to ROLP. It is evident that Penn Fishing (through petitioner's children 1988 Tax Ct. Memo LEXIS 251">289 who owned the majority of the stock) in effect called the advances owed to it by petitioner and ROLP when ROLP's business did not improve during 1977. Except for petitioner's Penn Fishing stock, neither petitioner nor ROLP possessed assets worth anywhere close to the $ 742,000 owed to Penn Fishing. Petitioner thus was forced to sell her Penn Fishing stock in order to repay the advances made by Penn Fishing. That petitioner was forced to sell her Penn Fishing stock alone might be sufficient evidence to an identifiable event showing ROLP's worthlessness; however, there are other identifiable events. Petitioner and Mr. Manchester ceased to do business under the ROLP name as of the end of 1977. They intended to dissolve the corporation, as evidenced by the two reports prepared by Mr. Kohn for the Commonwealth of Pennsylvania and by the filing of the applications for extensions of time to file a final Federal income tax return. That ROLP never was dissolved officially by the Commonwealth of Pennsylvania is a mere technicality not affecting the worthlessness of the stock. The grand jury investigation is another identifiable event which adversely affected the value of the ROLP stock. 1988 Tax Ct. Memo LEXIS 251">290 In fact, that investigation may have been the catalyst causing the stock finally to lose what potential value remained. As the grand jury questioned the customers and other business acquaintainces of Mr. Manchester and ROLP, the desire of customers, both potential customers as well as any with whom ROLP maintained ongoing activity, to enter into business dealings with ROLP surely was chilled. The rise of the phase selector technology as the standard equipment in the industry, however, most likely tolled the final death knell for any potential value remaining in ROLP's preemptor business. By the end of 1977, phase selection had become the preferred method of effecting priority control of stoplights. ROLP's total receipts for the twelve months ending June 30, 1977, had declined to only $ 43,704. Mr. Manchester and the other ROLP employees realized that the industry had changed and that phase selection had become the wave of the present, not just the future. In short, we find that ROLP's preemptor business had declined in value to such an extent that any potential value remaining in it surely was exceeded by ROLP's liabilities. We appreciate that ROLP employees may have begun tinkering 1988 Tax Ct. Memo LEXIS 251">291 with phase selector equipment before the end of 1977. However, we have seen no indication that ROLP ever developed a phase selector to a level whereby it could make available a functional phase selector to customers. Any efforts that had been put into phase selection by ROLP thus were of only nominal value as of the end of 1977. Respondent suggests that the continuation of petitioner and Mr. Manchester in the traffic control business, in the form of PDI, indicates that ROLP, as a traffic control business, at least had potential value at the end of 1977. Yet, the fact that a new corporation (PDI) developed a marketable phase selector does not show that ROLP had any value. 251988 Tax Ct. Memo LEXIS 251">292 Indeed, such a fact indicates that petitioner and Mr. Manchester finally had "thrown in the towel" on the preemption business and had decided that if they were to attempt to develop a phase selector, they would do so in another corporation, not in ROLP. The events we have noted are all identifiable events occurring in 1977 which would form the basis of reasonable grounds for abandoning hope of recovery in that year. Scifo v. Commissioner,68 T.C. 714">68 T.C. 726-727. Therefore, based on our consideration of all the surrounding facts and circumstances, we find that ROLP's stock became worthless in 1977. Having decided that petitioner is entitled to a deduction for 1977 for the worthlessness of the ROLP stock, we now must determine the amount of the deduction to which she is entitled. She still bears the burden of proof. Rule 142(a). There is no question that petitioner advanced large sums of money over the years to finance the operations of ROLP, as well as the operations of the other companies with which she and Mr. Manchester were associated. What is not so clear is the quantum of funds advanced to any one of the corporations, or the delineation between the operations of any one of the corporations and the operations of the other corporations. Petitioner, however, has only herself to blame of uncertainties 1988 Tax Ct. Memo LEXIS 251">293 because of the totally inadequate recordkeeping for the corporations she controlled and the substantial commingling of funds among those corporations and petitioner. See sec. 6001. The fact that it may be difficult for petitioner to establish her basis in her ROLP stock does not relieve her of her burden to do so. Burnet v. Houston,283 U.S. 223">283 U.S. 223, 283 U.S. 223">228 (1931); Coloman v. Commissioner,540 F.2d 427">540 F.2d 427, 540 F.2d 427">430 (9th Cir. 1976), affg. T.C. Memo. 1974-78. Petitioner and respondent have stipulated into evidence dozens of checks written by petitioner, as well as payments made by Penn Fishing to ROLP or Mr. Manchester. The various payments total over $ 3 million, and petitioner requests that we find that her basis in the ROLP is at least $ 2.97 million. Respondent contends, however, that petitioner's basis cannot be determined with any precision due to the lack of books and records and the pervasive commingling of funds. Petitioner in turn requests that we be sympathetic to the difficulty in producing original records for the years 1960-1977, especially in consideration of the fact that the trial herein did not take place until 1987. In light of petitioner's duty under section 6001 to keep 1988 Tax Ct. Memo LEXIS 251">294 adequate records, however, we find little reason to be sympathetic to petitioner's neglect of her duty. Rather, we agree with respondent's statement that petitioner is caught in a web of her own making. The Court is now asked to find its way through the labyrinth of petitioner's bewildering financial affairs and estimate what petitioner contributed to ROLP directly or expended on its behalf, what amounts were actually expended in the business operation of ROLP, and what amount passed through ROLP for the benefit of Alert or Manchester. Nevertheless, we are convinced that petitioner is entitled to some deduction for the ROLP stock, so, even though petitioner cannot adequately establish the full amount of the basis she claimed, it is improper for us to deny the deduction in its entirety. Edelson v. Commissioner,829 F.2d 828">829 F.2d 828, 829 F.2d 828">831 (9th Cir. 1987), affg. a Memorandum Opinion of this Court; Cohan v. Commissioner,39 F.2d 540">39 F.2d 540, 39 F.2d 540">544 (2d Cir. 1930). We certainly have enough evidence before us to establish that petitioner's basis was other than zero. Cf. Coloman v. Commissioner,540 F.2d 427">540 F.2d at 427. The record contains sufficient facts for us to make an approximation of petitioner's basis. 1988 Tax Ct. Memo LEXIS 251">295 See Williams v. United States,245 F.2d 559">245 F.2d 559, 245 F.2d 559">560 (5th Cir. 1957). 26 The necessity for making an approximation is a result of petitioner's chronic failure to maintain records. Any uncertainty as to amounts includable in petitioner's basis therefore will be weighed against petitioner because the inexactitude is of her own making. Browne v. Commissioner,73 T.C. 723">73 T.C. 723, 73 T.C. 723">729 (1980). See also Cohan v. Commissioner, 540 F.2d at 544. 26The first amounts to be included in petitioner's basis are her basis in property transferred to ROLP as its initial incorporation. ROLP was incorporated with Mr. Manchester's Erie franchise and the $ 200,000 Erie loan. Even though the franchise was in Mr. Manchester name, petitioner paid the $ 25,000 used by him to acquire the franchise, and she never attempted to enforce repayment of the amount. We hold that petitioner contributed as capital her right to repayment of that amount when ROLP was incorporated and that she therefore is entitled to a basis in ROLP for that amount. Petitioner also provided the $ 200,000 that was loaned to Erie, and we find that amount is includable in her ROLP basis. Petitioner 1988 Tax Ct. Memo LEXIS 251">296 therefore is entitled to a basis in ROLP of $ 2255,000. 27Petitioner's 1970 individual income tax return reported a sale of stock acquired in 1962 of "Rad-O-Lite, Inc." It appears to us that the reported stock sale was of ROLP shares. ROLP's subchapter S election represented the Mr. Manchester acquired his ROLP shares in the same year that petitioner's stock sale was reported, 1970. Petitioner first acquired stock in Erie in 1961, not in 1962, yet she acquired her ROLP stock in 1962. Finally, we wonder how petitioner could have sold Erie stock in 1970 when the company went out of existence in 1965 and had all of its assets sold at a 1966 1988 Tax Ct. Memo LEXIS 251">297 sheriff's sale. In short, we believe that the loss reported on petitioner's 1970 tax return was for the transfer of ROLP shares from her to Mr. Manchester. Since petitioner's 1970 return reported that she sold shares had a basis of $ 26,000 we find that her basis in ROLP stock must be decreased by that amount. For the 1972 and 1973 years petitioner reported flow through subchapter S losses from ROLP in the total amount of $ 151,172. We find that she must decrease her ROLP basis by that amount. 28 According to petitioner, the largest 1988 Tax Ct. Memo LEXIS 251">298 portion of her ROLP basis was attributable to the many payments made by her (either directly or through Penn Fishing) to or on behalf of ROLP. Petitioner points to checks totalling more than $ 3 million and alleges all represented payments for ROLP. It appears, however, that some of those payments were on behalf of Alert. That assessment is supported generally by the testimony at trial and specifically by Alert's 1977 corporate income tax return, which reported loans from shareholders in amounts of $ 728,615 and $ 843,222 at the beginning and end, respectively, of 1977. We also note that the evidence contains several dozen checks drawn on the ROLP account payable to Mr. Manchester, petitioner, or "Cash." We are unable to discern which of these checks were used to pay ROLP bills and which may have been used for other purposes. In short, we are unconvinced that all the checks in evidence were used, as petitioner asserts, for ROLP purposes, and we are unsure what amounts may have been partial repayments of the many advances to the corporation. We therefore shall accept the amount of the shareholder loans reported on ROLP's June 30, 1977, income tax return as being the net amount 1988 Tax Ct. Memo LEXIS 251">299 of petitioner's advances to and distributions from ROLP as of that date. 29 To that amount we shall add the amounts of checks drawn 30 by petitioner for ROLP purposes from July 1, 1977, until the cessation of business at the end of 1977. We also shall subtract from petitioner's basis any checks payable to her from ROLP during that period. We shall not decrease petitioner's ROLP loss by any amounts for assets "distributed" to petitioner because we are not convinced that those assets had significant value or did more than "rot on the lot." To the extent the inventory or the vehicles had any value upon distribution, we feel that the value was more than eclipsed by petitioner's 1988 Tax Ct. Memo LEXIS 251">300 payments for ROLP over the years that we have not included in her basis. 31 We therefore find that an approximation of petitioner's loss from the worthlessness of ROLP's stock is as follows: Initial incorporation$ 225,000.00Loans per 6/30/77 tax return643,904.00Petitioner's payments to ROLP after 6/30/77163,422.56Penn Fishing payments to ROLP after 6/30/7760,357.00Petitioner's payments to miscellaneouspayees after 6/30/77petitioner 321988 Tax Ct. Memo LEXIS 251">301 19,577.85Less: Basis deducted on 1970 return(26,000) S corporation losses (151,172) ROLP payments to petitioner after 6/30/77 (15,500) 33 $ 919,589.41 Carrybacks and CarryforwardsOn account of our findings with respect to the loss on ROLP stock, we must address petitioner's alternate argument that she is entitled in 1977 to use carryforwards and carrybacks from other years. Our decision on this issue is complicated by the fact that, until the eve of trial, both petitioner and respondent apparently did not fully focus on petitioner's reporting of the carryforwards on her 1977 return. Our task is further complicated by the fact that neither party has provided us with any authority that we consider relevant in our resolution of this issue. Nevertheless, we shall roll up our sleeves 1988 Tax Ct. Memo LEXIS 251">302 and proceed to the matter at hand. For the sake of brevity, we shall combine our findings of fact and opinion on this issue. On her 1977 individual income tax return, petitioner reported carryforwards of net operating losses ("NOL") and investment tax credits ("ITC") as follows: Year AroseUnused NOLUnused ITC1972 --$ 4,7091974 $ 208,860789 1975 52,619 -- Total Available for 1977$ 261,479$ 5,498Amount used on 1977return as filed $ 35,140 -0- The NOL of $ 35,140 reduced petitioner's 1977 taxable income to zero. The return reported that the remaining NOL of $ 226,339 was available for carryforward to 1978. None of the available ITC carryforwards were used on the return because the reported tax liability was already zero. On her 1978 and 1979 individual returns, petitioner reported additional NOLs arising in those years in the amounts of $ 90,571 and $ 198,720, respectively. 341988 Tax Ct. Memo LEXIS 251">303 The amount of deficiency determined in the notice of deficiency was computed by calculating the amount of capital gain without regard to any claimed loss from ROLP stock, and by decreasing petitioner's income by $ 750 to reflect a personal exemption available to her. Tax was then computed on that amount of income. The Statement-Income Tax Changes and the attached Explanation of Items that were included in the notice of deficiency make no mention of the carryforwards reported on the return. Attached to the notice of deficiency was a Form 4625 - Computation of Minimum Tax, which was used to compute an amount of minimum tax that was included in the calculation of the amount of the deficiency. Line 11 of the Form 4625 provides, "Enter amount of any 1977 net operating loss carryforward to 1978 (attach statement showing computation)." On line 11 of the Form 4625 prepared by respondent and attached to the notice of deficiency was entered "226,339," 1988 Tax Ct. Memo LEXIS 251">304 the dollar amount of the excess available NOL reported on petitioner's original return. That amount was used by respondent in his computation of the minimum tax included in the amount of the deficiency. In short, the amount of the deficiency computed in the notice of deficiency was computed taking into account an NOL for 1977 of $ 35,140 and an NOL carryforward from 1977 to 1978 of the additional $ 226,339. The original petition did not mention carryforwards or carrybacks of NOLs and ITCs. Petitioner filed a motion to amend her petition shortly before the date of trial. At trial, we granted petitioner's motion on the condition that she offer no evidence in support of the motion other than such evidence as would otherwise have been offered with respect to the issues in the case. Petitioner's amended petition asserted that she was entitled to unused NOL carryforwards "as reflected on her 1977 return in the amount of $ 226,339, and unused investment tax credits in the amount of $ 5,498." Petitioner also alleged her entitlement to "unused carryback losses from [Alert] and [PDI], both S corporations from the years 1978, 1979 and 1980, as reflected on those returns * * ." In his answer 1988 Tax Ct. Memo LEXIS 251">305 to the amended petition, respondent generally denied petitioner's assertions. Petitioner recognizes the basic concept that a statutory notice of deficiency carries a presumption of correctness that, except where provided in the Code or the Tax Court Rules, places on her the burden of proof and the burden of going forward with the evidence. Foster v. Commissioner,80 T.C. 34">80 T.C. 34, 80 T.C. 34">228 (1983), affd. in part and revd. in part on another issue 756 F.2d 1430">756 F.2d 1430 (9th Cir. 1985); Llorente v. Commissioner,74 T.C. 260">74 T.C. 260, 74 T.C. 260">263-264 (1980), revd. in part 649 F.2d 152">649 F.2d 152 (2d Cir. 1981). See also Welch v. Helvering,290 U.S. 111">290 U.S. at 115. Petitioner argues, however, that respondent has the burden to show petitioner's disentitlement to the NOLs and ITCs because respondent did not specify his disallowance of the NOLs and ITCs in the statements or explanation attached to the notice of deficiency. Respondent concedes the allowances of the $ 35,140 NOL; however, he argues that his determination of the amount of the deficiency implicitly disallowed the ITCs and any additional NOL because the amount of the deficiency is computed without allowing a deduction for any additional NOL and without allowing any reduction in 1988 Tax Ct. Memo LEXIS 251">306 tax for the ITCs. We agree with respondent on this issue. "The notice [of deficiency] is only to advise the person who is to pay the deficiency that the Commissioner means to assess him; anything that does this unequivocally is good enough." Olsen v. Helvering,88 F.2d 650">88 F.2d 650, 88 F.2d 650">651 (2d Cir. 1937). Respondent need not explain how the deficiencies were determined for a notice of deficiency to be valid. Scar v. Commissioner,814 F.2d 1363">814 F.2d 1363, 814 F.2d 1363">1367 (9th Cir. 1987), revg. on other grounds 81 T.C. 855">81 T.C. 855 (1983); Campbell v. Commissioner,90 T.C. 110">90 T.C. 110, 90 T.C. 110">115 (1988). The notice only must (1) advise the taxpayer that respondent in fact has determined a deficiency, and (2) specify the year and amount. 3590 T.C. 110">Campbell v. Commissioner, supra,Foster v. Commissioner, 80 T.C. 229-230. The notice of deficiency herein certainly provides that information. As we stated in Foster v. Commissioner, 80 T.C. 230: Petitioners do not cite any case in 1988 Tax Ct. Memo LEXIS 251">307 support of their position that the burden of proof is shifted to respondent if he fails to identify in the notice of deficiency the specific expenditures which are disallowed. We have previously considered similar contentions and rejected them. See, e.g., Pietz v. Commissioner, [59 T.C. 207">59 T.C. 207, 59 T.C. 207">213-214 (1972)]; Mayerson v. Commissioner, [47 T.C. 340">47 T.C. 340, 47 T.C. 340">348 (1966)]; Barnes Theater Ticket Service, Inc. v. Commissioner, T.C. memo. 1967-250, affd. sub nom. Barnes v. Commissioner,408 F.2d 65">408 F.2d 65, 408 F.2d 65">68 (7th Cir. 1969). We can see no reason to take any different position here. [Fn. ref. omitted.] Although the Foster Case spoke in terms of shifting the burden of proof and the issue before us is couched in terms of which party has the ultimate burden of persuasion, we think Foster is sufficiently analogous to the instant case. We similarly have been presented with no grounds to find that respondent has the burden of proof in the instant case. Even though the notice of deficiency made no specific mention of carryforwards or carrybacks of NOLs or ITCs, the computation of the amount of the deficiency is tax included no allowance of ITCs or of NOLs in excess of $ 35,140. The computation of the deficiency 1988 Tax Ct. Memo LEXIS 251">308 was such that an inspection by petitioner or her representatives would have revealed the implicit disallowance of the ITCs and additional NOLs; 36 the calculation of the deficiency certainly does not mislead anyone who compares the notice of deficiency to the return filed for 1977. 37 The absence of any reference to the NOLs or ITCs in the Explanation of Items is not sufficient reason to cause respondent to have the burden of proof with respect to the carryforwards and carrybacks. We therefore hold that petitioner has the burden of proof. The 1988 Tax Ct. Memo LEXIS 251">309 only evidence contained in the record regarding the existence of available ITCs and NOLs are tax returns from the years in which the NOLs or ITCs allegedly arose. The returns alone obviously are inadequate to sustain petitioner's burden of proof on disputed items such as the ITCs and NOLs herein at issue. Roberts v. Commissioner,62 T.C. 834">62 T.C. 834, 62 T.C. 834">839 (1974); Jones v. Commissioner,25 T.C. 110">25 T.C. 110, 25 T.C. 110">1104 (1956); revd. in part on another issue 259 F.2d 300">259 F.2d 300 (5th Cir. 1958); Holle v. Commissioner,7 T.C. 245">7 T.C. 245 (1946), affd. 175 F.2d 500">175 F.2d 500 (2d Cir. 1949), cert. denied 388 U.S. 949">388 U.S. 949 (1950). We therefore find petitioner has failed to prove her entitlement for 19977 to carryforwards and carrybacks of ITCs and NOLs. Rule 142(a). To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. Petitioner was also married to a Mr. Egly for a few years, apparently during the 1950's, and she is his widow. 2. Herbert Henze was still the president of Penn Fishing when the trial of this case took place. ↩3. The transaction was not reported as an installment sale. ↩4. The 100,000 shares represented approximately 13.5 percent of the outstanding Erie stock. The agreement for the sale of the 100,000 shares also provided that petitioner and Mr. Manchester would become the sole trustees of the Voting Trust through which the stock of the other principle Erie shareholders were controlled. 5. The rights to the patents had been assigned to ROLP as an initial contribution to capital when ROLP was incorporated. ROLP's policy apparently was to vest in the name of petitioner the ownership of all patents used by ROLP; petitioner appears to have been, in effect, a constructive trustee, holding the patents for ROLP. This policy seems to have been based on the understanding by the ROLP employees and shareholders (as evidenced by their testimony) that corporations may not apply for or own patents, although no authority has been cited for that proposition. Our understanding of patent law is that the individual inventor generally must file the actual application for the patent; however, the inventor may assign all his rights in the patent to another (such as his employer) even before making the patent application. 35 U.S.C. secs. 111, 152 (1982). See generally Chisum, Patents, secs. 2.03(2) and 11.02(2)↩ (1987). 6. Unless otherwise indicated, all section and Code references are to the Internal Revenue Code of 1954, as in effect during the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. ↩7. The tax returns for the years of 1967 through 1971 are not in evidence, and the parties were unable to produce copies of returns for those years. Frederick Levy, a partner in the accounting firm of Touche Ross & Co., noted that there were years in which ROLP apparently did not file tax returns. From time to time since 1968, Mr. Levy has represented petitioner, Penn Fishing, and other corporations in which she was involved. ↩8. The parties stipulated that petitioner's distributable share of the loss as reflected in the ROLP tax return was $ 180,227. That return, however, accurately computes petitioner's share of ROLP's income and losses as "93.5% x (189,713) = (177,382)." Petitioner's individual return also reported a loss from ROLP of $ 177,382, so we disregard the amount set forth in the parties' stipulation and find that $ 177,382 was the amount of loss reported on the returns of both petitioner and ROLP. See Jasionowski v. Commissioner,66 T.C. 312">66 T.C. 312, 66 T.C. 312">318↩ (1976). 9. The tax returns for 1975, 1976, and 1977 report the loans outstanding as "estimated" amounts. As noted in footnote 7, supra,↩ no returns are in evidence for the 1967-1971 years, and no balance sheet from any of those years is in evidence. The 1972, 1973, and 1974 ROLP returns did not include balance sheets. 10. Nothing in the record explains why the returns reflected petitioner as acquiring the stock in 1967 when Walter did not transfer it until 1968. We surmise, however, that when the accounting firm of Touche Ross & Co. began preparing the Alert tax return in 1971, the acquisition date of petitioner's stock was estimated because it would have no effect on the returns in the 1970's. We have no indication as to how petitioner acquired ownership of the Alert stock from ROLP. We note also that petitioner's disposition of 200 Alert shares in 1975 was not reflected on her 1975 individual tax return. ↩11. See United States v. Rad-O-Lite of Philadelphia, Inc.,612 F.2d 740">612 F.2d 740, 612 F.2d 740">741↩ (3d Cir. 1979). The Third Circuit makes no mention of Mr. Manchester's being indicted or convicted or subscribing to a false tax return; however, the parties stipulated as a fact that he was. 12. Mr. Manchester's actions comport with the overall canvas of Mr. Manchester and ROLP painted by the record in this case. Specifically, Mr. Manchester was a zealous, indefatigable eternal optimist in his belief in and promotion of ROLP equipment. In ROLP's appeal of the conviction, the Third Circuit noted, "Neither side suggested that Manchester's actions were outside of his responsibilities as vice-president and chief operating officer or taken for his own rather than Rad-O-Lite's benefit." United States v. Rad-O-Lite of Philadelphia, Inc.,612 F.2d 740">612 F.2d at 742-743↩. 13. Petitioner had disregarded the advice of Mr. Levy and others that ROLP should declare bankruptcy. ↩14. Petitioner's son noted that petitioner received from ROLP only a "dividend of headaches." ↩15. There is no indication that any physical count of the inventory was made on or near the date of December 31, 1977. ↩16. For a more thorough discussion of the changes in technology in the industry, see generally Preemption Devices, Inc. v. Minnesota Mining and Manufacturing Co.,559 F. Supp. 1250">559 F. Supp. 1250, 559 F. Supp. 1250">1254, 559 F. Supp. 1250">1261-1262 (E.D. Pa. 1983), affd. 732 F.2d 903">732 F.2d 903↩ (Fed. Cir. 1984). In that case Preemption Devices, Inc., another corporation owned by petitioner and Mr. Manchester and discussed in more detail herein, was contesting the patent rights of "3M Company" for a type of traffic control device. 17. Mr. Manchester later transferred his 20 shares to petitioner in October 1979. ↩18. The chief engineer for ROLP/PDI testified that he could not remember what year the focus of the business changed from preemption to phase selection, but he emphasized that "When the uniform traffic control manual was changed, we went into phase selection." The Manual on Uniform Traffic Control Devices for Streets and Highways, which is published by the Federal Highway Administration, was amended in 1978. The 1978 edition superseded the 1971 edition and remains in effect with minor revisions. 19. Mr. Manchester instead loaned (and later gave) the trucks to one of the former Erie stockholders because they were "rotting away on the lot." ↩20. We do not discuss petitioner's liquidation argument because she has not shown that her realized loss, net of distributions, would be any larger under section 331. 21. A significant portion of the funds advanced to or on behalf of ROLP by petitioner was treated as "Loans from Shareholders" on the balance sheets that were prepared from time to time for ROLP. Respondent asserts, and petitioner does not dispute, that the payments constituted equity, rather than indebtedness, for purposes of Federal taxation. We agree and have no doubt that the payments designated as "loans" were truly capital contributions. Thus, petitioner is entitled to a basis in her ROLP stock to the extent she shows that she actually advanced funds to ROLP, regardless of the designation of the payments on the balance sheets. 22. See also Hawkins v. Commissioner,T.C. Memo. 1987-91↩. 23. See Thun v. Commissioner,T.C. Memo. 1977-372↩. 24. See Duncan v. Commissioner,T.C. Memo. 1986-122↩. 25. Respondent also suggests that PDI's use of the triangular logo formerly used by ROLP shows that ROLP still had value. We do not agree and find that any value associated with the ROLP logo was only nominal, and certainly not sufficient to cause ROLP to have potential value. More likely, petitioner and Mr. Manchester did not take the effort to come up with another distinctive symbol for PDI to use. 26. See also Cedrone v. Commissioner,T.C. Memo. 1986-89↩. 27. Petitioner also argues that the various amounts paid by her in exchange for interests in Erie stock are includable in her ROLP basis. We have found that none of the Erie stock was ever owned by ROLP, so payments therefor are not properly includable as contribution to ROLP capital. Erie and ROLP were separate entities and must be recognized as such. Moline Properties, Inc. v. Commissioner,319 U.S. 436">319 U.S. 436, 319 U.S. 436">439↩ (1943). Deductions for her basis in Erie stock were properly allowable when the Erie stock became worthless, apparently in 1965 or 1966. 28. We do not decrease petitioner's basis by $ 177,382 -- petitioner's share of ROLP's 1974 loss. We acknowledge that section 1376(b)(1) (currently in effect as section 1367(a)(2)) required a decrease in the basis of stock for the amount of flow-through losses; however, we are not now determining petitioner's actual basis in her ROLP stock. We only are making a reasonable approximation of the quantum of her basis in the ROLP stock, and we decline to lower her basis in the amount of $ 177,382, especially in view of our decision herein disallowing petitioner's use of $ 226,339 of net operating loss carryforwards attributable in part to the 1974 ROLP loss. ↩29. Petitioner was the only shareholder by 1977. We accept the testimony of the several witnesses that Mr. Manchester had few, if any, assets and that the funding for ROLP came from petitioner and not from Mr. Manchester, even though Mr. Manchester was the ROLP general manager, primary salesman, "chief cook and bottle washer." ↩30. Petitioner appears to have used much of the cash she received upon the sale of her Penn Fishing stock to pay off ROLP creditors, either directly or through cash contributions to the corporation. ↩31. Although we suspect that petitioner over the years made contributions to ROLP's capital which were not intended as "shareholder loans," no Paid-in Capital was reported on the balance sheets included with the tax returns. ↩32. We have not included the total amounts of the post - 6/30/77 checks on Exhibit 75-BW because some of the payments appear to be on behalf of Alert. We have included in petitioner's ROLP basis only half of the amounts paid to Clemence Shearer, Mr. Kohn, and American Bureau Collection because these payees performed work for both Alert and ROLP. We have excluded a check written to Bell Telephone because it appears to be for the phone lines used by the alarms operated by Alert for which deductions were taken on Alert's tax return. 33. We appreciate that petitioner was taxed in 1977 on the relief of loans in the amount of $ 1,742,000 by virtue of the transaction in which she sold her Penn Fishing stock. When added to $ 843,222 (December 31, 1977, loans from shareholders as represented on the Alert tax return), however, the ROLP loss we have allowed petitioner exceeds the amount of loans of which she was relieved.↩34. The NOLs in those years were caused by the flow through to petitioner or claimed subchapter S losses from Alert and PDI. Petitioner also asserts that the 1980 subchapter S corporation losses for Alert and PDI caused her to generate an individual NOL for 1980. Her 1980 individual income tax return is not in evidence, however, and she has offered no indication as to the amount of any 1980 NOL, if indeed she had an NOL in 1980. We therefore deem her to have conceded that she is not entitled to a carryback to any NOL arising in 1980. 35. There is no suggestion by petitioner that respondent failed to make a determination of a deficiency for petitioner for 1977, that the notice of deficiency herein was not a valid deficiency determination, or that respondent's determination was arbitrary and capricious. ↩36. If a notice of deficiency does not adequately indicate the specific items disallowed by respondent, our Rules provide a mechanism by which taxpayers may ascertain the specific disallowances. See Campbell v. Commissioner,90 T.C. 110">90 T.C. 110, 90 T.C. 110">115 (1988); Foster v. Commissioner,80 T.C. 34">80 T.C. 34, 80 T.C. 34">230-231↩ (1983). 37. This Court normally does not look behind a notice of deficiency ( Greenberg's Express, Inc. v. Commissioner,62 T.C. 324">62 T.C. 324, 62 T.C. 324">328↩ (1974)); however, we suspect that if petitioner had brought the issue of the NOLs and ITCs to the attention of the examining agent, the notice of deficiency would have specifically addressed their allowance or disallowance.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625608/	RUDY G. STANKO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentStanko v. CommissionerDocket No. 25257-91United States Tax CourtT.C. Memo 1993-513; 1993 Tax Ct. Memo LEXIS 524; 66 T.C.M. 1216; T.C.M. (RIA) 93513; November 9, 1993, Filed 1993 Tax Ct. Memo LEXIS 524">524 An appropriate order will be issued granting respondent's motion to dismiss, and a decision will be entered for respondent. William R. Davis, Jr., for respondent. FAYFAYMEMORANDUM OPINION FAY, Judge: The instant case is before the Court on respondent's Motion to Dismiss for Lack of Prosecution. This motion was filed upon petitioner's failure to appear when this case was called for trial on February 8, 1993. We considered respondent's motion as a motion to dismiss for failure to properly prosecute pursuant to Rule 123(b) 1 when it was acted upon and granted in part at the hearing on February 8, 1993. By statutory notice of deficiency, respondent determined deficiencies in and additions to petitioner's Federal income tax in the following amounts: Additions to Tax Sec. Sec. Sec. Sec.YearDeficiency6651(a)6653(a)(1)6653(a)(2)66541984$ 961,134$ 228,520$ 48,0571$ 56,73019859,6112,40348115511993 Tax Ct. Memo LEXIS 524">525 Respondent also determined the liability of petitioner, as transferee of assets of Stanko Packing Company, Inc., as follows: Additions to TaxTaxYearSec.Sec.Sec.Sec.EndingDeficiency6651(a)(1)6653(a)(1)6653(a)(2)66556/21/85$ 1,324,964$ 323,806$ 66,2481$ 83,203By notice dated January 16, 1992, this case was set for trial at the Helena, Montana, trial session beginning on June 22, 1992. On March 18, 1992, petitioner filed a Motion to Change Place of Trial. Pursuant to a conference call held between the parties and this Court on1993 Tax Ct. Memo LEXIS 524">526 April 1, 1992, the Court, by Order dated April 3, 1992, granted petitioner's motion, changing the place of trial in this case from Helena, Montana, to Denver, Colorado. By notice dated September 2, 1992, the Court set this case for the February 8, 1993, Denver, Colorado, trial session. This notice specifically stated that "YOUR FAILURE TO APPEAR MAY RESULT IN DISMISSAL OF THE CASE AND ENTRY OF DECISION AGAINST YOU." On October 22, 1992, petitioner filed a second Motion to Change Place of Trial. On October 19, respondent filed her Notice of Objection to this motion, and on October 27, 1992, the Court denied petitioner's motion. Petitioner had filed a timely petition on November 4, 1991. Respondent filed a timely answer denying petitioner's allegations of error with respect to the foregoing deficiencies and additions to tax. Respondent also set forth specific affirmative allegations of fact in her answer supporting a finding that petitioner is liable as a transferee of Stanko Packing Company, Inc. (the transferor), for the transferor's deficiency and additions to tax. The affirmative allegations of fact in respondent's answer are as follows: 7. FURTHER ANSWERING the petition, 1993 Tax Ct. Memo LEXIS 524">527 and in support of the determination that the petitioner Rudy G. Stanko is liable as transferee at law and in equity of assets of Stanko Packing Company, Inc., transferor, for the deficiency in corporate income tax due from said transferor for the tax year ended June 21, 1985, plus interest thereon as provided by law, the respondent alleges: (a) Stanko Packing Company, Inc. (Stanko Packing) was incorporated under the laws of the State of Nebraska and had its principal place of business at 2605 North 7th Street, Box 127, Gering, Nebraska 69341. (b) On June 14, 1984, Stanko Packing adopted a plan of complete liquidation and on July 9, 1984, a Form 966, Corporate Dissolution or Liquidation, was filed with the Service. (c) The petitioner, Rudy G. Stanko, was the sole shareholder of Stanko Packing at the time the notice to dissolve was filed. (d) The majority of the operating assets of the corporation were sold to Packerland Packing Company, Inc. (Packerland) of Greenbay, Wisconsin in July of 1984. Stanko Packing and Packerland entered into a contract to sell the land, buildings, fixtures, improvements, machinery, equipment, furniture, and vehicles, shop supplies, repair parts, tools1993 Tax Ct. Memo LEXIS 524">528 and other supplies owned by Stanko Packing Company to Packerland. (e) The sale closed on July 16, 1984. The consideration for the sale to Packerland was cash and a promissory note dated July 16, 1984 in the total amount of $ 3,900,000.00. (f) At the end of the taxable year ended August 25, 1984, Stanko Packing had assets of approximately $ 6,213,454.00, which assets were distributed to the petitioner, Rudy G. Stanko by December 31, 1984. (g) Stanko Packing Company, Inc., a Nebraska Corporation, filed a Statement of Intent to Dissolve dated June 21, 1985, with the Secretary of State for the State of Nebraska. (h) The total distribution to the petitioner of the assets that are no longer in the possession of Stanko Packing amounts to $ 6,213,454.00, which exceeds the liability of the corporation for its final taxable year ended June 21, 1985. (i) The transfer of property by Stanko Packing to the petitioner was without consideration. (j) The fair market value of the assets transferred to the petitioner was $ 6,213,454.00, or an amount which exceeded the deficiency, additions to the tax, and interest as provided by law due from Stanko Packing. (k) By reason of the transfer of property1993 Tax Ct. Memo LEXIS 524">529 to the petitioner [Rudy G. Stanko] Stanko Packing was rendered insolvent. (l) No part of the deficiency in income tax or the additions to the tax, together with interest as provided by law, due from Stanko Packing has been paid. (m) By reason of the transfer of the assets of Stanko Packing in the amount of $ 6,213,454.00 to the petitioner, the petitioner became, and is a transferee of assets within the meaning of I.R.C. § 6901 and Neb. Rev. Stat. §§ 36-604, 606, 607, and as such is liable for the deficiency in income tax and additions to the tax due from Stanko Packing for the taxable year ended June 21, 1985. Petitioner timely filed his reply on February 18, 1992. The reply, asserted, inter alia, typical tax protester arguments but failed to expressly admit or deny any of the affirmative allegations with respect to the transferee liability issue set forth by respondent in her answer. During the available pretrial preparation period, petitioner failed to meet with respondent on at least three occasions when conferences were made available at petitioner's request and for his convenience. This case was called at the Court's trial calendar in Denver, Colorado, on February 8, 1993. 1993 Tax Ct. Memo LEXIS 524">530 Petitioner did not appear. At that time, respondent filed a Motion to Dismiss for Lack of Prosecution, seeking an order finding (1) the deficiencies and additions to tax as determined for petitioner for 1984 and 1985 and (2) petitioner liable as transferee for income tax liabilities of Stanko Packing Company, Inc., transferor, for the transferor's tax year ended June 21, 1985. After respondent's counsel was heard, the Court granted respondent's motion to dismiss with respect to those items for which petitioner had the burden of proof, 2 and took the transferee liability issue under consideration. The issue for decision is1993 Tax Ct. Memo LEXIS 524">531 whether petitioner Rudy G. Stanko is liable for the determined amounts as a transferee. Transferee LiabilityRespondent has the burden of proving that petitioner is the transferee of assets of the transferor. Sec. 6902(a); Rule 142(d). A transferee, to the extent of assets received, may be liable for the transferor's Federal income tax and resulting additions to tax and interest in the year of transfer and prior years even though the tax liability of the transferor was unknown at the time of the transfer. Swinks v. Commissioner, 51 T.C. 13">51 T.C. 13, 51 T.C. 13">17 (1968); Kreps v. Commissioner, 42 T.C. 660">42 T.C. 660, 42 T.C. 660">670 (1964), affd. 351 F.2d 1">351 F.2d 1 (2d Cir. 1965). Transferee liability is determined by a preponderance of the evidence. C.B.C. Super Markets, Inc. v. Commissioner, 54 T.C. 882">54 T.C. 882, 54 T.C. 882">898 (1970). Respondent is entitled to satisfy her burden by relying on facts deemed admitted. Bosurgi v. Commissioner, 87 T.C. 1403">87 T.C. 1403 (1986) (transferee liability); Marshall v. Commissioner, 85 T.C. 267">85 T.C. 267 (1985) (fraud); Doncaster v. Commissioner, 77 T.C. 334">77 T.C. 334 (1981)1993 Tax Ct. Memo LEXIS 524">532 (fraud). When a reply is filed, this Court's Rules establish that every affirmative allegation of fact set out in the answer and not expressly admitted or denied in the reply shall, without further action, be deemed to be a fact admitted. Rule 37(c); Beard v. Commissioner, 82 T.C. 766">82 T.C. 766, 82 T.C. 766">767-768 (1984), affd. 793 F.2d 139">793 F.2d 139 (6th Cir. 1986). 3 Although the affirmative allegations of fact contained in respondent's answer are deemed admitted pursuant to Rule 37(c) in this case, the entry of default under Rule 123(a) also has the effect of admitting all well-pleaded facts in respondent's answer. 87 T.C. 1403">Bosurgi v. Commissioner, supra at 1409. The entry of a decision against a taxpayer based on deemed admissions, where the Commissioner has the burden of proof and sufficient specific facts have been alleged1993 Tax Ct. Memo LEXIS 524">533 by the Commissioner thereby sustaining such burden, is within the sound judicial discretion of the Court. See Smith v. Commissioner, 91 T.C. 1049">91 T.C. 1049, 91 T.C. 1049">1058 (1988), affd. 926 F.2d 1470">926 F.2d 1470 (6th Cir. 1991); 87 T.C. 1403">Bosurgi v. Commissioner, supra at 1408. The Court may, where the pleadings set forth facts sufficient to support a judgment that the taxpayer is a transferee, enter judgment against the taxpayer if appropriate. 87 T.C. 1403">Bosurqi v. Commissioner, supra at 1408; see 91 T.C. 1049">Smith v. Commissioner, supra at 1057-1058 (default decision under Rule 123(a) appropriate with respect to finding of fraud against taxpayer). The Court may grant a motion for default 4 brought by the Commissioner based on facts deemed admitted under Rule 37(c), where sufficient facts have been admitted to justify a finding of fraud. Gilday v. Commissioner, 62 T.C. 260">62 T.C. 260, 62 T.C. 260">262-263 (1974). This similarly applies with respect to transferee liability. 87 T.C. 1403">Bosurqi v. Commissioner, supra at 1407-1409; see also Mizrahi v. Commissioner, T.C. Memo. 1992-2001993 Tax Ct. Memo LEXIS 524">534 (deemed admissions under Rule 90(c) finding of transferee liability).The substantive elements of whether a transferee is liable for the obligations of the transferor are determined under applicable State law. Commissioner v. Stern, 357 U.S. 39">357 U.S. 39 (1958). The Nebraska Uniform Fraudulent Conveyance Act, applicable here, provides: 36-604. Conveyance by insolvent; fraudulent. Every conveyance made and every obligation incurred by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to his or her actual intent if the conveyance is made or the obligation is incurred without a fair consideration. [Neb. Rev. Stat. sec. 36-604 (reissue 1988); emphasis added.] Although this statute has since been replaced, the statute covering substantive matters in effect at the time of the transaction will govern the instant case, not later enacted statutes. Schall v. Anderson's Implement, Inc., 484 N.W.2d 86">484 N.W.2d 86, 484 N.W.2d 86">89-90 (Neb. 1992).1993 Tax Ct. Memo LEXIS 524">535 As previously discussed, petitioner is deemed to have admitted all the affirmative allegations of fact in respondent's answer. Furthermore, we find that the affirmative allegations of fact contained in the answer are factually sufficient to establish transferee liability against petitioner, as to each and every element. See 87 T.C. 1403">Bosurgi v. Commissioner, supra at 1405-1406 (same allegations of fact used to establish substantially similar elements of transferee liability); Mizrahi v. Commissioner, supra (same allegations of fact used to establish substantially similar elements of transferee liability). Finally, on this record we find that respondent has met her burden of proof by way of her allegations of fact in establishing that petitioner is liable as a transferee for the amounts determined in the notice of deficiency and that respondent is entitled to a decision on this issue. Respondent's Motion to Dismiss Pursuant to Rule 123(b)When a taxpayer, inter alia, fails to properly prosecute his or her case or fails to comply with the Tax Court Rules of Practice and Procedure, or the Court finds cause it deems1993 Tax Ct. Memo LEXIS 524">536 sufficient, the Court may dismiss the taxpayer's case at any time and enter a decision against the taxpayer. Rule 123(b). It is well established that this Court can dismiss a case against a party if that party fails to follow our Rules or otherwise fails to properly prosecute his or her case. Rule 123(b); Ducommun v. Commissioner, 732 F.2d 752">732 F.2d 752 (10th Cir. 1983). As set forth above, petitioner's original designation of place of trial was Helena, Montana. Petitioner then filed a motion to change the place of trial to Denver, Colorado, such motion being granted by this Court. After thus shifting, maneuvering, and finally receiving his choice for the place of trial, petitioner failed to appear at the location which he went through so much trouble to designate. Moreover, we find that petitioner's failure to cooperate with respondent during the pretrial period made it impossible for respondent to conduct negotiations, exchange information, and stipulate mutually agreeable facts as required by Rule 91(c). The standing pretrial order has not been complied with by petitioner, nor the mandates of the Court in Branerton Corp. v. Commissioner, 61 T.C. 691">61 T.C. 691 (1974).1993 Tax Ct. Memo LEXIS 524">537 Furthermore, no trial memorandum was filed by or on behalf of petitioner. For the above discussed reasons, we granted respondent's motion at the hearing on February 8, 1993, as to the deficiencies and the additions to tax determined against petitioner for which petitioner bore the burden of proof. Furthermore, petitioner is liable in this case as a transferee. This fact, coupled with our ruling at the hearing on February 8, 1993, that petitioner failed to meet his burden of proof with respect to the transferor's tax liability, leads us to find that petitioner is liable for the deficiency and additions to tax determined against him as a transferee by respondent. To reflect the foregoing, An appropriate order will be issued granting respondent's motion to dismiss, and a decision will be entered for respondent. Footnotes1. All section references are to the Internal Revenue Code in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩1. The addition to tax under sec.6653(a)(2) is in an amount equal to 50 percent of the interest due with respect to the portion of the underpayment attributable to negligence or intentional disregard of rules and regulations.↩1. The addition to tax under sec. 6653(a)(2) is in an amount equal to 50 percent of the interest due with respect to the portion of the underpayment attributable to negligence or intentional disregard of rules and regulations.↩2. The petitioner bears the burden of proof to show that the individual deficiency and additions to tax determined against petitioner are erroneous. The burden of proof also rests with petitioner to establish that the transferor is not liable for the deficiency determined by respondent. Sec. 6902(a); Rule 142(d); Alonso v. Commissioner, 78 T.C. 577">78 T.C. 577, 78 T.C. 577">580↩ (1982).3. Respondent may file a motion seeking deemed admissions of affirmative allegations in the answer only where a reply is not filed.↩4. Under Rule 123(a), this Court may also hold a party in default on its own initiative.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625610/	John P. Davidson, Jr., and Mary R. Davidson, Petitioners, v. Commissioner of Internal Revenue, RespondentDavidson v. CommissionerDocket No. 732-62United States Tax Court42 T.C. 766; 1964 U.S. Tax Ct. LEXIS 73; July 23, 1964, Filed 1964 U.S. Tax Ct. LEXIS 73">73 Decision will be entered for the respondent. Held, that the amount which the principal petitioner paid during the taxable year through withholdings from his salary, as his employee contributions to the qualified pension and insurance plan of his employer, does not constitute an allowable deduction under section 162 or any other section of the Internal Revenue Code of 1954. Duncan Davidson, for the petitioners.Eugene L. Wilpon, for the respondent. Pierce, Judge. PIERCE 42 T.C. 766">766 The Commissioner determined a deficiency of $ 89.86 in the petitioners' income tax for their taxable year 1959. This deficiency1964 U.S. Tax Ct. LEXIS 73">74 resulted solely from the Commissioner's determination that the amount of $ 408.50 which the principal petitioner paid during said taxable year through withholdings from his salary, as his employee contributions to the qualified pension and insurance plan of his employer, does not constitute an allowable deduction under section 162 or any other section of the Internal Revenue Code of 1954. The sole issue to be here decided is the correctness of this determination.FINDINGS OF FACTSome of the facts have been stipulated. The stipulation of facts and all exhibits identified therein are incorporated herein by reference.The petitioners, John P. Davidson, Jr., and Mary R. Davidson, are husband and wife residing near Albany, N.Y. They filed a joint income tax return for their taxable calendar year 1959 with the district director of internal revenue at Albany. The wife is a party to this proceeding solely by reason of having joined in the filing of said return; and the husband is hereinafter referred to as the petitioner.42 T.C. 766">767 In the fall of 1956, petitioner made an arrangement with Rensselaer Polytechnic Institute, located in Troy, N.Y., to be employed as an assistant professor1964 U.S. Tax Ct. LEXIS 73">75 in said institute's physics department. He began such employment on February 1, 1957; and shortly thereafter on February 28 of the same year, he executed a written contract with the institute, under which he agreed to act in this same capacity for 3 academic years beginning on September 1, 1957, and ending on June 30, 1960, at a salary of $ 6,600 per year to be paid in monthly installments. This contract provided that it could be terminated by either party on June 30 of any year, upon written notice given not later than April 1 of that year. The contract was never so terminated. For the calendar year 1959 here involved, petitioner received from the institute salary in the increased amount of $ 9,930.13. And at the time of the trial herein, which was more than 6 1/2 years after the beginning of his employment, petitioner was still serving the institute in the more advanced position of associate professor.Rensselaer Polytechnic Institute had, at all times since October 1, 1944, a qualified retirement pension and insurance plan for the benefit of members of its faculty and certain other employees. From time to time this plan was revised and amended, with a view to improving and1964 U.S. Tax Ct. LEXIS 73">76 enlarging the employee benefits thereunder; and also at various times (and more particularly as of October 1, 1953, October 1, 1957, and October 1, 1960), printed booklets were issued by the institute to its employees, which set forth the provisions and highlights of the plan as amended, showed the amounts of the contributions thereto which were to be made by the institute and by member-employees, and also explained the nature of the benefits which would accrue to the employees thereunder.Effective as of October 1, 1957, both the pension benefits and the life insurance benefits under the plan were funded with a qualified insurance company, under group contracts; the amounts of the institute's contributions thereto were increased to approximately 8 percent of each member-employee's monthly earnings; and the amount of each employee's contributions continued, as before, to be approximately 6 percent of his earnings. The plan specifically provided that, if any employee left the service of the institute prior to retirement, he thereupon would become entitled to a return of all the contributions made by him since October 1, 1957, together with interest thereon. And the plan also provided1964 U.S. Tax Ct. LEXIS 73">77 in part:The Institute expects that all Faculty members and all Officers of the Administrative Staff, who are eligible for the Plan, will not only join the Plan when they are first eligible, but will remain in the Plan just as long as they are in the service of the Institute. * Petitioner received a copy of one of these explanatory booklets, at or about the time he commenced his employment with the institute.42 T.C. 766">768 On October 1, 1957, petitioner became eligible to participate as a member of said pension and insurance plan; and thereupon the institute commenced to make withholdings from his monthly salary payments, to cover his employee contributions thereto. Shortly after the first of these withholdings was made, petitioner called upon one of the officials of the institute, and there indicated that he wished to terminate his participation in said pension and insurance plan. Said officer thereupon informed petitioner (apparently with reference to the above-quoted provision, that all faculty members were expected to become and remain members of the plan as long as they were in the service of the institute) that the only way he could terminate his participation in the plan1964 U.S. Tax Ct. LEXIS 73">78 was to terminate also his employment contract with the institute. The result of this discussion was that petitioner thereupon elected not to terminate his employment contract; that he continued at all times subsequent, including the taxable year here involved, to be a participating member of the plan; and that he also continued at all such times to permit the institute to make withholdings from his monthly salary payments to cover his employee contributions to the plan.In the joint income tax return which petitioner and his wife filed for the taxable year 1959 (which year included part of the final period of his 3-year employment contract), petitioner deducted under the designation of "Deductions for involuntary pensions," the amount of $ 408.50 which was the amount which he had paid in said year as his employee contributions to said pension and insurance plan. The Commissioner, in his notice of deficiency herein, disallowed this claimed deduction on the basis of the determination hereinabove mentioned.OPINIONIt is our opinion that the Commissioner's disallowance of said claimed deduction was and is correct, for each of the following reasons:(1) Petitioner's payment of said 1964 U.S. Tax Ct. LEXIS 73">79 amount of $ 408.50 constituted a capital expenditure for the acquisition of pension benefits and life insurance benefits, and, as the Commissioner determined, it did not constitute a deductible item under section 162 or any other section of the 1954 Code. His contributions to the cost of these benefits were substantially less than the total actual cost thereof, by reason of the additional contributions which were made by the institute. And, in the event that he subsequently terminated his employment with the institute prior to his retirement date, he then would become entitled to have all of his contributions returned to him with interest. Hence, he was, in effect, making periodic payments toward the purchase of investments, which he could, if he desired, recover without loss. See in this connection T.D. 3112, 4 C.B. 76 (1921), cited with approval in Miller 42 T.C. 766">769 v. Commissioner, 144 F.2d 287 (C.A. 4), affirming 2 T.C. 267">2 T.C. 267, wherein it was ruled that amounts withheld from the basic salary of employees in the Civil Service of the United States were payments made toward the1964 U.S. Tax Ct. LEXIS 73">80 purchase of annuities and are not allowable deductions for income tax purposes. See also to the same effect Rev. Rul. 58-141, 1958-1 C.B. 101.(2) The amount so paid by petitioner, even if it can be regarded as an "expense," constituted an item of "personal * * * or family expenses" within the meaning of section 262 of the 1954 Code; and under the provisions of this section is not deductible. The purpose of such contributions was to provide an annuity for the personal benefit of petitioner on which payments would commence at the time of his retirement and continue during the remainder of his life, and also life insurance under which payment would be made at his death to his widow or other beneficiaries, or to his estate. See in this connection I.T. 4005, 1950-1 C.B. 47, wherein the Internal Revenue Service ruled that amounts deducted from employees' wages to provide benefits under the New York workmen's compensation law did not constitute ordinary and necessary expenses under section 23 (a)(1)(A) of the Internal Revenue Code of 1939 (cognate to section 162(a) of the 1954 Code); but rather, that such amounts constituted1964 U.S. Tax Ct. LEXIS 73">*81 personal expenses and were not deductible in computing net income for Federal income tax purposes.(3) Petitioner has cited no decision or other authority which would tend to indicate that the item in question is deductible under any provision of the 1954 Code; and our examination has failed to reveal any such authority.We decide the issue for the respondent.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625612/	MINNIE T. GRIPPIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. BESSIE G. HALL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ROLAND F. MYGATT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Grippin v. CommissionerDocket Nos. 66345, 66825, 67564.United States Board of Tax Appeals36 B.T.A. 1109; 1937 BTA LEXIS 627; December 8, 1937, Promulgated 1937 BTA LEXIS 627">627 The petitioners, stockholders of the American Founders Corporation and United Founders Corporation, received warrants in 1929 from those corporations entitling them to purchase shares of stock of the United States Electric Power Corporation at $15 per share, the warrants expiring on October 15, 1929. The reasonable value of shares of stock of the United States Electric Power Corporation at the time was not in excess of $15 per share, Held, that the petitioners derived no taxable income from the receipt of the stock purchase warrants. Arthur M. Marsh, Esq., for the petitioners. D. A. Taylor, Esq., for the respondent. SMITH36 B.T.A. 1109">1110 OPINION. SMITH: These proceedings, consolidated for hearing, are for the redetermination of deficiencies in income tax for 1929 as follows: PetitionerDocket No.DeficiencyMinnie T. Grippin66345$74,585.73Bessie G. Hall668257,497.74Roland F. Mygatt6756413,386.41These proceedings involve three isues, two of which are common to all three cases and the third of which is present in the Grippin and Hall cases only. The two issues in common are: First, the value of the stock1937 BTA LEXIS 627">628 of the United Founders Corporation received by the petitioners in exchange for stock of the American Founders Corporation for the purpose of determining the gain realized on the exchange. Second, the taxability as dividends of rights to subscribe to the common stock of the United States Electric Power Corporation received from the American Founders Corporation and United Founders Corporation. The third issue, which is common to the Grippin and Hall cases, is whether or not amounts received by the petitioners upon the sale of such of the rights as were sold should be included in taxable income. With respect to the first issue, the petitioners concede that the exchange gave rise to taxable income and the value of the stock on the dates of exchange is stipulated by the parties. The petitioners, Minnie T. Grippin and Bessie G. Hall, concede that they are taxable upon the proceeds realized by them from the sale of the warrants in 1929. The only question for the determination of the Board is the liability to income tax upon the value of the stock purchase warrants received by the petitioners from the American Founders Corporation and United Founders Corporation in 1929. 1937 BTA LEXIS 627">629 Minnie T. Grippin and Bessie G. Hall are residents of Bridgeport, Connecticut, and Roland F. Mygatt of New Milford, Connecticut. The petitioners were stockholders in 1929 of the American Founders Corporation and of the United Founders Corporation. These corporations were investment companies engaged in 1929 in the purchase and sale of shares of stock of public utility corporations. Up to October 1929 there was a great demand on the part of investors for shares of stock in such corporations. Taking advantage of the enormous demand for such securities, the American Founders Corporation and United Founders Corporation, which owned large blocks of stock in the Standard Gas & Electric Corporation, conceived the idea 36 B.T.A. 1109">1111 of organizing a holding public utility corporation and the sale of such shares to their stockholders. They accordingly, with other interests, organized the United States Electric Power Corporation on September 10, 1929, with a capitalization of: 1,000,000 shares of preferred stock, no par value 2,000,000 shares of class A stock, no par value 20,000,000 shares of common stock, no par value The American Founders Corporation and United Founders Corporation1937 BTA LEXIS 627">630 are hereinafter referred to as American Founders and United Founders, and the United States Electric Power Corporation as United States Electric. The organizers of United States Electric subscribed on September 10, 1929, for the 2,000,000 shares of class A stock at $10 per share and for 1,450,000 shares of common at $13.50 per share. Out of the foregoing, 700,000 shares of class A stock and 350,000 shares of common stock were subscribed and paid for by American Founders and United Founders. Payment for the 2,000,000 shares of class A stock and 1,450,000 shares of common stock was made partly in cash and partly in Standard Gas & Electric Corporation stock at $190 per share, which was approximately the selling price of that stock on the New York Stock Exchange at that time. Payment was made after September 14, 1929, and on or about September 17 and 19, 1929. On September 10, 1929, American Founders, by its president, Louis H. Seagrave, offered in writing to purchase from United States Electric such number of shares of the common stock of that corporation at $13.50 per share as would be: * * * necessary to afford to the holders of Common Stock of the undersigned Corporation1937 BTA LEXIS 627">631 at the close of business on September 14, 1929, the right to purchase one share of such stock for each two and one-half shares held by such holder, such amount estimated to be not less than 900,000 shares nor more than 1,100,000 shares and to make payment therefor in cash at the office of the Corporation on the 17th day of September, 1929. On the same date, United Founders, by its president, Louis H. Seagrave, likewise offered in writing to United States Electric to purchase such number of shares of its common stock at a price of $13.50 per share as would be necessary to afford to the holders of common stock of United Founders at the close of business on September 14, 1929, the right to purchase one share of such stock for each five shares held by such holder. The amount estimated to be needed was "not less than 1,100,000 shares nor more than 1,250,000 shares." Payment was to be made in cash on September 17, 1929, although payment was made partly in shares of stock of the Standard Gas & Electric Corporation at $190 per share. United States Electric common stock was listed on the Boston Stock Exchange on September 36 B.T.A. 1109">1112 23, 1929, and from the date of listing to October 7, 1929, a1937 BTA LEXIS 627">632 total of 25,946 shares were sold at prices ranging from $32 1/8 to $33 3/8. American Founders, on or about September 28, 1929, transmitted to its stockholders warrants to purchase a total of 1,017,239 shares, and United Founders on the same date transmitted to its stockholders warrants to purchase a total of 1,297,791 shares of common stock of United States Electric at $15 per share. The warrants expired on October 15, 1929. American Founders stockholders, or their assignees, by the exercise of warrants subscribed for 1,014,753 shares of United States Electric common stock, and United Founders stockholders, or their assignees, subscribed for 733,326 shares. Payment was made to the Equitable Trust Co. at $15 per share on or before October 15, 1929. The stock purchase warrants issued by American Founders and United Founders were not listed on any exchange, but there were over-the-counter transactions in them at $6.25 per right for those issued by American Founders and at $3.25 per right for those issued by United Founders. The parties have stipulated that the issuance of the warrants above described was at no time set up on the books of either company, either as a charge1937 BTA LEXIS 627">633 against gross profits or against surplus, or otherwise; also, that neither corporation formally or expressly declared such issue of warrants as a dividend or so entered them on their books. The parties have stipulated as follows: (32) The petitioners herein exercised certain of said rights so received between Sept 28 and Oct. 15, 1929, and sold certain others thereof between Sept. 28 and Oct. 15, 1929, all in the number, on the dates, and at the prices set opposite their respective names, as follows (prior to October 15, 1929): TotalExercisedSoldDateSale priceBESSIE G. HALLWarrants received from American915915NoneWarrants received from United1,03050980$3,185.00ROLAND F. MYGATTWarrants received from American1,3451,345NoneWarrants received from United2,0002,000NoneMINNIE T. GRIPPINWarrants received from American4,247 1/2None4,247 1/210/4/2928,670.63Warrants received from United10,50010,00050010/4/291,750.00The reasonable value of the shares of stock of the United States Electric Power Corporation in October 1929 was not in excess of $15 per share. The respondent in his computation1937 BTA LEXIS 627">634 of the deficiencies in tax due from these petitioners for the year 1929 determined that the receipt of the rights to purchase shares of stock of United States Electric from American Founders and United Founders constituted distributions of dividends by those corporations, and that for such purpose 36 B.T.A. 1109">1113 the rights received from American Founders had a value at the time of receipt of $6.25 per right, and those received from United Founders a value at the time of receipt of $3.25 per right. He has accordingly taxed the distributions as ordinary dividends at those values. It is plain from the lengthy stipulation of facts filed by the parties in these proceedings that American Founders and United Founders conceived the idea of marketing shares of stock of United States Electric to their stockholders at a substantial profit to themselves. They acted as a mere conduit for the sale of shares of United States Electric. Each realized a profit of $1.50 per share upon the shares which it sold to its stockholders. United States Electric had no assets except the amounts paid in to that corporation by American Founders and United Founders, viz., $13.50 per share, and it is further1937 BTA LEXIS 627">635 to be observed that a large part of the payment made by those corporations to United States Electric was in the form of shares of stock of the Standard Gas & Electric Corporation at $190 per share. Through this means the two Founders corporations were enabled to dispose of large quantities of Standard Gas & Electric Corporation stock without depressing the prices of those shares on the stock exchange. We think it clear from the stipulated facts that the reasonable and fair value of United States Electric was at no time in October 1929 in excess of $15 per share. The petitioners realized no income from the receipt of the stock purchase warrants from the two Founders corporations in which they held shares. As later events show, the stockholders would have been far better off if they had never received the warrants. In our opinion the decision upon the point in issue in these proceedings is squarely ruled by the decision of the Supreme Court in . In its opinion the Supreme Court stated: We think that a distribution of assets by a corporation to its stockholders by means of a sale, to which it is committed by appropriate1937 BTA LEXIS 627">636 corporate action at a time when their sale price represents their reasonable value, is not converted into a dividend by the mere circumstance that later, at the time of their delivery to stockholders, they have a higher value. The meaning of § 115 must be sought in the light of the situations to which it must be applied. * * * The "reasonable value" of United States Electric shares of common stock in October 1929 was not in excess of $15 per share. Therefore, the petitioners received no taxable income from the receipt of the stock purchase warrants. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625614/	JERRY R. AND PATRICIA A. DIXON, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Dixon v. CommissionerDocket Nos. 9382-83, 16900-83; 17640-83, 19321-83; 4201-84, 15135-84; 15907-84, 31236-84; 40159-84, 22783-85; 30010-85, 30965-85; 30979-85, 29643-86.United States Tax CourtT.C. Memo 1991-614; 1991 Tax Ct. Memo LEXIS 661; 62 T.C.M. 1440; T.C.M. (RIA) 91614; December 11, 1991, Filed Dixon v. Commissioner, 90 T.C. 237">90 T.C. 237, 1988 U.S. Tax Ct. LEXIS 15">1988 U.S. Tax Ct. LEXIS 15 (1988)1991 Tax Ct. Memo LEXIS 661">661 Decisions will be entered for the respondent in docket Nos. 9382-83, 16900-83, 17640-83, 19321-83, 4201-84, 15907-84, 31236-84, 40159-84, 22783-85, 30010-85, 30965-85, 30979-85, 29643-86. Decision will be entered under Rule 155 in docket No. 15135-84. Joe Alfred Izen, Jr., for the petitioners in docket Nos. 9382-83, 17640-83, 4201-84, 15907-84, 40159-84, 22783-85, 30010-85, 30979-85, and 29643-86. 2Luis C. DeCastro and Philip J. Hoskins, for the petitioners in docket Nos. 19321-83, 31236-84, and 30965-85. John R. Cravens, pro se in docket Nos. 16900-83 and 15135-84. Kenneth W. McWade, Jeffrey A. Hatfield1991 Tax Ct. Memo LEXIS 661">662 , and Thomas A. Dombrowski, for the respondent. GOFFE, JudgeGOFFEMEMORANDUM FINDINGS OF FACT AND OPINION The Commissioner determined deficiencies in and additions to petitioners' Federal income taxes, as follows: Jerry R. and Patricia A. Dixon3Additions to Tax, Secs. YearDeficiency6653(a)6653(a)(1)1977$ 9,885.00 $ 494.00 -- 197817,375.00868.75-- 197918,087.00904.35-- 198029,448.001,649.70-- 198128,061.00-- $ 1,759.90John R. and E. Maria CravensYearDeficiencySec. 6653(a) Addition to Tax1979$ 4,508.00 $ 225.40198019,251.70962.59Ralph J. RinaYearDeficiencySec. 6653(a) Addition to Tax1979$ 16,236.38$ 811.81 198039,015.001,950.751991 Tax Ct. Memo LEXIS 661">663 John R. and Maydee L. ThompsonAdditions to Tax, Secs.YearDeficiency6653(a)6653(a)(1)6651(a)(1)1979$ 18,161.00$ 908.00-- -- 198024,838.00-- -- -- 198136,294.52-- $ 1,958.28$ 4,934.32The Commissioner also determined an increased interest rate for 1981 under section 6621(c), formerly section 6621(d). Hoyt W. and Barbara D. YoungAdditions to Tax, Secs.YearDeficiency6653(a)6653(a)(1)6661(a)1979$ 15,658.00$ 783.00 -- -- 198023,582.001,179.00-- -- 198123,819.00-- $ 1,191.00-- 198213,773.59-- 688.68$ 1,377.3619832,163.42-- 108.17-- 1991 Tax Ct. Memo LEXIS 661">664 The Commissioner also determined an increased interest rate for 1982 and 1983 under section 6621(c). Robert L. and Carolyn S. DuFresneAdditions to Tax, Secs.YearDeficiency6653(a)6653(a)(1)6661(a)1980$ 25,877.00$ 1,293.85-- -- 198121,790.00-- $ 1,089.50-- 198216,684.70-- 834.24$ 1,668.47198315,851.64-- 792.581,585.16The Commissioner also determined an increased interest rate for 1982 and 1983 under section 6621(c). Terry D. and Gloria K. OwensYearDeficiencySec. 6653(a) Addition to Tax1975$ 4,341.00$ 217.0019762,786.00139.0019771,195.0060.0019781,069.0053.00Richard and Fidella HongsermeierYearDeficiencySec. 6653(a) Addition to Tax1978$ 9,303.00$ 465.00197911,866.00593.00198018,717.00936.00Petitioners resided in California, Hawaii, Tennessee, and Texas when they filed1991 Tax Ct. Memo LEXIS 661">665 their petitions. These cases have been selected by the parties as "test" cases which will resolve all of the common issues in a group of over 1,300 cases. The parties in the nontest cases have stipulated to be bound by the final outcome in the test cases. ISSUES The issues for decision are: (1) Whether this Court lacks jurisdiction over some of these cases because the notices of deficiency are invalid; (2) whether petitioners are entitled to deduct interest under section 163(a) in connection with their participation in certain investment programs involving the purchase of stock or an investment certificate; 41991 Tax Ct. Memo LEXIS 661">667 (3) if petitioners are so entitled, whether section 61 requires a corresponding increase in income based upon their receipt of corporate cash distributions; (4) whether petitioners Terry D. and Gloria K. Owens are entitled to deductions for losses and interest associated with certain entities structured as subchapter S corporations, 5 deductions for interest associated with a "mortgage funding" program, and deductions for investment expenses; (5) for any interest deductions from issues (2) and (4) to which petitioners are entitled, whether deductibility is limited 1991 Tax Ct. Memo LEXIS 661">666 by the investment interest provisions of section 163(d); (6) whether petitioners are liable for additions to tax for negligence under section 6653(a); (7) whether petitioners John R. and Maydee L. Thompson for 1981 are liable for an addition to tax under section 6651(a)(1) for failure to file a timely return; (8) whether petitioners Hoyt W. and Barbara D. Young for 1982, and petitioners Robert L. and Carolyn S. DuFresne for 1982 and 1983, are liable for additions to tax under section 6661(a) because of substantial understatements of income tax; and (9) whether petitioners Thompson for 1981, petitioners Young for 1982 and 1983, and petitioners DuFresne for 1982 and 1983 are liable for the increased interest rate provided in section 6621(c). We previously resolved other matters relating to these cases, concerning the issuance and execution of a search warrant, in Dixon v. Commissioner, 90 T.C. 237">90 T.C. 237 (1988). FINDINGS OF FACT I. Promoter BackgroundHenry Kersting (Kersting) created and administered the investment programs at issue in these cases, and also managed most of the participating corporations. Born in Germany in 1923, Kersting emigrated to Canada in 1951. Before leaving Germany, he graduated from high school, served in the military, spent several semesters pursuing but not attaining a college medical degree, and in 1949 married. In 1952 or 1953, while employed as an aircraft mechanic in Toronto, he started a mail order business that he managed until moving his family to Los Angeles, California, in 1959. While there he invested1991 Tax Ct. Memo LEXIS 661">668 in Eastern Lenders Services, which originated Federally approved mortgages. Among the subjects he learned about from this investment were originating, warehousing, and selling mortgages, and negotiating lines of credit. In about 1964, he separated from Eastern Lenders Services and invested in a savings and loan association in Ukiah, California. He moved to Hawaii in 1968 and has lived there ever since. One of the first entities that Kersting incorporated while living in Hawaii was First Atlas Funding Corporation in 1968, which engaged in what Kersting termed a "mortgage funding" business. A participating investor borrowed approximately 10 times his monthly home mortgage payment from a corporation with which Kersting was associated and invested this amount to start the program. Thereafter, the investor had both an investment account and a loan account with Kersting. For the investment account, the investor typically supplied funds in a constant monthly amount, and First Atlas Funding 6 reported investment results. From the loan account, the investor borrowed monthly amounts, approximately equal to his monthly investments, in order to make payments on his home mortgage. To1991 Tax Ct. Memo LEXIS 661">669 the extent that the balance in the investment account exceeded the balance in the loan account, periodic printed statements informed the investor that the overall account had a "net value." These statements also compared the investment earnings to the interest expenses for "net results." First Atlas Funding ceased operations in the mid-1970s. The State of Hawaii considered it involuntarily dissolved in 1977 for failure to make required annual filings with the State. In 1972 or 1973, Kersting organized his first of many automobile-leasing entities structured as subchapter S corporations. Prior to organizing this corporation, he had no direct experience in the leasing business, having only read about it. Over the next few years, this corporation leased 8 to 10 automobiles. 7 Kersting's involvement with subchapter S leasing corporations was considered1991 Tax Ct. Memo LEXIS 661">670 by this Court in some detail in Pike v. Commissioner, 78 T.C. 822">78 T.C. 822 (1982), affd. without published opinion 732 F.2d 164">732 F.2d 164 (9th Cir. 1984). Kersting has had no formal education or specialized training in either business or law. He and his wife, Ute Charlotte Kersting (Ute Kersting), have four children, including two daughters whose married names are Gabriele LeMond and Heidi Moseley. II. Kersting CorporationsA. GenerallyReferences herein to "Kersting corporations" are to corporations that participated in the investment programs Kersting oversaw during the years at issue. 8 He served as both a director and president of most of these corporations and also sometimes owned stock. For those corporations in which he served as president during the years at issue, 1991 Tax Ct. Memo LEXIS 661">671 he had exclusive management authority. His administrative assistant and secretary throughout these years was Sherrill Pang (Ms. Pang), who knew nearly as much as he did about the workings of his investment programs. Ms. Pang, who was heavily involved in the day-to-day clerical tasks associated with those programs, worked under Kersting's managerial control. For most of the Kersting corporations, Ute Kersting was an incorporator, an officer, a director, or some combination. She did not, however, play any meaningful active role in management or operations. Heidi Kersting had a similar status and eventually asked her father to stop using her name on corporate documents. Gabriele Kersting did some work related to the investment programs, at least to the extent of corresponding with investors on occasion. 1991 Tax Ct. Memo LEXIS 661">672 Most of the Kersting corporations most of the time had Hawaii offices located together, with one benefit being minimized expenses. These offices contained the normal trappings of a business office, including desks, telephones, and personnel. A given clerical worker generally performed duties for any of several corporations depending upon where the need was at the time. The Kersting corporations did not each maintain a separate file for a given investment transaction, but instead shared a file that was referenced by the name of the investor and one of the corporations involved in the transaction. Throughout the years at issue, at least some of the Kersting corporations solicited proxies from shareholders and, in combination rather than separately, held shareholders meetings that Kersting attended. Kersting generally held a sufficient number of proxies from shareholders to take the actions he desired regardless of how the attending shareholders voted. Although Kersting announced and attended shareholders meetings after 1981, he never prepared corporate minutes of these later-year meetings. The Kersting corporations did not prepare annual reports during the years at issue, and1991 Tax Ct. Memo LEXIS 661">673 there was no active market for their stock. Kersting did not participate in any public offerings of stock during this time. B. Holding Companies and Subsidiaries1. Charter Financial CorporationKersting organized Kershwin, Ltd., in the 1950s while living in Toronto. The shareholders during the years at issue were his four children and a trust for their benefit. In the early 1970s, Kershwin, Ltd., acquired most of the stock of Confidential Finance Company, Ltd., which had been incorporated in Hawaii in 1959. Confidential Finance had been an industrial loan company that dealt primarily with local people in Hawaii, and, with Kersting now the president, activity relating to outstanding loans continued. Kersting was initially both a director and the president of Colt Financial Corporation, which was incorporated in Hawaii in 1975 with Confidential Finance subscribing for the initial shares. Ms. Pang was also an initial director and officer. After a transaction involving exchanges of stock, Kershwin, Ltd., became the direct owner of about 80 percent of the Colt Financial stock, an interest that was first diluted over the years by the addition of new shareholders and1991 Tax Ct. Memo LEXIS 661">674 then eventually sold. Also as a result of the exchange transaction, Confidential Finance became a subsidiary of Colt Financial, which in 1976 changed its name to Charter Financial Corporation. Kersting acquired the outstanding stock and became a director of Carey Trading Inc., a Nevada corporation that changed its name in 1980 to Charter Financial Corporation. This new Charter Financial Corporation took over the activities of its Hawaii namesake, and, without corporate formalities or the issuance of new stock, Kersting began to treat the shareholders of the Charter Financial incorporated in Hawaii as shareholders of the Charter Financial incorporated in Nevada. 9 He was a director and the president of Charter Financial (Nevada) through the last year at issue. During this period, Ute Kersting was a director and both she and Ms. Pang were officers. 1991 Tax Ct. Memo LEXIS 661">675 Confidential Finance changed its name to Federated Finance Co., Ltd., in 1976, at which time Kersting was the president and Ute Kersting held the office of secretary. The State of Hawaii granted the renamed corporation an industrial loan business license in July of that year. In May of 1978, Federated Finance Co. Inc. was incorporated in Nevada. Kersting was an incorporator, an initial director, and through the last year at issue the president of Federated Finance (Nevada). Ms. Pang and Heidi Kersting were the other incorporators and initial directors, and Ms. Pang and Ute Kersting were the other officers during this time. At least most of the lending activity of Federated Finance (Nevada) consisted of loans to airline pilots to facilitate their purchases of stock. Federated Finance (Hawaii) at some point voluntarily surrendered its industrial loan business license, which the State of Hawaii then canceled in late 1981. Sometime before this, with the exception of outstanding loans owed to and retained by Federated Finance (Hawaii), the principal activities of that corporation, including the making of loans for stock purchases, shifted to Federated Finance (Nevada). Although1991 Tax Ct. Memo LEXIS 661">676 Federated Finance (Hawaii) never formally liquidated, the State of Hawaii considered the corporation involuntarily dissolved in December of 1983 for failure to make required filings with the State. In about 1975, the president of Cosmopolitan Financial Corporation, a widely held Hawaii corporation engaged primarily in factoring accounts receivable, discussed with Kersting the possibility of selling the corporation. Confidential Finance soon acquired most of the Cosmopolitan Financial stock through a tender offer, and in 1976 Cosmopolitan Financial changed its name to Federal Finance & Mortgage Ltd. Federal Finance & Mortgage sometimes made loans to pilots, but it was mainly a licensed industrial loan company involved in factoring accounts receivable. It was not a regular participant in the Kersting investment programs that are the subject of the instant cases. Kersting was an officer and director of Federal Finance & Mortgage for several years, and exercised management control, but he left these positions near the end of or after the years at issue. Federated Finance (Hawaii) was wholly owned by Charter Financial during the years at issue, and Charter Financial conducted no 1991 Tax Ct. Memo LEXIS 661">677 significant business other than as a holding company. Federated Finance (Nevada) was wholly owned by either Charter Financial or Federated Finance (Hawaii) during this time. At least from 1978 through 1981, Federated Finance (Hawaii) and Charter Financial owned 75 percent or more of the Federal Finance & Mortgage stock. At the end of 1983, a wholly owned subsidiary of Charter Financial named Quintana Investments, Inc., owned 89 percent of the Federal Finance & Mortgage common stock. Although most of the eventual Charter Financial shareholders were airline pilots, not all were. Kersting himself, for example, was a shareholder. Even the nonpilots, however, generally acquired their shares the same way the pilots did, as part of a Kersting investment program. An exception was Denis Alexander (Alexander), a broker and investor who knew that Charter Financial was a holding company. Throughout the years at issue, he held over 100,000 shares indirectly acquired in the mid-1970s. He had lent over $ 100,000 to assist in the acquisition of Cosmopolitan Financial, and this creditor's interest evolved into his stock interest in Charter Financial. As of December 30, 1988, Charter Financial, 1991 Tax Ct. Memo LEXIS 661">678 as common parent of an affiliated group, had filed consolidated Federal income tax returns for calendar years 1976, 1978, and 1979, but had filed no returns for 1977 or 1980 through 1983. 2. Investors Financial CorporationKersting and Alexander first met in Los Angeles in the early 1960s. Alexander, who moved to Hawaii in 1964, lent $ 80,000 to Kersting's subchapter S leasing corporations during the 1970s, which he understood would be used to purchase automobiles. The two met in about 1977 to discuss the possible acquisition of First Savings and Loan Association (First Savings) in Honolulu, Hawaii, a State-chartered and Federally insured institution. Alexander was a minority shareholder of First Savings and acquainted with the majority shareholder. Kersting and Alexander eventually arranged for the acquisition of most of the stock of First Savings, with 40-some Kersting clients (including petitioner John R. Thompson) becoming shareholders. Alexander, who expected First Savings to profit from its real estate loans, joined the acquiring group and thus added to his First Savings stockholdings. The total cost to the acquiring group was approximately $ 2.8 million, with about1991 Tax Ct. Memo LEXIS 661">679 $ 1 million of that amount paid in cash. The remaining $ 1.8 million was borrowed from First Hawaiian Bank, which required a pledge of the First Savings stock as security. Charter Financial was a guarantor on this loan, and Kersting corporations rather than the individual investors paid at least some of the interest. Kersting was an incorporator, an initial director, and the initial president of Investors Financial Corporation, which was incorporated in Nevada in April of 1978, the month after the acquisition of First Savings. Ms. Pang and Heidi Kersting were the other incorporators and initial directors. Kersting arranged for the members of the First Savings acquiring group to relinquish their stock in First Savings and become shareholders of Investors Financial, which was to be a holding company for First Savings. Investors Financial later began to sell its stock to other people than those in the First Savings acquiring group, including some of petitioners, thereby diluting the interests of the acquiring group. In 1980 Investors Financial had over 200 shareholders. Although Investors Financial applied to Federal banking authorities to be approved as a holding company for1991 Tax Ct. Memo LEXIS 661">680 First Savings, those authorities never approved the application. Michael Provan was the president of Investors Financial from 1978 to 1982. Alexander was an officer, a director, or both into 1980. For at least some parts of 1978 and 1979, Kersting was neither an officer nor a director. Beginning in 1980, he served as secretary/treasurer. He became the president in 1982 and continued at least through 1983, during which time the other officers included Ms. Pang and Ute Kersting. Sometime prior to February of 1980, during a period of sharply rising interest rates, Federal banking authorities determined that First Savings should be merged with another institution. The banking authorities forced a merger with First Federal Savings of Honolulu in February of 1980, which terminated the stock interest of Investors Financial in First Savings. Although the initial arrangement was for First Federal Savings to assume the liabilities of First Savings and to purchase the assets at a price somewhat above the audited net worth, First Federal Savings ultimately paid nothing to First Savings. Shortly after the forced merger, Federal banking authorities and First Hawaiian Bank commenced a lawsuit1991 Tax Ct. Memo LEXIS 661">681 against Mortgage Guarantee Insurance Corp. based upon a First Savings director-and-officer policy. Most members of the First Savings acquiring group assigned their interests in the litigation to First Hawaiian Bank, which agreed to release them from their obligations on the First Savings stock acquisition indebtedness. The parties eventually settled. Much of the over $ 3-million recovery went to First Hawaiian Bank and attorneys, but none of it went to the First Savings acquiring group or Investors Financial. Almost all members of the First Savings acquiring group eventually recouped their original cash investments from Kersting, who used Charter Financial funds. At the time of the forced merger, the only significant asset of Investors Financial was its stock interest in First Savings. Investors Financial has not acquired any additional significant assets since then. As of December 30, 1988, Investors Financial had filed Federal income tax returns for its taxable years ending in 1978 and 1980, 10 but for no years since. 1991 Tax Ct. Memo LEXIS 661">682 C. Acceptance CorporationsThe word "Acceptance" in the name of a Kersting corporation indicated that it was not licensed by the State of Hawaii, which did require licenses for certain types of lending institutions such as commercial banks and savings and loan institutions. Kersting acceptance corporations did not actively solicit business from the general public, but instead engaged in lending activity directed primarily at airline pilots. For each of the following entities, incorporated in Nevada in the year parenthetically indicated, Kersting was an incorporator, an initial director, and throughout the years of corporate existence that coincide with the years at issue the president of the corporation: Forbes Acceptance Corporation (1976), Fargo Acceptance Corporation (1977), Candace Acceptance Corporation (1978), Mahalo Acceptance Corporation (1978), Windsor Acceptance Corporation (1978), Delta Acceptance Corporation (1979), Avalon Acceptance Corporation (1980), and Lombard Acceptance Corporation (1982). The Fargo Acceptance incorporators signed the Certificate of Incorporation on March 11, 1977, and filed it with the State of Nevada on March 17, 1977. The other two 1991 Tax Ct. Memo LEXIS 661">683 incorporators and initial directors of these acceptance corporations were, with one exception, Ms. Pang and either Ute or Heidi Kersting. The exception was Larry Rinaldis, who, along with Kersting and Ms. Pang, was an incorporator and initial director of Forbes Acceptance. Rinaldis structured leases for Kersting's subchapter S leasing corporations. The other officers of these acceptance corporations throughout the years at issue were, with two exceptions, Ms. Pang and Ute Kersting. Rinaldis was an officer of Forbes Acceptance until Ute Kersting replaced him in 1977. Gabriele Kersting was an officer of Fargo Acceptance until Ute Kersting replaced her in 1977 or 1978. Kersting was also a director and the president of Aztec Acceptance Corporation, which was incorporated in Nevada in the late 1970s or early 1980s. Prior to the Nevada incorporation of Windsor Acceptance Corporation in 1978, Windsor Acceptance Corporation Ltd. had been incorporated in Hawaii in 1974 with Kersting's mother-in-law as the initial shareholder. The initial officers and directors had been Kersting and his two daughters. Without consideration of or adherence to legal formalities, Kersting considered the1991 Tax Ct. Memo LEXIS 661">684 corporation shifted from Hawaii to Nevada in 1978. Norwick Acceptance Corporation was incorporated in Nevada under another name, Mendocino Financial Corporation, in 1966. Kersting was an incorporator, an initial director, and the initial president of Mendocino Financial. The name change to Norwick Acceptance Corporation was filed with the State of Nevada in 1979, but an entity calling itself Norwick Acceptance engaged in transactions well before that time in connection with Kersting's subchapter S leasing corporations. 11 Kersting was the president of Mendocino Financial/Norwick Acceptance during all of the years at issue. Ute Kersting was also an officer throughout this period, as was Ms. Pang beginning in 1976. Except for Windsor Acceptance and Norwick Acceptance, the shareholders of each of the acceptance corporations were predominantly or entirely airline1991 Tax Ct. Memo LEXIS 661">685 pilots. Although Kersting required a pilot who became a shareholder to execute what was in form a subscription agreement for the purchase of additional stock, the acceptance corporation never issued the additional stock to the shareholder or otherwise sought to consummate the stock purchase transaction called for by the agreement. Sometime after 1981, Kersting authored a form letter 12 to investors that began as follows: If you have been with us over the years you will have noticed that we have organized by now eight Acceptance Companies. We will list below in which of these companies you became an investor and shareholder. All of these companies were structured to make a profit after a reasonable start-up period. This, in turn, assured the profit motive which the IRS expects of you when you engage in investments and the prospects of taxable income or gains. All of your companies are operating and money making entities today. The stock which you initially purchased has increased in value intrinsically which, I trust, will some day be reflected in a market price in excess of your acquisition cost. As it would be impractical to take each of the Acceptance Companies public1991 Tax Ct. Memo LEXIS 661">686 separately we decided years ago to combine all of the companies in a Financial Holding Company * * Kersting then discussed the mechanics of exchanging acceptance corporation stock for the stock of the proposed holding company, Escon Financial Corporation. As of December 30, 1988, Federal income tax returns had not been filed by Avalon Acceptance, Forbes Acceptance, and Lombard Acceptance for any taxable year that overlaps the years at issue. Four other acceptance corporations had filed the following returns on September 25, 1985, for taxable years ending as indicated, but no other returns that overlap the years at issue: Fargo Acceptance for 1977 and 1978, Mahalo Acceptance for 1978 and 1979, Candace Acceptance for 1979 and 1980, and Delta Acceptance for 1980 and 1981. Kersting signed each of these eight returns on September 10, 1985. Although Fargo Acceptance reported a tax liability1991 Tax Ct. Memo LEXIS 661">687 of over $ 30,000 on its initial return for a short taxable year ending in 1977, it has made no payments on this liability. D. Leasing CorporationsKersting was the initial president and an initial director of Aztec Leasing Inc., which filed articles of association with the State of Hawaii on October 1, 1974, and Maurier Leasing Inc., which made a similar filing on December 2, 1974. The other initial officers and directors of these two corporations were Gabriele Kersting and Heidi Kersting. All or almost all of the leasing activities of these corporations were with their respective shareholders. Aztec Leasing filed a U.S. Small Business Corporation Income Tax Return (Form 1120S) for calendar year 1975 that indicated December 1, 1974, as its date of election as a small business corporation. Maurier Leasing also filed a Form 1120S for calendar year 1975, which indicated March 15, 1975, as its date of election. Aztec Leasing and Maurier Leasing were abandoned as corporate entities in part due to Internal Revenue Service (IRS) audit challenges and in part due to the cumbersome administrative tasks attributable to the large number of Kersting's subchapter S corporations. The1991 Tax Ct. Memo LEXIS 661">688 first Kersting leasing corporation for which subchapter S status was not sought was Universal Leasing Corporation, incorporated in Nevada in 1976. 13 Kersting, who intended Universal Leasing to replace the several subchapter S leasing corporations, had the leases transferred from the subchapter S corporations to Universal Leasing. Anseth Leasing, Inc., and Escon Leasing Corporation were incorporated in Nevada in 1977. 14 The Escon Leasing incorporators signed the Certificate of Incorporation on February 4, 1977, and filed it with the State of Nevada on February 11, 1977. Kersting was an incorporator, an initial director, and through the last year at issue the president1991 Tax Ct. Memo LEXIS 661">689 of Universal Leasing, Anseth Leasing, and Escon Leasing. For Anseth Leasing and Escon Leasing, the other two incorporators and initial directors were Ms. Pang and Heidi Kersting, and the other officers throughout these years were Ms. Pang and Ute Kersting. Ms. Pang was also an incorporator, an initial director, and an officer of Universal Leasing. All three leasing corporations engaged in the business of automobile leasing, primarily to pilots, and Universal Leasing also leased other items such as boats and aircraft. They did not advertise, employ salespersons, or otherwise actively solicit a substantial amount of business from the general public. From its inception, however, Universal Leasing leased some automobiles to businesses, as did Anseth Leasing and Escon Leasing in 1980 and following years. Kersting's duties included structuring leases, negotiating purchases and trade-ins of automobiles, monitoring leasing revenue, and ensuring that the residual values of the automobiles would be realized. The leasing corporations, which annually filed corporate exhibits with the State of Nevada listing officers and directors, registered to do business in Hawaii as foreign corporations1991 Tax Ct. Memo LEXIS 661">690 in October of 1982. They repossessed automobiles occasionally and had dealings with General Motors Acceptance Corp. (GMAC). For 1977 and following years, Hawaii registration and ownership certificates that show Escon Leasing as the registered owner of automobiles also often show Federal Finance & Mortgage or GMAC as the "legal owner or lien holder." During this period, Hawaii registration certificates that show Universal Leasing as the registered owner show as the "legal owner or lien holder," among others, Universal Leasing itself, Federal Finance & Mortgage, and Federated Finance (Hawaii). Although Kersting's family-owned corporation, Kershwin, Ltd., initially subscribed for Universal Leasing stock, new shareholders, who were airline pilots, gradually replaced it. The shareholders of Anseth Leasing and Escon Leasing were also, for the most part, pilots, although beginning in 1978 or 1979 Universal Leasing held a $ 5,000 stock interest in Anseth Leasing. Universal Leasing also had a $ 240,000 investment in Mahalo Acceptance and a $ 120,000 investment in Investors Financial that began at this time. On September 25, 1985, Anseth Leasing filed Federal income tax returns for its1991 Tax Ct. Memo LEXIS 661">691 taxable years ending in 1977 through 1979 and 1981 through 1984. On the same date, Escon Leasing filed returns for its taxable years ending in 1977 through 1984. Kersting had signed all of these returns for the two leasing corporations on September 10, 1985. Although Universal Leasing filed a return in each of 1979 and 1981 for taxable years ending in 1977 and 1978, respectively, it did not file returns for its taxable years ending in 1979 and following until 1985 or later. E. Other Kersting CorporationsAtlas Funding Corporation, which made loans primarily to pilots, was incorporated in Nevada in 1976. Kersting was an incorporator, an initial director, and the president through the last year at issue. Ms. Pang was also an incorporator and initial director. From July of 1977, Ms. Pang and Ute Kersting were the only other officers. Kershwin, Ltd., was the initial stock subscriber and remained the sole shareholder. As of December 30, 1988, Atlas Funding had not filed a Federal income tax return for any taxable year other than that ending in 1976. Atlas Guarantee Corporation issued interest-bearing investment certificates as part of the Kersting investment program called1991 Tax Ct. Memo LEXIS 661">692 "CAT-FIT," described in part III (E), below. Kersting and Ute Kersting owned all of the stock. Ventures Funding Corporation, which became inactive before the mid-1980s, was incorporated in Nevada in 1978 and made loans for the purchase of stock in other Kersting corporations. Kersting was an incorporator, an initial director, and throughout its active existence the president of the corporation. The other incorporators and initial directors were Ms. Pang and Ute Kersting, both of whom were also officers from 1981 through 1983. No one outside of the immediate family of pilot Leon Lipsky, who was a corporate officer from 1978 to 1981, ever owned stock in Ventures Funding. As of January 6, 1989, Ventures Funding had not filed a Federal income tax return for any year. F. Books and Records; Tax Return PreparationAlice Combs was a bookkeeper, but not a certified public accountant, from 1942 until her retirement in 1983. She met Kersting through her employer shortly before becoming self-employed in 1971, and she eventually began to keep the books for some Kersting corporations. She and her daughter, Margo Akamine, were both self-employed as bookkeepers in the same office space1991 Tax Ct. Memo LEXIS 661">693 in the mid-1970s when Ms. Akamine began to assist her mother with Kersting's subchapter S corporations. The women incorporated a bookkeeping business in 1980, and when Ms. Combs retired in 1983, Ms. Akamine continued to perform bookkeeping duties for Kersting corporations. Ms. Combs and Ms. Akamine did not keep the books for all of the Kersting corporations. Ms. Akamine did no such work, for example, for Ventures Funding or Windsor Acceptance, and neither woman did such work for Norwick Acceptance or Atlas Funding. Federal Finance & Mortgage used its own in-house accountant and hired outside certified public accountants to prepare audited financial statements. The women generated manual journals and ledgers in a double-entry bookkeeping system, primarily from bank statements and canceled checks. Among the records they maintained were accounts receivable and related subsidiary accounts for the leasing and acceptance corporations, which accounts corresponded to a list of promissory notes supplied by the Kersting offices. The subsidiary accounts were eventually computerized. Ms. Combs did not keep a stock record book per se, but she attempted to keep records of Kersting's investors1991 Tax Ct. Memo LEXIS 661">694 by means of general ledger accounts such as accounts receivable, notes receivable, and capital stock. She was not aware of direct transfers of stock from shareholders to other individuals. At some point she suggested to Ms. Pang that better stock records should be kept. The women prepared financial statements (balance sheets and profit-and-loss statements) at Kersting's request and not on a regular monthly or quarterly basis. He usually requested financial statements, which were always done by hand rather than on a computer, at least once a year. The women also prepared Federal income tax returns for Kersting corporations, again when instructed by Kersting, and by 1976 Ms. Combs was experienced in preparing consolidated returns. They did not always prepare tax returns annually, and Ms. Akamine was never certain whether the returns she prepared were actually filed with the IRS. 151991 Tax Ct. Memo LEXIS 661">695 However, as far as Ms. Combs knew, Kersting and his associates did not alter the tax returns or bookkeeping work she submitted. For those acceptance and leasing corporations with outstanding subscription agreements applicable to their stock, Kersting often instructed Ms. Akamine to treat the interest received under those agreements as deferred and thus to exclude it from current taxable income. Among the returns that show a Schedule M adjustment reducing book income for deferred subscription interest are the following, for taxable years ending as indicated: Fargo Acceptance for 1978, Mahalo Acceptance for 1978 and 1979, Candace Acceptance for 1979 and 1980, Delta Acceptance for 1980 and 1981, Avalon Acceptance for 1981 and 1982, Anseth Leasing for 1977 through 1979 and 1981 through 1984, and Escon Leasing for 1977 through 1984. For at least most of these corporations, the deferred amounts were not reported as taxable income in following years. Based upon her experience with a public accounting firm, Ms. Combs believed that a 2-percent bad debt reserve, measured against outstanding receivables, was appropriate for the Kersting corporations. Ms. Akamine had been taught in a bookkeeping1991 Tax Ct. Memo LEXIS 661">696 class that 1 or 2 percent was an appropriate bad debt reserve figure, although she had no training relating specifically to reserves in the tax shelter area. Kersting told the women that 20 to 25 percent, or higher, was not inappropriate for the corporations. He directed them generally to set up reserves that would offset taxable income not otherwise offset by items such as net operating loss carryforwards. For corporations with taxable years ending as indicated, yearend bad debt reserves as a percentage of accounts receivable were as follows: Fargo Acceptance197830%Mahalo Acceptance1978, 197925%Candace Acceptance1979, 198025%Delta Acceptance1980, 198120%Universal Leasing197722%197829%197940%198145%198251%198367%198472%198592%Ms. Combs and Ms. Akamine kept the Kersting records in their office, which was at a different location than the Kersting offices. As detailed in Dixon v. Commissioner, 90 T.C. 237">90 T.C. 237 (1988), Kersting was under criminal investigation when the IRS executed a search warrant at his offices on January 22, 1981, and seized voluminous records. The IRS did not, however, take any Kersting records from1991 Tax Ct. Memo LEXIS 661">697 the bookkeepers. Their work was therefore largely unaffected, except occasionally when the Kersting offices informed one of them that the documents she was requesting had been taken by the IRS. Neither woman ever thought that anything she requested from the Kersting offices was intentionally withheld. Kersting sent a form letter to clients dated February 15, 1981, in which he began: Here at last are the tax reporting notices which we would have mailed to you in January had it not been for the IRS raid at our offices. I regret very much the delay by which these notices will be received by you. The IRS accomplished only a temporary disruption of our operations. We are back today to almost normal workings, but the shock and distaste will last for a while.In a May 30, 1981, form letter devoted largely to this IRS "raid," Kersting wrote: Over the weeks which have elapsed since the Raid, all of the Promissory Notes which are our most valuable asset have been returned to us. We have made copies of all of our records which we need to keep track of our accounts receivable and -payable. It has allowed us to return to normalcy of operations. * * The IRS returned1991 Tax Ct. Memo LEXIS 661">698 the bulk of the seized Kersting records beginning in late 1985 or early 1986. Ms. Akamine prepared only one return for a Kersting corporation in which she reported significant net taxable income. This was the Fargo Acceptance initial return for the short taxable year from March 17, 1977, through June 30, 1977, with reported interest income of $ 91,200 and no deductions. On the Schedule L balance sheet, she recorded $ 91,200 as an investment in Charter Financial and as unappropriated retained earnings, but she recorded no capital stock amount. No other acceptance corporation reported significant net taxable income in returns corresponding to the years at issue. Unlike the initial return of Fargo Acceptance, other initial returns of acceptance corporations included a bad debt reserve, a Schedule M adjustment for deferred subscription interest, or both. Ms. Akamine generally did not sign the returns she prepared for Kersting because she was not comfortable with some of the things he asked the women to do. In anticipation of selling her bookkeeping business, she prepared many returns for Kersting corporations during 1984. She sold her business in 1985 in part because Kersting 1991 Tax Ct. Memo LEXIS 661">699 was considering some transactions that she did not feel comfortable recording. One such transaction was a consolidation of several corporations. Kersting was prompted to consider these transactions because the bad debt reserves intended to offset income were so high compared to outstanding accounts receivable. By letter dated December 2, 1981, and addressed to an IRS revenue agent who had sought certain corporate tax returns, Kersting wrote: We have held back over the years the Tax Returns for the Acceptance Companies and some of the Leasing Companies as we expect that the decision Judge Drennen of the United States Tax Court is to render will have a material effect on all of these companies. You will recall that Norwick Acceptance Company was at issue in the US Tax Court proceedings and to some extent Universal Leasing Corporation.G. Collection LitigationFor lending and leasing matters originating during the years at issue but not relating directly to the Kersting investment programs, Kersting corporations sometimes sought relief in Hawaii State court. Delta Acceptance filed a complaint on March 16, 1983, based upon an $ 8,000 promissory note with a 1982 date, 1991 Tax Ct. Memo LEXIS 661">700 and obtained a default judgment in November 1983. Fargo Acceptance filed a complaint on May 12, 1986, based upon a $ 7,560 promissory note with a 1982 date. The court dismissed this case in January 1987 for lack of valid service on the defendant. Universal Leasing filed a complaint on May 20, 1982, based upon alleged unpaid lease obligations, and the court granted its motion for summary judgment in September 1984. Escon Leasing filed a complaint on June 23, 1983, based upon alleged unpaid lease obligations, and obtained a default judgment in December 1983. Anseth Leasing filed complaints on July 6, 1983, and June 4, 1986, also based upon alleged unpaid lease amounts. The court dismissed the first case for want of prosecution in May 1984, and the second resulted in default judgments against the defendants in November 1986. Atlas Funding filed a complaint on June 6, 1983, based upon a $ 13,440 promissory note with a 1980 date in favor of Delta Acceptance. The court entered judgment for Atlas Funding after a hearing in October 1983. As an assignee of Charter Financial, Atlas Funding filed a complaint on March 8, 1984, based upon a $ 22,000 promissory note with a 1981 date in 1991 Tax Ct. Memo LEXIS 661">701 favor of Charter Financial. Atlas Funding alleged that this amount had been lent to Larry Rinaldis to cover a margin call on a brokerage account. III. Kersting Investment ProgramsA. GenerallyMost of Kersting's investors, or clients, first heard about him and his investment programs by word-of-mouth from those already involved. He sometimes asked satisfied clients to introduce him to friends who might need tax assistance. He also paid a few "contact men," such as pilots Michael Provan and Robert Campbell at Continental Airlines, Inc. (Continental), to tell other pilots about the basic structure of the transactions and to encourage them to call or visit Kersting. Sometimes an accountant, such as Robert Knapp of Memphis, Tennessee, recommended to clients that they contact Kersting about his programs. Kersting was particularly interested in pilots, largely because of their high incomes. Kersting never registered with the Securities and Exchange Commission, the State of Hawaii, or the State of Nevada any of the stock sold through his investment programs. He met with a Securities and Exchange Commission attorney in California in the mid-1970s and also spoke on occasion1991 Tax Ct. Memo LEXIS 661">702 with the Hawaii Corporations Commissioner, discussing registration requirements with both men. He never took the procedural steps necessary, however, to determine formally whether registration was required under either Federal or State law. Kersting treated the stock as subject to a private offering exemption and never prepared any prospectuses. In a letter dated November 12, 1980, he described factors he considered important to exempt status: As we discussed we are walking on a very fine line separating us from offering securities publicly. We have claimed an exemption from registration over the years on the grounds that we are meeting the tests for offering securites [sic] without registration, i.e. that we are dealing with sophisticated investors, that everyone of our clients has a net worth in excess of $ 75,000.00 and that we do NOT SELL ANYTHING AND DO NOT ASK FOR ANY INVESTMENT, supported by the fact that we do not engage brokers or salespeople to whom sales commissions would be paid. If we were to advertise our services or offer our services by direct mail we would place the above mentioned premise in jeopardy. It is important that we observe that.Kersting also1991 Tax Ct. Memo LEXIS 661">703 operated on the premise that registration was not required for shares of a given corporation if those shares were offered to existing shareholders of that corporation. Thus, he sometimes had an acceptance corporation distribute to a shareholder a small amount of stock of a second acceptance corporation, commonly 100 shares, thereby making the investor a shareholder of the second corporation and setting the stage for an "exempt" offering of much more stock of the second corporation during the upcoming year. The stock subscription agreements used by Kersting, discussed in more detail below in connection with the specific investment programs, included representations by the investor that he was acquiring the subscribed stock for investment purposes rather than for resale and not as a representative of someone else. An investor made no such representations, however, for stock purchases not tied to the subscription agreements. Although a potential investor sometimes met with Kersting in his Hawaii offices, the first contact for many was by telephone or letter. Prior to starting someone in one of his programs, Kersting questioned him about his general financial situation. Because 1991 Tax Ct. Memo LEXIS 661">704 of Kersting's largely homogenous client base and the relatively standardized salary scales within an airline, he often knew the prospect's approximate salary even before being told. He rarely if ever asked for an application form or financial statements, and credit checks were also rare or nonexistent. Because he was aware of the grounds for certain IRS audit challenges to his programs, he sometimes informed a prospect that he had to have a profit motive. He never mentioned, however, that there would be ongoing profits in the form of normal corporate dividends. He always discussed anticipated tax benefits and often sent a pilot the documents associated with an investment program so he could examine them before deciding whether to participate. Although Kersting sometimes jotted down some notes while talking to a prospect, he discarded them by the time participation in his programs commenced. For those who agreed to participate in one or more of his programs, Kersting often recommended specific accountants the investors should consider using to prepare their tax returns. These included Gilbert Matsumoto, Earl LeMond, and enrolled agent Philip Scheff. Matsumoto, who had been the1991 Tax Ct. Memo LEXIS 661">705 accountant for Confidential Finance when Kersting became its president in the early 1970s, had later become the accountant for some of Kersting's subchapter S leasing corporations. The four main types of Kersting investment programs under consideration in these cases will be referred to as a Stock Purchase Plan, a Stock Subscription Plan, a Leasing Corporation Plan, and a CAT-FIT Plan. All involved both "primary" loans and notes and "leverage" loans and notes with Kersting corporations. 16 These notes, along with other investment initiating documents, sometimes bore a date that was long before the date on which the documents were actually executed and even before the date on which the investor informed Kersting he was ready to commence that investment program. 1991 Tax Ct. Memo LEXIS 661">706 A primary loan supplied the funds with which the investor purchased either stock of a Kersting corporation or, in the case of the CAT-FIT Plan, an investment certificate. A leverage loan, almost always made by an acceptance corporation, generally supplied the funds with which the investor paid interest on the primary loan and, if applicable, interest on an unpaid subscription balance. Sometimes leverage loans, in years after the investor's first year in a program, supplied the funds to pay off an outstanding leverage loan. In correspondence with investors and in summary schedules he prepared for their benefit, Kersting often referred to the amount payable as interest on a leverage loan as a "fee" or as a deductible "cost" of interest deductions. Primary notes (and leverage notes used in the Leasing Corporation Plan) were detailed, preprinted forms entitled "Note and Security Agreement" and containing appropriate blanks to be filled in. When completed and executed, these notes did not describe any collateral in the space so designated on the form, nor did they call for interest to be prepaid annually. Kersting considered the loans to be unsecured. Beginning in late 1979, the1991 Tax Ct. Memo LEXIS 661">707 designated space for a description of collateral usually contained a typed-in statement that the note was nonnegotiable and nonassignable. Leverage loans (except for those used in the Leasing Corporation Plan) were commonly documented with much shorter and simpler promissory note forms that made no mention of collateral, negotiability, or assignability. Both types of notes, primary and leverage, were in form recourse. 17The primary lender in a Kersting investment program was, except for the very early years, a different Kersting corporation than the leverage lender. In Battelstein v. Internal Revenue Service, 611 F.2d 1033">611 F.2d 1033 (5th Cir. 1980), on rehearing en banc 631 F.2d 1182">631 F.2d 1182 (5th Cir. 1980),1991 Tax Ct. Memo LEXIS 661">708 the court concluded that interest deductions were not allowable to taxpayers who had exchanged checks with their lender in the amount of the interest due. When asked by a concerned client about the implications of the analysis by the Court of Appeals, Kersting replied by letter dated January 11, 1981: There seems to be a fundamental distinction between the moves attributed to the Battlesteins and the leveraged interest deductions which we engender. Namely, where the Battlesteins used "the lenders cash" [sic] in making their interest payments we have always employed an arms-length-lender to create the second layer of debt and to engender the cash to make interest payments. We have studied several Tax Court decisions of related connotation before arriving at the strategy which we follow today. In the early phases of our enterprises we retained a Tax Consultant here in Honolulu, Clyde Lee, who had been a Conferee at the Internal Revenue Service in Honolulu. He pointed out to us at that time the perils which one evokes if "the lenders cash" is being used to make interest payments on the primary loan granted by the same lender. We have purposely and by design circumnavigated over1991 Tax Ct. Memo LEXIS 661">709 the years the obstacles which the Battlesteins apparently encountered.To enable Kersting better to control the flow of funds through his investment programs, Kersting corporations issued loan proceeds checks and annual distribution checks that were either unsigned by the drawer corporation or payable jointly to the investor and a Kersting corporation, 18 or both unsigned and payable jointly. A letter preceded or accompanied the first annual cash distribution made by a Kersting corporation, stating that the amount being distributed was not taxable to the shareholder. Subsequent distributions were also represented to be nontaxable. Often the letter characterized the distribution as a nontaxable "return of capital." The stated rationale for the tax-free status varied, sometimes emphasizing a lack of either corporate earnings or an earned surplus account, and other times emphasizing that the corporation charged1991 Tax Ct. Memo LEXIS 661">710 the distribution on the corporate books to paid-in capital rather than to earnings. 19Regardless of how a letter described a distribution, Kersting considered the distribution to be a partial return of the shareholder's investment. He believed that nontaxable treatment was available under applicable law, however, only if the corporation had no current or accumulated earnings and the books of the corporation reflected a charge to paid-in capital. He also believed that the trade-off for a nontaxable return-of-capital distribution was a corresponding reduction of the adjusted basis in the stock, which reduction was subject to "recapture" as a capital gain upon disposition of the stock. The acceptance corporations that sold their stock at $ 10 per share, as described in detail below, 1991 Tax Ct. Memo LEXIS 661">711 generally split contributed capital as described in this Avalon Acceptance form letter: However, so that your company will have the means to pay you later on this year a non-taxable (return of capital type) dividend we have decided to allocate 10% of your [stock acquisition] funds towards the common stock account on your company's books and 90% towards paid-in surplus. The result will be that your company can pay you this year a cash dividend which can be charged against the surplus account without any need to adjust the common stock account.Kersting did not believe, however, that a paid-in surplus balance was necessary to make a distribution nontaxable. Anseth Leasing, Escon Leasing, and Universal Leasing made distributions represented to be nontaxable even though none of the three ever had a paid-in surplus account during the years at issue. The bookkeepers recorded their distributions as debits to capital (common) stock. The capital stock account for Universal Leasing, which was reported at over $ 11 million in its initial tax return (for its taxable year ending in 1977), was smaller each succeeding year and was less than $ 4 million for its taxable year ending in1991 Tax Ct. Memo LEXIS 661">712 1984. The capital stock account for Escon Leasing, which was reported at $ 925,000 in its initial return (for its taxable year ending in 1977), was smaller each succeeding year except one. The one increase was from a negative $ 17,360 to over $ 600,000. Kersting wrote a form letter dated October 1, 1979, in which he stated: As we are going today into the last quarter of the current taxation year it seems appropriate that we remind you that only a few days will be available to you (and to us) to record your tax deductions for the year of 1979. We produced earlier this year certain documents which are to generate for you tax deductions which can be applied against your 1979 taxable income. Generally speaking, the tax deductions are to cost you 18% of the taxes retrieved or 9% of the deduction arranged. * * * Tax deductions will be of value to you only, however, if properly documented and recorded. That, in turn, has to be done well before year-end. If you have not already returned to us the documents which were mailed to you earlier this year, we urge you to attend to the matter at your earliest opportunity. On the other hand, if you do not wish to make use of the tax shelter1991 Tax Ct. Memo LEXIS 661">713 we will appreciate hearing from you to that effect.Kersting often encouraged his investors to adjust their withholding allowances with their employers. He wrote in a form letter sometime after October of 1979: So that you will gain maximum advantage from the Tax Shelter Plans in which you are involved we strongly suggest to you to file IRS Form W-4 (Employee Witholding [sic] Allowance Certificate) with your employer. * * Many of our clients have accomplished "wall to wall" protection from taxation. In that case "EXEMPT" could be entered on line 3b of Form W-4. No tax will be witheld [sic]. * * * If you find that you do not have a sufficient amount of tax deductions yet for this year please communicate with us by using attached coupon. We will be glad to make suggestions as to how you could reduce your taxes even further.B. Stock Purchase PlanA participant in the Stock Purchase Plan paid $ 40,000 or a multiple thereof for the stock of a Kersting holding company, either Charter Financial or Investors Financial. The holding company issued a stock certificate in the investor's name for the number of shares corresponding to a per-share price of $ 10.50. 1991 Tax Ct. Memo LEXIS 661">714 The stock certificate, as in all of the Kersting investment programs, was usually unnumbered. By means of a primary loan, the investor borrowed the funds from Federated Finance, at an annual interest rate of 18 percent, to acquire the stock of the holding company. The primary note was by its terms payable on demand or in 3 years if not demanded earlier. Federated Finance supplied the loan proceeds in the form of a two-party check made payable to the investor and the holding company, which, like all of the loan proceeds checks used in the investment programs, the investor was instructed to endorse and return. The investor also borrowed funds from an acceptance corporation, by means of a leverage loan with a 9-percent annual interest rate, to prepay the first year of interest on the primary loan. The leverage note was by its terms payable in 1 year. 20 The acceptance corporation, like Federated Finance, issued a two-party check for the loan proceeds, this time payable to the investor and Federated Finance. The investor had the option of paying the interest on the leverage loan in a lump sum or in six monthly installments. Leverage lenders in this and the other investment programs1991 Tax Ct. Memo LEXIS 661">715 frequently provided coupon payment books to those borrowers who preferred to make installment payments. The stock certificate, the primary note, the leverage note, and the checks representing loan proceeds all bore the same date, which was early in January or early in July. Like the initiating documents in the other investment programs, the investor generally received all of these documents together by mail, to be signed and (except for the stock certificate) returned1991 Tax Ct. Memo LEXIS 661">716 to the Kersting offices. The holding company issued a distribution check, 21 dated in December, payable to the investor in the amount of the principal balance of the leverage loan. As already noted, a preceding or accompanying letter stated that this amount was nontaxable. The letter also suggested that the investor endorse the check and return it to satisfy his obligation for the principal due on the leverage loan, which, to the best of Kersting's knowledge, invariably happened. The leverage note was then returned to the investor marked "paid." A condensed example of the Stock Purchase Plan is as follows. To make a $ 40,000 investment in the stock of a holding company, an investor borrowed $ 40,000 from Federated Finance (the primary loan) and $ 7,200 from an acceptance corporation (the leverage loan), with the stock certificate, notes, and loan proceeds1991 Tax Ct. Memo LEXIS 661">717 checks all bearing the same date. He applied the $ 7,200 to prepay the 18-percent annual interest on the primary loan and paid 9-percent annual interest on this borrowed $ 7,200, or $ 648, in either a lump sum or six installments. The holding company issued a $ 7,200 distribution check to the investor, dated in December, which he used to pay off the like principal balance of the leverage loan. By documents dated in early January or early July of the following year, the cycle was repeated. The investor used the proceeds of a new leverage loan from a different acceptance corporation, with the leverage note again providing for a 9-percent annual interest rate and a 1-year term, to prepay another year of interest on the outstanding primary loan. The leverage loan proceeds took the form of a check made payable to the investor. The holding company again issued a distribution check dated in December and payable to the investor, to enable him to satisfy his principal obligation on this new leverage loan. If the investor wished to participate beyond the 3-year term of the original primary note, he in effect renewed or refinanced the primary loan by executing a new note in favor of Federated1991 Tax Ct. Memo LEXIS 661">718 Finance for another 3-year term. Both Charter Financial and Investors Financial issued distribution checks dated December 15, 1980, for investors on a July annual cycle. C. Stock Subscription PlanIn the Stock Subscription Plan, an investor purchased stock of an acceptance corporation at $ 10 per share, 22 and the acceptance corporation issued a corresponding stock certificate in the investor's name. The investor also subscribed in writing for additional shares at $ 1 per share. The purchase amount and the subscription amount were equal, so a purchase of 6,000 shares, for example, at $ 10 per share accompanied a subscription for 60,000 additional shares at $ 1 per share. The subscription agreement began with a statement in the following form: "I hereby subscribe for and agree to purchase 23 from * * [a specific acceptance corporation, a specific number of] shares of common stock of $ 1.00 par value at a price of $ 1.00 per share." The agreement, with1991 Tax Ct. Memo LEXIS 661">719 an express term of 3 years, called for the investor to pay 12-percent annual interest on the unpaid subscription balance. The agreement also contained a provision acknowledging receipt by the acceptance corporation of a specific amount "paid on account" equal to a year of such interest. As Kersting viewed it, the subscription agreement did not give the investor the right to tender payment and thereby become entitled to the additional shares. Instead, Kersting understood the agreement to provide the acceptance corporation with the right at any time to require the investor to purchase the shares. Nonetheless, no acceptance corporation ever attempted to issue the stock or demand payment of the funds called for by a subscription agreement. As with the Stock Purchase Plan, the investor borrowed the funds necessary for the immediate stock purchase by means of a primary loan with an 18-percent annual interest rate. The primary lender was often Federated Finance, 1991 Tax Ct. Memo LEXIS 661">720 but others included Atlas Funding, Ventures Funding, and Windsor Acceptance. The primary note was by its terms payable on demand or in 2 years if not demanded earlier. The primary lender supplied the loan proceeds in the form of a two-party check made payable to the investor and the acceptance corporation. By means of a leverage loan with a 9-percent annual interest rate, 24 the investor borrowed funds from a second acceptance corporation in order to pay a year of interest on the primary loan and a year of interest on the unpaid subscription balance. The leverage note was by its terms payable in 1 year. This lending acceptance corporation issued a check for the loan proceeds made payable to the investor. The investor had the option of paying the interest on the leverage loan in a lump sum or in six monthly installments. In the early years, the investor could opt for 12 monthly payments. The stock certificate, 1991 Tax Ct. Memo LEXIS 661">721 the subscription agreement, the primary note, the leverage note, and the checks representing loan proceeds all bore the same date, which was usually early in January or early in July. At the outset, Kersting instructed those wishing to participate in the Stock Subscription Plan to open a checking account in Hawaii at a specified local bank at which Kersting corporations had accounts. This was generally Hawaii National Bank into 1979 and Liberty Bank from 1979 on. After the investor endorsed the leverage loan proceeds check and returned it with the other initiating documents, he received a form thank-you letter with instructions on how to complete the transaction. 25 In this letter, the investor was requested to send two signed checks drawn on his local account at the specified bank, along with some deposit slips for that account. One check was to be payable to the primary lender in the amount necessary to pay a year of interest on the primary loan. The other check was to be payable to the stock-issuing acceptance corporation in the amount necessary to pay a year of interest on the unpaid subscription balance. The letter also stated that a deposit (meaning the endorsed leverage1991 Tax Ct. Memo LEXIS 661">722 loan proceeds check) would be made to the investor's account to allow his two checks to clear. The investor wrote his checks on the account designated by Kersting. The stock-issuing acceptance corporation issued a distribution check, dated in December and payable to the investor, in the amount of the principal balance of the leverage loan. As noted, a preceding or accompanying letter stated that this amount was nontaxable. After the investor returned the endorsed check to the Kersting offices, the leverage note was marked "paid" and returned to the investor. An example of the Stock Subscription Plan is as follows. To purchase 6,000 shares of an acceptance corporation, an investor borrowed $ 60,000 from Federated Finance (the1991 Tax Ct. Memo LEXIS 661">723 primary loan) and signed a subscription agreement for additional shares, also in the amount of $ 60,000. With $ 18,000 borrowed from a second acceptance corporation (the leverage loan), he wrote checks for $ 10,800 to pay the 18-percent annual interest on the primary loan and $ 7,200 to pay the 12-percent annual interest on the unpaid subscription balance. The stock certificate, subscription agreement, notes, and loan proceeds checks all bore the same date. The first acceptance corporation issued a check for $ 18,000 to the investor, dated in December, which he used to pay off the like principal balance of the leverage loan from the second acceptance corporation. He paid 9-percent interest on the $ 18,000 leverage loan, or $ 1,620, in either a lump sum or six installments. Kersting offered the stock of a different acceptance corporation for each calendar year: Norwick Acceptance in 1975, Forbes Acceptance in 1976, Fargo Acceptance in 1977, Mahalo Acceptance in 1978, Candace Acceptance in 1979, Delta Acceptance in 1980, and Avalon Acceptance in 1981. He annually sent participants in the Stock Subscription Plan an order form with which they could select the desired amount of stock1991 Tax Ct. Memo LEXIS 661">724 for the next acceptance corporation. A common format was: Please arrange for me the purchase and financing of stock of * * * [a specific acceptance corporation] for a unit as indicated below:Amount ofTaxAnticipated Tax Refunds(Federal only)SharesDeduction30% Tax Bracket40% Bracket30,000$ 9,000 $ 2,700$ 3,60040,00012,0003,6004,80050,00015,0004,5006,00060,00018,0005,4007,200Sometimes the order form had an additional column labeled "Actual Cost to You," with the listed amounts of $ 810, $ 1,080, $ 1,350, and $ 1,620. There was typically no accompanying specific information about this new acceptance corporation other than that it would have the "same advantages" as the acceptance corporation in which the investor already held stock. An investor named Mil Harr returned to Kersting in January of 1977 executed initiating documents dated August 1, 1976, for a Forbes Acceptance Stock Subscription Plan. In his accompanying letter, which listed the enclosed documents, Harr asked Kersting about his investment: At this point I am sort of wondering what this is all about. I basically recognize all this as a deal where I bought1991 Tax Ct. Memo LEXIS 661">725 into Forbes Acceptance Corporation and borrowed money to do it (with resulting interest deductions on borrowed money), but where does this deal lead? Is this something you have structured for tax purposes only, or why am I desiring to be buying stock in Forbes Acceptance, other than that?In his written reply, Kersting stated: "At this time the deal has tax deduction purpose only. I can foresee, however, that the corporation will make a profit in its second year of operation." He further informed Harr that "The deal is self-liquidating as you can retire all of your debt by simple surrender of the stock certificate issued to you." Kersting wrote to another inquiring investor named Willis McComas in February of 1978: When I referred to a "closed deal" I meant to convey the impression that that deal would be available only for one year, such as Fargo Acceptance or this year Mahalo Acceptance Corp. The reason is quickly evident when you recall that Fargo Acceptance Corp. paid you a dividend in 1977 of $ 18,000.00 which was a return of capital. That can not be done the second year as the company is expected to make a profit then. Once there is an earned surplus account1991 Tax Ct. Memo LEXIS 661">726 all dividends become taxable dividends (unless the Carter Administration accomplishes to change that). It is for this reason that we have organized every year another Acceptance Corporation allowing us to pay the first dividend as a "return of capital." * * * All notes which you have executed are self-sustaining now. The cash dividends which Fargo Acceptance Corp. will pay you from now on will be sufficient to service the debt to which you are a party. As you will be receiving taxable dividends in [the] future you will also have a tax deduction in a like amount. The result will be a washout for taxation purposes.Sometime before 1977, Kersting wrote a form letter describing the Stock Subscription Plan and sent it to some of his clients, including petitioner Terry D. Owens. The letter began: In line with our policy to facilitate your involvement by arranging the financing we propose to you the following: 1. We will organize an Acceptance Corporation for the purpose of lease financing as you know it. You are invited to acquire equity in the corporation in $ 10,000.00 increments. We will arrange a loan for you for the full amount of the stock you wish to acquire. 1991 Tax Ct. Memo LEXIS 661">727 * * The advance will be a non-recourse loan confining your liability to the value of the stock to be acquired, none beyond that. * * In this letter, Kersting went on to describe both further mechanics of the program, including the subscription agreement and leverage loan, and detailed tax advantages. He also stated that the corporation would pay a dividend early the next year that the investor could use to pay off the principal balance of the leverage loan. Apart from "the purpose of lease financing," Kersting did not mention either the business or the profit potential of the acceptance corporation. Sometime later, Kersting wrote a similar tax-oriented letter entitled "The Acceptance Corporation Plan" that focused specifically on Candace Acceptance, but he did not refer to nonrecourse loans and lack of personal liability. He stated without elaboration that Candace Acceptance was organized for the purpose of "automobile and lease financing" and was "expected to make profits." He further stated that the investor's "actual out-of-pocket expense" and "only expense ever" would be 9 percent of the leverage loan amount. The letter ended with a standard order form for Candace1991 Tax Ct. Memo LEXIS 661">728 Acceptance stock. Kersting form letters that transmitted initiating documents for the Mahalo Acceptance, Delta Acceptance, and Avalon Acceptance Stock Subscription Plans also stated that the "actual out-of-pocket expense" would amount to 9 percent of the leverage loan. These letters ended with this sentence: "If you feel that you have benefited from our services, please introduce us to your friends who might also need tax assistance." A package of initiating documents sent to prospective investors in 1980 or 1981 contained this paragraph: The funds which will be generated by the promissory note you are about to execute will be applied in full to purchase for your account a certain amount of common stock of Avalon Acceptance Corporation. The stock which you will acquire will be equal in value to the face amount of the promissory note. As we go along the value of your stock is expected to be higher than the price you are paying today.D. Leasing Corporation PlanA participant in the Leasing Corporation Plan purchased stock at $ 1 per share from a Kersting leasing corporation (Anseth Leasing, Escon Leasing, or Universal Leasing), and the leasing corporation issued a 1991 Tax Ct. Memo LEXIS 661">729 corresponding stock certificate in the investor's name. The investor also subscribed for additional shares at $ 1 per share. Although a common ratio was a $ 19,000 stock purchase and a $ 55,000 subscription agreement, the ratio was often exactly 1 to 3. The subscription agreement was like that used in the Stock Subscription Plan, including an express term of 3 years, an annual interest rate of 12 percent on the unpaid subscription balance, and an acknowledgment of a year of interest "paid on account." The investor borrowed the funds necessary for the immediate stock purchase by means of a Federated Finance primary loan with an 18-percent annual interest rate. The primary note was by its terms payable on demand or in 2 years if not demanded earlier. Federated Finance supplied the loan proceeds in the form of a two-party check made payable to the investor and the leasing corporation. By means of a leverage loan with a 15-percent annual interest rate, the investor borrowed funds from an acceptance corporation in order to prepay interest on the primary loan and interest on the unpaid subscription balance. The leverage note was by its terms payable on demand or in 1 year if not 1991 Tax Ct. Memo LEXIS 661">730 demanded earlier. The acceptance corporation supplied the loan proceeds in the form of two-party checks, one payable to the investor and Federated Finance and one payable to the investor and the leasing corporation, in amounts equal to a year of interest on the primary loan and a year of interest on the unpaid subscription balance, respectively. The investor generally paid annual interest on the leverage loan in 12 monthly installments. The stock certificate, the subscription agreement, the primary note, the leverage note, and the checks representing loan proceeds all bore the same date, which was usually early in January or early in July. As an example of the Leasing Corporation Plan to this point, an investor borrowed $ 19,000 from Federated Finance at 18-percent annual interest (the primary loan), which he used to purchase 19,000 shares of leasing corporation stock. He subscribed for an additional 55,000 shares at $ 1 per share, agreeing to pay 12-percent annual interest on the unpaid balance of $ 55,000. With $ 10,020 borrowed from an acceptance corporation (the leverage loan), he used $ 3,420 to prepay a year of interest on the primary loan and $ 6,600 to prepay a year of1991 Tax Ct. Memo LEXIS 661">731 interest on the unpaid subscription balance. All of these documents were dated as of the same date. Each of the leasing corporations had two checking accounts at Liberty Bank, a "general" account and a "special" account. The leasing corporation annually issued a distribution check, with a January date, drawn on its general account and made payable to the investor in the amount of the principal balance of the leverage loan. Sometimes the distribution check was in an amount slightly less than the principal balance of the leverage loan; for example, the Escon Leasing distribution check corresponding to a leverage loan of $ 10,020 was in the amount of $ 9,990. A letter accompanying the distribution check stated that the distribution amount was nontaxable to the investor. This letter also informed the investor that his endorsed distribution check, after return to the Kersting offices, would be deposited to the special account, from which the leasing corporation would disburse funds to establish interest deductions for that year. The checks drawn on the special account, which were dated the same as and accompanied the distribution check, totaled to the amount of the distribution 1991 Tax Ct. Memo LEXIS 661">732 check. One check, in an amount equal to a year of interest on the Federated Finance primary loan, was payable to the investor and Federated Finance. The other check, in an amount equal to a year of interest on the unpaid subscription balance, was payable to the investor and the leasing corporation. For the occasional distribution check that did not equal the leverage loan amount, the check corresponding to subscription interest was less than a year of such interest by the same amount that the distribution check was less than the leverage loan amount. As a continuation of the example begun above, which is a $ 19,000 stock purchase coupled with a $ 55,000 subscription agreement, the leasing corporation sent to the investor the following group of checks: A distribution check from its general account for $ 10,020 payable to the investor; a check from its special account for $ 3,420 payable to the investor and Federated Finance; and a check again from its special account for $ 6,600 payable to the investor and the leasing corporation. Each year the investor signed a new 1-year leverage note in favor of a different acceptance corporation, again with a 15-percent annual interest rate1991 Tax Ct. Memo LEXIS 661">733 and the same principal amount as the original leverage loan. This was in effect a renewal of the leverage loan because the loan proceeds were applied to the outstanding leverage loan. The loan proceeds took the form of either a check payable to the investor or a two-party check payable to the investor and the acceptance corporation on the expiring leverage note. If an investor wished to participate in the Leasing Corporation Plan beyond the 2-year term of the original primary note, he in effect renewed the primary loan by executing a new note in favor of Federated Finance for another 2-year term. The loan proceeds took the form of either a check payable to the investor or a two-party check payable to the investor and Federated Finance. With documents dated a few days before the end of the 3-year term of the initial subscription agreement, the investor sometimes both borrowed funds to purchase additional stock from the leasing corporation and executed a new subscription agreement. The number of newly purchased shares plus the number of newly subscribed shares equaled the number of shares originally subscribed. Thus, if the original subscription agreement covered 55,000 shares, 1991 Tax Ct. Memo LEXIS 661">734 an investor who borrowed $ 36,000 to purchase 36,000 new shares also executed a new subscription agreement for 19,000 shares at $ 1 per share. The new stock acquisition note, in favor of an acceptance corporation, provided for 12-percent annual interest and payment on demand or in 3 years if not demanded earlier. The new subscription agreement, with a term of 3 years and an annual interest rate of 12 percent, acknowledged receipt of an amount "paid on account" equal to a year of subscription interest. In connection with this new stock purchase and subscription agreement, the leasing corporation again issued a January distribution check from its general account made payable to the investor in the amount of the outstanding leverage loan, except that again there was sometimes a slight difference in amount. The leasing corporation also issued three checks from its special account that together equaled the amount of the outstanding leverage loan. One check was payable to the investor and Federated Finance and equal to a year of interest on the renewed primary note, one check was payable to the investor and the leasing corporation and equal to a year of interest on the new subscription1991 Tax Ct. Memo LEXIS 661">735 agreement, and one check was payable to the investor and the new acceptance corporation and equal to a year of interest on the new stock acquisition loan. The sale and leaseback of an automobile was sometimes a part of the Leasing Corporation Plan. 26 In a common scenario, a pilot purchased an automobile outside of the Kersting organization, financing it through an airline credit union. The pilot then sold the automobile to a Kersting leasing corporation, which took subject to the credit union loan, and became a shareholder of the leasing corporation. Thereafter, as the pilot made lease payments to the leasing corporation, the leasing corporation made loan payments to the credit union. In a January 1980 letter to a potential client who was considering the purchase of a new automobile, Kersting urged him to consider the sale-leaseback benefits associated with the Leasing Corporation Plan: "The tax retrievals which this plan is scheduled to generate1991 Tax Ct. Memo LEXIS 661">736 for you will fully pay for all lease payments and other fees you sustain in the program. The result of this will be that you will be driving the car entirely free of any cost to you." A pamphlet entitled "The Universal Plan," which Kersting authored or at least authorized, describes an early version of the Leasing Corporation Plan with emphasis on the mechanics and the tax advantages. The cover lists Kersting and Ms. Pang as sources of further information. Although the pamphlet mentions an "investment opportunity," there is no reference to either the business of "Universal Corp." outside of this program or its profit potential. The investment opportunity is described not in terms of dividends or stock appreciation, but in terms of a tax savings return on the ultimate cash outlay: "A taxpayer in the 20% bracket would be entitled to a tax refund of $ 1485. In other words on an investment of $ 756 [for leverage loan interest] a return of $ 1485 can be obtained. This equals a percentage return of 196% which is entirely free of tax. An undated form letter to automobile lessees that included petitioner Terry D. Owens described, in addition to tax advantages, the economic benefits1991 Tax Ct. Memo LEXIS 661">737 available to shareholders in a Leasing Corporation Plan: As the leasing concept gains popularity, investment opportunities will become available comparable to the early stages of growth industries * * Profits in leasing are essentially generated from two sources: lease revenues and realization of residual values inherent in automobiles or equipment. Profits are, for all practical purposes, untaxed as they can be sheltered by generous depreciation allowances and investment credits. As a consequence, an accumulation of intrinsic values takes place at a faster rate than generally attainable if a portion of profits must be shared with the government. As profits go untaxed per share earnings will increase and additions to book value (or shareholders equity) will rise. This, in turn, will sooner or later be recognized in the market place if the stock of the company which we have organized shall be offered to the public.Following a description of the stock purchase, the letter stated that the purchaser "would be an investor only. He may expect, however, capital [sic] appreciation and dividend income as the years go by." In another undated form letter received by petitioner1991 Tax Ct. Memo LEXIS 661">738 Terry D. Owens, this one transmitting initiating documents for Universal Leasing, Kersting emphasized the tax aspects but also wrote: All of your debt, except your monthly payment obligation, can be discharged at any time at your option by surrender of the stock certificate which will be issued to you after we have received the executed documents from you. As a shareholder of this corporation you will have access to capital gains prospects which we intend to develop. If our judgment is secure and if we are successful in creating a public market for the stock of this company it is reasonable to assume that the stock of this company will eventually sell at an earnings multiplier well in excess of the price which you are paying today. We are convinced of this to the point where we are willing to accept your stock in settlement of your indebtedness.Kersting also wrote a form letter, as president of Anseth Leasing, marking the first anniversary of the recipients' participation in the Leasing Corporation Plan. He encouraged the shareholders to renew their outstanding leverage notes by executing new ones, and added that "you do have the continuing option to retire the existing1991 Tax Ct. Memo LEXIS 661">739 notes by a sale to your corporation of the stock which you have acquired." E. CAT-FIT Plan27Kersting made the CAT-FIT Plan available to those interested clients with children, generally at a participation level of $ 17,000 per child. The parent borrowed $ 17,000 from Windsor Acceptance by means of a primary loan with an annual interest rate of 12 percent. The primary note was by its terms payable on demand or in 2 or sometimes 3 years if not demanded earlier. Windsor Acceptance supplied the loan proceeds in the form of a check payable to the parent, and Atlas Guarantee issued a $ 17,000 "investment certificate" in the name of the child. The investment certificate stated that Atlas Guarantee would pay interest to the child at an annual rate of 12 percent. The parent usually borrowed funds from an acceptance corporation by means of a leverage loan, $ 2,040 for each child, to pay the annual interest1991 Tax Ct. Memo LEXIS 661">740 to the primary lender, Windsor Acceptance. The leverage note, with a 9-percent annual interest rate, 28 was by its terms payable in 1 year. The parent endorsed the loan proceeds check, which was payable to the parent, and, with the other initiating documents, sent it back to the Kersting offices. The parent usually paid interest on the leverage loan in a lump sum. The investment certificate, the primary note, the leverage note (if applicable), and the checks representing loan proceeds all bore the same date, which was early in January or early in July. As with the Stock Subscription Plan, Kersting at the outset instructed those wishing to participate in the leverage loan version of the CAT-FIT Plan to open a checking account in Hawaii at a specified local bank at which Kersting corporations had accounts. This was either Liberty Bank or Hawaii National Bank into 1979 and Liberty Bank 1991 Tax Ct. Memo LEXIS 661">741 from 1979 on. After the parent endorsed the proceeds check from the leverage loan and returned the initiating documents to Kersting, Atlas Guarantee sent a form letter with instructions on how to complete the transaction. 29 In this letter, Atlas Guarantee asked the parent to send a signed check drawn on his local account at the specified bank and made payable to Windsor Acceptance in the amount of a year of interest on the primary loan. The letter stated that an appropriate deposit (meaning the endorsed leverage loan proceeds check) would be made to the parent's account to allow his check to clear. Atlas Guarantee paid interest on the investment certificates semi-annually, with checks made payable to the child and dated in June or1991 Tax Ct. Memo LEXIS 661">742 July and December or January. By an accompanying letter or otherwise, the parent was requested to obtain the child's endorsement or endorse for the child, and then to return the check so that Atlas Guarantee could add the check amount to the face amount of the investment certificate. The parent usually agreed to this procedure, but some parents arranged to receive signed and negotiable interest checks. Kersting told these parents not to use the child's earnings from the investment certificate to discharge their normal parental obligations, such as the provision of food, shelter, and clothing. Otherwise, Kersting believed, the earnings belonged to the parents for income tax purposes. For the second and each succeeding year of the CAT-FIT Plan, the parent participating in the leverage loan version borrowed funds by means of a new leverage loan in order to pay another year of interest to Windsor Acceptance. The new leverage note, again with a 1-year term and a 9-percent interest rate, was in favor of a different acceptance corporation than the original leverage lender. The loan proceeds, in the amount of the annual interest payable to Windsor Acceptance, took the form of a check1991 Tax Ct. Memo LEXIS 661">743 payable to the parent. The parent again wrote a check to Windsor Acceptance drawn on his local account in an amount equal to a year of interest on the primary loan. If a parent wished to participate in the CAT-FIT Plan beyond the term of the original primary note, he in effect renewed or refinanced the primary loan by executing a new note in favor of Windsor Acceptance, again at an annual interest rate of 12 percent. Kersting at some point authored this description of the CAT-FIT Plan: Under existing tax regulations each parent * * * can make a TAX FREE gift of $ 3,000.00 per year to each of their children. Furthermore, they have a lifetime allowance of $ 30,000 of TAX FREE gifts to their children. No gift tax will be payable on either the annual gifts in the amount of $ 3,000 or the once-in-a-lifetime gift of $ 30,000. The object of the plan is to shift income from parents to their children. Children can be taxpayers in their own right and are permitted to earn as much as $ 2,300 per year before they begin to pay taxes. Although children under the CAT FIT PLAN become taxpayers by reason of the income they might earn, their parents will not loose [sic] the exemption, presently1991 Tax Ct. Memo LEXIS 661">744 $ 1,000 [per] child, if they contribute more than 50% of their children's annual support. The implementation of the plan requires a few simple steps: 1. Each parent will make a gift in the amount of $ 17,000 to any one or all of their children. A certificate savings account in the amount of $ 17,000 will be opened with Atlas Guarantee Corp. in the name of the child. The account will earn interest at the rate of 12% per year. The earnings will accrue to the child. 2. If the lifetime allowance or any part thereof is used, the savings account can be increased accordingly. 3. One of our subsidiary acceptance corporations will make a loan to the parents in the amount of $ 17,000 or whatever the savings account in the child's name should amount to. We will charge interest at the rate of 12% per year on that loan. The interest payment becomes a deduction for federal and state tax purposes to the parents. The effect of the above-described transaction will be that the children will earn a return on the savings account in their names which will be free of income tax to the point where they reach $ 2,300 and the parents will have a tax deduction in the amount of $ 2,040 1991 Tax Ct. Memo LEXIS 661">745 * * * The actual net return to parents and children, will depend upon the tax brackets of the parents * * In an undated form letter that accompanied initiating documents received by petitioner Terry D. Owens, Kersting wrote: Enclosed please find the promissory note (issued to our Acceptance Corporation) by which you will engender the funds needed to create the educational [sic] fund for your children. Please sign white copy of note and endorse the attached check. Return both to us. * * Upon receipt of your executed promissory note and check we will issue to your children Thrift Certificates as per enclosed sample copy. Your children will earn as of the date of the Thrift Certificate 12% interest on the face amount of the Certificate. For every $ 17,000.00 of Thrift Certificates your children will earn $ 2,040.00 per year. * * When a parent decided to discontinue participation in the CAT-FIT Plan, he sent the investment certificate back to Kersting to be redeemed. The redemption check sent to the child was endorsed, returned, and then used to pay off the primary loan. F. Flow of Funds1. GenerallyThe "waltz" was what Kersting called the procedure1991 Tax Ct. Memo LEXIS 661">746 he used to guide checks through the bank checking accounts of several corporations and investors on the same date. All of the Kersting corporations involved in a given waltz had checking accounts at the same local bank in Hawaii, either Hawaii National Bank or Liberty Bank. These waltzes were not always perfect in terms of same-day timing and identical amounts flowing between accounts, but both types of discrepancies were relatively few and insignificant. The Kersting corporations conducted banking transactions at Hawaii National Bank during the 1970s. Kersting himself made deposits to the accounts of the various Kersting corporations and to the accounts of various investors who had opened accounts at the bank. He often provided a schematic drawing to a bank employee and explained that the funds were moving from one party to the next in a circular fashion. Because there were usually negligible balances in the accounts affected by the circular transactions, the bank processed checks as a simultaneous transaction, in effect depositing and paying checks at the same time so that payment of a check from an account was covered by a deposit to that account of a like amount. Eventually, 1991 Tax Ct. Memo LEXIS 661">747 Hawaii National Bank became concerned about the nature of these transactions, specifically the possibility of check-kiting, 30 and informed Kersting that all accounts would be closed, which occurred in March of 1979. There had been no possibility of check-kiting up to this time because all of the affected accounts were within Hawaii National Bank. Nonetheless, Kersting was involving more and more accounts, and the Hawaii National Bank administrators, who began to track drawing-on-same-day-deposit reports, decided that the transactions should cease. Several Kersting corporations1991 Tax Ct. Memo LEXIS 661">748 had checking accounts at Liberty Bank even before closing of the accounts at Hawaii National Bank. At least from 1978 through 1983, either Kersting or women who worked in his offices would go to the Kahala Mall branch of Liberty Bank to conduct banking transactions. Several checks would usually be deposited, most or all of which were drawn on Liberty Bank. The total deposited amount was sometimes large enough to make the deposit volume for the branch on that day seem unusually high. Checks associated with Kersting's investment programs usually cleared the bank, Hawaii National Bank or Liberty Bank, at least several weeks after their dates, and sometimes the date difference was over a year. In addition, Kersting generally waltzed funds associated with primary loans separately from those funds associated with leverage loans, at least for the Stock Subscription Plan. These factors sometimes affected the work of the bookkeepers, who relied on bank statements and canceled checks. For example, as already noted, Fargo Acceptance in its initial income tax return for the period ending June 30, 1977, reported interest income of $ 91,200, but indicated no capital stock on the Schedule1991 Tax Ct. Memo LEXIS 661">749 L balance sheet. Kersting had waltzed leverage loan funds for a Fargo Acceptance Stock Subscription Plan on June 15, 1977, which included interest on subscription agreements of $ 91,200. He did not waltz the primary loan funds with which the investors purchased the Fargo Acceptance stock until July 29, 1977. Kersting's intercorporate fund transfers as part of a waltz were at least sometimes documented as loans or deposits (by means of notes or other evidences of indebtedness) or as stock purchases. 2. Stock Purchase PlanThe holding companies that participated in the Stock Purchase Plan, Charter Financial and Investors Financial, periodically transferred the funds received from new shareholders to Federated Finance. On February 8, 1980, Liberty Bank recorded 20 checks issued by Charter Financial in amounts of either $ 14,400 or $ 21,600. Among the deposits recorded on the same date were two for $ 151,200 each. The account balance was the same at both the beginning and end of the day, $ 1,399.36. For Candace Acceptance on the same date, Liberty Bank recorded three deposits totaling $ 302,400 (among other smaller deposits), with each of the three evenly divisible by $ 7,200. 1991 Tax Ct. Memo LEXIS 661">750 Among the issued checks recorded on the same date were two for $ 151,200 each. The ending account balance for the day differed by less than $ 50 from the beginning balance. On May 22, 1980, Liberty Bank recorded 37 checks issued by Charter Financial in amounts of $ 7,200, $ 14,400, and $ 21,600. Among the deposits recorded on the same date was one for $ 597,600. The account balance was the same at both the beginning and end of the day, $ 780.53. For Candace Acceptance on the same date, Liberty Bank recorded four deposits evenly divisible by $ 7,200 (among others not so divisible), and these four totaled $ 597,600. Among the issued checks recorded on the same date was one for $ 597,600. The ending account balance for the day, which was less than $ 900, differed by less than $ 30 from the beginning balance. 3. Stock Subscription PlanFor the Stock Subscription Plan, the waltz of primary loan funds typically occurred several months after the date on the initiating documents. After several investors had endorsed and returned to Kersting the two-party loan proceeds checks from their primary loans, the bank processed the following check transactions (paying a check1991 Tax Ct. Memo LEXIS 661">751 from the drawer's account and depositing it to the payee's account) on the same date: (1) The loan proceeds checks were paid from the account of the primary lender and deposited as a group to the account of the second payee named on the checks, which was the acceptance corporation selling its stock; (2) this acceptance corporation issued a check, equal to the amount deposited to its account, to Federated Finance; and (3) Federated Finance, if the primary lender was other than Federated Finance, issued a check in the same amount to the primary lender. Although the amount flowing from point to point in a waltz of this type often exceeded $ 500,000, it was not uncommon for the account balances of the primary lender and the acceptance corporation, immediately before and after the waltz, to equal a small fraction of the circulating amount. The waltz of leverage loan funds for the Stock Subscription Plan also typically occurred several months after the date on the initiating documents. This waltz incorporated the investor's checking account at the same bank into the loop. As part of the leverage loan transaction, the investor returned one check to Kersting and sent two of his own. 1991 Tax Ct. Memo LEXIS 661">752 More specifically, he endorsed and returned the leverage loan proceeds check and also sent two signed checks drawn on his account (for primary loan interest and subscription interest) that taken together equaled the amount of the proceeds check. After several investors had returned this three-check package, the bank processed the following check transactions on the same date: (1) The loan proceeds checks were paid from the account of the leverage lender and deposited separately to the account of each investor; (2) the check for subscription interest was paid from the account of each investor, and these checks were deposited as a group to the account of the acceptance corporation selling its stock; (3) the check for primary loan interest was paid from the account of each investor, and these checks were deposited as a group to the account of the primary lender; (4) the stock-issuing acceptance corporation and the primary lender issued checks, each equal to the amount deposited to its account, to Charter Financial or Federated Finance; and (5) Charter Financial or Federated Finance issued a check, equal to the amount deposited to its account, to the leverage lender. The amounts flowing1991 Tax Ct. Memo LEXIS 661">753 into and out of the accounts of the stock-issuing acceptance corporation and the primary lender usually exceeded $ 100,000. The amounts flowing into and out of the accounts of the leverage lender and Charter Financial usually exceeded $ 200,000. It was not uncommon, however, for each of these account balances, immediately before and after the waltz, to equal less than $ 1,000. 4. Leasing Corporation PlanThe leasing corporations that sold their stock under the Leasing Corporation Plan, like the holding companies in the Stock Purchase Plan, periodically transferred the funds received from new shareholders to Federated Finance. On July 22, 1981, Liberty Bank recorded deposits of $ 28,800 and $ 82,000 in the general account of Anseth Leasing. 31 The $ 28,800 consisted of checks from four individuals, three for $ 6,600 each and one for $ 9,000. The $ 82,000 consisted of checks from the same individuals, three for $ 19,000 and one for $ 25,000. As recorded on the same date, Anseth Leasing issued checks from this account that included one for $ 28,800 and another for $ 82,000. 1991 Tax Ct. Memo LEXIS 661">754 Also on July 22, 1981, Liberty Bank recorded deposits of $ 14,520 and $ 41,000 in the general account of Escon Leasing. The $ 14,520 consisted of checks from two individuals, one for $ 6,600 and one for $ 7,920. The $ 41,000 consisted of checks from the same individuals, one for $ 19,000 and one for $ 22,000. As recorded on the same date, Escon Leasing issued checks from this account that included one for $ 14,520 and another for $ 41,000. On April 27, 1978, Liberty Bank recorded the following activity in the Escon Leasing general account: 10 checks issued in the amount of $ 9,990, 5 of $ 6,480, 3 of $ 5,400, 2 each of $ 10,800, $ 8,640, $ 7,560, and $ 3,240, and 1 each of $ 8,100, $ 2,970, and $ 1,620, for a total of $ 221,670, and deposits of $ 143,730, $ 78,000, and $ 2,000. The recorded special account activity for the same date was a single deposit of $ 221,670 and 58 issued checks: 10 each of $ 6,570 and $ 3,420, 7 of $ 2,160, 5 each of $ 4,320 and $ 3,600, 3 each of $ 1,800 and $ 1,080, 2 each of $ 7,200, $ 5,760, $ 5,040, $ 2,880, and $ 2,520, and 1 each of $ 5,400, $ 2,700, $ 1,530, $ 1,440, and $ 540. The ending special account balance for the day was the same as 1991 Tax Ct. Memo LEXIS 661">755 the beginning balance, $ 100. On November 8, 1978, Liberty Bank recorded the following activity in the Escon Leasing general account: 5 checks issued in the amount of $ 9,990 and 1 each of $ 8,640, $ 6,480, and $ 3,240, for a total of $ 68,310, and deposits of $ 45,090 and $ 23,000. The recorded special account activity for the same date was a single deposit of $ 68,310 and 16 issued checks: 5 each of $ 6,570 and $ 3,420, 2 of $ 2,160, and 1 each of $ 5,760, $ 4,320, $ 2,880, and $ 1,080. The ending special account balance for the day was the same as the beginning balance, $ 88.77. On August 6, 1979, Liberty Bank recorded the following activity in the Anseth Leasing general account: 4 checks issued in the amount of $ 10,020 and 2 of $ 9,748.80, for a total of $ 59,577.60, and a deposit of $ 39,417.60. The recorded special account activity for the same date was a single deposit of $ 59,577.60 and 12 issued checks: 4 each of $ 6,600 and $ 3,420, and 2 each of $ 6,508.80 and $ 3,240. The ending special account balance for the day was the same as the beginning balance, $ 78.90. On August 16, 1979, Liberty Bank recorded the following activity in the Anseth Leasing general account: 1991 Tax Ct. Memo LEXIS 661">756 15 checks issued in the amount of $ 10,020, 6 of $ 9,748.80, 3 of $ 6,499.20, and 1 each of $ 5,416 and $ 4,062, for a total of $ 237,768.40, and deposits of $ 156,948.40 and $ 81,000. The recorded special account activity for the same date was a single deposit of $ 237,768.40 and 52 issued checks: 15 each of $ 6,600 and $ 3,420, 6 each of $ 6,508.80 and $ 3,240, 3 each of $ 4,339.20 and $ 2,160, 2 of $ 1,800, and 1 each of $ 3,616 and $ 2,262. The ending special account balance for the day was the same as the beginning balance, $ 78.90. 5. CAT-FIT PlanDuring 1979 and 1980, Liberty Bank recorded the following amounts in the accounts of Atlas Guarantee and Windsor Acceptance: 32Atlas GuaranteeWindsor AcceptanceDateChecks IssuedDeposits8/30/79 $ 500,000; $ 510,000$ 500,000; $ 510,0009/24/79 85,000 85,000 10/30/79408,000 408,000 11/29/79391,000 391,000 1/25/80 102,000 102,000 2/22/80 17,000; 17,000 34,000 3/ 7/80 17,000 17,000 3/18/80 17,000 17,000 4/18/80 339,000; 374,000 339,000; 374,000 7/24/80 459,000 459,000 8/ 8/80 17,000; 17,000 34,000 8/13/80 306,000 306,000 8/21/80 17,000; 17,000 34,000 11/19/80306,000 306,000 1991 Tax Ct. Memo LEXIS 661">757 On all of these dates, the deposits to the Atlas Guarantee account exactly offset Atlas Guarantee checks, and the checks paid from the Windsor Acceptance account (most of which were either $ 17,000 or a multiple thereof) exactly offset Windsor Acceptance deposits. Thus, the beginning and ending account balances for the day were equal. The Atlas Guarantee beginning and ending account balances never exceeded $ 100 on these dates, and the Windsor Acceptance account balances, with the exception of January 25, 1980, did not exceed $ 5,000. The waltz of leverage loan funds for the CAT-FIT Plan, like the Stock Subscription Plan waltzes, typically occurred several months after the date on the initiating documents. Like the waltz of Stock Subscription Plan leverage loan funds, this waltz incorporated the parent's checking account into1991 Tax Ct. Memo LEXIS 661">758 the loop. As part of the leverage loan version of the CAT-FIT Plan, the parent endorsed and returned the leverage loan proceeds check and also sent a signed check drawn on his account (for primary loan interest) that equaled the amount of the proceeds check. After several parents had sent both of these checks to Kersting, the bank processed the following check transactions on the same date: (1) The loan proceeds checks were paid from the account of the leverage lender and deposited separately to the account of each parent; (2) the parent's check for primary loan interest was paid from the account of each parent, and these checks were deposited as a group to the account of the primary lender, Windsor Acceptance; (3) Windsor Acceptance issued a check, equal to the amount deposited to its account, to Federated Finance; and (4) Federated Finance issued a check, equal to the amount deposited to its account, to the leverage lender. The amounts flowing into and out of the accounts of Windsor Acceptance and the leverage lender usually exceeded $ 50,000 for this type of waltz. It was not uncommon, however, for each of their account balances, immediately before and after the waltz, to equal1991 Tax Ct. Memo LEXIS 661">759 less than $ 500. G. Termination of Stock ProgramsBefore someone began a stock investment program, Kersting assured him that he could surrender the purchased stock at any time in full payment of the corresponding primary loan. For those relatively few who insisted on written documentation of this policy, which did not include any of petitioners, Kersting obliged them. In effect, he agreed with the investor to repurchase the shares at the price for which they were issued. As a mechanical matter, the investor generally returned an endorsed stock certificate in exchange for a check, which he endorsed and returned to pay off the outstanding primary loan. Although Kersting sometimes provided written assurances of the termination policy after an investor began participating, the letters in such instances merely confirmed the understanding reached before participation began. As an example of a letter confirming an earlier understanding, Kersting wrote to a new participant on July 28, 1977: We received today your executed note #420 of which I will be enclosing a copy for identification. This is to confirm that you have a continuing option to offset any obligation arising from1991 Tax Ct. Memo LEXIS 661">760 execution of this note by surrender of the Fargo Acceptance Corp. stock certificate which was issued to you (Certificate #39, 30,000 shares of stock).Similarly, on August 18, 1977, Kersting wrote to someone else: This is to confirm our verbal understanding that you will have a perpetual option to offset any obligation arising from execution of your note in the amount of $ 30,000.00 (copy attached for identification) by surrender of the stock certificate issued to you by Fargo Acceptance Corp. of which a copy is enclosed with this letter.Kersting sometimes represented that surrendered stock would satisfy all outstanding debt, which would include outstanding leverage loans. On January 18, 1978, he wrote to a prospective investor on behalf of Forbes Acceptance, Fargo Acceptance, Federated Finance, Federal Finance & Mortgage, Mahalo Acceptance, and Atlas Funding: "This is to confirm our verbal assurance that you will be permitted to offset any of the promissory notes which you might execute at one time or another to any of our lending companies by surrender of the stock certificates which will be issued to you in that connection." In some correspondence, Kersting disclosed1991 Tax Ct. Memo LEXIS 661">761 why he was reluctant to provide written assurance to all participants as a matter of course. A letter he wrote to a prospect on July 21, 1977, explained: there is, of course, no problem to reassure you of the self-sustaining and self-liquidating aspects of the transaction. We would, in fact, issue a letter to every participant in the deal outlining that understanding if it would not weaken YOUR position with the IRS. IRS wants to see you "at risk" and not on a non-recourse basis. The fact is, if they would determine that you are on a non-recourse basis you would likely lose your deduction.His February 1978 letter to Willis McComas similarly stated: As to the obligation under the promissory notes and subscription agreements there is no ongoing obligation as far as we are concerned. We will always repurchase the stock issued at a price sufficient to allow a borrower to discharge all of his debt. That, unfortunately, can not be stated before the Revenue Service. The Tax Reform Act of 1976 has essentially eliminated non-risk or non-recourse notes. Your deductions would be materially weakened if we would admit to an offset arrangment [sic] as to notes and stock1991 Tax Ct. Memo LEXIS 661">762 certificates. I wish I could be more explicit in writing.In a letter serving as a credit reference to a third party on December 10, 1980, Kersting described a specific client's typical investments: "His liabilities at * * * [the time of the stock purchases] and from there on would be equal to the assets acquired. His debt can be cancelled at any time of his choice by the sale of the assets in his possession. We maintain a stable and assured market for these securities." The letter also included this summation: "The results of this sort of investment planning have been considerable tax retrievals * * * at a nominal cost and negligible risk." Kersting did not always provide an original of a termination assurance letter directly to the concerned prospect or participant. In some instances, with the approval of the concerned party, he gave the original to a mutual acquaintance such as Michael Provan or Robert Campbell for safekeeping. In one instance, Kersting sent the original to a mutual acquaintance and attached a letter that read: "Be sure this never gets to the IRS. It would be most damaging to all of us." Although Kersting sometimes described the stock surrender part1991 Tax Ct. Memo LEXIS 661">763 of the transaction to a prospect as a stock redemption by the corporate issuer, he also sometimes characterized it as a direct sale to another buyer with Kersting acting in the role of a broker. Regardless of how Kersting characterized the transaction, the prospect understood that his surrender of stock would relieve him of liability on at least the principal balance of the primary loan. Kersting also assured all participants that if they conformed to the investment programs as set up and operated, they would not be liable for the principal amounts of their leverage loans. A participant in the Stock Purchase Plan or the Stock Subscription Plan understood from the beginning that annual distributions from the corporation would satisfy his principal balance obligation on the outstanding leverage loan. Kersting personnel processed terminations of these programs as of the end of the calendar year so that December distribution checks could be applied to pay off the last leverage loan. A participant in the Leasing Corporation Plan was assured that an outstanding leverage loan would be refinanced annually with a new leverage loan. At termination, the annual distribution check from the1991 Tax Ct. Memo LEXIS 661">764 leasing corporation satisfied the investor's obligation on the principal balance of the then outstanding leverage loan. H. Collection ActivitiesKersting wrote a letter dated September 25, 1980, to over 30 clients, which read in part: We have sent you several reminders, most of them friendly, now to encourage you to discharge the debt to which you are a party for some time. As it appears that our reminders had no bearing on you, we * * * alert you now to the prospect that your tax deductions which we have generated for you might evaporate. It is not reasonable to expect us to deliver and not be compensated for it in return. Please be advised that we will reverse on our records your tax deductions for which we have not been paid and as referenced above if we do not receive payment in full by not later than October 10, 1980. * * The programs involved were the Stock Subscription Plan, the Leasing Corporation Plan, and the CAT-FIT Plan. Of the various amounts sought from these people, none was over $ 4,000 and several coincided with the annual interest on a leverage loan for a typical Stock Subscription Plan or Leasing Corporation Plan. The Kersting corporations1991 Tax Ct. Memo LEXIS 661">765 sometimes engaged attorneys, including Kersting's son-in-law, Roger Moseley (Moseley), to pursue missed payments from those who participated in the investment programs during the years at issue. Some investors stopped making payments to Kersting after hearing of the IRS search and seizure activities on January 22, 1981. Collection activities were more vigorous after 1982 than before, and Kersting first engaged Moseley after 1983. At the time of trial, Moseley had been used for fewer than 10 debtors, with most of their cases involving more than one note. Generally, Moseley first sent a demand letter and then, if he received either no response or an unacceptable response, he took action to commence a lawsuit. Attorney Thomas Dunn filed a complaint in Hawaii State court in 1983 on behalf of Atlas Funding. Atlas Funding sought to collect $ 46,200 as the payee on a stock subscription plan renewal primary note dated June 1, 1979, with Continental pilot Steven Hane the maker. (A lower-case reference to a "stock purchase plan," "stock subscription plan," "leasing corporation plan," or "CAT-FIT plan" relates to a specific participant and indicates a program that, based on information1991 Tax Ct. Memo LEXIS 661">766 available in the record, is not materially inconsistent with its upper-case namesake described in part III (B), (C), (D), or (E), above.) The principal amount of the note was $ 30,000, and 3 years of 18-percent annual interest equaled $ 16,200. The court entered a default judgment in October 1983, but Atlas Funding voluntarily dismissed the case the next month. Carl Mott, a pilot with American Airlines, Inc., was the defendant in lawsuits commenced in Hawaii State court in 1985 by Aztec Acceptance, Avalon Acceptance, Delta Acceptance, Lombard Acceptance, and Candace Acceptance. Moseley filed the five complaints, which involved 15 leverage notes dated between January 1982 and January 1984, inclusive. Each corporation sought a year of interest on the note or notes attached to its complaint. The court entered default judgments in all five suits in February 1986, and Moseley with some success took steps to collect the judgments. In 1985, Moseley also filed lawsuits in Hawaii State court on behalf of Candace Acceptance and Mahalo Acceptance against George Vermef, another Continental pilot. Candace Acceptance sought to collect $ 38,700 on two stock purchase plan leverage notes, both1991 Tax Ct. Memo LEXIS 661">767 dated July 1, 1980. The principal amounts of the notes were $ 21,600 and $ 14,400. Mahalo Acceptance sought to collect $ 23,430 on two leverage notes, one, with a principal amount of $ 18,000, that related to a stock subscription plan, and the other, with a principal amount of $ 4,080, that related to a CAT-FIT plan. Both of these notes were dated July 1, 1980. The court entered default judgments for both Candace Acceptance and Mahalo Acceptance in April 1986. The court later vacated the judgments, after salary garnishment had begun, when the parties agreed to settle the cases. In 1986, Moseley filed a complaint in Hawaii State court on behalf of Delta Acceptance against Robert Peterson, a pilot for Delta Airlines. Delta Acceptance sought to collect $ 27,219 on two leverage notes, one, with a principal amount of $ 14,400, that related to a stock purchase plan, and the other, a renewal leverage note with a principal amount of $ 10,020, that related to a leasing corporation plan. The $ 14,400 note was dated July 1, 1980, and the $ 10,020 note was dated July 1, 1982. The $ 27,219 sought by Delta Acceptance equaled the sum of the principal amounts of the notes and one year of1991 Tax Ct. Memo LEXIS 661">768 interest on each. The court entered a default judgment for Delta Acceptance in June 1986, after which salary garnishment began, but later the court granted the defendant's motion to set aside the default and relieve him from judgment. I. Notices of DeficiencyThe Commissioner determined that specified amounts claimed as interest deductions in connection with the Kersting investment programs are not allowable because: (1) The transactions that gave rise to the claimed deductions were shams; (2) petitioners did not establish that they paid or properly accrued the interest claimed as deductions in the years claimed; and (3) the underlying transactions did not give rise to bona fide indebtedness or enforceable and bona fide obligations to pay compensation for the use or forbearance of money. The Commissioner further determined that, to the extent the claimed interest deductions are otherwise allowable, the amounts constitute investment interest the deductibility of which is subject to limitation under section 163(d), and petitioners failed to report properly the income received in the same transactions. IV. PetitionersA. Jerry R. and Patricia A. DixonPetitioners1991 Tax Ct. Memo LEXIS 661">769 Jerry R. Dixon (Dixon) and Patricia A. Dixon (Mrs. Dixon) resided in El Paso, Texas, when they filed their petition and throughout their years at issue, 1977 through 1981. They filed a joint Federal income tax return for each of these years with the Internal Revenue Service Center at Austin, Texas. Dixon, 56 years old at the time of trial, is a high school graduate with over 3 years of a college education in business administration. He served 4 years in the military, where he received pilot training from the Navy, before an honorable discharge in 1958. He has been employed by Continental continuously since 1959, except for a 3-year break in service after the years at issue attributable to Continental's bankruptcy and associated pilot strike. Mrs. Dixon was not employed during the years at issue. Dixon first heard of Kersting in about 1972 when fellow pilots were discussing the possibility of leasing an automobile from him for their use during layovers. By 1976, when Dixon decided he should try to shelter his income, he and Kersting were exchanging correspondence about Kersting's investment programs. Dixon had discussed these programs with other Continental pilots who were 1991 Tax Ct. Memo LEXIS 661">770 already involved, the most influential of whom were Michael Provan and Leon Lipsky. In Dixon's first letter to Kersting, in which he informed Kersting that he was a Continental pilot, he referred at the top to "CAT-FIT and Stock Sub-Program" and wrote: "I will gross about $ 50,000.00 this year and need some help if it is not too late. I would like to know about how much tax dollar return [there would be] per dollar spent on the two programs above." Dixon did not inquire about corporate profitability or stock appreciation potential in this letter. Later, in a letter with which he included a completed stock subscription form of some sort, he stated that he would like to participate in the CAT-FIT Plan "to the maximum extent" and to begin an "auto leasing program" as of January 1, 1977. He also asked Kersting for the name and address of the "tax man" Kersting used in southern California. In Kersting's reply letter dated November 20, 1976, he instructed Dixon to fill out a form to open an account at Hawaii National Bank. Dixon's first investments with Kersting were for 1977. Prior to this time, Dixon had been involved with one tax-favorable investment, an apartment building limited1991 Tax Ct. Memo LEXIS 661">771 partnership in El Paso. The largest amount the Dixons had borrowed was about $ 50,000 for the purchase of a home. Before investing in a Kersting program, Dixon did not receive printed material, such as a prospectus, nor did he receive financial statements or earnings histories of the participating corporations. He did, however, routinely receive written statements describing the tax benefits he might expect from particular Kersting investments. At the time of his investments, he knew that the leasing corporations in which he invested leased automobiles, and he thought that the other Kersting corporations in which he invested, including Investors Financial and Charter Financial, were in the business of making loans. He did not, however, know the number of shareholders of any of these Kersting corporations. By letter dated March 17, 1977, Gabriele Kersting, as vice president of Atlas Funding, apologized to Dixon for being "somewhat negligent in our correspondence." The rest of the letter read: If you are still interested in our Stock Subscription Agreement and CAT-FIT (gifts to children) programs, we would certainly like to have you participate. The SSA program would engender1991 Tax Ct. Memo LEXIS 661">772 a $ 9,000.00 deduction for you and CAT-FIT would generate a $ 6,120.00 deduction. If you are in the 30% tax bracket, these deductions would retrieve $ 4,536.00 for you for 1977, notwithstanding any deductions you may generate on your own. If you are interested, please notify me at your early convenience and I will see that the appropriate documents are sent to you immediately.With initiating documents dated January 2, 1977, the Dixons entered into CAT-FIT plans for three children, with each investment certificate in the face amount of $ 17,000. 33 As Dixon understood it, the CAT-FIT Plan was meant to facilitate tax-free transfers of up to $ 3,000 annually per child. The Dixon CAT-FIT plans differ from the CAT-FIT Plan in several respects. First, both Dixon and Mrs. Dixon were makers of separate primary notes by the terms of which Dixon promised to pay $ 25,500 and Mrs. Dixon promised to pay $ 21,000, for a total of $ 46,500. 34 Second, both Dixon and Mrs. Dixon were makers of separate renewal primary notes dated January 2, 1979, each of which included a promise to pay $ 25,500. Third, each of the third and fourth leverage notes, dated January 2, 1979, and January 2, 1980, 1991 Tax Ct. Memo LEXIS 661">773 was signed by both Dixon and Mrs. Dixon, and each of the leverage loan proceeds checks was payable to both. Kersting used Hawaii National Bank to waltz leverage1991 Tax Ct. Memo LEXIS 661">774 loan funds for the Dixon CAT-FIT plans on August 31, 1977, and June 9, 1978. The check that Dixon wrote for primary loan interest and that Kersting waltzed on August 31, 1977, was dated May 2, 1977. The similar check that Kersting waltzed on June 9, 1978, was dated May 24, 1978. By form letter dated January 1, 1980, Windsor Acceptance informed Dixon that, among other things, he could terminate his CAT-FIT plans by returning renewal documents unsigned along with the investment certificates. In 1980 or shortly thereafter, Dixon terminated the CAT-FIT plans by returning the investment certificates to Kersting. With initiating documents dated January 2, 1977, Dixon entered into a leasing corporation plan involving Escon Leasing ($ 19,000 purchase and $ 55,000 subscription), in connection with which he leased automobiles by means of sale-leaseback transactions throughout the years at issue. He had originally purchased the automobiles with financing from Conair Federal Credit Union or Coronado Bank, neither of which was associated with Kersting. This leasing corporation plan differs from the Leasing Corporation Plan in that Dixon's Escon Leasing stock certificate was dated July 1, 1991 Tax Ct. Memo LEXIS 661">775 1977, unlike the other initiating documents. With initiating documents dated January 2, 1977, January 3, 1978, January 3, 1979, and January 3, 1980, Dixon entered into stock subscription plans involving, respectively, Fargo Acceptance ($ 30,000 purchase and $ 30,000 subscription), Mahalo Acceptance ($ 60,000 purchase and $ 60,000 subscription), Candace Acceptance ($ 60,000 purchase and $ 60,000 subscription), and Delta Acceptance ($ 60,000 purchase and $ 60,000 subscription). He had started with Mahalo Acceptance by checking the box next to "60,000" shares on the standard acceptance corporation order form. He had responded the same way to a similar form for Candace Acceptance. His Fargo Acceptance stock subscription plan differs from the Stock Subscription Plan in that the primary note had a 1-year term rather than 2. For this Fargo Acceptance stock subscription plan, Kersting used Hawaii National Bank to waltz primary loan funds on July 29, 1977, and leverage loan funds on June 15, 1977. The checks Dixon wrote for primary loan interest and subscription interest were dated May 23, 1977. For Dixon's Mahalo Acceptance stock subscription plan, Kersting used Hawaii National Bank1991 Tax Ct. Memo LEXIS 661">776 to waltz leverage loan funds on May 12, 1978. The checks Dixon wrote for primary loan interest and subscription interest were dated April 20, 1978. For Dixon's Candace Acceptance stock subscription plan, Kersting used Liberty Bank to waltz primary loan funds on April 10, 1979, and leverage loan funds on May 2, 1979. The checks Dixon wrote for primary loan interest and subscription interest were dated April 15, 1979. Sometime after January 3, 1980, Kersting wrote Dixon that he had gone over Dixon's accounts and defined "the need for additional shelter" based in part on Dixon's response to a questionnaire. This letter continued: You will find that you will have total deductions of $ 84,901.80 for this year. All of it can be claimed as the meter started running for you on the 3rd day of January of 1980. Please return to us all documents called for by the additional deductions (Charter Fin. Corp. and Investors Fin. Corp.) at your early convenience so that we can put the checks through the Bank.With initiating documents dated January 3, 1980, Dixon entered into stock purchase plans involving Investors Financial ($ 120,000 purchase) and Charter Financial ($ 120,000 purchase). 1991 Tax Ct. Memo LEXIS 661">777 Although the Dixons had checking and savings accounts outside of Hawaii, Dixon had opened a checking account at Hawaii National Bank in 1977, which he used in dealings with Kersting. In early 1979, he closed this account and began to use another Hawaii bank account, a joint account with Mrs. Dixon at Liberty Bank. Kersting, through Atlas Funding, set up the Liberty Bank account for the Dixons by making an initial deposit of $ 100. Dixon was unusual among Kersting's investors in that he paid interest on leverage loans with checks drawn on Hawaii National Bank and Liberty Bank. Dixon became aware of the IRS search of the Kersting offices shortly after it occurred. Although he was still participating in Kersting investment programs during 1984 and 1985 in the sense that he continued to pay interest on some leverage notes, he and Mrs. Dixon no longer claimed interest deductions relating to those programs. This was due in part to the advice of their return preparer, an attorney and certified public accountant named Mary Mangrum who suggested waiting until any Tax Court controversy was resolved, and in part to Continental's 1983 bankruptcy, which resulted in lower pay to Dixon and1991 Tax Ct. Memo LEXIS 661">778 less need for deductions. Delta Acceptance sent Dixon a form letter dated August 28, 1985, which stated: Enclosed you will find the necessary checks to terminate any and all participation you have in our programs. Please endorse the backs of the checks as per instructions on each ticket stapled to the checks. Then, return them to us at your earliest convenience. We will use these funds to cancel your notes all of which will be sent to you upon their cancellation marked "PAID." Please refer now to any items marked below which may pertain to you. If you are requested to return any further documents, please include them along with the enclosed checks. * * XX Please return your Charter Financial * * * stock certificate for cancellation. PLEASE SIGN OFF ON BACK OF (EACH) CERTIFICATE! !This letter contained similar unchecked "cancellation" lines for leasing corporation stock certificates, acceptance corporation stock certificates, and CAT-FIT investment certificates. The Dixons reported adjusted gross income for the years 1977 through 1981 in the respective amounts of $ 61,964, $ 68,911, $ 91,535, $ 100,121, and $ 105,538. They reported no capital gains or losses1991 Tax Ct. Memo LEXIS 661">779 relating to Kersting corporations during these years and reported $ 117 of dividend income for 1978. For their taxable year 1977, the Dixons' return was prepared by a certified public accountant with the Haskins & Sells firm in El Paso. An acquaintance of Dixon's, whom Dixon knew to be involved in Kersting's investments, had recommended this accountant. Philip Scheff prepared the Dixons' 1978 and 1979 returns, and Earl LeMond, whom Kersting had recommended to Dixon, prepared their 1980 and 1981 returns. Among the information Dixon provided to the return preparers were yearend statements of interest paid that Kersting corporations had sent to him. In his notice of deficiency, the Commissioner disallowed claimed interest deductions as follows: Payee19771978197919801981Federated Finance$ 3,420$ 3,420$ 3,420$ 47,520$ 46,620Escon Leasing6,6006,6006,6002,2802,280Windsor Acceptance6,1206,1206,1206,120-- Fargo Acceptance3,6001,5031,745551-- Forbes Acceptance2,0281,688-- 428-- Atlas Funding5,40010,800-- -- -- Norwick Acceptance428-- -- -- -- Mahalo Acceptance-- 7,2001,2536,1914,320Candace Acceptance-- -- 7,2001,5033,888Ventures Funding-- -- 10,800-- -- Delta Acceptance-- -- -- 6001,503$ 27,596$ 37,331$ 37,138$ 65,193$ 58,6111991 Tax Ct. Memo LEXIS 661">780 B. John R. and E. Maria CravensPetitioners John R. Cravens (Cravens) and E. Maria Cravens (Mrs. Cravens) resided in Laguna Niguel, California, when they filed their petitions and throughout their years at issue, 1979 and 1980. They filed a joint Federal income tax return for each of these years with the Internal Revenue Service Center at Fresno, California. During these years, Cravens was a pilot with American Airlines. Mrs. Cravens was not employed during 1979 and worked as a flight attendant for American Airlines during 1980. After hearing about Kersting and his programs from several other pilots, Cravens, who was seeking a tax shelter, telephoned him to discuss possible investments. With initiating documents dated July 1, 1979, Cravens entered into a stock subscription plan involving Candace Acceptance ($ 60,000 purchase and $ 60,000 subscription), for which the primary lender was Ventures Funding and the leverage lender was Fargo Acceptance. Kersting used Liberty Bank to waltz primary loan funds on October 5, 1979, and leverage loan funds on October 26, 1979. Cravens had opened a checking account at Liberty Bank in September of 1979, and the checks he wrote for 1991 Tax Ct. Memo LEXIS 661">781 primary loan interest and subscription interest were dated October 1, 1979. For the next year, with initiating documents dated July 1, 1980, he entered into a stock subscription plan involving Delta Acceptance ($ 60,000 purchase and $ 60,000 subscription). He never did anything with a check issued by Candace Acceptance or Delta Acceptance except endorse and return it. Consistent with his understanding that he could terminate his participation in these programs at any time by selling his stock back to the corporation, Cravens did so for both stock subscription plans. He was very unusual among Kersting's clients in being content to report a capital gain after remaining in a program for only a year. By letter dated September 10, 1980, Candace Acceptance informed Cravens that an enclosed check represented the "repurchase of stock" of the corporation. The unsigned check, dated July 1, 1980, was payable to Cravens in the amount of $ 60,000. The letter asked him to endorse the check and return it to Candace Acceptance. He had earlier mailed his endorsed Candace Acceptance stock certificate to the Kersting offices and in exchange received the Ventures Funding primary note marked "paid." 1991 Tax Ct. Memo LEXIS 661">782 Along with his Candace Acceptance stock certificate, he had sent a handwritten letter stating in part: "I'm looking forward to receiving my $ 60,000 note and the paperwork for the 6,000 shares of Delta Corp." Cravens terminated his Delta Acceptance stock subscription plan in 1981, exchanging his stock certificate for a "paid" primary note and reporting a capital gain on the 1981 return. The Cravenses reported adjusted gross income for 1979 and 1980 of $ 64,694 and $ 75,394, respectively. In their 1980 return, they reported a Schedule D long-term capital gain of $ 18,000 on the Candace Acceptance stock, derived from a reported adjusted basis of $ 42,000 on the reported selling date, August 1, 1980. Because of a 60-percent capital gains deduction, they reported $ 7,200 as taxable income from this stock sale. They reported no other Schedule D transactions in either year. Neither the 1979 nor the 1980 return includes the name or signature of a paid preparer. In his notices of deficiency, the Commissioner disallowed claimed interest deductions as follows: Payee19791980Ventures Funding$ 5,400$ 5,400Candace Acceptance3,6003,600Fargo Acceptance810810Federated Finance-- 5,400Delta Acceptance-- 3,600Mahalo Acceptance-- 810$ 9,810$ 19,6201991 Tax Ct. Memo LEXIS 661">783 The disallowed amounts for Ventures Funding, Candace Acceptance, and Fargo Acceptance all related to the Candace Acceptance stock subscription plan. The disallowed amounts for the other three corporations related to the Delta Acceptance stock subscription plan. The Commissioner also increased the Cravenses' 1980 income by $ 18,000, which they had reported as a Schedule B nontaxable dividend distribution by Candace Acceptance. C. Ralph J. RinaPetitioner Ralph J. Rina (Rina) resided in Sunset Beach, California, when he filed his petition and throughout his years at issue, 1979 and 1980. He filed a Federal income tax return for each of these years with the Internal Revenue Service Center at Fresno, California. Rina completed high school and 3 years of college before he began to pilot aircraft full-time. He served 6 years in the Marine Corps reserve program beginning in 1964, and he has been employed as a pilot by Continental since 1966. Rina first learned of Kersting in 1978 or 1979 from pilots who had invested in his programs. Before this time, he had not been involved with tax shelters because he did not believe his salary warranted such investments. His annual salary1991 Tax Ct. Memo LEXIS 661">784 of $ 85,350 in 1979 was approximately 50 percent higher than his 1977 salary. He eventually met with Kersting in Kersting's Hawaii offices to discuss the programs. Kersting later sent Rina a letter dated November 7, 1979, which made no mention of profit potential for any Kersting corporation: I have structured the enclosed shelter program for you. You will find that you could have a total of $ 62,535.00 of total interest deductions this year, if you wish. However, due to the fact that interest must be apportioned from date of origination of a promissory note through year-end only 50% of the deductions could be claimed this year, i.e. $ 31,267.50. The remaining 50% can be claimed in 1980. If you want us to go ahead and produce the necessary documents, please call me upon receipt of this letter. * * * I will be enclosing forms to open a bank account here in Hawaii which we will need to facilitate clearing of tax deduction checks through your bank account before year-end.During a telephone conversation with Kersting on November 10, 1979, Rina gave his approval to document these deductions. In a short letter to Rina on November 12, 1979, Kersting wrote: "Candace Acceptance1991 Tax Ct. Memo LEXIS 661">785 Corp. documents still to come. We did not have sufficient time this weekend to complete all documentation. You can count on this deduction, however." Rina opened a checking account with Liberty Bank in November of 1979 by making an initial deposit of $ 100. Although he wrote checks drawn on this account, he never personally made another deposit, leaving that activity to Kersting, and he never used the account for anything other than Kersting-related transactions. He also had an account with Continental Federal Credit Union in 1979 and 1980, which he used to pay interest on his leverage loans. With initiating documents dated July 1, 1979, Rina entered into stock purchase plans involving Charter Financial ($ 80,000 purchase) and Investors Financial ($ 80,000 purchase), a stock subscription plan involving Candace Acceptance ($ 60,000 purchase and $ 60,000 subscription), and a leasing corporation plan involving Anseth Leasing ($ 19,000 purchase and $ 55,000 subscription). He did not lease an automobile as part of his leasing corporation plan, nor did he purchase additional stock under the subscription agreement. For his Candace Acceptance stock subscription plan, Kersting used1991 Tax Ct. Memo LEXIS 661">786 Liberty Bank to waltz primary loan funds on December 11, 1979, and leverage loan funds on December 17, 1979. The checks Rina wrote for primary loan interest and subscription interest were dated November 28, 1979. At the time of Rina's investments in Charter Financial, Investors Financial, and Candace Acceptance, he thought that they were lending institutions of some sort, but he did not have an idea of the specific types of loans they made. He knew of several pilots who were Charter Financial shareholders, but he did not know how many shareholders there were in total. He also did not know how long Charter Financial and Investors Financial had been in existence at the time he purchased their stock. He had heard from Kersting and participants in leasing corporation plans that Anseth Leasing owned automobiles. Kersting also told him that Anseth Leasing might enter into a leasing transaction with Rina for aircraft that neither Rina nor Anseth Leasing then owned, but which Rina was interested in acquiring. Whatever information Rina had about the businesses of any of the Kersting corporations in which he invested was obtained from other participating pilots or Kersting himself. 1991 Tax Ct. Memo LEXIS 661">787 He believed that at least some of the corporations had access to lendable funds that were available for purposes other than Kersting's investment programs. One of Rina's fellow pilots and acquaintances at Continental was Matt Bomis. Rina received an undated letter from Kersting that read in part: "Matt Bomis asked us this week to produce an additional $ 35,000.00 of tax deductions for you which we have done and which is summarized on enclosed sheet. You will have now a total of $ 81,906.00 in tax offsets." The enclosed sheet, which lacked any information meaningful to Rina except tax information, included three investments that were to be dated January 3, 1980: Charter Financial, Delta Acceptance, and Escon Leasing. Later, with initiating documents dated January 3, 1980, Rina entered into a stock purchase plan involving Charter Financial ($ 40,000 purchase) and a stock subscription plan involving Delta Acceptance ($ 60,000 purchase and $ 60,000 subscription). This stock subscription plan differs from the Stock Subscription Plan in that the Delta Acceptance stock certificate had a January 1983 date rather than a January 1980 date. Rina decided not to enter into the Escon Leasing1991 Tax Ct. Memo LEXIS 661">788 leasing corporation plan and mailed that package of documents back to Kersting unsigned. Rina did nothing with any check received from a Kersting corporation except endorse and return it, as instructed. He did not think it unusual that Kersting corporations issued two-party checks as loan proceeds. To him this was a reasonable procedure to assure the lender that the loan proceeds would be used consistently with the purpose of the loan. Prior to entering a Kersting investment program, Rina never received a prospectus, a projection of income for the corporations participating, or a written indication of anticipated appreciation in stock value. He did, however, sometimes receive written projected summaries of the annual interest deductions he could expect from specific Kersting investments. Even after entering a program, he never received a financial statement from a Kersting corporation or otherwise acquired any meaningful firsthand knowledge about whether the corporations ever had profits. He sometimes received requests for proxies and notices of shareholders meetings, but he did not attend. Acting upon assurances by Kersting that he would never have any trouble selling his1991 Tax Ct. Memo LEXIS 661">789 stock, Rina did so by returning the endorsed stock certificate to Kersting, a procedure that Rina thought was comparable to using a broker. On at least one occasion, Kersting told him that he was matching him as seller with a specific buyer. Rina and Kersting had no prearranged understanding on valuing stock that was inconsistent with Kersting's treating its value as equal to its original issuance price. For his Charter Financial stock, Rina received in return the primary note marked "paid" and nothing else. He has not attempted to sell his Investors Financial stock. He also still has his Delta Acceptance stock, and Kersting has not demanded payment of the principal balance of the associated primary loan. Rina and Kersting agreed to await the outcome of litigation and IRS investigations concerning the investment programs. Rina reported adjusted gross income for 1979 and 1980 of $ 80,647 and $ 121,938, respectively. He reported no capital gains or losses relating to Kersting corporations for either year. His return preparer for 1979 was Philip Scheff and for 1980 was Earl LeMond. He did not tell his return preparers how to report the annual distributions received from Kersting1991 Tax Ct. Memo LEXIS 661">790 corporations. In his notice of deficiency, the Commissioner disallowed claimed interest deductions as follows: Payee19791980Federated Finance$ 16,110$ 49,806Candace Acceptance3,6006,192Anseth Leasing3,3003,300Ventures Funding5,4005,400Fargo Acceptance-- 3,123Delta Acceptance-- 8,496Mahalo Acceptance-- 1,620$ 28,410$ 77,937D. John R. and Maydee L. ThompsonPetitioners John R. Thompson (Thompson) and Maydee L. Thompson (Mrs. Thompson) resided in Camarillo, California, when they filed their petitions. They filed a joint Federal income tax return for 1979 with the Internal Revenue Service Center at Fresno, California. They also filed joint returns for their other years at issue, 1980 and 1981. Throughout most of the years at issue, the Thompsons resided in Hawaii, returning to California in 1982. Thompson had a high school education but no college when he entered the Army Air Corps in 1942 at age 19. Except for military service during the Korean War, he worked for Continental from 1946 until his retirement in October of 1982. Mrs. Thompson was not employed during the years at issue. From 1946 to 1980, Thompson had 1991 Tax Ct. Memo LEXIS 661">791 some technical training and courses both in and out of the military, but he never received any formal instruction in business or accounting. When involved in business transactions, he sometimes relied on other people, including professionals, for guidance. Thompson first heard of Kersting in mid-1977 from Michael Provan when the two pilots were discussing ways to lessen and avoid income taxes. Thompson began a Kersting investment in that year, but the accounting firm that prepared the Thompsons' 1977 return refused to include the associated deductions because it wanted nothing to do with the Kersting programs. Provan also told Thompson about an investment opportunity concerning First Savings (described in part II (B), above), in which Thompson invested $ 20,000 cash. He knew that Kersting was promoting this investment to pilots, and First Savings appeared to him to be a healthy business when he visited and observed the premises. Sometime after 1979, Kersting returned Thompson's $ 20,000 investment by making a deposit to the Thompsons' Liberty Bank account. Kersting at some point also arranged for the Thompsons to finance a Hawaii home purchase through a savings/mortgage program1991 Tax Ct. Memo LEXIS 661">792 that had a below-market interest rate on the mortgage. They lost several thousand dollars in this program. By 1979, the Thompsons' first year at issue, Thompson was already participating in a leasing corporation plan involving Escon Leasing ($ 19,000 purchase and $ 55,000 subscription), in connection with which he leased an automobile. With initiating documents dated January 3, 1980, Thompson entered into stock purchase plans involving Investors Financial ($ 80,000 purchase) and Charter Financial ($ 120,000 purchase), and a stock subscription plan involving Delta Acceptance ($ 60,000 purchase and $ 60,000 subscription). Kersting had sent him a letter that, without mentioning anything else about the corporations, listed the annual interest deductions from these "tax shelter" investments. The letter also stated: "While this might not yet make you a zero taxpayer it will get you close to the zero line." Thompson knew nothing about the businesses of Charter Financial, Investors Financial, and Delta Acceptance, or who the other shareholders were, when he bought their stock. He also did not receive prospectuses, which he thought always accompanied stock transactions of this sort. 1991 Tax Ct. Memo LEXIS 661">793 Thompson did not own stock in the corporations that made the primary and leverage loans for his investments. He made interest payments on leverage loans for 1980 with checks drawn on the Thompsons' account at Liberty Bank, which was the only account they had at the time. Thompson quit participating in Kersting's programs beginning in 1982 when he received a notice from the IRS regarding the Thompsons' 1978 taxes. He immediately telephoned Kersting, who said he would take care of the problem. Thompson was not satisfied with Kersting's assistance, so he eventually sought out tax lawyers and settled the dispute with the IRS. When Thompson had originally begun participating in the Kersting programs, Kersting had assured him that he could return his stock certificates at any time in exchange for the notes used to acquire the shares. Nonetheless, when Thompson twice tendered his stock certificates after 1982, they were not accepted. He has not received back canceled or "paid" promissory notes. Kersting sent Thompson a letter dated March 31, 1986, which, in addition to showing a "total amount owing" of $ 11,844, read: "As we are trying to terminate your accounts I find that there1991 Tax Ct. Memo LEXIS 661">794 are some unattended bills on our books of which you might not be aware. All of the bills reflect interest on leverage notes which, as you know, produce the funds to pay interest on the primary notes." By letter dated August 23, 1986, Kersting informed the Thompsons that he had turned their file over to attorney Moseley, and added: Since the odds * * * are in favor of imminent litigation I consider it to be my obligation to point out to you the consequences: The day after you have allowed your attorneys to file suit I will declare all notes which you have executed to our companies in default and begin collection proceedings. We will make an effort to collect from you not only the $ 11,844.00 of interest on promissory notes of which we have sent you billings several times[,] we will also file suit to collect the principal of all notes which we hold. The aggregate sum is well in excess of $ 250,000.00, as you know.At the time of trial, Kersting was still not committed to taking the litigation initiative to pursue Thompson's outstanding principal amounts. The Thompsons reported adjusted gross income for 1979 through 1981 in the respective amounts of $ 86,158, $ 89,571, 1991 Tax Ct. Memo LEXIS 661">795 and $ 113,711. They reported no capital gains or losses relating to Kersting corporations for these years. Their return preparer for 1979 was Philip Scheff and for 1981 was Earl LeMond. Their 1980 return does not include the name or signature of a paid preparer. In his notices of deficiency, the Commissioner disallowed claimed interest deductions as follows: Payee197919801981Ventures Funding$ 10,800-- -- Candace Acceptance7,200-- -- Fargo Acceptance2,124-- -- Escon Leasing6,600$ 2,280-- Federated Finance11,25057,420-- Mahalo Acceptance1,5035,940-- Delta Acceptance-- 7,200-- Unidentified-- -- $ 89,782$ 39,477$ 72,840$ 89,782E. Hoyt W. and Barbara D. YoungPetitioners Hoyt W. Young (Young), also known as Wayne Young, and Barbara D. Young (Mrs. Young) resided in Cordova, Tennessee, when they filed their petitions. They also resided in Tennessee throughout their years at issue, 1979 through 1983. They filed joint Federal income tax returns for 1979 and 1980 with the Internal Revenue Service Center at Memphis, Tennessee, and also filed joint returns for 1981, 1982, and 1983. Young, 1991 Tax Ct. Memo LEXIS 661">796 50 years old at the time of trial, earned a college degree in business administration in 1961. He then served in the Marine Corps for 10 years, toward the beginning of which he learned to pilot aircraft at Naval Flight School, and was honorably discharged in 1971. In that year he became a registered representative for Waddell & Reed, selling mostly mutual funds and term insurance. During the years at issue, he was a pilot for Federal Express Corp., where he had worked since 1972. Mrs. Young was not employed during 1979, 1980, and 1983, but on the 1981 and 1982 returns, each of which includes a Schedule C relating to Amway products, she reported a "sales" occupation. Young first learned of Kersting and his investment programs in about 1978 from a former Federal Express employee, Gary Humphries. Because of his increasing income, Young was interested in possible tax shelters. Humphries explained the tax advantages of the Kersting programs with reference to interest deductions. Prior to making his Kersting investments, Young had some finance company borrowing experience, but the most money he had ever borrowed at one time related to the purchase of an automobile. He had never1991 Tax Ct. Memo LEXIS 661">797 leased an automobile. He had previously owned common stock, with mixed results. Young did not fill out a loan application or submit financial statements prior to borrowing funds from Kersting corporations, but Kersting was aware of his occupation. Although Young understood what a prospectus was, he neither requested nor received any relating to Kersting investments. He received written projections of tax benefits for Kersting programs and annual statements reflecting interest he had paid during the year, but he did not receive profit or income projections for any Kersting corporation. Although he had no firsthand knowledge of the business operations of the corporations in which he invested, Kersting and other participants told him that they engaged in lending and automobile leasing. With initiating documents dated July 1, 1979, Young entered into stock purchase plans involving Charter Financial ($ 120,000 purchase) and Investors Financial ($ 120,000 purchase), and a stock subscription plan involving Candace Acceptance ($ 60,000 purchase and $ 60,000 subscription). He also entered into a leasing corporation plan as of the same date involving Anseth Leasing ($ 19,000 purchase1991 Tax Ct. Memo LEXIS 661">798 and $ 55,000 subscription), in connection with which he neither leased an automobile nor executed a subsequent subscription agreement. He received other documents dated July 1, 1979, relating to a CAT-FIT plan, but he did not participate. The form letters that accompanied Young's 1979 and 1980 annual distributions from Charter Financial included this sentence: "We recommend to you * * * to remain a shareholder so that you will participate in the progress of your company in the future." Each of the letters that accompanied his 1979 annual distribution from Candace Acceptance and his 1980 annual distribution from Delta Acceptance included a similar sentence and also stated: "The investment funds of your company * * * are primarily employed in lending and lease financing." At the request of Kersting, Young opened a Liberty Bank checking account in 1979. He made an opening deposit of $ 100 with a check drawn on his account at First Tennessee Bank and dated December 22, 1979. Kersting or persons associated with Kersting corporations made all subsequent deposits to this Liberty Bank account. Young did not pay interest on leverage loans from the Liberty Bank account, making those payments1991 Tax Ct. Memo LEXIS 661">799 instead from his account at First Tennessee Bank. At least some of the acceptance corporations that served as his leverage lenders provided him with payment coupon books for the payment of interest on the leverage loans. With initiating documents dated January 3, 1980, Young entered into a stock subscription plan involving Delta Acceptance ($ 60,000 purchase and $ 60,000 subscription). He informed Kersting of his desire to start this program by checking the box (and filling in the blanks) next to this statement on a Kersting order form: "Last year, I had the 60/60 plan which generated for me a tax deduction of $ 18,000. I would like the same plan." Later, on January 8, 1980, he telephoned Kersting and asked him to hold this stock subscription plan until he decided whether he needed the deduction. Kersting sent Young a list of investments, including initiating dates and amounts of deductions, accompanied by a short letter stating in part: "These are the deductions you have for the year of 1980. Total of $ 78,231.00. It should afford you freedom from taxes for all practical purposes." Young did not visit the Kersting offices until 1983 or 1984 when he and Mrs. Young 1991 Tax Ct. Memo LEXIS 661">800 vacationed in Hawaii. Before that time, he transacted his business with Kersting by mail. He was somewhat concerned about sending large checks with his endorsement through the mail, but he realized that he had no practical alternative if he wanted to participate, plus he assumed that the endorsement of the second party, a corporation, on two-party checks would be difficult to forge. As Young understood them, the subscription agreements gave him the right and the obligation to purchase additional shares at $ 1 per share if the corporations "called" the subscription agreements. Despite believing that he had the right to tender payment on his own initiative and receive the additional shares, he never attempted to exercise this perceived right, nor did he seek an outside appraisal or other information as to the value of his Candace Acceptance or Anseth Leasing shares. He knew nothing about the change in value of his Anseth Leasing stock, if any, from July 1, 1979, to July 1, 1982. Young disposed of all of his stock in Kersting corporations prior to trial by returning the stock certificates to the Kersting offices by certified or registered mail. He received back his primary notes1991 Tax Ct. Memo LEXIS 661">801 marked "paid." The Youngs reported adjusted gross income for 1979 through 1983 in the respective amounts of $ 72,955, $ 83,214, $ 92,303, $ 87,908, and $ 78,360. They did not report capital gains or losses relating to Kersting corporations for any of these years. For each of 1980 and 1981, they reported nontaxable dividend distributions of $ 21,600 from Investors Financial, $ 21,600 from Charter Financial, $ 18,000 from Delta Acceptance, and $ 10,020 from Anseth Leasing. For 1982, they reported these same amounts as nontaxable dividend distributions from Investors Financial, Charter Financial, and Anseth Leasing, but reported nothing for Delta Acceptance. Their return preparers were Philip Scheff for 1979 and Robert Knapp for 1980 through 1983. In his notices of deficiency, the Commissioner disallowed claimed interest deductions as follows: Payee197919801981351982 1983Federated Finance$ 23,310$ 57,420$ 57,420$ 46,620.00-- Candace Acceptance4,8962,592-- 1,252.50-- Anseth Leasing3,3006,6002,2802,280.00-- Fargo Acceptance5402,458-- -- -- Ventures Funding5,400-- -- -- -- Delta Acceptance-- 10,440-- 375.75$ 1,127.25Mahalo Acceptance-- 1,871-- 4,320.00-- Aztec Acceptance-- -- -- 3,888.00-- Avalon Acceptance-- -- -- 648.00375.75Lombard Acceptance-- -- -- -- 3,888.00Avalon, Delta, Fargo-- -- 12,833-- -- Mahalo, Candace-- -- 5,823-- -- $ 37,446$ 81,381$ 78,356$ 59,384.25$ 5,391.001991 Tax Ct. Memo LEXIS 661">802 In addition, for 1980 and 1981 the Commissioner disallowed claimed sales tax deductions of $ 138 and $ 56, respectively. For 1981 he disallowed $ 4,352 claimed as business deductions on Schedule C and $ 880 claimed as an insurance deduction on Schedule A. For 1982 he disallowed $ 960 deducted as insurance on Schedule A. F. Robert L. and Carolyn S. DuFresnePetitioners Robert L. DuFresne (DuFresne) and Carolyn S. DuFresne (Mrs. DuFresne) resided in Memphis, Tennessee, when they filed their petitions and throughout their years at issue, 1980 through 1983. They filed a joint Federal income tax return for each of these years with the Internal Revenue Service Center at Memphis, Tennessee. DuFresne is a high school graduate who at the time of trial was 46 years old and enrolled in a marketing degree program at Memphis State University. He had accumulated over 2 years1991 Tax Ct. Memo LEXIS 661">803 of a college education at various institutions by that time. Although he had some military experience, from which he was honorably discharged, he learned to pilot aircraft privately and at his own expense in about 1963. During the years at issue, DuFresne was a pilot with Federal Express, as he had been since 1972. His annual salary, which in 1972 was approximately $ 18,000, increased substantially in 1978 because of airline deregulation. Mrs. DuFresne worked as a bookkeeper in 1980. The returns for the other years at issue, each of which includes a Schedule C relating to Amway products, show her occupation as "sales." DuFresne's daughter, Carolyn, lived in his house at the beginning of 1980. DuFresne first heard of Kersting and his investments in about 1980 from a friend and fellow Federal Express employee, petitioner Young, who was already participating in the Kersting programs. Young did not go into much detail with DuFresne other than brief mention of leasing activity and loan and financing companies, but instead provided him with Kersting's telephone number and offered to mention him to Kersting. When DuFresne later telephoned, Kersting already knew who he was. Kersting1991 Tax Ct. Memo LEXIS 661">804 inquired about his background, including finances, during one or more of their first few conversations, but DuFresne never provided Kersting with a written application or qualification form. Kersting described some of the corporations as leasing corporations and said that most of the corporations dealt with money. DuFresne had heard over the years that financial institutions were often good investments. Prior to 1980, the only stock DuFresne had owned was that of Federal Express, some of which he purchased through a broker, and the only automobile he had leased was a 1974 Pontiac, the lessor of which was not a Kersting corporation. He had borrowed money from and paid interest to financial institutions, with his largest borrowing, a home mortgage loan, amounting to about $ 65,000. He did not have any experience with tax shelters before 1980. At no time was DuFresne provided with a prospectus or other written statement of any of the Kersting programs in which he participated. Nor did he receive any financial statements or projections of net income or stock value appreciation for any of the Kersting corporations. He did, however, hear about the tax advantages before investing. 1991 Tax Ct. Memo LEXIS 661">805 With initiating documents dated January 3, 1980, DuFresne entered into stock purchase plans involving Charter Financial ($ 120,000 purchase) and Investors Financial ($ 80,000 purchase), CAT-FIT plans for three children (each investment certificate with a face amount of $ 17,000), and a stock subscription plan involving Delta Acceptance ($ 60,000 purchase and $ 60,000 subscription). At the time of his investments in Charter Financial and Investors Financial, he assumed their business was that of a lending institution. The DuFresnes opened a checking account at Liberty Bank in May of 1980 at Kersting's suggestion. DuFresne made an initial deposit of $ 100 with a check dated May 8, 1980, and drawn on his account at First Tennessee Bank. He sent the $ 100 check and signature cards to Kersting at the same time he returned executed documents for his Delta Acceptance stock subscription plan. He or Mrs. DuFresne wrote checks drawn on First Tennessee Bank to pay interest on his leverage loans. DuFresne's understanding of the legal effect of the Delta Acceptance subscription agreement coincided with that of Kersting. He did not think it unusual that someone else made deposits to his1991 Tax Ct. Memo LEXIS 661">806 account in the course of these transactions, in part because his employer, Federal Express, had been doing it for years. DuFresne understood from Kersting that there would be no problem in selling his stock when he wanted to dispose of it. Although DuFresne would have been deeply concerned if his salary had been his only source for paying back his Kersting loans, he assumed that disposition of the underlying stock would serve that purpose. After he decided to terminate his participation in the CAT-FIT plans, he returned the originals of the investment certificates to Kersting in January of 1981, receiving back his primary note marked "paid." He disposed of his Charter Financial and Investors Financial stock, sometime after the years at issue, by first talking to Kersting about liquidating his investments and then returning the stock certificates to Kersting. On the disposition of the Charter Financial stock, the DuFresnes reported a capital gain attributable to reduced basis rather than increased value. DuFresne sent two letters to Kersting dated June 22, 1984. In the handwritten one he wrote: The enclosed letter is for the benefit of our friends at the IRS and the courts. 1991 Tax Ct. Memo LEXIS 661">807 I have retained a copy for my files and I believe the wording will justify the sale and the reinvestment. I strongly suggest that the actual transfer of funds take place to be able to prove later that a financial transaction did in fact take place. They'll be looking for a shuffling of paper, so we want to be sure to dot all of our 'Is' and to cross all of our 'Ts.' * * I would destroy this note, after you have read it.His second letter, which was typewritten and addressed to Charter Financial, stated: Per our conversation, I am returning my stock certificate for 11,429 shares of Charter Financial Corporation. These shares which I purchased in January, 1980 for approximately $ 10.50 per share should yeild [sic] $ 12.25 or a total return of $ 140,000.00. It's unfortunate that this only represents a yeild [sic] of about 5% per annum. I had certainly hoped for a higher return on my investment. Rather than return any of the above funds directly to me; I would like to request, if convenient with you, that you make one check payable to Federated Finance Company in the amount of $ 120,000.00 (One Hundred and Twenty Thousand Dollars) to clear IN FULL my 'Demand Loan' 1991 Tax Ct. Memo LEXIS 661">808 that is outstanding with that company. Secondly, make a second check payable to Federal Finance Company in the amount of $ 20,000.00 (Twenty Thousand Dollars), the capital gain on the above mentioned stock. This monies [sic] will be deposited in their savings system at 16%. Needless to say, a much better growth potential than with your company.The DuFresnes reported adjusted gross income for 1980 through 1983 in the respective amounts of $ 95,885, $ 93,800, $ 86,774, and $ 96,326. They reported no capital gains or losses relating to Kersting corporations for any of these years. For each of 1981, 1982, and 1983, they reported nontaxable dividend distributions of $ 21,600 from Charter Financial and $ 14,400 from Investors Financial. They also reported dividend income for 1981 from First Union Bancorp and for 1982 and 1983 from Centerre Bancorporation. Their return preparer for 1980 was Earl LeMond, for 1981 and 1982 was Robert Knapp, and for 1983 was William Lenahan. In his notices of deficiency, the Commissioner disallowed claimed interest deductions as follows: Payee1980198119821983Federated Finance$ 46,800$ 36,000$ 36,000-- Delta Acceptance10,440-- -- -- Windsor Acceptance6,120-- -- -- Mahalo Acceptance2,171-- -- -- Avalon Acceptance-- 3,240-- -- Aztec Acceptance-- -- 3,240-- Lombard Acceptance-- -- -- $ 3,240Charter Financial-- -- -- 21,600Investors Financial-- -- -- 14,400$ 65,531$ 39,240$ 39,240$ 39,2401991 Tax Ct. Memo LEXIS 661">809 For 1980 the Commissioner also disallowed a dependency exemption for DuFresne's daughter, Carolyn. For 1981 he disallowed a claimed Schedule C loss of $ 5,012 and decreased a Schedule A sales tax deduction by $ 30, both of which have been conceded by the DuFresnes. G. Terry D. and Gloria K. OwensPetitioners Terry D. Owens (Owens) and Gloria K. Owens (Mrs. Owens) resided in Kailua, Hawaii, when they filed their petition. They filed a joint Federal income tax return for each of their years at issue, 1975 through 1978, with the Internal Revenue Service Center at Fresno, California. They filed an amended 1975 return in 1976, and amended 1978 returns in 1982 and again in 1983. Owens, 51 years old at the time of trial, is a high school graduate with over 3 years of college spent pursuing a medical degree. After college, he began military service in 1958, went through Naval Flight School, and continued to fly in the military until his honorable discharge in 1966. Since July of 1966 he has been employed by Continental, first as a pilot and since 1978 as a management pilot. Mrs. Owens was not employed during the years at issue. Except for a short 1978 stint in Houston, Texas, 1991 Tax Ct. Memo LEXIS 661">810 Owens lived in Honolulu, Hawaii, from 1970 until 1982. He first learned of Kersting in about 1971 from a fellow Continental pilot who did not go into much detail. Owens later participated in a group meeting with Kersting. Kersting's offices at the time were in a different Hawaii location than presently. Owens visited the Kersting offices many times over the years and discussed business there with Kersting. He also met Gabriele Kersting at these offices. In the early 1970s, the Owenses opened a checking account at Hawaii National Bank, which remains open, and Owens used this account for personal purposes as well as Kersting-related transactions. They also had an account at Bank of Hawaii during the years at issue, which Owens usually used to write checks to Kersting corporations. Mrs. Owens also sometimes wrote checks on this Bank of Hawaii account to Kersting corporations. Owens used the Hawaii National Bank account, however, to pay interest on the primary loan for his CAT-FIT plans and to pay primary loan interest and subscription interest for his stock subscription plans. Owens often bought and sold exchange-listed securities, beginning before the years at issue. His 1991 Tax Ct. Memo LEXIS 661">811 first tax-advantaged investment and first investment with Kersting was a mortgage funding program (described in part I, above), which he began in 1971 or 1972. Shortly before or after beginning this program, Owens saw a copy of a favorable Dun & Bradstreet report on Kersting. In connection with this program and by means of a Note and Security Agreement dated April 1, 1974, he borrowed $ 4,000 at 18-percent annual interest from Confidential Finance in a refinancing transaction of some sort. His second tax-advantaged investment was a CAT-FIT plan, which he began in about 1973, followed by some sort of automobile leasing program. Beginning in about 1973, he occasionally borrowed funds from, and paid interest to, Confidential Finance for things like his children's private school expenses. During 1975 and 1976, he continued his participation in the mortgage funding program. From the investment account of this program he withdrew $ 2,700 to satisfy an IRS judgment, which amount he reported as a long-term capital gain on the 1975 return. He wrote a check for $ 500 drawn on his account at Hawaii National Bank and dated December 15, 1975, that was payable to First Atlas Funding and included1991 Tax Ct. Memo LEXIS 661">812 the notation "Inv. Advisory Fee." With initiating documents dated January 2, 1975, Owens entered into CAT-FIT plans for two children, with each investment certificate in the face amount of $ 17,000. On April 20, 1977, after having been the subject of several IRS audits, he informed Kersting that he would not claim CAT-FIT deductions on the Owenses' 1976 return. Kersting used Hawaii National Bank to waltz leverage loan funds for the Owens CAT-FIT plans on August 8, 1978. The check Owens wrote for primary loan interest was dated August 2, 1978. With initiating documents dated August 10, 1975, Owens entered into a stock subscription plan involving Norwick Acceptance ($ 20,000 purchase and $ 20,000 subscription), which differs from the Stock Subscription Plan in the following respects: The primary loan proceeds check was not a two-party check, but was payable to Norwick Acceptance alone; Owens was provided with a copy of the stock certificate, but Windsor Acceptance kept the original as collateral for its primary loan; the subscription agreement did not have an expiration date; the leverage note was on its face a demand note; the leverage lender was First Atlas Funding rather than1991 Tax Ct. Memo LEXIS 661">813 an acceptance corporation; and the date on the leverage note was December 1, 1975, rather than the August date of the other initiating documents. Sometime around August of 1977, Owens received a form letter asking him to renew the primary note. This letter concluded: Norwick Acceptance Corp. will pay you once a year from now on a dividend in an amount equal to the interest required to service the note to Mahalo Acceptance Corporation. The result will be that there will be no further cost to you. You can anticipate, as time goes by, capital appreciation and perhaps cash dividends out of your investment in Norwick Acceptance Corp. stock. In the meanwhile, you can be at ease knowing that the transaction is self-sustaining.During 1975, Owens was one of 10 shareholders of the subchapter S leasing corporation named Maurier Leasing. He leased at least one automobile himself from Maurier Leasing. The 1976 Form 1120S for Maurier Leasing indicates that he was the owner of 7,000 shares from January 1, 1975, to January 1, 1976. Owens received a "Summary of Tax Deductions, Tax Losses and Tax Refunds" dated July 28, 1975, that listed $ 6,143.25 as the purchase price of an automobile, 1991 Tax Ct. Memo LEXIS 661">814 7,000 as the shares of stock in a "Leasing Co.," $ 105 as monthly interest payments ($ 1,260 per year), and $ 138 as monthly lease payments ($ 1,656 per year). This statement also listed anticipated tax refunds of from $ 1,652 to $ 4,130, depending on the applicable tax bracket. By the terms of a Note and Security Agreement (#1573) dated July 28, 1975, Owens promised to pay Confidential Finance $ 7,000 on July 28, 1977, if not demanded earlier, with interest payable monthly at an annual rate of 18 percent. According to this document, associated loan proceeds would be in the form of checks issued to Owens and Maurier Leasing. Confidential Finance issued a check for $ 7,000, dated July 28, 1975, payable to Owens and Maurier Leasing. By the terms of another Note and Security Agreement (#1574) dated July 28, 1975, Owens promised to pay Confidential Finance $ 2,916 on May 15, 1976, with interest payable monthly at an annual rate of 18 percent. According to this document, associated loan proceeds would be in the form of checks issued to Owens and Confidential Finance for $ 1,260 and to Owens and Maurier Leasing for $ 1,656. Confidential Finance issued two conforming checks dated 1991 Tax Ct. Memo LEXIS 661">815 July 28, 1975, and also issued a receipt to Owens dated August 8, 1975, for $ 1,260 of interest attributable to loan number 1573. By letter dated October 15, 1975, Kersting informed Owens that because of a 4-percent gross income tax imposed by the State of Hawaii, his monthly lease payment beginning in January of 1976 would be $ 143.52, an increase of $ 5.52 per month over the tax summary sheet amount. Kersting also requested $ 27.60 (which is $ 5.52 multiplied by 5) by December of 1975 to adjust lease payments already made. By the terms of a Note and Security Agreement dated May 19, 1976, Owens promised to pay Confidential Finance $ 2,982.24 on May 19, 1977, if not demanded earlier, with interest payable monthly at an annual rate of 18 percent. According to this document, associated loan proceeds would be in the form of checks issued to Owens and Confidential Finance for $ 1,260, to Owens and Maurier Leasing for $ 1,656, and again to Owens and Maurier Leasing for $ 66.24 (which is $ 5.52 multiplied by 12) for excise tax. In 1976, Owens was a first officer earning between $ 30,000 and $ 40,000 annually. Because he worked under a contract based on an hourly rate, he could project1991 Tax Ct. Memo LEXIS 661">816 his salary in advance for a year covered by the contract. With initiating documents dated September 1, 1976, Owens entered into a leasing corporation plan involving Universal Leasing ($ 14,000 purchase and $ 42,000 subscription), in connection with which he leased an automobile. A "Summary Sheet of Expenses and Deductions" dated September 1, 1976, listed monthly lease payments of $ 130 on an automobile costing $ 4,500 ($ 1,560 per year) and monthly State sales tax payments of $ 5.20 ($ 62.40 per year). Most of this sheet was devoted to projected interest deductions and Federal and State tax refunds. Universal Leasing later sent Owens a letter that stated near the top, "Interest paid to Universal Leasing $ 5,040" and "Interest paid to Federated Finance Co. $ 2,520," and further stated: You will be pleased to know that we have recorded for you the above listed interest deductions which can be claimed against your 1976 income. These deductions pertain only to your involvement in Universal Leasing Corp. They do not include the interest deductions which you will be able to claim as a shareholder of one of our SubChapter S companies or as a result of any other investment you may1991 Tax Ct. Memo LEXIS 661">817 have made with us. Those deductions will be reported to you in due course. As you are a shareholder now of Universal Leasing Corporation we have terminated your participation in the SubChapter S Leasing Company. Please return to us your stock certificate (if one had been issued to you) so that we can cancel the note which corresponded with it. No further obligation on your part exists with respect to the old program, except your monthly charges if your account is not current at this time. A full accounting will be prepared shortly and you will receive either a rebate or a billing. So that we can begin the New Year with a clean slate we would like you to remit your monthly payment from now on as called for in the summary sheet which was mailed to you with the documents reflecting your entry into Universal Leasing Corp. To refresh your memory, your monthly payments were scheduled as follows: $ 114.00 to Federal Finance & Mortg. Co. $ 135.20 to Universal CorporationOwens' leasing corporation plan with Universal Leasing differs from the Leasing Corporation Plan in the following respects: The subscription agreement had no expiration date; the leverage lender was Federal1991 Tax Ct. Memo LEXIS 661">818 Finance & Mortgage rather than an acceptance corporation; the leverage note had a 2-year term rather than 1; and the leverage note indicated that the loan proceeds would include an additional check made payable to Owens and Universal Leasing in the amount of $ 1,560, which was to prepay automobile lease amounts. With initiating documents dated October 10, 1976, Owens entered into a stock subscription plan involving Forbes Acceptance ($ 30,000 purchase and $ 30,000 subscription), which differs from the Stock Subscription Plan in that the primary note was payable on March 1, 1978, if not demanded earlier, in contrast to the standard 2-year term. The form letter that transmitted the initiating documents, which was signed by Gabriele Kersting, advised the investor to "Keep the [stock] certificate in a safe place as you will need it later to retire the $ 30,000.00 note." With initiating documents dated April 1, 1978, Owens entered into a stock subscription plan involving Mahalo Acceptance ($ 30,000 purchase and $ 30,000 subscription). Kersting used Hawaii National Bank to waltz primary loan funds on September 18, 1978, and leverage loan funds on September 19, 1978. The checks Owens1991 Tax Ct. Memo LEXIS 661">819 wrote for primary loan interest and subscription interest were dated September 8, 1978. Owens understood his subscription agreements to give him the right and the obligation to purchase the additional shares at $ 1 per share if called upon by the corporation. He never purchased additional shares pursuant to these agreements. He did not receive a prospectus for any of his Kersting investments, nor a written description of anticipated net income or stock value appreciation. He did, however, routinely receive written statements about anticipated tax benefits. He occasionally received a proxy statement from Kersting and at least once signed and returned it. He did not ever vote his shares in person. Owens did not participate in Kersting investment programs after 1978 primarily because of the IRS audits that his Kersting investments attracted. At some point he received a "paid" primary note in exchange for his Norwick Acceptance stock. The Owenses reported adjusted gross income for 1975 through 1978 in the respective amounts of $ 24,582 ($ 28,364 in the amended return), $ 41,770, $ 48,466, and $ 59,962. The only capital gains or losses relating to Kersting corporations that they1991 Tax Ct. Memo LEXIS 661">820 reported for these years were a $ 2,700 long-term capital gain for 1975, which was from the investment account of the mortgage funding program, and a $ 1,100 long-term capital gain for 1976, both relating to First Atlas Funding. They reported no dividend income for 1977 or 1978. For 1975, 1977, and 1978, their returns, including amended returns, were prepared by Gilbert Matsumoto or someone else at the accounting firm with which he was affiliated, Matsumoto & Murakami. Matsumoto was Owens' tax adviser from 1971 through the years at issue. In his notice of deficiency, the Commissioner disallowed claimed interest deductions as follows: Payee1975197619771978Windsor Acceptance$ 3,600$ 360$ 180-- Norwick Acceptance2,400-- -- -- First Atlas Funding2,231-- -- -- Confidential Finance1,8403,122-- -- Atlas Funding-- 1,800-- -- Forbes Acceptance-- 840798$ 652Federated Finance-- 840240-- Universal Leasing-- 840-- -- $ 10,071$ 7,802$ 1,218$ 652The Commissioner disallowed subchapter S losses of $ 7,207 from Maurier Leasing in 1975 and $ 67 from Aztec Leasing in 1976, and investment expenses1991 Tax Ct. Memo LEXIS 661">821 of $ 500 for 1975 and $ 600 for 1976. The grounds for disallowance of the subchapter S losses were that the corporations were not "viable tax entities," that they had excessive interest income that caused an automatic termination of subchapter S status, and that they did not file timely subchapter S elections. The Commissioner also disallowed an investment tax credit carryback of $ 11,294 from 1981, which the Owenses claimed in their first amended return for 1978, and education expenses of $ 9,234 for 1978, which they claimed in their second amended return for that year. H. Richard and Fidella HongsermeierPetitioners Richard Hongsermeier (Hongsermeier) and Fidella Hongsermeier (Mrs. Hongsermeier) resided in Spring, Texas, when they filed their petition, and in Seal Beach, California, during their years at issue, 1978 through 1980. They filed a joint Federal income tax return for each of these years with the Internal Revenue Service Center at Fresno, California. Hongsermeier completed high school and then attended 1-1/2 years of junior college. Afterwards, he joined the Navy, attended flight school, and flew aircraft in the Navy for 12 years. He started flying for Continental1991 Tax Ct. Memo LEXIS 661">822 in 1967 and has worked there ever since. He has no formal accounting background. Mrs. Hongsermeier was not employed during the years at issue. Hongsermeier first learned of Kersting and his programs in about 1976 from fellow Continental pilot Michael Provan, who told him about the tax advantages and that Kersting corporations leased automobiles and factored accounts. His first investments with Kersting began in 1977 when his annual salary was approximately $ 35,000, after he sent a letter to Kersting inquiring about mortgage funding and the CAT-FIT Plan. Because of the working contract under which he was employed, he was fairly certain that his income would be increasing. Kersting did not make representations about profit potential or anticipated stock value appreciation for the corporations in which Hongsermeier considered investing. Hongsermeier did receive, however, statements of anticipated tax benefits and summary sheets showing loans, interest, and tax effects. He relied on word-of-mouth from other pilots, who he understood to do the same, for information on the progress of a program. With initiating documents dated January 1, 1977, Hongsermeier entered into a CAT-FIT1991 Tax Ct. Memo LEXIS 661">823 plan with an investment certificate in the face amount of $ 25,000. In 1977 he felt that his income, savings, and other investments were sufficient to enable him to pay off a $ 25,000 debt. With initiating documents dated January 1, 1978, he entered into a CAT-FIT plan for a second child, again with a $ 25,000 investment certificate. His understanding of his CAT-FIT plans was that he borrowed $ 25,000, on which he paid interest, to be invested in an income-generating certificate for the child. A letter dated March 29, 1977, which was signed by Gabriele Kersting, explained the program to him: Windsor Acceptance Corp. lends you $ 25,000, at 12% per annum. With that $ 25,000, you invest in a thrift certificate with Atlas Guarantee Corp. in your child's name for the exact same amount. Your child will earn 12% per annum on the certificate, so the transaction, in essence, becomes a wash-out. Another lender, Norwick Acceptance Corp., then makes you a loan for $ 3,000, which is one year's interest on the $ 25,000 note. Norwick Acceptance charges you 6% per annum on the $ 3,000, which is your only real expense in the program. (It amounts to $ 180.00 per year.) However, you have1991 Tax Ct. Memo LEXIS 661">824 sent us $ 250.00, which I imagine, you felt you must pay every month. But as I have stated, you have already paid the $ 3,000, with a loan from Norwick Acceptance Corp. Incidentally, we have not received the original signed copy from you yet.In addition to the $ 25,000 amounts, the Hongsermeier CAT-FIT plans were unusual because of the absence of a leverage loan. Hongsermeier elected not to borrow funds from Norwick Acceptance to pay interest on the primary loans, deciding instead to remit monthly amounts of $ 250 for each child with checks drawn on Wells Fargo Bank in California. The Hongsermeiers were also unusual in depositing the interest checks they received to the children's savings accounts, which Mrs. Hongsermeier supervised, rather than endorsing and returning them. One interest check issued by Atlas Guarantee in 1977 was returned by the drawee bank for insufficient funds when Hongsermeier tried to cash it. Kersting apologized in a letter dated September 6, 1977, stating that all of his other CAT-FIT clients "receive their interest checks as a credit" to their accounts rather than as cash, and thus there was generally no need to keep funds on deposit for Atlas 1991 Tax Ct. Memo LEXIS 661">825 Guarantee. Windsor Acceptance rather than Atlas Guarantee issued some of the interest checks to the Hongsermeier children. Hongsermeier terminated the CAT-FIT plans sometime after the years at issue, and he received the original of at least one of his primary notes marked "paid." He did not use interest income deposited in the children's savings accounts to pay off the primary loans. With initiating documents dated January 1, 1977, and January 2, 1977, Hongsermeier entered into leasing corporation plans involving, respectively, Universal Leasing ($ 12,000 purchase and $ 36,000 subscription) and Escon Leasing ($ 19,000 purchase and $ 55,000 subscription). In connection with the Universal Leasing plan, he leased at least one automobile. He had originally purchased a Toyota Celica in 1977 from a California dealer unrelated to Kersting, financing the purchase through Continental Federal Credit Union. After he sold the automobile to Universal Leasing in 1977, to which he then made lease payments, Universal Leasing took over his payments to the credit union. He later leased a Toyota Corolla for 2 or 3 years from a Kersting leasing corporation. At the end of the lease term for the1991 Tax Ct. Memo LEXIS 661">826 Corolla, the vehicle was sold and the proceeds went to the leasing corporation. Hongsermeier's leasing corporation plan with Universal Leasing differs from the Leasing Corporation Plan in these respects: Checks issued by Universal Leasing had a July date rather than January; the subscription agreement had a stated expiration date that coincided with the date of the subscription agreement; and the subsequent stock acquisition note had a term of 2 years rather than 3 years. Hongsermeier's leasing corporation plan with Escon Leasing differs from the Leasing Corporation Plan in that the subsequent stock acquisition note by its terms was a demand note. With initiating documents dated January 3, 1980, Hongsermeier entered into a stock subscription plan involving Delta Acceptance ($ 40,000 purchase and $ 40,000 subscription) and a leasing corporation plan involving Anseth Leasing ($ 19,000 purchase and $ 55,000 subscription), in connection with which he did not lease an automobile. He instructed Kersting to commence the Delta Acceptance program with the standard order form on which he checked "40,000" shares. Hongsermeier transferred the balance of the Hongsermeiers' Hawaii National1991 Tax Ct. Memo LEXIS 661">827 Bank account to a new account at Liberty Bank in May of 1980. He wrote checks drawn on this new account and dated May 29, 1980, to pay primary loan interest and subscription interest for his Delta Acceptance stock subscription plan. The Hongsermeiers reported adjusted gross income for 1978, 1979, and 1980, in the respective amounts of $ 55,069, $ 67,667, and $ 78,733. They reported no capital gains or losses relating to Kersting corporations for these years. Hongsermeier's tax accountant and adviser during these years was Philip Scheff, who had been recommended to Hongsermeier by someone he knew to be involved in Kersting investments. Scheff prepared the Hongsermeier returns for 1978 and 1979 based in part on statements of interest paid provided to Hongsermeier by Kersting corporations. Earl LeMond prepared the 1980 return. Hongsermeier also provided his accountants with statements he received from Kersting corporations concerning their annual distribution checks. In his notice of deficiency, the Commissioner disallowed claimed interest deductions as follows: Payee197819791980Escon Leasing$ 6,600$ 6,600$ 2,280Federated Finance5,5805,58014,040Windsor Acceptance5,5006,0006,000Universal Leasing4,3201,440-- Fargo Acceptance2,2692,4751,253Mahalo Acceptance-- 2,8805,606Anseth Leasing-- -- 6,600Delta Acceptance-- -- 4,800Candace Acceptance-- -- 1,503$ 24,269$ 24,975$ 42,0821991 Tax Ct. Memo LEXIS 661">828 The Commissioner also determined that income averaging was not available for 1979. OPINION As the first of three preliminary matters, we address the filed stipulations of fact in these cases totaling approximately 140 pages and incorporating exhibits of many times that volume. In some instances, stipulated narrative facts are inconsistent with their referenced exhibits. In other instances, narrative facts and exhibits that are not inconsistent with one another inexplicably conflict with other parts of the record. For example, the parties stipulated that specific referenced documents related to the Youngs' "claimed interest deductions arising from their alleged investment" in a July 1979 CAT-FIT plan with Windsor Acceptance. The Youngs' tax return for neither 1979 nor 1980, however, includes a claimed interest deduction for payments to Windsor Acceptance. Furthermore, Young testified that although he received the CAT-FIT documents in question, he did not execute them or otherwise enter into the program. The parties then agreed in their briefs, contrary to the stipulation, that the Youngs did not participate in a CAT-FIT plan. The evidence similarly rebutted a stipulated fact1991 Tax Ct. Memo LEXIS 661">829 concerning Rina's participation in a leasing corporation plan with Escon Leasing. In view of the questionable reliability of the stipulations, we have not expressly adopted them in our findings of fact. We have instead derived those findings from the record as a whole. The second preliminary matter concerns petitioners' proposed findings, offered in their opening briefs in accordance with Rule 151(e)(3). Although we have considered each proposed finding, many have not survived our scrutiny. Of those that we have not adopted, many are based largely or exclusively on Kersting's testimony. Because of Kersting's central role in the transactions at issue in these cases, his written and spoken words comprise a major portion of the record. Nonetheless, based upon our observations at trial and our review of the record, we have concluded that he lacks credibility, especially on those matters tending to reflect upon the tax viability of his investment programs. Some examples follow. Regarding the filing of Federal income tax returns for the various Kersting corporations, Kersting testified that prior to the IRS seizure of his records in 1981, "I think they were current on all filings." 1991 Tax Ct. Memo LEXIS 661">830 In reality, many returns for taxable years ending before 1981 were not even signed by Kersting before 1985, including returns for Fargo Acceptance, Mahalo Acceptance, Candace Acceptance, Anseth Leasing, and Escon Leasing. Also contradicting his testimony is his letter of December 2, 1981, in which he admitted to a revenue agent that he had intentionally "held back over the years the Tax Returns for the Acceptance Companies and some of the Leasing Companies." According to Kersting, return filings were no longer timely made after seizure of his records because there was "no basis on which to prepare statements or prepare tax returns." This testimony conflicts with Kersting form letters to clients in the months following, in which he referred to "only a temporary disruption" and, by late May of 1981, a "return to normalcy of operations." In addition, the bookkeepers maintained their own records, which the IRS never seized, and Ms. Combs testified credibly that their work was largely unaffected by Kersting's misfortune. Indeed, Ms. Akamine prepared several returns in 1984 while Kersting's records were still in the hands of the IRS. Kersting sought to squeeze even more mileage out 1991 Tax Ct. Memo LEXIS 661">831 of what he termed the IRS "raid" in 1981. He testified that Hawaii National Bank had been "scared" by the raid and so asked him to close his accounts and take his business elsewhere in mid-1981. An employee of the bank, however, testified that the account closings resulted from fear of check-kiting and occurred before 1981. Bank statements in the record support this employee in indicating that five Kersting corporations closed their Hawaii National Bank accounts in March of 1979. The record contains no Hawaii National Bank statement covering a subsequent period for any Kersting corporation. Another straightforward indication of the overall unreliability of Kersting's testimony relates to his daughter, Gabriele, who Kersting said did not actively participate in day-to-day corporate operations. The documentary evidence establishes otherwise, as her signature appears on both personalized letters and form letters concerning both CAT-FIT plans and stock subscription plans. Also, although petitioner Owens could not remember precisely when he met Gabriele Kersting, he did recall that the location was the Kersting offices. As the third preliminary matter, the notices of deficiency 1991 Tax Ct. Memo LEXIS 661">832 in these cases raised several issues that do not relate directly to the Kersting investment programs (not including additions to tax and increased interest). In their briefs, petitioners have neither directed us to specific evidence nor advanced arguments contrary to these adjustments by the Commissioner. We accordingly deem petitioners to have conceded these issues. Issue 1: Validity of Deficiency NoticesAs a threshold jurisdictional issue, all petitioners except the Cravenses and the Thompsons challenge the notices of deficiency, citing Scar v. Commissioner, 814 F.2d 1363">814 F.2d 1363 (9th Cir. 1987), revg. 81 T.C. 855">81 T.C. 855 (1983). These petitioners contend that the Commissioner failed to audit their returns or request their records before issuing the notices of deficiency, thereby rendering those notices null and void. Earlier in these proceedings, the Hongsermeiers made similar arguments with extensive elaboration in a motion to dismiss for lack of jurisdiction and supplements thereto. The Court denied that motion as without merit. In Scar, the notice of deficiency disallowed a deduction from a partnership with which the taxpayers were not connected. 1991 Tax Ct. Memo LEXIS 661">833 Documents attached to the notice of deficiency indicated that the deficiency was arrived at without an examination of the taxpayers' return. The Court of Appeals, in concluding that this Court lacked jurisdiction, stated that "the Commissioner must consider information that relates to a particular taxpayer before it can be said that the Commissioner has 'determined' a 'deficiency' in respect to that taxpayer." 814 F.2d 1363">814 F.2d at 1368. This principle does not override the presumption of a deficiency determination, however, if the notice itself reveals that the deficiency was based on information relating to the taxpayer. Clapp v. Commissioner, 875 F.2d 1396">875 F.2d 1396, 875 F.2d 1396">1402 (9th Cir. 1989); Campbell v. Commissioner, 90 T.C. 110">90 T.C. 110, 90 T.C. 110">113-114 (1988). Unlike the notice of deficiency in Scar, the notices that petitioners have called into question here bear a discernible connection to the subject tax returns. Not only are specific claimed deductions disallowed in the notices, but the adjusting computational schedules in the notices incorporate other amounts reported by petitioners in those returns. The attempt by petitioners to have us in effect1991 Tax Ct. Memo LEXIS 661">834 reconsider and reverse our denial of the Hongsermeier motion to dismiss is unavailing. The notices of deficiency are not invalid on the basis of Scar. Issue 2: Section 163(a) Interest DeductionsSection 163(a) allows as a deduction "all interest paid or accrued within the taxable year on indebtedness." The principal substantive issue in these cases is whether petitioners are entitled to deductions for interest corresponding to primary loans, leverage loans, and subscription agreements. Primary loans and leverage loans were integral parts of all four of the main Kersting investment programs, except that a leverage loan was not always a part of the CAT-FIT Plan. Subscription agreements were used in the Stock Subscription Plan and the Leasing Corporation Plan. Respondent contends primarily that the transactions giving rise to the disallowed interest deductions were shams. Before turning to the sham analysis, we address both a general policy argument by petitioners and another example of Kersting's deceptive testimony, which together provide an appropriate introductory overview of the stock transactions. The CAT-FIT Plan, which involves a different type of investment1991 Tax Ct. Memo LEXIS 661">835 asset, will be considered separately. A. Stock Programs1. GenerallyPetitioners attempt to lay a policy foundation for their position by emphasizing on brief that the Kersting investment programs resulted in "mere" tax deferral until "the moment of reckoning when their stock was sold, deemed to be abandoned, or otherwise disposed of." (We take this to mean that petitioners claimed deductions that they later offset with recognized gains, thereby benefiting solely by virtue of the time value of money.) We do not agree with petitioners' implication that if the only benefit of a series of transactions is tax deferral, then the form of the transactions must be respected. Regardless, petitioners have failed to describe how the transactional and tax reporting details support their "mere" tax deferral characterization, which is not surprising in light of what those details reveal. There is only one Kersting stock investment made by petitioners for which the tax returns in the record clearly document the termination. That investment is Cravens' stock subscription plan with Candace Acceptance, which is illustrative of the Stock Subscription Plan and which the Cravenses appear1991 Tax Ct. Memo LEXIS 661">836 to have reported in a manner consistent with how Kersting viewed the transactions. During the reported 1-year holding period, which touched on 2 taxable years because of a mid-year initiating date, the Cravenses claimed interest deductions of $ 19,620, consisting of the following: $ 10,800 as 18-percent interest to Ventures Funding on the $ 60,000 primary loan; $ 7,200 as 12-percent interest to Candace Acceptance on the $ 60,000 unpaid subscription balance; and $ 1,620 as 9-percent interest to Fargo Acceptance on the $ 18,000 leverage loan. When they reported the sale of the stock, they subtracted an adjusted basis of $ 42,000 from an amount realized of $ 60,000 for a resulting long-term capital gain of $ 18,000. The $ 18,000 drop in basis from the original cost presumably resulted from what they reported as a Candace Acceptance nontaxable distribution on Schedule B of the return. Such a distribution under the Stock Subscription Plan was applied to pay off the leverage loan. At this point, the Stock Subscription Plan does appear to be largely a tax deferral mechanism. Interest deductions of $ 19,620 are offset by $ 18,000 of gross income. Further, although a $ 1,620 tax deduction1991 Tax Ct. Memo LEXIS 661">837 escapes offset, the investor actually parts with his own cash in that amount. What we have not yet factored into the analysis, however, is the effect of the capital gains deduction. Section 1202(a) in 1980 provided for a deduction from gross income of 60 percent of an individual's net capital gain, defined in section 1222(11) as the excess of net long-term capital gain over net short-term capital loss. The Cravenses reported only this one capital transaction in 1980, and they therefore included in their taxable income only $ 7,200 of the $ 18,000 gain. The final balancing upon disposition of the stock thus shows claimed interest deductions of $ 19,620 offset by only $ 7,200 of taxable income. Similar differences would result from the Stock Purchase Plan and the Leasing Corporation Plan. Although the capital gains deduction of section 1202(a) was modified in some respects between 1975 and 1983, the period before the Court, it provided a significant tax benefit under the appropriate circumstances in all of these years. Clearly, even assuming that all other petitioners were like Cravens in reporting back-end consequences, these are not situations that warrant characterization 1991 Tax Ct. Memo LEXIS 661">838 as mere tax deferrals. One area of Kersting's testimony serves not only to reinforce our view of his credibility, but also to illustrate indirectly how much the characterization of the annual distributions (as taxable or nontaxable) contributes to the deferral benefits. Kersting was repeatedly asked, at both his pretrial deposition and at trial, why he organized new acceptance corporations so often. He repeatedly replied that he was wary of the "Battelstein" case, which according to Kersting stood for the proposition that an interest deduction was not allowable if the funds used to make the interest payment were provided by the same entity that made the original loan. Kersting was indeed aware of a case called Battelstein v. Internal Revenue Service, 611 F.2d 1033">611 F.2d 1033 (5th Cir. 1980), on rehearing en banc 631 F.2d 1182">631 F.2d 1182 (5th Cir. 1980), that had such facts and held against the taxpayers. What taints Kersting's credibility is, first, that the Court of Appeals first decided the Battelstein case against the taxpayers in February of 1980, years after Kersting had established a habit of organizing new acceptance corporations. Although a lower court1991 Tax Ct. Memo LEXIS 661">839 decided the case in 1977, that decision was for the taxpayers on this issue. In re Battelstein, 1977 U.S. Dist. LEXIS 15435">1977 U.S. Dist. LEXIS 15435, 41 A.F.T.R.2d (RIA) 942, 77-2 U.S. Tax Cas. (CCH) P9516 (Bankr. S.D. Tex. 1977). Second, Kersting's explanation is in actuality a reason for having a leverage lender that differs from the primary lender. It is irrelevant to the annual changing of leverage lenders or the organizing of new acceptance corporations. In fact, in his 1981 letter to an investor who had inquired about the implications of Battelstein, Kersting focused on the danger of using the same lender for both the primary and leverage loans. Kersting offered an altogether different reason for the many acceptance corporations in the letter he wrote to Willis McComas in 1978. In that letter, he indicated that his objective was to ensure the nontaxability of corporate distributions. When asked at trial about this as an explanation, but without specific reference to the letter, he denied it. As Kersting explained it in the McComas letter, the Stock Subscription Plan was a 1-year wonder. Only in the first year of existence of an acceptance corporation would its books show a loss permitting a distribution1991 Tax Ct. Memo LEXIS 661">840 that was nontaxable to the shareholder. In subsequent years of that existence, the books would show a profit, which would convert what had been a nontaxable distribution in the first year into a taxable dividend in these following years. This taxable dividend would cancel the deduction for primary loan interest and subscription interest. The net tax effect in the subsequent years would be a deduction merely for out-of-pocket interest payments on the leverage loan. Accordingly, the perpetual organizing of new acceptance corporations with first-year losses on their books would benefit those investors seeking large deductions year after year. As appealing as this is as an alternative to Kersting's "Battelstein" rationale, the other evidence does not clearly support the Kersting explanation in the McComas letter. Dixon entered into a 1977 Fargo Acceptance stock subscription plan, but he and Mrs. Dixon reported only $ 117 of dividend income for the second year, 1978, instead of the $ 9,000 suggested by the McComas letter. Owens entered into 1975 and 1976 stock subscription plans with Norwick Acceptance and Forbes Acceptance, respectively, yet he and Mrs. Owens reported no dividend1991 Tax Ct. Memo LEXIS 661">841 income at all for 1977 and 1978. The evidence does not establish that any of these three programs terminated before the end of its second year. Moreover, the problem was not with unwitting return preparers. The Dixons used Philip Scheff for 1978 and the Owenses used Gilbert Matsumoto for 1977 and 1978, both of whom were familiar with Kersting programs. On the other hand, perhaps the return preparers netted the interest deductions and taxable dividends before preparing the returns, reporting neither rather than both, thus conforming at least to the spirit of the McComas letter. In any event, with its conservative view of the tax consequences, that letter (the rationale of which, as noted, Kersting did not adopt at trial) serves as a contrasting reference point to the consequences of perpetual "nontaxable" distributions. By inflating bad debt reserves and deferring subscription agreement interest (or by simply not filing corporate tax returns), Kersting could indefinitely extend the corporate loss years beyond the first. In addition to the obvious benefit of avoiding corporate tax liability, these loss years would provide him with a foundation for characterizing the annual distributions1991 Tax Ct. Memo LEXIS 661">842 as nontaxable returns of capital, which would result in large interest deductions without income offset year after year in the same program. Because these returns of capital would reduce the investor's adjusted basis in his stock, a gain would theoretically result upon termination of the program, as illustrated above by Cravens' Candace Acceptance stock subscription plan. Kersting's conversion into returns of capital of what under the McComas explanation would be taxable dividends, in effect would change current ordinary income into deferred capital gains with no compensating reduction in ongoing interest deductions. 2. Sham AnalysisTaxpayers are generally free to structure their business transactions as they please, even if motivated by tax avoidance considerations. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 293 U.S. 465">469, 79 L. Ed. 596">79 L. Ed. 596, 55 S. Ct. 266">55 S. Ct. 266 (1935); Rice's Toyota World, Inc. v. Commissioner, 81 T.C. 184">81 T.C. 184, 81 T.C. 184">196 (1983), affd. in part, revd. in part, and remanded 752 F.2d 89">752 F.2d 89 (4th Cir. 1985). Nonetheless, to be accorded recognition for tax purposes, a transaction should generally have "economic substance which is compelled or encouraged by business or regulatory1991 Tax Ct. Memo LEXIS 661">843 realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached." Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 435 U.S. 561">583-584, 55 L. Ed. 2d 550">55 L. Ed. 2d 550, 98 S. Ct. 1291">98 S. Ct. 1291 (1978). The substance of a transaction and not its form will control the tax consequences. Rice's Toyota World, Inc. v. Commissioner, 81 T.C. 184">81 T.C. 196. In deciding whether a transaction is a sham to be disregarded for tax purposes, as respondent here contends, the courts often analyze generally whether the transaction has any practical economic effects other than the creation of income tax losses. E.g., Bryant v. Commissioner, 928 F.2d 745">928 F.2d 745, 928 F.2d 745">748 (6th Cir. 1991), affg. in part, revg. in part, and revg. and remanding in part a Memorandum Opinion of this Court; Karr v. Commissioner, 924 F.2d 1018">924 F.2d 1018, 924 F.2d 1018">1022-1023 (11th Cir. 1991), affg. Smith v. Commissioner, 91 T.C. 733">91 T.C. 733 (1988); Casebeer v. Commissioner, 909 F.2d 1360">909 F.2d 1360, 909 F.2d 1360">1363 (9th Cir. 1990), affg. in part, revg. and remanding in part Larsen v. Commissioner, 89 T.C. 1229">89 T.C. 1229 (1987), and affg. Memorandum Opinions1991 Tax Ct. Memo LEXIS 661">844 of this Court; James v. Commissioner, 899 F.2d 905">899 F.2d 905, 899 F.2d 905">908-909 (10th Cir. 1990), affg. 87 T.C. 905">87 T.C. 905 (1986); Friedman v. Commissioner, 869 F.2d 785">869 F.2d 785, 869 F.2d 785">792 (4th Cir. 1989), affg. Glass v. Commissioner, 87 T.C. 1087">87 T.C. 1087 (1986); Rose v. Commissioner, 868 F.2d 851">868 F.2d 851, 868 F.2d 851">853-854 (6th Cir. 1989), affg. 88 T.C. 386">88 T.C. 386 (1987); see, e.g., Jacobson v. Commissioner, 915 F.2d 832">915 F.2d 832, 915 F.2d 832">837 (2d Cir. 1990), affg. in part, revg. and remanding in part a Memorandum Opinion of this Court; Shriver v. Commissioner, 899 F.2d 724">899 F.2d 724, 899 F.2d 724">727 (8th Cir. 1990), affg. a Memorandum Opinion of this Court. More precise considerations in this analysis, both of which we find relevant here, are: (1) Whether the taxpayer is motivated in entering the transaction by a business purpose other than obtaining tax benefits, and (2) whether the transaction has economic substance. Casebeer v. Commissioner, 909 F.2d 1360">909 F.2d at 1363; James v. Commissioner, 899 F.2d 905">899 F.2d at 908-909; Rose v. Commissioner, 868 F.2d 851">868 F.2d at 853; Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89">752 F.2d 89 at 752 F.2d 89">91-92.1991 Tax Ct. Memo LEXIS 661">845 A transaction imbued with economic substance will be recognized for tax purposes by this Court even in the absence of a business purpose. Larsen v. Commissioner, 89 T.C. 1229">89 T.C. 1229, 89 T.C. 1229">1253 (1987), affd. in part, revd. and remanded in part sub nom. Casebeer v. Commissioner, 909 F.2d 1360">909 F.2d 1360 (9th Cir. 1990). On the other hand, the existence of a subjective business purpose does not mandate the recognition of a transaction lacking economic substance. Kirchman v. Commissioner, 862 F.2d 1486">862 F.2d 1486, 862 F.2d 1486">1492 (11th Cir. 1989), affg. Glass v. Commissioner, 87 T.C. 1087">87 T.C. 1087 (1986); Cherin v. Commissioner, 89 T.C. 986">89 T.C. 986, 89 T.C. 986">993 (1987). Petitioners contend, in more than one context, that the Kersting corporations involved in these cases were viable entities that engaged in business activities apart from the investment programs challenged by respondent. According to petitioners, these corporations were "bona fide entities engaging in substantive and substantial business transactions with an economic purpose motivated by the pursuit of profit." Petitioners' support for this proposition is primarily Kersting's uncorroborated1991 Tax Ct. Memo LEXIS 661">846 testimony on various topics, including whether or not the leasing corporations had a line of credit with GMAC for their use in purchasing automobiles directly from dealers. Respondent argues on brief that the Kersting corporations did nothing but occupy office space and generate paperwork for the investment programs, and we have already noted that we attach little credence to Kersting's testimony in areas such as this. Nonetheless, in view of scattered reliable evidence, we are confident that at least some of these corporations engaged in business unrelated to the Kersting programs. One resulting inference, petitioners maintain, is that the challenged transactions were not shams. We do not doubt that the viability and activities of the Kersting corporations are relevant considerations. As defined in rule 401 of the Federal Rules of Evidence, relevant evidence has a tendency to make the existence of a consequential fact more or less probable than without the evidence. A fictional or sham "corporation" is more likely to be a part of a transaction that should be disregarded for tax purposes than is a viable operating entity. We are not required to find that the Kersting corporations1991 Tax Ct. Memo LEXIS 661">847 were themselves shams, however, in order to uphold the Commissioner's determinations. The notices of deficiency focus on the sham nature of the transactions rather than the sham nature of the corporations. Under the subjective business purpose test, we must decide whether petitioners have shown that they had a business purpose for engaging in the transactions other than tax avoidance. Casebeer v. Commissioner, 909 F.2d 1360">909 F.2d at 1363; Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89">752 F.2d at 92; Packard v. Commissioner, 85 T.C. 397">85 T.C. 397, 85 T.C. 397">417 (1985). The only business purpose offered by petitioners is the pursuit of profits. Although one common means of profiting from a stock investment is through receipt of cash dividends, 36 potential dividends are not a factor we need dwell upon for these cases. Kersting testified that he never told investors there would be "current profit like high dividends or things of that type," and no petitioner testified specifically that he expected to profit from dividends. Furthermore, there was no profit potential inherent in the annual distributions that were a part of the investment programs. These1991 Tax Ct. Memo LEXIS 661">848 amounts were not retained by the investors, but were instead recycled into the programs to be applied either to the principal balances of outstanding leverage loans or, for ongoing Leasing Corporation Plans, to fund interest payments on primary loans and subscription agreements. Finally, no petitioner claimed to have entered into a transaction expecting to profit by diverting distributions to his personal use. Absent some compensating adjustment or transaction, such a diversion of funds from the Stock Purchase Plan or the Stock Subscription Plan would not have been ultimately profitable in any event, because the investor would still have been obligated for the principal amount of a leverage loan. Apart from cash dividends, the other common way to profit from a stock investment is to sell the stock after it increases in value. The testifying petitioners, except Cravens, generally articulated1991 Tax Ct. Memo LEXIS 661">849 their profit motivations in terms of expectations of stock value appreciation. In light of the self-serving nature of this testimony, we have looked beyond naked assertions for corroboration and explanation. Ideally in this regard, a stock investor would show that he knew details about the corporation in terms of, among other things, history, management, financial condition, products offered, markets served, and growth potential. He would also demonstrate that he was familiar with the industries involved and general economic conditions. Building on this foundation, he would establish why he expected the corporation to be profitable and why he expected his stock to increase in value. Admittedly, an investor with a legitimate profit motive could fall well short of this ideal, one example being someone who knows little about the corporation but much about the industry and economy. Another example is an investor who relies on an informed recommendation from a knowledgeable source. We note initially that each of the testifying petitioners was at least a high school graduate engaged in an occupation, the piloting of aircraft, that demands clear thinking and reasoned judgments. 371991 Tax Ct. Memo LEXIS 661">850 At the time of investing with Kersting, each had been employed by a major airline for several years, thus demonstrating that he had satisfactorily exhibited these professional qualifications over time. 38 Given this educational and professional background, coupled with our observations at trial, we do not believe that any of these men was so lacking in intelligence or common sense as to believe that stock, solely by virtue of being stock, had an inherent propensity to appreciate rather than decline in value. There are several factors common to all of the testifying petitioners that, taken together, weigh heavily against them in their quest to persuade us that they were motivated by stock appreciation profits in entering into these transactions. As to their knowledge of the business activities of the corporations in which they invested, none of them could have 1991 Tax Ct. Memo LEXIS 661">851 learned anything from a prospectus or something comparable because Kersting never prepared one. Nor did anyone establish that, at the time of investment, he knew much, if anything, other than that a corporation engaged in lending or automobile leasing. Although Owens had firsthand knowledge about the outside lending activities of at least one Kersting corporation in which he did not invest, no one claimed to have had such knowledge about a corporation from which he acquired stock. As to industry knowledge, although some petitioners had borrowed money or leased an automobile prior to investing in Kersting corporations, no one exhibited or professed to have a background in or specialized knowledge about the lending and leasing industries. As to the economy, other than an occasional mention of high interest rates, no petitioner testified about how the prevailing economic conditions affected his investment decisions with Kersting. Despite this apparent lack of knowledge about the Kersting corporations, the industries, and the economy, no petitioner claimed that he relied on or even had access to an independent adviser with such expertise. Petitioners offered very little testimony, 1991 Tax Ct. Memo LEXIS 661">852 and virtually none that was specific, about reliance upon Kersting correspondence for their purported business purpose. This is understandable in view of the typical shortcomings of those letters in this regard. Most Kersting letters mailed specifically to petitioners or generally to investors stressed tax benefits and sometimes transaction mechanics, without even mentioning corporate profitability or stock value appreciation. In most of those letters in which Kersting did mention such things, he still weighted the discussion disproportionately toward tax consequences. Such was the case with a transmittal letter for Universal Leasing documents sent to Owens and others. In another tax-oriented form letter that described a Candace Acceptance Stock Subscription Plan, Kersting wrote without further detail that Candace Acceptance was organized for the purpose of "automobile and lease financing" and was "expected to make profits." Kersting sent other form letters not so slanted toward tax consequences stating that the stock of a corporation had increased in value or could be expected to increase in value, or that a corporation was profitable. Often, however, these were for investors1991 Tax Ct. Memo LEXIS 661">853 who had already purchased or committed to purchase the stock and thus could not have been influenced in forming an initial business purpose. An example is Kersting's post-1981 form letter to acceptance corporation shareholders concerning the proposed exchange of their stock for the stock of a new holding company. This letter informed the shareholders at this late date that the acceptance corporations "were structured to make a profit." Mil Harr, similarly, was not informed about potential corporate profits until after he returned executed initiating documents. Also similar is the Avalon Acceptance package of initiating documents sent out in 1980 or 1981, part of which informed recipients that the stock they were about to purchase was expected to increase in value. By this time, however, the recipients presumably had already committed to the transaction, as is evident by the reference to the promissory note "you are about to execute." Despite the insistence of the testifying petitioners that they anticipated increases in the value of their stock, not one established how he determined that the initial purchase price was reasonable and appropriate. Young testified on the subject, 1991 Tax Ct. Memo LEXIS 661">854 but his testimony was essentially that the stock was worth $ x per share because $ x per share is what he paid for it. This one-sided, seller valuation is also apparent from the Avalon Acceptance document package, which assured investors that "The stock which you will acquire will be equal in value to the face amount of the promissory note." When DuFresne was asked at trial what he considered the value of his Investors Financial stock to be, he did not address the value at purchase, but instead described vaguely how he assumed the value was increasing as he held it. We are not disposed to believe a petitioner's claim that he intended to cash in on appreciating stock when he fails to show that the purchase price in his mind was something other than arbitrary. Petitioners are mistaken in arguing that respondent bears the burden of overcoming a presumption of "reasonable" values arrived at in the ordinary course of business. Even if that were true, however, respondent would have met his burden. The evidence convinces us that petitioners were indifferent to the actual value of their stock. Each of the testifying petitioners except Owens entered into at least one stock subscription1991 Tax Ct. Memo LEXIS 661">855 plan that, by the face of the initiating documents, involved a purchase of stock at $ 10 per share and a subscription for 10 times as many shares at one-tenth the price, $ 1 per share. Kersting attempted to explain the discrepancy at trial, insisting that the investors actually made the initial purchase at $ 1 per share because on the books of the corporation the $ 10 price was allocated $ 1 to the capital stock account and $ 9 to the paid-in surplus account. In essence, according to Kersting, the investors purchased their initial shares at $ 1 per share and simultaneously purchased a paid-in surplus fund from which their nontaxable distributions would be paid in the future. No testifying petitioner confirmed, however, that this was how he viewed the transaction. Another indication that petitioners were indifferent to the value of their purchased stock is that Kersting failed to explain clearly, consistently, or credibly at trial how he determined that value. If he could not sensibly explain in the courtroom how he valued the stock, we have no basis for believing that he had a legitimate valuation method or, going a step further, that he communicated a method that made sense 1991 Tax Ct. Memo LEXIS 661">856 to petitioners. The Court and Kersting engaged in the following exchange regarding Charter Financial stock: THE COURT: I'd like to ask a question at this point. How did you decide on $ 10.50 a share? KERSTING: I think we applied a book value measure. THE COURT: When? KERSTING: Somewhere in '76, '75. Around that time. THE COURT: You mean the first time you sold some of Charter stock to a pilot it had a book value of [$ ] 10.50? KERSTING: Let me think for a minute. I'm inclined to think we went by a book value -- valuation. But it might have been that we added to it some premium for the fact that it was a going concern by that time, and the companies were prospering. So it might have been a premium over book value. THE COURT: But then you never checked the book value for any later sales of the stock. KERSTING: No. The price stayed constant. Counsel for the Thompsons pursued the rationale for the constant price: DE CASTRO: In your opinion, was Charter Financial worth more in 1981 as a company than it was in 1976? KERSTING: It would have been worth more to the public, for sure. DE CASTRO: No, was it, as a company, worth more in 1981 than it was in 1976? KERSTING: 1991 Tax Ct. Memo LEXIS 661">857 It's hard to determine. There was no market for it. * * * DE CASTRO: Well, wasn't increasing the number of shareholders also increasing its capital base? KERSTING: True. But as more shareholders participate in the same base, the value doesn't go up. DE CASTRO: Well, but it's using its base to produce a profit, is it not? KERSTING: Sure. DE CASTRO: Well, if it's using its base to produce a profit, there's a residue over the base. KERSTING: True. DE CASTRO: And that residue over the base should have produced a profit that would make the company worth more. KERSTING: True. DE CASTRO: Is that true? KERSTING: I agree with you. DE CASTRO: That the company was worth more? KERSTING: I agree with you. But there was no public market for the company, so how do you determine value, if you don't have a public bid?As final general points on petitioners' asserted business purpose, we note that there is no reliable evidence here that any petitioner ever profited from these transactions in the sense of selling stock for more than the original purchase price. More importantly, no one testified that he was surprised or dismayed not to profit in this sense. Further, no one claimed1991 Tax Ct. Memo LEXIS 661">858 that he ever attended a shareholders meeting for a Kersting corporation. Finally, although some petitioners other than Thompson still hold Kersting stock, we do not interpret that as suggesting a profit motive. Rather, we believe that they are merely waiting for the audit and litigation dust to settle, as Rina and Kersting had agreed for Rina's stock. Turning now to specific testimony and circumstances regarding profits, we consider first what Kersting may have told potential investors about his programs. In his deposition prior to trial, Kersting testified that he always discussed profit expectations ahead of time in terms of a necessary profit motive for the investor and the "prospect" for profits. He also stated that he told people they could expect an annual 10- to 15-percent increase in the value of their purchased stock. We have found as a fact, based upon his own testimony, that because Kersting was aware of the grounds for certain IRS challenges to his programs, he at least sometimes informed a potential client of the need to have a profit motive. Hearing that the IRS wanted to see a profit motive would not alone, of course, create that motive. Moreover, we do not 1991 Tax Ct. Memo LEXIS 661">859 believe that Kersting told prospects to expect an annual 10- to 15-percent increase in stock value, in part because only one petitioner came close to corroborating this testimony. For each of the testifying petitioners, we have carefully considered, as summarized below, his relevant testimony and individual circumstances not already mentioned. None has persuaded us that he had any motivation in entering into these transactions other than tax avoidance. Cravens, who testified only briefly, stated that his purpose in entering these transactions was "mainly" for tax shelter, but he offered no other purpose. He terminated his Candace Acceptance stock subscription plan without economic profit but with a significant tax benefit after just 1 year. He entered into a second stock subscription plan, in the same amount but with a different acceptance corporation, knowing that the first had yielded no economic profit. Indeed, despite the economic results of his Candace Acceptance investment, he informed Kersting at termination that he was "looking forward" to the Delta Acceptance paperwork. He terminated his Delta Acceptance stock subscription plan again after just 1 year. Dixon's initial1991 Tax Ct. Memo LEXIS 661">860 letter to Kersting inquired only about tax savings and made no reference to profit potential. He received no financial statements or earnings histories for Kersting corporations, and he used the standard Kersting order form, containing four choices for number of shares and three columns of corresponding tax consequences, to arrange purchases of Mahalo Acceptance and Candace Acceptance stock. His 1980 investments in Investors Financial and Charter Financial began after Kersting determined a "need for additional shelter." When questioned at trial about whether he expected a return on his stock purchases, Dixon, with a college background in business administration, answered that he "hoped" his stock would either hold its value or increase in value. He admitted that what he knew about the Kersting corporations at the time he invested in 1977 was "not a great deal." He described the businesses of Candace Acceptance, Mahalo Acceptance, Investors Financial, and Charter Financial as making loans, even though the latter two were holding companies, and he did not know the number of shareholders of any corporation in which he invested. When asked how he kept up with how the lending business1991 Tax Ct. Memo LEXIS 661">861 of Mahalo Acceptance progressed after his investment, he replied that he did not keep up and did not attend shareholders meetings. Rina, also with a college background, testified that he expected to earn a return on his Charter Financial stock because "it was a new investment firm that would be increasing profitability" and that he "was getting in on the ground floor in buying stock." He further testified that his purpose in buying Anseth Leasing stock was to invest in the growth of the corporation. He invested in Investors Financial purportedly for "The same reason as I wanted stock in the other corporations, the belief that I was getting in on the ground floor, and that the stock would increase in value." Contrary to his "ground floor" rationale, however, he admitted on cross-examination that at the time of his investments he did not know how long Charter Financial and Investors Financial had been operating. He also admitted that he did not know the number of Charter Financial shareholders. He then shifted his emphasis away from the "ground floor" idea to an incompatible one, the potential increases in size and value attributable to ongoing activity by fellow pilots of whom 1991 Tax Ct. Memo LEXIS 661">862 he was aware. Rina also stated that, at the time of his investments, lending in an environment of fairly high interest rates appeared to be the way to make money. However, despite this purported attraction to the prosperous lending industry, he did not describe any such non-Kersting investments he entered into or even considered during this time. When asked how he knew that the corporations in which he invested made money, he replied that he "assumed" they did based upon his knowledge of other pilots involved and his own opportunities to borrow funds from the corporations. These opportunities led him to believe there were funds available to lend. Obviously, as Rina was intelligent enough to know, the presence of other investors indicates nothing about profitability, and the existence at a given time of relatively small amounts available for lending is little better. Kersting's letter of November 7, 1979, described Rina's first investments as a "shelter program" and failed to mention profit potential for any of the Kersting corporations. Kersting later started him in 1980 investments with Charter Financial and Delta Acceptance after hearing from a mutual acquaintance that Rina1991 Tax Ct. Memo LEXIS 661">863 wanted an additional $ 35,000 of deductions. Prior to investing, he received neither income projections for the corporations nor stock value projections. He never attended a shareholders meeting, for which he occasionally received notice, never received a financial statement, and never acquired meaningful firsthand knowledge of corporate profitability. At one point, Thompson testified that he expected to make a profit on some of his stock investments, but later spoke in terms of a "profitability possibility" and the "possibility of a gain." Still later, when asked if he felt that there could be a substantial gain from holding the stock for a long time, he replied: "It's hard for me to explain the feeling that I had. The feeling was that I could anticipate some profitability, return in a capital gains sense, from these investments." He undercut his own vague testimony when he stated that at the time of his investments, at least for Charter Financial, Investors Financial, and Delta Acceptance, he did not even know the business of the corporations or the names of other shareholders. Although he thought that prospectuses always accompanied stock purchase transactions of this sort, 1991 Tax Ct. Memo LEXIS 661">864 he, like all of the other investors, never received one. The Thompsons argue on brief that they had come to rely on Kersting for business and investment advice and thus became innocent victims of his complicated scheming. They contend specifically that Thompson's previous investment in First Savings, which he had personally visited on occasion and therefore knew to be a viable operating entity, contributed to his profit motive for the later Kersting investments that are at issue here. We do not believe, however, that mere observation of an apparently healthy First Savings created a profit motive in Thompson's mind for other Kersting investments, especially since he had already encountered accountants who had communicated to him serious misgivings about Kersting investments. In addition, the First Savings deal, which involved a $ 20,000 initial cash outlay coupled with a pledge of the stock to First Hawaiian Bank, was structured not at all like the Thompson investments at issue here. Young's testimony was top-heavy in the sense that he stated in several variations that he expected to profit, but provided little in the way of a foundation for those expectations. Although like 1991 Tax Ct. Memo LEXIS 661">865 Thompson he understood what a prospectus was, he never even requested one. He did not receive income projections for any Kersting corporation, and his knowledge of business activities was vague and secondhand. He started his Delta Acceptance stock subscription plan by checking an order form box for the "same plan" as "last year." He then held up the transaction temporarily while he decided whether he needed the associated deduction. Although he received annual distribution transmittal letters either recommending that he remain a shareholder to participate in the progress of the corporation or informing him that the business of the corporation was lending and lease financing, these after-the-fact statements could not have affected his business purpose initially. Young first heard of the Kersting programs from a former Federal Express employee. He testified that this friend described the program as having "some subsequent tax advantages, as well as potential for profit." He later testified that "the primary purpose of the program was to obtain stock in a private enterprise, private corporations, with the hope that these corporations would expand and grow and be profitable, and someday1991 Tax Ct. Memo LEXIS 661">866 go public, maybe." When questioned specifically about his motives in purchasing Anseth Leasing stock, he replied simply, "Profit." We do not believe this testimony, largely because these statements sound purposely and unrealistically slanted toward profits and away from tax sheltering. Also, Young's credibility suffered when he stated that he probably would have exercised his perceived rights under the Anseth Leasing subscription agreement if the value of the stock had increased. When later asked what he knew about the value of the stock during the 3 years following the purchase date, he replied, "Nothing." When asked to elaborate about where a profit would come from with respect to the Anseth Leasing stock, Young testified: "Stock, in the hopes that it would inflate there, increase in value, appreciate -- sell it, realize the capital gain, and realize the profit." On cross-examination, he was asked on what specifically he based his profit expectation, to which he replied: "Common sense. If you buy a share of stock, you hope that it appreciates." He also described his feelings as "A dream, a hope." This is a man who had earned a college degree in business administration, worked1991 Tax Ct. Memo LEXIS 661">867 in the financial services industry, and previously owned stock with mixed results. DuFresne testified that "along the years, somebody has said to me that any time I could invest in banks and lending institutions, that it was a good investment." He testified that he felt there was growth potential in financial institutions, especially with the high interest rates in the early 1980s. Because the DuFresnes reported dividend income for 1981 from First Union Bancorp and for 1982 and 1983 from Centerre Bancorporation, we found as a fact that DuFresne had heard that financial institutions were often good investments. However, contrary to the implication of his testimony, we do not believe that he thought every financial institution, including those he knew virtually nothing about, was a good investment. He did not testify specifically about what led to the investments in First Union Bancorp and Centerre Bancorporation, so we have no way of knowing how those decision processes compared to those preceding his Kersting investments. DuFresne also testified that petitioner Young informed him that Kersting's investments "had the potential for some growth, stock growth, and also would afford1991 Tax Ct. Memo LEXIS 661">868 some realistic tax mileage." After acknowledging that most of the stock he buys decreases in value, DuFresne added that "you hope it will go up." He also claimed that he assumed from conversations with Kersting that his Investors Financial and Charter Financial shares were increasing in value. He did not, however, receive financial statements or projections of net income or stock value appreciation for any of the Kersting corporations. Although he testified that he thought Kersting sent him written information on the "universal plan" and "something about the leasing corporations," he did not produce copies at trial. Even assuming that he had received "The Universal Plan" pamphlet, we see nothing in there that would have prompted his asserted business purpose. Finally, DuFresne's demonstrated willingness to manufacture documents "for the benefit of our friends at the IRS and the courts," as revealed by his correspondence dated June 22, 1984, is sufficient grounds for us not to believe his testimony concerning his profit motivations. Indeed, his testimony about the transaction covered in the typed letter, the disposition of his Charter Financial stock, was inconsistent with that1991 Tax Ct. Memo LEXIS 661">869 letter. Whereas the letter indicated an amount realized that exceeded the original cost by $ 20,000, DuFresne testified that at the time of disposition "The stock had devalued itself back down to its original value" and that the capital gain he reported on the transaction was attributable to a change in adjusted basis. Owens testified about his knowledge of the businesses for only a few of the corporations in which he invested, and even for those few, leasing automobiles and lending money were the most detailed activities he mentioned. He testified that he could not remember whether he had asked his accountant, Gilbert Matsumoto, to review the operations of the corporations in which he invested. He answered with a simple "yes," however, when asked whether one of his motivations in entering into the transactions was making a profit. Although he had seen a favorable Dun & Bradstreet report on Kersting personally, he did not receive a written description of anticipated net income or stock value appreciation for the corporations. He received notices of shareholders meetings occasionally, but he did not claim to have attended. The stipulated exhibits relating to the Owens investments1991 Tax Ct. Memo LEXIS 661">870 include more Kersting correspondence than the exhibits relating to any of the other petitioners. Owens did not establish, however, that these letters gave rise to a business purpose of making a profit. In a pre-1977 form letter describing the Stock Subscription Plan to Owens, Kersting stated that an unnamed acceptance corporation would be organized "for the purpose of lease financing," but he mentioned nothing else about the business or the profit potential. Owens also received a 1977 form letter telling him he could anticipate "capital appreciation and perhaps cash dividends" from Norwick Acceptance. This letter arrived, however, 2 years after his investment commenced. At least two undated form letters received by Owens included information that possibly would have caused a reader to enter an investment believing that economic profits were on the horizon. Both related to the Leasing Corporation Plan, the first discussing profit sources in leasing, "accumulation of intrinsic values," and increasing book value. The second, pertaining to Universal Leasing, spoke of "access to capital gains prospects" and stock selling at a future increased "earnings multiplier." When asked whether1991 Tax Ct. Memo LEXIS 661">871 he relied on Kersting memoranda for advice, however, Owens answered in terms of after-the-fact progress reports: "Yes, I did. Usually it was a 'how goes it' in the progress of the corporation, or 'how goes it' with the investments that I'd made." He gave this response while testifying about the Universal Leasing letter. He then testified about the more general Leasing Corporation Plan letter, but he did not refer to the profits discussion or how it influenced him. Hongsermeier also offered no detailed testimony as to the business activities of those Kersting corporations in which he invested. He mentioned "factoring" several times, but demonstrated that he meant nothing different by that term than an ordinary loan to a business borrower. Concerning the income potential of the various corporations, his testimony was, in part, that lending and leasing activities by their nature generate revenue. He also claimed that he had heard from other people, mainly pilots already involved, that these corporations were prosperous and successful. He did not name any of these individuals. His vague testimony about what he expected to get out of his purchase of Delta Acceptance stock was as1991 Tax Ct. Memo LEXIS 661">872 follows: "I thought I would own stock in the company and I'd receive benefits from the income from the company, whatever -- if the company progressed or didn't, that type of operation, where -- just like buying stock anywhere." He admitted that Kersting did not make representations about profit potential or anticipated stock value appreciation for the corporations in which he considered investing. To satisfy the economic substance portion of the sham analysis, petitioners must show that the transactions had economic substance beyond the creation of tax benefits. Casebeer v. Commissioner, 909 F.2d 1360">909 F.2d 1360, 909 F.2d 1360">1363, 909 F.2d 1360">1365 (9th Cir. 1990), affg. in part, revg. and remanding in part Larsen v. Commissioner, 89 T.C. 1229">89 T.C. 1229 (1987), and affg. Memorandum Opinions of this Court; Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543">820 F.2d 1543, 820 F.2d 1543">1549 (9th Cir. 1987), affg. a Memorandum Opinion of this Court. The economic substance inquiry typically involves an objective determination of whether a reasonable possibility of profit existed. Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89">752 F.2d 89, 752 F.2d 89">94 (4th Cir. 1985), affg. 1991 Tax Ct. Memo LEXIS 661">873 in part, revg. in part, and remanding 81 T.C. 184">81 T.C. 184 (1983); Packard v. Commissioner, 85 T.C. 397">85 T.C. 397, 85 T.C. 397">417 (1985). For a speculative investment, economic substance depends upon whether the taxpayer made a bona fide investment or whether he merely purchased tax deductions. Bryant v. Commissioner, 928 F.2d 745">928 F.2d 745 (6th Cir. 1991), affg. in part, revg. in part, and revg. and remanding in part a Memorandum Opinion of this Court. We dispense first with petitioners' arguments on brief that they viewed their Kersting stock purchases as speculative investments. Although petitioners presumably seek a relaxing of our scrutiny of the profit possibilities, their post-trial positions do not square with the evidence. Petitioners did not testify that they viewed these investments as higher-than-normal risk. A fortiori, they did not testify that they foresaw opportunities for higher-than-normal returns that would offset the higher risk. On the contrary, they seemed to go to great lengths to depict their purchases as garden-variety stock investments. Kersting also did not claim that this was a high-risk, high-return type of investment. We therefore1991 Tax Ct. Memo LEXIS 661">874 reject petitioners' "speculative" characterization. Fundamentally, a realistic profit possibility for a shareholder depends to a large extent upon profitability at the corporate level. A profitable corporation, compared to an unprofitable one, is more likely to generate cash dividends for the shareholders, and its stock is more likely to increase in value. Petitioners argue again, but in this different context, that the Kersting corporations carried on substantial business activities, lending and leasing, that were unrelated to the Kersting investment programs. The inference petitioners would have us draw is that these were viable, dynamic enterprises with profit potential at the corporate level. Although we have acknowledged that at least some of the Kersting corporations engaged in business activities unrelated to the challenged investment programs, this is not enough for us to infer corporate profit potential. Petitioners have not shown that these other activities were more than insignificant relative to the Kersting programs, nor that they were (or the extent they were) ever profitable. The Thompsons contend that the most telling evidence of a reasonable profit possibility1991 Tax Ct. Memo LEXIS 661">875 from the transactions is that the corporations in which Thompson invested were in fact profitable. Although the corporate tax returns in evidence (with one exception of any significance) show no taxable income, the Thompsons argue that Kersting's testimony "established that there was a profit for the various companies and that it was only by making certain write-offs for bad debt reserves that he was able to accomplish the result of having no taxable earnings." We will not dwell upon the value of Kersting's testimony in this regard, but the tax returns warrant some consideration. Admittedly, Kersting seems to have undertaken the reporting adjustments of which we are aware, including the deferral of subscription interest income, to eliminate what otherwise would have been reported income. On this record, however, we are not prepared to accept all other parts of the returns as accurate and complete. One of the return preparers, Ms. Akamine, declined to sign returns she prepared because she was not comfortable with some of the things Kersting asked her to do. Her testimony did not expressly limit these things to bad debt additions and deferred subscription interest adjustments. 1991 Tax Ct. Memo LEXIS 661">876 Even if we were to accept the returns (after adjusting for deferred subscription interest and inflated bad debt reserves) as accurate reflections of recognized financial accounting principles, we would not adopt the results as indicative of corporate profitability for purposes of our economic substance analysis. The reported income of the acceptance corporations, for example, would consist largely or entirely of interest on unpaid subscription balances and outstanding leverage loans. We conclude below that the so-called subscription interest is not truly interest and that the investors did not actually pay those amounts. Thus, the subscription interest does not contribute to corporate profitability. The Thompsons in effect beg the question by asking us to use corporate profitability (after adjusting for deferred subscription interest and inflated bad debt reserves) as an input to the economic substance analysis, when the degree of profitability is also one of the outputs. 391991 Tax Ct. Memo LEXIS 661">877 Another shortcoming of the Thompsons' analysis is its presumed equivalence between corporate and shareholder profitability. The link between a profit at the corporate level and a profit at the shareholder level is not automatic. A profitable corporation may elect not to distribute dividends, for example, because of a cash shortage or a capital expansion plan. Accordingly, even assuming petitioners had persuaded us that there was a reasonable possibility of corporate profitability, they would also have to clear the additional hurdle of showing that corporate profitability would translate into shareholder profitability. This they have failed to do. Specifically, petitioners have not shown that any of the Kersting corporations in which petitioners held stock had the resources to make dividend-like distributions that were not intended to be immediately returned to Kersting as part of his investment programs. Petitioners also have not shown that the per-share stock value of any Kersting corporation fluctuated with the corporation's profitability or with anything else. These values as reflected in prices offered to new participants were constant (except for a change in the early1991 Tax Ct. Memo LEXIS 661">878 years of the Stock Subscription Plan) over the years at issue: Charter Financial and Investors Financial stock always sold at $ 10.50 per share; acceptance corporation stock, regardless of the corporation, sold at $ 10 per share with an accompanying subscription agreement at $ 1 per share; and leasing corporation stock sold at $ 1 per share with an accompanying subscription agreement also at $ 1 per share. Kersting's quoted testimony above about how he determined the value of Charter Financial stock also suggests that corporate profitability had no effect on stock value. Even assuming petitioners had persuaded us that there was a reasonable possibility of corporate profitability and that corporate profitability would lead to increased value of the stock held by shareholders, they would confront another obstacle. For the shareholders to have profited from their investments, there must have been a means to sell their stock at the increased value. Kersting or the issuing corporation was always available as a buyer, but petitioners have not shown that this transaction ever resulted in cash beyond what was necessary to pay off outstanding loans related to the stock. Even Kersting 1991 Tax Ct. Memo LEXIS 661">879 did not claim that an investor ever received excess cash. On this point, although Kersting testified that his corporate files contained the DuFresne letters of June 22, 1984, in which DuFresne referred to a $ 20,000 cash return on his Charter Financial investment, Kersting did not testify about the contents of those letters. Nonetheless, the existence of this option on the part of petitioners to return their stock to Kersting does not by itself mean that they had no other way to dispose of their stock and possibly earn a profit. In fact, Kersting testified that he intended at some point to take these corporations public and thereby "realize the retail value of the securities." He claimed that he told this to investors, and a few form letters quoted in our findings contain references to going public. We do not believe, however, that Kersting ever gave serious consideration to going public with his corporations. In his post-1981 letter to acceptance corporation shareholders, which proposed an exchange of their stock for that of a new holding company, we believe his reference to going public was meant only to provide shareholders (or the IRS) with a justification for his creation1991 Tax Ct. Memo LEXIS 661">880 of a holding company structure. The actual reason for that proposed restructuring was apparently to facilitate favorable tax reporting, as suggested by Ms. Akamine's testimony. In addition, although Kersting claimed that he had talked to underwriters several times over the years about the possibility of going public, his testimony was vague and uncorroborated. The one investigation and negotiation he described in detail supposedly began in 1985 or 1986, after the years at issue and many years after the IRS had begun to question his investment programs. Further, throughout the years at issue he was never involved in a public offering, even before his reputation had supposedly become tarnished in the eyes of underwriters by the IRS criminal investigation. Petitioners have failed at each step of the way (corporate profitability, increased stock value, and a means to realize the increased value) to establish that from an objective standpoint there existed a possibility of a profit. We are left to conclude, as fully analyzed in our discussion of the primary loans, below, that neither Kersting nor petitioners ever contemplated that petitioners would transfer their stock anywhere other1991 Tax Ct. Memo LEXIS 661">881 than back to Kersting and for consideration other than its original purchase price. Because petitioners had one way and one way only to dispose of their stock, and for a constant amount, they had no reason to care about what its actual value relative to the price might be. That being the case, the initial "value" of the stock (i.e., the primary loan amount) could be anything Kersting decided. A further indication of the lack of economic substance here is the unusual relationship between the price of the stock, which was constant, and the annual corporate distributions. Once a year the investor received a distribution equal to 18 percent or more of the original total cost of his stock, which Kersting considered a return of capital that reduced the investor's adjusted basis in the stock. This type of transaction from a corporate accounting standpoint normally reduces both sides of the balance sheet, as a debit to capital stock and a credit to cash. From an economic standpoint, similarly, this transaction ordinarily shrinks the corporate asset base because of the cash outflow with no compensating inflow. Neither Kersting nor petitioners have explained how under these circumstances1991 Tax Ct. Memo LEXIS 661">882 the actual economic value of the investor's stock could remain unchanged. In contrast to the expected correlation between returns of capital and stock value, the Kersting programs in operation demonstrated no correlation whatsoever. Thus, while the capital stock account of Universal Leasing plummeted by over 60 percent from 1977 to 1984 and while the capital stock account of Escon Leasing fell by almost $ 1 million and went negative (both drops attributable to Leasing Corporation Plan returns of capital), the stock price to new participants and the selling price for ongoing shareholders never changed from $ 1 per share. Also consistent with a lack of economic substance is Kersting's disregard of standard corporate business practices. For corporations such as Charter Financial (Hawaii), Federated Finance (Hawaii), and Windsor Acceptance (Hawaii), he simply reincorporated them in Nevada by filing the appropriate papers with that State. He had no apparent concern with dissolving or liquidating the Hawaii corporation or effecting a formal transfer of assets. As far as Kersting was concerned, the corporations continued to operate out of the same Hawaii offices and to engage in the1991 Tax Ct. Memo LEXIS 661">883 same activities, so legal formalities other than simple incorporation were unnecessary. The stock certificates provided to investors were generally unnumbered, and records of shares and shareholders were available to the Kersting corporations if at all only from bookkeeping accounts not intended for that purpose. Whether or not Kersting was technically in violation of State or Federal securities laws, there can be no doubt that stock without substance is much easier to manipulate when "exempt" than when subject to the formal oversight of registration. Another specific offshoot of Kersting's disregard of standard business practices is unreasonable timing, as exemplified by the extended period of typically several months between the date on the Stock Subscription Plan initiating documents and Kersting's waltzing of the primary loan funds. Either it was not important to Kersting promptly to consummate the stock acquisition transaction with transferred funds or he backdated the initiating documents. Both explanations cut against underlying economic substance. As to the former, a corporation engaging in genuine stock transactions would not ordinarily wait patiently for several months1991 Tax Ct. Memo LEXIS 661">884 to receive sales proceeds of this magnitude unenhanced by interest. As to the latter, a corporation engaging in genuine stock transactions would not normally treat someone as a shareholder retroactive to a time before that person had even decided to become one. A particularly revealing example is the Stock Subscription Plan for the stock of Fargo Acceptance. Although Dixon's initiating documents were dated January 2, 1977, the initial tax return for Fargo Acceptance, for the period ending June 30, 1977, shows absolutely no issued capital stock on the ending balance sheet. The reason is that the bookkeepers recorded transactions based on canceled checks and bank statements, and Kersting did not waltz primary loan funds for Dixon and others until July 29, 1977. Dixon, then, was supposedly a Fargo Acceptance shareholder long before the corporation even acknowledged his existence in its books and tax return. Although the record does not disclose when the Fargo Acceptance return was prepared, there would have been no apparent need to prepare it before a bank statement appeared covering July 29, 1977. In any event, Kersting did not sign the return until 1985. That the return adheres1991 Tax Ct. Memo LEXIS 661">885 to the waltz date rather than the date on Dixon's initiating documents demonstrates that the tail (bookkeeping) was wagging the dog (stock ownership). Moreover, Dixon was supposedly a shareholder of Fargo Acceptance before the corporation even existed. The Certificate of Incorporation was not filed with the State of Nevada until March 17, 1977, and the incorporators executed it less than a week before that date. Similarly, Dixon and Hongsermeier supposedly purchased stock from Escon Leasing with initiating documents dated January 2, 1977, even though the incorporators did not execute the Certificate of Incorporation until over a month later, on February 4, 1977. In the totality of these circumstances, we conclude that petitioners' stock investments as part of a Stock Purchase Plan, a Stock Subscription Plan, or a Leasing Corporation Plan were devoid of economic substance. When we couple this lack of economic substance with both our earlier conclusion that petitioners had no motivations other than tax avoidance in entering into these transactions and our failure to see any practical economic effects, these stock transactions must be characterized as shams. A finding that an underlying1991 Tax Ct. Memo LEXIS 661">886 purchase transaction is a sham does not mean that all of the purported indebtedness associated with that transaction is not genuine and may be disregarded for tax purposes. Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89">752 F.2d 89, 752 F.2d 89">95-96 (4th Cir. 1985), revg. on this issue 81 T.C. 184">81 T.C. 184 (1983); see Jacobson v. Commissioner, 915 F.2d 832">915 F.2d 832, 915 F.2d 832">840 (2d Cir. 1990), affg. in part, revg. and remanding in part a Memorandum Opinion of this Court. The requirement of a profit objective is not one of the limitations in section 163 on the deduction of interest actually paid. Rose v. Commissioner, 88 T.C. 386">88 T.C. 386, 88 T.C. 386">423 (1987), affd. 868 F.2d 851">868 F.2d 851 (6th Cir. 1989); Stanton v. Commissioner, 34 T.C. 1">34 T.C. 1, 34 T.C. 1">7 (1960). If there is actual payment of interest attributable to the use or forebearance of amounts due on genuine indebtedness, then that interest is deductible. Rose v. Commissioner, 88 T.C. 386">88 T.C. 423-424. Accordingly, we cannot disregard in its entirety a transaction involving the use of loans to fund a tax avoidance scheme unless we separately examine the substance of the loans. 1991 Tax Ct. Memo LEXIS 661">887 Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543">820 F.2d 1543, 820 F.2d 1543">1548-1549 (9th Cir. 1987), affg. a Memorandum Opinion of this Court. 3. Subscription AgreementsWe begin our examination of the loans by considering the stock subscription agreements used in the Stock Subscription Plan and the Leasing Corporation Plan. Petitioners maintain that they paid interest on the unpaid subscription balances and thus are entitled to deductions under section 163(a) for those payments. Interest has been defined as the amount one has contracted to pay for the use of borrowed money, Old Colony Railroad Co. v. Commissioner, 284 U.S. 552">284 U.S. 552, 284 U.S. 552">560, 76 L. Ed. 484">76 L. Ed. 484, 52 S. Ct. 211">52 S. Ct. 211 (1932), and as compensation for the use or forbearance of money. Deputy v. du Pont, 308 U.S. 488">308 U.S. 488, 308 U.S. 488">498, 84 L. Ed. 416">84 L. Ed. 416, 60 S. Ct. 363">60 S. Ct. 363 (1940). This Court has described interest as a payment for the use of money that the lender had the legal right to possess, prior to relinquishing possession rights to the debtor. Albertson's, Inc. v. Commissioner, 95 T.C. 415">95 T.C. 415, 95 T.C. 415">421 (1990). To be deductible under section 163(a), amounts paid as interest must be paid on indebtedness in substance and not merely in form. 1991 Tax Ct. Memo LEXIS 661">888 Knetsch v. United States, 364 U.S. 361">364 U.S. 361, 364 U.S. 361">365-366, 5 L. Ed. 2d 128">5 L. Ed. 2d 128, 81 S. Ct. 132">81 S. Ct. 132 (1960); Estate of Franklin v. Commissioner, 544 F.2d 1045">544 F.2d 1045, 544 F.2d 1045">1049 (9th Cir. 1976), affg. 64 T.C. 752">64 T.C. 752 (1975). An indebtedness is an existing, unconditional, and legally enforceable obligation for the payment of a principal sum. Howlett v. Commissioner, 56 T.C. 951">56 T.C. 951, 56 T.C. 951">960 (1971). A typical subscription agreement contained this operative provision: "I hereby subscribe for and agree to purchase from * * [a specific acceptance corporation or leasing corporation, a specific number of] shares of common stock of $ 1.00 par value at a price of $ 1.00 per share." The agreement called for the investor to pay 12-percent annual interest on the unpaid subscription balance and contained a provision acknowledging receipt of a specific amount "paid on account" equal to a year of such interest. The corporation did not advance funds to the investor pursuant to the subscription agreement, nor did it issue subscribed stock as of the date on the agreement. Kersting interpreted the agreement to give the corporation the right at any time to require the investor to purchase the subscribed1991 Tax Ct. Memo LEXIS 661">889 shares. The agreement did not, in Kersting's view, give the investor the right to tender payment and request the issuance of the shares. Some petitioners testified about their understandings of the legal effects of the subscription agreements, though not altogether clearly, and there was some disagreement with Kersting's interpretation. This Court considered subscription agreement interest for similar Kersting investment programs in Pike v. Commissioner, 78 T.C. 822">78 T.C. 822 (1982), affd. without published opinion 732 F.2d 164">732 F.2d 164 (9th Cir. 1984). Although petitioners here argue that they purchased a valuable intangible right to acquire stock at the agreed price, this description is not at odds with what we stated in Pike: We are somewhat mystified why the payments to Norwick under the stock subscription agreements were classified as "interest" in any event. The agreements simply stated that the participants agreed to buy X number of shares from Y company for $ 1 per share. No date for performance was specified. Interest on the unpaid balance of the agreement was to be 1 percent per month. It is stipulated that the agreements were never called1991 Tax Ct. Memo LEXIS 661">890 by Norwick, and petitioners did not buy any stock under the agreements. Hence, they presumably owed nothing under the agreement for which "interest" would accrue. At best, the amounts paid would be some sort of a fee for an option to purchase. [Pike v. Commissioner, 78 T.C. 822">78 T.C. 850 n.54; emphasis supplied.]Petitioners also contend that upon signing their subscription agreements, they became absolutely and unconditionally liable to pay interest on the unpaid subscription balances. Our attention is not diverted by this argument from the more appropriate threshold inquiry suggested by Pike: whether the subscription agreements created an unconditional "obligation for the payment of a principal sum." 56 T.C. 951">Howlett v. Commissioner, supra at 960. In these circumstances, until the corporation either advanced funds or issued stock, any debt obligation was not yet unconditional. The acceptance corporations, for their part, never sought to consummate the stock purchases called for in their subscription agreements. Kersting testified, however, that a leasing corporation sometimes exercised its perceived right to require an investor to purchase1991 Tax Ct. Memo LEXIS 661">891 subscribed shares. The documentary evidence does not conclusively support this testimony, but the evidence does reveal that under the Leasing Corporation Plan, the investor sometimes purchased additional stock from the leasing corporation and executed a new subscription agreement. Because the sum of the newly purchased shares and the newly subscribed shares equaled the subscribed shares under the original subscription agreement, this could have been intended as a partial consummation of the original subscription agreement. For present purposes, we assume without deciding that it was so intended. Although the unpaid subscription balance as of the date of the original subscription agreement was not an unconditional obligation, this is not by itself always a fatal shortcoming. The courts have sometimes permitted an interest deduction for a period before a debt obligation existed or became unconditional. In Dunlap v. Commissioner, 74 T.C. 1377">74 T.C. 1377 (1980), revd. on other grounds 670 F.2d 785">670 F.2d 785 (8th Cir. 1982), the taxpayer entered into an agreement on July 1, 1971, to purchase the stock of a savings bank. Part of the purchase price was in the form of1991 Tax Ct. Memo LEXIS 661">892 promissory notes bearing interest at 9-1/2 percent from that date. Closing of the transaction was contingent upon approval by the Federal Reserve Board, and after that approval the parties to the agreement closed the transaction on July 12, 1972. On that date, the taxpayer paid to the sellers an amount designated as interest for the period from July 1, 1971, to June 30, 1972, computed at 9-1/2 percent of the principal amount of the notes. We decided that the indebtedness did not become unconditional until the closing date, but we held that the interest was deductible based upon Monon Railroad v. Commissioner, 55 T.C. 345">55 T.C. 345 (1970). In Monon Railroad, a corporate taxpayer issued 6-percent debentures on April 1, 1958, in exchange for shares of its outstanding class A common stock. Although the taxpayer did not even invite the shareholders to participate in the exchange until January of 1958, it dated the debentures January 1, 1957. We concluded that the taxpayer paid deductible interest for the 15-month period prior to the issuance of the debentures, relying upon Commissioner v. Philadelphia Transportation Co., 174 F.2d 255">174 F.2d 255 (3d Cir. 1949),1991 Tax Ct. Memo LEXIS 661">893 affg. 9 T.C. 1018">9 T.C. 1018 (1947), affd. per curiam 338 U.S. 883">338 U.S. 883 (1949). Part of the rationale of both Monon Railroad and Philadelphia Transportation Co. was that the taxpayer could have achieved the same effect without using a preissue date by providing for a correspondingly higher postissue interest rate. Commissioner v. Philadelphia Transportation Co., 174 F.2d 255">174 F.2d at 256; 55 T.C. 345">Monon Railroad v. Commissioner, supra at 362-363. We recently considered these cases and related others in Midkiff v. Commissioner, 96 T.C. 724">96 T.C. 724 (1991), which concerned an eminent domain action in Hawaii for acquisition by lessees of a residential lot they occupied. In settlement of the action, the lessees paid the lessor the value of the lot as of the date the Hawaii Housing Authority designated the lot for acquisition, plus "blight of summons damages," at the annual rate of 5 percent of the designated value, from the date of designation to the date of closing. We held that this additional amount was not paid on indebtedness within the meaning of section 163(a) and thus was not deductible as interest. The instant 1991 Tax Ct. Memo LEXIS 661">894 cases are distinguishable from cases such as 74 T.C. 1377">Dunlap v. Commissioner, supra, and 55 T.C. 345">Monon Railroad v. Commissioner, supra, because the Kersting investor's obligation for the purported indebtedness (the cost of the subscribed stock) never became unconditional. When the investor purchased new leasing corporation stock, which purchase we have assumed was pursuant to the subscription agreement, he borrowed the acquisition funds for the newly purchased shares from an acceptance corporation, thus extinguishing his obligation to the leasing corporation for a principal amount at the same time that it unconditionally arose. As we stated in 96 T.C. 724">Midkiff v. Commissioner, supra at 742-743: In the instant case, the asserted purpose of the disputed "interest" amount was to compensate the estate for delay in payment from the date of designation to the date of closing; that "interest" related solely to the period prior to the date of closing. Thus, the situation is not one where * * * [the lessees] could have provided for a higher rate of interest for the period after the obligation rose to the level of an indebtedness within the1991 Tax Ct. Memo LEXIS 661">895 meaning of section 163(a); on that date, they simultaneously extinguished the entire indebtedness. * Petitioners cite two cases in support of their position concerning the deductibility of subscription interest, one of which is Unitex Industries, Inc. v. Commissioner, 30 T.C. 468">30 T.C. 468 (1958), affd. per curiam 267 F.2d 40">267 F.2d 40 (5th Cir. 1959). Although the case indeed involves unpaid stock subscriptions, that similarity is the total extent of the meaningful common facts. We there considered whether the subscribers were properly characterized as shareholders receiving dividends or as creditors receiving interest payments, ultimately concluding the former. The party seeking the interest deduction was the corporation, not the stock subscribers. Petitioners here are on the other end of the purported loan transactions, as debtors. Petitioners' other cited case, United States v. Title Guarantee & Trust Co., 133 F.2d 990">133 F.2d 990 (6th Cir. 1943), is likewise inapposite. Again, the court there considered whether amounts paid by a corporation to shareholders were dividends or interest. Respondent emphasizes the circular flow of funds in a1991 Tax Ct. Memo LEXIS 661">896 Kersting waltz as a reason to disallow petitioners' claimed interest deductions. Before turning to that position in the context of subscription interest, we review the state of the record regarding waltzes. In general, the waltz was a circular flow of checks among Kersting corporations and investors at the same bank on the same day. Although the funds in one sense flowed step-by-step from one entity to another, the banks processed check transactions on a daily basis, thereby collapsing the step-by-step flow into a closed circle without a definitive beginning or end. Our findings include step-by-step summaries of only two Kersting waltzes affecting stock investment programs, primary loan funds for the Stock Subscription Plan and leverage loan funds also for the Stock Subscription Plan and leverage loan funds also for the Stock Subscription Plan. The evidence that provides the detail for these two waltzes includes connections to specific petitioners and transactions. There are several other potential waltz situations, however, including primary loans, leverage loans, and annual distributions for the Stock Purchase Plan; annual distributions for the Stock Purchase Plan; annual 1991 Tax Ct. Memo LEXIS 661">897 distributions for the Stock Subscription Plan; and primary loans, leverage loans, and annual distributions for the Leasing Corporation Plan. Respondent in his opening brief proposed as a fact that waltzes were parts of essentially all Kersting stock transactions. Petitioners objected that this proposed finding was misleading and contrary to the evidence. In view of this dispute, we examined the incomplete bank records and included in our findings detailed bank account activity that, as we discuss hereinafter, suggests the existence of these other waltzes. In contrast, despite petitioners' objection to respondent's proposed finding, they have failed to direct us to any evidence tending to prove that these other waltzes did not exist. Generally, a circular flow of funds among related persons suggests that a transaction lacks economic substance. Merryman v. Commissioner, 873 F.2d 879">873 F.2d 879, 873 F.2d 879">882 (5th Cir. 1989), affg. a Memorandum Opinion of this Court; Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543">820 F.2d 1543, 820 F.2d 1543">1549 (9th Cir. 1987), affg. a Memorandum Opinion of this Court. For loans, the specific analysis may vary depending upon whether 1991 Tax Ct. Memo LEXIS 661">898 the taxpayer uses borrowed funds to pay interest.40 A comparison of Karme v. Commissioner, 73 T.C. 1163">73 T.C. 1163 (1980), affd. 673 F.2d 1062">673 F.2d 1062 (9th Cir. 1982), and Beck v. Commissioner, 74 T.C. 1534">74 T.C. 1534 (1980), affd. 678 F.2d 818">678 F.2d 818 (9th Cir. 1982), highlights the analytical distinction.In Karme, which like the instant cases involved a stock purchase entirely financed with borrowed funds, we ultimately denied a section 163(a) interest deduction because there was no genuine debt obligation and the loan transaction was a sham. Among the factors we considered important to this conclusion were the terms and 1991 Tax Ct. Memo LEXIS 661">899 circumstances of the purported loan. Among those circumstances was the fact that the loan proceeds, which were invested in a speculative stock venture, traveled in a circle among entities that (except for the bank) the taxpayers' tax planner effectively controlled. A similar circular funds flow occurred, this time in reverse, when the stock purchase was canceled. In Beck, we concluded that interest was not "paid" within the meaning of section 163(a) when limited partnerships used borrowed funds to pay interest points that completed a check circle back to the lender. We there relied upon United States v. Clardy, 612 F.2d 1139">612 F.2d 1139 (9th Cir. 1980), in which the essence of the transactions, in our words, was that "the so-called loan providing funds for the interest payment was made from a fictitious bank balance created by a deposit of the interest itself." Beck v. Commissioner, 74 T.C. 1534">74 T.C. 1563. We further stated: The instant case fits within the Clardy mold. The payment construct * * was nothing more than an illusory facade constructed by means of check swapping. There was no payment of interest here because no money nor bankable1991 Tax Ct. Memo LEXIS 661">900 funds were employed or were even available. To paraphrase the Ninth Circuit in Clardy, since no financial resources were required, there was no limit to the amount that could be paid using this technique: $ 3 million could have been paid as easily as the approximately $ 300,000 that was paid. United States v. Clardy, 612 F.2d 1139">612 F.2d at 1152. The section 163(a) payment provision requires substantially greater substance and reality than either the facts of Clardy or this case demonstrate. [Beck v. Commissioner, 74 T.C. 1534">74 T.C. 1564.]Of the two stock program waltzes summarized step-by-step in our findings, the Stock Subscription Plan leverage loan waltz is factually similar, in terms of a circular flow, to the loans in both Karme and Beck. The borrower used the leverage loan amount to pay interest on other loans, specifically on primary loans and unpaid subscription balances, and the Beck rationale suggests that this borrowed amount was not truly "paid." Karme suggests that even if the leverage loan borrower did not use the funds to pay interest on other obligations, the borrowed amount was not a genuine debt obligation to1991 Tax Ct. Memo LEXIS 661">901 which interest could attach. In contrast to the Stock Subscription Plan leverage loan waltz, the primary loan waltz does not implicate Beck directly. A borrower used the primary loan only to purchase stock, not to pay interest on other loans. The Commissioner's notices of deficiency provide as one ground for disallowance of interest deductions that petitioners did not establish that they paid or properly accrued interest in the years for which they claimed deductions. 41 The notices of deficiency provide as another ground that the underlying transactions did not give rise to bona fide indebtedness. Accordingly, the issues we considered in both Karme and Beck are properly before us in the instant cases. 1991 Tax Ct. Memo LEXIS 661">902 Subscription interest arose under both the Stock Subscription Plan and the Leasing Corporation Plan. In the Stock Subscription Plan, the investor borrowed funds by means of a leverage loan to pay a year of interest on the primary loan and a year of interest on the unpaid subscription balance. The leverage loan proceeds check was not a two-party check, but was instead payable to the investor alone. The investor wrote two of his own checks, one for primary loan interest and one for subscription interest. On the day of the waltz, as summarized in our findings, the funds flowed from the leverage lender to the investor, where they split and went to the primary lender and the stock-issuing acceptance corporation, after which they reconverged and flowed to the leverage lender. In essence, the deposit to the leverage lender's account consisted of the same funds that it lent to investors as leverage loan proceeds on the same day. The closed circle, with all participants being investors or Kersting corporations having accounts at this same bank, enabled Kersting to transact a Stock Subscription Plan leverage loan (a part of which was subscription interest) entirely on paper without any1991 Tax Ct. Memo LEXIS 661">903 actual cash involved. We see no meaningful distinction from the "illusory facade" in Beck. Petitioners did not "pay" interest on unpaid subscription balances in the Stock Subscription Plan, even assuming there were principal obligations to which interest could attach. As noted, the record does not provide clear and complete transactional detail on the flow of subscription interest funds under the Leasing Corporation Plan. The evidence suggests, however, that Kersting waltzed such subscription interest. We have considered both ways in which an investor paid subscription interest in the Leasing Corporation Plan. For the first year, which was similar in this respect to the Stock Subscription Plan, a leverage loan from an acceptance corporation supplied the funds for the payment of that interest. For checks deposited to the Liberty Bank general accounts of Anseth Leasing and Escon Leasing on July 22, 1981, four different individuals appeared on the deposit slips for a two-check set of deposits in the amounts of $ 19,000 and $ 6,600. These check amounts coincide with a typical stock purchase under the Leasing Corporation Plan of $ 19,000, which typically accompanied a $ 55,0001991 Tax Ct. Memo LEXIS 661">904 subscription agreement calling for $ 6,600 of subscription interest. The checks for the other two individuals exhibit a similar pattern, with one two-check set of deposits consisting of $ 22,000 and $ 7,920, and the other consisting of $ 25,000 and $ 9,000. Dividing $ 7,920 by the standard 12-percent subscription interest rate gives $ 66,000, which is exactly three times $ 22,000, again a typical ratio for the Leasing Corporation Plan. Similarly, dividing $ 9,000 by the standard 12-percent subscription interest rate gives $ 75,000, which is exactly three times $ 25,000. In short, these bank accounts for July 22, 1981, have activity corresponding to three standard size variations of the Leasing Corporation Plan: A $ 19,000 stock purchase and $ 55,000 subscription, a $ 22,000 purchase and $ 66,000 subscription, and a $ 25,000 purchase and $ 75,000 subscription. For present purposes, the important point is that the apparent subscription interest amounts of $ 6,600, $ 7,920, and $ 9,000 entered and exited the account on the same day, just as subscription interest did in the Stock Subscription Plan leverage loan waltz. The source of subscription interest for subsequent years of the1991 Tax Ct. Memo LEXIS 661">905 Leasing Corporation Plan was the annual distribution check from the leasing corporation general account. Bank statements for Escon Leasing covering April 27, 1978, and November 8, 1978, appear to illustrate that the bank paid an annual distribution check from the general account on the same day that it paid the corresponding primary loan interest check and subscription interest check from the special account. Specifically, of the 37 checks listed in our findings and paid from the general account on these two dates, each can be matched with a set of two checks paid from the special account that together equal the amount of the general account check. Further, in all but 1 of the 37 two-check groupings in the special account, the checks correspond to primary loan interest at 18 percent and subscription interest at 12 percent for either a $ 19,000 purchase and $ 55,000 subscription program or a program with an exact ratio of 1 to 3 between purchase and subscription. The majority of the checks for Anseth Leasing on August 6, 1979, and August 16, 1979, can be similarly matched and categorized. Accordingly, after an investor endorsed the distribution check and the two accompanying checks1991 Tax Ct. Memo LEXIS 661">906 and then returned all three to Kersting, the following appears to have occurred at the bank on the same day: (1) The endorsed distribution check was paid from the general account and deposited to the special account; (2) the checks for primary loan interest and subscription interest were paid from the special account; and (3) the check for subscription interest was deposited to the general account. The support for step (3) is the exact match between a deposit of unknown origin to the leasing corporation general account and what we have derived as apparent subscription interest checks issued from the special account for each of August 6, 1979, August 16, 1979, and November 8, 1978. Those amounts are, respectively, $ 39,417.60, $ 156,948.40, and $ 45,090. For the date that is not an exact match, April 27, 1978, the numbers are close: a $ 143,730 deposit to the general account and $ 146,430 in apparent subscription interest checks issued from the special account. In sum, because Kersting appears to have waltzed the funds used for subscription interest in the Leasing Corporation Plan, either as part of a leverage loan waltz (the first year) or as part of a distribution check waltz1991 Tax Ct. Memo LEXIS 661">907 (in subsequent years), petitioners have not met their burden of showing that they "paid" subscription interest in the Leasing Corporation Plan. 4. Primary LoansWe consider now the primary loans in the Stock Purchase Plan, the Stock Subscription Plan, and the Leasing Corporation Plan, which petitioners used to purchase stock from Kersting corporations. The notes corresponding to the primary loan transactions were in form recourse. Interest actually paid on recourse notes may be deductible even if the purchase transaction being financed is itself a sham. Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89">752 F.2d 89, 752 F.2d 89">95-96 (4th Cir. 1985), revg. on this issue 81 T.C. 184">81 T.C. 184 (1983). We conclude here, however, that the purported recourse obligations were not in the nature of genuine indebtedness and that petitioners have not shown they paid the associated interest. We have found as a fact that Kersting and his investors had an understanding at the commencement of an investment program that the primary loan obligation could be satisfied in full at any time by a mere surrender of the associated stock certificate. Given the importance of this underlying1991 Tax Ct. Memo LEXIS 661">908 fact in these cases, the support for our finding merits some discussion. Kersting steadfastly maintained at trial that he did not represent to investors that they could exchange stock for a canceled primary note at any time. Instead, according to Kersting, he merely told them that should they desire to terminate he would try to find a buyer for the stock, generally a new participant in that particular program. 42 He seemed to say that although termination always occurred as an even stock-for-note swap if the investor was current on leverage loan interest payments, this was merely a fortuitous result that he did not promise to investors initially. He testified that he provided so-called "comfort letters" only to those "nervous Nellies" who insisted on having them, which did not include any of petitioners. 1991 Tax Ct. Memo LEXIS 661">909 We do not doubt that Kersting only provided these personalized comfort letters to investors who insisted and that petitioners were not among that group. It does not necessarily follow, however, that the policy embodied in the letters was unknown or unavailable to petitioners or other investors. In fact, the record contains several indications, covering a span of several years, that Kersting applied this policy to everyone whether they requested personalized comfort letters or not: (1) Thompson testified that Kersting assured him of the policy at the outset, and no other petitioner testified that he tendered stock to Kersting and was refused. Kersting's refusal to accommodate Thompson is reasonably attributed to the serious falling out that occurred previously and to Thompson's apparent refusal to pay leverage loan interest. (2) Kersting described the 1976 Forbes Acceptance Stock Subscription Plan to Mil Harr this way: "The deal is self-liquidating as you can retire all of your debt by simple surrender of the stock certificate issued to you." (3) Gabriele Kersting sent a form letter to Owens also relating to a 1976 Forbes Acceptance Stock Subscription Plan, in which she advised1991 Tax Ct. Memo LEXIS 661">910 him to "Keep the [stock] certificate in a safe place as you will need it later to retire the $ 30,000.00 note." (4) In a form letter transmitting initiating documents for the Leasing Corporation Plan of Universal Leasing, Kersting stated: "All of your debt, except your monthly payment obligation, can be discharged at any time at your option by surrender of the stock certificate which will be issued to you after we have received the executed documents from you." (5) In a form letter marking the first anniversary of a Leasing Corporation Plan for Anseth Leasing, Kersting noted that "you do have the continuing option to retire the existing notes by a sale to your corporation of the stock which you have acquired." (6) Although in the form of a personalized comfort letter, Kersting wrote expansively in 1977: "there is, of course, no problem to reassure you of the self-sustaining and self-liquidating aspects of the transaction. We would, in fact, issue a letter to every participant in the deal outlining that understanding if it would not weaken YOUR position with the IRS." (7) In another personalized comfort letter, this time from 1978, Kersting again wrote broadly: "As to the 1991 Tax Ct. Memo LEXIS 661">911 obligation under the promissory notes and subscription agreements there is no ongoing obligation as far as we are concerned. We will always repurchase the stock issued at a price sufficient to allow a borrower to discharge all of his debt." (8) In a 1980 credit-reference letter to a third party, Kersting wrote that the investor's "liabilities at * * * [the time of his stock purchases] and from there on would be equal to the assets acquired. His debt can be cancelled at any time of his choice by the sale of the assets in his possession." (9) Dixon received a 1985 form letter that told him how to terminate his participation in his Charter Financial stock purchase plan by returning an endorsed stock certificate, after which his notes and stock certificate would be canceled and notes marked "paid" would be returned to him. The letter contained similar unused "cancellation" lines for leasing corporation stock certificates and acceptance corporation stock certificates. Going beyond our conclusion that Kersting and petitioners had a prearranged understanding of the available stock surrender policy, we are convinced that neither Kersting nor petitioners ever contemplated that the1991 Tax Ct. Memo LEXIS 661">912 principal obligation on a primary loan would be paid except by a surrender of the stock. Only during the later years at issue did primary notes include an express notation that they were nonnegotiable and nonassignable. For all the record shows, however, they were always regarded as such. We have seen no evidence of any primary note that ended up in the hands of an individual or corporation not associated with Kersting. From Kersting's perspective, although he inquired about a prospect's general financial situation at the outset, the only things he could readily verify or apparently cared to verify were occupation status as a pilot and approximate salary. He at most infrequently required a loan application or financial statements (and only Owens claimed to have ever submitted either), and he also seldom if ever did credit checks. He did not even retain notes of his discussions with potential investors. The primary loans were unsecured, with the primary notes failing to list even the purchased stock as collateral. From petitioners' perspectives, we simply do not believe that at their high but not sky-high income levels, they would take on sizable primary loan liabilities1991 Tax Ct. Memo LEXIS 661">913 to purchase stock about which they knew little or nothing unless they had no expectation or intention of ever paying off those loans with cash. Although recourse in form, the primary loans in the stock investment programs were not genuine indebtedness in substance and thus cannot support interest deductions under section 163(a). Admittedly, in the early versions of his stock programs Kersting made no secret of the nonrecourse nature of the loans involved. In our list above of evidence supporting a pervasive stock surrender policy, items (2), (3), and (4) perhaps relate to such nonrecourse loans. Owens was also presumably involved in such transactions. Calling the loans nonrecourse, however, does not without more provide the missing substance. The emphasis in all three of items (2), (3), and (4) is in terms of the ultimate exchange transaction, stock for satisfaction of debt, rather than in terms of liability limited to the stock. Moreover, the failure to introduce proof of stock value, which in a genuine transaction would at least approximate the amount of the nonrecourse loan, has been termed a fatal defect. Estate of Franklin v. Commissioner, 544 F.2d 1045">544 F.2d 1045, 544 F.2d 1045">1048 (9th Cir. 1976),1991 Tax Ct. Memo LEXIS 661">914 affg. 64 T.C. 752">64 T.C. 752 (1975); Narver v. Commissioner, 75 T.C. 53">75 T.C. 53, 75 T.C. 53">98-99 (1980), affd. per curiam 670 F.2d 855">670 F.2d 855 (9th Cir. 1982). Petitioners have failed to introduce any such proof other than the testimony of Kersting, which on this point like many others was vague, inconsistent, and not credible. Further support for our characterization of the primary loans as other than genuine indebtedness lies in the apparent circular flow of all primary loan funds, similar to the flow in Karme v. Commissioner, 73 T.C. 1163">73 T.C. 1163 (1980), affd. 673 F.2d 1062">673 F.2d 1062 (9th Cir. 1982). In the Stock Subscription Plan on waltz day, as summarized step-by-step in our findings, two-party loan proceeds checks that originated with the primary lender were deposited to the account of the stock-issuing acceptance corporation, which transferred funds (either indirectly through Federated Finance or directly) back to the account of the primary lender. In essence, the deposit to the primary lender's account consisted of the same funds that it lent to investors as primary loan proceeds. The record does not provide clear and complete transactional1991 Tax Ct. Memo LEXIS 661">915 detail on the flow of primary loan funds in the Stock Purchase Plan and the Leasing Corporation Plan. We have cause to believe, however, that waltzes similar to that in the Stock Subscription Plan were parts of these two programs. First, the primary loan served the same fundamental function in all three programs, as an acquisition loan for the purchase of stock. Second, Kersting admitted that the holding companies in the Stock Purchase Plan and the leasing corporations in the Leasing Corporation Plan periodically transferred the funds received from new shareholders back to Federated Finance, the primary lender. In addition, Liberty Bank statements for Charter Financial and Candace Acceptance covering February 8, 1980, and May 22, 1980, seem to indicate that waltzes (albeit of a different type) were part of the Stock Purchase Plan. On May 22, 1980, the bank recorded 37 checks issued by Charter Financial in amounts of $ 7,200, $ 14,400, or $ 21,600, which happen to correspond to leverage loan amounts for standard Stock Purchase Plans of $ 40,000, $ 80,000, and $ 120,000, respectively. Among the deposits recorded was one for $ 597,600. For Candace Acceptance, the bank recorded1991 Tax Ct. Memo LEXIS 661">916 four deposits evenly divisible by $ 7,200, which totaled $ 597,600. Among the issued checks recorded was one for $ 597,600. The relationships were similar on February 8, 1980, when the common amount was $ 302,400. Accordingly, after several investors endorsed and returned their Stock Purchase Plan annual distribution checks, the following appears to have occurred at the bank on the same day: (1) The distribution checks were paid from the account of the holding company and deposited to the account of the leverage lender to pay off the leverage loans; and (2) the leverage lender issued a check in the amount deposited to its account to the holding company. Under this scenario, the same distribution amount was both deposited to and paid from the account of the holding company, with a stop in between at the leverage lender to provide a bank record of a satisfied leverage loan obligation. If Kersting waltzed distribution checks in the Stock Purchase Plan, as this bank account activity suggests, we do not doubt that he handled primary loan funds in the same program similarly. For primary loan funds in the Leasing Corporation Plan, Liberty Bank statements for Anseth Leasing and Escon1991 Tax Ct. Memo LEXIS 661">917 Leasing covering July 22, 1981, are instructive. We have already described these statements in connection with the circular flow of subscription interest. We there concluded that the account activity corresponded to three size variations of the Leasing Corporation Plan: A $ 19,000 stock purchase and $ 55,000 subscription, a $ 22,000 purchase and $ 66,000 subscription, and a $ 25,000 purchase and $ 75,000 subscription. For present purposes, we need only add that the apparent primary loan amounts of $ 19,000, $ 22,000, and $ 25,000 entered and exited the leasing corporation general account on the same day, a trademark of a Kersting waltz. In sum, in addition to the waltz of primary loan funds in the Stock Subscription Plan, which we know existed, we have described an apparent waltz of a different type in the Stock Purchase Plan and a partial apparent waltz of primary loan funds in the Leasing Corporation Plan. Kersting seems to have waltzed primary loan funds in these latter two programs in much the same way that he waltzed such funds in the Stock Subscription Plan. Another important factor in our consideration of the genuineness of an indebtedness is the backdating of documents1991 Tax Ct. Memo LEXIS 661">918 relevant to the loan transaction. Karme v. Commissioner, 73 T.C. 1163">73 T.C. 1163, 73 T.C. 1163">1191-1192 (1980), affd. 673 F.2d 1062">673 F.2d 1062 (9th Cir. 1982). 43 Backdating is not always meaningful in this analysis, such as when the documents are meant only to reduce to written form an agreement reached orally on the earlier date. The circumstances in the instant cases, however, are not so readily explained. Initiating documents sometimes bore a date that was long before the date that the documents were actually executed and even before the date that the investor informed Kersting he was ready to commence an investment program. Although we discuss backdating here in the context of the genuineness of primary loans, this analysis applies also to the other loans at issue in these cases. 1991 Tax Ct. Memo LEXIS 661">919 Rina, as one example, entered into four different programs with initiating documents dated July 1, 1979, including a stock subscription plan involving Candace Acceptance. Yet Kersting sent him a letter dated November 7, 1979, describing available interest deductions for 1979 and stating that "necessary documents" would be produced when Kersting heard from him. In a letter dated November 12, 1979, Kersting informed him that "We did not have sufficient time this weekend to complete all documentation" for Candace Acceptance. Notably, but not surprisingly, the primary loan proceeds check for Rina's Candace Acceptance stock subscription plan was dated July 1, 1979, but not deposited into the account of Candace Acceptance as part of a primary loan waltz until December 11, 1979. Although DuFresne returned his executed initiating documents for a Delta Acceptance stock subscription plan in May of 1980 at the same time that he opened a Liberty Bank account, those documents were dated January 3, 1980. Mil Harr similarly returned executed initiating documents for his Forbes Acceptance stock subscription plan 6 months after the date on the documents. More generally, Kersting's form letter1991 Tax Ct. Memo LEXIS 661">920 of October 1, 1979, urged investors to have their tax deductions properly documented and recorded well before yearend. He referred specifically to deduction-generating documents that he sent out earlier in 1979, and asked the investors either to return the documents, implying that they be in executed form, or to inform him if they did not wish to "make use of the tax shelter." Concerning the incentive for backdating, Kersting presumably preferred an early January date for the initiating documents not only as a recordkeeping and administrative convenience for himself and his staff, but also as a deduction maximizer for his investors. If the loans were outstanding for the entire year, then a full year of interest was deductible if paid. If the loans were outstanding for less than the entire year, then even prepayment of a full year of interest would not support a full-year deduction. For a taxpayer using the cash method of accounting, paid interest that is allocable to a later year (excepting certain "points" associated with a principal residence) is not deductible in the year paid. Sec. 461(g). In reply to respondent's intimations of backdating, petitioners argue that the exact1991 Tax Ct. Memo LEXIS 661">921 date of entering an investment program is not important. According to petitioners, the appropriate consideration is whether they had an economic interest and thus a risk of loss in the program sometime before the end of the calendar year. This response, however, ignores the lack-of-substance inference that arises from parties who are not concerned with respecting the form of their transactions. Because of the document uniformity among the investors within a given program, this inference could justifiably carry over to even those investors whose documents were not backdated. Even if the primary loans did represent genuine indebtedness, petitioners have not shown that they paid the associated interest within the meaning of Beck v. Commissioner, 74 T.C. 1534">74 T.C. 1534 (1980), affd. 678 F.2d 818">678 F.2d 818 (9th Cir. 1982). The question in this context is not whether Kersting waltzed primary loan funds, which we just considered, but whether he waltzed the funds used to pay interest on the primary loans. This is in large part a question of whether Kersting waltzed leverage loan funds, because leverage loans for the Stock Purchase Plan, the Stock Subscription Plan, and1991 Tax Ct. Memo LEXIS 661">922 the first year of the Leasing Corporation Plan supplied the funds to pay primary loan interest. As summarized in both our findings and our earlier analysis of subscription interest, Kersting did indeed waltz leverage loan funds in the Stock Subscription Plan. We also described in our analysis of subscription interest how Liberty Bank activity on July 22, 1981, appears to reveal a waltz of first-year subscription interest, which we would expect to be coupled with a waltz of primary loan interest, in the Leasing Corporation Plan. Whether Kersting waltzed primary loan interest in the subsequent years of the Leasing Corporation Plan turns on whether he waltzed distribution checks. We have already described the apparent subscription interest portion of a distribution check waltz based upon Liberty Bank statements for leasing corporations covering April 27, 1978, November 8, 1978, August 6, 1979, and August 16, 1979. In that context, we concluded that after an investor returned to Kersting an endorsed distribution check and the two accompanying checks, the following appears to have occurred on the same day: (1) The endorsed distribution check was paid from the general account and deposited1991 Tax Ct. Memo LEXIS 661">923 to the special account; (2) the checks for primary loan interest and subscription interest were paid from the special account; and (3) the check for subscription interest was deposited to the general account. For present purposes, we replace the third step and add a fourth: (3) The check for primary loan interest was deposited to the account of Federated Finance; and (4) Federated Finance issued a check in the amount deposited to its account to the general account of the leasing corporation. Although the record does not include the Federated Finance bank statements necessary to confirm these two new steps, a close match exists between a deposit of unknown origin to the leasing corporation general account and what we have derived as apparent checks to Federated Finance issued from the special account. For August 16, 1979, apparent checks to Federated Finance issued from the Anseth Leasing special account total $ 80,820, while the Anseth Leasing general account shows a deposit of $ 81,000. For Escon Leasing on April 27, 1978, the respective amounts are $ 75,240 and $ 78,000. For Escon Leasing on November 8, 1978, the respective amounts are $ 23,220 and $ 23,000. 5. Leverage1991 Tax Ct. Memo LEXIS 661">924 LoansThe one remaining type of loan for which petitioners claimed interest deductions under the stock plans is the leverage loan. In the Stock Purchase Plan, the investor used the proceeds of the leverage loan to pay interest on the primary loan. In the Stock Subscription Plan, he used the proceeds of the leverage loan to pay interest on both the primary loan and the subscription agreement. In the Leasing Corporation Plan, he used the proceeds of the initial leverage loan to pay interest on both the primary loan and the subscription agreement; subsequent leverage loans retired outstanding leverage loans. A leverage note, like a primary note, did not limit the personal liability of the maker. Contrary to the form, however, Kersting told some investors that surrendered stock would satisfy all outstanding debt, which would include leverage loans. Further, whether in the form of a personalized comfort letter or otherwise, an investor understood from Kersting that he would not be called upon to pay off his leverage loan if he followed instructions for participating in the applicable program. This meant endorsing and returning annual distribution checks for the Stock Purchase1991 Tax Ct. Memo LEXIS 661">925 Plan and the Stock Subscription Plan, and returning a renewal leverage note for the Leasing Corporation Plan. We have already analyzed, in the context of interest paid on subscription balances and primary loans, the waltz of leverage loan funds in the Stock Subscription Plan and the apparent waltzes of such funds (both first year and subsequent year) in the Leasing Corporation Plan. A particularly striking feature of a leverage loan is its common date with the other initiating documents in a stock program. Like the corresponding primary loan, the leverage loan was outstanding for the entire year in a typical January-initiated program. Because the primary note did not call for prepaid interest, an obvious question arises as to why investors obligated themselves to pay 9- or 15-percent annual interest on a seemingly premature leverage loan. 44 The more rational approach economically from the investor's standpoint would be to wait as long as possible before committing to the leverage loan, thus minimizing accumulating interest. Indeed, the interest on a leverage loan was not even part of the tax shelter benefits of a Kersting program because that amount, dwarfed by primary loan1991 Tax Ct. Memo LEXIS 661">926 interest and subscription interest, came straight out of the investor's pocket. The timing of the leverage loans appears especially suspect in the Stock Subscription Plan, in which the investor indirectly used leverage loan proceeds to pay primary loan interest and subscription interest. The use was indirect because the investor actually wrote his own checks for these amounts, after having been assured that the leverage loan proceeds check would be deposited to his account to cover the two checks. Kersting could not waltz the leverage loan proceeds until he had received the investor's checks, which the investor typically wrote several months after the date on the initiating documents. Thus, by the time Kersting waltzed the investor's checks and1991 Tax Ct. Memo LEXIS 661">927 the leverage loan proceeds check together, the initiating date was long past. In effect, the investor had accumulated an interest liability for several months prior to the waltz date on which he first had use of the leverage loan proceeds. In these circumstances of circular funds flows, backdating, substance not following form, and mutual expectations of no personal liability, the leverage loans were not genuine indebtedness that could support petitioners' claimed interest deductions. 6. Other Waltz IssuesAlthough neither respondent nor petitioners delved into the Kersting waltz details to the extent we did, both parties devoted a good portion of their arguments on brief to other aspects of the waltzes. Respondent, for his part, makes much of the small bank account balances that often prevailed among the Kersting corporations immediately before and after a waltz. Petitioners counter that sound cash management practices do not include tying up sizable amounts of investable funds in bank checking accounts, that the Kersting corporations involved in a waltz had immediate access to funds from other Kersting corporations in the event of insufficient funds, and that banking 1991 Tax Ct. Memo LEXIS 661">928 today is commonly transacted with offsetting deposits and withdrawals in ways analogous to Government deficit spending. We are reluctant to place too much direct emphasis on the size of the account balances. We note first that small balances, while definitely the rule, were not universal. Furthermore, small beginning and ending balances on waltz days were often accompanied by unidentified check transactions in addition to the identified waltzed funds. For days that have not been established as waltz days, the record does not reveal the origins of most deposited checks or the destinations of most issued checks appearing in the bank statements. In any event, we do not believe that small account balances are necessary to respondent's position if the circular flow of funds can be established without reference to the underlying account balances, as we have done here. In our consideration of whether interest was paid and whether there was genuine indebtedness, the size of the account balances, after all, makes the flow of funds neither more nor less of a circle. We do agree with respondent, however, that the prevalence of small account balances on waltz days serves to illustrate that1991 Tax Ct. Memo LEXIS 661">929 the waltzes as designed and implemented were paper transactions, with no need for actual cash to be involved. Petitioners urge us to downplay the significance of the Kersting waltzes by adopting the analysis from a recent criminal case, United States v. Kilpatrick, 726 F. Supp. 789">726 F. Supp. 789 (D. Colo. 1989), which dealt with deductions attributable to two types of tax shelters. One was a set of coal leasing programs in which participating sublessees sought to increase their deductible advance minimum royalty payments through nonrecourse borrowing repayable solely by coal production from the subleased properties. The other was a set of limited partnerships created for the purported purpose of developing processes to convert coal to methanol, with the tax advantage intended to come from payment of a deductible research and development expense partially with borrowed funds. The defendants were individuals related to corporations that sponsored, administered, and participated in the programs. The Government's burden was to prove beyond a reasonable doubt that each of them willfully participated in schemes designed to create false and fictitious tax deductions with the intent1991 Tax Ct. Memo LEXIS 661">930 to defraud the Government. The court, after acknowledging the existence of circular financing and check-swapping from bank accounts with otherwise inadequate balances, found the defendants not guilty. Before turning to petitioners' specific arguments, and without deciding whether we agree with the Kilpatrick analysis or holdings, we observe that the heightened burden-of-proof standard in Kilpatrick, which there rested on the Government in a losing cause, precludes us from attaching much significance to the case. The court summarized the Government's proof shortcomings as follows: although the government has admitted hundreds of exhibits and weeks of testimony, there are too many missing pieces to complete the picture portrayed by * * the indictment. If this were a civil case, the defendants would be required to explain many things to meet a strong prima facie case of fraud. Here, however, the defendants need explain nothing. The government's approach to this prosecution has been simplistic: proof of check circles is proof of tax fraud. It is not that easy. * * * [726 F. Supp. 789">United States v. Kilpatrick, supra at 798-799.]Petitioners' main contention1991 Tax Ct. Memo LEXIS 661">931 derived from Kilpatrick is that waltzes of checks, including those passing through low-balance accounts, "had economic substance and constituted bona fide consideration." Petitioners draw on language in the opinion suggesting that the check-swapping parties in the coal leasing programs had new rights and obligations relating to coal production immediately after the swap. 726 F. Supp. 789">726 F. Supp. at 791, 793. The facts here are similar, argue petitioners, because they "became the owners of shares of stock after execution of the original promissory notes and funding of the loan proceeds by check." We reject petitioners' characterization of their stock purchases. A Kersting waltz of primary loan funds typically occurred up to several months after the date on the stock certificate. Although petitioners vaguely emphasize that they became shareholders "after" certain events, they understandably have not attempted to argue that they became shareholders on or after the waltz dates, which would contradict the dates on the initiating documents that started the interest clock running. Petitioners' assertion that Kersting corporations came away from a stock purchase with enforceable1991 Tax Ct. Memo LEXIS 661">932 recourse notes, thus establishing bilateral economic substance, again ignores the questions of when and how those obligations supposedly arose, which was not on the date of or by means of the waltz. Even Kersting did not maintain that the waltz affected the rights and obligations already purportedly established by the initiating documents as dated. Unlike the examples petitioners cite from Kilpatrick, the Kersting waltzes were not intended to manufacture anything of economic substance. Petitioners also direct us to what the court in Kilpatrick considered a mitigating factor in the otherwise somewhat "sinister" (in the words of that court) circular flow of checks: the circularity and the amounts of the account balances were well known to the bank officers who participated in the financing. 726 F. Supp. 789">726 F. Supp. at 792. Although this factor is admittedly present in the instant cases, petitioners conveniently ignore the court's second mitigating factor, which is clearly absent here: the defendants freely distributed offering memoranda to the public. 726 F. Supp. 789">726 F. Supp. at 792. Petitioners' final argument directly related to Kilpatrick concerns, for 1991 Tax Ct. Memo LEXIS 661">933 the coal leasing programs, the court's reference to "the government's failure to disprove the underlying assumption that the coal reserves were adequate to support the values underlying the transaction." 726 F. Supp. 789">726 F. Supp. at 793-794. Seemingly recognizing that they must establish the "underlying assumption" in these cases, petitioners assert that if their notes constituted bona fide indebtedness, then that indebtedness would have been adequate to support the purchase of stock. We need say nothing more than that this position begs the question of whether the indebtedness was bona fide. Petitioners also seem to consider their high incomes analogous to the coal reserves in the quoted passage, as adequately underlying the transactions. Petitioners suggest that coal reserves were intended to pay off the nonrecourse loans in Kilpatrick just as high incomes were intended to pay off the recourse loans in these cases. The distinction, however, is that coal reserves were the subject matter of the coal leasing programs, not just a repayment method, whereas the pilots' incomes had no connection to the subject matter (i.e., the stock) of Kersting's investment programs. As a1991 Tax Ct. Memo LEXIS 661">934 final point on the Kersting waltzes, and one not stressed by either respondent or petitioners, we are mindful of the fact that transfers between Kersting corporations in a waltz were sometimes themselves documented as loans or as stock purchases, which suggests a change in economic position among the corporations that arguably provides some substance to the circular funds flow. We have already concluded, however, that petitioners' stock purchases in the three stock investment programs were shams, and we have no reason to believe that intercorporate stock transactions were any more substantive. As to documented loans, petitioners have pointed to no evidence that suggests the corporations respected the loan documents in terms of either interest or principal obligations. We would not be surprised to discover that the principal obligations were satisfied by a reverse circular flow of a subsequent waltz. 7. Collection LitigationPetitioners emphasize throughout their briefs that several Kersting corporations pursued litigation relating to promissory notes not involving petitioners, sometimes obtaining judgments and collecting portions of amounts due. According to petitioners, 1991 Tax Ct. Memo LEXIS 661">935 this confirms that the specific notes and underlying obligations at issue here were in substance, as well as in form, genuine recourse indebtedness. For many of these litigated actions, however, the evidence does not establish that the underlying transactions were the same as or even similar to those in the instant cases. The acts of litigating and even prevailing, therefore, do not aid petitioners' cause on the question of genuine recourse indebtedness. We have noted in our part II findings certain corporate litigation relating to the years at issue, but we believe this litigation is relevant only to the question of whether Kersting corporations carried on business activities outside of the investment programs. Nonetheless, the evidence does include some litigation that bears a direct relationship to the Kersting investment programs that are the subject of the instant cases. For these, we must address petitioners' argument concerning an inference of genuine recourse indebtedness. As to primary loans, the record contains only one established example of litigation regarding a primary note allegedly executed during the years at issue. In 1983, Atlas Funding commenced an action1991 Tax Ct. Memo LEXIS 661">936 against Continental pilot Steven Hane based upon a $ 30,000 renewal primary note for a stock subscription plan. No one testified, however, about the circumstances surrounding this action, and Hane did not testify at all, so we have no way of knowing whether he even tendered the acceptance corporation stock certificate. Nor did anyone explain how Hane had managed to accumulate 3 years of unpaid primary loan interest, which normally would have been paid by means of annual leverage loans. In any event, Atlas Funding dismissed the action voluntarily shortly after obtaining a default judgment. Although Kersting corporations pursued collection litigation on leverage loans against three other participants in stock investment programs, Carl Mott, George Vermef, and Robert Peterson, we do not believe that these activities give rise to an inference of genuine recourse indebtedness. Five Kersting corporations commenced actions against Carl Mott based upon a year of unpaid interest on 15 leverage notes, but the principal amounts of the notes were not in issue. The record is replete with copies of checks, drawn on personal bank accounts other than Liberty Bank or Hawaii National Bank, that1991 Tax Ct. Memo LEXIS 661">937 petitioners used to pay interest on leverage notes. Respondent does not dispute that Kersting insisted on these interest payments, but maintains that to the extent they were made they must be characterized as fees to Kersting for providing tax deductions. Consequently, that Carl Mott allegedly failed to pay interest on leverage notes is of no significance to the substance of his or anybody else's leverage loans. The litigation involving George Vermef and Robert Peterson has more potential probative value because both defendants were alleged to owe principal as well as interest on their leverage notes. Because investors were not automatically insulated from paying back the leverage loans with out-of-pocket funds, the argument goes, this demonstrates that the notes represented genuine recourse indebtedness. Although this is an appealing position at first glance, it does not survive closer analysis. If indeed these gentlemen owed principal amounts on the notes, there are only two readily apparent reasons why that situation might have arisen. As one possibility, the corporations in which they owned stock might have failed to issue distribution checks to extinguish the notes. 451991 Tax Ct. Memo LEXIS 661">938 This would be consistent, however, with neither the way the investment programs were intended to operate nor the way they apparently actually operated. In the latter regard, two of the leverage notes in the Vermef litigation and one in the Peterson litigation, all of which are dated July 1, 1980, relate to stock purchase plans. Both holding companies, Charter Financial and Investors Financial, issued distribution checks dated December 15, 1980, for stock purchase plans on a July annual cycle. If Vermef and Peterson did not receive distribution checks, this is an unexplained circumstance that can have no bearing on whether petitioners' leverage loans had substance. As the second possibility for principal owing on leverage notes, Vermef and Peterson may have received December distribution checks but failed to return them for application to their leverage notes. 46 Again, however, 1991 Tax Ct. Memo LEXIS 661">939 any such failure is inconsistent with the intended operation of the investment plans and, as such, does not suggest that the leverage loans were genuine. Indeed, Kersting could not recall at either his pretrial deposition or at trial a single Stock Purchase Plan situation in which an investor failed to return a distribution check for application to the leverage loan. As illustrated by Kersting's pay-or-else letter to over 30 clients on September 25, 1980, and his 1986 correspondence with the Thompsons, his overriding concern was to be compensated by means of leverage loan interest. It was this amount that even he often referred to as a "fee" or a deductible "cost" of tax deductions. In encouraging clients by means of the September 25, 1980, letter to "discharge the debt to which you are a party," he sought only small amounts that could not have represented typical primary or leverage loans. His letters1991 Tax Ct. Memo LEXIS 661">940 to the Thompsons indicate that he only threatened or pursued collection of principal obligations when the investor neglected or refused to pay leverage loan interest. This rare occurrence, which Kersting did not testify he either intended or expected, is not sufficient to transform any of petitioners' loans from Kersting corporations into genuine recourse indebtedness. 8. SummaryWe have concluded that petitioners' investments in stock associated with the Stock Purchase Plan, the Stock Subscription Plan, and the Leasing Corporation Plan were sham transactions. We have further concluded that the subscription agreements, primary loans, and leverage loans giving rise to petitioners' claimed interest deductions were not in the nature of genuine indebtedness and that petitioners did not show that they paid, within the meaning of section 163(a), either subscription interest or primary loan interest. We have considered the specific differences between petitioners' programs and, as applicable, the Stock Purchase Plan, the Stock Subscription Plan, and the Leasing Corporation Plan, and we have found those differences to be without significance to our conclusions. Accordingly, we 1991 Tax Ct. Memo LEXIS 661">941 sustain the Commissioner's disallowance of claimed interest deductions attributable to the Kersting stock programs. B. CAT-FITWe have set apart our analysis of the CAT-FIT Plan from our analysis of the Kersting stock investment programs. Although there are similarities (such as primary loans and leverage loans) that stretch across all four programs, the investment certificate used in the CAT-FIT Plan differs in form and function from a stock certificate. The CAT-FIT Plan differs from the other three programs in a second major respect. Despite the voluminous record in these cases, there remain significant gaps in the details of the CAT-FIT Plan that prevent us from fully understanding how it operated or how Kersting intended it to operate. This is especially troublesome because of the intrafamily transactions involved. Transactions among family members that create tax benefits are subject to careful scrutiny by the courts. Muserlian v. Commissioner, 932 F.2d 109">932 F.2d 109 (2d Cir. 1991), affg. a Memorandum Opinion of this Court. As the CAT-FIT Plan in form unfolded, the parent borrowed the investment certificate acquisition funds from Windsor Acceptance, and1991 Tax Ct. Memo LEXIS 661">942 Atlas Guarantee issued an investment certificate in the child's name. At this point, the parent had a loan repayment obligation to the primary lender and the child had an investment certificate of a like face amount, typically $ 17,000. Although this suggests that the parent made or was deemed to have made a gift to the child, the nature and form of such a gift are unclear. Regarding the nature of the apparent gift, the parent might have made a gift of the primary loan proceeds to the child, who then purchased the investment certificate, or the parent might have purchased the investment certificate with the primary loan proceeds and then made a gift of that certificate to the child. Kersting's written description of the CAT-FIT Plan, which states that "Each parent will make a gift in the amount of $ 17,000," is vague on this point, as is his deposition testimony that "The proceeds would be applied to buy for the child a thrift certificate." Hongsermeier's testimony on this point was conflicting, and even petitioners' opening brief fails to adopt clearly one theory over the other. Regarding the form of the apparent gift, the record does not disclose whether it was made outright, 1991 Tax Ct. Memo LEXIS 661">943 or as the subject of a custodial arrangement such as under the Uniform Gifts to Minors Act, or in trust. DuFresne testified that he held most of his daughters' legal documents, including the CAT-FIT investment certificates, and "took care of them for them." Kersting testified that he wanted to avoid involvement in custodial affairs, and only by rare special request might he have included a notation to the Uniform Gifts to Minors Act on the investment certificate. No such notated investment certificate appears in the record. Kersting also testified that he never intended or set up a Clifford trust arrangement. Owens described the program as setting up a "semi-trust" that he funded for his children, and, on brief, petitioners characterize CAT-FIT as an "educational benefit trust or account." The record, however, contains no relevant trust documents. Also a mystery is the ultimate destination of the interest checks received by a child in the leverage loan version of the CAT-FIT Plan. By the terms of the investment certificate, the child was to receive 12-percent annual interest on the face amount of the certificate. Atlas Guarantee periodically issued checks made payable to the1991 Tax Ct. Memo LEXIS 661">944 child, which, after endorsement, the parent generally returned to be added, supposedly, to the face amount of the certificate. The record, however, contains neither reissued certificates in increased face amounts nor separate supplementary certificates. Nor did the child receive increasing interest as the years passed, yet such an increase would be expected from a constant interest percentage applied to an increasing investment balance. Although there is no reliable evidence regarding how the parent paid off the annual leverage loan in the CAT-FIT Plan, the particulars of the three stock programs suggest that the endorsed interest checks could have served that purpose. When a parent decided to terminate, he returned the investment certificate to Kersting. His repayment obligation on the primary loan was then deemed satisfied, and he did not receive any cash from the termination. The rest of the termination stage is unclear. Kersting testified that there was essentially an exchange of the certificate for the primary note. However, because the investment certificate was in the name of the child rather than the parent, Kersting's explanation seems to entail, as a condition precedent, 1991 Tax Ct. Memo LEXIS 661">945 a gift of the certificate from the child to the parent. 47The Dixons, the DuFresnes, and the Owenses, in their opening brief, requested the Court to find the following core facts relating to their CAT-FIT plans: (1) The parent paid all of the support for the child during the time of CAT-FIT participation; and (2) the CAT-FIT "funds," "monies," "proceeds of the funds," and "earnings from the funds" were not used to pay expenses "incidental to support" of the child. These petitioners have not enlightened us as to how these proposed1991 Tax Ct. Memo LEXIS 661">946 facts are relevant to the issues before us, 48 but we assume that they seek in part to persuade us that the interest income from an investment certificate was taxable to the child rather than the parent. Although income derived from transferred property under common custodial arrangements is generally taxable to the child, the IRS view of such income used to satisfy a legal obligation to support the child is that the income is taxable to the person so obligated. Rev. Rul. 59-357, 1959-2 C.B. 212. Similarly, trust income will be taxable to the grantor if applied or distributed for the support of a beneficiary whom the grantor is legally obligated to support. Sec. 677(b). Whether the interest income is taxable to the parent or the child, however, is not directly in issue in these cases. The Commissioner's notices of deficiency do not include increases to the interest income of these petitioners. 1991 Tax Ct. Memo LEXIS 661">947 Petitioners' second proposed fact inexplicably focuses on "funds" and "proceeds" of the CAT-FIT Plan, implying that participating parents received cash from the program. Petitioners have not established, however, that the leverage loan CAT-FIT Plan generated cash at any stage. At initiation, neither the parent nor the child retained the primary loan proceeds because the check was used to purchase the investment certificate. The leverage loan proceeds check, similarly, was endorsed and returned to Kersting to offset the parent's check for interest on the primary loan. Also, the parent immediately returned to Kersting the endorsed checks representing earnings on the investment certificate. Finally, no net cash came out of the termination transaction. Although Dixon testified that he and Mrs. Dixon used CAT-FIT funds to educate their children, he failed to explain the source of those funds. Under the sham analysis as we have described and applied it to the Kersting stock programs, the acquisition of the Atlas Guarantee investment certificate is much more easily disposed of than the stock programs, but on similar principles. In terms of practical economic effects other than the1991 Tax Ct. Memo LEXIS 661">948 creation of income tax losses, we see none. First, none of the participating petitioners testified that he acquired the investment certificate with a profit motive, and we therefore conclude that they all lacked such a motive. 49 Second, there is nothing in this record suggesting a profit possibility. Kersting in fact described the investment certificate as just like a bank certificate of deposit, differing only in name. Although a bank certificate of deposit pays an interest "profit," that 12-percent annual profit on an Atlas Guarantee investment certificate was exactly offset by 12-percent annual interest paid to Windsor Acceptance on the primary loan. In these circumstances, the purchased investment certificate was totally lacking in economic substance. Its face value, typically $ 17,000, had no meaning except as a computational reference point for the interest amounts Kersting desired. 1991 Tax Ct. Memo LEXIS 661">949 In Kersting's written description of the CAT-FIT Plan, he characterized the "object of the plan" as "to shift income from parents to their children." A more accurate description of the program is that Kersting created interest income and corresponding interest deductions out of nothingness and allocated them within the family unit to where the favorable tax effect of the manufactured deductions would more than offset the unfavorable tax effect of the manufactured income. The appropriate allocation was income to the child and deductions to the parent. Closer analysis reveals that the CAT-FIT Plan was at best a break-even proposition economically, with or without a leverage loan. The Hongsermeier version of the CAT-FIT Plan, with no leverage loans, was a precise "wash-out" as described by Gabriele Kersting in her letter to Hongsermeier of March 29, 1977. With checks that were paid and deposited without waltzing, the Hongsermeier family both received 12-percent annual interest and paid out 12-percent annual interest while holding on to an investment asset of unchanging redemption value. At the other end of these checks were Atlas Guarantee and Windsor Acceptance, which were paying1991 Tax Ct. Memo LEXIS 661">950 at 12 percent when the Hongsermeiers were receiving and receiving at 12 percent when the Hongsermeiers were paying. Because there was no apparent economic benefit on the Kersting side of the transaction, he presumably offered this uncommon version of the CAT-FIT Plan as a type of inducement to potential stock investors or as a reward to present clients. The leverage loan version of the CAT-FIT Plan was even less beneficial to the parent (and correspondingly more beneficial to Kersting). Economically, the parent now paid out-of-pocket interest on the leverage loan that he did not pay in the Hongsermeier version. From a tax standpoint, the parent in essence purchased the additional deduction for leverage loan interest dollar-for-dollar for cash, even though the tax benefit of the deduction would be something less than dollar-for-dollar. The primary and leverage loans underlying the CAT-FIT purchase transaction suffer from the same shortcomings as the loans in the stock programs, including at least occasional backdating of documents. The Dixons, for example, entered into CAT-FIT plans for three children with initiating documents dated January 2, 1977, yet Gabriele Kersting inquired1991 Tax Ct. Memo LEXIS 661">951 by letter dated March 17, 1977, whether Dixon was still interested in the CAT-FIT program, and added: "If you are interested, please notify me at your early convenience and I will see that the appropriate documents are sent to you immediately." The CAT-FIT primary loan, while in form recourse, was not in the nature of a genuine indebtedness because the parties never contemplated that it would be paid except by means of a redemption of the investment certificate, which had a constant arbitrary value and no apparent secondary market. In this sense, the relationship between the investment certificate and the primary loan is like that between stock and primary loan in the stock investment programs. Although the record does not provide transactional detail on the flow of primary loan funds in the CAT-FIT Plan, in our findings we list several dates in 1979 and 1980 on which Atlas Guarantee checks matched Windsor Acceptance deposits. This suggests a waltz of the primary loan funds and a lack of genuine indebtedness. Karme v. Commissioner, 73 T.C. 1163">73 T.C. 1163 (1980), affd. 673 F.2d 1062">673 F.2d 1062 (9th Cir. 1982). Our findings summarize step-by-step the waltz of CAT-FIT1991 Tax Ct. Memo LEXIS 661">952 Plan leverage loan funds. In this waltz, the funds flowed from the leverage lender to the parent's account, then to the primary lender (as interest on the primary loan), then to Federated Finance, and finally back to the leverage lender. There is nothing unusual about this waltz compared to the Stock Subscription Plan waltz, and we accordingly reach the same conclusion. As we held in a similar situation in Beck v. Commissioner, 74 T.C. 1534">74 T.C. 1534 (1980), affd. 678 F.2d 818">678 F.2d 818 (9th Cir. 1982), petitioners with leverage loan CAT-FIT plans did not pay interest on their primary loans. Regarding the deductibility of interest on CAT-FIT leverage loans, participating petitioners have the burden of showing the existence of a genuine indebtedness. Because they have not established even how the leverage loan principal obligations were satisfied or intended to be satisfied, the lawsuit by Mahalo Acceptance against George Vermef based upon an allegedly unpaid leverage note does not tend to prove that the leverage loans were genuine recourse indebtedness. Further, the waltz of leverage loan funds suggests a lack of genuine indebtedness. Like the leverage loans1991 Tax Ct. Memo LEXIS 661">953 in the Stock Subscription Plan, Kersting did not waltz the loan proceeds until a date long after the initiating date on the documents, so a parent in effect accumulated an interest liability for several months prior to the waltz date on which he first had use of the leverage loan proceeds. Petitioners have not met their burden of showing that their CAT-FIT Plan leverage loans were in the nature of genuine indebtedness. Consequently, petitioners must be denied deductions under section 163(a) for interest on those loans. Finally, we believe that the CAT-FIT Plan is similar to the loan transactions that were the subject of Goldstein v. Commissioner, 364 F.2d 734">364 F.2d 734 (2d Cir. 1966), affg. 44 T.C. 284">44 T.C. 284 (1965). In Goldstein, an Irish Sweepstakes winner purchased Treasury notes with funds borrowed from two banks, pledging the Treasury notes as collateral to secure the loans. The loans bore interest at rates appreciably higher than the interest yield on the Treasury notes. Late in December, the cash basis taxpayer prepaid interest covering 1-1/2 years on one loan and covering over 2-1/2 years on the other, and claimed the prepayment amounts as a deduction1991 Tax Ct. Memo LEXIS 661">954 under section 163(a). The Court of Appeals concluded that this Court had been justified in finding that the taxpayer had entered into the transactions solely to secure a large interest deduction. The court rejected the deduction, holding that section 163(a) "does not permit a deduction for interest paid or accrued in loan arrangements, like those now before us, that can not with reason be said to have purpose, substance, or utility apart from their anticipated tax consequences." 364 F.2d 734">364 F.2d at 740. After acknowledging that deductible interest need not serve a business purpose, be ordinary and necessary, or even be reasonable, the court elaborated upon its "purpose, substance, or utility" standard: In order fully to implement this Congressional policy of encouraging purposive activity to be financed through borrowing, Section 163(a) should be construed to permit the deductibility of interest when a taxpayer has borrowed funds and incurred an obligation to pay interest in order to engage in what with reason can be termed purposive activity, even though he decided to borrow in order to gain an interest deduction rather than to finance the activity in some other way. 1991 Tax Ct. Memo LEXIS 661">955 In other words, the interest deduction should be permitted whenever it can be said that the taxpayer's desire to secure an interest deduction is only one of mixed motives that prompts the taxpayer to borrow funds; or, put a third way, the deduction is proper if there is some substance to the loan arrangement beyond the taxpayer's desire to secure the deduction. * * [Goldstein v. Commissioner, 364 F.2d 734">364 F.2d at 741.]This Court has interpreted Goldstein to mean that form will not be exalted over substance when the sole objective of a transaction is an interest deduction, even if the transaction has some minimal economic gain potential. Sheldon v. Commissioner, 94 T.C. 738">94 T.C. 738, 94 T.C. 738">767 (1990). As in Goldstein, those petitioners involved in CAT-FIT plans sought only to secure large interest deductions by participating in transactions that they did not anticipate being economically profitable. The CAT-FIT Plan lacks even the minimal economic gain potential mentioned in 94 T.C. 738">Sheldon v. Commissioner, supra.We hold, as an alternative to the sham analysis, that petitioners are not entitled to CAT-FIT Plan interest deductions, 1991 Tax Ct. Memo LEXIS 661">956 whether purportedly paid on primary loans or leverage loans, based upon the Goldstein rationale. We have considered the specific differences between petitioners' CAT-FIT plans and the CAT-FIT Plan. We have found those differences to be without significance to the above conclusions. Issue 3: Income from Corporate DistributionsRespondent contends that if petitioners are entitled to any interest deductions based upon their participation in the Kersting investment programs, then they must also report additional income because of their receipt of so-called "nontaxable" distributions from Kersting corporations. Because we have concluded that the interest deductions are not allowable, we need not address this issue as framed by respondent. We observe, however, that in the Cravenses' notice of deficiency for 1980, in addition to disallowing the interest deductions, the Commissioner increased income by $ 18,000 for what the Cravenses had reported as a nontaxable dividend distribution from Candace Acceptance. The Rule 155 calculation for the Cravenses should be consistent with the language in the various notices of deficiency and with respondent's opening brief, both of which1991 Tax Ct. Memo LEXIS 661">957 treat the income adjustment as only an alternate position. On a related point, the Cravenses' 1980 return includes a reported long-term capital gain of $ 7,200, after the 60-percent capital gains deduction, on the disposition of Candace Acceptance stock. In his notice of deficiency, the Commissioner did not reduce income in this amount, which is arguably inconsistent with his position that the underlying transaction was a sham. Petitioners' counsel Izen made this inconsistency argument in a different context, without specific reference to the Cravenses, in petitioners' motion to reopen evidence filed on January 23, 1991. Respondent, in his notice of objection filed on February 26, 1991, apparently overlooked the Cravens circumstances in agreeing that this was indeed an improper inconsistency: 3. In the test case litigation, each of the party petitioners claimed interest expense deductions based upon Kersting interest expense programs which were disallowed by the respondent on the basis that the transaction[s] giving rise to the alleged interest expense were shams. None of the test case petitioners, to respondent's knowledge, reported any capital gain based upon their termination1991 Tax Ct. Memo LEXIS 661">958 of their participation in the Kersting interest deduction programs, which gains would be recognizable as the transactions were structured, to the extent the interest expense deductions are allowed or are allowable, the alleged "non-taxable" dividends used to "pay" this expense constituting a basis adjustment to the underlying stock. In those instances where participants in Mr. Kersting's programs have agreed to the disallowance of the claimed interest associated therewith, the respondent has always allowed an adjustment to the amount of the resulting deficiency to reverse the tax imposed based upon associated and reported capital gains. Only a small number of the Kersting participants actually reported capital gain upon the termination of their participation. To disallow the interest expense, but not allow adjustment of the capital gain reported, would result in almost doubling the tax consequences of the interest disallowance, a result that would be improper. [Emphasis supplied.]Again, the Rule 155 calculation for the Cravenses should be consistent with respondent's stated position in the record concerning the treatment of reported capital gains. Issue 4: Owens Subchapter1991 Tax Ct. Memo LEXIS 661">959 S Corporations, Mortgage Funding, and Investment ExpensesIn the Owenses' notice of deficiency, the Commissioner disallowed subchapter S losses of $ 7,207 from Maurier Leasing in 1975 and $ 67 from Aztec Leasing in 1976, on three grounds: The corporations were not viable tax entities, they had excessive interest income that caused an automatic termination of subchapter S status, and they did not file timely subchapter S elections. The Commissioner disallowed claimed interest deductions associated with these corporations on three other grounds: The transactions giving rise to the deductions were shams, the amounts were not paid or properly accrued, and the transactions did not result in any bona fide indebtedness or in any enforceable and bona fide obligation to pay compensation for the use or forbearance of money. Pursuant to Rule 90, respondent requested the following admission from the Owenses, as filed with the Court on August 25, 1988: 1. The Henry Kersting transactions for 1975 and 1976 underlying adjustments for subchapter S losses from Maurier Leasing and Aztec Leasing, interest expense and investment expense in the statutory notice, and as petitioned as assignments1991 Tax Ct. Memo LEXIS 661">960 of error * , are the same as the Henry Kersting transactions considered in and decided by the Court in the case of Pike v. Commissioner, 78 T.C. 822">78 T.C. 822 (1982) [,affd. without published opinion 732 F.2d 164">732 F.2d 164 (9th Cir. 1984)].Rule 90(c) deems a matter admitted unless the party who is requested to admit its truthfulness answers timely and specifically in writing. On September 21, 1988, the Owenses filed a motion for enlargement of time to November 5, 1988, within which to respond to the request for admission. Although the Court granted the motion, they did not so respond. At trial, when counsel for respondent asked the Court to rule on whether the matter was deemed admitted, counsel for the Owenses stated he had discussed the request for admission with Owens and "We concede that at this time, that the same forms were used, and that the investment was structured, as far as filling out documents, similar to the Pike v. Commissioner investments." The Court then ruled that the matter was deemed admitted. Counsel for respondent later objected that opposing counsel was eliciting testimony from Owens pertaining to the matter deemed admitted. 1991 Tax Ct. Memo LEXIS 661">961 However, because respondent had not moved for an order to show cause why the Owenses' case should not be controlled by Pike v. Commissioner, 78 T.C. 822">78 T.C. 822 (1982), affd. without published opinion 732 F.2d 164">732 F.2d 164 (9th Cir. 1984), the Court overruled the objection.50In Pike, this Court addressed the net operating losses of Kersting subchapter S automobile-leasing corporations. Respondent1991 Tax Ct. Memo LEXIS 661">962 made several arguments against the pass-through of the net operating losses to the shareholders. We agreed with one and found it unnecessary to consider the others. The position we adopted was that the shareholders had no bases in the corporations and that, therefore, section 1374(c) precluded net operating loss deductions at the shareholder level. 78 T.C. 822">78 T.C. 838-839. Specifically, we concluded that the shareholders lacked a necessary "investment" in terms of an actual economic outlay. 78 T.C. 822">78 T.C. 839-840. Clearly, the shareholder-oriented rationale for our decision in Pike concerning subchapter S net operating losses does not coincide with any of the Commissioner's three asserted grounds in the notice of deficiency here, all of which focus on the corporation. We cannot adopt the result of Pike summarily, even with deemed admitted facts, when the analytical link between the Pike facts and result is not before us in this case. Nonetheless, despite the Owenses' prevailing on this point, they have not provided us with an appropriate setting within which to reach the substantive merits of their claimed subchapter S loss deductions. Simply1991 Tax Ct. Memo LEXIS 661">963 put, they have not met their burden of proof under Rule 142(a) to show that the Commissioner's determinations were erroneous. Regardless of whether they addressed the tax viability of the corporations at trial and on brief, they plainly ignored respondent's excess interest and untimely election positions. We therefore sustain respondent in his disallowance of loss deductions attributable to Maurier Leasing and Aztec Leasing. Regarding the claimed interest deductions attributable to Owens' involvement with these subchapter S corporations, respondent's grounds for disallowance are the same as those advanced against the other petitioners outside of the subchapter S realm. Although this Court in Pike did not analyze the leasing corporation transactions at issue there as "shams," we believe that the Pike analysis overall is consistent with our analysis of Issue 2 above and is therefore implicit in this part of the notice of deficiency. These petitioners do not argue that Pike was decided incorrectly or is no longer good law, but instead seek to distinguish the case factually. This position necessitates a return to their deemed admission and a consideration of which facts1991 Tax Ct. Memo LEXIS 661">964 in Pike that admission covers. As noted, the Owenses are deemed to have admitted that their Maurier Leasing and Aztec Leasing "transactions" are the same as the "transactions" considered in Pike. Bearing in mind that respondent drafted the request for admission and that ambiguities are generally construed against the drafter, we believe that "transactions" should be interpreted narrowly to mean that the form and structure, including documents, were the same. Counsel for the Owenses conceded such similar form and structure. These petitioners argue that Owens differs from the taxpayers in Pike in two respects, the first being that the taxpayers' lease payments in Pike were set artificially low. We disagree that this is a distinction. Even with a narrow interpretation of "transaction" similarity for purposes of the deemed admission, below-market lease rates were a part of the transaction "structure": "By structuring the transaction in this manner, the participants could claim a $ 900 interest deduction for tax purposes each year and were able to lease the cars for less than the fair rental value." Pike v. Commissioner, 78 T.C. 822">78 T.C. 828-829.1991 Tax Ct. Memo LEXIS 661">965 (Emphasis supplied.) The Owenses are thus deemed to have admitted that Owens paid a below-market monthly lease rate. Furthermore, we attach no significance to Owens' testimony that he believed the rate was "reasonable" for the type of automobile he leased from Universal Leasing in 1966. He did not testify about the particular knowledge or experience that enabled him to reach this conclusion, nor did he testify at all about the reasonableness of his lease payments to Maurier Leasing or Aztec Leasing. The Owenses' second purported distinction from the taxpayers in Pike is that those taxpayers had no bona fide intention or reasonable possibility of making a profit. Because the profit-motive part of this argument does not relate directly to the form or structure of the transactions, it is not foreclosed by the deemed admission. For the reasons discussed above in Issue 2, however, we conclude that Owens had neither a profit motive nor a reasonable possibility of a profit in entering into his Maurier Leasing and Aztec Leasing investments. Moreover, these petitioners have not explained the discrepancy between the 1976 Form 1120S for Maurier Leasing, which indicates that Owens 1991 Tax Ct. Memo LEXIS 661">966 owned 7,000 shares throughout 1975, and the documents apparently relating to the purchase of 7,000 Maurier Leasing shares as of July 28, 1975. We accordingly sustain the Commissioner's disallowance of interest deductions corresponding to Maurier Leasing and Aztec Leasing. We have also considered the Owenses' claimed interest deductions relating to the mortgage funding program and their claimed investment expenses. The scant documentary evidence and vague testimony do not suffice to satisfy their burden of proof on these matters. Issue 5: Section 163(d) Investment Interest LimitationSection 163(d) generally limits the deductibility of interest paid on indebtedness associated with investment property to a set amount plus the amount of net investment income. Because we have held that petitioners are not entitled to any of the interest deductions addressed under Issues 2 and 4, we need not consider whether section 163(d) serves to limit otherwise deductible interest. Issue 6: Section 6653(a) NegligenceIf any part of an underpayment is due to negligence or intentional disregard of rules or regulations, section 6653(a) (and section 6653(a)(1) for taxable years after1991 Tax Ct. Memo LEXIS 661">967 1980) provides for the imposition of an addition to tax equal to 5 percent of the underpayment. Section 6653(a)(2) (effective for taxable years after 1980) imposes an additional amount equal to 50 percent of the interest payable on the portion of the underpayment attributable to such negligence or intentional disregard. Negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985). The taxpayer bears the burden of proving that the Commissioner's determination is erroneous. Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 58 T.C. 757">791-792 (1972). Except for the Thompsons' taxable year 1980, the Commissioner determined a section 6653(a) or (a)(1) addition to tax for all taxable years of all petitioners. He determined a section 6653(a)(2) addition for each of the post-1980 taxable years of the Thompsons, the Youngs, and the DuFresnes. This Court has held that in the case of a sham transaction known to be so by the taxpayer, the imposition of the addition to tax under section 6653(a) is appropriate. Brown v. Commissioner, 85 T.C. 968">85 T.C. 968, 85 T.C. 968">1001 (1985),1991 Tax Ct. Memo LEXIS 661">968 affd. sub nom. Sochin v. Commissioner, 843 F.2d 351">843 F.2d 351 (9th Cir. 1988). As recently noted by the court in Howard v. Commissioner, 931 F.2d 578">931 F.2d 578, 931 F.2d 578">582 (9th Cir. 1991), affg. a Memorandum Opinion of this Court: In a case such as this where the taxpayers have been found to have entered into sham transactions without a primary profit motivation, they have failed to meet their burden of showing due care. No reasonably prudent person would have acted as they did. The penalties for negligence under * * [section] 6653(a)(1) and (2) are appropriate.We have already discussed in great detail the sham nature of the transactions at issue, including our conclusions that none of petitioners had a business purpose in entering into the transactions. We have also discussed petitioners' knowledge of the key components of the programs that indicate a lack of economic substance. In particular, they knew that the only real "value" of their investment asset was in satisfaction of a primary loan obligation and, from the opposite perspective, that their obligation on the primary loan was limited to the "value" of the investment asset. With these two variables1991 Tax Ct. Memo LEXIS 661">969 playing off one another, there was no reason for petitioners to care about the actual value of the stock or the face amount of the primary note. Each of these men was intelligent enough to know how a typical stock investment or borrowing transaction worked, and that their Kersting programs had no comparable economic substance. After all, we are dealing with simple stocks, certificates of deposit, and loans, and not with complex investment assets or markets that would cause us to question how much of the process the taxpayers actually understood. All of the complexity here resulted from manipulation of the loans for favorable tax effect. Petitioners knew that these transactions were shams. Petitioners generally offer two arguments against the imposition of these additions to tax. The first is that they relied on advice from certified public accountants in claiming interest deductions from the Kersting investment programs. The second is that they made full disclosure of all records to their accountants and return preparers. We consider the circumstances of the Cravenses separately. Reliance on a tax professional does not by itself insulate a taxpayer from the section 6653(a)1991 Tax Ct. Memo LEXIS 661">970 additions to tax. United States v. Boyle, 469 U.S. 241">469 U.S. 241, 469 U.S. 241">250, 83 L. Ed. 2d 622">83 L. Ed. 2d 622, 105 S. Ct. 687">105 S. Ct. 687 (1985). Such reliance must be reasonable under the circumstances. Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93, 864 F.2d 93">96 (9th Cir. 1989), affg. Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086 (1987). Unsophisticated, moderate-income taxpayers may be reasonable in relying on financial advisers and accountants. Here, however, although none of petitioners appear to fit a "sophisticated investor" profile, all were relatively high-income taxpayers, which is precisely the reason Kersting coveted them. With only a few exceptions, the return preparers and tax advisers used by petitioners were Philip Scheff, Earl LeMond, Gilbert Matsumoto, and Robert Knapp, all of whom had connections to Kersting and thus were not disinterested parties. Notably, no petitioner testified that he was unaware of a relationship between Kersting and any preparer he used. The Dixons used an accountant at Haskins & Sells for 1977, but even that accountant Dixon knew to be already involved with at least one Kersting investor. Although the evidence does not establish that the DuFresnes' 1983 preparer, William Lenahan, 1991 Tax Ct. Memo LEXIS 661">971 was related to Kersting in any way, it also does not establish that he was not so related. A reasonable and ordinarily prudent person would have sought out independent and disinterested advice on transactions such as these. Such independent and disinterested advice does not include that of Kersting, whom the Thompsons claim to have relied upon, because to inquire of the promoter if the investment is sound will not overcome the addition to tax for negligence. Rybak v. Commissioner, 91 T.C. 524">91 T.C. 524, 91 T.C. 524">565 (1988). More fundamentally, if no reliable evidence reveals the nature of professional tax advice received, purported reliance on such advice is of no assistance to the taxpayer in the negligence analysis. 931 F.2d 578">Howard v. Commissioner, supra at 582. In the instant cases, the record contains no reliable evidence regarding the nature of the advice. Indeed, coupled with the scarcity of petitioner testimony about their dealings with their tax accountants is a complete lack of testimony from any of those accountants. Even if we were to find that petitioners received and relied upon professional advice, they would also have to show that the advice 1991 Tax Ct. Memo LEXIS 661">972 was based upon all of the facts. Leonhart v. Commissioner, 414 F.2d 749">414 F.2d 749, 414 F.2d 749">750 (4th Cir. 1969), affg. a Memorandum Opinion of this Court. Petitioners testified very little about disclosures made to return preparers and advisers. What we find credible is contained in our findings of fact, and it is hardly enough to support petitioners' purported full disclosure of all records. Because the Cravenses' tax returns show no paid preparer, and Cravens did not testify about one, this forecloses the arguments raised by the other petitioners. The record also does not disclose Cravens' educational or investment background, which might lend support to an "unsophisticated investor" position. The Cravenses, like the other petitioners, have failed to persuade us that they were not negligent. We therefore sustain the Commissioner's negligence determinations under section 6653(a), including the section 6653(a)(2) amounts based upon the full amount of the deficiencies for the post-1980 years of the Thompsons, the Youngs, and the DuFresnes. Issue 7: Section 6651(a)(1) Failure to FileThe Commissioner determined an addition to tax under section 6651(a)(1) for the Thompsons' 1991 Tax Ct. Memo LEXIS 661">973 1981 taxable year. That section provides generally that the failure to file a return on the prescribed date, including applicable extensions, results in an addition of 5 percent of the tax for each month the return is late, up to 25 percent, unless it is shown that the failure to file is due to reasonable cause and not due to willful neglect. The burden of proof is on the taxpayer. Jackson v. Commissioner, 86 T.C. 492">86 T.C. 492, 86 T.C. 492">538 (1986), affd. 864 F.2d 1521">864 F.2d 1521 (10th Cir. 1989); Estate of Lang v. Commissioner, 613 F.2d 770">613 F.2d 770, 613 F.2d 770">774 (9th Cir. 1980), affg. in part and revg. in part 64 T.C. 404">64 T.C. 404 (1975). The Thompsons did not present evidence on this matter, nor did they contest it in their brief. In these circumstances, the Thompsons are deemed to have conceded the addition to tax under section 6651(a)(1). Issue 8: Section 6661(a) Substantial UnderstatementSection 6661 provides for an addition to tax for a substantial understatement of income tax liability. An understatement is substantial if it exceeds the greater of 10 percent of the tax required to be shown on the return, or $ 5,000. Sec. 6661(b)(1)(A). The Commissioner1991 Tax Ct. Memo LEXIS 661">974 determined that the Youngs for 1982 and the DuFresnes for 1982 and 1983 are liable for additions to tax under section 6661(a). During those years, the addition to tax was equal to 10 percent of the underpayment attributable to the understatement, and the Commissioner applied the 10-percent rate in his notices of deficiency here. Congress changed the rate to 25 percent in section 8002(a) of the Omnibus Budget Reconciliation Act of 1986 (OBRA), Pub. L. 99-509, 100 Stat. 1951. The 25-percent rate applies to section 6661 additions to tax assessed after October 21, 1986. OBRA, Pub. L. 99-509, sec. 8002(b), 100 Stat. 1951; Pallottini v. Commissioner, 90 T.C. 498">90 T.C. 498 (1988). On brief, respondent seeks imposition of the 25-percent rate. However, because his original filed answers contain no reference to a rate other than that appearing in the notices of deficiency and because he has not amended his answers in this regard, we limit our consideration to the 10-percent rate. See Schirmer v. Commissioner, 89 T.C. 277">89 T.C. 277, 89 T.C. 277">286 n.8 (1987). The parties have not raised issues that often arise under section 6661, such as possible reduction of the understatement1991 Tax Ct. Memo LEXIS 661">975 on the grounds of substantial authority or adequate disclosure, sec. 6661(b)(2)(B), and special rules for "tax shelters," sec. 6661(b)(2)(C). The only argument offered by the Youngs and the DuFresnes is that their liability depends upon respondent's prevailing on their deficiencies to a sufficient extent to exceed the substantial understatement threshold of section 6661(b)(1)(A). Respondent has so prevailed. We therefore sustain his determinations concerning section 6661 liability. Issue 9: Section 6621(c) Increased Interest RateThe Commissioner determined an increased interest rate under section 6621(c) for the Thompsons in 1981, for the Youngs in 1982 and 1983, and for the DuFresnes in 1982 and 1983, asserting for each year that the entire underpayment was attributable to tax-motivated transactions. In his opening brief, respondent contends that section 6621(c) is in dispute for every year and every petitioner. For petitioners other than the Thompsons, the Youngs, and the DuFresnes, however, neither the notices of deficiency nor the pleadings refer to this section. We will not consider the application of section 6621(c) to these other petitioners absent proper pleading1991 Tax Ct. Memo LEXIS 661">976 of the issue. Law v. Commissioner, 84 T.C. 985">84 T.C. 985 (1985). Section 6621(c) provides for an increase in the rate of interest accruing on tax underpayments if there is a "substantial underpayment" (an underpayment exceeding $ 1,000) in any taxable year "attributable to 1 or more tax-motivated transactions." The increased interest rate is effective for interest accruing after December 31, 1984, even for transactions entered into before that time. Solowiejczyk v. Commissioner, 85 T.C. 552">85 T.C. 552, 85 T.C. 552">556 (1985), affd. without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986). Section 6621(c)(3) defines tax-motivated transactions to include "any sham or fraudulent transaction." Sec. 6621(c)(3)(A)(v). A transaction that lacks economic substance and in which the taxpayer lacks a profit motive is a sham transaction within the meaning of section 6621(c)(3)(A)(v). Friendship Dairies, Inc. v. Commissioner, 90 T.C. 1054">90 T.C. 1054, 90 T.C. 1054">1068 (1988); Cherin v. Commissioner, 89 T.C. 986">89 T.C. 986, 89 T.C. 986">1000 (1987); see Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 88 T.C. 1086">1128-1129 (1987); affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186">856 F.2d 186 (4th Cir. 1988),1991 Tax Ct. Memo LEXIS 661">977 affd. sub nom. Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93 (9th Cir. 1989), affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865">868 F.2d 865 (6th Cir. 1989). Because the entire underpayments for the Thompsons in 1981, the DuFresnes in 1982 and 1983, and the Youngs in 1983 were attributable to what we have concluded were sham transactions, they are liable for the increased rate of interest based on those underpayments. The underpayment for the Youngs in 1982 was attributable to what we have concluded were sham transactions and to a disallowed insurance deduction. Because the Youngs did not attempt to prove that the claimed insurance deduction was not attributable to a tax-motivated transaction, they are liable for the increased rate of interest based on their entire underpayment for 1982. To reflect the foregoing, Decisions will be entered for the respondent in docket Nos. 9382-83, 16900-83, 17640-83, 19321-83, 4201-84, 15907-84, 31236-84, 40159-84, 22783-85, 30010-85, 30965-85, 30979-85, 29643-86. Decision will be entered under Rule 155 in docket1991 Tax Ct. Memo LEXIS 661">978 No. 15135-84. Footnotes1. Cases of the following petitioners are consolidated herewith: John R. and E. Maria Cravens, docket Nos. 16900-83, 15135-84; Ralph J. Rina, docket No. 17640-83; John R. and Maydee L. Thompson, docket Nos. 19321-83, 31236-84; 30965-85; Hoyt W. and Barbara D. Young, docket Nos. 4201-84, 22783-85, 30010-85; Robert L. and Carolyn S. DuFresne, docket Nos. 15907-84, 30979-85; Terry D. and Gloria K. Owens, docket No. 40159-84; and Richard and Fidella Hongsermeier, docket No. 29643-86.↩2. Subsequent to the filing of the Court's opinion in Dixon v. Commissioner, 90 T.C. 237">90 T.C. 237↩ (1988), which addresses certain matters severed from the issues herein, the Court granted the motions of Robert J. Chicoine, Darrell D. Hallett, and Robert M. McCallum to withdraw as counsel of record for the petitioners in docket Nos. 9382-83, 17640-83, 4201-84, 15907-84, 40159-84, 22783-85, 30010-85, and 30979-85, and the motions of Robert M. McCallum and L. N. Nevels, Jr., to withdraw as counsel of record for the petitioners in docket No. 29643-86.3. Unless otherwise indicated, section references are to the Internal Revenue Code of 1954 as amended and in effect for the relevant years, and Rule references are to the Tax Court Rules of Practice and Procedure.↩. The Commissioner did not determine an addition to tax under sec. 6653(a)(2) for 1981.↩. Plus, under sec. 6653(a)(2), 50 percent of the interest due on the deficiency.↩. Plus, under sec. 6653(a)(2), 50 percent of the interest due on the deficiency.↩. Plus, under sec. 6653(a)(2), 50 percent of the interest due on the deficiency.↩4. Unless otherwise clear from the context, the following words, their derivatives, and related terms are used for narrative convenience only, following the forms of the various transactions: "invest," "purchase," "borrow," "subscribe," "pay," "distribute," "promise," "lease," "loan," "note," "sale," "agreement," "obligation," and "interest." By our use of such terms, we do not mean to suggest any conclusions concerning the actual substance or characterization of the transactions for tax purposes.↩5. References to "subchapter S" corporations are in keeping with how the shareholders and others treated the entities, and are not meant to suggest that the applicable provisions of subchapter S of chapter 1, subtitle A, Internal Revenue Code, were necessarily satisfied.↩6. For convenience, corporations with name endings such as "Corporation," "Inc.," "Co.," or "Ltd." will often be referred to with the ending after the first reference.↩7. "Lease" as a verb in ordinary usage can refer to what the lessor does or what the lessee does. As we use the term herein, a corporation that "leases" is a lessor and an individual who "leases" is a lessee.↩8. The "years at issue" outside of part IV of these findings are 1975 through 1983. The "years at issue" within part IV are the years before the Court for the particular petitioner or petitioners being discussed.↩9. We sometimes distinguish these entities and others by parenthetical reference to the State of incorporation, such as Charter Financial (Hawaii) and Charter Financial (Nevada). References without State designation are general and not directed specifically toward either.↩10. Investors Financial, like most of the other Kersting corporations, used a noncalendar taxable year.↩11. Pike v. Commissioner, 78 T.C. 822">78 T.C. 822, 78 T.C. 822">845 & n.36 (1982), affd. without published opinion 732 F.2d 164">732 F.2d 164↩ (9th Cir. 1984).12. A "form letter" is a typed letter with a general "Dear Friend" or "Dear Friends" salutation rather than a personalized one.↩13. Although both names appear on documents in the record, Universal Leasing Corporation and Universal Corporation are the same entity.↩14. Unless otherwise indicated, a reference hereinafter to an unspecified "leasing corporation" or "leasing corporations" is to one or more of the three non-subchapter S corporations described in this part II (D).↩15. The record contains some prepared and signed corporate tax returns that were not filed with the IRS. In describing return contents, we refer to both filed and unfiled returns.↩16. Although the usual function of a note is to document a lending transaction, the note and loan must sometimes be distinguished. Under the Uniform Commercial Code, for example, a negotiable note and its underlying obligation can be independently actionable. U.C.C. sec. 3-310(b)↩ (1990). Nonetheless, because the parties do not attempt to differentiate between the notes and their underlying obligations in the context of these transactions, we likewise generally assume only one obligation, except in our more precise descriptions of collection litigation undertaken by Kersting corporations.17. In the early years of Kersting's investment programs, these loans were nonrecourse. The sec. 465 at-risk provisions, added to the Internal Revenue Code by the Tax Reform Act of 1976, Pub. L. 94-455, sec. 204, 90 Stat. 1520, 1531-1532, caused Kersting to make the change from nonrecourse to recourse.↩18. We sometimes refer to these checks having "and" between two listed payees as "two-party" checks.↩19. Paid-in or contributed capital, in this context, is the sum of capital stock recorded at par value and paid-in surplus. Paid-in surplus is sometimes known as paid-in capital in excess of par value or as additional paid-in capital.↩20. On the short and simple promissory note forms for this and the other investment programs, Kersting's clerical personnel always typed in "on demand" before the preprinted words "after date." Because the note contained two typed-in dates, an effective date and a "due" date, it is not clear from the face of the note when the demand feature became operative. When we describe the term of a leverage note as some number of years, without express reference to a demand nature, we are referring to the time period between the effective date and the due date.↩21. "Distribution" checks are those issued by Kersting corporations to their shareholders as part of the investment programs, and not representing loan proceeds.↩22. From 1975 into 1978 the cost was $ 1 per share.↩23. The word "buy" often appeared instead of "purchase."↩24. The annual interest rate was 6 percent during 1975 and 1976 and 7 percent during 1977 and into 1978.↩25. Sometimes the instructions on how to complete the transaction were included with the package of initiating documents sent to the investor. In such a case, Kersting expected the investor to return signed initiating documents and comply with the additional instructions at the same time.↩26. The tax effect of lease payments is not at issue in these cases.↩27. CAT-FIT is an inexact acronym for Children's Assistance To Financially Indigent (or Indolent) Parents.↩28. The annual interest rate on CAT-FIT leverage loans was 6 percent in 1976, 6 or 7 percent in 1977, and 7 percent into 1978.↩29. Sometimes the instructions on how to complete the transaction were included with the package of initiating documents sent to the parent. In such a case, Kersting expected the parent to return signed initiating documents and comply with the additional instructions at the same time.↩30. Check-kiting is a fraudulent scheme in which the wrongdoer profits from a continual interchange of worthless checks between accounts at two or more banks, taking advantage of both the several-day check collection process and the willingness of the banks to pay a check even though the account balance consists only of a deposited check not yet collected. See generally H. Bailey, Brady on Bank Checks, par. 18.11, pp. 18-22 to 18-25 (6th ed. 1987).↩31. The activity in the general accounts of the leasing corporations often included deposits and checks in addition to those we mention specifically.↩32. The listed dates are not all of those with recorded activity during 1979 and 1980. For a given date, the listed amounts do not necessarily represent the only activity in the accounts.↩33. We do not find as facts that Dixon and the other investing petitioners necessarily executed the various initiating documents (or even necessarily received complete sets of the documents) described in our part III discussion of the four investment programs. When we state in our findings that a petitioner "entered into" a given program, we mean only that he, in some way satisfactory to Kersting, commenced an investment that was patterned after the applicable program in part III. Although our findings disclose certain inconsistencies between a petitioner's specific transactions and their part III counterparts, we do not mean to imply that in all other respects precise or complete conformance with our part III descriptions has been established.↩34. Dixon's primary note, however, listed loan proceeds of $ 30,000, making the combined loan proceeds $ 51,000.↩35. The notice of deficiency erroneously arrives at $ 59,383.75, a 50-cent discrepancy, as the sum of the 1982 disallowed interest deductions.↩36. As we use the term here, "dividend" does not include an annual distribution made as part of a Kersting investment program.↩37. The record does not disclose Cravens' educational background.↩38. The record does not disclose Cravens' length of service with American Airlines.↩39. Kersting applied similar reasoning in explaining at trial why the bad debt reserves were so large. He testified that because of IRS challenges to his investment programs, large contingency reserves were set up in case the funds would have to be returned to investors. In that sense, the large reserves would be a result or output of his investment programs. On the other hand, those reserves were also an important input because they enabled Kersting to pay annual distributions that he could characterize as nontaxable, thus enhancing the tax benefits of his programs.↩40. Using borrowed funds from a third party to pay interest does not alone cause the payment to be nondeductible. Beck v. Commissioner, 74 T.C. 1534">74 T.C. 1534, 74 T.C. 1534">1564 (1980), affd. 678 F.2d 818">678 F.2d 818 (9th Cir. 1982); McAdams v. Commissioner, 15 T.C. 231">15 T.C. 231, 15 T.C. 231">235 (1950), affd. 198 F.2d 54">198 F.2d 54↩ (5th Cir. 1952).41. We do not find it necessary to decide in these cases whether petitioners "paid" interest amounts in the sense of writing or endorsing checks and sending them to the lender, followed by the applicable bank recording payments and deposits based on those checks. We note, however, that if we did confront this issue, at least some petitioners for at least some transactions would fall short in their burdens of proof. Although it is understandable that testifying petitioners had memory lapses when trying to recall specifics of complex transactions that commenced several years before trial, these memory gaps were not always filled in with documentary evidence. The completeness of the documentary record varies from petitioner to petitioner and from transaction to transaction for a given petitioner.↩42. Because the acceptance corporation selling stock changed from year to year, we are left to wonder how Kersting supposedly matched buyers and sellers in the Stock Subscription Plan. There is no evidence that a new participant acquired stock of an obsolete acceptance corporation.↩43. In Karme v. Commissioner, 73 T.C. 1163">73 T.C. 1163, 73 T.C. 1163">1191 (1980), affd. 673 F.2d 1062">673 F.2d 1062↩ (9th Cir. 1982), we distinguished between documents that were "backdated" and those that "were not executed, and sometimes not even written in final form, until long after their purported dates." Our references herein to "backdating" encompass all situations in which a document bears a date prior to the date of its execution.44. The subscription agreements in the Stock Subscription Plan and the Leasing Corporation Plan did in effect call for a year of prepaid interest on the unpaid subscription balance. These agreements acknowledged amounts "paid on account" as of the dates of the agreements.↩45. Alternatively, an acceptance corporation may have failed to provide a renewal leverage note for Peterson's leasing corporation plan.↩46. Alternatively, Peterson may have failed to return a renewal leverage note for his leasing corporation plan.↩47. Hongsermeier testified to a different form of termination that bypasses the apparent gift. He claimed that he paid off the principal on his two primary loans with his own funds and that, in a separate transaction, his children cashed their investment certificates for the face amounts. We did not find this as a fact. We left the record open for Hongsermeier to produce complete copies of the personal checks he purportedly used to pay off the loans, but such checks were not produced.↩48. Whether DuFresne paid over half the support for his daughter, Carolyn, appears to be relevant to whether she was a dependent under section 152, which was necessary for the DuFresnes to be entitled to an exemption for her under section 151. The Commissioner denied this exemption for 1980 in his notice of deficiency. In an earlier 30-day letter from the IRS to the DuFresnes, the examining agent wrote: "You advised us at the opening conference that you should not had [sic] claimed your daughter Carolyn as a dependent in 1980 as she did not qualify." The agent also noted that Carolyn lived with her mother in California and had gross income of over $ 6,000 in 1980. Because DuFresne did not even mention the contents of the 30-day letter during his testimony, we do not find his testimony about providing all of Carolyn's support sufficient to meet the DuFresnes' burden of proof on the disallowed exemption issue.↩49. DuFresne testified that he returned his children's investment certificates to Kersting because "They were not proving out to be a particularly good investment," but then referred to the earnings of his two older daughters, suggesting that the "investment" feature he had in mind was the avoidance of tax.↩50. Counsel for respondent, in arguing at trial that the deemed admission related to "the issues underlying the transactions, and how the Court decided it," stretched the request for admission beyond its express terms. The request refers to "transactions * * * decided by the Court," which we read to mean transactions for which the Court reached a conclusion or holding. In other words, this merely identifies the transactions; it does not by its terms incorporate the Court's analysis or holdings. We will not deem the Owenses to have admitted something that respondent did not place before them.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625615/	Republic Supply Company, A Delaware Corporation, Petitioner v. Commissioner of Internal Revenue, RespondentRepublic Supply Co. v. CommissionerDocket No. 6164-73United States Tax Court66 T.C. 446; 1976 U.S. Tax Ct. LEXIS 96; June 14, 1976, Filed 1976 U.S. Tax Ct. LEXIS 96">96 Decision will be entered under Rule 155. Petitioner acquired the operating assets of an existing oil field products business. To accomplish the purchase petitioner borrowed funds of which the repayment of a portion was guaranteed by Phillips (Phillips loan). Phillips also agreed to purchase a determined amount of products from petitioner who was to repay the Phillips loan with a percentage of its gross profit from these sales. A year later Tascosa was organized and was part of a series of agreements between itself, petitioner, and Phillips. Pursuant to these agreements Tascosa advanced funds to petitioner (Tascosa loan) to be used to repay the Phillips loan. The Tascosa loan was to be repaid from a portion of the gross profit petitioner realized on undetermined sales made to Phillips. The last month such sales were made was December 1969. Tascosa was also required to develop and sell natural gas to Phillips produced on properties acquired from Phillips. When these agreements expired petitioner owed Tascosa $ 318,108.99 which petitioner had no obligation to repay. Held, the Tascosa loan is a debt between petitioner and Tascosa, the release of which represents income1976 U.S. Tax Ct. LEXIS 96">97 to petitioner in 1969. Julian P. Kornfeld, T. Ray Phillips III, and Tom G. Parrott, for the petitioner.James D. Thomas, for the respondent. Sterrett, Judge. STERRETT66 T.C. 446">447 OPINIONThe respondent determined 1976 U.S. Tax Ct. LEXIS 96">98 a deficiency in petitioner's Federal income tax for the taxable year 1969 in the amount of $ 184,914.56. One issue having been settled the sole remaining issue is whether petitioner realized additional income of $ 318,108.99 upon the expiration of an agreement with Tascosa Gas Co., and if so, whether such income was realized in 1969 or 1970.All of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference. This case was submitted by the parties for decision under Rule 122 of this Court's Rules of Practice and Procedure.Petitioner was originally incorporated under the laws of Delaware as Kermac Corp. on March 30, 1948, and then changed its name to Republic Supply Co. on April 19, 1948. For convenience Republic Supply Co. (Delaware) will hereinafter be referred to as the petitioner or Kermac.Petitioner, as noted a corporation organized and existing under the laws of Delaware, had its principal place of business in Oklahoma City, Okla., at the time of filing its petition herein. Petitioner filed its corporate Federal income tax return for the taxable year 1969 with the Director, 1976 U.S. Tax Ct. LEXIS 96">99 Internal Revenue Service Center, Southwest Region, Austin, Tex. For Federal income tax purposes, petitioner employs the accrual method of accounting. Petitioner's principal business is the sale of oil field tubular goods and other oil field products.66 T.C. 446">448 On April 3, 1948, April 20, 1948, and December 22, 1949, all of the common stock of petitioner was owned as follows: 14/3/484/20/48Number ofPercentNumber ofPercentShareholdersharesof sharessharesof sharesR. S. Kerr13,60054.46,25025D. A. McGee8,087.532.357,168.7528.68F. C. Love25012501T. M. Kerr1,701.46.81851.43.41T. W. Fentem850.5753.4850.5753.4Dean Terrill510.5252.04510.5252.04R. S. Kerr, trustee7,35029.4D. A. McGee, trustee918.753.67T. M. Kerr, trustee8503.4Total shares outstanding25,00010025,00010012/22/49Number ofPercentShareholdersharesof sharesR. S. Kerr12,50025D. A. McGee14,337.528.68F. C. Love5001T. M. Kerr1,702.83.41T. W. Fentem1,701.153.4Dean Terrill1,021.052.04R. S. Kerr, trustee14,70029.4D. A. McGee, trustee1,837.53.67T. M. Kerr, trustee1,7003.4Total shares outstanding50,0001001976 U.S. Tax Ct. LEXIS 96">100 On April 18, 1948, and December 22, 1949, the directors of petitioner were:4/18/4812/22/49Robert S. KerrRobert S. KerrD. A. McGeeD.A. McGeeT. M. KerrT.M. KerrT. W. FentemT.W. FentemDean TerrillDean TerrillF. C. LoveF.C. LoveDon L. CollinsJ.H. Lollar, Jr.H.B. CatlowAfter its organization Kermac entered into negotiations to purchase from the Republic Steel Corp. (hereinafter Republic Steel), the sole shareholder of a company then known as Republic Supply Co. which was organized under the laws of Texas, substantially all of the assets of Republic Supply Co. Kermac also entered into negotiations with the First National Bank of Chicago (hereinafter the bank) to arrange for a loan to finance the acquisition.On April 16, 1948, Kermac and Republic Supply Co. (Texas) executed a purchase agreement which provided for the sale of those assets that Kermac wished 1976 U.S. Tax Ct. LEXIS 96">101 to acquire. The transaction was closed on April 19, 1948, and Kermac on this date adopted the appropriate resolution to effect the change in the corporate name to Republic Supply Co. (Delaware). On April 22, 1948, petitioner's board of directors was advised that the acquisition 66 T.C. 446">449 had been completed, the corporation's name had been changed, and that the corporation was actively conducting business.To finance the acquisition Kermac applied to the bank for a loan of $ 11,500,000 which it received on or about April 16, 1948. Under the terms of the loan agreement the principal amount of the loan was divided into an A loan and a B loan. The former was to be in the amount of $ 6 million and the latter was itself divided into two portions in amounts of $ 1,375,000 2 and $ 4,125,000. Repayment of the funds provided by the B loan was subordinated to the repayment of the A loan.Kermac agreed to execute three promissory notes in the above1976 U.S. Tax Ct. LEXIS 96">102 amounts in the bank's behalf with the B loan notes being due in 5 years. Phillips Petroleum Co. (hereinafter Phillips) agreed to guarantee unconditionally the prompt payment of the $ 4,125,000 portion of the B loan (hereinafter the Phillips loan). Kermac also covenanted that the proceeds of these loans were to be used to acquire the assets of Republic Supply Co. (Texas) and for additional working capital.Phillips caused the loan to be advanced to Kermac under the following circumstances. After Kermac was organized and as it was negotiating with Republic Supply Co. (Texas), it entered into contracts with other concerns to assure adequate supplies for its prospective business. Kermac then agreed to sell, and Phillips agreed to buy, certain fixed amounts of oil field tubular products, and petitioner further agreed to apply 50 percent of its gross profit on such sales towards the repayment of the Phillips loan. These payments were to be made by petitioner to either the bank or Phillips. 31976 U.S. Tax Ct. LEXIS 96">103 Tascosa Gas Co. (hereinafter Tascosa) was incorporated under the laws of Delaware on December 6, 1949. It was authorized to issue 1,000 shares with a par value of $ 10. The aggregate number of its allotted shares was 500 shares of common stock with a par value of $ 10 per share. On December 22, 1949, said common stock was owned as follows: 66 T.C. 446">450 ShareholderNumber of sharesPercent of sharesRobert S. Kerr12525Robert S. Kerr, trustee14729.4D. A. McGee143.37528.68D. A. McGee, trustee18.3753.67T. M. Kerr17.0283.41T. M. Kerr, trustee173.4F. C. Love51Dean Terrill10.212.04T. W. Fentem17.0123.4Total shares outstanding500100The principal officers and directors of Tascosa on December 16, 1969, were:PositionIndividualPresidentD. A. McGeeSecretaryDean TerrillTreasurerT. W. FentemDirectorF. C. LoveDirectorT. M. KerrDirectorRobert S. KerrSoon after it was organized Tascosa applied to the bank and the Prudential Insurance Co. of America (hereinafter Prudential) for a loan of $ 7,128,000. In the loan agreement Tascosa stated that $ 4,125,000 of these funds would be loaned to petitioner (hereinafter1976 U.S. Tax Ct. LEXIS 96">104 the Tascosa loan) 4 and that the remainder would be used for its business purposes. Tascosa's business was the drilling, testing, and equipping of wells that were to be drilled pursuant to certain gas rights that Tascosa was to acquire, and which were subsequently acquired from Phillips.The loan agreement was approved and Tascosa received the funds it requested on or about December 22, 1949. Tascosa effected the Tascosa loan by transferring the funds into petitioner's checking account with the bank. With respect to this amount, a credit to an account entitled "Notes Payable-Tascosa" was made on petitioner's books.Petitioner then used these funds and an additional $ 802.08 to repay the Phillips loan. Petitioner's note for $ 4,125,000 to the bank, which was guaranteed by Phillips, was marked "paid" and "cancelled" by the bank and was returned to petitioner.66 T.C. 446">451 These events that transpired in December1976 U.S. Tax Ct. LEXIS 96">105 1949 were all prescribed by contracts and agreements that were entered into between petitioner, Phillips, and Tascosa. These documents which established certain rights and obligations between these parties will hereinafter be referred to as the agreement, the Republic contract, the obligation, the gas purchase contract, and the assignment and agreement. Prior to the execution of these agreements Phillips and Kerr-McGee Oil Industries, Inc. (hereinafter Kerr-McGee), had negotiations with respect to a transaction very similar to the one concluded by the above parties in December 1949. 51976 U.S. Tax Ct. LEXIS 96">106 Under the terms of the assignment and agreement Phillips conveyed to Tascosa its interest in the dry gas rights under specified oil and gas leases. Phillips, however, reserved to itself an overriding royalty of 16 percent of the dry gas produced on these properties prior to the time that these properties "paid out" and 48 percent after that event occurred. 6 Tascosa agreed to develop the assigned properties at its own risk and expense.Under the terms of the gas purchase contract Phillips agreed to purchase, at a specified price, all of the natural gas produced by Tascosa from the above-conveyed properties except for the amounts needed to fulfill Phillips' reserved royalty interest and 66 T.C. 446">452 other minor amounts. Phillips was committed1976 U.S. Tax Ct. LEXIS 96">107 to supply certain amounts of natural gas to a pipeline company.The Republic contract between Phillips and petitioner first acknowledged the Phillips loan, the parties' previous agreement in 1948, the Tascosa loan, and the use of the latter to satisfy the former. The contract then provided that, in consideration of the above events, petitioner agreed to sell to Phillips various amounts of oil field tubular products 7 for 20 years until January 1, 1970, beginning with the calendar year 1950, or until the properties received by Tascosa from Phillips were "paid out," whichever was later.The Republic contract further provided that petitioner would remit one-half of its gross profit on such above sales to Tascosa "the first sums so received * * * to be applied by Tascosa to the payment of Tascosa's loan of $ 4,125,000 to [petitioner], which loan is 1976 U.S. Tax Ct. LEXIS 96">108 evidenced by a debenture." The contract finally provided that it replaced the previous agreement which was hereby terminated.The agreement between Tascosa and Phillips first acknowledged the assignment and agreement, the gas purchase contract, the Republic contract, and that Tascosa was negotiating for its loan from the bank and Prudential. The agreement then provided that Tascosa would make the Tascosa loan which was to be used to satisfy the Phillips loan. Tascosa also agreed to apply the amounts it was to receive from petitioner against the Tascosa loan and that, after the assigned properties had been "paid out," it would remit 48 percent of its receipts from petitioner to Phillips.The agreement also established a schedule of expected minimum sales of gas to be made under the gas purchase contract and that, as payment towards such purchases, Phillips was to receive a credit equal to the amount that Tascosa was receiving from petitioner. The agreement closed with a statement that it was being "entered into as part of the transaction covered by this agreement and other instruments referred to [above] * * and all thereof shall be construed together."Under the terms of the obligation1976 U.S. Tax Ct. LEXIS 96">109 petitioner agreed to make the payments to Tascosa as provided in the Republic contract. The obligation further provided that:66 T.C. 446">453 It is a condition of this Obligation that [petitioner] is obligated to make payments to Tascosa hereunder or by reason of the Republic Contract only out of funds derived from 50% of the "gross profit" from said sales to Phillips by [petitioner] pursuant to the Republic Contract and that [petitioner] shall have no obligation to Tascosa under or by reason of or in connection with said loan of $ 4,125,000.00 and this Obligation evidencing the same except as stated in this instrument and that none of the assets of [petitioner] shall be in any way subjected to the obligation of this instrument except in conformity with the provisions hereof, and that from and after the 21st day of the month following the last month of the period of the Republic Contract, [petitioner] shall be discharged, automatically without the necessity of any act or writing of or from any person, from any and all liability and obligation of any kind or character to Tascosa, its successors, assigns and representatives with respect to said loan of $ 4,125,000.00 and under or by reason1976 U.S. Tax Ct. LEXIS 96">110 of this Obligation except for obligations or liabilities of [petitioner] under this Obligation accrued prior to said date and not satisfied or discharged.Having modified their relationships as established in April 1948, petitioner, Kerr-McGee, and the bank executed an agreement to modify the 1948 loan agreement. This document first acknowledged the terms of petitioner's earlier loan, that the Phillips loan had been satisfied by the Tascosa loan, and that the obligation had been executed to evidence the Tascosa loan. In consideration of these events petitioner's loan agreement was modified to remove all references to the Phillips loan and to make the now amended loan agreement subject to the Republic contract and the obligation.Shortly after these agreements were signed F. C. Love (hereinafter Love), a shareholder and director of petitioner and Tascosa, sent a letter to petitioner's president in which he enclosed documents that related to this transaction. Included was the obligation which Love referred to as being "issued in exchange for and as evidence of a loan in the amount of $ 4,125,000 made by [Tascosa] to [petitioner]." A copy of petitioner's balance sheet for the period1976 U.S. Tax Ct. LEXIS 96">111 ended December 31, 1949, reveals that the Tascosa loan was reported by petitioner as a note payable in the long-term debt section of that report.In January 1950 Love forwarded to petitioner's secretary-treasurer the legal opinion of a law firm located in Chicago, Ill., with respect to the transaction between petitioner, Tascosa, and Phillips. After reviewing the facts, which included the recognition of the common ownership of petitioner and Tascosa, it was their opinion that:66 T.C. 446">454 No gain will be derived by either [petitioner] or TASCOSA upon the payment by TASCOSA to [petitioner] of the $ 4,125,000 and the execution by [petitioner] of its "Obligation", providing for the payment to TASCOSA of $ 4,125,000 pursuant to the terms of the said Obligation. This constitutes a loan by TASCOSA which [petitioner] is obligated to repay on the basis set out in its Obligation, and we have been informed that the parties contemplate that the 50% profit on sales made by [petitioner] to Phillips Petroleum Company will result in the payment of the full obligation in due course.In accordance with the terms of the agreements petitioner began to account for its sales to Phillips. From at least1976 U.S. Tax Ct. LEXIS 96">112 1955 petitioner carried the Tascosa loan in a notes payable account which reflected the payments made and the outstanding balance. A review of these amounts shows that 50 percent of the gross profit earned in one month was paid in the following month. This practice continued so that 50 percent of the gross profit earned in December 1969 was not paid to Tascosa until January 1970. All such payments were applied to principal.In October 1958 petitioner's shareholders entered into an agreement to sell their stock to Republic Steel. One of the buyer's concerns was its prospective liability with respect to the existing and continuing Republic contract and the obligation. This agreement established that "the maximum amount to be paid prior to such termination [of the Republic contract] shall be one-half of the above-mentioned gross profits for each month from and after August 31, 1958 until the [petitioner] shall have so paid the sum of $ 2,112,553.34 [sic] and thereafter 24 percent of such gross profits for each month or portion thereof prior to such termination." The above figure represented the outstanding balance of the Tascosa loan as of the above date.At the end of the Republic1976 U.S. Tax Ct. LEXIS 96">113 contract petitioner had paid to Tascosa $ 3,806,891.01 leaving an outstanding balance of $ 318,108.99. To reflect the termination of the Republic contract petitioner recorded a journal entry dated December 31, 1969, in which it debited the Tascosa loan account for $ 318,108.99 (thereby reducing it to zero) and credited profit and loss (current year) for a like amount. The accompanying explanation to this entry reveals that this amount represented a special credit to the profit and loss account after taxes.Petitioner reported this amount on its 1969 tax return in Schedule M-2 Analysis of Unappropriated Retained Earnings Per Books as an increase to retained earnings caused by a 66 T.C. 446">455 "Forgiveness of contingent liability on note payable." Respondent in his deficiency notice included the $ 318,108.99 in income for 1969 as follows:(a) It is determined that upon expiration of the terms of an agreement entered into with Tascosa Gas Company you realized income in the amount of $ 318,108.99 computed as follows:Value received under theterms of the agreement$ 4,125,000.00Consideration paid3,806,891.01Income realized318,108.99Therefore, your taxable income is increased1976 U.S. Tax Ct. LEXIS 96">114 by $ 318,108.99.We believe this case presents for our primary consideration the oft-litigated problem of whether money advanced to a taxpayer represents a debt or equity investment. In this instance the petitioner has chosen the equity side of this controversy as that position avoids the recognition of ordinary income under section 61(a)(12) by reason of the fact that a portion of the funds advanced will not be repaid. Although the issue is presented in a somewhat different manner, our analysis, using the applicable legal principles, will not be altered. Ragland Investment Co., 52 T.C. 867">52 T.C. 867, 52 T.C. 867">875 (1969), affd. per curiam 435 F.2d 118">435 F.2d 118 (6th Cir. 1970).If any point in this area is settled it is that no particular set of standards can be uniformly applied. Although a variety of related, relevant factors have been established, it is clear that no one element is determinative and that it is the individual factual pattern of each case, which obviously differs, that brings forth those elements on which the ultimate conclusion is based. Sec. 385; John Kelley Co. v. Commissioner, 326 U.S. 521">326 U.S. 521 (1946);1976 U.S. Tax Ct. LEXIS 96">115 Dillin v. United States, 433 F.2d 1097">433 F.2d 1097, 433 F.2d 1097">1100 (5th Cir. 1970); Litton Business Systems, Inc., 61 T.C. 367">61 T.C. 367, 61 T.C. 367">376 (1973).We also believe that our task is further complicated by the unique and complex nature of the transactions entered into between Phillips, Tascosa, and petitioner, and to some extent Kerr-McGee. The facts in this case have been fully stipulated. We have made every effort to get the flavor of the involved transactions from the dry legal phrases of the stipulated documents. We also might add that respondent's clear disavowal that the Tascosa loan does not represent debt had caused us to pause before embarking on our course.66 T.C. 446">456 In 1948 Kermac was organized to acquire Republic Supply Co.'s (Texas) operating assets, adopt its name, and pursue its existing business. The necessary funds needed to finance this project were borrowed from the bank. It is the $ 4,125,000 portion of the B loan (the Phillips loan) that ultimately spawned the Tascosa loan and the current controversy. Petitioner executed three promissory notes to evidence the bank loan including one for the Phillips loan.Under the terms of 1976 U.S. Tax Ct. LEXIS 96">116 the loan agreement between the bank and petitioner, Phillips agreed to guarantee the Phillips loan. Pursuant to this guarantee petitioner and Phillips entered into an agreement. Under its terms Phillips agreed to purchase from petitioner a certain amount of its oil field products and petitioner agreed to apply 50 percent of its gross profits from these sales towards the repayment of the Phillips loan. Phillips also agreed that for the first 20 years it would bear the primary obligation to repay the Phillips loan.The following year Phillips and Kerr-McGee entered into negotiations with a view to Phillips securing a release from its obligations under the Phillips loan and the accompanying agreement and also having certain of its gas fields developed. An agreement between Phillips and Kerr-McGee never materialized but the substance of their negotiations was reflected in the subsequent agreements between petitioner, Tascosa, and Phillips which were described and referred to previously as the agreement, the Republic contract, the obligation, the gas purchase contract, and the assignment and agreement.Under the terms of these agreements Tascosa acquired from Phillips, as a farm-out, 1976 U.S. Tax Ct. LEXIS 96">117 certain gas properties and assumed the responsibility of developing them. Phillips retained an overriding royalty and agreed to purchase a minimum amount of the gas eventually produced over a period of years. Tascosa also agreed to make the Tascosa loan which petitioner was to use to satisfy the Phillips loan thereby releasing Phillips of its obligations in that respect. To finance its obligations Tascosa received a loan from the bank and Prudential covered by a loan agreement in which Tascosa's use of the loan proceeds was acknowledged.Petitioner and Phillips entered into an agreement, which terminated their earlier agreement, under which Phillips agreed to purchase oil field products from petitioner, but no longer in any minimum amount, and petitioner agreed to remit 50 percent 66 T.C. 446">457 of its gross profit from such sales to Tascosa in payment of the Tascosa loan. This contract was to last for 20 years or until the gas properties received by Tascosa from Phillips "paid out," whichever was later.Petitioner acknowledged the receipt of the Tascosa loan and evidenced its intention to make the above payments to Tascosa but solely based on the gross profit it realized from those1976 U.S. Tax Ct. LEXIS 96">118 sales to Phillips. Tascosa also agreed that it would credit Phillips' gas purchase account in an amount equal to the amount it was receiving from petitioner and that, after the gas properties "paid out," it would remit to Phillips 48 percent of petitioner's payments to it. It was further provided that these agreements were entered into in consideration of one another and that they were to be construed together.Petitioner's primary position is that the funds advanced to petitioner by Tascosa should hereinafter be referred to as the Tascosa equity in lieu of the Tascosa loan. By so doing, petitioner asserts that the $ 318,108.99, that remained unpaid when petitioner's obligations under Republic contract terminated, represents a contribution to petitioner's capital which is excludable from gross income under section 118 and not a discharge of indebtedness which would be includable in gross income under section 61(a)(12).Respondent's position is that petitioner should have properly treated the receipt of the $ 4,125,000 as income in 1949 and its periodic payments to Tascosa as a deductible expense incurred to produce this income. However, respondent continues, petitioner has treated1976 U.S. Tax Ct. LEXIS 96">119 this transaction as a loan and such treatment constitutes a method of accounting pursuant to section 446 which cannot now be changed without respondent's consent. Using petitioner's method respondent asserts that the $ 318,108.99 represents income to petitioner when its obligation to make any further payments was extinguished.Thus, respondent in a roundabout fashion ultimately concludes that the Tascosa loan should be treated as debt, the release of which represents income to petitioner. However, we do not believe that his analysis is proper because we do not agree that the characterization and treatment of the transaction in issue represents an accounting method. Sec. 1.446-1(e)(2)(ii)(b), Income Tax Regs. Rather we believe that our ultimate conclusion must rest on a determination of what might be termed 66 T.C. 446">458 the merits of whether the Tascosa loan represents a debt or equity investment.Petitioner has taken the position that due to nonexistence of several factors commonly associated with a debt instrument the Tascosa loan must be considered an equity investment. These factors which petitioner has documented in his brief as being relevant include:(1) No written unconditional1976 U.S. Tax Ct. LEXIS 96">120 obligation to pay a fixed amount on a fixed date;(2) No provision for interest;(3) Subordination of the Tascosa loan to other creditors;(4) A high debt-equity ratio;(5) Use of the Tascosa loan to acquire capital assets;(6) Identity of shareholder interest in petitioner and Tascosa;(7) Lack of collateral;(8) Inability to obtain a similar loan from an unrelated lender; and(9) Lack of an acceleration clause.Petitioner's argument also includes a discussion of those factors that indicate the existence of debt which include the accounting treatment accorded to the transaction, the payment history, and the existence of the prior Phillips loan.Although petitioner's attention to these factors has been complete and proper, we believe that it has failed to relate them to the transaction as a whole in an attempt to explain its nature, purpose, and/or extent. In 61 T.C. 367">Litton Business Systems, Inc., supra at 377, we said:In view of the many decided cases in this area, we think the determinative question, to which an evaluation of the various independent factors should ultimately point, is as follows: Was there a genuine intention to create a debt, with a reasonable1976 U.S. Tax Ct. LEXIS 96">121 expectation of repayment, and did that intention comport with the economic reality of creating a debtor-creditor relationship?After a review of the entire factual pattern of this case in this context, we believe that each part of the above question should be answered in the affirmative.Our starting point is petitioner's creation and the Phillips loan. Petitioner was incorporated with only a minor amount of equity capital. It needed the entire amount of the bank loan to acquire the necessary operating assets. The note petitioner executed to the bank to evidence the Phillips loan indicated that repayment 66 T.C. 446">459 was to be made in 5 years with interest at 3 1/2 percent and that it was guaranteed by Phillips.Petitioner argues that this arrangement effectively conveyed an equity interest in petitioner to Phillips in the nature of preferred stock. It points to the agreement between petitioner and Phillips whereby the latter assumed the primary responsibility for the Phillips loan, the latter's right to direct the payments made by petitioner, the source and contingent nature of the repayments, and several of the other factors mentioned above. Petitioner's purpose in making this1976 U.S. Tax Ct. LEXIS 96">122 seemingly premature argument is that the Tascosa loan can then be viewed as the substitution of one equity interest for another. We do not believe that the Phillips loan represents an equity investment by Phillips.In connection with its incorporation petitioner applied for and received a loan from the bank. Petitioner executed notes in its name to evidence the loan. It seems that these funds were advanced to petitioner by the bank with the latter expecting the former to make the repayments. Further, Phillips is not included in the stipulated list of petitioner's shareholders.We do not believe that Phillips' guarantee or the terms of the agreement between petitioner and Phillips whereby Phillips assumed primary responsibility for repayment should change our conclusion. The agreement between petitioner and Phillips was just that, which had no effect on the bank's rights. The fact that Phillips could direct the payments by petitioner either to it or the bank seems irrelevant.As noted above one of the points of our inquiry is whether there was a reasonable expectation of repayment. We agree that the source and method of repayment belies the existence of debt, but we believe 1976 U.S. Tax Ct. LEXIS 96">123 the above criteria has been met. Under the terms of their agreement Phillips was to purchase a fixed amount of petitioner's goods with 50 percent of the gross profits on such sales to be applied towards the satisfaction of the loan. Although not made a part of the record, we can only believe that projections were made which led the bank to believe that there was an adequate source of funds for repayment.When Phillips and Kerr-McGee conducted their negotiations they estimated that the latter's investment would be returned in approximately 15 years. As will be discussed later their proposed transaction was substantially the same as the one in issue and 66 T.C. 446">460 that the gas properties Tascosa received did "pay out" in approximately 15 years. This leads us to believe that financial projections of this transaction could be made and that they could be accurate.Further, we find that the projections were demonstrably realistic. Petitioner was paying more than $ 11 million for the operating assets of an existing company that produced a marketable product. Petitioner had entered into other contracts to assure itself of supplies. This was not a situation where additional funds were1976 U.S. Tax Ct. LEXIS 96">124 needed to finance a speculative or untested venture. We also believe that these factors reduce much of the force behind the effect of the high debt-equity ratio.In addition to providing for repayment of the Tascosa loan, we also believe that the agreements between the parties provided for interest payments. Petitioner's obligation to make its payments to Tascosa was to last for 20 years or until the gas properties "paid out," whichever was longer. The parties estimated that the properties would "pay out" in 15 years. The fact that the properties "paid out" meant that Tascosa's investment had been recovered, which included the funds that constituted the principal portion of the Tascosa loan. Yet it was provided that the petitioner would be required to continue to make repayments on the Tascosa loan for another 5 years. We find these payments, in effect, represented interest on the Tascosa loan.Not only did the agreement provide for a source of repayment, but clearly it provided for a definite repayment schedule. It certainly appears that Phillips' guarantee was a decisive factor, but we cannot believe that either the bank or Phillips expected or intended that the latter, under1976 U.S. Tax Ct. LEXIS 96">125 normal circumstances, would be called on its guarantee.The next year, in the middle of 1949, the negotiations alluded to previously between Phillips and Kerr-McGee occurred. Although these parties never reached any agreement the substance of their negotiations served as the basis and set the tone for the transaction in issue.Tascosa was organized in late 1949 and was owned by the same interests and in the same proportions as petitioner. It has been stipulated that petitioner's shareholders held a strong interest in Kerr-McGee. We can only believe that Tascosa was organized by Kerr-McGee interests to take its place in the prospective transaction with Phillips.66 T.C. 446">461 In this context we believe that the summary of the negotiations as recorded by Phillips' executive committee as set out in footnote 5, supra, provides us with some insight to the transaction. The summary indicates that Kerr-McGee was to borrow the necessary funds (the funds that Tascosa subsequently borrowed) and use them to satisfy the Phillips loan (the Tascosa loan was used by petitioner to satisfy the Phillips loan) and develop gas properties it was to receive from Phillips (Tascosa did acquire the gas1976 U.S. Tax Ct. LEXIS 96">126 properties from Phillips to develop).The summary also indicates that it was expected that Kerr-McGee would recover its investment plus other costs in approximately 15 years. The source of this recovery was the retention of 81 percent of the gas sale income with Phillips receiving the remainder. The negotiations also provided for an increase in Phillips' share of the gas sale income after Kerr-McGee recovered its costs including the $ 4,125,000 it was using to satisfy the Phillips loan.As detailed in the initial phase of this opinion and as later summarized, this is effectively the transaction entered into between Phillips, Tascosa, and petitioner. Although the figures used and the source of the "pay out" are somewhat different, we note that the estimated "pay out" period of the Phillips-Kerr-McGee transaction closely approximates the actual "pay out" period of the transaction in issue.It is apparent that one of the effects of the transaction in issue was to shift the guarantee obligation of the Phillips loan from Phillips to Tascosa. Having determined that the Phillips loan represented a debt transaction we conclude that the Tascosa loan which was an integral part of the entire1976 U.S. Tax Ct. LEXIS 96">127 transaction must be accorded the same treatment.Petitioner argues that the prospects of repayment of the Tascosa loan were even more contingent than the repayment of the Phillips loan because Phillips now was not required to purchase any products from petitioner which was to produce the source of the payments petitioner would make to Tascosa. However we find that the effect of the agreements merely shifted Phillips' obligation from buying oil field products from petitioner to buying gas from Tascosa leaving the parties and the repayment prospects in essentially the same position.Under the new agreements Phillips was required to purchase a minimum amount of gas from Tascosa and it was to receive a 66 T.C. 446">462 credit from Tascosa equal to the amount received by Tascosa from petitioner. Clearly since Phillips was required to purchase the gas it was in its best interests to purchase petitioner's products. Further, after the gas properties "paid out" Phillips was to receive an additional payment from Tascosa and petitioner's payments to Tascosa were one of the sources from which the gas properties could be paid out.When Tascosa applied for its loan, the bank and Prudential were aware1976 U.S. Tax Ct. LEXIS 96">128 of Tascosa's intention to make the Tascosa loan and that in large part their repayment prospects depended on the reality of the arrangement between petitioner, Tascosa, and Phillips. We can only believe that they were fully apprised of the facts and that they acted accordingly. See Jack Daniel Distillery v. United States, 180 Ct. Cl. 308">180 Ct. Cl. 308, 379 F.2d 569">379 F.2d 569, 379 F.2d 569">580-585 (1967).As noted earlier one of our points of inquiry is whether there was a genuine intention to create a debt. The intention of the parties is always a difficult factor to gauge and in this case we have only the recorded history of the contested events. However, every indication we have from the records points to the conclusion that the parties intended to create a debtor-creditor situation. We find this factor important and see no reason why petitioner should be lowered from the petard by which it has hoisted itself.Petitioner applied for and received a loan from the bank for which it issued promissory notes. The note evidencing the Phillips loan was marked paid and returned to petitioner when the proceeds of the Tascosa loan were received and applied. Petitioner then 1976 U.S. Tax Ct. LEXIS 96">129 entered into the obligation to evidence the Tascosa loan.Petitioner argues that the clear language of the obligation limiting petitioner's repayment liability supports its position. This point is well taken but we have previously concluded that there were reasonable prospects for repayment thereby mitigating the effect of this language. Further, we have found that the obligation had been referred to in the accompanying agreements and by Love as representing evidence of the Tascosa loan.Petitioner also received the legal opinion of a Chicago law firm which concluded that Tascosa had made a loan to petitioner. This conclusion was based on the representations made by the parties to the firm which included a copy of the obligation. We 66 T.C. 446">463 also note that it was represented to the firm that the parties expected the Tascosa loan to be repaid in due course. We find the representations with respect to this transaction made by those involved and at the time the events transpired significant.Petitioner's treatment of this transaction on its books and records also supports our conclusion. It is evident that from beginning to end the Tascosa loan was treated as a loan. Upon receipt1976 U.S. Tax Ct. LEXIS 96">130 of the funds a note payable account was established and the yearend balance in this account was reported in the liability section of its balance sheet. This account was reduced as the payments were made. When petitioner's repayment responsibilities were terminated the account was closed with a corresponding increase to retained earnings. This entry was reflected on petitioner's 1969 tax return as an increase to retained earnings after taxes with an accompanying explanation that the increase was due to a "forgiveness of a contingent liability on note payable."We agree with petitioner's assertion that bookkeeping entries are not determinative, but in a highly complex arrangement which exhibits tendencies on both sides we believe that this factor takes an added importance. Zilkha & Sons, Inc., 52 T.C. 607">52 T.C. 607, 52 T.C. 607">612-613 (1969). Further, we are hard pressed to sponsor petitioner's position when it appears that this stance has been adopted for the first time at this time.Finally, we note that when petitioner's shareholders sold their stock to Republic Steel in 1958, petitioner's obligations under the various agreements were considered. There is no mention1976 U.S. Tax Ct. LEXIS 96">131 of a possible Tascosa equity interest and we believe it would be news to Republic Steel to discover that it had acquired a new equity partner in petitioner.Petitioner has been quite thorough in the presentation of its argument. We have considered its points and the support therefor. It is our belief, however, that the whole of this case is more impressive than the individual parts, and that our reaction to the stipulated events reduces much of the force of some of these parts. It is our conclusion then that the Tascosa loan was a genuine debt, with reasonable prospects for repayment, and that the intention of the parties "comports with the economic reality of creating a debtor-creditor relationship." 61 T.C. 367">Litton Business Systems, Inc., supra at 377.66 T.C. 446">464 At the outset we noted that the nature of this question made reference to other cases difficult. However we are compelled to state that we have relied to some extent on the factual patterns and results of the following cases: Byerlite Corp. v. Williams, 286 F.2d 285">286 F.2d 285 (6th Cir. 1960); 61 T.C. 367">Litton Business Systems, Inc., supra;180 Ct. Cl. 308">Jack Daniel Distillery v. United States, supra;1976 U.S. Tax Ct. LEXIS 96">132 American Processing & Sales Co. v. United States, 178 Ct. Cl. 353">178 Ct. Cl. 353, 371 F.2d 842">371 F.2d 842 (1967).Anticipating a possible finding that the Tascosa loan represented a debt instrument, petitioner has advanced alternative arguments in an attempt to avoid the effect of respondent's determination. Petitioner first points to the identity of petitioner's and Tascosa's shareholders and argues that effectively the debt was forgiven by petitioner's own shareholders which represents a contribution to capital which is excludable from petitioner's income. Sec. 1.61-12(a), Income Tax Regs. With this argument petitioner is asking us to ignore Tascosa's corporate vitality or to hold that Tascosa made the Tascosa loan for its shareholders' personal benefit. See Rapid Electric Co., 61 T.C. 232">61 T.C. 232 (1973); James Kuper, 61 T.C. 624">61 T.C. 624 (1974), on appeal (5th Cir. Aug. 12, 1974).Tascosa was organized to serve a definite purpose in this multisided transaction. It borrowed the necessary funds to fulfill its obligations which included making the Tascosa loan and developing the gas properties. The transaction was1976 U.S. Tax Ct. LEXIS 96">133 economically sound and Tascosa stood to, and from the record it appears that it did, earn a substantial return. Further, the Chicago law firm was aware of petitioner's and Tascosa's common ownership when it issued its opinion. We cannot now say that the integral part Tascosa played should be ignored or that it was not done for its own benefit.Petitioner next argues that under the language of the obligation, petitioner's repayment liability was limited so that at the outset there existed the possibility that petitioner would not be required to repay the full amount. From this petitioner concludes that the forgiveness of indebtedness occurred when the obligation was executed in December 1949.Although the face value language of the obligation supports petitioner's position we do not believe that it comports with the economic realities of the situation. As we have previously found the parties expected that the Tascosa loan would be fully repaid 66 T.C. 446">465 from a realistic source of revenue. Further, the terms of the Republic contract, which is to be construed in conjunction with the obligation, tend to weaken petitioner's position.The Republic contract provided that petitioner 1976 U.S. Tax Ct. LEXIS 96">134 was to make its payments to Tascosa for 20 years or until the gas properties "paid out," whichever was longer. From the record it appears that the gas properties could only "pay out" from two sources -- the proceeds received from Tascosa's gas sales to Phillips, and petitioner's payments. Although the parties contemplated that the "pay out" would occur in 15 years and that the Republic contract would consequently last 20 years, Tascosa was assured that, if difficulties arose with developing the gas properties adversely affecting this source of revenue, petitioner's payments would continue for as long as necessary (until the gas properties "paid out") to make up the difference. It does not appear that Tascosa was forgiving anything when it entered into the obligation with petitioner. Further, it could not have known, in 1949, how much to forgive.Petitioner also points to the language of the obligation and argues that under its terms petitioner did not have to perform any additional acts to discharge the debt. In such a situation the effective date of the cancellation is the date the terms of the cancellation are established. In support of this contention petitioner has cited 1976 U.S. Tax Ct. LEXIS 96">135 United States v. Ingalls, 399 F.2d 143">399 F.2d 143 (5th Cir. 1968), and Temple W. Seay, T.C. Memo. 1974-305.In both of these cases differences arose between the creditor and the debtor, with the former obliged to pay the latter for services rendered or to be rendered. The agreement reached by the parties provided that their opposing obligations would be used as offsets against each. The decisions hold that the agreements effected the cancellation of the indebtedness and that the income must be recognized at that time even though the actual mechanics of the agreement (debtor credited with the income which was then used to satisfy the debt) occurred over a period of years.We believe the above situation is clearly distinguishable from the transaction in issue. As we have found, the obligation did not effect an immediate or prospective cancellation of the Tascosa loan. The agreements in the above cases represented a settlement of the respective disputes, whereas the obligation established the method by which the Tascosa loan would be repaid. We believe 66 T.C. 446">466 the holdings of the above cases are inapplicable to the situation at1976 U.S. Tax Ct. LEXIS 96">136 hand.Having determined that the cancellation of the Tascosa loan did not occur in December 1949, we must now consider petitioner's argument that it occurred in January 1970 rather than December 1969 and therefore not within the year noted in respondent's determination. For support petitioner relies on the terms of the Republic contract and the obligation.When the gas properties "paid out" in November 1965 it was then known that the 20-year period would serve as the length of the Republic contract. Such period was described as encompassing "the calendar year 1950 and each year thereafter until January 1, 1970." Under the terms of the obligation petitioner was to make its payments to Tascosa on the 20th day of each month based on the preceding month's sales and petitioner's liability would be discharged "from and after the 21st day of the month [January 1970] following the last month [December 1969] of the period of the Republic Contract."Petitioner admits that the Republic contract ended on December 31, 1969, but argues that petitioner was not discharged from its obligations until January 1970. We believe that petitioner's admission, which we find to be accurate, is fatal to 1976 U.S. Tax Ct. LEXIS 96">137 its claim.Petitioner as an accrual basis taxpayer must include items in income "when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy." Sec. 1.446-1(c)(1)(ii), Income Tax Regs. It is clear that the sales made in December 1969 were the last to be made under the Republic contract. By the end of the month all of the events had occurred and the outstanding balance of the Tascosa loan could be easily determined.We do not attach much significance to the January 1970 payment. It represented the amount due Tascosa from the December 1969 sales made by petitioner to Phillips. There were no events (sales) that occurred in January 1970 that affected this payment. As such it was merely "the ministerial act of computation" which should have no effect on the timing of the recognition of income. Judith Schneider, 65 T.C. 18">65 T.C. 18, 65 T.C. 18">28 (1975).We have found that the petitioner incurred a true indebtedness when it received the proceeds of the Tascosa loan. Upon receipt of the loan it entered into a series of agreements which provided for 66 T.C. 446">467 the loan's repayment. Subsequently1976 U.S. Tax Ct. LEXIS 96">*138 petitioner was relieved of its liability for less than the loan's full value. We believe this represents cancellation of indebtedness income which must be realized by the petitioner and which must be reported in 1969. Sec. 61(a)(12); United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1 (1931); Helvering v. American Chicle Co., 291 U.S. 426">291 U.S. 426 (1934).Decision will be entered under Rule 155. Footnotes1. As of Apr. 12, 1948, one or more of the shareholders who controlled petitioner also owned control of Kerr-McGee Oil Industries, Inc.↩2. This portion of the B loan was guaranteed by Kerr-McGee Oil Industries, Inc.↩3. As part of the agreement between petitioner and Phillips it was agreed that "as between the parties, the primary obligation prior to 20 years from the date to repay said advance or loan of $ 4,125,000 other than by the repayments herein provided shall be that of Phillips and not that of Kermac."This action by Phillips was authorized at an executive committee meeting at which the entire transaction was discussed and the repayment of this sum was termed as "a direct obligation of Phillips."↩4. Use of this phrase does not necessarily connote a finding of law, but is used for narrative purposes only.↩5. The above conclusion is evident from the following portion of the minutes of the July 26, 1949, meeting of the executive committee of Phillips Petroleum Co.:"In order to relieve Phillips of this obligation, [the Phillips loan] it is proposed, and negotiations are now in progress by which Phillips will assign to Kerr-McGee certain gas acreage located in the Panhandle and Hugoton Fields, and Kerr-McGee will agree to drill thereupon 100 wells, and will assume and pay at once the $ 4,125,000 note of [petitioner]. Kerr-McGee will drill these 100 wells without cost to Phillips. In order to accomplish this, Kerr-McGee proposes to borrow $ 7,125,000 at 4% interest for 15 years. Kerr-McGee will retain 81% of the income from the sale of gas from the wells to cover the repayment of the entire amount of borrowed capital plus interest and income taxes, and its share of the operating expenses. Phillips will receive the remainder, or 19% of the income and will pay its proportionate share of the cost of operating the 100 wells. It is assumed that this division of the income will return to Kerr-McGee the $ 4,125,000 note obligation and the cost of development of the properties within 15 years."If and when Kerr-McGee has been reimbursed to this extent, the proportionate interests in the 100 gas wells shall be revised and Phillips shall receive at least 5/8 of the net income and Kerr-McGee 3/8 thereof. The estimated ultimate life of the properties is 35 years and the proposed plan of financing and development is estimated to repay Kerr-McGee its entire investment and the $ 4,125,000 Republic Supply Company note and an additional profit of $ 2,422,000, and to return to Phillips a profit of $ 8,000,000 over the same period."[Emphasis added.]↩6. These properties would be "paid out" when Tascosa repaid its loan and it received funds equal to the amounts needed, in excess of the funds provided by the loan, to operate and maintain the properties. The properties were "paid out" as that term was defined during November 1965.↩7. The Republic contract only provided for the maximum amounts that Phillips could purchase, but Phillips was under no obligation to purchase any products from petitioner.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625616/	RICHARD A. REEVES, JR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Reeves v. CommissionerDocket No. 7636-73.United States Tax CourtT.C. Memo 1977-114; 1977 Tax Ct. Memo LEXIS 329; 36 T.C.M. 500; T.C.M. (RIA) 770114; April 18, 1977, Filed 1977 Tax Ct. Memo LEXIS 329">329 Over a number of years, taxpayer, an accountant, secured funds from a client ostensibly to pay her taxes. The monies received were diverted to his own use. Held, taxpayer received unreported taxable income in the amounts of the money so received each year. Held further, other issues resolved by determination of additional income and taxpayer's failure to meet his burden of proof. Richard A. Reeves, Jr., Pro Se. Robert P. Ruwe, for the respondent. BRUCE MEMORANDUM FINDINGS OF FACT AND OPINION BRUCE, Judge: Respondent determined deficiencies in Federal income tax and additions to tax under section 6653(a) 1 for negligence or intentional disregard of rules and regulations, for the calendar years and in the amounts as follows: Addition to Tax YearDeficiencySec. 6653(a)1968$2,938.13$146.9119696,939.65351.1119704,724.16236.211971739.0036.95The issues for decision are (1) whether petitioner received taxable income during 1968 through 1971 which he failed to report1977 Tax Ct. Memo LEXIS 329">330 on his returns for those years, (2) whether petitioner is entitled to deductions for depreciation in excess of the amounts allowed by respondent for each year, (3) whether petitioner is entitled to net operating loss carryover deductions for 1968, 1969, and 1971, (4) whether petitioner is liable for additional self-employment taxes for 1968 through 1971, and (5) whether petitioner is liable for the additions to tax determined by respondent. FINDINGS OF FACT Some of the facts have been stipulated by the parties and they are so found. Petitioner Richard A. Reeves, Jr., resided in Indianapolis, Indiana, during the taxable years in issue and at the time his petition was filed herein. Petitioner filed Federal income tax returns for 1968 and 1969, including amended returns for both years, with the district director of internal revenue at Indianapolis, Indiana. His returns for 1970 and 1971 were filed with the internal revenue service center located at Cincinnati, Ohio. Petitioner's filing status each year was that of a married individual filing a separate return. Petitioner has been engaged in the accounting business since 1952, but is not, and never has been, a certified public1977 Tax Ct. Memo LEXIS 329">331 accountant in the state of Indiana, nor has he ever been licensed as a public accountant by the state of Indiana. In 1965 he was recommended to Jean Goettman, who had just started operating two motels in Anderson, Indiana, as someone who could take care of her tax work. Petitioner misrepresented himself to Mrs. Goettman as a certified public accountant and gained employment to handle all of her accounting and tax affairs. Included in petitioner's duties pursuant to such employment were preparation of Mrs. Goettman and her husband's Federal income tax returns and payment of various taxes owed by them. In 1968 petitioner secured a power of attorney from the Goettmans designating him as their representative in connection with their Federal tax liabilities. During 1968 through 1971 petitioner received the following amounts of currency from Mrs. Goettman for the ostensible purpose of satisfying her tax liabilities: YearAmount1968$21,147.00196918,895.00197022,955.0019717,374.00No Federal income tax returns were filed by or on behalf of the Goettmans for the taxable years 1966, 1967, 1968, 196 9, and 1971, and the return filed on their behalf for1977 Tax Ct. Memo LEXIS 329">332 1970 showed zero tax liability. Petitioner made no payments on behalf of the Goettmans for their Federal income tax liabilities for any of these years. 2Respondent determined that, with certain exceptions, the money received by petitioner from Mrs. Goettman constituted unreported taxable income to him, and we agree. The amounts, as adjusted, are set forth below: YearAmount1968$16,928.52196916,728.12197020,850.0019713,998.50Respondent also disallowed 50 percent of the depreciation deductions claimed by petitioner each year based on his determination that the assets on which depreciation was claimed were used in both petitioner's business and the separate bookkeeping business operated by petitioner's wife. Respondent further disallowed a portion of the additional first year depreciation deduction claimed by petitioner in 1970. Petitioner has adduced no evidence which would show that respondent1977 Tax Ct. Memo LEXIS 329">333 erred in his partial disallowance of these deductions. Petitioner claimed net operating loss carryover deductions in 1968, 1969, and 1971, which were also disallowed by respondent. The deductions for 1969 and 1971 were based on net operating losses computed for 1968 and 1970, which losses are extinguished by the additional unreported income determined herein. Petitioner offered no evidence to establish a net operating loss that could properly be carried over to 1968. Petitioner's liability for additional self-employment tax for 1968 through 1971 is dependent upon our resolution of other issues in this case. At least a part of the deficiency in each year was due to negligence or intentional disregard of rules and regulations. OPINION In the taxable years 1968 through 1971 petitioner received monies from his client, Jean Goettman, which were diverted to his own use. Under the doctrine of North American Oil v. Burnet,286 U.S. 417">286 U.S. 417 (1932), as reaffirmed and expanded in James v. United States,366 U.S. 213">366 U.S. 213 (1961), petitioner is chargeable with having realized income of the amounts received. Quinn v. Commissioner,524 F.2d 6171977 Tax Ct. Memo LEXIS 329">334 (7 Cir, 1975), affirming 62 T.C. 223">62 T.C. 223 (1974); Peters v. Commissioner,51 T.C. 226">51 T.C. 226 (1968). Petitioner has offered no satisfactory evidence that would establish respondent's determinations of the amounts of unreported income in each year to be erroneous. The remaining issues are resolved either by our conclusion that petitioner realized additional unreported income as aforesaid, or by petitioner's failure to adduce evidence that respondent's determinations are erroneous. Rules 142(a) and 149(b), Tax Court Rules of Practice and Procedure.Decision will be entered for respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue.↩2. This whole matter came to light when in 1971 the intelligence division of the internal revenue service initiated an investigation of the Goettmans for their alleged failure to file Federal income tax returns for the years 1966 through 1969.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625619/	Estate of Frank Charles Smith, Deceased, Commonwealth Trust Company of Pittsburgh, Executor, and Nancy Y. Smith, Executor, Petitioners v. Commissioner of Internal Revenue, Respondent.Estate of Frank Charles Smith v. Commissioner of Internal RevenueDocket No. 31197.United States Tax Court1952 Tax Ct. Memo LEXIS 25; 11 T.C.M. 1167; T.C.M. (RIA) 52343; November 28, 1952Ross W. Thompson, Esq., 2620 Grant Bldg., Pittsburgh, Pa., for the petitioners, James A. Anderson, Esq., for the respondent. LEMIRE Memorandum Findings of Fact and Opinion This proceeding is for the redetermination of a deficiency in income tax for the year 1947 in the amount of $7,201. The issues presented are: (1) Whether petitioner is entitled to deduct under section 23 (u) of the Internal Revenue Code payments allegedly made in 1947 by Frank Charles Smith, deceased, to his divorced wife, pursuant to an agreement incident to a decree of divorce; and (2) whether the amount of $2,000, representing legal fees paid by decedent in 1947 for services rendered in negotiating the aforesaid agreement, is deductible1952 Tax Ct. Memo LEXIS 25">26 as a nonbusiness expense under section 23 (a) (2) of the Code. All the facts have been stipulated and are found accordingly. Findings of Fact The Commonwealth Trust Company of Pittsburgh, Pennsylvania, and Nancy Y. Smith are coexecutors of the estate of Frank Charles Smith, deceased. The decedent was a resident of Pittsburgh, Pennsylvania. He died November 24, 1949. The return for the year 1947 was filed by the decedent with the collector of internal revenue for the twenty-third district of Pennsylvania. Decedent and Mabel Q. Smith were married on June 6, 1921. By reason of disputes and unhappy differences arising out of their marital relationship, they separated on December 8, 1945, and thereafter remained apart. In May 1946 preliminary negotiations were entered into for the purpose of securing a divorce, making a property settlement and arranging for the payment of alimony. On November 29, 1946, the decedent and Mabel Q. Smith executed an agreement wherein it was agreed, inter alia: "FIRST: That the husband shall pay to the wife the sum of twenty-five thousand ($25,000.00) Dollars in ten (10) equal semi-annually installments, * . "SECOND: That the husband shall pay1952 Tax Ct. Memo LEXIS 25">27 to the wife in addition thereto, the sum of Three hundred ($300.00) Dollars every month, beginning on the 1st day of December, 1946, payable on the 1st day of every month hereafter for a period of five (5) years, beginning with the day of the first payment as aforesaid. "THIRD: That the husband shall pay in addition thereto to the wife, the sum of One hundred ($100.00) Dollars on the 1st day of December, 1951, and on the 1st day of each calendar month thereafter, a monthly sum or payment of One hundred ($100.00) Dollars, for and during the term of the remainder of the natural life of the wife. * * "FIFTH: The husband hereby agrees to name his wife beneficiary of certain life insurance policies as follows: - "NAME OF COMPANYAMOUNT1. Continental Casualty$5,000.002. London Guarantee & Accdt.Co.$4,500.003. Prudential Ins. Co. of America$4,000.004. Prudential Ins. Co. of America$5,000.005. Metropolitan Life Ins. Co.$5,000.00"The provision in this paragraph of the husband 'never to change the beneficiary thereof' is hereby construed by the parties hereto to mean 'never to change the beneficiary during the lifetime of the wife, and, in1952 Tax Ct. Memo LEXIS 25">28 the event the wife should die before the husband, then, all her interest in said policies shall cease and the husband shall have the right in such case to change the beneficiary.' G.D.W. /s/ A. F. Burkardt /s/ And he does hereby assign and set over to her, all his right, title, claim and interest herein and agrees never to change the beneficiary thereof, and to pay the premiums as and when they become due on the said policies, and to keep the said policies in full force and effect at all times in the future. * * "EIGHTH: The husband hereby agrees to furnish the said wife during the term of her natural life, a new automobile of standard make every year, and to maintain the same in good running repair as necessary by reason of ordinary wear and tear. "The wife hereby agrees to turn in and surrender to the husband her used automobile every time he furnishes her a new car. "NINTH: All and each of the payments as aforesaid shall be made by the husband to the wife, free of any Federal Income Taxes to herself. That is to say, that in addition to the face value of the payments provided as above, the husband shall pay any and all Federal Income Taxes due thereon. "TENTH: 1952 Tax Ct. Memo LEXIS 25">29 The husband shall have the right to accelerate or anticipate any of the payments due hereunder at any time, and in that event, an allowance shall be made to him amounting to Four (4%) per cent annually on payments so made in advance of the due date. * * "FOURTEENTH: This agreement shall be in full settlement, adjustment and compromise of all property questions and rights between the husband and wife. "FIFTEENTH: The payment by the husband to the wife of the sums herein provided shall be a complete discharge by the husband of all liability to support and maintain his wife." On the same date, Mabel Q. Smith signed a libel in divorce against decedent which was filed in the Court of Common Pleas of Allegheny County, Pennsylvania, on December 3, 1946. After the trial a decree in favor of Mabel Q. Smith was entered on March 5, 1947. The decree makes no mention of the separation agreement of November 29, 1946, and contains no provision for alimony. The agreement was executed by the parties incident to and in contemplation of divorce. Pursuant to paragraph "FIRST" of the agreement of November 29, 1946, the decedent drew a check for $2,500 to the order of Mabel Q. Smith, which1952 Tax Ct. Memo LEXIS 25">30 was delivered to her attorney and held by him until after the entry of the divorce decree on March 5, 1947. The check was cashed by Mabel Q. Smith on March 11, 1947. On August 7, 1947, the decedent made a further payment to his former wife of $2,500 under paragraph "FIRST" of the agreement. The decedent pursuant to paragraph "SECOND" of the agreement made 12 monthly payments of $300 each to his former wife. The first three of such payments were made on dates prior to the entry of the divorce decree. In 1947 the decedent paid premiums amounting to $400 on certain life insurance policies enumerated in paragraph "FIFTH" of the agreement. On December 16, 1947, the decedent, with the intention of complying with paragraph "NINTH", drew a check to the order of Mabel Q. Smith for the amount of $2,300. This check was not cashed until January 10, 1949. In 1947 the decedent paid the sum of $2,000 to his legal advisor for services rendered in negotiating the agreement of November 29, 1946. In 1947, pursuant to paragraph "EIGHTH" of the aforesaid agreement, the decedent provided his former wife with a new Ford automobile at a cost to him of $500. In determining his deficiency the respondent1952 Tax Ct. Memo LEXIS 25">31 disallowed the amount of $11,300 representing cash payments to the decedent's former wife and the $400 representing insurance premiums claimed by decedent on his 1947 return. The amount of $500 representing the cost to decedent of the new automobile and the amount of $2,000 paid for legal services were not claimed as deductions on the decedent's return for 1947. In the petition filed herein these amounts are alleged to constitute allowable deductions. Opinion LEMIRE, Judge: The primary question presented is whether the payments made by the decedent in the taxable year 1947 to his divorced wife, pursuant to the agreement incident to and in contemplation of divorce, are properly deductible under section 23 (u) of the Internal Revenue Code. Petitioner contends that the agreement of November 29, 1946, must be construed as a whole, and so construed all the payments in question are "periodic payments" within the purview of section 22 (k) of the Code. The respondent contends that since the parties in drafting the agreement have segregated the payments no unified plan of payments was intended, and the character of the payments is to be determined on the basis1952 Tax Ct. Memo LEXIS 25">32 of the specific paragraph of the agreement under which such payments were made. In the case of Edward Bartsch, 18 T.C. 65">18 T.C. 65 (on appeal, C.A. 2), which involved similar contentions, we sustained the position taken by the respondent. Upon the rationale of the Bartsch case the respondent's contention is sustained. Whether any of the payments constitute proper deductions will be determined in the light of the separate paragraphs of the agreement under which they were made. In 1947 two payments of $2,500 each were made pursuant to paragraph "FIRST" of the agreement. The obligation under such paragraph was the payment of a principal sum of $25,000 in ten equal semi-annual installments commencing on February 15, 1947. Section 22 (k) of the Internal Revenue Code specifically provides that installment payments discharging a part of an obligation, the principal of which is specified in the decree or instrument, shall not be considered periodic payments. Clearly, the two payments in question are not periodic payments, and as they do not meet the conditions set forth in section 22 (k) they are not properly deductible under the provisions of section 23 (u) of1952 Tax Ct. Memo LEXIS 25">33 the Code. The respondent's disallowance of the deduction of the $5,000 paid in 1947 under paragraph "FIRST" of the agreement is sustained. So holding, it is unnecssary to consider the further contention of the respondent that the first payment of $2,500 is not properly deductible since it was not made subsequent to the entry of the decree, as required by section 22 (k) of the Code. In 1947 the decedent made 12 monthly payments to his divorced wife in the sum of $300 each. These monthly payments were made pursuant to paragraph "SECOND" of the agreement, which provides for monthly payments of $300 for a period of five years. Although the principal sum is not specified in the agreement it is mathematically determinable. The rule is well established that payments of specific amounts for a definite period constitute installment and not periodic payments within the purview of section 22 (k) of the Code. Estate of Frank P. Orsatti, 12 T.C. 188">12 T.C. 188; J. B. Steinel, 10 T.C. 409">10 T.C. 409; Frank R. Casey, 12 T.C. 224">12 T.C. 224. On the basis of these authorities we sustain the respondent's disallowance of the monthly payments aggregating $3,600 made pursuant to paragraph "SECOND" 1952 Tax Ct. Memo LEXIS 25">34 of the agreement. We, therefore, find it unnecessary to consider the respondent's alternative contention that the first three monthly payments, having been made prior to the entry of the decree of divorce, do not meet the conditions of section 22 (k) and, therefore, do not constitute proper deductions under section 23 (u) of the Code. In 1947 the decedent paid the sum of $400 as premiums on certain of the insurance policies set forth in paragraph "FIFTH" of the agreement. The petitioner contends that such amount constitutes additional alimony properly deductible under section 23 (u), under the rationale of Lemuel Alexander Carmichael, 14 T.C. 1356">14 T.C. 1356. The respondent argues that the Carmichael case is distinguishable on its facts and is not a controlling authority here. We agree. Several insurance policies were involved in the Carmichael case. One of the policies for $5,000 designated the divorced wife as the primary beneficiary and the daughter as secondary beneficiary. Another $5,000 policy designated the daughter as primary beneficiary and the wife as secondary beneficiary. The decree provided that the husband could not change the beneficiaries at any future time. We1952 Tax Ct. Memo LEXIS 25">35 held with respect to the policy in which the wife was the primary beneficiary that the premium paid on such policy constituted additional alimony and was deductible under section 23 (u). We denied any deduction with respect to the $5,000 policy in which the divorced wife was named as the secondary beneficiary. In the instant case, although the divorced wife is the primary beneficiary, the agreement provides, in effect, that the designation of the wife as beneficiary shall not be changed during her lifetime. Hence, in the event the divorced wife predeceased the decedent, the latter would regain full possession and control of the policy. This material fact, in our opinion, supports our conclusion that the Carmichael case is not a controlling authority here. As the insurance premium in question was not paid for the sole benefit of the divorced wife, we think, it could not be taxed to her as additional alimony under section 22 (k) of the Code. See, also, Anita Quinby Stewart, 9 T.C. 195">9 T.C. 195; Estate of Boies C. Hart, 11 T.C. 16">11 T.C. 16. We sustain the respondent's disallowance of the sum of $400 claimed as a deduction under section 23 (u) of the Code. Petitioner contends1952 Tax Ct. Memo LEXIS 25">36 that the amount of $2,300 allegedly paid in 1947, pursuant to paragraph "NINTH" of the agreement providing, in substance, that the decedent is to pay all federal income taxes due on the amounts paid to his divorced wife, is deductible as additional alimony. This record merely shows that decedent drew a check to the order of his divorced wife in the face amount of $2,300 on December 16, 1947, and that the check was cashed on January 10, 1949, one year and 24 days later. The record is silent as to the time the check was delivered. Petitioner has the burden of showing actual payment in order to be entitled to a deduction. A mere showing that a check was drawn without establishing the fact of delivery to and acceptance by the payee is insufficient, in our opinion, to establish payment in the taxable year involved. For failure of proof, we sustain the respondent's disallowance as a deduction in the sum of $2,300 as additional alimony under section 23 (u) of the Code. Petitioner further contends that the sum of $500, which decedent paid to obtain a new automobile in compliance with paragraph "EIGHTH" of the agreement, constitutes a proper deduction. Such amount was not claimed as a deduction1952 Tax Ct. Memo LEXIS 25">37 in the decedent's return for the year 1947. However, the petition filed herein alleges the deductibility of such amount. The record merely shows that the decedent provided his divorced wife with a new car in 1947 at a cost to him of $500. The time when the payment was made and the car delivered to the divorced wife has not been established. We are unable to determine from the record whether the transaction occurred prior or subsequent to the entry of the decree of divorce. For lack of sufficient proof, we hold that petitioner is not entitled to a deduction in 1947 of the sum of $500, representing the cost to decedent of a new automobile. A further issue raised by the petition is the deductibility as a nonbusiness expense of the amount of $2,000, which the decedent paid to his attorney for legal services in negotiating the settlement agreement. Since neither the main brief nor the reply brief filed by petitioner make an argument in connection with this issue, it may be that its claim has been abandoned. However, if the petitioner has not intended to abandon its claim, we think it is well established that legal fees paid under the circumstances here presented are of a personal character1952 Tax Ct. Memo LEXIS 25">38 and are not deductible under section 23 (a) (2) of the Code as nonbusiness expenses. Lindsay C. Howard, 16 T.C. 157">16 T.C. 157. Cf. Baer v. Commissioner, 196 Fed. (2d) 646. We, therefore, hold that petitioner is not entitled to a deduction in the amount of $2,000 paid to his attorney for legal services in connection with the settlement agreement. The alternative contention of petitioner that it is entitled to a deduction in the amount of $8,474, represening ten per cent of the principal sums payable under the excepting clause of section 22 (k), is without merit. The excepting clause relied upon provides, in substance, that an installment payment shall be considered a periodic payment if the principal sum specified in the decree or instrument is to be paid within a period ending more than ten years from the date of the decree. Under the agreement in question both principal sums specified therein are to be paid within the first five years. We think it is clear that the excepting clause is not applicable under the facts here in question. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625621/	MARLBOROUGH HOUSE, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. BONDHOLDERS COMMITTEE, MARLBOROUGH INVESTMENT CO., FIRST MORTGAGE BONDS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Marlborough House, Inc. v. CommissionerDocket Nos. 90452, 90486, 90487.United States Board of Tax Appeals40 B.T.A. 882; 1939 BTA LEXIS 786; November 9, 1939, Promulgated 1939 BTA LEXIS 786">786 X corporation erected an apartment building in 1927 and issued its bonds in the amount of $500,000, secured by a mortgage on this property. In 1932 X defaulted on these bonds and a bondholders' protective committee was formed under a deposit agreement which gave it broad powers. This committee instructed the trustee under the mortgage to foreclose, and at the foreclosure sale the committee bid in, with the bonds deposited with it plus cash, the property for $340,425. Thereafter the committee held and operated the property for several months and later transferred it to a new corporation, which issued all its stock to the depositing bondholders of X. Held, these acts constituted a reorganization and the basis for depreciation of the property in the hands of the committee and the new corporation is the same as the basis in the hands of X, following Commissioner v. Kitselman, 89 Fed.(2d) 458, and Commissioner v. Newberry Lumber & Chemical Co., 94 Fed.(2d) 447; held, further, that the bondholders' committee was not a liquidating trust but was an association taxable as a corporation as to the income received by it while it held and operated1939 BTA LEXIS 786">787 the property, and that since it failed to file any return of such income it was liable for an additional tax of 25 percent; held, further, that under the facts the building acquired by petitioners had an economic and useful life of 30 years from July 1, 1933, and the rate of depreciation should be fixed accordingly. Wm. Z. Kerr, Esq., and Harold L. Scott, C.P.A., for the petitioners. Edward C. Adams, Esq., for the respondent. KERN 40 B.T.A. 882">882 These proceedings, consolidated for hearing, involve deficiencies in income tax liability. In Docket No. 90486, wherein Bondholders Committee, Marlborough Investment Co., First Mortgage Bonds is petitioner, the deficiency is in the sum of $1,498.02, representing income determined by respondent to have been received by this petitioner during the period July 1 to November 20, 1933, inclusive, plus an additional tax of 25 percent for failure to file a return of such income. In Docket No. 90487, wherein Marlborough House, Inc., is petitioner, the deficiency determined by respondent is in the sum of $245.33 and involves the income tax liability of that petitioner for the period of November 1 to December 31, 1933, inclusive. 1939 BTA LEXIS 786">788 The same party is petitioner in Docket No. 90452, which involves a deficiency determined by respondent for the year 1934 40 B.T.A. 882">883 in the sum of $441.76 and for the year 1935 in the sum of $1,120.35. In the two proceedings in which Marlborough House, Inc., is petitioner those parts of the deficiencies are in issue which result from respondent's determination that the basis for depreciation of the property owned by petitioner is the price bid and paid for it at a foreclosure sale in 1933, and that the estimated remaining life of the property was 45 years. Petitioner claimed a greater basis and a shorter life for the property in calculating depreciation. In the proceeding in which the bondholders' committee is petitioner the deficiency results from respondent's determination that petitioner is not a liquidating trust, but is an association taxable as a corporation and, therefore, should be taxed at corporation rates on the income received by it from July 1 to November 20, 1933, and, furthermore, that having filed no return of such income it was liable for an additional tax of 25 percent as penalty. The same issue of basis and rate of depreciation is present in this proceeding. 1939 BTA LEXIS 786">789 Other issues presented by the pleadings in these proceedings were either not supported by any evidence at the hearing herein, and may therefore be considered as having been abandoned, or were expressly waived and conceded. FINDINGS OF FACT. Under date of May 20, 1927, the Marlborough Investment Co., a corporation, issued its bonds in the aggregate principal sum of $500,000, and to secure them executed a mortgage or deed of trust on certain real and personal property located in Seattle, Washington, being an apartment building known as the Marlborough House, together with the personal property situated therein, all of which it then owned. Default in the payment of these bonds occurred May 10, 1932, at which time the amount of outstanding bonds was $453,900. Shortly after the default a bondholders' committee was organized, consisting of William D. Perkins, W. O. Bulette, and Harvey Lantz, and a written "Deposit Agreement" was executed by the above three persons constituting the committee, in which the National Bank of Commerce of Seattle was designated as depository. The deposit agreement as a whole is incorporated herein by reference. One especially pertinent provision is1939 BTA LEXIS 786">790 as follows: Section 2. Without derogation from the general powers hereby conferred upon the committee, the committee shall have power and authority to enforce, protect, discharge, collect, sue for, extend or adjust all rights at law or in equity attaching to said bonds and coupons thereto attached; to transfer any bond or coupon hereunder into its own name or the name or names of its nominees; to declare due and/or to request the trustee under said indenture to declare due the principal of any and all bonds, whether or not the same be deposited hereunder, and to revoke any such declaration; to dismiss and/or 40 B.T.A. 882">884 request the trustee under said indenture to dismiss, upon terms satisfactory to the committee, any suit or proceeding instituted by the committee and/or said trustee upon said bonds or under said indenture, and/or against the company to waive any default or defaults by the company under the terms of said bonds or the indenture securing the same; to request the trustee under said indenture to make such waivers; to apply for or secure the removal of any trustee and/or the substitution of other trustees under said indenture; to appoint additional depositaries under1939 BTA LEXIS 786">791 this agreement, and to remove any depositaries and appoint successors thereto; to purchase or settle at such prices as they deem proper any claims against the company; to pay or cause to be paid taxes and/or assessments on the property described in the mortgaged lease; to effect or continue insurance thereon; to borrow or advance money or give guarantees for the purpose of carrying out any plan adopted by the committee for the purpose of protecting the mortgaged property and/or the interests of the depositors, including the payment of taxes and/or assessments on the mortgaged property, costs of operation of the mortgaged property, or for the purchase of claims against the company, or for the exercise of any power hereby granted to the committee, or for the purpose of making, in the discretion of the committee, advances to the depositors upon deposited bonds and/or coupons or upon certificates of deposit, or for such periods and upon such terms and conditions as the committee may decide; to pledge the deposited bonds and/or coupons as security for loans which the committee may deem necessary or proper for the protection of the mortgaged property and/or the interests of the depositors; 1939 BTA LEXIS 786">792 to subordinate the lien of the indenture securing the deposited bonds to a new lien upon the mortgaged property for the purpose of borrowing and/or securing funds to protect the mortgaged property and the interests of the depositors; to pledge or sell any deposited bonds or coupons or the avails thereof, or any other property at any time coming into the possession or control of the committee for the payment of any money so borrowed or agreed to be paid or advanced by the committee or for the performance of any other obligation incurred by the committee hereunder, or for the payment of any expenses incurred by the committee hereunder, or for the securing of any guaranty given by the committee; to exchange the deposited bonds and/or coupons, in whole or in part, for other securities or property; to sell, redeem, surrender, pledge or in any manner charge the deposited bonds and/or coupons as part of any plan adopted by the committee for the protection of the mortgaged property and/or the interest of the depositors; to institute, defend or become parties to, compound, forbear, settle or conduct any legal proceedings at law or in equity; to file or prove with any receiver, court or referee1939 BTA LEXIS 786">793 or committee, all or any part of the bonds and/or coupons deposited hereunder; to apply for receivers or the removal of receivers and for the termination of any receivership; to enter into arrangements for decrees or to facilitate or hasten the course of any litigation; to accept and waive notices of every character in legal proceedings or otherwise; to make requests or demands upon the trustee under the indenture securing said bonds; to consent to the issuance of receivers' certificates having priority over deposited bonds and/or coupons; to purchase any such certificates; to make and/or consent to such modifications in the indenture securing the bonds as the committee deems necessary and proper; to take such action as the committee deems necessary and proper to promote or to secure or prevent a sale of the mortgaged property upon foreclosure or otherwise; to prevent, to delay or to adjourn any such sale at its discretion; to bid or refrain from bidding at any such sale; to procure the organization of a new corporation or corporations, or to 40 B.T.A. 882">885 adopt or use any existing or future corporations; to take, hold, subscribe, pay for or otherwise give value for the securities and1939 BTA LEXIS 786">794 obligations of such corporation or corporations; to receive any new securities to be created and to vote upon the stock of any corporation now or in the future organized as part of any plan adopted by the committee for the protection of the depositors; to employ counsel, accountants, agents and assistants, and to pay the expenses thereof as part of the expenses of the committee, and to incur and discharge any and all expenses which the committee deems necessary and proper in functioning hereunder; to cause a new corporation to be formed to take over and/or acquire the mortgaged property, and to surrender and/or exchange the deposited bonds and/or coupons, in whole or in part, for all or part of the stock of such corporation upon such basis of exchange as the committee may determine. Bonds were deposited under the agreement to the extent of more than 97 percent of the whole. The holders of $441,100 of par value bonds came in under the deposit agreement, deposited their bonds thereunder, and authorized the bondholders' committee to act for them. The holders of $12,800 par value of bonds failed to deposit. Under date of August 15, 1932, the bondholders' committee in writing requested1939 BTA LEXIS 786">795 the National Bank of Commerce of Seattle, the trustee under the trust deed and mortgage, to commence foreclosure proceedings because of the existing defaults in payments, and it did so on August 26, 1932. While the foreclosure proceedings were pending, a written stipulation was entered into between certain of the defendants in the action and the trustee bank, as plaintiff, under date of July 1, 1933, by which the parties consented to the entry of a decree of foreclosure, and by the further terms of which the record owners of the property, i.e., State Developers, Inc., a corporation, and Russell L. Cooley and Lillian A. Cooley, his wife, each executed and delivered a quitclaim deed to all the property in question in consideration of the payment of the sum of $10,025 cash. In these deeds the name of the grantee was left blank. The stipulation specifically authorized the plaintiff and/or its attorneys to insert the name of the grantee in the deeds. On September 28, 1938, the attorneys for the plaintiff, acting under the written authority conferred in the stipulation, filled in the name of Russell C. Perkins, trustee for the bondholders' committee, as grantee in each of the deeds1939 BTA LEXIS 786">796 and on the same day Perkins, as trustee, executed and delivered a quitclaim deed covering all the property to Marlborough House, Inc., a corporation, which was organized by the bondholders on or about November 10, 1933, to take over and manage the property acquired by the bondholders at the foreclosure sale. By the stipulation, the defendants further agreed to turn over to the plaintiff or its nominees, on July 1, 1933, the possession of the 40 B.T.A. 882">886 real and personal property involved. The bondholders' committee put up the money for the purchase of the property from the record owners and was made the nominee of the plaintiff, to whom the possession of the property was turned over. The committee appointed Russell C. Perkins its agent to collect the rents and pay the expenses of the general management of the building and to take physical possession of the building for the committee. Perkins, on the first day of July 1933, took physical possession of the property, and thereafter, until November 20, 1933, managed the property, collected the rents, and paid the expenses for the committee. After the passing of title to this property from State Developers, Inc., and Russell1939 BTA LEXIS 786">797 L. Cooley and wife by the quitclaim deeds dated July 1, 1933, the foreclosure action was prosecuted to judgment and sale. The judgment and decree of foreclosure was entered in accordance with the stipulation and on the same date as the stipulation. The sheriff's foreclosure sale was held on the 30th day of September 1933, and the bondholders' committee was the successful bidder and purchaser. The sale was thereafter duly confirmed by the Superior Court having jurisdiction of the matter and thereafter the sheriff's certificate of purchase covering the property was made out to the bondholders' committee and was duly assigned by the committee on the back page thereof to Marlborough House, Inc. After the year of redemption had gone by and the property had not been redeemed the sheriff's deed to the property was issued directly to Marlborough House, Inc., assignee of the bondholders' committee. The bid price at the sheriff's sale submitted by the bondholders' committee was $340,425. This bid was accepted and the property was sold to the bondholders' committee. The purchase price was paid mainly by a surrender of the deposited bonds, the remainder by cash. The total amount of the1939 BTA LEXIS 786">798 bonds deposited with the sheriff to apply upon the purchase price of the real and personal property was $441,100. The holders of the nondeposited bonds were paid in cash their proportion of the purchase price after deducting their pro rata cost and expense of the foreclosure, which resulted in a payment to them of 73.58 percent of the face value of their bonds. The reason the committee arrived at the bid price of $340,425 was twofold: First, the amount of the bid was governed to some extent by the amount of cash available for payment to the nondepositing bondholders, and, second, in the event of redemption of the property, the bondholders wished to assure themselves and adequate and fair return on their investment. Neither the fair market value of the bonds deposited with the committee plus the cash used by it in partial payment of the bid price nor the fair market value of the property sold was in excess of $340,425 at the date of the foreclosure sale or on July 1, 1933. 40 B.T.A. 882">887 Subsequent to the passing of the title from the record owners by the quitchaim deeds dated July 1, 1933, the bondholders' committee made no attempt to sell the property, since, because of the severe1939 BTA LEXIS 786">799 financial depression, there was no market for a sale. Marlborough House, Inc., after it was organized and took possession of the property, issued all of its stock to the bondholders of the Marlborough Investment Co. who had deposited their bonds with the committee. The steps taken by the bondholders' committee after the institution of the foreclosure suit and until the final vesting of title in Marlborough House, Inc., were pursuant to a plan of reorganization formulated by the committee for the benefit of the bondholders pursuant to the power granted to it by the deposit agreement. The basis for depreciation on the property in the bonds of the bondholders' committee and Marlborough House, Inc., was the same as in the hands of the Marlborough Investment Co., less the depreciation already taken by the latter. Bondholders Committee, the petitioner in Docket No. 90486, did not file an income tax return for any period. Marlborough House, Inc., the petitioner in Docket Nos. 90487 and 90452, at the time of filing its first return, included figures of gross income and deductions for the period between July 1 and December 31, 1933, which period covers the period of existence of1939 BTA LEXIS 786">800 the bondholders' committee and the first period of existence within the year 1933 of the corporation. The committee was an association taxable as a corporation. The Marlborough Apartment Building is a modern 12-story apartment building of concrete, steel, and brick with two elevators, and was constructed in 1927. It contains approximately 81 apartments and 254 rooms. It is well constructed and probably is the best of its type as of the date of construction. As of July 1, 1933, it had an economic and useful life of 30 years. OPINION. KERN: The first issue to be determined in these proceedings has to do with the basis for depreciation of the property held by petitioners. The answer depends upon whether the acquisition by the bondholders of a corporation of the latter's property as a result of a foreclosure action, and the subsequent acquisition of the same property by another corporation organized for that purpose by the bondholders, constitute a reorganization within the meaning of the statute, so that the basis for depreciation of the property in the hands of the bondholders and later in the hands of the second corporation would be the same as the basis for depreciation1939 BTA LEXIS 786">801 in the hands of the first corporation against which the foreclosure action was brought. 40 B.T.A. 882">888 It is the contention of petitioners that there was such a reorganization. Respondent contends that there was no reorganization and that the basis for depreciation in the hands of the petitioners must be the amount bid for the property at the foreclosure sale. The rule applied by us until recently in similar cases was that the basis for depreciation in the hands of foreclosing bondholders and corporations organized by them for the purpose of acquiring the property foreclosed was either the fair market value of the property at the time it was sold on foreclosure, or the fair market value of the bonds used by the bondholders in payment of the price bid at the foreclosure sale. Suncrest Lumber Co.,25 B.T.A. 375">25 B.T.A. 375; Newberry Lumber & Chemical Co.,33 B.T.A. 150">33 B.T.A. 150. But in the case of Commissioner v. Kitselman, 89 Fed.(2d) 458 (certiorari denied, 302 U.S. 709">302 U.S. 709), the Circuit Court of Appeals for the Seventh Circuit, in reversing our decision reported in 1939 BTA LEXIS 786">802 33 B.T.A. 494">33 B.T.A. 494, held under similar circumstances that there was a reorganization as defined in section 112(i) of the 1928 Act. To the same effect is Commissioner v. Newberry Lumber & Chemical Co., 94 Fed.(2d) 447 (reversing 33 B.T.A. 150">33 B.T.A. 150), decided by the Circuit Court of Appeals for the Sixth Circuit. In that case the precise question presented by the instant proceedings was considered and it was held that the basis for depreciation in the hands of the corporation organized by the bondholders to take over the assets upon foreclosure would be the same as that of the mortgagor corporation. In the cases of Lucien H. Tyng,36 B.T.A. 21">36 B.T.A. 21 (affirmed on this issue, 106 Fed.(2d) 55), and Frederick L. Leckie,37 B.T.A. 252">37 B.T.A. 252, we indicated our intention to now apply the rule laid down in Commissioner v. Kitselman, supra, and Commissioner v. Newberry Lumber & Chemical Co., supra.In one respect the instant proceedings differ from the Kitselman case and the Newberry Lumber & Chemical Co. case. The record here does not contain any evidence specifically1939 BTA LEXIS 786">803 relating to a plan of reorganization. There is testimony as to the different steps taken by which the second corporation acquired title after the foreclosure proceedings and the bondholders of the first corporation became the stockholders of the second. There is also testimony to the effect that, since no market existed for the sale of the property, no attempt at liquidation was made by the bondholders upon foreclosure. The deposit agreement, which was put in evidence and under which the committee was created, grants broad powers to the committee such as are usual in corporate reorganizations, and makes several references to a "plan" to be adopted by the committee for the purpose of protecting the interests of the depositors. In other words, the record discloses a reason for a reorganization rather than a liquidation, 40 B.T.A. 882">889 and also discloses the taking of steps usual in the most common type of reorganization. Cf. I.T. 2071, III-2, C.B. 34. As we said in William H. Redfield,34 B.T.A. 967">34 B.T.A. 967, 34 B.T.A. 967">973: "It is not necessary, however, that such a plan of reorganization be evidenced by a formal written document, such as a contract or corporate minutes. 1939 BTA LEXIS 786">804 It is sufficient if the circumstances indicate that the various steps taken were pursuant to a definite plan of reorganization." We can not doubt that under the circumstances present in these proceedings there was a plan of reorganization formulated by the committee and pursuant to which the steps were taken as disclosed by the record. Holding as we do that there was here a reorganization within the meaning of sections 112(a)(3) and 112(i), Act of 1932, it follows that the basis for depreciation in the hands of petitioners will be the same as that in the hands of the predecessor corporation, the Marlborough Investment Co., less the depreciation already taken by such predecessor. Sec. 113(a)(6), Act of 1932. The next issue has to do with the income received by the Bondholders Committee, Marlborough Investment Co., First Mortgage Bonds, petitioner in Docket No. 90486, while it was in possession of the property from July 1 to November 20, 1933. The double question is raised of who should have returned this income and the rate at which it should have been taxed. This income was reported in the return of the new corporate petitioner, but the committee made no return of any kind. 1939 BTA LEXIS 786">805 It is plain that this procedure was erroneous (see Chicago, Rock Island & Pacific Railway Co. v. Commissioner, 47 Fed.(2d) 990) and petitioners do not now contend otherwise. The petitioner Bondholders' Committee now contends, however, that it is taxable as a liquidating trust and not as a corporation, and that its failure to file a return was due to reasonable cause. Respondent, on the other hand, contends that the committee was an association doing business in an organized capacity, the net income of which was distributable to its members in proportion to the capital each had invested, and was, therefore, taxable as a corporation (see arts. 1312 and 1314, Regulations 77); and he further contends that an additional tax of 25 per centum is to be properly assessed against the committee because of its failure to file a return pursuant to section 291 of the Revenue Act of 1932. The pertinent cases relied on by petitioner are Broadway-Brompton Buildings Liquidation Trust,34 B.T.A. 1089">34 B.T.A. 1089, and Delese & Shepherd Co.,30 B.T.A. 1171">30 B.T.A. 1171. The pertinent case relied upon by respondent is Bondholders Protective Committee v.United States1939 BTA LEXIS 786">806 (U.S. Dist. Ct., So. Dist. Calif., Nov. 16, 1938). Having held as we have that the acts of petitioners constituted a reorganization and that there was a plan of reorganization, we can not consistently adopt the view urged on us by petitioners that the 40 B.T.A. 882">890 primary object of the committee was the liquidation of the property and not its transfer to a newly organized corporation. A careful reading of the deposit agreement convinces us that the primary object of the committee was to hold, manage, and operate the property after foreclosure and pending the organization of the corporation which would take over the property in consummation of the plan of reorganization worked out by the committee. There is nothing in the record to indicate that liquidation by selling the property on the market was ever contemplated or desired. The mere fact that the committee had an incidental power to sell which could have been exercised in the event the contemplated reorganization was unsuccessful does not persuade us that the activities of the committee constituted a liquidation. Since it was not a liquidating trust but an association meeting the tests laid down in 1939 BTA LEXIS 786">807 Morrissey v. Commissioner,296 U.S. 344">296 U.S. 344, we hold that the Bondholders Committee, Marlborough Investment Co., First Mortgage Bonds was properly taxalbe as a corporation on the income received by it. Since the committee filed no return, it is liable for the additional tax of 25 per centum computed upon its taxable income, regardless of the reason for its failure to file such a return. Moulton Green, Trustee,24 B.T.A. 1121">24 B.T.A. 1121; Harry D. Kremer,31 B.T.A. 566">31 B.T.A. 566. The next issue involves the proper rate to be applied in ascertaining the amount of depreciation to be deducted by petitioners for the taxable years. It is the contention of petitioners that the apartment building had an economically useful life of only 30 years after July 1, 1933, instead of 45 years as determined by the respondent, and that respondent, in applying a rate of depreciation determined by estimating a remaining life of 45 years, did not include a reasonable allowance for obsolescence as required by section 23(k) of the Act of 1932 and section 23(l) of the Act of 1934. Two witnesses testified as experts on behalf of petitioners. 1939 BTA LEXIS 786">808 They were familiar with the history of apartment house values in the city of Seattle and were familiar with the general location and general construction of the apartment house building owned by petitioners. Their testimony was that such an apartment building had a useful life of from 30 to 35 years, and they justified their conclusion by relating case histories of other apartment buildings of similar type and location which had lost their value within such a period by reason of the construction of newer apartment buildings better and more suitably arranged with more modern plumbing and equipment, and also by reason of the shifting of regions thought desirable for apartment buildings. They further testified to the effect that the economic and useful life of an apartment building was not as long as that of an office building because of the former's continuous use throughout the full day. While this evidence was, as 40 B.T.A. 882">891 respondent points out, rather general in its scope, it nevertheless embraced and definitely referred to the property in question, and since it is uncontradicted and we have no special knowledge on our own part which would justify its rejection, we can not disregard1939 BTA LEXIS 786">809 it. Pittsburgh Hotels Co. v. Commissioner, 43 Fed.(2d) 345, and cases there cited. Therefore, we must conclude that the apartment building owned by the petitioners had an economic and useful life of 35 years after it was constructed in 1927. Since under the pleadings the petitioners claim depreciation calculated on a basis of a useful life of the property of 30 years from July 1, 1933, we have made our finding to that effect. The rate of depreciation will be determined accordingly. Petitioners have, apparently, abandoned the issues having to do with accrued interest on bonded indebtedness and accrued taxes. No evidence was adduced to substantiate the assignments of error in regard thereto which were set out in the petitions. The determination of the respondent as to these issues is affirmed. Petitioners concede that the allocation of the basis for depreciation as between real and personal property is correctly made by respondent. They also concede that the rate used as to the personal property is correct. 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/4625622/	John D. and Janice L. Edwards, Petitioners, v. Commissioner of Internal Revenue, RespondentEdwards v. CommissionerDocket No. 78657United States Tax Court39 T.C. 78; 1962 U.S. Tax Ct. LEXIS 54; October 11, 1962, Filed 1962 U.S. Tax Ct. LEXIS 54">54 Decision will be entered under Rule 50. 1. Held, petitioner, receiving the entire amount due him as a bonus from his employer pursuant to a settlement agreement, cannot claim any withholding tax credit for amounts not actually withheld by his employer.2. Held, further, petitioner, receiving $ 134 for 3 full days' salary while he was hospitalized, pursuant to a wage continuation plan, may exclude only $ 50 from income under sec. 105, I.R.C. 1954, inasmuch as he normally worked a 6-day week and such exclusion is limited to a weekly rate of $ 100.3. Held, further, the premiums paid by petitioner for health and accident insurance policies providing indemnity for accidental loss of life, limb, sight, and time are, subject to the statutory limitation of 3 percent of the adjusted gross income, deductible as medical expenses under sec. 213, I.R.C. 1954. Donald G. Kilgore, 38 T.C. 340">38 T.C. 340 (1962), on appeal (C.A. 5, Sept. 27, 1962). John D. Edwards, pro se.Robert H. Elliott, Jr., Esq., and Aaron S. Resnik, Esq., for the respondent. Fisher, Judge. FISHER39 T.C. 78">78 Respondent determined a deficiency in petitioners' income tax in the amount of $ 1,440.47 for the taxable year 1955.Janice L. Edwards, wife of John D. Edwards, is a party only because she and her husband filed a joint return1962 U.S. Tax Ct. LEXIS 54">56 for the year in question. The issues before us relate solely to the activities of John D. Edwards who will be referred to herein as petitioner.Some of the issues have been stipulated. The only issues remaining for our consideration concern: (1) Whether petitioner, receiving in 1955 the entire amount due him as a bonus from his employer pursuant to a settlement agreement, is entitled to claim any withholding tax credit for amounts not actually withheld by his employer; (2) the amount which petitioner may exclude as sick pay in 1955; and (3) the deductibility of premiums paid by petitioner for health and accident insurance policies in 1955.39 T.C. 78">79 FINDINGS OF FACT.Some of the facts have been stipulated and are incorporated herein by this reference.During the year 1953 petitioner was employed as a structural steel superintendent for the Arthur Fralick Construction Company (hereinafter referred to as the company) at an hourly wage plus a bonus of $ 1,000 if the construction was completed at a cost less than the estimated $ 30,000. The construction was completed by petitioner at a cost of approximately $ 23,000. No bonus was paid to petitioner at that time.During the year 19541962 U.S. Tax Ct. LEXIS 54">57 petitioner was employed as a steel erection foreman for the company at an hourly wage. In addition, he was to receive one-half of the savings below the company's cost estimate for the project.As the project neared completion it became apparent that the project would be completed at a cost considerably below the original estimate. Petitioner was then discharged from his employment without cause in an attempt to avoid payment of the bonus.Petitioner filed a workman's lien and sued the company in the King County Superior Court for the amount of the bonuses due, plus an additional $ 12,000 damages. He received judgment in the amount of $ 1,000 for the 1953 bonus, and $ 14,155 for the 1954 bonus, or a total judgment of $ 15,155. A countersuit against petitioner based upon an unpaid debt resulted in a judgment against petitioner in the amount of $ 476.18.Consolidated with petitioner's suit was an action by a coemployee, Ernest Janet, against the company. Janet received judgment in the amount of $ 13,610. The combined judgments of petitioner and Janet totaled $ 28,765.The company considered the possibility of appealing from the judgment recovered by petitioner. It had, however, 1962 U.S. Tax Ct. LEXIS 54">58 been awarded a contract for another construction project and in order to obtain a bond as required by the contract it was necessary to dispose of all outstanding litigation. To that end it discussed with its attorney the possibility of settling the judgment with petitioner and Janet. The company's attorney entered into settlement negotiations with the attorney for petitioner and Janet and submitted a memorandum of the company's alternatives, which states, in part, as follows:Possible Solutions.1. Immediate Settlement.We have offered $ 22,500.00 and Hunter [attorney for petitioner and Janet] has counteroffered $ 26,500.00 but stated informally on the phone that he thought his people would go down to $ 25,000.00.39 T.C. 78">80 2. Partial Settlement.This would involve a settlement of only the Edwards case which would give us a chance on appeal on the Janet case. Edwards has more personal need of money right now than Janet. Such a course would substantially reduce the threat of a judgment for attorneys' fees on the lien foreclosure and would make it possible to get Manson taken care of immediately.Petitioner and Janet authorized their attorney to settle their outstanding1962 U.S. Tax Ct. LEXIS 54">59 judgments in the total amount of $ 24,250. This amount was in settlement of the total liability owing to petitioner and Janet after deduction of the company's judgment against petitioner.During the year 1955, petitioner received $ 13,027.21, less the amount of the judgment against him, attorney's fees and other costs. The computation of the distribution of the settlement was made by petitioner's attorney as follows:ACCOUNTINGAmount of judgments:Janet$ 13,610.00Edwards14,155.00Edwards1,000.0028,765.00Amount of settlement24,250.00Plus amount of judgment against Edwards476.1824,726.18Settlement less than judgments by4,038.82$ 13,610$ 28,765 of difference deductible from Janet$ 1,911.03$ 15,155$ 28,765 of difference deductible from Edwards2,127.79Janet:$ 13,610 less $ 1,911.0311,698.97less 1/3 attorneys fees3,899.667,799.31Edwards:$ 14,155 less $ 2,127.7912,027.21less 1/3 attorneys fees4,009.078,018.14$ 1,000 less attorneys fees of $ 333.33666.778,684.91Total costs:Depositions$ 329.60Wernecke200.00Ronning233.00Witness fees40.00Reporter44.10Judgment fee12.00Process Service61.40920.101962 U.S. Tax Ct. LEXIS 54">60 39 T.C. 78">81 Note: additional statement received for service fees -- $ 4.20 (1/2 charged against each).Janet: $ 7,799.31 less 1/2 costs ($ 460.05)$ 7,339.26Edwards: $ 8,684.91 less 1/2 costs ($ 460.05)8,224.86Less judgment on note ($ 476.18)7,748.68Remittance to Janet$ 7,339.26Plus costs advanced and herein charged200.007,539.26Remittance to Edwards7,748.68Plus costs advanced and herein charged180.007,928.68Less balance on divorce272.007,656.68Petitioner received no W-2 form from the company for the year 1955 nor any other notice indicating that the company had withheld any amount for taxes from the settlement paid to petitioner and Janet. The company did not withhold any amount on account of Federal income taxes from the sum paid in settlement of the litigation. The company paid no amount to the Internal Revenue Service on account of withholding on any payment to petitioner in 1955.Petitioner and his wife filed a joint Federal income tax return for the calendar year 1955 with the district director of internal revenue, Tacoma, Washington. On his original return, petitioner reported the net amount received by him from the1962 U.S. Tax Ct. LEXIS 54">61 settlement after the payment of costs and attorney's fees. No credit was claimed for taxes withheld by the company from the settlement.By an amended return for the year 1955 filed May 21, 1958, petitioner reported as income the full amount of the judgment originally recovered against the company of $ 15,155, and claimed a credit for taxes withheld by the company in the amount of $ 2,604.30, which he stated was his computation of the tax "which should have been paid" by the company.On November 30, 1955, petitioner was injured while employed as a steel construction foreman in Alaska. As a result of the injury, he was hospitalized from November 30 until December 23, 1955, and was absent from work for a period of 5 weeks following the injury.Prior to and following petitioner's absence from work due to the injury petitioner worked 6 days in each week. At the time of the 39 T.C. 78">82 injury petitioner had been employed for a period of 2 months. Pursuant to the employer's regular plan of wage continuation, petitioner was paid for the day of injury and for 1 day for each month previously worked, or 3 full days' pay, totaling $ 134.On his return for 1955 petitioner claimed an exclusion1962 U.S. Tax Ct. LEXIS 54">62 for sick pay in the amount of $ 96.During 1955 petitioner paid premiums of $ 198 on two health and accident insurance policies issued by the Capitol Life Insurance Company. Of the total premiums paid, $ 146.48 was to provide guaranteed weekly payments for a specified period of time in case of the total or partial disability of petitioner, $ 46.52 was to provide for payments of various specified sums in the event of petitioner's dismemberment or loss of sight, and $ 5 was to provide $ 10,000 of life insurance in case of petitioner's accidental death. The policies made no provision for payments measured by or conditioned on any charges for hospital, surgical, or other medical services.On his return for 1955 petitioner included the full amount of such premiums in his schedule of medical expenses, and deducted such expenses to the extent they exceeded 3 percent of his reported adjusted gross income.Respondent, in his deficiency letter (in addition to adjustments not here in issue), reduced the amount of the bonus settlement to be includable in income from $ 15,155 to $ 13,027.21, without allowing any credit for taxes withheld from such amount, reduced the amount of excludable sick1962 U.S. Tax Ct. LEXIS 54">63 pay from $ 96 to $ 33.34, and disallowed the deduction as a medical expense of the premiums paid on the health and accident insurance policies.OPINION.In a suit by petitioner against his former employer, petitioner recovered a judgment in the amount of $ 15,155. After settlement negotiations between the parties (taking into consideration the judgment on a countersuit), petitioner in 1955 received the amount of $ 13,027.21, or $ 2,127.79 less than the amount of the judgment.In his amended return for the year 1955, petitioner reported the full amount of the judgment, $ 15,155, in income, and claimed a credit for taxes withheld in the amount of $ 2,127.79. Respondent determined that the amount of the judgment to be included in income is $ 13,027.21, and disallowed any credit for taxes withheld concerning such amount.Section 31(a)(1), I.R.C. 1954, provides as follows:SEC. 31. TAX WITHHELD ON WAGES.(a) Wage Withholding for Income Tax Purposes. -- (1) In General. -- The amount withheld under section 3402 as tax on the wages of any individual shall be allowed to the recipient of the income as a credit against the tax imposed by this subtitle.39 T.C. 78">83 Petitioner, therefore, 1962 U.S. Tax Ct. LEXIS 54">64 would be allowed a credit for taxes withheld only to the extent of the amount that was actually withheld from him by his employer in compliance with the withholding provisions.The record clearly shows that, while petitioner received an amount less than the total amount of the judgment recovered by him, such amount was arrived at, after negotiations, as in full satisfaction of the judgment. The parties did not negotiate or include in their settlement agreement any figure reflecting withholding taxes or any liability therefor.This is not a situation such as that in Basil F. Basila, 36 T.C. 111">36 T.C. 111, 36 T.C. 111">118et seq. (1961), in which in determining the amount of a bonus constructively received, we inferred circumstantially that the employer had complied with the withholding provisions of the law. The evidence in this case clearly shows, however, that the employer did not comply with the withholding provisions but paid to petitioner the entire amount agreed to by the parties in full satisfaction of the judgment.Arthur Fralick, president of the company, testified that no amounts were withheld by the company from the bonuses paid to petitioner. Petitioner 1962 U.S. Tax Ct. LEXIS 54">65 testified that he did not receive a W-2 form indicating any withholding by the company and that he was never informed by the company that the excess of the judgment over the amount received was withheld as taxes by the company. Petitioner received the entire amount due him under the settlement agreement in 1955. Inasmuch as nothing was withheld from such amounts pursuant to the withholding provisions, petitioner cannot be allowed a credit for taxes attributable thereto.In the alternative, petitioner contends that although he received the entire amount due him from the company, inasmuch as the company was under a duty to withhold an amount for taxes from the amount paid to petitioner, the company, rather than petitioner, is liable to the taxing authority in the amount required to have been withheld, with any adjustments between the company and petitioner being a private matter between them.The Code specifically provides that before an employee may receive any credit for taxes withheld, such amounts must have actually been withheld from him by his employer. While the actual payment by the employer of such withheld amounts to the Government does not affect the employee's right1962 U.S. Tax Ct. LEXIS 54">66 to receive a tax credit for such amounts, an employee cannot receive the full amount of his earnings and at the same time claim a credit for an amount which was never actually withheld from him. We agree with petitioner that an employer is liable to the taxing authorities for any amount which it was required to withhold, regardless of whether or not it was actually withheld. Therefore, 39 T.C. 78">84 had the respondent chosen to do so, he could have attempted to collect from the company the amount which it was required to withhold from the settlement payment. Respondent, however, need not do so, but may assess the tax against the employee upon whom, in the final analysis, the tax burden must fall. The employee of an employer failing to properly withhold amounts for tax is not entitled to a credit for amounts which were never withheld from him.We conclude, therefore, that the entire amount of the settlement of $ 13,027.21 is includable in the income for 1955 and that petitioner is not to be allowed any credit for taxes withheld since none were, in fact, withheld.The second issue concerns what is commonly referred to as the sick pay exclusion. Petitioner during 1955 was injured and, 1962 U.S. Tax Ct. LEXIS 54">67 pursuant to a wage continuation plan of his employer, received salary for 3 full days totaling $ 134 while he was hospitalized, attributable to the day of the injury and 2 days thereafter.Petitioner excluded $ 96 of this amount from his income for 1955. On brief, however, he contends that the entire amount of $ 134 should be excluded from income.Section 105(d), I.R.C. 1954, provides as follows:SEC. 105. AMOUNTS RECEIVED UNDER ACCIDENT AND HEALTH PLANS.(d) Wage Continuation Plans. -- Gross income does not include amounts referred to in subsection (a) if such amounts constitute wages or payments in lieu of wages for a period during which the employee is absent from work on account of personal injuries or sickness; but this subsection shall not apply to the extent that such amounts exceed a weekly rate of $ 100. In the case of a period during which the employee is absent from work on account of sickness, the preceding sentence shall not apply to amounts attributable to the first 7 calendar days in such period unless the employee is hospitalized on account of sickness for at least one day during such period. If such amounts are not paid on the basis of a weekly pay period, the1962 U.S. Tax Ct. LEXIS 54">68 Secretary or his delegate shall by regulations prescribe the method of determining the weekly rate at which such amounts are paid.The theory upon which petitioner appears to rely is that the limitation on the exclusion to the rate of $ 100 per week refers to the period during which he was absent from work, and that, inasmuch as he was absent for a period of approximately 5 weeks, he is entitled to exclude all payments received by him during that period up to a maximum of $ 500. We cannot agree.There is no doubt that under the wage continuation plan in effect, petitioner was paid only for the first 3 days of his injury rather than a smaller daily rate for the entire period of his absence from work. Sec. 1.105-4 (d)(2) of the Income Tax Regs. provides:(2) Daily exclusion. If an employee receives payments under a wage continuation plan for less than a full pay period, the extent to which such benefits are excludable under section 105(d) shall be determined by computing the daily rate of the benefits which can be excluded under section 105(d). Such 39 T.C. 78">85 daily rate is determined by dividing the weekly rate at which wage continuation payments are excludable ($ 100) by the1962 U.S. Tax Ct. LEXIS 54">69 number of work days in a normal work week. * The above regulation is a proper implementation of the provisions of section 105(d), I.R.C. 1954. Arthur O. Graves, 37 T.C. 133">37 T.C. 133 (1961). The weekly rate of $ 100 in the statute applies to the period for which payment was made, rather than, as petitioner contends, for the period during which petitioner was absent from work.Petitioner normally worked a 6-day week, resulting in a daily exclusion rate of $ 16.67. Inasmuch as petitioner received 3 full days' pay, the total exclusion would be limited to three times this amount, or $ 50.01. Stated another way, petitioner was paid for one-half of his normal working week. He would, therefore, be allowed to exclude one-half of the $ 100 weekly rate limitation or $ 50.The final issue concerns the deductibility, as a medical expense, of $ 198 in premiums paid by petitioner during 1955 for accident and health policies providing guaranteed weekly payments in the event of his total or partial disability, payment of certain amounts in the event of dismemberment or loss of sight, and payment of a specified sum in the event of his accidental death.We have recently1962 U.S. Tax Ct. LEXIS 54">70 held that we shall no longer follow our opinion in Drayton Heard, 30 T.C. 1093">30 T.C. 1093 (1958), revd. 269 F.2d 911 (C.A. 3, 1959), relied on by respondent, and will henceforth deem premiums paid for health and accident insurance policies to be deductible as expense for medical care under section 213, I.R.C. 1954, subject to the statutory limitation of 3 percent of the adjusted gross income. Donald G. Kilgore, 38 T.C. 340">38 T.C. 340 (1962), on appeal (C.A. 5, Sept. 27, 1962). Petitioner, therefore, may deduct the entire amount of the premiums paid for such policies, $ 198, subject to such limitation.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625624/	ANDREW J. McALISTER, JR. and ALBERTA L. McALISTER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMcAlister v. CommissionerDocket No. 7657-73United States Tax CourtT.C. Memo 1976-51; 1976 Tax Ct. Memo LEXIS 351; 35 T.C.M. 232; T.C.M. (RIA) 760051; February 26, 1976, Filed James L. Edgar, for the petitioners. Michael J. O'Brien, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent has determined a deficiency in petitioners' Federal income tax for the taxable year 1970 in the amount of $2,323.56 plus an addition to tax under section 6653(a) 1 in the amount of $116.18. The issues for decision are: (1) Whether, to the extent they remained unpaid, amounts advanced by petitioners to the corporation in which they were majority shareholders represented capital contributions or bad debts. Further, if the sums were bad debts, whether such sums were business or nonbusiness bad debts; (2) Whether petitioners understated1976 Tax Ct. Memo LEXIS 351">352 their taxable income for the tax year 1970; (3) Whether any part of any underpayment of petitioners' income tax liability for the taxable year 1970 was due to negligence or intentional disregard of rules and regulations. 2FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The petitioners, Andrew J. McAlister, Jr. (Andrew) and Alberta L. McAlister (Alberta), husband and wife, maintained their legal residence in Tulsa, Oklahoma at the time their petition was filed herein. They filed joint Federal income tax returns for the taxable year 1970, using the cash basis method of accounting, with the internal revenue service center in Austin, Texas. Since 1947 Andrew has been an engineer in the field of construction, services, and repairs relating1976 Tax Ct. Memo LEXIS 351">353 generally to the oil and gas industry. Andrew was an employee of Warren Petroleum Company until 1959, when he left to become president of Pioneer Drilling Company. In 1963 Andrew formed a new corporation, Mac Engineering Company, (Mac Engineering) which was primarily engaged in the engineering and construction of natural gas plants and its related facilities. Upon incorporation, Mac Engineering issued 1,500 shares of stock with a par value of $1 each, thereby generating a stated capital of $1,500. From the time of the incorporation in 1963, until the company ceased operation in 1970, petitioners owned at least 70 to 80 percent of the stock of Mac Engineering. As of January 1, 1970 petitioners were the sole shareholders. Andrew was president of Mac Engineering during the life of the corporation. Beginning on July 3, 1963, petitioners made a series of advances to the corporation. These advances are evidenced by checks issued from petitioners to Mac Engineering on the following dates and in the following amounts: July 3, 1963$9,000March 10, 19657,000March 12, 19652,500 3December 11, 1967450January 31, 19681,000February 1, 1968500February 7, 19687,000September 11, 19691,5001976 Tax Ct. Memo LEXIS 351">354 Some of the advances were evidenced by notes and some were not. Notes in the following amounts were executed on the dates indicated by Mac Engineering in favor of petitioners: July 12, 1963$9,000March 10, 19657,000March 12, 19652,500December 3, 19653,500 41976 Tax Ct. Memo LEXIS 351">355 The advances made by petitioners were otherwise unsecured. Although each of the notes carried an interest rate of 6 percent, no interest was paid on any of the advances. Petitioners characterized the advances as loans, but there were no specific terms for repayment. 5The sums advanced were intended to give Mac Engineering sufficient funds on which to operate. They were typically given to Mac Engineering in order to fund particular jobs. Repayment of the advances depended on the success of the particular operation. Mac Engineering was chronically short of funds. During 1968 and 1969, Mac Engineering was engaged in the construction of a gasoline plant in Kansas for Kathol Natural Gas Company (Kathol). Sometime in 1969, Kathol ceased making payments to Mac Engineering for the construction work it was performing. Shortly after the cessation of these payments, Andrew suffered1976 Tax Ct. Memo LEXIS 351">356 a heart attack. By October 1969, the combination of these two events caused Mac Engineering to cease its construction and engineering projects. Andrew returned to work in early 1970 and attempted to revive Mac Engineering's business. Unfortunately, his efforts were not successful. In June of 1970 an involuntary petition in bankruptcy was filed against Mac Engineering in the United States District Court for the Northern District of Oklahoma. Shortly thereafter, the corporation was adjudicated bankrupt. Most of Mac Engineering's tangible assets had been purchased by Andrew personally a few months prior to the involuntary petition. The only assets listed by Mac Engineering in its schedule of assets was cash of $21.34 and a chose in action against Kathol for $176,880.29. 6The liabilities to unsecured creditors amounted to $65,750.75. Among those liabilities listed was a debt owing to A.J. McAlister, Jr., for $14,809.57. Andrew had received payments from Mac Engineering in 1969 in excess of $16,600. 71976 Tax Ct. Memo LEXIS 351">357 On their joint return for 1970, petitioners claimed a bad debt deduction of $18,000 for worthless loans to Mac Engineering. Respondent has disallowed these amounts in full. Petitioners reported $12,000 income from "consulting, self-employment," and $16 interest income for 1970. Thus, adjusted gross income as reported on their return for 1970 was $12,016. In his statutory notice of deficiency, respondent reconstructed petitioners' income using the source and application of funds method. In finding petitioners had understated their income by $4,739.48, respondent made the following computation: Application of Funds ItemAmountIncrease Bank AccountUtica BankBalance 1/1/70$ 398.72Balance 12/31/701,241.20Increase$ 842.48Advances to:Mac Engineering1,245.00Southland Steel4,000.00Personal Living ExpenseFood2,600.00Housing2,721.00Transportation1,600.00Clothing600.00Medical1,700.00Taxes847.00Entertainment and Misc.600.00$10,668.00Total Application of Funds$16,755.48Source of FundsAdjusted Gross Income per Return$12,016.00Increased Income$ 4,739.481976 Tax Ct. Memo LEXIS 351">358 During 1970, the McAlister household consisted of 5 persons--petitioners and their 3 daughters. OPINION Our first task is to determine how much of the sums advanced by petitioners to Mac Engineering remained unpaid in 1970. On their 1970 return petitioners deducted $18,000 as a bad debt. Petitioners now claim that the unpaid balance of the sums advanced to Mac Engineering amounted to $33,805. Respondent has disallowed petitioners' deduction in full, taking the position that petitioners have failed to establish the amount of the advances to Mac Engineering which remained unpaid as of December 31, 1970. Petitioners have been able to establish, by cancelled checks, advances to Mac Engineering totaling $29,950. The extent to which these advances were repaid by Mac Engineering, however, is less clear. The record suggests a variety of possibilities. Viewing the evidence as a whole, with particular emphasis on the "Schedules of Bankrupt" 8 filed by Mac Engineering, in the bankruptcy proceeding, we have determined that the unpaid advances amounted to $14,809.57. Having decided the amount of the unpaid advances, the character of these sums must be determined. Petitioners have characterized1976 Tax Ct. Memo LEXIS 351">359 these advances as bad debts. Respondent, on the other hand, argues that the advances were in fact contributions to capital. Whether advances to a corporation by shareholders create a debt or constitute contributions to capital is a question of fact on which the petitioner has the burden of proof. Gilbert v. Commissioner,262 F.2d 512">262 F.2d 512 (2nd Cir. 1959); Yale Avenue Corp., 58 T.C. 1062">58 T.C. 1062 (1972). In determining whether such advances more closely resemble debt or equity the Courts have looked to a number of factors, e.g., the relationship between the parties, whether there is adequate capitalization, whether interest was paid or payable on the advances, whether an outside investor would have made similar investments without security, and whether such advances were placed at the risk of the business and thus constituted risk capital. See O. H. Kruse Grain & Milling v. Commissioner,279 F.2d 123">279 F.2d 123 (9th Cir. 1960); Road Materials, Inc. v. Commissioner,407 F.2d 1121">407 F.2d 1121 (4th Cir. 1969); 262 F.2d 512">Gilbert v. Commissioner,supra;58 T.C. 1062">Yale Avenue Corp., supra.The facts here make it clear that petitioners' 1976 Tax Ct. Memo LEXIS 351">360 advances to Mac Engineering represented contributions to capital. No interest was paid on any of the advances. In most cases, the advances were not even evidenced by notes. Aside from the notes, there was no security given for any of the advances. No written agreement establishing the term or condition of the "loans" was executed between petitioners and Mac Engineering. Mac Engineering was under-capitalized and needed the funds in order to operate. These funds were then placed at the risk of the business; repayments depended upon the success of the particular project in which the business was engaged at the time of the advances. Under these circumstances no prudent outside lender would have made similar advances. We therefore conclude that the advances made by petitioners represented an equity investment, and could not properly be characterized as loans. Respondent further contends that if the advances were equity rather than debt, the stock representing such equity became worthless in 1969, rather than 1970. The year in which these equity investments become worthless is likewise a question of fact. Boehm v. Commissioner,326 U.S. 287">326 U.S. 287 (1945); Joseph C. Lincoln,24 T.C. 669">24 T.C. 669, 24 T.C. 669">694 (1955).1976 Tax Ct. Memo LEXIS 351">361 In determining the year in which stock becomes worthless, it must be established that the stock has no current liquidating value, and further, that such stock has no potential value. 24 T.C. 669">Joseph C. Lincoln,supra;SterlingMorton,38 B.T.A. 1270">38 B.T.A. 1270 (1938), affd. 112 F.2d 320">112 F.2d 320 (7th Cir. 1940). As we observed in 38 B.T.A. 1270">Morton at 1278-9: The ultimate value of stock, and conversely its worthlessness, willedapend not only on its current liquidating value, but also on what value it may acquire in the future through the foreseeable operations of the corporation. Both factors of value must be wiped out before we can definitely fix the loss. If the assets of the corporation exceed its liabilities, the stock has a liquidating value. If its assets are less than its liabilities but there is a reasonable hope and expectation that the assets will exceed the liabilities of the corporation in the future, its stock, while having no liquidating value, has a potential value and can not be said to be worthless. The loss of potential value, if it exists, can be established ordinarily with satisfaction only by some "identifiable event" in the corporation's life1976 Tax Ct. Memo LEXIS 351">362 which puts an end to such hope and expectation. While the corporation was very clearly in difficult financial straits late in 1969, it was not until early 1970 that it became apparent that there was little if any hope for Mac Engineering's future. The filing of the involuntary bankruptcy petition in June of 1970 completely foreclosed any possibility that the business could be revived. We therefore find that petitioner's equity advances to Mac Engineering became worthless in 1970. Respondent has determined that petitioners' books and records were inadequate and has reconstructed their income using the source and application of funds method. See Engene Vassallo,23 T.C. 656">23 T.C. 656 (1955); Max Cohen,9 T.C. 1156">9 T.C. 1156 (1947), affd. 176 F.2d 394">176 F.2d 394 (10th Cir. 1949); United States v. Caserta,199 F.2d 905">199 F.2d 905 (3d Cir. 1952). Cf. United States v. Johnson,319 U.S. 503">319 U.S. 503 (1943). Using this method, respondent has determined that petitioners have understated their 1970 income by $4,739.48. The source and application of funds method is based upon the assumption that the amount by which a taxpayer's application of funds during1976 Tax Ct. Memo LEXIS 351">363 a taxable period exceeds his known sources of income for that period is taxable income, unless the taxpayer can show his expenditures were made from some nontaxable source of funds. In the instant case petitioners do not challenge the items used by respondent in computing petitioners' application of funds during 1970. Instead, petitioners argue that any excess expenditures were made from a nontaxable source of funds, namely, the sale of certain property on which no gain was recognizable. We have concluded, however, that petitioners' evidence is insufficient to establish the existence of this source of funds. Petitioners introduced into evidence a copy of an unexecuted duplicate draft drawn on a Texas bank in the amount of $9,000, dated January 1, 1970 and payable to Andrew. Petitioners contend that this exhibit represented the proceeds of a sale of Andrew's interest in an oil and gas lease in Kansas which had been purchased by Andrew in July, 1969 for $10,000. Since the overall transaction resulted in a $1,000 loss petitioners conclude that the $9,000 represents a capital loss, and therefore a nontaxable source of income. Unfortunately, the exhibit introduced into evidence by petitioners1976 Tax Ct. Memo LEXIS 351">364 does not establish to our satisfaction the existence of a nontaxable source of funds. There is no indication on the face of the document that the transaction which it purports to represent was ever completed. The Court, therefore, left the record open to give petitioners the opportunity of producing the original of this exhibit. Petitioners, however, failed to produce the original or give an explanation of why they were unable to obtain it. In addition to the insufficiency of the exhibit itself, there was no corroborating evidence presented by petitioners which might prove that a sale took place and that the proceeds therefrom were nontaxable. Although petitioners' bank records were introduced into evidence, a $9,000 deposit appears nowhere among them. No loss was taken on petitioners' return. In fact, there is no evidence in the record at all which might be helpful in establishing this $9,000 source of funds. We must, therefore, sustain respondent's determination on this issue. Finally, respondent has determined additions to tax pursuant to section 6653(a). Section 6653(a) provides that "If any part of any underpayment * * is due to negligence or intentional disregard of rules1976 Tax Ct. Memo LEXIS 351">*365 and regulations (but without intent to defraud), there shall be added to the tax an amount equal to 5 percent of the underpayment." Petitioners have the burden of proving that this addition to tax is erroneous. Vaira v. Commissioner,444 F.2d, 770 (3d Cir. 1971); Mark Bixby,58 T.C. 757">58 T.C. 757 (1972); Terry C. Rosano,46 T.C. 681">46 T.C. 681 (1966). Petitioner has not presented any evidence on this issue. Consequently, we must sustain respondent's determination as to the additions to tax. Rule 149(b), Tax Court Rules of Practice and Procedure.James S. Reily,53 T.C. 8">53 T.C. 8 (1969). Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise stated.↩2. Although there is some dispute over the amount of self-employment taxes (see section 1401) owed by petitioners for 1970, the parties agree that the amount of such taxes will be determined by the resolution of the remaining issues in this proceeding. The allowable medical deductions for that year will likewise depend on such resolution. Accordingly, both will be handled in the Rule 155 computation.↩3. This check was made payable to the National Bank of Tulsa, and not to Mac Engineering directly. Mac Engineering had borrowed money from the bank by factoring certain accounts receivable. When the receivables were not paid, Mac Engineering did not have the money to repay the bank from its own funds. Petitioners therefore paid the bank with their personal checks.↩4. While we have a copy of this note, there is no evidence (e.g., cancelled check) that the underlying advance was made to Mac Engineering. Petitioners claim that most of their personal records were destroyed when a bank foreclosed against another corporation in which they had a substantial interest. We have not, however, found petitioners' explanation very compelling. Moreover, petitioners have not provided the Court with any evidence other than their own testimony which might lend support for this explanation. Despite their difficulty, petitioners did have most of the records needed for trial.↩5. The balance sheet for February 28, 1966 lists as a longterm liability "Note payable-shareholder $6,000." In the June 30, 1966 balance sheet this sum is $1,046. Finally, on the November 30, 1968 balance sheet the sum of $5,447 is listed under the heading "Notes Payable" without further designation.↩6. The amount due from Kathol had been assigned to the Fourth National Bank of Tulsa, Tulsa, Oklahoma as collateral for its loans outstanding to Mac Engineering.↩7. It is doubtful much of this amount represented salary. Andrew's actual wages from Mac Engineering were generally quite low (e.g., 1963- $0; 1966-$1,321.56; 1967-$1,232.50).↩8. These schedules were sworn to under oath by Andrew.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625625/	THE DILL MANUFACTURING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Dill Mfg. Co. v. CommissionerDocket No. 89583.United States Board of Tax Appeals39 B.T.A. 1023; 1939 BTA LEXIS 944; May 24, 1939, Promulgated 1939 BTA LEXIS 944">944 1. Petitioner was a manufacturing corporation, organized in 1909. Because of dissension between its majority and minority stockholders, it acquired the stockholdings of the latter in 1932. This stock was immediately retired and the stated capital reduced. As a part of the consideration for this stock, petitioner transferred to the stockholders United States bonds, having a face value of $200,000, which had cost petitioner $202,687.51, and a then market value of $170,562.50. The contract for the acquisition of the minority stock provided for the payment of $188,000 in assets of the petitioner, of which the sum of $176,000 was to be payable by delivery of United States bonds in a face value of $200,000. Held, the transaction constituted a partial liquidation and the transfer of the United States bonds was a distribution in kind upon which no gain or loss was sustained by the petitioner. 2. Respondent failed to sustain his burden here of establishing that petitioner, a manufacturing and not a holding company, was "formed or availed of [during the taxable year] for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting1939 BTA LEXIS 944">945 its gains and profits to accumulate instead of being divided or distributed," and petitioner is, therefore, not subject to the tax which respondent, in this proceeding, affirmatively alleges is due under section 104 of the Revenue Act of 1932. F. E. Gleach, Esq., and H. A. Mihills, C.P.A., for the petitioner. Elmer L. Corbin, Esq., H. D. Thomas, Esq., and A. D. King, Esq., for the respondent. LEECH39 B.T.A. 1023">1023 Respondent determined a deficiency of $4,992.92 in petitioner's income tax for the fiscal year ending November 30, 1932. The deficiency arose, primarily, from the disallowance of a deduction of $32,125.01, taken by petitioner on its return for that year, which was alleged to constitute a loss sustained on its disposition of United States bonds. Subsequent to the filing of the petition and answer in this proceeding, respondent, by amended answer, asked an increase of the deficiency in the amount of $105,087.02, because of his proposed imposition of the 50 percent penalty of petitioner's net income for that year, under the provisions of section 104 of the Revenue Act of 1932. Respondent affirmatively alleges that petitioner was availed1939 BTA LEXIS 944">946 of, during the tax year, for the purpose of preventing the imposition of surtax upon its shareholders through the medium of permitting its gains and profits to accumulate beyond the reasonable needs of its business. 39 B.T.A. 1023">1024 FINDINGS OF FACT. Petitioner was organized in 1909 under the laws of Ohio. Its authorized and issued stock was 50 shares of a par value of $100. It was organized by three men for the manufacture of dust caps for automobile tire valves. These men have always directed the activities of the company and now own, as they did originally, all of its capital stock. From the date of its organization, petitioner was successful. But, due to its extremely limited capital, its organizers pursued the policy of investing its earnings in additional plant facilities to take care of the increase in its business. In 1925, as a result of competition, it became necessary for petitioner to expand the scope of its manufacture. Therefore, it undertook the manufacture of the entire automobile tire valve. This change and expansion necessitated a heavy financial outlay for plant facilities, since the machines used in this additional operation were different from those1939 BTA LEXIS 944">947 it had formerly used. At this time, petitioner's accumulated surplus was approximately $382,000, but almost all of it was invested in plant, equipment, and inventory. In order to secure the essential funds for this necessary change and expansion in operations, in 1925, petitioner procured an investment in the company by a syndicate headed by A. C. Ernst and R. V. Mitchell (hereinafter called the syndicate). At the time of this investment, the petitioner was reorganized and recapitalized by the cancellation of its original stock and the issuance of 50,000 shares of common stock, without par value. Of these 50,000 shares, 38,890 were issued to the original stockholders for the 50 shares then held by them. The balance, 11,110 shares, was issued to the syndicate for $200,000 cash. The original stockholders then sold to the syndicate 13,880 shares of the 38,890 shares issued to them, whereupon the original stockholders owned 25,010 shares and the syndicate 24,990 shares of the total of 50,000 shares issued. The original stockholders, in their income tax returns for 1925, reported their gains upon their sales of stock to the syndicate and paid the income tax thereon. The additional1939 BTA LEXIS 944">948 capital thus obtained by petitioner was invested in the facilities needed for the change and expansion of the manufacturing plant. These funds were inadequate, since the cost of the changes was in excess of $750,000. The necessary additional funds were provided through loans from banks and from the earnings of the petitioner in subsequent years. This expansion proved successful. The corporate earnings had decreased steadily from a high of $94,082.74 in 1921, to $31,299 in 1924. They increased in 1925 to $166,137.40; in 1926 to $104,265.62; and in 1927 to $106,283.79. During these last three years, no dividends 39 B.T.A. 1023">1025 were paid and the earnings were used to defray the additional cost of the expansion program over and above the amount invested by the syndicate and the bank loans for that purpose. From 1928 through 1933, dividends were paid by petitioner, as follows: 1928$40,000.00192950,000.00193050,000.001931$50,000.00193248,152.981933106,441.40During this same period, petitioner's net earnings were: 1928$153,706.901929107,318.51193090,757.901931$245,816.101932210,174.031933283,427.34The1939 BTA LEXIS 944">949 balance sheet of the petitioner for the years indicated follows: 193119321933AssetsCash$149,554.23$343,959.08$162,126.86Notes receivable13,790.8831,818.9446,088.46Accounts receivable110,279.0388,057.28120,221.88Less: Reserve for bad debts(10,000.00)(20,000.00)(20,000.00)U.S. Gov't. claimsInventories350,131.81311,770.65409,765.97Investments: (nontaxable) U.S. Obligations320,071.4193,774.42342,796.09Other investments:Preferred stock (treasury)47,727.0079,897.50Deferred charges:Insurance1,695.762,296.211,802.99Taxes77.42605.437,097.80OtherPlant and equipment656,916.25660,868.21519,450.38Less: Reserve for depreciation(316,707.29)(353,723.58)(239,755.99)Patents1.001.001.00Deposits in closed banks111,214.72Less: Reserve(96,257.14)Deposits and other investments6,754.226,378.326,031.16Associated Co. account56,417.5158,093.8548,317.77Misc. accounts receivable1,355.631,681.781,625.17Total assets1,340,337.861,273,308.591,500,424.62LiabilitiesNotes payableAccounts payable$39,914.38$50,516.36$68,396.66Accrued expense:InterestDividends payable12,500.0011,467.0071,689.50Taxes3,501.523,080.5210,206.51Other250.00801.39334.60Reserve for contingencies17,000.0017,000.0031,955.58Reserve for Federal tax29,679.5923,100.0041,000.00Reserve for loss37,872.3144,553.4230,683.31Reserve for depreciationPreferred stock425,000.00399,700.00Common stock700,000.00100,000.00100,000.00Surplus499,620.06597,789.90746,458.46Surplus - capitalTotal liabilities1,340,337.861,273,308.591,500,424.621939 BTA LEXIS 944">950 The valve manufactured by petitioner contained a metal stem. Metal stem valves underwent numerous alterations because of changes in wheel design. This not only adversely affected petitioner's sales from 1925 to 1932, but also bred the necessity for numerous changes in manufacturing machinery, and caused obsolescence of existing equipment. A large portion of such equipment of petitioner had to be replaced. Further expansion was occasioned 39 B.T.A. 1023">1026 by patent research and investigations of the changes in valve designs, to enable petitioner to keep pace with the various modifications demanded by its customers. Competition was keen. The Firestone Tire & Rubber Co., which had been trying to make its own valves with metal stems purchased from petitioner, turned its business over to the Bridgeport Brass Co. in 1931. The latter, and another big competitor of petitioner, A. Schroeder & Sons Co., had a competitive advantage over petitioner in having their own brass mills, while petitioner was required to buy its brass from outsiders. Petitioner used large quantities of brass and copper. The market for these materials fluctuated. Petitioner's purchases of them, in some years, aggregated1939 BTA LEXIS 944">951 as much as $300,000. To secure these metals at an advantageous price, it was necessary for petitioner to make commitments in advance and to maintain a substantial amount in cash and liquid securities in order to take advantage of fluctuations in the market. In this connection, it had been its practice to invest considerable sums of cash on hand in United States bonds instead of depositing these funds in banks. The interest return from this investment was comparable to or exceeded the interest returns paid on bank deposits in the community in which petitioner was located, and such investment was safer. The sums thus invested in United States bonds, which began in 1919 with an investment of $10,635.70, varied from a low in 1924 of $906.44 to a high of $342,796.09 in 1933. Subsequent to 1925 and the investment by the syndicate in petitioner's business, and prior to 1930, it became evident that further expansion and diversification of the manufacturing operations of petitioner were necessary if it was to continue, securely, as an independent concern. In its efforts to thus compensate for its actual and expected loss of the valve business, petitioner spent a substantial amount of1939 BTA LEXIS 944">952 time and money in the investigation, patenting, perfecting, manufacturing, and sale of new products. In 1929 and 1930 experiments were conducted with a permanent wave machine, which proved unsuccessful and cost petitioner $150,000. In 1932, a device for patching tires was developed, which proved successful. Other products investigated included a tire inflation device and cake mixer. These efforts, as well as others in the same category, all required the use of a comparatively large amount of cash, particularly since it had been the experience of the organizers of petitioner, who continued as its active operating heads, that these expenditures were, in most cases, substantially in excess of their estimated cost. Further, as matters existed in 1932, the granting of certain patent applications would have resulted in the need for large capital outlays for the production of new articles. Beginning in 1930, petitioner began to suffer competition from a type of automobile tire valve that was made with a rubber stem 39 B.T.A. 1023">1027 instead of a metal one. One of petitioner's customers, a large tire company, began making these valves itself, which indicated that it, as well as other companies, 1939 BTA LEXIS 944">953 would thereafter buy from petitioner only a small brass insert for the valve instead of the entire unit. The metal stem business declined. It thus became necessary for petitioner to install entirely new equipment for the rubber stem valves. During the years from 1932 to 1937, machinery costing the petitioner $87,858.36 for the making of the metal stem valves was scrapped. During the same period, new rubber stem equipment was bought, costing petitioner $134,725.94. Petitioner was handicapped by insufficient plant space because of the installation of new equipment. In 1929, it bought land upon which to erect a new plant which was then estimated to cost $450,000. The cost of moving to the new plant and loss of business from such transfer will exceed the cost of the new construction. It negotiated with the Nickel Plate Railroad Co. for a railroad switch therefor. In the tax year, petitioner set up a reserve for this renewal and expansion of its plant facilities. In the fiscal year ending in 1933, petitioner purchased United States bonds with $320,000. These bonds, in the amount of $204,591.08, were placed in this reserve fund and the balance was held for inventory purchases. 1939 BTA LEXIS 944">954 The plans for new construction were interrupted by the 1929 financial crash, and the petitioner, though still owning and paying taxes on the land upon which the new plant is to be erected, is still awaiting an appropriate time to begin construction. The consistent policy of petitioner's operating group, consisting of its organizers, was to secure the financial and economic independence of petitioner. In doing so, the earnings in excess of the dividends paid were retained. The syndicate members had expected larger dividend returns, but realized the soundness of the policy of the operating group if petitioner was to continue secure, as an independent manufacturing company. However, the syndicate group desired to sell the business or to merge it with a bigger concern, in which event it could be operated as a branch of the larger business. The operating group opposed this, since it had been so successful and represented their life work. As a result of this dissension, a plan was formulated by the operating group to buy the syndicate holdings and retire that stock. This plan culminated in an offer by the operating group to the members of the syndicate, providing for the acquisition1939 BTA LEXIS 944">955 of the stockholdings of the latter by petitioner. It was originally intended that the members of the operating group sell the syndicate ten additional shares of common stock, that the charter of petitioner be amended to authorize the issuance of 4,250 shares of preferred stock, with a 39 B.T.A. 1023">1028 par value of $100, and that the 25,000 shares of common stock then held by the syndicate be acquired by petitioner in exchange for this preferred stock and $188,000, in cash. Because of the inability of petitioner to raise that sum in cash, the plan, as evidenced by the written proposal, provided for the delivery by petitioner to the syndicate of $12,000 cash and United States bonds, owned by petitioner, with a par value of $200,000, which had a then market value of $176,000. Under this plan, the 25,000 shares of common stock acquired from the syndicate were to be retired and the stated capital of petitioner reduced from $700,000 to $100,000. The offer of the operating group was accepted, with slight modification, the transaction was carried out, and the 25,000 shares of common stock thus acquired by petitioner were retired and its stated capital thus reduced. The petitioner agreed1939 BTA LEXIS 944">956 to retire the preferred stock thus received by the syndicate members within five years, at an annual minimum rate. This preferred stock issue was so used to avoid jeopardizing the financial and business position of the petitioner. The United States bonds which petitioner delivered to the syndicate cost it $202,687.51. When their transfer to the syndicate was consummated, their market value had decreased to $170,562.50, which was below the amount at which the syndicate was to accept them. However, in view of the agreement, upon receipt of these bonds, petitioner was credited in the amount of $176,000 on account of its $188,000 obligation. In its return for the taxable fiscal year, petitioner deducted as a loss upon its disposition of these bonds the difference between their cost to it and the market price of the bonds on the date of the transfer to the syndicate. The three organizers and officers of the petitioner who are now the owners of all of its stock received the same salaries for the fiscal years ending in 1931, 1932, and 1933, which were, respectively, $15,000, $14,625, and $13,500. The preferred stock of a par value of $425,000, issued by petitioner in 1932 to the1939 BTA LEXIS 944">957 syndicate as part of the consideration in the acquisition of the common stock of the syndicate, was all retired by the year 1937. During the fiscal year 1932, $47,727 was expended by petitioner on this account. The shareholders of petitioner paid less surtax for the taxable year than they would have been obliged to pay if the earnings of petitioner for that year had been distributed to them. Respondent has not sustained his burden of establishing that petitioner was "formed or availed of [during the taxable year] for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed." 39 B.T.A. 1023">1029 OPINION. LEECH: In the first issue, respondent bases his disallowance of a deduction for loss on the United States bonds on that part of Regulations 77, article 71, which reads as follows: " * * No gain or loss is realized by a corporation from the mere distribution of its assets in kind in partial or complete liquidation, however they may be appreciated or depreciated in value since their acquisition * * ." 1939 BTA LEXIS 944">958 Similar regulations, with slight differences in wording immaterial here, have been in force since the Revenue Act of 1918. Because such regulations had long been in force without change in the law, Regulations 69, article 548, the prototype of and substantially similar for present purposes to the quoted regulations, was held to be valid in , although there it was found no distribution in kind on dissolution occurred. See also . A like conclusion of validity was reached in . In that case, a bank, in competition with the petitioner bank, acquired all of petitioner's outstanding stock through a nominee, and turned it over to the latter. Petitioner thereupon conveyed all of its assets to the competing bank, then the sole stockholder, and dissolved. The stock was surrendered for cancellation. It was held on the basis of the same regulation that the petitioner had realized no gain or loss when it distributed its assets to its sole stockholder in complete liquidation. 1939 BTA LEXIS 944">959 Distributions in complete or partial liquidation result in no gain or loss to the distributing corporation. , affirming ; ; affd., ; ; . Was the transfer of cash, preferred stock, the United States bonds to the syndicate, in exchange for 25,000 shares of common stock in petitioner, a distribution in partial liquidation of petitioner? The original intention of the parties may have been that the petitioner should acquire the syndicate's common stock with its preferred stock and cash. However, that intention was abandoned. It was not carried out. Petitioner did not, in fact, do that, and the fact controls the tax incidence here. ; ; 1939 BTA LEXIS 944">960 ; ; affd., . The plan, finally adopted and executed, obligated the petitioner to deliver to the syndicate, preferred stock, cash, and United States bonds. The obligation to deliver United States bonds was not a debt payable in money. It could not have been satisfied except 39 B.T.A. 1023">1030 by the transfer of those bonds, assets of the petitioner. See The position of petitioner is that since it had no intention to liquidate any portion of its business in the acquisition of this stock interest, no liquidation occurred. However, absence of intent does not contradict the statutory status of liquidation if, in fact, a liquidation occurred, by the cancellation or redemption of capital stock. ; . Here a partial liquidation actually occurred. The capitalization of petitioner was reduced from $700,000 to $100,000. The 25,000 shares of common stock, so reacquired, were not held in petitioner's1939 BTA LEXIS 944">961 treasury for resale but were canceled and retired. The authorized capital stock of petitioner was reduced from 50,000 to 25,000 shares. Cf. . It follows that petitioner suffered no allowable loss by the distribution of the United States bonds as a part consideration for 25,000 shares of its outstanding common stock. The second issue is raised by the affirmative allegation in respondent's amended answer that petitioner is subject to the 50 percent penalty of net income for the taxable year, under section 104 of the Revenue Act of 1932, and the consequent request for an increase in the deficiency of $4,992.92, as determined, to the sum of $110,079.94. Respondent supports this allegation on the ground that petitioner was "availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed." Respondent has the burden of proof. Rule 32 of the Board's Rules of Practice; 1939 BTA LEXIS 944">962 . It may be conceded that the shareholders of petitioner would have been obliged to pay surtaxes in a larger amount if more of petitioner's gains and profits had been distributed during the taxable year. "But the taxes under these statutory provisions are not imposed because of effects; avoidance per se is not prohibited. It is the purpose, the intention motivating a course of conduct, which is made controlling by the very words of the statute. Unless the purpose was to prevent the imposition of surtaxes, the tax may not be imposed." ; affd., ; certiorari denied, . True, the proscribed purpose may be evidenced in many ways. See ; certiorari denied, ; . But the contested tax is "highly penal" and thus "While the plain intent of such a statute must be 39 B.T.A. 1023">1031 given full effect, 1939 BTA LEXIS 944">963 it should be strictly construed and should not be extended to cover cases which do not fall within its letter." Since the respondent has the burden of proof and petitioner is not a holding company, no presumption of the existence of the proscribed purpose may be indulged here until it be established by the weight of the evidence that there was an unnecessary accumulation of gains and profits. Moreover, respondent is limited to the contention, as he admits, that petitioner "was availed of" during the taxable year, for the prohibited purpose. The respondent argues that the record sustains his burden of establishing that in the taxable year petitioner permitted its gains and profits to accumulate beyond the reasonable needs of its business and that the consequent presumption of the existence of the penalized purpose has not been overcome. See . The question of what are reasonable or unreasonable needs of business is always one of fact. The answer is rarely easy to find. However, the law does not require that "a business should remain static; 1939 BTA LEXIS 944">964 it must be assumed that any business shall have the right to grow." A fortiori, a corporation certainly must have the untrammeled right, within reasonable limits, to financially protect itself and its shareholders. Justice Holmes once said "A page of history is worth a volume of logic." . Thus, the economic history of the country and this company is both pertinent and illuminating. So, particularly where, as here, the petitioner is not a holding company but is engaged in a manufacturing business, which is so obviously hazardous from a business viewpoint, we will hesitate before substituting our judgment upon the reasonableness of the corporate accumulations, for that of the directors. See . The attitude of petitioner toward its earlier gains and profits may have a bearing upon the reasonableness of the accumulation existing in the tax year. See ; and 1939 BTA LEXIS 944">965 But respondent points to the large corporate surplus account of petitioner in the tax year as constituting "accumulated gains and profits" under the act. However, the greater part of this surplus is the result of accumulations over many years and represents physical plant and improved manufacturing facilities by which the petitioner has been enabled to sustain and increase its income upon which it has already paid income tax. Little benefit can be obtained by repeating the evidence here. That the plant and production facilities represented by such a large part of petitioner's accumulations were actually used in its business 39 B.T.A. 1023">1032 can scarcely be doubted. Nor, in view of the evidence, does it seem any less certain that they were reasonably needed in the business. The Board has said in , that: * * * No corporation which is actively engaged in business is to be subjected to the penalty of the statute unless and until it permits its course of conduct to be diverted from its normal business interests by a purpose to save its stockholders from surtax. 1939 BTA LEXIS 944">966 Respondent argues that the liquidation of the syndicate common stock was planned when the syndicate bought that stock in 1925; that this was a diversion from its ordinary business interests for the purpose of saving surtax to its stockholders and that this procedure can be repeated and thus deprive the Government of its taxes unless the penalty is imposed here. The answer is that the existence of no such plan is disclosed. In fact, we are convinced the plan to liquidate was born when the liquidation occurred as the result of the petitioner's then pressing and reasonable business need. At the close of the fiscal year ended in 1931, petitioner had cash on hand in the amount of $149,554.23, and Government bonds which cost it $320,071.41. During the fiscal year ended in 1932, here involved, it realized net earnings of $210,174.03. At the close of the latter year, it had cash on hand in the amount of $343,959.08 and United States bonds which cost it $93,774.42. During this year it had expended about $200,000 in liquidating the common stock interest of the syndicate, and, in addition thereto, it had paid dividends for that year in the amount of $48,152.98. 1939 BTA LEXIS 944">967 Investments in securities of outside companies may be evidence that the funds thus used were not reasonably necessary in a corporate business. See . But such an investment is a far cry from the purchase of Government bonds here. Such investment, per se, is not evidence in the present circumstances of the absence of reasonable necessity for the retention of the funds thus used. Nor is that conclusion affected by the facts that the preferred stock was being acquired by petitioner at a price under par and retired, that its earnings for the taxable year, in the amount of $47,727, were used in that acquisition and that the entire preferred issue was retired before maturity. The amount of these investments in Government bonds, just as the cash on hand, is their only value as evidence in the present situation. More might be said. But, in the face of this record, the conclusion seems inescapable that petitioner has not "[permitted] its course of conduct to be diverted from its normal business interest by a purpose to save its stockholders from surtax." 1939 BTA LEXIS 944">968 39 B.T.A. 1023">1033 The consistently conservative policy of petitioner's management was merely continued through the tax year. It is not disclosed that the petitioner loaned money to its shareholders either with or without interest. See ; affd., ; certiorari denied, ; ; and Not only that, but the salaries of its officers were actually reduced for the taxable year. The petitioner constituted the life work of its operating officers. They had built it and were proud of it. The protection of the economic and financial independence of that work was scarcely less warranted as a business purpose than if petitioner had been an individual. The issue of preferred stock with the obligation to retire it within five years evidenced a debt. ; 1939 BTA LEXIS 944">969 ; ; affd., . And this record, at most, does not establish that the liquidation of the syndicate stock by the partial use of that preferred stock, under the circumstances here, was not required by a reasonable business necessity. Cf. ; . The dividend policy of petitioner may have been conservative. The company was successful. However, on the whole record, it certainly has not been established that petitioner, during the taxable year, permitted its gains and profits to accumulate beyond the reasonable needs of its business. And, even if it had been so established, we believe the same record conclusively overcomes any presumption that such accumulations and the failure to distribute them as dividends were permitted "for the purpose of preventing the imposition of the surtax upon [petitioner's] * * shareholders." It follows that the contested penalty proposed under section 104 of the Revenue Act of 1932, falls. 1939 BTA LEXIS 944">*970 Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625626/	Chester Rutana and Theresa M. Rutana, Petitioners v. Commissioner of Internal Revenue, RespondentRutana v. CommissionerDocket No. 6759-84United States Tax Court88 T.C. 1329; 1987 U.S. Tax Ct. LEXIS 74; 88 T.C. No. 74; May 19, 1987. May 19, 1987, Filed 1987 U.S. Tax Ct. LEXIS 74">74 Ps moved for an award of litigation costs after we decided for Ps in Rutana v. Commissioner, T.C. Memo. 1986-336, the sole issue of which was whether Ps fraudulently intended to evade tax. R's counsel should have known that the facts available to R at trial could not clearly and convincingly establish fraud. R's counsel disregarded Ps' explanations as self-serving but had no supportable basis for believing Ps to be untruthful. Held, R did not have a reasonable basis in law or fact for believing that he could prove that Ps acted with intent to evade tax, Wyandotte Savings Bank v. N.L.R.B., 682 F.2d 119">682 F.2d 119 (6th Cir. 1982), and his position in this litigation was, therefore, unreasonable; Don Casey Co. v. Commissioner, 87 T.C. 847">87 T.C. 847 (1986). Held, further, Ps' counsel's hours billed and rates charged were reasonable and a "fully compensatory fee" is awardable, Hensley v. Eckerhardt, 461 U.S. 424">461 U.S. 424 (1983). Held, further, litigation costs in the amount of $ 22,720.56 are awarded. Joseph R. Young, Jr., for the petitioners.Steven M. Walk, for the respondent. 1987 U.S. Tax Ct. LEXIS 74">75 Williams, Judge. WILLIAMS88 T.C. 1329">1330 OPINIONThis case is before us on petitioners' motion for award of litigation costs pursuant to section 7430. 1 The issues we must decide are (1) whether the position of the United States in the litigation against petitioners was unreasonable within the meaning of section 7430(c)(2)(A)(i); and (2) if so, the amount of litigation costs to be awarded.Respondent determined deficiencies in petitioners' Federal income tax and additions to tax for fraud pursuant to section 6653(b) for the taxable years 1975 and 1976. Petitioners paid the deficiency for 1976. They agreed that the deficiency determined for 1975 was correct, but respondent conceded that the statute of limitations barred assessment and collection of the deficiency unless petitioners' 1975 return was false and fraudulent within the meaning of section 6501(c). The sole issue at trial was whether any1987 U.S. Tax Ct. LEXIS 74">76 part of the underpayment of tax for 1975 or 1976 was due to fraud.The trial in this case was held on February 24 to 25, 1986, at Cleveland, Ohio. On August 4, 1986, we filed our opinion 2 that petitioners were not liable for the addition to tax for fraud for 1975 and 1976, and that the statute of limitations barred assessment and collection of the deficiency for 1975. On September 3, 1986, petitioners filed their motion for award of litigation costs pursuant to section 7430 and Rules 231 and 232. 3 Pursuant to our order, respondent filed his response on November 17, 1986, and filed a supplemental response on December 22, 1986. On January 15, 1987, we granted the parties' joint motion to submit evidence on the amount of litigation costs incurred by way of affidavit and deposition in lieu of a hearing. 88 T.C. 1329">1331 Petitioners filed affidavits of counsel on January 20 and March 18, 1987. Petitioners and respondent filed transcripts of depositions of petitioners' counsel on February 26, 1987.1987 U.S. Tax Ct. LEXIS 74">77 Our opinion filed on August 4, 1986, sets forth the limited education of petitioners, Chester and Theresa Rutana. We found that Chester had difficulty with simple arithmetic and that Theresa had no training in bookkeeping or accounting other than an introductory course in high school in the 1940s. Petitioners' crude records, banking practices, and rudimentary single-entry bookkeeping system were the source of many of the errors that respondent found. Theresa did not know what it meant to reconcile a check register until instructed by John Funcheon, C.P.A., in 1978, whom petitioners retained to assist them during their audit. Until instructed by Funcheon, Theresa was incapable of accurate record keeping. Under her accounting system in 1975 and 1976, it was impossible to determine Rutana Landscaping's income and expenses.During the audit of petitioners' 1975 and 1976 income tax returns, Scott Simmerman, respondent's agent, discovered a significant disparity between petitioners' gross receipts as listed on monthly receipts sheets that Theresa maintained and the total amount of bank deposits in 1975 and 1976 and requested additional information from Theresa. Theresa cooperated 1987 U.S. Tax Ct. LEXIS 74">78 fully with Simmerman. She provided Simmerman consistent explanations for the omitted items. Simmerman also found numerous mathematical errors on Theresa's receipts sheets resulting in understatements of income, including a transposition error on the August 1975 receipts sheet that resulted in a $ 3,600 understatement of gross receipts. For other months, Theresa's mathematical errors resulted in overstatements of income.Simmerman did not believe Theresa's explanations for the omitted income items. He also did not believe that the $ 3,600 understatement of income on the August 1975 receipts sheet was the result of a transposition error. It was not until trial, however, that Simmerman understood the inadequacy of the bookkeeping system that Theresa used.At trial, we found petitioners to be thoroughly credible witnesses. Their testimony was wholly consistent with the explanations they gave Simmerman and which he recorded 88 T.C. 1329">1332 in his interview notes. In part, we discounted Simmerman's testimony because he had little independent recollection of the audit and his testimony was tied almost entirely to his notes. We concluded that petitioners' bookkeeping methods were used out1987 U.S. Tax Ct. LEXIS 74">79 of ignorance and not with an intent to evade taxes.Section 7430 provides that this Court and other Federal courts may award reasonable litigation costs up to $ 25,000 to the prevailing party in a civil tax proceeding. Sec. 7430(b)(1). The party seeking litigation costs bears the burden of proving his entitlement to them. Rule 232(e); see Baker v. Commissioner, 83 T.C. 822">83 T.C. 822, 83 T.C. 822">827 (1984), vacated and remanded on other grounds 787 F.2d 637">787 F.2d 637 (D.C. Cir. 1986). Respondent concedes that petitioners have exhausted their administrative remedies and substantially prevailed with respect to the sole issue presented, but contends that he acted reasonably in pursuing this litigation and that petitioners are, therefore, not prevailing parties. See sec. 7430(b)(2) and (c)(2).This Court has interpreted the requirement that the party seeking litigation costs be the prevailing party "in a civil proceeding" to mean that only respondent's actions after a petition is filed may be considered in determining whether respondent acted reasonably. Wasie v. Commissioner, 86 T.C. 962">86 T.C. 962 (1986); Baker v. Commissioner, 83 T.C. 822">83 T.C. 827.1987 U.S. Tax Ct. LEXIS 74">80 4 We do not review the actions of respondent's agents before a petition is filed for reasonableness. We can and must, however, review the events that occur before a petition is filed to determine whether respondent acted reasonably in pursuing the litigation. See Don Casey Co. v. Commissioner, 87 T.C. 847">87 T.C. 847, 87 T.C. 847">862 (1986).1987 U.S. Tax Ct. LEXIS 74">81 88 T.C. 1329">1333 The legislative history of section 7430 provides guidelines for determining whether respondent's conduct was unreasonable:The committee intends that the determination by the court on this issue is to be made on the basis of the facts and legal precedents relating to the case as revealed in the record. Other factors the committee believes might be taken into account in making this determination include, (1) whether the government used the costs and expenses of litigation against its position to extract concessions from the taxpayer that were not justified under the circumstances of the case, (2) whether the government pursued the litigation against the taxpayer for purposes of harassment or embarrassment, or out of political motivation, and (3) such other factors as the court finds relevant. * * * [H. Rept. 97-404, at 12 (1981).]We find no evidence that respondent used the cost of litigation to extract concessions from petitioners or that he pursued the litigation to harass or embarrass the petitioners, or out of political motivation. Case law interpreting the Equal Access to Justice Act (28 U.S.C. section 2412(d)(1)(A) (1982)), 1987 U.S. Tax Ct. LEXIS 74">82 however, sheds some light on the nature of the "other factors" that we should consider.Under the Equal Access to Justice Act, a successful litigant must show that the position of the United States was not "substantially justified" to recover litigation costs. 28 U.S.C. sec. 2412(d)(1)(A) (1982). The litigating position of the United States is substantially justified if it has a "reasonable basis both in law and fact." H. Rept. 96-1418, at 10 (1980), reprinted in 1980 U.S. Code Cong. & Admin. News 4953, 4984, 4989. In Wyandotte Savings Bank v. N.L.R.B., 682 F.2d 119">682 F.2d 119, 682 F.2d 119">120 (6th Cir. 1982), the Sixth Circuit equated the "substantially justified" standard with the reasonableness test of section 7430(c)(2)(A)(i). The court held, quoting the legislative history of the Equal Access to Justice Act, that the Government's litigating position was substantially justified because it had a "reasonable basis both in law and fact." 682 F.2d 119">Wyandotte Savings Bank v. N.L.R.B., supra (quoting H. Rept. 96-1418, supra). An appeal in this case would lie to the Sixth Circuit. To determine whether respondent's1987 U.S. Tax Ct. LEXIS 74">83 litigating position was reasonable, we, therefore, consider whether respondent had a reasonable basis in law and fact for believing that he could prove fraud as to petitioners. See Golsen v. Commissioner, 88 T.C. 1329">1334 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940 (1971).Respondent argues that our decision for petitioners was based solely on a judgment that petitioners were credible witnesses and Simmerman was not, and that we must consider the reasonableness of respondent's position based only on the facts available to him prior to trial. Respondent further contends that the evidence at all times gave him a reasonable basis in law and fact for believing that he could prove fraud. We agree that we must determine the reasonableness of respondent's position based on what he should have known prior to trial. As we stated in Devenney v. Commissioner, 85 T.C. 927">85 T.C. 927, 85 T.C. 927">930 (1985), "our determination as to whether respondent acted reasonably in this case turns upon the legal basis for respondent's position in light of the facts available to1987 U.S. Tax Ct. LEXIS 74">84 him at the time of trial." Respondent, however, had no facts available that would establish clearly and convincingly that petitioners fraudulently understated their income for 1975 and 1976. 87 T.C. 847">Don Casey Co. v. Commissioner, supra.He argues that petitioners' statements in the course of the audit were self-serving and not credible, yet he had no supportable basis for believing that petitioners were not being truthful. In fact, the evidence available to respondent's counsel, had he investigated it, would have refuted conclusively his client's position. Respondent's counsel cannot ignore the evidence and then attempt to justify an unreasonable litigating position on the ground that our decision was based in part on our assessment of the witnesses' credibility at trial.Respondent did not have a reasonable basis in law and fact for arguing that Chester acted with intent to evade tax in filing his returns with Theresa in 1975 and 1976. Section 6653(b)(4) provides that in the case of a joint return, the addition to tax for fraud "shall not apply with respect to the tax of the spouse unless some part of the underpayment is due to the fraud of such spouse." 1987 U.S. Tax Ct. LEXIS 74">85 Respondent contends that he acted reasonably in pursuing the addition to tax for fraud against Chester because of his "complete involvement in the landscaping business, including the billing process, as well as the level of family personal expenditures," which exceeded reported income during the years in issue. In their 88 T.C. 1329">1335 petition, however, petitioners alleged that Chester did not complete high school, did not participate in banking activities, or in the preparation of petitioners' tax returns for 1975 and 1976, and has written only one check in his life, which he prepared improperly. The petition also described petitioners' rudimentary bookkeeping system and indicated that Chester's only role was to record the hours he and his men worked for each customer and the supplies used so that Theresa knew who and how much to bill. Simmerman's audit notes support these allegations. He dealt almost entirely with Theresa in the course of the audit and discovered that she did all of the banking and most of the bookkeeping for Rutana Landscaping.Respondent nonetheless denied these allegations "for lack of sufficient knowledge or information upon which to base a belief as to the 1987 U.S. Tax Ct. LEXIS 74">86 truth of the allegations." If the allegations were true, as we found them to be at trial, they would preclude a finding of fraud as to Chester. See sec. 6653(b)(4). Yet, subsequent to filing his answer, respondent's counsel apparently made no investigation of Chester's role in record keeping and tax return preparation for Rutana Landscaping. Instead, he relied on Simmerman's conclusion, which was based on suspicion and not on fact, that the fraud addition should be assessed against both petitioners. Respondent's counsel has a duty to conduct further investigation to ascertain whether the evidence to be adduced at trial is clear and convincing as to each petitioner. Don Casey Co. v. Commissioner, 87 T.C. 847">87 T.C. 864. Respondent had no basis in law or fact for pursuing the addition to tax for fraud against Chester. Chester is, therefore, a prevailing party within the meaning of section 7430(c)(2) and is entitled to an award of litigation costs.Respondent also lacked a reasonable basis in law and fact for believing that he could prove that Theresa acted with intent to evade tax in 1975 and 1976. Respondent's counsel relied heavily on Simmerman's audit1987 U.S. Tax Ct. LEXIS 74">87 report to establish fraud as to Theresa. When he read Simmerman's report, however, respondent's counsel should have been alerted that the evidence was not sufficient to prove fraud by clear and convincing evidence. The report indicated that Simmerman suspected fraud, but contained little evidence to confirm his 88 T.C. 1329">1336 suspicions. Again respondent's counsel conducted no further investigation into Theresa's accounting and banking practices.Factors that courts have considered indicative of fraud include failure to report income over an extended period of time, failure to keep adequate books and records, failure to furnish the Government with access to records, concealment of bank accounts, and the taxpayer's experience or knowledge, and especially knowledge of the tax laws. Solomon v. Commissioner, 732 F.2d 1459">732 F.2d 1459, 732 F.2d 1459">1461 (6th Cir. 1984). Simmerman suspected fraud because Theresa omitted numerous checks from the gross receipts sheets and understated petitioners' income for 1975 and 1976. He also suspected that Theresa was attempting to conceal income because petitioners' expenditures in 1975 and 1976 exceeded their reported gross receipts. Neither1987 U.S. Tax Ct. LEXIS 74">88 petitioners' records nor the audit report, however, reveals any pattern to Theresa's omissions of income. She overreported income almost as frequently as she underreported it. Several checks that were omitted from income in 1976 were received in December and recorded with the January 1977 gross receipts. The checks Theresa omitted from the gross receipts sheets correlated with the unexplained checking account deposits that Simmerman found. In addition, if respondent sought to rely on a pattern of underreporting over a period of time to establish fraud, he should have known that investigation of other years would be necessary because courts generally will not infer fraud from mere understatements of income unless there has been a pattern of consistent underreporting over several years. 5 See, e.g., Solomon v. Commissioner, 732 F.2d 1459">732 F.2d at 1461 (4-year pattern of underreporting); Brooks v. Commissioner, 82 T.C. 413">82 T.C. 413, 82 T.C. 413">431 (1984), affd. without published opinion 772 F.2d 910">772 F.2d 910 (9th Cir. 1985) (7-year pattern of 88 T.C. 1329">1337 underreporting); Otsuki v. Commissioner, 53 T.C. 96">53 T.C. 96, 53 T.C. 96">108 (1969)1987 U.S. Tax Ct. LEXIS 74">89 (5-year pattern of underreporting).A significant part of Theresa's underreporting and overreporting of income resulted from mathematical errors. In 1 month, a transposition error resulted in a $ 3,600 understatement of gross1987 U.S. Tax Ct. LEXIS 74">90 receipts. The transposition of numbers (in this case 84 to 48) is a common error which Theresa's bookkeeping system did not allow her to catch. Simmerman, and apparently also respondent's counsel preparing this case for trial, simply refused to believe that the understatement resulted from a transposition error, though no other explanation is supportable on the record.In the course of discovery, respondent's counsel interviewed many of petitioners' customers. He apparently found no evidence indicating that petitioners had additional unreported income because he did not rely on their statements at trial and has not referred to their statements to show that he acted reasonably in pursuing this litigation.The types of errors that Theresa made, the manner in which she kept records, her limited education, and her willingness to cooperate with Simmerman during the audit should have alerted respondent's counsel that the omissions of income were not likely to have been intentional. Yet, he continued to maintain that Theresa's explanations were self-serving and not credible, with no evidence to support his conclusion. Funcheon, the C.P.A. who reviewed petitioners' records, testified1987 U.S. Tax Ct. LEXIS 74">91 that no one with any knowledge of accounting would keep records the way Theresa did. When he reviewed the records, respondent's counsel should have known that further investigation was needed. Instead, respondent's counsel relied on Simmerman's conclusion that Theresa's records were adequate and did not discover until trial that Theresa was incapable of adequate record keeping and that with the records she kept she had no way of knowing what petitioners' income and expenses were.The evidence respondent's counsel had available in preparing for trial may have shown that Theresa was negligent. Respondent's counsel, however, had no more than a mere suspicion of fraud, which further investigation would have shown was unwarranted. Because respondent did not have a reasonable basis in law and fact for believing that he could 88 T.C. 1329">1338 prove fraud by clear and convincing evidence and knew that litigation would be expensive and burdensome for petitioners, pursuing this case was unreasonable. Our conclusion in Don Casey Co. v. Commissioner, is equally applicable here:Finally, when we weigh the weakness of the Commissioner's case and the fact that the litigation might have been avoided1987 U.S. Tax Ct. LEXIS 74">92 if he had conducted the indicated investigation against the burden imposed upon the petitioner by the Commissioner's pursuing this litigation, we conclude that the Commissioner should not have (and it was unreasonable for him to have) pursued the litigation. Since he chose to do so, we believe that he should bear the petitioner's costs of litigation, and we so hold. [87 T.C. 847">87 T.C. 864-865.]Theresa is, therefore, also a prevailing party.Next we must determine the amount of litigation costs to which petitioners are entitled. Petitioners ask this Court to award $ 22,720.56 in litigation costs, computed as follows:Attorney fees$ 19,048.00Court filing fees60.00Trial transcripts580.90Travel expenses127.85Deposition expenses401.00Miscellaneous expenses591.61Fees of expert witness John Funcheon, C.P.A.1,911.20Total 6 22,720.56Respondent contends that the amount petitioners claim as attorney fees is excessive and reflects the inexperience of counsel in pursuing litigation before this Court. Respondent does not raise any specific objection to the other costs petitioners claim.1987 U.S. Tax Ct. LEXIS 74">93 88 T.C. 1329">1339 In Johnson v. Georgia Highway Express, Inc., 488 F.2d 714">488 F.2d 714, 488 F.2d 714">717-719 (5th Cir. 1974), the Fifth Circuit cited 12 factors to consider in determining a reasonable attorney's fee award. 71987 U.S. Tax Ct. LEXIS 74">95 Congress, in enacting the Civil Rights Attorney Fee Awards Act of 1976 (Pub. L. 94-559, 90 Stat. 2641 (42 U.S.C. sec. 1988 (1982)), cited with approval the 12 factors set forth in Johnson. See S. Rept. 94-1011, at 6 (1976), reprinted in 1980 U.S. Code Cong. & Admin. News 5908, 5913; see also Hensley v. Eckerhart, 461 U.S. 424">461 U.S. 424, 461 U.S. 424">429-430 (1983). 8 The Sixth Circuit, however, has rejected the "checklist" approach of Johnson in favor of an analytical approach based on the number of hours reasonably expended on the case multiplied by the attorney's normal hourly billing rate. See Northcross v. Board of Education of the Memphis City Schools, 611 F.2d 624">611 F.2d 624, 611 F.2d 624">642-643 (6th Cir. 1979), cert. denied 447 U.S. 911">447 U.S. 911 (1980). The Sixth Circuit concluded that many of the Johnson factors would be subsumed in an analysis of the reasonableness1987 U.S. Tax Ct. LEXIS 74">94 of the number of hours expended and the fee charged. The fee award could then be adjusted upward or downward to reflect any unusual factors in the case. Northcross v. Board of Education of the Memphis City Schools, 611 F.2d 624">611 F.2d at 643. We need not decide whether the Johnson or Northcross approach is preferable because an appeal in this case would lie to the Sixth Circuit and we are bound by the precedent in that circuit. Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940 (1971). 988 T.C. 1329">1340 To present petitioners' case, counsel had to become completely familiar with petitioners' bookkeeping1987 U.S. Tax Ct. LEXIS 74">96 and banking system, which required lengthy conversations with Theresa, a review and analysis of the source documents she provided, and the retention of John Funcheon, C.P.A. Counsel had to review petitioners' income tax returns from 1971 through 1979 because respondent alleged that they showed a pattern of underreporting of income. Counsel also had to review in depth the audit report with Theresa because respondent alleged that Theresa was uncooperative, but Theresa had no recollection of her lack of cooperation. 10 Counsel then had to prepare petitioners and expert witness John Funcheon for examination at trial. After trial, counsel performed significant work reviewing the record and preparing petitioners' post-trial briefs.The hours petitioners' counsel spent on this case may be broken down as follows:ActivityHoursPreparation of pleadings24.8Discovery27 Trial preparation, settlement negotiations, and93 stipulation of facts Calendar call and trial22.3Post trial briefs89.8Motion for litigation costs34.11987 U.S. Tax Ct. LEXIS 74">97 Counsel, except for Jeffrey D. Heintz, charged less than their usual hourly rate in this case to help keep petitioners' costs down. Their fees were also less than the prevailing rate in Youngstown, Ohio, of $ 100 per hour for representation in tax matters. Three attorneys worked on petitioners' case. Joseph R. Young, Jr., counsel of record, charged petitioners $ 60 per hour for his services. His usual hourly rate was $ 65. Robert Dineen charged petitioners $ 75 per hour. His usual hourly rate was $ 85. Jeffrey D. Heintz charged petitioners his usual hourly rate of $ 65, but billed significantly fewer hours than the other attorneys in the case.88 T.C. 1329">1341 We find that the hours billed and the rates charged in this case were reasonable, and that $ 22,720.56, representing the number of hours billed multiplied by the hourly rates charged, plus additional costs incurred, provides a reasonable award. As the Supreme Court stated in Hensley v. Eckerhart, 461 U.S. 424">461 U.S. 424, 461 U.S. 424">435 (1983), "Where a plaintiff has obtained excellent results, his attorney should recover a fully compensatory fee." We, therefore, award petitioners $ 22,720.56 in litigation costs. 1987 U.S. Tax Ct. LEXIS 74">*98 An appropriate order will be entered. Footnotes1. All section references are to the Internal Revenue Code of 1954 as amended and in effect during the years in issue.↩2. Rutana v. Commissioner, T.C. Memo. 1986-336↩.3. All Rule references are to the Tax Court Rules of Practice and Procedure.↩4. The circuit courts that have considered this issue are split as to whether a court may also consider administrative actions occurring prior to the filing of a petition in determining whether respondent's actions were reasonable. Compare Ewing and Thomas, P.A. v. Heye, 803 F.2d 613">803 F.2d 613 (11th Cir. 1986); Baker v. Commissioner, 787 F.2d 637">787 F.2d 637, 787 F.2d 637">641 and n. 8 (D.C. Cir. 1986); United States v. Balanced Financial Management, Inc., 769 F.2d 1440">769 F.2d 1440, 769 F.2d 1440">1450 (10th Cir. 1985); Ashburn v. United States, 740 F.2d 843">740 F.2d 843, 740 F.2d 843">848 (11th Cir. 1984) (holding statute only permits examination of Government's litigation position), with Powell v. Commissioner, 791 F.2d 385">791 F.2d 385, 791 F.2d 385">391 (5th Cir. 1986); Kaufman v. Egger, 758 F.2d 1">758 F.2d 1, 758 F.2d 1">4 (1st Cir. 1985) (holding both pre-litigation and litigation positions may be examined). The Sixth Circuit, to which this case is appealable, has not considered this issue. The District Court for the Northern District of Ohio, however, has held that actions on the administrative level are relevant in determining the reasonableness of respondent's positions. Rosenbaum v. I.R.S., 615 F. Supp. 23">615 F. Supp. 23, 615 F. Supp. 23">24↩ (N.D. Ohio 1985).5. On brief, respondent argued that petitioners' income tax returns for 1971 through 1979 show a pattern of underreporting. Their reported gross receipts and net income were significantly lower in the years prior to the audit than in subsequent years. During the same period, petitioners' itemized deductions did not change, leading respondent to conclude that petitioners' income remained fairly consistent from 1971 to 1979 and that they intentionally and consistently underreported their profits from Rutana Landscaping between 1971 and 1976. Respondent did not, however, conduct an audit of petitioners' income tax returns for the years 1971 through 1976 to ascertain whether they had, in fact, underreported their income. Once again his position is based on supposition and suspicion, not on fact.↩6. In their original motion for award of litigation costs filed on Sept. 3, 1986, petitioners requested $ 20,337.68. At the depositions of petitioners' counsel on Jan. 31, 1987, counsel agreed to reduce their request for attorney fees to eliminate charges for work performed before the petition was filed and, therefore, not incurred in a civil proceeding, and for expenses not properly billed to petitioners' account. In their supplemental motion for award of litigation costs filed on Mar. 18, 1987, counsel increased their original request to reflect the following costs incurred between Nov. 1, 1986, and Jan. 31, 1987, in connection with petitioners' motion for award of litigation costs:Attorney fees$ 2,121.00Deposition transcripts401.00Miscellaneous expenses12.27Total If the other conditions for a fee award are met, petitioners' counsel are entitled to be compensated for their time spent litigating the attorney's fee issue. See Northcross v. Board of Education of the Memphis City Schools, 611 F.2d 624">611 F.2d 624, 611 F.2d 624">643 (6th Cir. 1979), cert. denied 447 U.S. 911">447 U.S. 911↩ (1980).7. These factors are (1) the time and labor required; (2) the novelty and difficulty of the questions; (3) the skill requisite to perform the legal service properly; (4) the preclusion of other employment by the attorney due to acceptance of the case; (5) the customary fee; (6) whether the fee is fixed or contingent; (7) time limitations imposed by the client or the circumstances; (8) the amount involved and the result obtained; (9) the experience, reputation, and ability of the attorneys; (10) the "undesirability" of the case; (11) the nature and length of the professional relationship with the client; and (12) awards in similar cases. These 12 factors are consistent with the American Bar Association Code of Professional Responsibility, Disciplinary Rule 2-106 (1980). See Johnson v. Georgia Highway Express, Inc., 488 F.2d 714">488 F.2d 714, 488 F.2d 714">719↩ (5th Cir. 1974).8. The U.S. Supreme Court noted in Hensley v. Eckerhart, 461 U.S. 424">461 U.S. 424, 461 U.S. 424">433 n. 7 (1983), that although Hensley was a Civil Rights Act case, the standards set forth in Hensley↩ "are generally applicable in all cases in which Congress has authorized an award of fees to a "prevailing party.'"9. In Hensley v. Eckerhart, 461 U.S. 424">461 U.S. at 429-430, the Supreme Court cited the Johnson factors as the appropriate standard for determining a reasonable attorney's fee award. The Supreme Court noted, however, as the Sixth Circuit did in Northcross v. Board of Education of the Memphis City Schools, 611 F.2d 624">611 F.2d at 642, that many of the Johnson factors may be subsumed in the calculation of hours reasonably expended at a reasonable hourly rate. Hensley v. Eckerhart, 461 U.S. 424">461 U.S. at 434 n. 9. Thus, it appears that the Johnson and Northcross↩ standards are compatible.10. Consistent with Theresa's recollection, the record indicated that she fully cooperated with Simmerman.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625627/	CANNON VALLEY MILLING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Cannon Valley Milling Co. v. CommissionerDocket No. 96330.United States Board of Tax Appeals44 B.T.A. 763; 1941 BTA LEXIS 1275; June 19, 1941, Promulgated 1941 BTA LEXIS 1275">1275 During its fiscal year ended in 1937 petitioner entered into agreements with and reimbursed its vendees for a portion of processing taxes which it had included in the price of wheat products sold to them in May and June 1935. Held:(1) In order to clearly reflect petitioner's income for the fiscal year ended June 30, 1935, such reimbursements are deductible in computing its net income for that year under the provisions of section 43 of the Revenue Act of 1934. (2) Respondent's determination that the special treatment provided for in section 43 should not be applied is not conclusive. Kenneth Taylor, Esq., for the petitioner. L. W. Shaw, Esq., for the respondent. MELLOTT44 B.T.A. 763">764 OPINION. MELLOTT: The respondent determined a deficiency of $101,249.37 in petitioner's income tax and a deficiency of $36,579.21 in its excess profits tax for the fiscal year ended June 30, 1935. The instant proceeding involves only the portion of the deficiencies attributable to the disallowance of a claimed deduction of $29,423.45 from gross income. It was submitted upon a stipulation of facts, all of which we find to be as stipulated. Stated generally, 1941 BTA LEXIS 1275">1276 the question is: May petitioner be allowed a deduction of $29,423.45 from its gross income in 1935, this being the aggregate amount paid to its vendees in 1937 in compromise of their claims for reimbursement of processing taxes included in the selling price of wheat products sold by petitioner to them during May and June 1935? For present purposes the facts may be summarized as follows: Petitioner, a Minnesota corporation, having its principal office at Minneapolis, duly filed its income tax return for the fiscal year ended June 30, 1935, with the collector of internal revenue for the district of Minnesota. Its books were kept on an accrual, as distinguished from a cash, basis. During the taxable year and for many years prior thereto petitioner was engaged in the business of milling wheat and selling flour and other wheat products. As a first domestic processor of wheat it was subject to the provisions of the Agricultural Adjustment Act of 1933, as amended. Pursuant to the provisions of that act, it paid to the Federal Government a tax of 30 cents a bushel on the wheat processed from July 1, 1933, to April 30, 1935, inclusive. In June 1935 petitioner instituted an action1941 BTA LEXIS 1275">1277 in the United States District Court of the District of Minnesota to enjoin the collector of internal revenue for the district of Minnesota from collecting processing taxes upon wheat processed during the months of May and June 1935. The court granted temporary injunctions upon the condition that petitioner deposit with it the amount of taxes due on account of wheat processed during these months, pending final decision 44 B.T.A. 763">765 as to the constitutionality of the Agricultural Adjustment Act. Pursuant to the order of the court petitioner made the following deposits: Tax due for - Date depositedAmountMay 1935July 1, 1935$28,126.50June 1935Aug. 2, 193525,021.50Total53,148.00During subsequent months of 1935, under similar conditions, amounts aggregating $170,131.50 were deposited. Following the decision of the Supreme Court of the United States in United States v. Butler,297 U.S. 1">297 U.S. 1 (Jan. 6, 1936), declaring the Agricultural Adjustment Act invalid, the injunctions were made final and on January 23, 1936, there was returned to petitioner the sum of $222,998.24 ($223,279.50 less a deposit fee of $281.26 retained by the1941 BTA LEXIS 1275">1278 clerk of the court). On that date petitioner set up on its books a reserve account reading "Processing Tax Payable Special - $222,998.24." No part of this sum was reported as income in petitioner's returns either for the fiscal year ended June 30, 1936, or for the fiscal year ended June 30, 1937. All of the wheat products processed and sold by petitioner during the months of May and June 1935 were sold under written contracts fixing a definite price for the products, which included, but did not apportion nor separately state, the amount of processing tax payable by petitioner under the Agricultural Adjustment Act. These contracts contained a provision that if any increase in the processing tax should become effective while any portion of the commodities covered by the contract should remain undelivered, the amount thereof should be paid by the buyer. They also provided: Any decrease in the processing tax as now or hereafter imposed by the United States shall inure to the benefit of the buyer and be credited against the contract price named in this contract to the extent - and only to the extent - that the grain used in the manufacture of the product covered by this contract1941 BTA LEXIS 1275">1279 is milled after the decrease in the processing tax takes effect and to the extent that the seller is thereby relieved from the processing tax; * * All deliveries under contracts for the sale of products processed and sold by petitioner during the months of May and June 1935 were made by petitioner as required by the contracts referred to above prior to July 1, 1935, and the full purchase prices provided in the contracts were paid to the petitioner by the vendees thereunder prior to January 1, 1936. The contracts contained no provision for a refund to the vendees of all or any part of the processing tax in the event such tax should be held to be illegal. 44 B.T.A. 763">766 From and during May and June 1935 and thereafter, and particularly after the decision in 297 U.S. 1">United States v. Butler, supra, numerous claims were made against petitioner by vendees to whom it had sold wheat products processed during the months of May and June 1935 and during the latter part of 1935, for reimbursement of the amount of processing tax upon the products purchased by them from petitioner during that period. Petitioner at all times refused to admit any legal liability, either under the1941 BTA LEXIS 1275">1280 provisions of the contracts of sale set out in the stipulation or upon any other ground. In order to avoid threatened litigation, to keep the good will of its customers, and to compromise the claims, however, petitioner, during its fiscal year ended June 30, 1937, refunded to its vendees amounts aggregating $134,190.91. Payments to the vendees were made upon the basis of $1 of the approximately $1.38 of processing tax applicable to a barrel of the product purchased. $29,423.45 of the amount refunded to petitioner's vendees was paid in connection with wheat processed and sold during May and June 1935, the balance ($104,757.46) being in connection with wheat processed and sold during petitioner's fiscal year ended June 30, 1936, and prior to January 6, 1936. In petitioner's Federal income and excess profits tax return for the year ended June 30, 1935, it deducted the sum of $53,148 on account of processing taxes for the months of May and June 1935. In the notice of deficiency this deduction was disallowed by the respondent. The petition alleges that the "respondent's action in disallowing the deduction of processing taxes in the amount of $53,148.00 * * * is improper unless1941 BTA LEXIS 1275">1281 there be allowed as a deduction from gross income for the taxable year the amount of reimbursements made by the taxpayer to its customers on account of unpaid processing taxes with respect to deliveries made during the taxable year * ." The following schedule summarizes many of the facts and indicates the contentions of the respective parties: Net incomeABCDYearReported on returnWithout considering deductions because of reimbursementsPer petitioner's contentionPer respondent's contention19351 ($577.31)$50,464.032 $21,040.58$50,464.031936Not shown154,540.692 49,773.23154,540.691937(18,032.22)(18,032.23)(18,032.22)3 ($152,223.13)1941 BTA LEXIS 1275">1282 44 B.T.A. 763">767 The Department has ruled 1 that amounts paid by processors in settlement of contracts containing the clauses set out above, which contracts were entered into during the "injunctive period", are deductible as ordinary and necessary business expenses. The ruling concludes in the following language: It is held that the deductions on account of such reimbursements under the contracts here in question may be taken by the processors for the year in which reimbursements were actually made or, where the processors keep their accounts and file their returns on the accrual basis, for the year in which they agreed with the vendees to settle or compromise the disputed claims. Obviously relying upon and giving effect to this ruling, respondent has stipulated that the payments to petitioner's vendees in the total amount of $134,190.91 "are properly deductible from gross income in computing petitioner's net income for some taxable year." He claims, however, that under the stipulated facts the payments are deductible only in the return for the fiscal year ended June 30, 1937. Petitioner places its chief reliance upon1941 BTA LEXIS 1275">1283 section 43 of the Revenue Act of 1934. It contends that the payments to its vendees, being proper deductions from its gross income for some taxable year, should be prorated and the proportion thereof allocable to the products sold in the fiscal year 1935 should be allowed as a deduction in computing its income for that period "in order to clearly reflect its income." The section relied upon and related sections 41 and 42 are shown in the margin. 21941 BTA LEXIS 1275">1284 The first query that arises is: Are the payments deductions within the meaning of the revenue act? Apparently both parties consider 44 B.T.A. 763">768 them to be, though their stipulation to that effect is not controlling. Ohio Clover Leaf Dairy Co.,8 B.T.A. 1249">8 B.T.A. 1249; affd., 34 Fed.(2d) 1022; certiorari denied, 288 U.S. 588">288 U.S. 588; William Ernest Seatree,25 B.T.A. 396">25 B.T.A. 396; affd., 72 Fed.(2d) 67. They were made, in the language of the stipulation, "in order to avoid threatened litigation, keep the good will of its [petitioner's] customers, and compromise" the "numerous [disputed] claims * * * made against petitioner by vendees to whom it had sold wheat products processed during the months of May and June, 1935." Such payments, we think, must be held to be ordinary and necessary expenses of carrying on a trade or business and hence "deductions" under section 23(a) of the Revenue Act of 1934. Superheater Co.,12 B.T.A. 5">12 B.T.A. 5; affd., 38 Fed.(2d) 69; 1941 BTA LEXIS 1275">1285 O'Day Investment Co.,13 B.T.A. 1230">13 B.T.A. 1230; H. M. Howard,22 B.T.A. 375">22 B.T.A. 375; International Shoe Co.,38 B.T.A. 81">38 B.T.A. 81, 38 B.T.A. 81">95; Helvering v. Hampton, 79 Fed.(2d) 358; and Welch v. Helvering,290 U.S. 111">290 U.S. 111. The income tax is assessed upon the basis of annual returns showing the net result of all the taxpayer's transactions during a fixed period according to the method of accounting employed. Burnet v. Sanford & Brooks Co.,282 U.S. 359">282 U.S. 359. Under an accrual, as distinguished from a cash, basis, the general rule is that income and deductions are accruable when all events have occurred fixing the liability and determining the amount. North American Oil Consolidated v. Burnet,286 U.S. 417">286 U.S. 417; United States v. Anderson,269 U.S. 422">269 U.S. 422; American National Co. v. United States,274 U.S. 99">274 U.S. 99; Helvering v. Union Pacific Railroad Co.,293 U.S. 282">293 U.S. 282. "As to both income and deductions it is the fixation of the rights of the parties that is controlling." 1941 BTA LEXIS 1275">1286 Commissioner v. Darnell, Inc., 60 Fed.(2d) 82. The cases applying the general rule referred to above are numerous. Many of them, and especially those which have held that a deduction can not be taken by a taxpayer on an accrual basis until the year in which its disputed liability is finally determined or admitted, are cited by respondent. Lucas v. American Code Co.,280 U.S. 445">280 U.S. 445; Tomson & Co. v. Commissioner, 82 Fed.(2d) 398; Price Iron & Steel Co. v. Burnet, 45 Fed.(2d) 921; Central Trust Co. v. Burnet, 45 Fed.(2d) 922; New Process Cork Co.,3 B.T.A. 1339">3 B.T.A. 1339; Bump Confectionery Co.,4 B.T.A. 50">4 B.T.A. 50; Louis Kratter,4 B.T.A. 52">4 B.T.A. 52; Hamler Coal Co.,4 B.T.A. 947">4 B.T.A. 947; Empire Printing & Box Co.,5 B.T.A. 203">5 B.T.A. 203; Lynchburg Colliery Co.,7 B.T.A. 282">7 B.T.A. 282; Thorne, Neale & Co.,13 B.T.A. 490">13 B.T.A. 490; Trippensee Manufacturing Co.,15 B.T.A. 15">15 B.T.A. 15; 1941 BTA LEXIS 1275">1287 Arabol Manufacturing Co.,26 B.T.A. 1068">26 B.T.A. 1068. In this connection he relies especially upon the fact that the 1935 sales contracts did not impose upon petitioner any legal obligation to make the reimbursements to its vendees. Most of the cited cases arose under acts prior to the 1924 Act, which, through section 200(d) thereof, first incorporated in the 44 B.T.A. 763">769 revenue law the provision set out in the concluding clause of the first sentence of section 43, supra. They involved the application of the general rule for the accrual and deduction of liabilities under the accrual method of accounting and the exception now under consideration was not involved or discussed. Petitioner cites and relies principally upon William S. Linderman, Executor,28 B.T.A. 113">28 B.T.A. 113; reversed on rehearing, 84 Fed.(2d) 727; certiorari denied, 299 U.S. 589">299 U.S. 589; Carondelet Building Co. v. Fontenot, 111 Fed.(2d) 267; K. Taylor Distilling Co.,42 B.T.A. 7">42 B.T.A. 7 (on appeal C.C.A., 6th Cir.); 1941 BTA LEXIS 1275">1288 Sanford Cotton Mills, Inc.,42 B.T.A. 190">42 B.T.A. 190. The two last mentioned cases are distinguishable from the instant proceeding on their facts, and, since they do not involve any departure from the regular accrual method of accounting, it would serve no useful purpose to discuss them. In the Linderman case, the books and accounts of a deceased incompetent had been kept and returns of her income had been filed on the cash basis. Expenses incurred prior to her death on November 13, 1929, were not paid until subsequent thereto. This Board and the Circuit Court of Appeals for the Third Circuit held that the expenses incurred during the guardianship should be deducted from the gross income of that period rather than from the gross income of the estate in order that the net income of the guardianship should be clearly and properly reflected. Section 43 of the Revenue Act of 1928 was cited, which is identical to the first sentence of section 43 of the Revenue Act of 1934, supra. On rehearing the deduction was disallowed by the court on the ground that the guardianship expenses were not business expenses, an issue which was not raised before the Board. 1941 BTA LEXIS 1275">1289 In Carondelet Building Co. v. Fontenot, supra, the taxpayer was on an accrual basis, its fiscal year ending September 30. On May 10, 1934, the day following its organization, it purchased a building and its income consisted almost entirely of rents therefrom. Prior to the purchase, the building had been assessed for 1934 taxes. City taxes amounting to $24,406 were paid on September 26, 1934, and state taxes amounting to $10,326 were paid on December 28, 1934. The taxpayer treated the aggregate taxes as an expense incurred in earning the monthly rents, prorated the taxes one-twelfth to each calendar month, and claimed a deduction for taxes accrued of $13,517 for the period May 10 to September 30, 1934. The Circuit Court of Appeals for the Fifth Circuit approved the taxpayer's method of proration on the ground that the rents ought to bear the monthly pro rata of the annual taxes in order fairly to reflect net income, although it held that the taxes did not, in strictness, become a liability of the taxpayer until it decided to assume and pay them. 44 B.T.A. 763">770 The cases cited by the respective parties furnish but slight aid in determining the issue now before1941 BTA LEXIS 1275">1290 us. Despite the presence of the remedial provision in all of the revenue acts from 1924 to the present, few instances have arisen in which the courts or this Board have had occasion to consider it. Perhaps that is so because, in the great majority of cases, income is clearly reflected by taking the deductions and credits in accordance with the method of accounting employed. Yet the provision is not meaningless and its presence in the revenue act should not be ignored. Respondent does not contend that it should be; his principal argument is that no facts are shown justifying its application. Implicit in the argument of the parties and, we think, in the section itself, is the conclusion that each case must be considered upon its facts in order to determine if the method of accounting regularly employed should be disregarded "in order to clearly reflect the income." The legislative history likewise supports this view. 3 It is appropriate, therefore, that the facts be examined carefully. 1941 BTA LEXIS 1275">1291 It will be noted that, whether petitioner's income is computed by the method which it insists should be used, or by the method used by the respondent, the result of the three years' operations is the same, viz., a net income of $52,781.59 or an average of approximately $17,593 per year. This amount is much larger than petitioner's net income for any of the five years immediately preceding, or for either of the two years immediately succeeding, the period set out in the computation, though the number of barrels of flour produced did not vary greatly. (Petitioner's net income from 1930 to 1934 ranged from a net loss of $21,354.43 in 1932 to a net income of $7,305.14 in 1933. Its net loss was $22,192.59 in 1938 and $33,657.72 in 1939.) But petitioner is not asking that the three years be consolidated and its income be computed upon that basis. Manifestly that could not be done. 282 U.S. 359">Burnet v. Sanford & Brooks Co., supra.It urges only that, in computing its income for the years 1935 and 1936 (only 1935, however, is involved in this proceeding), it should be permitted to deduct the reimbursements actually made in 1937 to its vendees upon the products purchased by1941 BTA LEXIS 1275">1292 them in such years. It is obvious from an examination of the computation made by the respondent that petitioner is being taxed upon an income of $50,464.03 in 1935 and $154,540.69 in 1936, a total of $205,004.72, whereas in fact - if the subsequent reimbursements to its vendees upon, and 44 B.T.A. 763">771 applicable to, the sales in those years be considered - the actual result of its operations was a net income of $21,040.58 for 1935 and a net income of $49,773.23 for 1936, or a total of $70,813.81. Under respondent's computation a similar distortion of petitioner's true income for 1937 also results. Thus, the business actually transacted by it during 1937 resulted in a net loss of $18,032.22 (assuming in this connection that the amount reported by it in its return is correct). If the amounts paid to its vendees which have no relation whatever to the sales made in that year are deducted, the result of its operations is a loss of $152,223.13. The real issue here is: What is the correct amount of petitioner's taxable income for its fiscal year ended June 30, 1935? We now know that it is not entitled to the deduction for processing taxes which it accrued upon its books and claimed1941 BTA LEXIS 1275">1293 in its return. We also know that it made certain deductible reimbursements in a later year of part of the proceeds of the sales made during the period covered by the return. Obviously the disallowance of the deduction for the processing taxes and a disallowance of the deduction now claimed for reimbursements will result in petitioner being taxed upon a greater profit than was realized from its 1935 sales. "Taxation is an intensely practical matter, and laws in respect of it should be construed and applied with a view of avoiding, so far as possible, unjust and oppressive consequences." Farmers Loan & Trust Co. v. State of Minnesota,280 U.S. 204">280 U.S. 204, 280 U.S. 204">212. The objective of all accounting methods is to "clearly reflect income." The ideal method would be to charge against income earned during a taxable period the expenses attributable to the earning of it. The computation of net income upon the basis of a taxpayer's annual accounting period in accordance with the method of accounting regularly employed does not always accomplish the desired objective. Section 43 was intended to aid in accomplishing it. While no limitation was placed upon its application, we are1941 BTA LEXIS 1275">1294 of the opinion that it was intended to apply to unusual and exceptional situations such as we have here. It is quite unlikely that this petitioner will ever again make, or be called upon to make, any reimbursements of the kind here involved. They were of a nonrecurring nature and resulted primarily from a judicial decision that the act imposing the processing tax was invalid. They could not have been foreseen on June 30, 1935, the end of petitioner's fiscal year. They, however, represented payments under claims relating to 1935 sales. If such sales had not been made there would have been no basis for the claims and no reimbursements. They were not in any sense of the word related to sales made in 1937 and were not proper charges against the income of that year. 44 B.T.A. 763">772 Upon brief respondent urges that petitioner can not be given the relief sought because of the provisions of article 43-1(a) of Regulations 86. 4 He points out that a similar regulation has been in effect for many years; that the regulations have always required his decision "as to whether the special treatment of section 43 is applicable"; that he has determined it is not applicable in the instant proceeding; 1941 BTA LEXIS 1275">1295 and that "the regulations, making [his] decision final, having stood through many reenactments of the statute, now have the force and effect of law." Helvering v. Reynolds Tobacco Co.,306 U.S. 110">306 U.S. 110, is cited in support of this contention. 1941 BTA LEXIS 1275">1296 Section 41 provides that if no method of accounting has been employed by a taxpayer, or if the method employed does not clearly reflect the income, "the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income." This section, however, is not applicable here and no such language is used in section 43. It authorizes deductions or credits to be taken in a different period if necessary "to clearly reflect the income." The Commissioner's decision is not made a prerequisite and the statute does not provide that any decision made by him is final.If the regulation should undertake to do so (though we do not so interpret it) it would, to that extent, be a nullity; for the Department can not, by regulation, either extend or limit an act of Congress. Helvering v. Powers,293 U.S. 214">293 U.S. 214. The power to prescribe rules and regulations "is not the power to make law * * * [but] * * * to carry into effect the will of Congress as expressed by the statute." 1941 BTA LEXIS 1275">1297 Manhattan General Equipment Co. v. Commissioner,297 U.S. 129">297 U.S. 129; Commissioner v. Winslow, 113 Fed.(2d) 418. But in the view which we take, it is unnecessary to determine whether the regulation is, or is not, a proper one. No doubt it is desirable, from an administrative standpoint, that the Commissioner determine if a taxpayer shall be permitted to take his deductions in a different period, just as he determines "what is carrying on a business, subject to reexamination of the facts by the Board of Tax Appeals and ultimately to review on the law by the courts on which jurisdiction is 44 B.T.A. 763">773 conferred." Higgins v. Commissioner,312 U.S. 212">312 U.S. 212. So applied, the regulation would no doubt be valid, especially in a situation where a taxpayer has made payments in an earlier year which should appropriately be deducted from the income of a later year. Here, however, the payments, which we believe should appropriately be deducted from the income of an earlier year, were not made until a later year. The regulation was not designed to take care of the latter situation. But that need not disturb us; for the statute makes no distinction. 1941 BTA LEXIS 1275">1298 It is to be applied whenever such application is necessary "in order to clearly reflect income." We are of the opinion that the claimed deduction should be allowed in recomputing petitioner's income for the taxable period before us. Reviewed by the Board. Decision will be entered under Rule 50.DISNEY, KERN, and OPPER concur only in the result. MURDOCK, ARNOLD MURDOCK, dissenting: The prevailing opinion recognizes that this is not a case under section 41 involving an improper system of accounting for and reporting income. It also recognizes that the amounts in controversy were not actually accrued and could not have been accrued during the taxable year because no events had occurred during that year fixing a liability or determining the amount of any liability. The opinion is based entirely upon the proposition that the peculiar facts in this case require a deduction under section 43 in order to clearly reflect income, even though the item was not paid, accrued, or incurred during 1935, and even though, in all other respects, the accounting method of the taxpayer was entirely satisfactory. The Board apparently finds that the item is deductible under1941 BTA LEXIS 1275">1299 section 23(a), 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." This item was not paid or incurred during the taxable year. Since it was not an accruable expense of that year, it can not be allowed as a deduction for 1935 unless section 43 applies. The prevailing opinion does not demonstrate to my satisfaction that section 43 applies. The only relation which the item has to 1935 is that it grew out of transactions which occurred in that year. In so far as it was paid in 1937 to retain the good will of customers, it could not be justified under any theory as an ordinary and necessary expense of 1935. The petitioner earned a certain amount in 1935 which it thereafter retained as its own. Although as time went on vendees began to make claims, the petitioner consistently denied 44 B.T.A. 763">774 liability on those claims and no liability is established. After thus denying liability, and after paying only a part of the sums claimed by the vendees, the petitioner asks for relief under section 43. So far as the evidence shows, the petitioner might never have paid anything to the vendees1941 BTA LEXIS 1275">1300 had it not desired to retain their good will after 1937. I see no justification for relating back to 1935 under section 43 an amount thus paid in 1937. This case presents no exception to the general rule that deductions must be taken only when they are paid, accrued, or incurred in accordance with the accounting system regularly used. Cf. Estate of William H. Block,39 B.T.A. 338">39 B.T.A. 338; affd., 111 Fed.(2d) 60. TYSON agrees with this dissent. ARNOLD, dissenting: I do not agree with the conclusion of the majority because in my opinion it errs in two respects. In the first place, the justification for the conclusion reached rests solely upon the exception contained in section 43, the application of which, it is held, will more clearly reflect petitioner's income for the taxable year. Secondly, while the majority opinion relies upon section 43, it ignores the reasonable requirement contained in the Commissioner's regulations dealing with the application of the exception. In my opinion petitioner's income is more clearly reflected by a computation in accordance with the method of accounting regularly employed in keeping its books than by the departure1941 BTA LEXIS 1275">1301 therefrom approved by the majority. Petitioner's 1935 sales of flour were closed and completed transactions of that year. No obligation, express or implied, existed during 1935 to make reimbursement of any part of that year's gross sales. The liability to vendees was first "paid or accrued" or "paid or incurred" in 1937 under agreements voluntarily entered into in that year, and, under the accrual system of accounting regularly employed by petitioner, such disbursements should properly be accounted for in that year. Accounting for 1937 liabilities in 1935 will not clearly reflect 1935 income; it distorts the income of both years. This Board should not permit a remedial provision of the statute to be used to distort income merely because the net result of shifting the deduction is to lessen a taxpayer's liability for taxes. Section 43, so far as pertinent, appeared first in the Revenue Act of 1921, and provided that losses should be deducted in the year sustained, "unless, in order to clearly reflect the income, the loss should, in the opinion of the Commissioner, be accounted for as of a different period." Sec. 234(a)(4). In the Revenue Act of 1924, Congress extended1941 BTA LEXIS 1275">1302 the principle in the 1921 Act relating to deduction of losses to all deductions and credits.44 B.T.A. 763">775 In section 200(d) thereof it provided that "The deductions and credits provided for in this title shall be taken for the taxable year in which 'paid or accrued' or 'paid or incurred', dependent upon the method of accounting upon the basis of which the net income is computed under sections 212 or 232, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period." Section 212 of the Revenue Acts of 1924 and 1926 and section 41 of each succeeding revenue act delegate to the respondent the power to determine whether the method of accounting employed by a taxpayer clearly reflects its income, and, "if the method employed does not clearly reflect the income", the statute provides that "the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income." Sec. 41, Revenue Acts of 1934 and 1936. Respondent's regulations have consistently construed section 43 and its prototypes as requiring compliance with certain formalities as a prerequisite to shifting a deduction1941 BTA LEXIS 1275">1303 to a different period. Art. 146, Regulation 62; art. 43-1, Regulations 86 and 94. See also T.D. 3261 (1921), I-1 C.B. 148. The regulations have always required a taxpayer to take the deduction in the year "paid or accrued" or "paid or incurred" and to submit with the return a complete statement of facts upon which it relies to take deductions as of a different taxable year. The Commissioner would then have the information before him and the years affected, from which it could be determined whether income would be more clearly reflected by shifting the deduction to the period requested. The requirement in the regulations is, in my opinion, a reasonable one and imposes no hardship upon a taxpayer. The successive reenactments of the statutory provisions without alteration must be taken as an approval by Congress of the administrative construction and to have imparted to the regulations the force and effect of law, Helvering v. Reynolds Tobacco Co.,306 U.S. 110">306 U.S. 110, and unless petitioner has complied with the distinct method provided for in the regulations, it can not avail itself of the exception contained in section 43. 1941 BTA LEXIS 1275">1304 Stokes v. United States,19 Fed.Supp. 577, 580. The record here does not show that petitioner deducted the repayments on its 1937 return or submitted a statement of facts upon which it relies, or requested that such deductions be taken as of a different period. Had the petitioner complied with the requirements of the regulations and had the Commissioner disallowed the deduction from 1935 gross income, it would be the province of the Board to determine whether or not petitioner's income would be more clearly reflected by allowing the deduction as of the period claimed. Any shifting of credits and deductions from the year in which they are "paid or accrued" or "paid or incurred" to another 44 B.T.A. 763">776 taxable period changes the net income of both periods. Unless the information called for in the regulations is furnished the Commissioner, he can not determine whether the income will be more clearly reflected or not, nor can the Board on review of the Commissioner's determination. The majority opinion computes net income upon the net result of a transaction or series of transactions spread over two or more taxable years. Such an interpretation will lead to1941 BTA LEXIS 1275">1305 endless delays and confusion in determining and closing tax liabilities. While here the exception works to the taxpayer's advantage, taxable income, to be clearly reflected, can not be determined upon the basis of advantage or disadvantage either to the taxpayer or the Government in any one particular year. Footnotes1. The figures in parentheses indicate losses. ↩2. Petitioner deducts from its net income as shown in column B the $29,423.45 paid to its vendees on account of wheat processed and sold during May and June 1935, and the $104,757.46 paid to its vendees in connection with wheat products sold during its fiscal year ended June 30, 1936, and prior to January 6, 1936, thus arriving at the above amounts.↩3. Respondent has not yet audited or revised petitioner's return for 1937. He claims, however, that the payments to petitioner's vendees, aggregating $134,190.91, are deductible only on its income and excess profits tax returns for the year 1937.↩1. G.C.M. 20134↩, C.B. 1938-1, p. 122. 2. SEC. 41. GENERAL RULE. The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer's annual accounting period is other than a fiscal year as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year. (For use of inventories, see section 22(c).) SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED. The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period. In the case of the death of a taxpayer there shall be included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period. SEC. 43. PERIOD FOR WHICH DEDUCTIONS AND CREDITS TAKEN. The deductions and credits provided for in this title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred", dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period. In the case of the death of a taxpayer there shall be allowed as deductions and credits for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly allowable in respect of such period or a prior period. ↩3. When the amendment incorporating the exception in the act was being considered in Congress the Ways and Means Committee in its report said: " * * The necessity for such a provision arises in cases in which a taxpayer pays in one year interest or rental payments or other items for a period of years. If he is forced to deduct the amount in the year in which paid, it may result in a distortion of his income which will cause him to pay either more or less taxes than he properly should." Rept. No. 179, Committee on Ways and Means, 68th Cong., 1st sess., p. 11. ↩4. ART. 43-1. "Paid or incurred" and "paid or accrued." - (a)↩ The terms "paid or incurred" and "paid or accrued" will be construed according to the method of accounting upon the basis of which the net income is computed by the taxpayer. (See section 48(c).) The deductions and credits provided for in Title I must be taken for the taxable year in which "paid or accrued" or "paid or incurred," unless in order clearly to reflect the income such deductions or credits should be taken as of a different period. If a taxpayer desires to claim a deduction or a credit as of a period other than the period in which it was "paid or accrued" or "paid or incurred," he shall attach to his return a statement setting forth his request for consideration of the case by the Commissioner together with a complete statment of the facts upon which he relies. However, in his income tax return he shall take the deduction or credit only for the taxable period in which it was actually "paid or incurred," or "paid or accrued," as the case may be. Upon the audit of the return, the Commissioner will decide whether the case is within the exception provided by the Act. and the taxpayer will be advised as to the period for which the deduction or credit is properly allowable.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625629/	CRAIG J. HATTIER and CHARLOTTE WOOD HATTIER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentHattier v. CommissionerDocket No. 3724-86United States Tax CourtT.C. Memo 1990-2; 1990 Tax Ct. Memo LEXIS 2; 58 T.C.M. 1109; T.C.M. (RIA) 90002; January 2, 1990Gary James Joslin, for the petitioners. Linda West, for the respondent. JACOBSMEMORANDUM FINDINGS OF FACT AND OPINION JACOBS, Judge: Respondent determined a deficiency in petitioners' 1982 Federal income tax in the amount of $ 55,179, together with additions to tax pursuant to sections 6653(a)(1), 16653(a)(2) and 6661(a) in the respective amounts of $ 2,759, 50 percent of the interest due on $ 55,179, and $ 5,518. Respondent also determined that the entire deficiency was attributable to a tax motivated transaction and thus seeks increased interest pursuant to section 6621(c). 21990 Tax Ct. Memo LEXIS 2">4 The issues for decision are: (1) whether petitioners are entitled to a claimed deduction for research and experimental expenditures; (2) whether petitioners are liable for additions to tax pursuant to section 6653(a) for negligence; (3) whether petitioners are liable for the addition to tax pursuant to section 6661(a) for substantial understatement of income tax; and (4) whether petitioners are liable for additional interest pursuant to section 6621(c) for an underpayment attributable to a tax motivated transaction. FINDINGS OF FACT Some of the facts have been stipulated and are so found. So much of the stipulation of facts and exhibits attached thereto as we find relevant are incorporated herein by this reference. Craig J. Hattier (hereinafter referred to as petitioner) and Charlotte Wood Hattier, husband and wife, resided in New Orleans, Louisiana, at the time the petition herein was filed. Petitioner is an attorney engaged in the general practice of law as a sole practitioner. Having had an exceptionally profitable year from his law practice in 1982, petitioner sought an investment offering tax advantages. In this regard, he spoke to Walter Wainwright (Wainwright), 1990 Tax Ct. Memo LEXIS 2">5 whom he had known for years, concerning a potential investment in the Sea Star 2 research and development program (the Sea Star R&D program). The Sea Star R&D program was marketed by Sea Star Industries, Inc. (Sea Star), a Canadian corporation, through its president Lawrence Matanski (Matanski), pursuant to a private placement memorandum dated August 1, 1982 (the Offering Memorandum). Under the terms of the offering, Sea Star was to perform research (on behalf of the investor) leading to the development of components for a twin-engine amphibian airplane (designed by Matanski) to be known as the Avalon Twin Star 800 (Avalon Twin) and manufactured by Airmaster, Inc. (Airmaster), a Washington state corporation. (Wainwright was an officer of Sea Star and was involved in the promotion of the Sea Star R&D program.) The Avalon Twin was an advanced version of a single-engine plane known as the Avalon 60 (the Avalon), which like the Avalon Twin had been designed by Matanski. A prototype of the Avalon was built and flight tested; however, as of the date of trial, no certificate of airworthiness had been obtained from the FAA for the Avalon. The Avalon Twin consisted of 185 components. 1990 Tax Ct. Memo LEXIS 2">6 Pursuant to the Sea Star R&D program, each investor paid Sea Star a fixed price for the research and development (R&D) associated with the particular component purchased by him, and each investor obtained the right to commercially exploit the technological information obtained from such research. (R&D of the components for the Avalon had previously been marketed by Tri-Liner International, a corporation in which both Matanski and Wainwright had an interest.) The aggregate price for all 185 components was to be $ 4,856,600, $ 1,618,865 of which was payable currently in cash and $ 3,237,735 in deferred installments. As of January 1985, 51 investors had paid for research for components (which comprised approximately one-half of the plane) for a total price of $ 3,651,655. (The price paid for the components included design, drawings, stress analyses, tooling, and manufacture of a prototype part, as well as their assembly.) On August 13, 1982, Sea Star subcontracted the R&D work it was to perform on behalf of the investors to Airmaster. Pursuant to the subcontract agreement Airmaster was obligated to: (a) carry out the detailed engineering and fabrication of such components for1990 Tax Ct. Memo LEXIS 2">7 the aircraft as specified by Sea Star; (b) design and construct such prototype and production tooling as specified by Sea Star; (c) assemble all components into and complete fabrication of the prototype aircraft; and (d) conduct all flight and other tests required in order to obtain an FAA certificate for the aircraft. Airmaster's services were to be performed in accordance with the budget prepared by Sea Star; Sea Star was to provide all funds necessary for Airmaster to carry out its obligation under the subcontract. The basic design of the Avalon Twin had been completed in 1981. A prototype of the Avalon Twin was not built because of its similarities with the Avalon. Due to financial difficulties, the Avalon Twin never reached the assembly stage. Petitioner decided to invest $ 40,500 in cash in the Sea Star R&D program; at petitioner's request, Wainwright "pick[ed] out components that matched that amount." On November 15, 1982, petitioner signed an agreement (the Purchase Agreement) to purchase R&D associated with the following three components for the Avalon Twin: ComponentPriceWater pumping manifold lines$ 4,400and assemblyTop fuselage frames and tooling112,000Fuselage tail cone and tooling mould5,100Total Purchase Price$ 121,5001990 Tax Ct. Memo LEXIS 2">8 The $ 121,500 purchase price was payable as follows: $ 20,500 upon signing the Purchase Agreement; $ 20,000 in five consecutive monthly installments of $ 4,000 each, the first of which was to commence on December 15, 1982; and $ 81,000 on December 31, 1992, with interest at the rate of 10 percent per annum (petitioner's obligation to make this latter payment was evidenced by a recourse note). Concurrently with the execution of the Purchase Agreement, petitioner entered into a nonexclusive licensing agreement (License Agreement) with Sea Star and Airmaster for the commercialization of the R&D to be performed on his behalf. The License Agreement gave both Airmaster and Sea Star the right to use the research information (owned by petitioner) in connection with the manufacturing and marketing of the individual components; petitioner was to receive a royalty payment of $ 1,215 each time his three components were manufactured, assembled, and installed on an aircraft. Petitioner paid Sea Star $ 20,500 on November 15, 1982, and $ 4,000 on December 15, 1982. Because of personal financial difficulties, petitioner made no further payments to Sea Star, and Sea Star made no efforts to collect1990 Tax Ct. Memo LEXIS 2">9 the amount owed. Instead, Matanski modified Sea Star's records in order to reduce the amount of cash petitioner had invested ($ 24,500 rather than the $ 40,500) and to reduce the amount of petitioner's debt obligation. (Most investors in Sea Star's R&D program paid one-third of the purchase price in cash and incurred a debt obligation for the remaining two-thirds. Matanski reduced the amount of petitioner's note to $ 49,000 in order to maintain a two to one ratio between debt and cash financing.) Matanski testified that he did not want Sea Star to pay taxes on petitioner's $ 16,000 cash shortfall and that he intended to proportionately reduce the royalties to which petitioner was entitled. (At the time of trial, no Avalon Twins had been sold; accordingly, no royalties had been generated.) The successful exploitation of the R&D information owned by each investor depended upon the R&D being performed on other components. The components associated with petitioner's investment would not, without modification, fit a plane other than the Avalon Twin. The Offering Memorandum consisted of 24 pages, one-third of which dealt with tax considerations. The Offering Memorandum recommended1990 Tax Ct. Memo LEXIS 2">10 that each investor adopt the accrual method of accounting for tax purposes. The Offering Memorandum stated that all R&D would be completed by the end of 1982 because the Internal Revenue Service might otherwise "dispute the amount of the contract price for purposes of deducting research and experimental expenses incurred if the work were not completed before the year end by asserting that the promissory note may only be treated as an expense incurred in the year in which services are rendered." By letter dated December 26, 1982, Sea Star notified petitioner that the R&D with respect to his components had been completed; a certificate of completion signed by Matanski accompanied the letter. (Airmaster did not keep records as to when R&D on specific components began or ended. The only evidence produced at trial to substantiate when the R&D took place (other than the certificate of completion) were two undated drawings of a portion of the Avalon Twin. Matanski testified that although he had no personal knowledge as to when the R&D on petitioner's components was completed, he was informed by one of the draftsmen that such R&D was completed in December 1982.) Although petitioner1990 Tax Ct. Memo LEXIS 2">11 was entitled to receive the plans and other information resulting from the R&D to be performed on his behalf, he did not request them. During 1984 and 1985, Sea Star offered each investor an opportunity to have a portion of the interest due under his note forgiven if the investor made an advance payment in an amount equal to two years of interest; each investor was also given an opportunity to receive stock in Sea Star in exchange for making an advance payment with respect to his note. Matanski testified that in 1986 all investor notes were assigned to a Mr. Chou in exchange for Chou's agreement to have the Chinese government purchase airplanes totaling $ 10 million. In 1987, a new corporation (Avalon Aircraft, Ltd.) was formed to acquire ownership of all the technology owned by the investors in the Avalon and the Avalon Twin components in exchange for stock of such new corporation. Petitioners' 1982 return (which was filed on July 29, 1983) included several Schedules C. On one of said Schedules C, petitioner was named as the proprietor of an aircraft development business, the cash method was indicated as the accounting method used by said business, and a deduction for R&D1990 Tax Ct. Memo LEXIS 2">12 was taken in the amount of $ 121,500 (which gave rise to a loss in a like amount). Respondent disallowed the claimed R&D deduction and resulting loss; he contends that petitioner was not engaged in the trade or business of developing and marketing aircraft components. Alternatively, respondent contends that even if petitioner were in such a business, he failed to prove that the R&D was conducted in 1982. Finally, respondent argues that petitioner was not at risk with respect to his debt obligation to Sea Star. OPINION Section 174(a)(1) provides that a taxpayer may elect to "treat research or experimental expenditures which are paid or incurred by him during the taxable year in connection with his trade or business as expenses which are not chargeable to capital account." Expenses so treated are deductible in the taxable year in which paid or incurred. The provisions of section 174(a)(1) apply not only to costs paid or incurred by the taxpayer for R&D undertaken directly by him, but also to costs paid or incurred on his behalf by someone else. Sec. 1.174-2(a)(2), Income Tax Regs.1990 Tax Ct. Memo LEXIS 2">13 Thus, initially we must determine whether petitioner was engaged in the trade or business of manufacturing and marketing aircraft components. In Green v. Commissioner, 83 T.C. 667">83 T.C. 667, 83 T.C. 667">686 (1984), we held that, for purposes of section 174, the phrase "in connection with a trade or business" should not be construed as restrictively as the term "trade or business" used elsewhere in the Code. We cautioned that in order to be permitted a deduction under section 174: the taxpayer must still be engaged in a trade or business at some time, and we must still determine, through an examination of the facts of each case, whether the taxpayer's activities in connection with a product are sufficiently substantial and regular to constitute a trade or business * * * [83 T.C. 667">Green v. Commissioner, supra at 686-687.] Passive investment and delegation of business responsibilities to others do not constitute a trade or business. See Drobny v. Commissioner, 86 T.C. 1326">86 T.C. 1326, 86 T.C. 1326">1343-1348 (1986). Petitioner contends that his trade or business consisted1990 Tax Ct. Memo LEXIS 2">14 of his right to license and market aircraft component technology developed on his behalf by Sea Star and Airmaster. Such contention, respondent claims, "amounts to an attempt to transmogrify a passive investment into a trade or business in order to qualify for deductions under section 174." We agree with respondent. To constitute a trade or business, a venture must be entered into with an actual and honest objective of making a profit. Section 183; Soriano v. Commissioner, 90 T.C. 44">90 T.C. 44 (1988); 83 T.C. 667">Green v. Commissioner, supra at 687. In this regard, "profit" means economic profit, independent of tax savings. Beck v. Commissioner, 85 T.C. 557">85 T.C. 557 (1985). A venture devoid of economic substance is not recognized for tax purposes. Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 435 U.S. 561">573 (1978); Knetch v. United States, 364 U.S. 361">364 U.S. 361, 364 U.S. 361">366 (1960). In Rose v. Commissioner, 88 T.C. 386">88 T.C. 386, 88 T.C. 386">414 (1987), affd. 868 F.2d 851">868 F.2d 851 (6th Cir. 1989), we 1990 Tax Ct. Memo LEXIS 2">15 applied an integrated approach to "separate the real economic aspects from the 'financial fantasies' surrounding a transaction." The Rose approach first investigates whether the venture was primarily organized to generate tax savings and should be deemed a generic tax shelter. Once categorized as a generic tax shelter, the venture is then analyzed with objective factors to determine whether it is devoid of economic substance and should be disregarded for tax purposes. In Rose, we noted that while the subjective test is well founded in section 183, a unified approach emphasizing objective factors is preferable in cases involving generic tax shelters. 88 T.C. 386">Rose v. Commissioner, supra at 414. Under the Rose analysis, the objective and subjective tests merge into an approach in which the objective test incorporates factors considered relevant in cases decided under section 183, as well as concepts underlying sections 162 and 167. 88 T.C. 386">Rose v. Commissioner, supra at 414-415. Generic Tax ShelterA generic tax shelter possesses some or all of1990 Tax Ct. Memo LEXIS 2">16 the following common characteristics: (1) Tax benefits were the focus of the promotional materials; (2) the investors accepted the terms of purchase without price negotiation; (3) the assets in question consist of packages of purported rights, difficult to value in the abstract and substantially overvalued in relation to the 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 substance. [88 T.C. 386">Rose v. Commissioner, supra at 412.] Here, we believe the Sea Star R&D program is a generic tax shelter because: (1) tax benefits were the focus of the promotional materials; (2) petitioner accepted the terms of the purchase without price negotiation; in fact, the components with respect to which petitioner allegedly purchased R&D apparently were selected by Wainwright (who financially benefitted from petitioner's investment) without consulting petitioner and after petitioner told him how much he could invest; (3) the R&D petitioner purchased1990 Tax Ct. Memo LEXIS 2">17 was difficult to value and consisted of little, if any, tangible property; and (4) approximately two-thirds of the purchase price was deferred using a promissory note which was in effect disregarded by the parties. As a generic tax shelter, we must next decide whether the Sea Star R&D program lacked economic substance. Smith v. Commissioner, 91 T.C. 733">91 T.C. 733, 91 T.C. 733">753-756 (1988). Economic SubstanceIn Rose, we found the following four factors to be of particular significance in our analysis of whether the transaction had economic substance consonant with its intended tax effect: 1) the dealings between the promoter and petitioners, 2) the relationship between sales price and fair market value, 3) structure of the financing, and 4) perceived congressional intent. 88 T.C. 386">Rose v. Commissioner, supra at 415-422. Application of these objective factors to the facts in this case (as discussed hereafter) demonstrates that the Sea Star R&D program lacked economic substance. 1. The Dealings Between Sea Star and PetitionerThe information petitioner1990 Tax Ct. Memo LEXIS 2">18 received from Sea Star was geared significantly toward tax advantages that purportedly would be derived from investing in the Sea Star R&D program. Petitioner neither sought nor received any information regarding how he could commercially exploit the components unless the Avalon Twin was successfully completed. Nor did petitioner analyze the probability that the Avalon Twin would be completed. The agreement petitioner entered with Sea Star did not guarantee production of any airplanes; in fact, the agreement pointed out that nothing of commercial value might ever result from the research. Although the agreements entered into by petitioner gave him the right to market the components to other airplane manufacturers, it is doubtful that the components would be of any commercial value to anyone other than Airmaster and Sea Star given the fact that the components would not, without modification, fit any plane other than the Avalon Twin. Furthermore, the agreements petitioner entered into gave him no input into the management of the R&D with respect to his components or to their marketing. The Avalon Twin was divided into 185 component parts, and such parts were sold to 51 investors.1990 Tax Ct. Memo LEXIS 2">19 Altogether, the investors purchased approximately one-half of the plane. Therefore, even if the investors banded together to market the components, they would be attempting to market one-half of a plane, and one-half a plane will not fly. Not surprisingly, petitioner never did (and apparently never will) receive income from his investment in the R&D. In our opinion, petitioner did not act in a businesslike manner. He failed to seek or receive independent valuation or distribution information despite the fact that he was utterly inexperienced in the aircraft industry. Moreover, there is no evidence that petitioner received or analyzed any cash flow or income projections with respect to the Sea Star R&D program. Instead, he chose to rely upon the advice of Wainwright, who promoted such program. In summary, petitioner failed to show that he devoted the time or effort with respect to his investment in the Sea Star R&D program consonant with an actual profit objective. 2. Relationship Between Sales Price and Fair Market ValuePetitioner agreed to pay Sea Star $ 121,500 to have R&D performed on his behalf. Of this amount, only one-third was to be paid currently in cash, 1990 Tax Ct. Memo LEXIS 2">20 and the balance was deferred over a 10-year period. Neither party presented testimony with respect to the fair market value of the R&D information purchased by petitioner. Nor was any evidence presented regarding the method employed by Sea Star in setting the purchase price. We note that the Purchase Agreement provided that the R&D would be completed by 1982 year end; however, the only funds available to pay for the R&D were the cash payments which constituted one-third of the purchase price. Thus, if only one-third of the purchase price was currently available to complete the R&D, it would appear that either the price of the R&D was inflated, or the project was underfunded and doomed to failure from the beginning. Given the circumstances of the transaction, we believe the former to be more likely than the latter. We further note that in fact petitioner paid only $ 24,500 of his purported $ 121,500 investment. He nonetheless deducted the entire $ 121,500 on his 1982 Federal income tax return which resulted in tax savings of over $ 50,000. 3. Structure of the Financing1990 Tax Ct. Memo LEXIS 2">21 The presence of deferred debt that is in substance or in fact not likely to be paid is an indication of lack of, or exaggeration of, economic substance. 88 T.C. 386">Rose v. Commissioner, supra at 419 and cases cited therein. On the other hand, bona fide third-party debt may indicate that a transaction, or at least part of it, should be recognized. 88 T.C. 386">Rose v. Commissioner, supra at 419-420; see Packard v. Commissioner, 85 T.C. 397">85 T.C. 397, 85 T.C. 397">426-428 (1985). Here, petitioner was obligated to pay one-third of the purchase price in cash as follows: $ 20,500 at the time of signing the purchase agreement on November 15, 1982, and five consecutive monthly installments of $ 4,000 each, beginning on December 15, 1982, and then on the 15th of each succeeding month. He failed to pay four of the $ 4,000 installments, or a total of $ 16,000. And neither Sea Star nor Matanski made any effort to collect the unpaid amount. Moreover, various deals were offered to investors with respect to their notes. Further, the notes, which were not due until 1992, were allegedly assigned to a man in China in return for his promise to persuade the Chinese government to1990 Tax Ct. Memo LEXIS 2">22 purchase planes from Sea Star. In 1982, petitioner had already received the benefit he sought from his investment (the $ 121,500 tax deduction). Thus, he has no incentive to repay his note. Matanski's reducing the face amount of petitioner's note and concomitant "writing down" of the royalties petitioner was to receive was a feeble attempt to encourage payment, given the fact that no sales of the Avalon Twin had occurred or were likely to occur. In our opinion, the likelihood of petitioner ever fulfilling his obligation, or Sea Star or Matanski making any meaningful effort to enforce repayment of petitioner's note, was virtually nonexistent. The function of the note was solely to increase the amount of tax deductions; the note did not represent a true obligation of petitioner. 4. Perceived Congressional IntentPetitioner contends his deduction was a legitimate use of the section 174 deduction for R&D expenses created by Congress to encourage "research and experimentation" by "small or pioneering business enterprises, as well as by established ongoing businesses," and its purpose is to somewhat "'equalize the tax benefits of the ongoing companies and those that are1990 Tax Ct. Memo LEXIS 2">23 upcoming and about to reach the market.'" 83 T.C. 667">Green v. Commissioner, supra at 686, citing Snow v. Commissioner, 416 U.S. 500">416 U.S. 500, 416 U.S. 500">502-503, 416 U.S. 500">504 (1974). We do not believe that the Sea Star R&D program is the type Congress sought to encourage through the enactment of section 174. From our examination of the record herein we are satisfied that petitioner's involvement in the Sea Star R&D program was to obtain tax deductions rather than to develop a new product. In our opinion, petitioner engaged in the Sea Star R&D program primarily, if not exclusively, to obtain tax deductions in order to avoid the tax obligation due as a result of the substantial income he had derived from his law practice in 1982. Petitioner's activity was limited to the signing of various agreements and transferring money to Sea Star. He made virtually no effort to increase his knowledge with respect to his investment and spent virtually no time monitoring his investment. Sea Star may have had a valid business purpose in engaging in the R&D. However, the mere presence of a valid business purpose at one level of a transaction does not automatically entitle passive investors distant1990 Tax Ct. Memo LEXIS 2">24 from day-to-day operations of the enterprise to the associated tax benefits. Beck v. Commissioner, 85 T.C. 557">85 T.C. 557, 85 T.C. 557">580 (1985). The activities of petitioner never surpassed those of an investor purchasing tax benefits; there is no reason to believe that the activities engaged in by petitioner are the type which Congress intended to promote through the enactment of section 174. The nature of the dealings between petitioner and Sea Star, the disparity between the purchase price and the fair market value of the property acquired by petitioner, and the illusory nature of the financing convince us that petitioner's purchase of aircraft component technology from Sea Star is devoid of economic substance. Accordingly, respondent's denial of the R&D deductions (and resulting loss) claimed by petitioner is sustained. Because we have held that the transaction was devoid of economic substance, we need not address respondent's alternate arguments. We note, however, our doubt as to the extent to which the R&D was undertaken during 1982. Additions to Tax1. Sections 6653(a)(1) and (a)(2)The next issue for decision is whether petitioner's underpayment of tax1990 Tax Ct. Memo LEXIS 2">25 for the year 1982 was due to negligence or intentional disregard of rules and regulations under section 6653(a). Negligence has been defined as a lack of due care or failure to do what a reasonable and ordinarily prudent person would do in a similar situation. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985). Respondent's determination that the underpayment was due to negligence is presumptively correct, and petitioners bear the burden of proving otherwise by a preponderance of the evidence. Luman v. Commissioner, 79 T.C. 846">79 T.C. 846, 79 T.C. 846">860-861 (1982); Rule 142(a). Petitioner seeks to avoid the application of the section 6653(a) additions to tax by claiming that he relied upon his accountant to accurately prepare the return. As a general rule, the duty of filing accurate returns cannot be avoided by placing the responsibility on the tax return preparer. Pritchett v. Commissioner, 63 T.C. 149">63 T.C. 149, 63 T.C. 149">174 (1974); Enoch v. Commissioner, 57 T.C. 781">57 T.C. 781, 57 T.C. 781">802 (1972).1990 Tax Ct. Memo LEXIS 2">26 Petitioner presented insufficient evidence to show that the general rule should not apply in this case and has presented insufficient evidence to overcome the presumption of correctness attached to respondent's determination. Thus, we conclude that petitioners are liable for the additions to tax under sections 6653(a)(1) and (a)(2). 2. Section 6661With respect to returns filed after December 31, 1982, section 6661(a) imposes an addition to tax on any underpayment attributable to a substantial understatement of income tax. Section 6661(b)(1) defines a substantial understatement of income tax as an understatement exceeding the greater of 10 percent of the tax required to be shown on the return for the year or $ 5,000. Petitioners clearly understated their 1982 tax liability. The correct rate of the addition to tax is 25 percent of the underpayment attributable to such understatement. Section 6661(a); Pallottini v. Commissioner, 90 T.C. 498">90 T.C. 498 (1988). However, respondent concedes that because he determined the addition to tax at a rate of 10 percent in the1990 Tax Ct. Memo LEXIS 2">27 notice of deficiency and failed to subsequently claim the addition to tax at the correct rate, if petitioners are liable for the addition to tax, it should be applied at the rate of 10 percent of the underpayment. Pursuant to section 6661(b)(2)(B) the amount of the understatement is to be reduced by the portion of the understatement which is attributable to: (i) the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment, or (ii) any item with respect to which the relevant facts affecting the item's tax treatment are adequately disclosed in the return or in a statement attached to the return. However, special understatement reduction rules apply to tax shelters. Under section 6661, tax shelters are defined as follows: (I) a partnership or other entity, (II) any investment plan or arrangement, or (III) any other plan or arrangement, if the principal purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax. Section 6661(b)(2)(C)(ii). We are satisfied that the principal purpose1990 Tax Ct. Memo LEXIS 2">28 of petitioner's investment in the Sea Star R&D program was the avoidance of Federal income tax. Our decision that such program lacked economic substance reinforces this conclusion. Because petitioner's understatement was attributable to his involvement in a tax shelter, we shall apply the special rules applicable to tax shelters in determining whether petitioners' understatement should be reduced. Where a tax shelter is involved, disclosure of relevant facts affecting an item's tax treatment does not reduce the amount of the understatement. Section 6661(b) (2)(C)(i)(I). However, the understatement is reduced if the taxpayer has substantial authority for his treatment of the item and he reasonably believes that the tax treatment of such item was more likely than not the proper treatment. Section 6661(b)(2)(C)(i)(II). Petitioners have not provided any substantial authority for their $ 121,500 R&D deduction, nor do we believe petitioners reasonably believed that their tax treatment of the item was more likely than not the proper treatment. Accordingly, respondent's determination of the section 6661 addition to tax, at a rate of 10 percent of the underpayment, is sustained. 3. 1990 Tax Ct. Memo LEXIS 2">29 Section 6621(c)The final issue for decision is whether petitioners are liable for increased interest pursuant to section 6621(c). 3Section 6621(c) imposes interest at a rate of 120 percent of the statutory rate for substantial underpayments (defined as underpayments of at least $ 1,000) attributable to tax motivated transactions. Section 6621(c)(1). Tax motivated transactions include valuation overstatements (as defined in section 6659), as well as sham or fraudulent transactions. Sections 6621(c)(3)(A)(i) and (v). Sham or fraudulent transactions include those in which the taxpayer lacks a profit objective and which are without economic substance. Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 88 T.C. 1086">1128-1129 (1987), affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186">856 F.2d 186 (4th Cir. 1988), affd. without published opinion Patin v. Commissioner, 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989),1990 Tax Ct. Memo LEXIS 2">*30 affd. Gomberg v. Commissioner, 868 F.2d 865">868 F.2d 865 (6th Cir. 1989), and affd. Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93 (9th Cir. 1989). We have concluded that the transaction at issue was without economic substance; petitioners are therefore liable for the increased interest as provided in section 6621(c). 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 all Rule references are to the Tax Court Rules of Practice and Procedure. All dollar amounts are rounded. ↩2. Subsec. (d) of sec. 6621 was redesignated subsec. (c) and amended by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1511(c)(1)(A)-(C), 100 Stat. 2744. Herein, the reference to section 6621↩ is as redesignated and amended.3. The additional interest accrues after December 31, 1984, regardless of the filing date of the returns. DeMartino v. Commissioner, 88 T.C. 583">88 T.C. 583, 88 T.C. 583">589↩ (1987).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625630/	Charles D. Cook and Carolyn C. Cook, Petitioners v. Commissioner of Internal Revenue, RespondentCook v. CommissionerDocket No. 6463-80United States Tax Court80 T.C. 512; 1983 U.S. Tax Ct. LEXIS 107; 80 T.C. No. 23; March 8, 1983, Filed 1983 U.S. Tax Ct. LEXIS 107">107 Decision will be entered under Rule 155. Petitioner and his former wife, Sheila, were divorced in Connecticut in 1976. In a brief memorandum of decision, the divorce court ordered petitioner to transfer to Sheila certain assets he had acquired during the marriage by gift or purchase from Sheila and her parents. Held, the transfer was in the nature of a division of property and was not a taxable transaction. United States v. Davis, 370 U.S. 65">370 U.S. 65 (1962), distinguished. Julian S. Greenspun, for the petitioners.Robert E. Marum, for the respondent. Drennen, Judge. DRENNEN80 T.C. 512">513 Respondent determined a deficiency in, and an addition to, petitioners' 1976 Federal income tax in the amounts of $ 384,437 and $ 19,222, respectively. The issues for decision are (1) whether the transfer of appreciated stock and real properties by Charles D. Cook to his former wife pursuant to a divorce decree was a taxable transaction, and (2) whether petitioners are liable for an addition to tax pursuant to section1983 U.S. Tax Ct. LEXIS 107">109 6653(a). 1FINDINGS OF FACTPetitioner Charles D. Cook (petitioner) and Carolyn C. Cook, husband and wife, resided in Cos Cob, Conn., at the time they filed their petition herein. They filed a joint return for the taxable year 1976 with the Internal Revenue Service, Andover, Mass. Petitioner Carolyn C. Cook is a party herein only because she filed a joint return with her husband.Petitioner was married to Sheila Gamble Cook (hereinafter referred to as Sheila or the former wife) on March 10, 1945. Sheila was the daughter of John Gamble, one of the founders and principal stockholders of Procter & Gamble Co. Petitioner and Sheila separated in 1974, and their marriage was formally dissolved on May 12, 1976. Pursuant to a court order in respect of the marital dissolution, petitioner transferred to Sheila 8,995 shares of Procter & Gamble stock and his interest in three1983 U.S. Tax Ct. LEXIS 107">110 parcels of real property located in Maine. The dispute herein centers on whether such transfer constitutes a taxable disposition.At the time of their divorce, petitioner and Sheila each submitted an individual financial statement to the divorce court. These statements indicated that petitioner had assets valued at $ 1,851,777, while Sheila had assets valued at $ 2,587,957. Petitioner's assets included at least 8,995 shares of Procter & Gamble stock, 2 and an interest in three parcels of 80 T.C. 512">514 land located in and around Sorrento, Maine. The facts surrounding his acquisition of these assets follow.Procter & Gamble StockPetitioner acquired his Procter & Gamble stock by way of gifts from Sheila, as well as from his father-in-law, John Gamble, and his mother-in-law, Elizabeth Gamble (hereinafter referred to as his in-laws). These gifts were made each year beginning in 1947 and continuing through 1961. The following table reflects1983 U.S. Tax Ct. LEXIS 107">111 the amount and value of the Procter & Gamble stock received by petitioner from Sheila and his in-laws:Gifts from SheilaNumberMarket valueYearof sharesat date of gift194745$ 3,072.651948452,947.501949403,182.80195075065,737.501951805,813.601952855,695.001953885,900.401954805,852.801955656,040.45Gifts from in-laws 1NumberMarket valueYearof sharesat date of gift1947805,546.401948805,140.001949605,000.001950805,536.801951805,746.401952805,497.601953805,500.801954605,745.001955605,922.0019561205,936.8019571205,904.001958604,452.601959302,669.401960302,922.001961202,799.6080 T.C. 512">515 Due to various stock splits, petitioner held 17,118 shares of Procter & Gamble stock in October 1974.Sheila decided to make yearly gifts of her Procter & Gamble stock in order to equalize her and petitioner's respective financial1983 U.S. Tax Ct. LEXIS 107">112 positions. The in-laws made yearly gifts to petitioner, as well as to his and Sheila's four children, in equal amounts. The number of shares given each year by each of the donors was measured by the number of shares that could be given without incurring gift tax liability.The gifts were made free of any restrictions on petitioner's use of the stock. At the time the gifts were made, ownership was transferred to petitioner's name on Procter & Gamble's books, and dividends on such stock were paid to him. 3 However, it was the hope of the donors that the stock would remain Gamble "family resources," and petitioner testified that he did not feel free to sell his stock "without family consultation."In November 1974, after petitioner and Sheila had separated, petitioner sold 8,000 shares of his Procter & Gamble stock. 4 There was no way of determining1983 U.S. Tax Ct. LEXIS 107">113 whether the stock sold had been received from Sheila, or from his in-laws. The proceeds received from this sale, as well as the dividends received on his Procter & Gamble stock, were deposited into petitioner's separate account at the Loring Wolcott agency, which was his and Sheila's investment counselor. These funds later were used to pay for both family expenses and personal investment. 580 T.C. 512">516 The Maine PropertiesOn February 16, 1961, petitioner purchased a one-half interest in real property known as Calf Island from his father-in-law for $ 9,500, the fair market value of the property. This property was located1983 U.S. Tax Ct. LEXIS 107">114 in Sorrento, Maine, and consisted of Calf Island and two smaller islands. The remaining one-half interest was purchased by Sheila's brother, James B. Gamble, Jr. Calf Island had been used by the Gamble family for summer vacations for many years, and John Gamble was buried there.On October 16, 1961, petitioner and Sheila, as joint tenants, purchased a one-half interest in real property located in Sorrento, Maine, known as Shoremead. The property was purchased from Christine J. Sommer for $ 5,000, its fair market value at that time.On November 19, 1963, petitioner purchased real property located in Sorrento, Maine, known as Doan's Point. The property was purchased from his mother-in-law, Elizabeth Gamble, for $ 2,500, its fair market value at that time.Petitioner initiated a divorce action against Sheila on November 26, 1974, seeking to have the marriage dissolved. In a cross-complaint filed on May 3, 1976, Sheila also sought to have the marriage dissolved and claimed, inter alia, her right (1) to alimony; (2) to the return of assets acquired by reason of their marriage, including but not limited to, realty and stocks; and (3) to counsel fees.In a "Memorandum of Decision" filed1983 U.S. Tax Ct. LEXIS 107">115 by the divorce court on May 12, 1976, petitioner's marriage to Sheila was dissolved. The decision did not indicate which party prevailed; it simply found that there had been an irretrievable breakdown of the marriage and that "The marriage is dissolved." This decision made no provision for alimony or counsel fees sought by Sheila. The court did, however, order that --title and ownership of the following assets of the plaintiff [petitioner] be transferred by the plaintiff to the defendant [Sheila]:(1) 8,995 shares of Procter & Gamble;(2) An undivided one-half of Calf Island, Sorrento, Maine;(3) Doan's Point, Sorrento, Maine; and(4) A one-quarter share of Shoremead, Sorrento, Maine.The order stated no reason or basis for the directed transfer.Thereafter, on June 7, 1976, petitioner filed a "Motion for 80 T.C. 512">517 Clarification and/or Modification of Judgment" with the divorce court. It was petitioner's position that the court's decision omitted an essential element, namely, the income tax consequences of the above-ordered transfer. The stock and real properties had all appreciated in value, and on May 6, 1976, the date of the dissolution proceeding, their aggregate value1983 U.S. Tax Ct. LEXIS 107">116 was $ 1,037,475.60. The aggregate basis of these properties was $ 26,553.30, and thus the potential gain realized on the transfer was $ 1,010,922.30. On brief, in support of his motion, petitioner stated that the "memorandum of decision does not make clear whether the property transfer is in settlement of marital rights or simply a division of property. The distinction is highly relevant for tax purposes." Petitioner concluded that because of the unfairness which he perceived would result by virtue of the court's order, the court should modify its decision of May 12, 1976, by ordering the transfer of the property indicated therein "net of all taxes."The divorce court entered a "Memorandum of Decision" on August 12, 1976, denying petitioner's motion without explanation. Petitioner was dismayed by the decision since he believed he would incur a large tax liability as a result of the court-ordered transfer, and discussed the situation with the divorce court judge, Judge Dube. At that time, petitioner was told not to worry since the transfer was merely a "return of property" and therefore was not taxable.On his return filed for the taxable year 1976, petitioner did not report a1983 U.S. Tax Ct. LEXIS 107">117 gain from the transfer of property pursuant to his divorce. He did, however, disclose on the return that he had "Distributed to Sheila G. Cook 8,995 SHS Procter & Gamble Co. In Accordance With Court Order of 5/6/76."Petitioner and Carolyn Cook were married in June 1976.Respondent determined in his statutory notice of deficiency that petitioner realized a long-term capital gain on the transfer of the properties herein to Sheila to the extent that the fair market value of such properties on the date of the dissolution proceeding (May 6, 1976), exceeded their adjusted bases.OPINIONThe primary issue for decision is whether petitioner's transfer of appreciated stock and real property (hereinafter 80 T.C. 512">518 sometimes referred to collectively as properties) to Sheila pursuant to a court order in respect of their divorce constitutes a taxable disposition.Petitioner maintains that Sheila was the "actual owner" of the properties transferred and, therefore, no taxable disposition occurred. Alternatively, he claims that under Connecticut law, Sheila had a vested interest in the properties which amounted to a "species of common ownership" and that assuming a transfer of ownership did occur, 1983 U.S. Tax Ct. LEXIS 107">118 it was a nontaxable division of property between co-owners.Respondent claims that petitioner was the owner of the properties in question and that the transfer was a disposition in satisfaction of Sheila's marital rights. Therefore, he claims that petitioner realized a taxable gain on the transfer to the extent that the value of the properties exceeded their aggregate basis.The leading case on this issue is United States v. Davis, 370 U.S. 65">370 U.S. 65 (1962). In that case, the parties entered into a settlement agreement, which was incorporated in the divorce decree, pursuant to which the husband agreed, specifically as a "division in settlement of their property," to transfer 1,000 shares of Dupont Co. stock to the wife. The stock was the husband's separate property and had appreciated in value while he owned it. Under Delaware law, the State wherein the divorce action was instituted, the wife had only statutory marital rights in the husband's property, including a right of intestate succession and a right upon divorce to a share of the husband's property. Under the settlement agreement, the wife accepted the division "in full settlement and satisfaction1983 U.S. Tax Ct. LEXIS 107">119 of any and all claims and rights against the husband whatsoever (including but not by way of limitation, dower and all rights under the laws of testacy and intestacy)."The Supreme Court recognized that the accretion in value of the stock was taxable but the question was when -- at the time of the transfer to the wife or at a later time when the wife sold the stock? The taxpayer-husband asserted that the present transfer was comparable to a nontaxable division of property between two co-owners, while the Government contended that it more resembled a taxable transfer of property in exchange for the release of an independent legal obligation, the husband's duty to support his wife.80 T.C. 512">519 The Court found that under Delaware law, the "inchoate rights granted a wife in her husband's property by the Delaware law do not even remotely reach the dignity of co-ownership" and, since the wife had no other interest in the husband's property, upon dissolution of the marriage the wife shares in the husband's property only to such extent as the Court deems reasonable, as provided in Delaware law. The Court found that the Delaware law only placed a burden on the husband's property, rather1983 U.S. Tax Ct. LEXIS 107">120 than making the wife a part owner thereof, which partook more of a personal liability, such as the husband's obligation of support and alimony, rather than creating a property interest in the wife. The Court thus concluded that the transfer was not a division of property and, consequently, was a taxable event.The Court next turned to the question of how to measure the taxable gain. Admittedly, this was the difference between the husband's basis in the stock transferred and the value of the property received in exchange. The property received in exchange was the release of the wife's inchoate marital rights. Since there is no accurate method of measuring the value of these rights, in prior cases some courts had refused to impose a tax because the gain was found to be indeterminable. Mesta v. Commissioner, 42 B.T.A. 933">42 B.T.A. 933 (1940), revd. 123 F.2d 986">123 F.2d 986 (3d Cir. 1941); Halliwell v. Commissioner, 44 B.T.A. 740">44 B.T.A. 740 (1941), revd. 131 F.2d 642">131 F.2d 642 (2d Cir. 1942), cert. denied 319 U.S. 741">319 U.S. 741 (1943); Commissioner v. Marshman, 279 F.2d 27">279 F.2d 27 (6th Cir. 1960),1983 U.S. Tax Ct. LEXIS 107">121 revg. 31 T.C. 269">31 T.C. 269 (1958). The Supreme Court found this approach to be erroneous on the theory that if the parties acting at arm's length judged the marital rights to be equal in value to the property for which they were exchanged, it was permissible to assume, for purposes of measuring the gain, that the value of the marital rights released was equal to the value of the property received in exchange therefor. The amount of the gain was thus found to be the difference between the husband's basis in the stock transferred and the fair market value of that stock at the time of the transfer.The Davis case has been applied by various courts to mean that if the wife had no rights in the property that rose to the dignity of co-ownership, there was no division of property, and the transaction was held to be taxable as a transfer of the property involved in exchange for the release of the spouse's 80 T.C. 512">520 marital rights. Pulliam v. Commissioner, 39 T.C. 883">39 T.C. 883 (1963), affd. 329 F.2d 97">329 F.2d 97 (10th Cir. 1964), cert. denied 379 U.S. 836">379 U.S. 836 (1964); Collins v. Commissioner, 46 T.C. 461">46 T.C. 461 (1966),1983 U.S. Tax Ct. LEXIS 107">122 affd. 388 F.2d 353">388 F.2d 353 (10th Cir. 1968), revd. per curiam 393 U.S. 215">393 U.S. 215 (1968); 6Wiles v. Commissioner, 60 T.C. 56">60 T.C. 56 (1973), affd. 499 F.2d 255">499 F.2d 255 (10th Cir. 1974). See also Thomas v. Thomas, 159 Conn. 477">159 Conn. 477, 271 A.2d 62">271 A.2d 62 (1970). The Supreme Court of Connecticut, in 271 A.2d 62">Thomas v. Thomas, supra at 66, said --the law seems clear: a federal capital gains tax will be incurred on a transfer of property made between a husband and a wife pursuant to a divorce or legal separation unless local law holds that the wife had a vested interest in the property transferred similar to coownership as in a community property state. No such vested interest in the wife is recognized in Connecticut. 7 * About the only recent cases we have found holding that a transfer of property, pursuant to divorce, under State statutes similar to those of Delaware (Davis) and Connecticut (this case), was not a taxable transaction are cases where the State courts have held that under those State statutes, the wife has rights in the husband's property amounting1983 U.S. Tax Ct. LEXIS 107">123 to co-ownership. See Imel v. United States, 523 F.2d 853">523 F.2d 853 (10th Cir. 1975); Collins v. Commissioner, 412 F.2d 211">412 F.2d 211 (10th Cir. 1969). 8 Compare Beard v. Commissioner, 77 T.C. 1275">77 T.C. 1275 (1981), on appeal (9th Cir., June 15, 1982).1983 U.S. Tax Ct. LEXIS 107">124 We now consider whether Sheila had an interest in petitioner's property that can be construed as co-ownership. Ownership of property is determined under State law. Legal interests and rights are created by, and exist under, State law. Federal law determines whether transactions involving interests or rights created by State law shall be taxed. 523 F.2d 853">Imel v. United States, supra at 855.80 T.C. 512">521 The stock here involved was apparently given to petitioner outright by either Sheila or her parents. The stock was transferred to petitioner's name on the corporate records, he received the dividends thereon, he sold some of the stock in his own name, and reinvested some of the proceeds in assets title to which was taken in his name, alone. If there were any strings attached to the gifts, they are not revealed in the record. In fact, to accomplish the tax-savings purpose of the Gambles, the stock had to be transferred to petitioner outright. We do not believe there can be any doubt that legal title to the stock was in petitioner.We reach the same conclusion with respect to petitioner's interests in the Maine real estate that was transferred to Sheila pursuant1983 U.S. Tax Ct. LEXIS 107">125 to the divorce decree. In 1961, petitioner purchased with his own funds an undivided one-half interest in Calf Island with his brother-in-law James F. Gamble, Jr., at its fair market value. In 1961, petitioner and Sheila purchased, as joint tenants, a one-half interest in real property located in Sorrento, Maine, known as Shoremead. In 1963, petitioner purchased from his mother-in-law real property located in Sorrento, Maine, known as Doan's Point. The deed was to petitioner, alone. The divorce decree ordered that title and ownership of these three parcels of real estate be transferred by petitioner to Sheila. It is clear that legal title to petitioner's one-half interest in Calf Island and legal title to Doan's Point were in petitioner alone. Sheila did have an interest as joint tenant in the one-half interest in Shoremead.We next consider why the divorce court ordered petitioner to transfer the properties to Sheila. Compare 77 T.C. 1275">Beard v. Commissioner, supra.While the law of the State where real property is located controls the title and ownership of that property, the law of the State wherein the parties are domiciled and where the divorce takes1983 U.S. Tax Ct. LEXIS 107">126 place controls what the divorce court can direct with respect to those properties. In this case, that would be the law of Connecticut. However, we do not find there is sufficient difference between the statutory laws of Connecticut and Maine to require different conclusions, either as to the property interests and rights of a married couple or in the authority of a divorce court judge to direct what shall be done 80 T.C. 512">522 with that property. Consequently, we will limit our discussion to the laws of Connecticut. 9Connecticut General Statutes Annotated, section 46-9 (West 1978), provides that neither husband nor wife shall acquire by marriage any right to or interest in any property1983 U.S. Tax Ct. LEXIS 107">127 held by the other before or acquired after such marriage, except the share of the survivor in the property as provided by section 46-12. Section 46-12 provides, inter alia, that "On the death * * * of the husband or wife, the survivor shall be entitled to the use for life of one-third in value of all the property, real and personal, legally or equitably owned by the other at the time of his or her death." In 159 Conn. 477">Thomas v. Thomas, supra, the Supreme Court of Connecticut found that neither husband nor wife acquires by statute any right in the property of the other except for certain survivorship rights, whether such property is acquired before or after the marriage, and that such right does not amount to co-ownership. On the surface, it would appear that Sheila had no vested interest in any of the property owned by petitioner that he transferred to Sheila pursuant to the divorce decree. Tobey v. Tobey, 165 Conn. 742">165 Conn. 742, 345 A.2d 21">345 A.2d 21, 345 A.2d 21">25 (1974).Conn. Gen. Stat. Ann. sec. 46-51 (West 1978), provides as follows:At the time of entering a decree annulling or dissolving a marriage or for legal separation1983 U.S. Tax Ct. LEXIS 107">128 pursuant to a complaint under section 46-36, the superior court may assign to either the husband or wife all or any part of the estate of the other; and may pass title to real property, without any act on the part of either the husband or the wife, to the other party or to a third person or may order the sale of such real property, when in the judgment of the court, it is the proper mode to carry such decree into effect. * * In fixing the nature and value of the property, if any, to be so assigned, the court, after hearing the witnesses, if any, of each party, except as provided in subsection (a) of section 46-48, shall consider the length of the marriage, the causes for the annulment, dissolution of the marriage or legal separation, the age, health, station, occupation, amount and sources of income, vocational skills, employability, estate, liabilities and needs of each of the parties and the opportunity of each for future acquisition of capital assets and income. The court shall also consider the contribution of each of the parties in the 80 T.C. 512">523 acquisition, preservation or appreciation in value of their respective estates. 101983 U.S. Tax Ct. LEXIS 107">129 This statute empowers the divorce court to transfer property held separately by one spouse to the other, irrespective of whether the property was acquired prior to, or subsequent to, the marriage. In determining whether to order a transfer of such property, and if so, how much, the court has wide discretion. Ross v. Ross, 172 Conn. 269">172 Conn. 269, 374 A.2d 185">374 A.2d 185 (1977); Pasquariello v. Pasquariello, 168 Conn. 579">168 Conn. 579, 362 A.2d 835">362 A.2d 835 (1975).Petitioner argues that the properties transferred were already owned by Sheila, resting on the theory that the divorce court invoked equitable principles pursuant to Connecticut law and determined that Sheila was the "true owner" of such properties. Specifically, he claims that the court either imposed a constructive trust or recognized the existence of a resulting trust over such properties in favor of Sheila, and that the actual transfer under such circumstances was not a taxable transaction. This argument is appealing because it would produce a seemingly more equitable result and would also seem more consistent with the testimony of Judge Dube, the divorce court judge1983 U.S. Tax Ct. LEXIS 107">130 who directed the transfer. Technically, however, we cannot find that the circumstances support either a constructive or a resulting trust.Generally speaking, a constructive trust is an equitable remedy which compels one who unfairly holds a property interest to convey that interest to another to whom it justly belongs. See 5 A. Scott, Trusts 410 (3d ed. 1967). The trust is imposed, not on the basis of the intentions of the parties (as is a resulting trust), but in order to prevent unjust enrichment. 5 A. Scott, supra at 3415. The Supreme Court of Connecticut has stated that a constructive trust arises as a result of fraud, imposition, circumvention, artifice or concealment, or abuse of confidential relations. Worobey v. Sibieth, 136 Conn. 352">136 Conn. 352, 71 A.2d 80">71 A.2d 80 (1949).Petitioner does not assert that the alleged constructive trust resulted from any particular conduct on his part. Rather, he 80 T.C. 512">524 simply asserts that imposition of such trust was necessary to prevent him from being unjustly enriched, since the properties he had acquired, both by gift and by purchase, were Gamble family resources. He relies on several Connecticut1983 U.S. Tax Ct. LEXIS 107">131 cases in support of his assertion. Such reliance is misplaced.In Manyak v. Manyak, 29 Conn. Supp. 1">29 Conn. Supp. 1, 268 A.2d 806">268 A.2d 806 (1970), the husband filed a complaint seeking the imposition of a constructive trust over property held jointly with his wife at the time of their divorce proceeding. The court found that the conveyance to the wife of her one-half interest had been induced by fraud, and imposed a constructive trust over such interest in favor of the husband.In Hieble v. Hieble, 164 Conn. 56">164 Conn. 56, 316 A.2d 777">316 A.2d 777 (1972), the owner of property, fearing the reoccurrence of cancer, transferred title to her son for estate tax purposes with the understanding that the transfer was conditional, and the property was to be returned to her, should she recover. After his mother recovered, the son refused to reconvey the property to her, and the court therefore imposed a constructive trust over such property in her behalf.There are no facts in the instant case similar to those in the above two cases which caused the courts to impose constructive trusts, and those cases are readily distinguishable.On the other1983 U.S. Tax Ct. LEXIS 107">132 hand, if a disposition of property is made under circumstances that raise an inference that it was not intended that the person taking the property should have the beneficial interest in such property, a resulting trust arises in favor of the transferor. 5 A. Scott, Trusts 404.1 (3d ed. 1967). For example, a resulting trust is presumed to arise where property is purchased by one person, while legal title is taken in the name of another. 5 A. Scott, supra at 404.1. However, in the case of a husband and wife, a gift is presumed under such circumstances unless rebutted by a showing that no gift was intended. See Whitney v. Whitney, 171 Conn. 23">171 Conn. 23, 368 A.2d 96">368 A.2d 96 (1976); Walter v. Home National Bank & Trust Co. of Meriden, 148 Conn. 635">148 Conn. 635, 173 A.2d 503">173 A.2d 503 (1961).Under the circumstances herein, we cannot find that a resulting trust arose with respect to either the Maine properties or the Procter & Gamble stock. Petitioner's interest in the Maine properties was acquired by purchase with his own funds for fair market value, and the deeds of transfer contained no 80 T.C. 512">525 restrictions on petitioner's1983 U.S. Tax Ct. LEXIS 107">133 use or alienation of such properties. The Procter & Gamble stock was acquired by gift from Sheila and her mother and father, and the gifts were completed. While we accept as true petitioner's representation that the properties were considered part of the Gamble family resources, and that petitioner was given the stock and was sold the real estate only because of his status as a member of the Gamble family, we are not convinced that any of these properties were acquired and held only on the condition that the marriage continue.Petitioner relies on two other cases to support his assertion that the divorce court simply recognized Sheila's actual ownership of properties transferred even though title was held in petitioner's name. In Dubicki v. Dubicki, 186 Conn. 709">186 Conn. 709, 443 A.2d 1268">443 A.2d 1268 (1982), the divorce court ordered the husband to transfer his interest in jointly owned property to his wife. The property had been acquired by a gift from the wife's mother. The court did not, however, impose a constructive trust over the husband's interest in the property, as petitioner suggests, or otherwise recognize an ownership interest in such property1983 U.S. Tax Ct. LEXIS 107">134 in the wife prior to the divorce. Rather, as the Supreme Court of Connecticut noted, the divorce court simply determined what it believed to be a reasonable and equitable division of marital assets pursuant to Conn. Gen. Stat. Ann. sec. 46-51 (West 1973), taking into consideration the manner in which the property had been acquired.In Kroop v. Kroop, 186 Conn. 211">186 Conn. 211, 440 A.2d 293">440 A.2d 293 (1982), the divorce court ordered the husband to transfer to his wife his stock interest in a business which they had operated jointly. The business originally had been acquired with a downpayment by the wife and a note endorsed by the wife's father. The wife owned a one-half interest in the business. Over the years, the husband had failed to pay to the wife her share of the profits from the business in an amount approximately equal to the value of his stock interest at the time of divorce. The Supreme Court of Connecticut upheld the order of transfer and, in dicta, stated that such transfer was not taxable to the husband because the wife already had the beneficial interest in his stock and the transfer merely restored the full value of such stock to her.80 T.C. 512">526 1983 U.S. Tax Ct. LEXIS 107">135 The reason the divorce court in the instant case ordered the transfer of petitioner's properties to Sheila appears to be based on the theory espoused in Dubicki and Kroop.Petitioner offered the oral testimony of Judge Norman Dube, the State trial referee who presided at the divorce proceedings and entered the memorandum of decision directing the transfer of the properties to Sheila, to explain the theory on which the transfer was ordered. Respondent objected to the testimony on the grounds that the order was not ambiguous and parole or extrinsic evidence is not admissible to explain, modify, or contradict the terms of a written instrument where upon its face there is no ambiguity. There was certainly no ambiguity on the face of the order. It very succinctly ordered that "the title and ownership of the following assets of the plaintiff be transferred by the plaintiff to the defendant," thereafter listing the assets. However, it gave no reason or theory for directing the transfer. Under Connecticut law, Judge Dube had the right to order the transfer and we doubt that he was required to give his reasons therefor in the order. Nevertheless, the theory or reason for ordering1983 U.S. Tax Ct. LEXIS 107">136 the transfer has considerable bearing on the Federal tax issue before us, and we do not believe that the parole evidence rule, if available to respondent in the first place (see Estate of Craft v. Commissioner, 68 T.C. 249">68 T.C. 249, 68 T.C. 249">259-264 (1977), affd. per curiam 608 F.2d 240">608 F.2d 240 (5th Cir. 1979)), should deny this Court and the parties the firsthand testimony of the judge who entered the order, explaining the basis for his decision, as long as his testimony is consistent with the order. Schumert & Warfield v. Security Brewing Co., 199 F. 358">199 F. 358 (E.D. La. 1912); Gorham v. City of New Haven, 79 Conn. 670">79 Conn. 670, 66 A. 505">66 A. 505 (1907); Brinkerhoff v. Home Trust & Savings Bank, 109 Kan. 700">109 Kan. 700, 205 P. 779">205 P. 779 (1921). We conclude that the testimony of Judge Dube was admissible and we give consideration to it. 11 See 77 T.C. 1275">Beard v. Commissioner, supra.1983 U.S. Tax Ct. LEXIS 107">137 Judge Dube testified, in essence, that his reaction to the 80 T.C. 512">527 evidence received in the divorce proceeding was that the stock was given to Charles, and the real estate was conveyed to him because of his marriage to Sheila, that there was "more or less a quasi-ownership" in Sheila in the property, that the properties were considered by the Gambles to be a part of the family estate, that when the contract of marriage was broken, Sheila should get back what she and her family had given Charles, and that the purpose of the transfer he ordered was "To give back to Mrs. Cook that which I felt was rightfully hers." He also testified that he did not award any alimony or attorney's fees because both parties had enough income and that the properties ordered transferred were not in exchange for the release of any marital obligations that Charles had towards Sheila. He testified, further, that when Charles asked him to modify the order to take into consideration the Federal tax consequences, he denied it without a hearing because he did not "see how Uncle Sam could get any tax money from this, because this was hers"; and that he did not feel there were any tax consequences because, although1983 U.S. Tax Ct. LEXIS 107">138 the property was in Charles' name, it was actually owned by Sheila.Thus, while the order of transfer enforced by the divorce court was not a "division of property" in the ordinary meaning of those words, 12 neither was the transfer ordered to discharge Charles' marital obligations to Sheila.Unlike in Davis, petitioner and Sheila did not enter into a settlement agreement and Sheila did not specifically surrender any marital rights, nor was she specifically required by the court order to surrender any other property or rights, tangible or intangible. Petitioner received nothing in exchange for the assets transferred, and we cannot find that he received anything that could be considered taxable income to him. Petitioner received nothing to which an assumed value could be attached, as in Davis. While it is difficult to classify the transaction in the terminology usually used with reference1983 U.S. Tax Ct. LEXIS 107">139 to this issue, we think the divorce judge simply intended to return to Sheila the property he thought belonged to her, regardless of legal title. He apparently gave considerable weight to the last factor mentioned in Conn. Gen. Stat. Ann. 80 T.C. 512">528 sec. 46-51, supra, which requires the divorce court to give consideration to the contribution of each party in the acquisition of the assets in making a division of property. He intended to return the parties to the same positions in which they were with respect to these properties before they were married. 13 Judge Dube believed that Sheila had some sort of interest in these properties, tangible or intangible, legal or equitable, which became vested in her when the marriage contract was dissolved.We conclude that under these particular circumstances, the transfer of the properties1983 U.S. Tax Ct. LEXIS 107">140 was more in the nature of a division of property rather than a satisfaction of any marital obligations of petitioner to Sheila. 77 T.C. 1275">Beard v. Commissioner, supra.We do not believe Davis or any of its progeny requires a different conclusion. We recognize that the divorce decree herein cut off Sheila's right to share in petitioner's estate in the event of his death and that opinions in some of the decided cases (the Davis progeny) suggest that this factor is sufficient, in the absence of a finding of co-ownership, to constitute a taxable event. See, e.g., Wiles v. Commissioner, 60 T.C. 61-62, 499 F.2d at 258; McKinney v. Commissioner, 64 T.C. 263">64 T.C. 263, 64 T.C. 263">267 (1975); Pulliam v. Commissioner, 39 T.C. 885, 329 F.2d at 99-100. But none of these cases involved a situation such as exists herein, where the source of the taxpayer's property was his spouse or her family. Cf. 77 T.C. 1275">Beard v. Commissioner, supra, and particularly 77 T.C. 1275">77 T.C. 1290 n. 9 (second paragraph). They are therefore distinguishable. Indeed, 1983 U.S. Tax Ct. LEXIS 107">141 Davis itself emphasized the context of the particular case and recognized the possibility that there might be situations where the enunciated rule might not apply. See 370 U.S. 65">370 U.S. at 70-71. We hold that the transaction was not taxable to petitioner.Having decided the substantive issue for petitioner, we need not address the issue of the addition to tax for negligence. Nevertheless, we will briefly express our views on that issue. The substantive issue herein concerning the taxability of the transfer of the property involved substantial questions of law, as indicated by our rather lengthy discussion above. See also Kasey v. Commissioner, 54 T.C. 1642">54 T.C. 1642, 54 T.C. 1642">1651 (1970), affd. per 80 T.C. 512">529 curiam 457 F.2d 369">457 F.2d 369 (9th Cir. 1972), cert. denied 409 U.S. 869">409 U.S. 869 (1972). The situation herein, in our view, simply does not warrant the imposition of an addition to tax for negligence, and, indeed, as revealed in the transcript, we were somewhat dismayed at respondent's refusal to concede this issue at trial. If called upon, we would hold that petitioner is not liable for the addition to1983 U.S. Tax Ct. LEXIS 107">*142 tax asserted by respondent.Because of concessions by the parties,Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended and in effect during the taxable year 1976.↩2. The facts were unclear as to whether petitioner held more than this amount.↩1. These figures indicate the total amount of stock transferred from both John Gamble and Elizabeth Gamble. From 1959 through 1961, only Elizabeth Gamble made gifts to petitioner.↩3. On his 1974 tax return, petitioner reported $ 30,939 of dividends on his Procter & Gamble stock. On his 1976 return, he reported $ 14,302 of dividends on such stock.↩4. This stock was sold on the recommendation of the Gambles' investment adviser that they all sell a part of their Procter & Gamble stock. Sheila and other members of the Gamble family also followed this advice.↩5. For example, petitioner withdrew $ 148,000 from the Loring Wolcott account in 1975 to purchase a home in Cos Cob, Conn., where he resided at the time of filing the petition herein.↩6. After affirmance by the Tenth Circuit, the Oklahoma Supreme Court held that the transfer involved "merely operated to finalize the extent of the wife's vested interest in property she and her husband held under a 'species of common ownership,'" and that the transfer was a nontaxable division of property by co-owners. The U.S. Supreme Court thereupon remanded the Federal case to the Tenth Circuit for consideration in light of the opinion of the Oklahoma court. The Tenth Circuit then found the transfer to be a nontaxable division of property.↩7. A State court would not normally decide a Federal tax question, but the question was argued by the defendant in that case.↩8. We have found no case which explains why, if the transfer is not a division of property, it must, under any and all circumstances, be a taxable event.↩9. In the divorce proceedings, neither petitioner nor Sheila requested the court to take judicial notice of and to apply Maine law. That being the case, the court was not required to apply Maine law, and there is no evidence that it did so. See Wood v. Wood, 165 Conn. 777">165 Conn. 777, 345 A.2d 5">345 A.2d 5↩ (1974).10. Sec. 46-52, Conn. Gen. Stat. Ann.↩ (West 1978), which provides for the award of alimony, mentions all of the same factors for consideration except that contained in the last sentence above.11. We sustain respondent's objection to the admission of the revenue agent's report offered by petitioner to prove that at one time during the audit, respondent's agent referred to the transfer as a "property settlement." The agent was not present to testify, the statement contained in the report was pure hearsay, the use of the term "property settlement" was ambiguous, and respondent is not bound by the statements made by his agents prior to the issuance of the notice of deficiency. Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324">62 T.C. 324↩ (1974).12. The court apparently gave no consideration to dividing any of the other properties owned by both Charles and Sheila.↩13. Of course, the stock given to petitioner by Sheila's family and the Maine real estate were not owned by Sheila prior to the marriage but they were a part of Sheila's family assets.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625631/	HAROLD W. GRUBART, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentGrubart v. CommissionerDocket No. 2800-78.United States Tax CourtT.C. Memo 1979-409; 1979 Tax Ct. Memo LEXIS 114; 39 T.C.M. 283; T.C.M. (RIA) 79409; September 27, 1979, Filed Harold W. Grubart, pro se. Joan Ronder Domike, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: On April 14, 1978, respondent filed a motion to dismiss this case for lack of jurisdiction on the ground that the petition was not filed within the 90-day statutory period prescribed by sections 6213(a) 1 and 7502. Petitioner timely filed written objections to such motion and a hearing was held on the motion in New York, New York, on October 16, 1978.Respondent determined a deficiency in income tax due from petitioner for the taxable years 1972 and 1973 in the amounts of $3,371.84 and $17,981.011979 Tax Ct. Memo LEXIS 114">116 respectively, and additions to tax for those years of $1,685.92 and $8,990.50 respectively, based on the fraud provisions of section 6653. Respondent notified petitioner by a statutory notice of deficiency mailed to petitioner by certified mail on November 23, 1977. FINDINGS OF FACT The period provided by section 6213(a) 2 during which petitioner could timely file a petition with this Court expired on February 21, 1978, which was not a legal holiday within the District of Columbia. 1979 Tax Ct. Memo LEXIS 114">117 On March 17, 1978, the petition herein was filed 114 days after the mailing of the notice of deficiency. It had been mailed by regular mail from New York, New York, on March 13, 1978. A petitioner for redetermination of a deficiency must be filed with this Court within 90 days after the notice of deficiency is mailed to the taxpayer. Section 6213. Failure to file within the prescribed period requires that the petition be dismissed for lack of jurisdiction. . . The date of the actual receipt by this Court of the petition in this case was March 17, 1978, which was 114 days after the mailing of the notice of deficiency. Therefore, petitioner is relying on section 6212(b)(1) 3 to establish that the deficiency was not mailed to his "last known address," within the meaning of that section. 1979 Tax Ct. Memo LEXIS 114">118 OPINION Under section 6212(b)(1), a statutory ntice of deficiency will be sufficient if mailed to the taxpayer's last known address. The "last known address" is the last known permanent address or legal residence of a taxpayer, or last known temporary address of a definite duration or period to which all communication (by the Commissioner) during such period should be sent. , , F. Supp. (1944). The purpose of the statutes dealing with notice of deficiency has previously been described as being "to give the taxpayer ntice that the Commissioner means to assess a deficiency tax against him and to give him an opportunity to have such ruling reviewed by the Tax Court before it becomes effective." , revg. a Memorandum Opinion of this Court. The last known address issue was not raised by petitioner in his petition, although he did assert that the statute of limitations barred recovery (presumably because he had not received1979 Tax Ct. Memo LEXIS 114">119 "actual notice"). However, in response to respondent's motion to dismiss for lack of jurisdiction, petitioner, in a "Memorandum of Law" in opposition to respondent's motion, and in support of petitioner's motion to dismiss, stated: The petitioner alleges that he did not receive the subject notice of deficiency although he resides at 155 East 38th Street, New York City, but that same came to his attention only accidentally in the early part of February 1978 while he was unpacking his furnishings in his new apartment, after having removed from his former apartment. * * * From the record it appears that the deficiency notice was sent to petitioner's legal residence, 155 East 38th Street, New York, New York. However, petitioner had used his business address, 9 East 46th Street, New York New York, as his address for the taxable years at issue herein, as he had for numerous other years. Hence, petitioner claims, the notice of deficiency was not sent to his last known address. Petitioner asserts that: It cannot be denied [by respondent] that the 90-day letter was not sent to petitioner's last known address, i.e., 9 East 46th Street, New York City 10017, where he had maintained1979 Tax Ct. Memo LEXIS 114">120 his office for a period of almost 40 years. * * We find petitioner's argument, although original, to be totally without merit. First, we find that where the taxpayer, in his petition or on brief, states that he resided at the address to which the statutory notice was sent, he can hardly complain that the notice was not mailed to the taxpayer at his last known address. See , 9 Mertens, Law of Federal Income Taxation, section 50.11 (rev. 1977). Petitioner places great emphasis on the fact that he found the deficiency notice only after unpacking during a move from his personal residence. However, he ultimately admitted that the address of his personal residence is still the same--155 East 38th Street, New York, New York--because he merely moved from one apartment to another in the same building. Hence there could have been no delay in the mails due to a change of address. Petitioner also surmised that the deficiency was mislaid by a maid or household member and thus argues that he should not be held accountable for not receiving personal, actual notice of the deficiency. Petitioner is an attorney, and1979 Tax Ct. Memo LEXIS 114">121 surely must realize the necessity of keeping both business and personal records in order. It is clear that the statutory notice arrived at his personal residence, while he was residing there, by certified mail, and this is sufficient to constitute notice for purposes of the statute. "Actual" notice of a subjective, personal nature is not required, and would render the statute impossible to administer. In addition, petitioner relies heavily on his assertion that the telephone calls regarding the audit by the Commissioner were made to and from his business phone at his business address, and that numerous other communications from the Commissioner were sent to that address. However, it is well understood that there may be more than only one correct "last known" address upon which the Commissioner may reasonably rely. In , affg. a Memorandum Opinion of this Court, cert. denied , the Commissioner had two addresses for the taxpayer, both of which were equally suitable. In speaking of the purpose of section 6212(b)(1), the court stated: Section 6212(b)(1) was intended to apply1979 Tax Ct. Memo LEXIS 114">122 only in situations where the Secretary did not have the taxpayer's correct address because of the failure or inability of the taxpayer to notify him of a change. This section was enacted to protect the Secretary in this circumstance and is not a sword to be used by the taxpayer. The language "shall be sufficient" is the first key to this analysis. It immediately suggests that although other means may be equally suitable and, perhaps, even better, the Government is protected if the notice is sent to the last known address. * * * [. Emphasis added.] Thus, there may be more than one address which the Commissioner may reasonably believe is an address where the taxpayer will receive the notice of deficiency. In the instant case, petitioner himself used his personal residence address in at least one of his communications with respondent. Petitioner's consent form fixing the period of limitation upon assessment of income tax was mailed to the Commissioner in an envelope bearing a postmark of September 28, 1976 and a return of address of 155 East 38th Street, petitioner's personal residence. In addition on the1979 Tax Ct. Memo LEXIS 114">123 consent form itself, signed by petitioner on or about September 24, 1976, petitioner gave his personal residence address as his address. From these instances, we find that respondent was reasonable in mailing a notice of deficiency to petitioner's personal address, even though it was not the address given on his Federal income tax returns for the years in issue. As stated in , "It might have been reasonable for [the Commissioner] to adopt a different course * * but surely it must be recognized that there was reason for the course that he adopted." . Although petitioner herein apparently did not learn of the asserted deficiency until after the 90-day statutory period had expired, that was clearly the result of his own negligence or carelessness. Both parties cite numerous cases to support their respective positions, and, indeed, there is a myriad of cases concerning a taxpayer's "last known address." However, none of the cases we found are exactly on point. To hold, in effect, that the Commissioner must choose, and choose correctly, from several of what he knows, 1979 Tax Ct. Memo LEXIS 114">124 or has reasonable basis to believe, to be taxpayer's actual addresses (such as taxpayer's home and business addresses), would place an undue administrative burden upon the Commissioner, and result in an absurd application of the last known address statutory standard. 4Accordingly, respondent's motion will be granted and, An appropriate order will be issued.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect for the taxable years at issue herein, unless otherwise provided.↩2. SEC. 6213. RESTRICTIONS APPLICABLE TO DEFICIENCIES; PETITION TO TAX COURT. (a) TIME FOR FILING PETITION AND RESTRICTION ON ASSESSMENT.--Within 90 days, or 150 days if the notice is addressed to a person outside the States of the Union and the District of Columbia, after the notice of deficiency authorized in section 6212 is mailed (not counting Saturday, Sunday, or a legal holiday in the District of Columbia as the lat day), the taxpayer may file a petition with the Tax Court for a redetermination of the deficiency. Except as otherwise provided in section 6861 no assessment of a deficiency in respect of any tax imposed by sutitle A or B or chapter 42 and no levy or proceeding in court for its collection shall be made, begun, or prosecuted until such notice has been mailed to the taxpayer, nor until the expiration of such 90-day or 150-day period, as the case may be, nor, if a petition has been filed with the Tax Court, until the decision of the Tax Court has become final. Notwithstanding the provisions of section 7421(a), the making of such assessment or the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court.↩3. SEC. 6212. NOTICE OF DEFICIENCY. * *(b) ADDRESS FOR NOTICE OF DEFICIENCY.-- (1) INCOME AND GIFT TAXES AND TAXES IMPOSED BY CHAPTER 42.--In the absence of notice to the Secretary or his delegate under section 6903 of the existence of a fiduciary relationship, notice of a deficiency in respect of a tax imposed by subtitle A, chapter 12, or chapter 42, if mailed to the taxpayer at his last known address, shall be sufficient for purposes of subtitle A, chapter 12, chapter 42, and this chapter even if such taxpayer is deceased, or is under a legal disability, or, in the case of a corporation, has terminated its existence. (2) JOINT INCOME TAX RETURN.--In the case of a joint income tax return filed by husband and wife, such notice of deficiency may be a single joint notice, except that if the Secretary or his delegate has been notified by either spouse that separate residences have been established, then, in lieu of the single joint notice, a duplicate original of the joint notice shall be sent by certified mail or registered mail to each spouse at his last known address. (3) ESTATE TAX.--In the absence of notice to the Secretary or his delegate under section 6903 of the existence of a fiduciary relationship, notice of a deficiency in respect of a tax imposed by chapter 11, if addressed in the name of the decedent or other person subject to liability and mailed to his last known address, shall be sufficient for purposes of chapter 11 and of this chapter.↩4. Indeed, in the instant case, petitioner's personal address, despite his move within the building, had remained the same, and his business address had since changed.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625634/	Aluminum Company of America, Petitioner, v. Commissioner of Internal Revenue, RespondentAluminum Co. of America v. CommissionerDocket No. 41037United States Tax Court23 T.C. 189; 1954 U.S. Tax Ct. LEXIS 56; October 29, 1954, Filed 1954 U.S. Tax Ct. LEXIS 56">56 Decision will be entered under Rule 50. Vinson Act -- Subcontracts -- Sec. 401, Second Revenue Act of 1940. -- Subcontracts were made in 1946 with respect to a prime contract entered into in 1945 for the manufacture of engines for naval aircraft. The prime contract was exempt from the profit-limiting provisions of the Vinson Act under section 401 of the Second Revenue Act of 1940 since it was entered into in a taxable year to which the excess profits tax was applicable. Held, the subcontracts are also exempt from the Vinson Act, even though they were entered into after the expiration of the excess profits tax, since section 3 of the Vinson Act does not apply to subcontracts unless they are under prime contracts to which that section applies. Paul G. Rodewald, Esq., and Carl Cherin, Esq., for the petitioner.Albert J. O'Connor, Esq., for the respondent. Murdock, Judge. MURDOCK 23 T.C. 189">189 OPINION.The Commissioner has determined that the petitioner owes $ 2,692.05 of excess profits on a Navy contract under section 3 of chapter 95 of the Act of March 27, 1934, the Vinson Act, as amended, 48 Stat. 503, 505. The jurisdiction of this Court arises by reason of provisions 1954 U.S. Tax Ct. LEXIS 56">58 in the Vinson Act making all provisions of law 23 T.C. 189">190 applicable with respect to taxes applicable to the assessment, collection, or payment of amounts due under the Vinson Act. The facts have been submitted by a stipulation which is adopted as the findings of fact. The only question for decision is whether subcontracts entered into by the petitioner in 1946 are subject to the profit-limiting provisions of the Vinson Act.The Vinson Act authorized new naval construction to bring the United States Navy up to the strength permitted under prior agreements with foreign powers. H. Rept. No. 338, 73d Cong., 2d Sess. The purpose of section 3 of that act was to limit the profits that might be made from the anticipated construction by contractors and subcontractors. H. Rept. No. 1024, 73d Cong., 2d Sess., p. 5; 78 Cong. Rec. 5174 (1934). Section 3 provided "that no contract shall be made by the Secretary of the Navy for the construction and/or manufacture of any complete naval vessel or aircraft, or any portion thereof, herein, heretofore, or hereafter authorized unless the contractor agrees" to various conditions set forth in subparagraphs (a) through (e). Only (b) and (e) need be1954 U.S. Tax Ct. LEXIS 56">59 mentioned here. Subparagraph (b) required that the prime contractor would agree to pay into the Treasury all of his profits in excess of a certain per cent on contracts covered by the section which were completed by the paticular contracting party within any income taxable year. Subparagraph (e) required that the prime contractor would agree "to make no subcontract unless the subcontractor agrees to the foregoing conditions." Section 401 of the Second Revenue Act of 1940 provided that the portions of section 3 of the Vinson Act, to which reference has been made, "shall not apply to contracts or subcontracts * * which are entered into in any taxable year to which the excess profits tax provided in subchapter E of Chapter 2 of the Internal Revenue Code is applicable * * * ." Congress felt that the special provisions of the Vinson Act should not apply while the excess profits tax, applying to all corporations, was in effect. H. Rept. No. 2894, 76th Cong., 3d Sess., p. 15, 1940-2 C. B. 496, 507.Pratt & Whitney Aircraft Division of United Aircraft Corporation entered into a prime contract with the Government of the United States on February 8, 1945, for1954 U.S. Tax Ct. LEXIS 56">60 the manufacture of aircraft engines for naval aircraft. Subchapter E of chapter 2 of the Internal Revenue Code was then in effect but was repealed by section 122 (a) of the Revenue Act of 1945 with respect to taxable years beginning after December 31, 1945. The petitioner entered into certain subcontracts in 1946 under the prime contract just mentioned and completed them in that year.The petitioner argues that the subcontracts here in question are not subject to section 3 of the Vinson Act under the wording of that 23 T.C. 189">191 section and under long-standing regulations and prior rulings with respect to section 3 and other similar statutory provisions. The respondent contends that section 401 of the Second Revenue Act of 1940 suspended the profit-limiting provisions of the Vinson Act on contracts and subcontracts only while the excess profits tax was in effect; the excess profits tax had been repealed before the subcontracts here in question were entered into; and, therefore, the profit-limiting provisions of the Vinson Act apply to these subcontracts.Section 401 of the Second Revenue Act of 1940, upon which the Commissioner relies, imposed no limitation on the profits of a contractor1954 U.S. Tax Ct. LEXIS 56">61 or a subcontractor. Its only effect, so far as this case is concerned, was to render inoperative the profit-limiting provisions of the Vinson Act while the excess profits tax was in effect, with the result that the prime contract was entered into at a time when section 3 of the Vinson Act did not apply. The only authority which the Government has for collecting excess profits from this petitioner is in the Vinson Act, as amended. It is reasonably clear from the words of section 3 of the Vinson Act that it applies and was intended to apply only to subcontracts under a prime contract to which it also applies. That section and similar provisions in the Act of June 28, 1940, 54 Stat. 676, have been interpreted as applying only to subcontracts made with respect to a prime contract to which the same Act applied. Sec. 17.3, T. D. 4906, 1939-2 C. B. 404, 408; art. 2, T. D. 4723, 1937-1 C. B. 519, 521; sec. 16.2, T. D. 4909, 1939-2 C. B. 422, 425; I. T. 3394, 1940-2 C. B. 394, insofar as it relates to section 2 (b) of the Act of June 1954 U.S. Tax Ct. LEXIS 56">62 28, 1940; sec. 26.1, T. D. 5000, 1940-2 C. B. 397, 400. Had Congress intended a different result, it would have expressly provided for it as it did in section 3 of the Act of June 28, 1940, where it stated the Act should apply to "contracts or subcontracts entered into after the date of approval of this Act." See I. T. 3394, supra, insofar as it relates to section 3 of the Act of June 28, 1940.The applicability of the Vinson Act to the petitioner as a subcontractor therefore depends upon whether it applies to the prime contract. The Commissioner makes no argument that it applies to the prime contract and clearly it does not. This is so despite the fact that the profits of the prime contractor under that contract for its taxable years beginning after December 31, 1945, were not subject to excess profits tax. Congress realized, when it enacted section 401, that contracts to which that section would apply but which would be completed after the repeal of the excess profits tax would not be subject to the Vinson Act. S. Rept. No. 2114, 76th Cong., 3d Sess., 1940-2 C. B. 528, 544. There was no obligation on the1954 U.S. Tax Ct. LEXIS 56">63 prime contractor, at the time it entered into these subcontracts with the petitioner, to require the petitioner, as subcontractor, to agree to the 23 T.C. 189">192 requirements of section 3 of the Vinson Act, and section 3 of the Vinson Act imposes no obligation upon the petitioner as a subcontractor to repay any portion of its profits from those subcontracts.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625635/	DOUGLAS H. ACREA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAcrea v. CommissionerDocket No. 9745-75.United States Tax CourtT.C. Memo 1979-18; 1979 Tax Ct. Memo LEXIS 506; 38 T.C.M. 59; T.C.M. (RIA) 79018; January 10, 1979, Filed Douglas H. Acrea, pro se. Charles C. Cobb, for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: The Commissioner determined a deficiency in petitioner's income tax for the taxable year 1973 in the amount of $ 1,194. Petitioner offered no credible proof to prove the determination of the Commissioner in his statutory notice of deficiency was erroneous. Instead petitioner relies upon a series of frivolous motions he filed at the trial. FINDINGS OF FACT Petitioner resided in Sepulveda, California, when he filed his petition. He filed his Federal income tax return for the taxable year 1973 with the Internal Revenue Service at Fresno, California. The Commissioner, in his statutory notice of deficiency, disallowed the deductions petitioner claimed for employee business1979 Tax Ct. Memo LEXIS 506">507 expenses in the amount of $ 2,426, miscellaneous expenses in the amount of $ 1,819 and medical expenses in the amount of $ 447. OPINION When the case was called for trial, petitioner filed the following motions: (1) Motion for Tax Court to Order that I.R.S. Employees and Officers to be Obedient to the Intent and Purpose of: Art. 1, Sec. 2, Cl. 3; Art. 1, Sec. 9, Cl. r; 16 Amendment; Art. 1, Sec. 8, Cl. 4, U.S. Constitution and Article 5, Bill of Rights, last phrase. (2) Motion for Equal Protection of the Law as Per Articles 5 and 9, Bill of Rights. (3) Motion for Tax Court Notice Regarding Mis-Application of the IRS Code. (4) Motion for a Fair Trial and Motion for Procedural Safeguards. (5) Motion for Assistance of Counsel (6) Motion for Immunity as Per 18 U.S.C. 6004. All of petitioner's motions are frivolous and we denied them at trial.Petitioner then sought to call as a witness a Dr. Frank Brockway, who petitioner identified as his tax consultant. Respondent objected on the grounds of relevance and we inquired of petitioner as to the nature of the testimony to be elicited from Dr. Brockway. Petitioner stated that Dr. Brockway was "an1979 Tax Ct. Memo LEXIS 506">508 expert in taxation in relationship to the Constitution." Petitioner admitted that Dr. Brockway did not prepare his income tax return. We sustained respondent's objection to the testimony of Dr. Brockway. After petitioner argued other frivolous grounds, we asked him whether he desired to offer any proof as to the deductions disallowed by the Commissioner which he declined to do. Petitioner has the burden of proving that the Commissioner's determination of his income tax liability is erroneous. Rule 142(a), Tax Court Rules of Practice and Procedure. Petitioner has offered no evidence to sustain his burden of proof. The determination of the Commissioner in his statutory notice of deficiency is, therefore, sustained. Montgomery v. Commissioner,367 F.2d 917">367 F.2d 917 (9th Cir. 1966). 1Decision will be entered for the respondent.Footnotes1. Tanner v. Commissioner,T.C. Memo 1977-206, affd. F.2d (10th Cir. Apr. 8, 1978), 78-1 USTC par. 9399; Anderson v. Commissioner,T.C. Memo 1978-444; Cameron v. Commissioner,T.C. Memo 1978-272↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625638/	Estate of B. W. Cadwallader, Deceased, Rose M. Cadwallader, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent. Rose M. Cadwallader, Petitioner, v. Commissioner of Internal Revenue, RespondentCadwallader v. CommissionerDocket Nos. 798, 803United States Tax Court13 T.C. 214; 1949 U.S. Tax Ct. LEXIS 106; August 19, 1949, Promulgated 1949 U.S. Tax Ct. LEXIS 106">106 Decisions will be entered under Rule 50. 1. Act of Legislature of Philippine Islands barring claims against a decedent's estate not filed with probate court within specified period does not bar claims for income taxes due the United States from residents of Philippine Islands under revenue acts of Congress. The general power delegated by Congress to Philippine Legislature extended only to regulation of domestic affairs and not to matters contravening the revenue acts of the United States.2. Decision of this Court in a prior proceeding involving estate tax liability is not res judicata in this proceeding involving decedent's income tax liability, where the question of such income tax liability was not raised or decided in the prior proceeding.3. Stockholders of Philippine corporation are not entitled to credit for purpose of normal tax under section 216 of the Revenue Act of 1918 for dividends received from that corporation when it made all sales of lumber for United States customers in Manila to United States brokers and had no taxable sources of income within the United States.4. Amount of credit allowable against United States income tax of decedent for taxes paid to1949 U.S. Tax Ct. LEXIS 106">107 the Philippine Islands in 1919 redetermined. Clark J. Milliron, Esq., for the petitioners.Robert H. Kinderman, Esq., for the respondent. LeMire, Judge. LeMIRE 13 T.C. 214">215 These proceedings, consolidated for hearing and opinion, involve deficiencies in income taxes as follows:PetitionerYearDeficiencyEstate of B. W. Cadwallader, deceased1918$ 1,119.88191914,164.96191912,146.56Rose M. Cadwallader19363,518.02Prior to the hearing the parties stipulated that there is no deficiency due from and no overpayment of tax by Rose M. Cadwallader for 1936. That stipulation will be given effect under a Rule 50 decision. 1949 U.S. Tax Ct. LEXIS 106">108 The issues presented for decision are:(1) Whether the assessment and collection of the deficiencies involved are barred by section 695 of the Code of Civil Procedure of the Philippine Islands;(2) Whether the assessment and collection of the deficiencies involved are barred by application of the doctrine of res judicata;(3) Whether dividends received by the petitioners from the Cadwallader-Gibson Lumber Co. in 1919 are subject to the normal tax for that year; and(4) Whether the petitioner, the estate of B. W. Cadwallader, deceased, is entitled in the computation of its income tax liability for the years 1918 and 1919 to credits in those years for income taxes paid to the Philippine Islands in the years 1919 and 1920, respectively.Some of the facts have been stipulated and are so found. The stipulation filed is incorporated herein by reference.FINDINGS OF FACT.B. W. Cadwallader, deceased, hereinafter referred to as the decedent, during 1918 and 1919 and all periods material hereto, was a citizen of the United States and a resident of Manila, Philippine Islands. During the year 1918 and until June 7, 1919, the decedent was married to Anna G. Cadwallader. From June 8 to 1949 U.S. Tax Ct. LEXIS 106">109 June 27, 1919, decedent was unmarried. From June 28, 1919, until he died on November 20, 1936, decedent was married to Rose M. Cadwallader, his executrix, hereinafter referred to as the petitioner.13 T.C. 214">216 The decedent filed Philippine income tax returns with the collector of internal revenue at Manila, Philippine Islands, for the years 1917, 1918, and 1919, paying Philippine income taxes as follows:YearYear paidAmount paid19171918$ 97.7319181919432.16191919206,358.40All of the income of the decedent in the years 1918 and 1919 was from sources in the Philippine Islands. The decedent and his wife did not file United States income tax returns for the years 1918 and 1919 until March 29, 1939.During the years 1917 through 1920 decedent was a stockholder and an active officer of the Cadwallader-Gibson Lumber Co., a Philippine corporation, engaged principally in the business of selling Philippine lumber to purchasers in the United States. The lumber company did not have offices or any sales organization of its own in the United States, but was represented by the brokerage firm of Henry W. Peabody & Co. in New York City. Peabody & Co. procured orders1949 U.S. Tax Ct. LEXIS 106">110 from American purchasers for Philippine lumber and forwarded them to the lumber company in Manila. If the orders were accepted, the lumber company loaded the lumber aboard ships in Manila and consigned it to Peabody & Co., who paid all freight and insurance expenses from that point to final delivery to the customer in the United States. Peabody & Co. had the lumber measured and delivered to the customer and billed the customer for it. When the customer paid for the lumber, Peabody & Co. deducted its total expenses and its 5 per cent broker's commission and credited the balance to the lumber company's account.No lumber was ever shipped to Peabody & Co. for future sale or sold directly to Peabody & Co. Lumber was shipped only to fill customers' orders forwarded by Peabody & Co. to the lumber company in Manila. All sales of lumber were made in Manila through brokers located in the United States. The Cadwallader-Gibson Lumber Co. did not do business in the United States in 1919.The Cadwallader-Gibson Lumber Co. did not file any United States income or profits tax returns and did not pay any United States income or profits taxes in 1919. The amount of $ 51,790.24 was received by1949 U.S. Tax Ct. LEXIS 106">111 the conjugal partnership of decedent and his wife as dividends from the Cadwallader-Gibson Lumber Co. in 1919.After decedent's death on November 20, 1936, petition for probate of his estate was filed in the Court of First Instance, Manila, Philippine Islands. Brooke D. Caldwallader was appointed administrator 13 T.C. 214">217 of the estate of the decedent. Proceedings for the administration of the estate were had in the Philippine Islands. Notice to creditors of the estate, requiring the filing of claims with the committee on claims for the estate, was duly published.On January 29, 1937, petitioner was appointed executrix of decedent's ancillary estate in the Superior Court of the State of California in the County of Los Angeles. She filed an estate tax return for the estate with the collector of internal revenue for the sixth district of California on February 19, 1938, showing no net estate and no estate tax due. Included in the return was the following statement by petitioner under Exhibit A to schedule F:(k) The Executrix has been informed that the Government of the United States claims additional income tax to be due on the income from the conjugal partnership for the years 1949 U.S. Tax Ct. LEXIS 106">112 from 1917 to date in an unknown amount. This liability is not admitted by the Executrix.On August 7, 1938, respondent mailed to petitioner a notice of deficiency in estate tax. Petitioner appealed to the Board of Tax Appeals, which adjudicated the amount of estate tax due and entered its decision in Estate of Brooke W. Cadwallader, Docket No. 95988, on March 20, 1941. The decision of the Board of Tax Appeals was affirmed by the Circuit Court of Appeals for the Ninth Circuit on April 30, 1942. Commissioner v. Cadwallader, 127 Fed. (2d) 547.In the proceeding before the Board of Tax Appeals, the issues for adjudication were the domicile of B. W. and Rose M. Cadwallader at the time of the decedent's death, the time of acquisition of property included in the estate, the amount of property contributed to the conjugal partnership by the petitioner, and the correctness of the valuation of the estate for estate tax purposes. No allowance was made for the deduction of any income tax claim against the estate for the years here involved, 1918 and 1919.After petitioner was appointed executrix of the estate of the decedent she was advised that income1949 U.S. Tax Ct. LEXIS 106">113 tax returns were required to be filed on behalf of the decedent and herself for the years 1918 to 1936. On March 29, 1939, the petitioner filed income tax returns for years 1918 and 1919 for the decedent and for 1919 for herself with the collector of internal revenue at Baltimore, Maryland. In these income tax returns petitioner set forth all of the income of the decedent for 1918 and 1919 and of herself for 1919, but claimed that no income tax was due for those years.The deficiencies involved in these proceedings were determined by respondent in connection with those returns on the grounds here put in issue. Deficiency notices were mailed November 25, 1942.The decedent, during the years 1918 and 1919, and the petitioner, during the year 1919, kept their records and rendered their income tax returns on the basis of cash receipts and disbursements.13 T.C. 214">218 OPINION.The petitioner's first contention is that the assessment and collection of any income tax due on the income of the conjugal partnership of the decedent and the petitioner is barred by the provisions of section 695 of the Code of Civil Procedure of the Philippine Islands. This contention is founded upon the respondent's1949 U.S. Tax Ct. LEXIS 106">114 failure to file a claim for unpaid income taxes against the decedent's estate in the Court of First Instance in Manila, P. I., when proceedings were had therein for the administration of the estate.Section 695 of the Code of Civil Procedure of the Philippine Islands, an act of the Philippine Legislature under authority of the Congress of the United States, provides that:Sec. 695. Claims Not Presented Barred. -- A person having a claim against a deceased person proper to be allowed by the committee, who does not, after publication of the required notice, exhibit his claim to the committee as provided in this chapter, shall be barred from recovering such demand or from pleading the same in offset to any action, except as hereinafter provided.Petitioner argues that this section of the Code of Civil Procedure of the Philippine Islands is, in fact, an act of the Congress of the United States of a special nature, and that it takes precedence over later acts of legislation of a general nature, in the absence of express repeal or modification in later acts of Congress. Petitioner's argument is based on the premise that the Philippine Code of Civil Procedure was never repealed or 1949 U.S. Tax Ct. LEXIS 106">115 annulled, although Congress reserved the power to do so. 48 U.S. C. A. 1054. However, legislation of the Philippine Legislature passed within the general legislative power delegated to it by Congress, 48 U.S. C. A. 1041, is not equivalent to an act of Congress merely because Congress failed to exercise its power to annul or repeal the legislation. Springer v. Government of the Philippine Islands, 277 U.S. 189">277 U.S. 189. The power of the Philippine Legislature and the force of its enactments depend upon the intent of the original delegation of power to it by Congress. Berger v. Chase National Bank, 105 Fed. (2d) 1001; affd., 309 U.S. 632">309 U.S. 632. The intent of Congress to delegate general legislative power to the Philippine Legislature to regulate the natural internal affairs of the Islands is apparent from the Jones Act, or Autonomy Act, of 1902, 48 U.S. C. A. 1001, wherein Congress expressed its intent to place in the hands of the people of the Philippines "as large a control of their domestic1949 U.S. Tax Ct. LEXIS 106">116 affairs as can be given them without, in the meantime, impairing the exercise of the rights of sovereignty by the people of the United States." There was clearly no delegation of power to the Philippine Legislature to enact any legislation in contravention of any act of Congress itself. Certainly, there was no delegation of power to enact special legislation destroying the obligation of taxpayers to pay taxes under the internal revenue laws of the United States.13 T.C. 214">219 We conclude that section 695 of the Philippine Code of Civil Procedure can not operate as a bar to the assessment and collection of income taxes due under the revenue acts of the United States, and that it does not bar the assessment and collection of the deficiencies herein determined by the respondent.Petitioner then contends that the assessment and collection of the deficiencies here involved are barred because the issues in this proceeding were finally determined by the Board of Tax Appeals in Estate of Brooke W. Cadwallader, supra, and affirmed by the Circuit Court of Appeals for the Ninth Circuit, and the judgment in that action is res judicata as to the determination of the issues in this proceeding. 1949 U.S. Tax Ct. LEXIS 106">117 The judicial doctrine of res judicata was created by the courts to prevent repetitious litigation by the same parties upon the same cause of action after the issues had once been decided on the merits by a court of competent jurisdiction. When final judgment has been entered on the merits in a cause of action, the parties are thereafter bound as to all matters offered or which could have been offered to sustain the claim or demand upon which the cause of action was founded. However, the parties are free to litigate in a later action points which were not in issue in the first proceeding, even though they might have been tendered and decided at that time. Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591.In these proceedings the Federal tax involved is the income tax, and not the estate tax as in the prior proceeding; different issues and different years are involved; and the parties are not the same. The fact that the issues here involved might have been raised in the former proceeding is of no consequence, since in fact they were not. The record in the former proceeding fails to disclose any demand made by the respondent for income taxes due or any1949 U.S. Tax Ct. LEXIS 106">118 allowance or deduction claimed by the petitioner, acting as the executrix of the decedent's estate, for income tax liability. Income tax liability of the decedent was not put in issue, considered, or decided by the Board of Tax Appeals or the Circuit Court of Appeals in the former proceeding. We conclude that the doctrine of res judicata is not applicable to the determination of income tax liability in these proceedings as to either decedent or petitioner. See 333 U.S. 591">Commissioner v. Sunnen, supra.Petitioner also contends that the dividends which she and decedent received from the Cadwallader-Gibson Lumber Co. in 1919 are not subject to normal tax by reason of the fact that the corporation was engaged in business in the United States and was taxable upon its net income. There is no statutory provision for exempting from income tax the dividends of a corporation whose earnings are subject to corporation income tax. Section 216 of the Revenue Act of 1918 provides for the allowance of a credit for the purpose of the normal tax of dividends 13 T.C. 214">220 received from corporations taxable upon their net income. Individuals were allowed to credit against1949 U.S. Tax Ct. LEXIS 106">119 income for the purpose of the normal tax only the amount of dividends received from corporations taxable upon their net income under section 230 of the Act of 1918, as prescribed by sections 232, 233, and 234 of that act.The evidence adduced with respect to the nature of the corporation's business activities in 1919 shows that it did not do business or derive gross income from sources in the United States in 1919, within the meaning of the Act of 1918. The corporation had no offices or sales organization of its own within the United States and did not solicit business there. Orders for lumber were procured by the import-export brokerage firm of Henry W. Peabody & Co. of New York. The orders were forwarded to the lumber company in Manila, where it either accepted or rejected them as it saw fit. It filled orders by loading the lumber aboard ships in Manila under on-board bills of lading to Peabody & Co. The brokers then took complete charge of the lumber shipment, paying all freight and insurance expenses during shipment and delivery and billing the customer in the United States. When Peabody & Co. received payment for the lumber it deducted all expenses and its commissions and1949 U.S. Tax Ct. LEXIS 106">120 credited the balance to the lumber company. Lumber was not shipped for future sale or consignment or sold directly to Peabody & Co. but was always shipped to fill purchase orders solicited by and received from the brokers. There is no evidence of any agreements between the lumber company and the brokers which would indicate the existence of any other arrangement for handling lumber or making sales. We conclude that the lumber was sold in Manila and that the lumber company's gross income was derived there. It follows that petitioner and decedent's estate are not entitled to any credit for the purpose of the normal tax of amounts received as dividends from the Cadwallader-Gibson Lumber Co. in 1919. Cf. Compania General de Tabacos de Filipinas v. Collector, 279 U.S. 306">279 U.S. 306; East Coast Oil Co., S. A., 31 B. T. A. 558; affd., 85 Fed. (2d) 322; certiorari denied, 299 U.S. 608">299 U.S. 608; and Ronrico Corporation, 44 B. T. A. 1130.The final issue is raised only as to the estate of B. W. Cadwallader, deceased. It involves the correctness of the respondent's1949 U.S. Tax Ct. LEXIS 106">121 allowance of credit for income tax paid to the Philippine Islands in the years 1918 and 1919 in accordance with section 222 (a) (1) of the Revenue Act of 1918. 1 In the income tax returns filed for 1918 and 1919, for decedent and petitioner, credits were claimed in 1918 for taxes paid to 13 T.C. 214">221 the Philippine Islands in 1919, and in 1919 for taxes paid in 1920. Since decedent and petitioner kept their records and rendered their income tax returns on the basis of cash receipts and disbursements, respondent's disallowance of the credits claimed was clearly correct. Petitioner has not pressed the point on brief, so she must be deemed to have abandoned it.However, the petitioner1949 U.S. Tax Ct. LEXIS 106">122 does urge on brief that respondent erred in allowing as a credit against the income tax of the decedent in the year 1919 only $ 419.20 instead of $ 432.16, a difference of $ 12.96. It was stipulated by the parties, and so found, that the correct amount paid in income taxes to the Philippine Islands in 1919 was $ 432.16. Respondent erred in failing to credit this amount in full.Decisions will be entered under Rule 50. Footnotes1. Sec. 222. (a) That the tax computed under Part II of this title shall be credited with:(1) In the case of a citizen of the United States, the amount of any income, war-profits and excess-profits taxes paid during the taxable year to any foreign country, upon income derived from sources therein, or to any possession of the United States; * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625639/	JAMES GODINE, JR. AND HIAWATHA GODINE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentGodine v. CommissionerDocket No. 4855-75United States Tax CourtT.C. Memo 1977-393; 1977 Tax Ct. Memo LEXIS 50; 36 T.C.M. 1595; T.C.M. (RIA) 770393; November 14, 1977, Filed E. J. Brenner, for the petitioners. William E. Saul, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined a $1,665.75 deficiency in petitioners' 1971 income tax. The questions presented1977 Tax Ct. Memo LEXIS 50">51 are: 1. Are petitioners entitled to recognize a loss on the disposition of their Baker Street property, or did they enter into a tax-free exchange of their Baker Street property for the Templeton Avenue property? 2. In the alternative, are petitioners entitled to a theft loss deduction in 1971? FINDINGS OF FACT Some of the facts have been stipulated by the parties and are found accordingly. At the time they filed their petition, petitioners resided in Daly City, California. In 1968 petitioners purchased a large, old residential building, containing six rental flats, at the corner of Baker and Turk Streets, San Francisco (hereinafter referred to as the "Baker Street property"). The property was in bad condition and had no tenants living in it. Petitioners proceeded to cut down overgrowth, put in a lawn, and clean and paint the apartments. At first, they and their friends did the work, but later they employed the assistance of a roofing contractor, a window installer and Robert Pierre ("Pierre"), a "contractor." Petitioners moved into the Baker Street property in November, 1970, by which time they had one tenant. Prior to moving in they lived in a rented apartment.1977 Tax Ct. Memo LEXIS 50">52 While living in that apartment they watched Pierre remodeling the unit next to their rental unit, and observed his work on a daily basis. In their opinion, the quality of Pierre's work was very good, and the owner of the apartment was pleased with it. Petitioners hired Pierre to make substantial alterations and improvements on the Baker Street property. Pierre represented to petitioners that he was a licensed contractor, and that he was doing a job for the Government at Hunter's Point. Pierre had a truck with his name and telephone number on the side. However, the State Contractor's License Board has no record of Pierre ever having been a licensed contractor in California. Pierre also represented that his work would satisfy all legal requirements and that he would bring the building "up to code," and that he would get the necessary permits. Petitioners paid approximately $11,000 to Pierre and to suppliers from whom Pierre ordered supplies up to the time of Pierre's disappearance. The proportion of the amount paid suppliers as compared to Pierre is unknown; the proportion of the $11,000 spent in 1970 was estimated by petitioners to be $6,000. Pierre commenced work in March1977 Tax Ct. Memo LEXIS 50">53 1970 and continued until May 1971. Petitioners learned for the first time that Pierre had not obtained the necessary building permits when a building inspector of the City and County of San Francisco stopped by to inquire about the new front steps. His visit was followed by a visit the next day by the same inspector, accompanied by a plumbing inspector, an electrical inspector and one or two others. This visit occurred before May 1971. The inspectors found numerous code violations: single-colored wiring, a plumbing pipe repaired with a beer can, improper flues and venting and other defects. To discover some of the defects the inspectors had to cut into the walls. The inspectors advised petitioners that the building would have to be brought "up to code" within thirty days, which period was later extended to ninety days when petitioners protested that they could not bring the building "up to code" in thirty days. At about the same time the inspectors were making their inspection, petitioners had other problems with the building. The drain in the shower in an upstairs apartment would not carry away the water. When the water pressure rose sufficiently to cause water to run freely, 1977 Tax Ct. Memo LEXIS 50">54 the ceiling and carpets of the apartment below were ruined. Petitioners then attempted to contact Pierre. They called him and were told by his wife that she also was looking for him. Later when they called again the operator informed them that the number was not in service. Petitioners then drove to Pierre's residence, but found it vacant. They contacted the person who worked with Pierre, but he didn't know Pierre's whereabouts. The building inspectors tried to find Pierre, but couldn't. Petitioners abandoned their efforts to locate Pierre because of lack of money to hire an investigator. They never saw Pierre after May 1971. In September 1971 petitioners called the real estate broker through whom they had purchased the Baker Street property, Clyde Cournale ("Cournale"), and told him they didn't have the money to fix the property and wanted to sell it and get out their equity. Cournale estimated it would take $12,000 to $15,000 to bring the property "up to code." Petitioners intended to resume renting because they had expended their savings and were living off their combined earnings. Cournale offered to help petitioners "get out of" the Baker Street property by selling1977 Tax Ct. Memo LEXIS 50">55 it and getting them their equity. However, he did not take a written listing on the property. The parties orally negotiated that the amount of the petitioners' equity in the Baker Street property was $5,808.28. Later this amount was applied on a duplex on Templeton Avenue in Daly City ("Templeton Avenue property"). Cournale attempted to sell the Baker Street property and showed it to at least one party after petitioners had agreed to acquire the Templeton Avenue property. Approximately a week after petitioners contracted Cournale, Cournale called petitioners about buying a home he had for sale. First Cournale suggested a little house on Shield Street, which petitioners inspected and rejected. Later Cournale showed petitioners the duplex on Templeton Avenue, which petitioners reluctantly inspected. Petitioners agreed to purchase the Templeton Avenue property if they had enough money. In October 1971 petitioners agreed to transfer the Baker Street property to Cournale & Co., Inc. (Cournale's real estate business) and on or about the same time Cournale & Co., Inc., agreed to transfer to petitioners the Templeton Avenue property. The deed from petitioners to Cournale & Co. 1977 Tax Ct. Memo LEXIS 50">56 , Inc. to the Baker Street property was recorded in the Recorder's office in San Francisco on December 22, 1971. The deed to the Templeton Avenue property from Cournale & Co., Inc. to petitioners was recorded in the Recorder's office in Redwood City on December 27, 1971. No escrow was employed. The transactions as reflected in the buyer's and seller's statements and instructions were handled by bookkeeping entries except for the additional cash paid by petitioners in the amount of $1,207.80 to balance the debits and credits on the transfer of the Baker Street property and an additional $499.10 to balance the debits and credits on the transfer of the Templeton Avenue property. Cournale would not have acquired the Baker Street property unless petitioners agreed to acquire the Templeton Avenue property from him. The only other circumstances under which Cournale would have acquired the Baker Street property would have been the petitioners' abandonment thereof. Cournale would not have purchased it for cash. Petitioners moved from Baker Street to Templeton Avenue on October 28, 1971. Petitioners and Cournale intended to exchange the Baker Street property for the Templeton Avenue1977 Tax Ct. Memo LEXIS 50">57 property. Petitioners realized a loss on the exchange. Neither party considered the tax effect of such an exchange. OPINION The first question is whether petitioners entered into a tax-free exchange when they exchanged the Baker Street property plus some cash for the Templeton Avenue property. The evidence shows that the parties intended to do what they did, namely, exchange one property for the other. What petitioners did not consider or intend was the tax-free consequences of such an exchange. Section 1031(a)1 provides that "no gain or loss shall be recognized if property held * * for investment * * * is exchanged solely for property of a like kind to be held * * * for investment." And subsection (c) of section 1031 provides that "if an exchange would be within the provisions of subsection (a) * * * if it were not for the fact that the property received in exchange consists not only of property permitted by such provision to be received without the recognition of gain or loss, but also of * * * money, then no loss from the exchange shall be recognized." 1977 Tax Ct. Memo LEXIS 50">58 Section 1031 is not subject to election or waiver; it is applicable to any transaction within the scope of its provisions. United States v. Vardine, 305 F.2d 60, 66 (2d Cir. 1962). Section 1031 represents an exception to the general rule requiring the recognition of all gains and losses, and should be strictly construed. Section 1.1002-1(b), Income Tax Regs.2"Nonrecognition is accorded by the Code only if the exchange is one which satisfies both (1) the specific description in the Code of an excepted exchange, and (2) the underlying purpose for which such exchange is excepted from the general rule." Regs., section 1.1002-1(b). 1977 Tax Ct. Memo LEXIS 50">59 Legislative history indicates that the reason for nonrecognition of gain or loss in the case of section 1031 exchanges was that Congress considered it inappropriate to recognize the "theoretical" gain or loss when the taxpayer's investment continues in like kind property, and the administrative burden of valuing the property received in exchange for thousands of horse trades and similar barter transactions each year would not be justified by the increased revenues to be derived therefrom. H.R. Rept. No. 704, Revenue Act of 1934, 73d Cong., 2d Sess., 1939-1 (Pt. 2) C.B. 554, 564. See Leslie Co. v. Commissioner,539 F.2d 943 (3rd Cir. 1976), affg. 64 T.C. 247">64 T.C. 247 (1975). The exchange of the Baker Street property for the Templeton Avenue property falls within the specific description in section 1031 of a tax-free exchange. An exchange is the reciprocal transfer of property as distinguished from a transfer of property for monetary consideration only. Leslie Co. v. Commissioner,supra, at 945-949; Regs., section 1.1002-1(d). The buyer's1977 Tax Ct. Memo LEXIS 50">60 and seller's statements and instructions clearly demonstrate a reciprocal exchange of property. The transaction also falls within the legislative purpose for excepting the exchange from recognition in that the petitioners' investment remains in like kind property. 3 We therefore conclude that the transaction in question is within the purview of section 1031, and no loss is recognized by petitioners on the exchange. Petitioners assert, however, that they did not intend an exchange, and that their motive should be dispositive of the tax effect of their transaction regardless of the fact that petitioners did in fact exchange the Baker Street property. We do not agree. Section 1031 cuts both ways in that neither gains nor losses are recognized in tax-free exchanges. A taxpayer realizing a loss on a transaction may argue it was a sale, whereas the taxpayer with gain may argue that in substance the transaction is an exchange. What actually1977 Tax Ct. Memo LEXIS 50">61 occurred must control, and not the mere motives or intent of the parties. See Alderson v. Commissioner,317 F.2d 790, 794 (9th Cir. 1963), revg. 38 T.C. 215">38 T.C. 215 (1962). We hold that in this case the petitioners' exchanged their Baker Street property for the Templeton Avenue property, and therefore are not entitled to recognize the loss realized on the exchange.The alternative issue is whether petitioners are entitled to a theft loss deduction for all or any part of the $11,000 paid to Pierre and suppliers. Petitioners claim that they suffered an $11,000 loss by reason of the crime of false pretenses in 1971 (the year of discovery of the loss). Respondent contends that petitioners cannot establish that Pierre took money by false pretenses with criminal intent, and that they cannot establish the amount of the loss, if any. We agree with respondent. Section 165(c) provides that an individual is entitled to deduct a theft loss. "Theft" includes obtaining funds by false pretenses if that is a crime under the laws of the State where the loss occurred. California1977 Tax Ct. Memo LEXIS 50">62 has such a crime. California Penal Code, section 484 (West 1970), provides in pertinent part: Every person * * who shall knowingly and designedly, by any false or fraudulent representation or pretense, defraud any other person of money * * * is guilty of theft. Petitioners claim that Pierre knowingly and designedly fraudulently represented that he was a licensed contractor, which he was not, and that he would bring the building "up to code," which he did not do. Petitioners, however, have failed to prove that Pierre "knowingly and designedly" made the false statements. Norton v. Commissioner,333 F.2d 1005 (9th Cir. 1964), affg. 40 T.C. 500">40 T.C. 500 (1963). He apparently performed satisfactory work for petitioners' former landlord. See Hartley v. Commissioner,36 T.C.M. 1281, 46 P-H Memo. T.C. par. 77,317 (1977). Petitioner merely assumes from Pierre's failure to bring the building "up to code," from his disappearance and from the fact that he was not a licensed contractor that he had the required criminal intent. 1977 Tax Ct. Memo LEXIS 50">*63 To carry the day, petitioners must present persuasive evidence. Rule 142(a), Tax Court Rules of Practice and Procedure. This they have failed to do. Petitioner's main complaint is that Pierre did not do satisfactory work. That is not a crime. But even assuming Pierre did knowingly and designedly fraudulently misrepresent to petitioners that he was a licensed contractor and that he would bring the building "up to code," there is no evidence of the amount, if any, of the $11,000 with which Pierre absconded. To the extent the $11,000 was paid for labor performed and for materials, petitioners have not suffered a theft loss.See Miller v. Commissioner,19 T.C. 1046">19 T.C. 1046, 19 T.C. 1046">1048 (1953).To be entitled to the deduction, petitioners must not only prove that they suffered a theft loss, but also the amount thereof. J. J. Dix, Inc. v. Commissioner,223 F.2d 436 (2nd Cir. 1955), cert. denied 350 U.S. 894">350 U.S. 894 (1955). This they have failed to do. Decision will be entered for respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the year in issue.↩2. Section 1002 was repealed by P.L. 94-455, effective for taxable years beginning after December 31, 1976. The provision on the recognition of gain or loss on the sale or exchange of property is now contained in section 1001(c).↩3. No question was raised that the two properties were not like kind until respondent, in his brief, suggested that part of both properties were petitioners' residences. Respondent has raised this issue too late for us to consider it.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625643/	MICHAEL K. INABA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentInaba v. CommissionerDocket Nos. 28486-82, 10007-84.United States Tax CourtT.C. Memo 1985-407; 1985 Tax Ct. Memo LEXIS 219; 50 T.C.M. 687; T.C.M. (RIA) 85407; August 12, 1985. Peter R. Stromer, for the petitioner. Frank W. Louis, for the respondent. CLAPPMEMORANDUM OPINION CLAPP, Judge: In these consolidated cases, respondent determined the following deficiencies in, and additions to petitioner's Federal income taxes: DocketNo.YearDeficiency1 6651(a)(1) 28486-821980$6,569.29$654.8310007-8419817,830.001,307.25DocketAdditions to TaxNo.6653(a)6653(a)(1)6653(a)(2)6654(a)28486-82$328.64$104.4410007-84$391.50350.841985 Tax Ct. Memo LEXIS 219">220 Petitioner, Michael K. Inaba, resided in West Redding, Connecticut, when he filed the petitions herein. The petitions allege, inter alia, that respondent ignored petitioner's irrevocable vow of proverty. On February 4, 1985, respondent filed a Motion To Calendar and Consolidate for Trial, Briefing, and Opinion, requesting that these cases be set for trial on June 3, 1985. Petitioner was directed to file an objection, if any, by April 12, 1985. No objection having been received, the motion was granted and the cases were calendared for trial on June 3, 1985, at Hartford, Connecticut, by order of the Court, dated April 30, 1985, and served on both parties. At the call of the calendar there was no appearance by or on behalf of petitioner. Counsel for respondent appeared and made an oral motion to dismiss for lack of prosecution. The first matter before the Court is petitioner's Motion For Summary Judgment filed on May 31, 1985, one business day before the case was scheduled for trial. Petitioner's basis for this motion is the contention that "[t]he Tax Court lacks jurisdiction to determine constitutional issues such as the validity of a vow of proverty executed by a member1985 Tax Ct. Memo LEXIS 219">221 of a religious order who engages in secular employment as directed by his ecclesiastical superiors." Petitioner relies on the case of for this proposition. This identical argument has been raised in several previous cases and has been rejected as lacking in merit. ; ; ; , on appeal (9th Cir., Oct. 5, 1984). In fact, the present motion is substantially similar to that which had been previously filed in one of these cases, docket No. 28486-82, and which was denied on February 9, 1984. The only new material in the present motion is petitioner's reliance on the 1984 Amendments to the Bankruptcy Act and on the government's stipulations in a Court of Claims case, to bolster his contention that the Tax Court as an Article I court has no jurisdiction over constitutional issues. We fail to see how any of this irrelevant material provides any basis1985 Tax Ct. Memo LEXIS 219">222 whatsoever for reconsideration of petitioner's contentions already fully explored and discussed in the cases cited above. Accordingly, petitioner's motion is denied. The second matter before the Court is respondent's oral motion to dismiss for the failure by petitioner properly to prosecute these cases. Neither petitioner nor counsel for petitioner appeared at the calendar call of these cases. While the order setting these cases for trial was issued a little more than a month before the trial date, petitioner had notice of respondent's request to calendar these cases in February and did not object. Petitioner's only response to the order for trial has been the above-mentioned frivolous motion for summary judgment. The mere filing of a motion for summary judgment does not excuse petitioner from appearing on the scheduled trial date, in particular in these circumstances, where there was virtually no time in which the Court could act on the motion. Petitioner's counsel is well aware that similar motions for summary judgment, including one in this case, have been denied on numerous occasions, and it is clear to the Court that this motion was filed purely for the purpose of delay, 1985 Tax Ct. Memo LEXIS 219">223 harassment of respondent, and abuse of the Tax Court process. The failure of petitioner to appear in person or by counsel is unexplained and, therefore, we grant respondent's motion to dismiss these cases for failure properly to prosecute pursuant to Rule 123(b). Accordingly, a decision will be entered for respondent in the amounts of the deficiencies and additions to tax determined in the notices of deficiency. The final matter we consider is whether, in the circumstances of these cases, we should, on our own motion, award damages to the United States under section 6673. Section 6673 provides: Whenever it appears to the Tax Court that proceedings before it have been instituted or maintained by the taxpayer primarily for delay or that taxpayer's position in such proceedings is frivolous or groundless, damages in an amount not in excess of $5,000 shall be awarded to the United States by the Tax Court in its decision. * * The petitions filed in these cases, with the exception of matters which were specific to this petitioner, such as name, residence, years and amounts in issue and the like, were identical to the one filed in ,1985 Tax Ct. Memo LEXIS 219">224 on appeal (9th Cir., April 4, 1985). That case concluded that damages under section 6673 were appropriate in view of the number of cases which had already rejected the taxpayer's claims and which had to be known to the taxpayer since his counsel was also counsel for the taxpayer in the other cases. To that list of cases, namely, , affd. without published opinion ; ;;; and , affd. , we would also add Teuscher whose results were known to petitioner's counsel prior to the scheduled trial date. Moreover, in the present controversy, we have the additional factor that a motion for summary judgment was filed by petitioner even though one virtually identical to it had already been denied. This Court concludes that this action was brought and has been maintained for the primary purpose of delay and that petitioner's position is frivolous1985 Tax Ct. Memo LEXIS 219">225 and groundless. We hereby award damages to the United States in the amount of $5,000. Appropriate orders and decisions for respondent will be entered.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue, and all references to Rules are to the Tax Court Rules of Practice and Procedure.↩*. Fifty percent of the interest due on $5,228.98 ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625644/	David Glickman v. Commissioner.Glickman v. CommissionerDocket No. 24693.United States Tax Court1951 Tax Ct. Memo LEXIS 230; 10 T.C.M. 454; T.C.M. (RIA) 51144; May 15, 19511951 Tax Ct. Memo LEXIS 230">230 Peter J. George, Esq., 305 Broadway, New York 7, N. Y., for the petitioner. Nicholas Tomasulo, Esq., for the respondent. TURNER Memorandum Findings of Fact and Opinion TURNER, Judge: Respondent determined a deficiency in income tax against petitioner for the year 1944 in the amount of $1,545.20. The question presented is whether $5,545.29 of the amount of $9,645.29, received by petitioner in 1944 as compensation for services rendered, constituted "back pay" within the meaning of section 107 (d) (2) of the Internal Revenue Code. Findings of Fact The stipulated facts are found as stipulated and are included herein by this reference. Petitioner is a resident of Brooklyn, New York, and filed his income tax return for the year 1944 with the Collector of Internal Revenue for the First District of New York. In the return petitioner reported as income salary received from Madame Sabo, Inc. during 1944 in the amount of $9,645.29, of which he treated $5,545.29 as "back pay" within the meaning of section 107 (d) (2) of the Internal Revenue Code. In computing the tax the years for which "back pay" was claimed were 1933 to 1937, 1951 Tax Ct. Memo LEXIS 230">231 both inclusive, 1939, 1940 and 1941. Prior to January 29, 1932, Mathilda Sabo operated an embroidery business in the city of New York under the name of Madame Sabo. At that time petitioner was employed as a salesman. On January 20, 1932, petitioner entered into an agreement with Mathilda Sabo and her husband, Louis Sabo, in contemplation of the incorporation of the business. It was provided in the agreement, inter alia, that petitioner and Mathilda Sabo would each purchase 50 shares of the capital stock of Madame Sabo, Inc., which shares were to be without par value; that they would pay for the shares by transferring all their right, title and interest in and to the furniture, fixtures, machinery and stock of the existing business to the corporation; that petitioner and Mathilda Sabo would each loan to the corporation $1,000; that they, and a person appointed by them, would constitute the board of directors; that Mathilda Sabo would be president and petitioner would be secretary and treasurer; that "each of them shall devote their entire time, effort and energy for the benefit and for the welfare of the corporation; that the salaries of each of the said parties * * * shall be the1951 Tax Ct. Memo LEXIS 230">232 sum of Forty Dollars ( $40) per week for each of them"; that the net profits of the corporation would be apportioned equally between petitioner and Mathilda Sabo at the end of each fiscal year; and that Louis Sabo shall be employed by the corporation "as manager, foreman and general man at a salary of Thirty-five Dollars ($35.00) per week." The business was incorporated on January 29, 1932, with the corporate name Madame Sabo, Inc. Fifty per cent of the non-par value stock was issued to petitioner and 50 per cent was issued to Mathilda Sabo. The agreement of January 20, 1932 was adopted by corporate action to be effective from January 29, 1932. Petitioner and Mathilda Sabo executed their bill of sale on January 29, 1932, through which they conveyed to the corporation all furniture, fixtures, machinery and stock in trade used by them in the business they had previously conducted as Madame Sabo. Petitioner paid in approximately $2,000 in cash. There were some debts outstanding at the time the business was incorporated and they were paid from the $2,000 paid in by petitioner. The book capital of Madame Sabo, Inc. at the time of incorporation was shown as $3,714.59. Mathilda Sabo became1951 Tax Ct. Memo LEXIS 230">233 president of the corporation and petitioner, secretary and treasurer. They were also named as two of the three directors. Rose Sonnenschein became the third director. Petitioner held the offices of secretary and treasurer until December 31, 1948, and has been an officer and a stockholder of the business since its incorporation until the present date. The minutes of a stockholders meeting on December 24, 1934, show the adoption of a resolution to the effect that officers salaries be increased to $50 per week effective January 1, 1935. By 1944 Louis Sabo had become an officer and stockholder in the corporation. On June 1, 1944, Madame Sabo, Inc. made application to the Salary Stabilization Unit, Bureau of Internal Revenue, for increases in the compensation of its three officers from $2,600 to $5,200. On July 5, 1944, the corporation was notified that the Unit had approved salaries of the officers at $3,900. On July 13, 1944, the corporation requested a review of the Unit's action and after holding a conference with petitioner on August 1, 1944, the Unit, on August 5, 1944, approved salary increases of the respective officers to $5,200. Madame Sabo, Inc. sustained cash losses for1951 Tax Ct. Memo LEXIS 230">234 the years and in the amounts listed below: Corporation LossYearfor the year1932$1,894.301933483.281934127.081935122.47193633.411937158.75193817.771939993.761940609.7119411,278.8019424,680.561943$636.78 - Profit1944$2,450.53 - ProfitThe cash balances for the corporation at December 31 for the period commencing December 31, 1932 to December 31, 1942 were as follows: YearAmountDecember 31, 1932$ 17.91December 31, 193324.95December 31, 1934260.51December 31, 193525.08December 31, 1936173.33December 31, 193724.49December 31, 193842.60December 31, 193979.26December 31, 1940865.59December 31, 1941419.11December 31, 194271.37(overdraft)Petitioner received and reported the following as earnings from Madame Sabo, Inc. for the following years: YearReceived and Reported1932$ 828.931933764.1619341,297.7019351,704.9719362,301.4119372,131.7519382,726.2519391,870.0019402,017.7019412,606.0319422,235.8919433,919.92Madame Sabo, Inc., in its 1944 income tax return took a deduction for1951 Tax Ct. Memo LEXIS 230">235 salaries paid to its officers in the respective amounts: Mathilda Sabo, President$8,011.84David Glickman, Secretary-Treasurer9,645.29Louis Sabo, Vice President6,616.65Petitioner in his 1944 return, showed his salary adjustments for the years 1932 through 1944, as follows: Total IncomeReported onBack Pay Re-Original taxAdjustedceived in 1944Adjusted(IncludedTaxApplied asYearReceivedBack PayIncomeMrs. G.) ReturnsFollows1932$ 828.93$1,251.07$2,080$2,080.0019331 744.161,315.842,0802,080.00$1,224.7119341,297.70782.302,080$1,297.702,080.00782.3019351,704.97895.032,6001,704.972,600.00895.0319362,301.41298.592,6002,301.412,600.00298.5919372,131.75468.252,6002,131.752,600.00468.2519382,726.25(126.25)2,6002,726.252,726.25019392 1,670.00930.002,600 2,855.713,785.71930.0019402,017.70582.302,600 4,905.705,488.00582.3019412,606.03(6.03)2,6002,606.032,606.03019422,235.89364.112,6002,235.892,600.00364.1119433,919.92(1,209.92)2,7103,919.922,710.00019449,645.29(5,545.29)4,1004,100.00$5,545.291951 Tax Ct. Memo LEXIS 230">236 The corporation followed a practice of discounting its accounts receivables with a factor or factors rather than that of making the collections itself. Petitioner and Mathilda Sabo did not always receive the same amounts from the corporation as compensation but usually there was not a great difference at the end of the year in the aggregate of the amounts they received. Opinion The petitioner contends that of the $9,645.29 received by him in 1944 as compensation, $5,545.29 was back pay attributable to services rendered in prior years, within the meaning of section 107 (d) of the Internal Revenue Code. 1 More particularly, the petitioner contends that for the years 1933 to 1944 the corporation, by reason of its liability for amounts due and owing by it to its officers for services rendered in those years, was insolvent, and in such circumstances, the amounts paid in 1944 and claimed as back pay fall within the provisions of section 107 (d) (2) (iv) of the Code. Relying1951 Tax Ct. Memo LEXIS 230">237 on that provision, it is argued that while the corporation was not actually in bankruptcy or receivership, as described by section 107 (d) (2) (i), the insolvency or precarious financial state of the corporation made of that condition or circumstance "any other event * * * similar in nature" to bankruptcy or receivership. The petitioner relies on Estate of R. L. Langer v. Commissioner, 183 Fed. (2d) 758, reversing 13 T.C. 419">13 T.C. 419. 1951 Tax Ct. Memo LEXIS 230">238 The difficulty is that, assuming the proposition stated to be legally sound, the petitioner has not established the necessary factual basis therefor. While the record as a whole does indicate that the corporation was, over the years, operating on a narrow margin financially, we cannot say that it was insolvent, even if we accept the view that there was a continuing liability for unpaid salaries, as claimed. When the corporation was organized, it took over the business, including assets, equipment and inventory, of an individual enterprise which previously had been operated by Mathilda Sabo, and the petitioner put in some cash. The petitioner himself when called as a witness could not state what the amount was, but it possibly was somewhere in the neighborhood of $2,000. Some of the cash was used to pay the obligations of the business outstanding at the time of incorporation. About the only other fact which is clear as to financial condition at incorporation is that book capital was shown as $3,714.59. Aside from the corporate resolutions of January 29, 1932, and December 24, 1934, dealing with officers' salaries, the claim that the corporation was rendered insolvent by reason1951 Tax Ct. Memo LEXIS 230">239 of the existence of liability for unpaid salaries is factually based on the stipulated statements of "cash losses" over the years, and of cash balances at the end of each year, plus the testimony of the petitioner and two other witnesses, who as bookkeepers or auditors had something to do with the corporate books during the period under consideration. The tenor of petitioner's argument seems to be that the statements of "cash losses" and cash balances are sufficient, when effect is given to the claim that liability for unpaid salaries existed, to establish the insolvency of the corporation, notice being taken that the books of account were kept on a cash basis. Assertions and argument are not proof. The books were not produced and we do not know what conclusions might have been drawn from them. The stipulation of "cash losses" and of cash balances is, to say the least, inconclusive. We are not advised as to the effect, if any, given to accounts receivable, accounts payable, or inventory, and the information of record as to machinery, equipment and fixtures is so meager that it may be regarded as inconsequential. In short, we do not know whether the corporation was insolvent, regardless1951 Tax Ct. Memo LEXIS 230">240 of whether there were existing and continuing liabilities for unpaid salaries to officers. Aside from the question of insolvency of the corporation we do not think that petitioner has shown that there was over the years an existing and continuing liability for unpaid salaries as claimed. It is true that the results of a mathematical computation made on the basis of the resolution of January 29, 1932 and December 24, 1934, would, after making allowance for the salary payments actually made, reflect back pay in the amounts and for the years claimed. It is admitted that the items in question were not carried on the books of account. It is claimed, however, that the books were kept on a cash basis and the salary items, being accrued but unpaid liabilities, would not properly appear therein. The fact is we do not know with any certainty just how the books were kept. The 1932 and 1944 returns which are in evidence bear statements that they are cash basis returns. The same is true of the 1934 return from which one witness testified to some extent. In the 1932 return the cost of goods sold was shown by the use of inventories and both the 1932 and 1934 returns carried balance sheets at the1951 Tax Ct. Memo LEXIS 230">241 beginning and end of the year. The 1932 balance sheets carried accounts receivable, inventories, other investments, capital assets, accounts payable and as of the end of the year $290 as salaries payable. The balance sheet constituting part of the 1934 return showed unpaid salaries as of the beginning of the year at $999 and at the end of the year $970. It thus appears that assets and liabilities accounts were maintained in some manner whether the books as a whole be regarded as having been kept by an accrual method or on a cash basis. Of greater significance, however, is the fact that even though there was a representation of existing and accrued liabilities, including liability for unpaid salaries, the salary item shown at the end of 1932 and at the beginning and end of 1934 did not include the salary items involved in this case. If it had been intended that the corporation should be liable over the years as here claimed, and it was so liable, then at the end of 1932 there should have been included in the liability item of salaries $1,091.07 as the amount owing to petitioner alone and at the end of 1934 there should have been included on account of liability to petitioner for unpaid1951 Tax Ct. Memo LEXIS 230">242 salaries a total of $3,189.21. The only explanation offered was by the man who set up the books and kept them for a number of years and to say merely that the tenor and purport of the explanation made is not clear is a charitable statement. The explanation was " * * in so far as the balance sheet reflected cash income for the year in order if I were to show all the liabilities after a minus on income, net income, which would more or less prove that there was no particular business at that particular year." On the record made we are not convinced that the corporation and its officers actually regarded the amounts in question as being due and owing over the years. From the picture as a whole we are constrained to conclude that the claim that the differences between the amounts paid and those computed pursuant to the resolutions were continuing liabilities of the corporation was in reality an after thought and nothing more. Though the existence of the corporation is not here in question the testimony and other evidence of record indicate that the actual operations were as informally conducted as if they had been the individual operations of petitioner, Mathilda Sabo, and her husband. 1951 Tax Ct. Memo LEXIS 230">243 They did go through the formality of placing the salary resolutions upon the minute books but from the incompleted state of the minute forms which were placed in evidence there might well be some basis for doubt as to whether or not corporate meetings did in fact occur. With respect to the resolution of January 29, 1932, it is to be noted that it also provided that after the amounts designated as salaries were paid the remaining profits were to be divided 50 per cent to Mathilda Sabo and 50 per cent to petitioner 2 In other words the resolution as adopted provided for the disposition of the entire profits of the corporation, what they might be, without leaving the matter to later and current action of the board of directors or stockholders as is the usual case in handling corporate affairs. If they intended the resolutions as an effective determination of officers' salaries from year to year without regard to earnings, then we must conclude that their failure to carry liability therefor in the balance sheets made as a part of their income tax returns puts them in a light of actual, if not deliberate, misrepresentation of the financial condition of the corporation. We are rather of1951 Tax Ct. Memo LEXIS 230">244 the opinion that the situation here was in over-all effect similar to that which existed in the case of Stern-Slegman-Prins Co. v. Commissioner, 79 Fed. (2d) 289, where before the end of each year the salaries of the three owners of the corporate business were adjusted downward from the established salaries as of the beginning of the year to coincide with the amounts actually drawn during the year. The difference between the two cases is that there the corporate owners did currently indulge in the formality of reducing salaries to the amounts paid as of the end of the year whereas in this instance the acts and attitude of the owners of Madame Sabo, Inc. as reflected in the over-all picture rather indicate that they did not regard the resolutions of January 1932 and December 1934 as having definitely established liability for salaries over and above the amounts currently paid. Norbert J. Kenny, 4 T.C. 750">4 T.C. 750;1951 Tax Ct. Memo LEXIS 230">245 James Newton Dean, 10 T.C. 672">10 T.C. 672, and Frederick H. Hagner, 14 T.C. 643">14 T.C. 643, cited and relied on by petitioner are distinguishable and that without regard to the soundness of petitioner's contention as to the scope and meaning of section 107 (d) (2) (iv), supra, Estate of R. L. Langer v. Commissioner, supra, likewise is not in point for the reason that petitioner here has not established the insolvency of the corporation. Decision will be entered for the respondent. Footnotes1. Stipulated as $764.16. ↩2. Stipulated as $1,870. ↩. Includes Mrs. Glickman's earnings. There is no explanation of why adjusted income for 1943 is $2,710 rather than $2,600.↩1. SEC. 107. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF THIRTY-SIX MONTHS OR MORE AND BACK PAY. * (d) BACK PAY. - (1) In General. - If the amount of the back pay received or accrued by an individual during the taxable year exceeds 15 per centum of the gross income of the individual for such year, the part of the tax attributable to the inclusion of such back pay in gross income for the taxable year shall not be greater than the aggregate of the increases in the taxes which would have resulted from the inclusion of the respective portions of such back pay in gross income for the taxable years to which such portions are respectively attributable, as determined under the regulations prescribed by the Commissioner with the approval of the Secretary. (2) Definition of Back Pay. - For the purposes of this subsection, "back pay" means (A) remuneration, including wages, salaries, * * received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which would have been paid prior to the taxable year except for the intervention of one of the following events: (i) bankruptcy or receivership of the employer; (ii) dispute as to the liability * * ; (iii) if the employer is the United States, a State * , lack of funds appropriated to pay such remuneration; or (iv) any other event determined to be similar in nature under regulations prescribed by the Commissioner with the approval of the Secretary; * *↩2. At some undisclosed date Mathilda Sabo's husband became a stockholder but we do not know what the stockholdings were thereafter. Neither are we advised as to whether any action was taken with respect to the profits, if any, over and above current salaries to officers.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625647/	ESTATE OF R. JACK SIMPSON, DECEASED, KENNETH A. WHITTAKER, PERSONAL REPRESENTATIVE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Simpson v. CommissionerDocket No. 4397-92United States Tax CourtT.C. Memo 1994-259; 1994 Tax Ct. Memo LEXIS 261; 67 T.C.M. 3062; June 7, 1994, Filed 1994 Tax Ct. Memo LEXIS 261">261 For petitioner: David M. Presnick and Richard O. Jones. For respondent: Jane T. Dickinson. CLAPPCLAPPMEMORANDUM FINDINGS OF FACT AND OPINION CLAPP, Judge: Respondent determined a deficiency in petitioner's estate tax in the amount of $ 536,140 and an addition to tax under section 6651(a)(1) in the amount of $ 52,228. After concessions, the issues for decision are: (1) Whether petitioner is entitled to a marital deduction in the amount of $ 504,499. We hold that it is not. (2) Whether petitioner is entitled to a charitable deduction in the amount of $ 1,145,318. We hold that it is not. (3) Whether petitioner is liable for an addition to tax under section 6651(a)(1). We hold that it is. All section references are to the Internal Revenue Code in effect at the date of decedent's death, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. FINDINGS OF FACT We incorporate by reference the stipulation of facts and attached exhibits. Petitioner is the Estate of R. Jack Simpson (decedent). Decedent was a resident of Cocoa, Brevard County, Florida, when he died on June 3, 1987. Pursuant to decedent's last will and testament, 1994 Tax Ct. Memo LEXIS 261">262 First American Bank and Trust (First American), subsequently known as Comerica Trust Company of Florida, N.A. (Comerica), was appointed personal representative of the estate of decedent, with letters of administration being issued by the Circuit Court for Brevard County, Florida (circuit court), on December 18, 1987. At the time the petition was filed, Comerica's principal place of business was in Palm Beach, Florida. Comerica subsequently was replaced by Kenneth A. Whittaker (Whittaker), of Melbourne, Florida, as successor personal representative pursuant to the July 2, 1992, order of the circuit court. Decedent had been engaged in the real estate business, buying and developing property, and buying mortgages and loaning money. Over a 15-year period, decedent was advised in the legal aspects of his real estate business by John Minot (Minot), a Florida attorney. Minot has practiced real estate and probate law in Florida for over 30 years. Decedent was diagnosed with terminal cancer in 1985. Decedent married Hazel Catechis (Mrs. Simpson or surviving spouse) on March 22, 1986. Two days before their marriage, decedent and the then Ms. Catechis entered into an antenuptial agreement1994 Tax Ct. Memo LEXIS 261">263 prepared by Minot. The parties to the agreement waived all statutory rights to and interests in each other's property. Decedent and Ms. Catechis executed three originals of the agreement, one for each party thereto, and one for Minot, which remained in his possession. The agreement did not preclude either spouse from making lifetime or testamentary gifts or provisions in favor of the other. Minot and decedent developed an estate plan for decedent through consultations with people more experienced in estate planning, including a senior vice president and trust officer from First American, John C. Patten (Patten). Decedent had no issue and several brothers and sisters whom he did not feel deserved to share in his estate. Decedent wished to benefit certain organizations, provide for the education of certain nieces and nephews, provide for a memorial to a brother killed in World War II, and make minimal provisions for his spouse. Once decedent's estate plan was developed, Lester Lintz (Lintz), a Florida attorney specializing in real estate and estate planning and administration, drafted decedent's last will and testament and revocable trust agreement. The draft documents were 1994 Tax Ct. Memo LEXIS 261">264 circulated to Patten, who was aware of the antenuptial agreement. Lintz did not know of the antenuptial agreement at the time he prepared the will and trust agreement. On October 27, 1986, decedent created a revocable trust and executed a last will and testament. Decedent named Minot as personal representative of his estate and First American as alternate or successor. Decedent acted as the sole trustee of the trust until his death, after which Minot and First American were named as cotrustees. Under the provisions of decedent's will, any of his property that had not been transferred into the trust during his lifetime would, after payment of debts, taxes, and specific devises, "pour over" to fund the trust at his death. Both the will and the trust agreement contained a provision devising decedent's residence to his spouse, if surviving. The trust agreement provided for distributions equal to 1 percent of the balance of the remaining trust estate to the following five organizations: The Salvation Army, the Fleet Reserve Association at Cocoa, Florida, the Cocoa Lions Club, the Free and Accepted Masons at St. Petersburg, Florida, and the Arabic Ancient Order of the Nobles of the1994 Tax Ct. Memo LEXIS 261">265 Mystic Shrine -- Azan Temple. There was no requirement that the beneficiaries be qualified charities for purposes of a deduction under section 2055; however, respondent conceded that all named organizations were so qualified. The trust agreement also established educational trusts for nieces, nephews, and grandchildren of Mrs. Simpson, established a memorial fund for decedent's brother, and provided for the establishment of a residuary trust. The property of the residuary trust was to be held by decedent's trustees during the lifetime of his spouse and, pursuant to the terms of the trust, decedent's surviving spouse was to receive the lesser of $ 30,000 per year (payable in monthly installments of $ 2,500), or an annual income from the residuary trust. The trustees were empowered to make distributions to the surviving spouse during each year in excess of $ 30,000 from the income or principal of the trust, as the trustees determined to be necessary or desirable for her proper health, maintenance, and support. Upon the death of decedent's spouse, the trustees were directed to distribute the remaining principal and undistributed income of the residuary trust in equal shares to the1994 Tax Ct. Memo LEXIS 261">266 above-named charitable organizations. Decedent caused Minot to amend the revocable trust agreement twice in May 1987. Decedent eliminated the memorial fund for his brother on May 7, 1987, and created specific devises to a brother and a sister on May 15, 1987. On February 5, 1987, and on May 27, 1987, decedent transferred assets (real properties and mortgages) from his closely held corporation, Rebel Jack, Inc., to the revocable trust. Minot prepared all of the transfer documents. Decedent died on June 3, 1987, at the age of 67, survived by his spouse, who was then age 50. Minot waived his right to act as personal representative of the estate, and First American was appointed personal representative on December 18, 1987. Minot delivered decedent's will and an executed original of the antenuptial agreement to First American. First American commenced an action on January 21, 1988, in the circuit court requesting a determination as to whether decedent's February and May 1987 transfers of assets from Rebel Jack, Inc., to the revocable trust were valid and proper. The only parties involved were First American, as decedent's personal representative, and a guardian ad litem appointed1994 Tax Ct. Memo LEXIS 261">267 to represent the trust's interests. Minot, who prepared the amendment transferring the assets into the trust and who was cotrustee of the trust, was not involved in the proceeding. The named charitable beneficiaries of decedent's trust were not parties to the litigation, nor were they aware of it. The original complaint alleged that the transfers of assets into the inter vivos trust were negligently made and could result in an extremely large Federal tax liability for both Rebel Jack, Inc., and the estate, so as to "destroy a large portion of the estate, and subvert the purpose and intent of the decedent to pass his estate on to his heirs and beneficiaries." The complaint was amended later to delete references to Minot's negligence and the tax consequences, stating instead that decedent relied on material misrepresentations of the applicable law and facts, and did not intend for either the corporation or the estate to incur the adverse consequences of the transactions. The guardian ad litem denied these allegations in his answer to the original and amended complaints. By counterclaim, the guardian ad litem requested a mandatory injunction requiring First American, as personal1994 Tax Ct. Memo LEXIS 261">268 representative, to deliver over all of decedent's shares of Rebel Jack, Inc., pursuant to the terms of decedent's last will and testament. After a telephone hearing, the circuit court entered a final judgment on November 29, 1988, holding that decedent would not have made the conveyances had he not been under a mistake of fact and law and if he had had professional advice and direction. The circuit court directed the transfer of all properties back to Rebel Jack, Inc., and the transfer of Rebel Jack, Inc.'s stock from First American, as personal representative, to the guardian ad litem of decedent's trust. The estate tax return for decedent's estate, Form 706, was filed with the Atlanta Service Center on December 8, 1988, more than 3 months after its due date of September 3, 1988. On the Form 706, the estate took marital and charitable deductions based on the desired outcome of the yet-to-be-instituted proceedings in the circuit court. Petitioner has conceded that there was no reasonable cause for the late filing of the Federal estate tax return. Decedent's surviving spouse timely filed a claim to take her elective share of decedent's estate on January 5, 1989, pursuant to Fla. 1994 Tax Ct. Memo LEXIS 261">269 Stat. Ann. sec. 732.201 (West 1976). On March 7, 1989, First American, as decedent's personal representative, filed a complaint in the circuit court asking for three declarations: The legal effect of the antenuptial agreement, the effect of the court's findings with respect to the antenuptial agreement upon the distribution of the estate, and whether it was decedent's intent that the balance of the trust estate pass solely to tax-exempt organizations qualified under section 501(c)(3). In the complaint, First American stated that, based on information and belief, decedent intended to revoke the antenuptial agreement by his actions. Neither our record nor the record of the circuit court proceeding reveals the basis for that belief. In the declaratory action, decedent's surviving spouse filed a motion for summary judgment and an affidavit in support claiming that after they married, she and decedent decided to revoke the antenuptial agreement and that to her knowledge decedent destroyed the original. She thereafter assumed it was revoked. One of the charitable beneficiaries, the Free and Accepted Masons, objected to Mrs. Simpson's motion for summary judgment on the basis of Florida's1994 Tax Ct. Memo LEXIS 261">270 "Dead Man's Statute", Fla. Stat. Ann. sec. 90.602 (West 1976). The motion was otherwise unopposed. Without a hearing, the circuit court entered an order on October 3, 1990, on the summary judgment motion holding that the antenuptial agreement had been revoked by the actions of decedent and that the surviving spouse was entitled to an elective share of decedent's estate, payable at the rate of $ 2,500 per month until the estate was settled when the balance of the elective share would be paid. The order also provided for a family allowance of $ 6,000. The court additionally ordered that the remaining assets of decedent's estate and trust be distributed as though the surviving spouse had predeceased decedent pursuant to Fla. Stat. Ann. sec. 732.211 (West 1976). The charities and Mrs. Simpson entered into an agreement in which the charities agreed not to appeal the circuit court's decision in return for Mrs. Simpson's giving up any rights, title, or interest in the trust. Under the terms of the agreement, Mrs. Simpson received outright almost $ 600,000 from the estate. The estate did not file an appeal because all of the beneficiaries had agreed. Neither proceeding before the 1994 Tax Ct. Memo LEXIS 261">271 circuit court was an adversary proceeding. The estate and the beneficiaries were in agreement, and the circuit court granted the results requested by the personal representative. OPINION Marital DeductionThe first issue for decision is whether petitioner is entitled to a marital deduction. Section 2056(a) provides in pertinent part: For purposes of the tax imposed by section 2001, the value of the taxable estate shall * * be determined by deducting from the value of the gross estate 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.Section 2056(b), however, disallows a marital deduction for a "terminable interest" in property that will terminate or fail either on the lapse of time or on the occurrence of an event or contingency. An interest in the nature of a life estate is ineligible for the martial deduction. Estate of Bennett v. Commissioner, 100 T.C. 42">100 T.C. 42, 100 T.C. 42">55 (1993); Estate of Nicholson v. Commissioner, 94 T.C. 666">94 T.C. 666, 94 T.C. 666">671 (1990).1994 Tax Ct. Memo LEXIS 261">272 Congress modified the terminable interest requirement by allowing a marital deduction for "qualified terminable interest property" (QTIP). Sec. 2056(b)(7)(B); Economic Recovery Tax Act of 1981 (ERTA), Pub. L. 97-34, sec. 403(d), 95 Stat. 172, 302. QTIP interests are those in which a decedent passes to a surviving spouse "a qualifying income interest for life." Sec. 2056(b)(7)(B)(i)(II). Under section 2056(b)(7)(B)(ii)(I), a qualifying income interest is one under which the surviving spouse is entitled to "all the income from the property, payable annually or at more frequent intervals," and, while the surviving spouse is still alive, no one else can appoint any part of the property to anyone but the surviving spouse. 94 T.C. 666">Estate of Nicholson v. Commissioner, supra.Under the terms of decedent's will and trust, Mrs. Simpson received a specific bequest of the residence outright and a lifetime interest in a limited amount of the annual income from the residuary trust, with the remainder interest passing to charities upon her death. The parties are in agreement that the residence qualifies for the marital deduction. The provision for payment to her from1994 Tax Ct. Memo LEXIS 261">273 the residuary trust, however, is a nondeductible terminable interest not qualifying for the marital deduction. Sec. 2056(b). Petitioner does not argue otherwise. Rather, petitioner contends that the interest passing to Mrs. Simpson as a result of the circuit court proceeding and the agreement of the parties qualifies for the marital deduction. Generally, the character of the interest passing to a surviving spouse taking under a decedent's will is determined by the will. If, however, a surviving spouse claims a statutory elective share against the will, then the property interest retained by her is considered to have passed from the decedent to the surviving spouse. Sec. 20.2056(e)-2(c), Estate Tax Regs. The marital deduction consequently is based upon the interest received by the surviving spouse pursuant to the election. Mrs. Simpson's election to take against the will in the face of the antenuptial agreement caused the estate to seek a declaration from the circuit court. When the circuit court rendered a judgment that the antenuptial agreement was null and void, the surviving spouse and the charities entered into an agreement regarding Mrs. Simpson's interest in decedent's1994 Tax Ct. Memo LEXIS 261">274 estate. Property passing to a surviving spouse as a result of a will contest or similar litigation will qualify for the marital deduction only if the property interests assigned or surrendered to the surviving spouse are received in "bona fide recognition of enforceable rights of the surviving spouse in the decedent's estate." Sec. 20.2056(e)-2(d)(2), Estate Tax Regs.; Estate of Hubert v. Commissioner, 101 T.C. 314">101 T.C. 314, 101 T.C. 314">318 (1993). A bona fide recognition is presumed where the assignment or surrender was made pursuant to a decision of a local court upon the merits in an adversary proceeding following a genuine and active contest. A local court's decision will be accepted only to the extent that the court passed upon the facts upon which deductibility of the property interests depends. An assignment or surrender, made pursuant to a decree rendered by consent or agreement not to contest the will, will not necessarily be accepted as a bona fide evaluation of the rights of the spouse. 101 T.C. 314">Estate of Hubert v. Commissioner, supra; sec. 20.2056(e)-2(d)(2), Estate Tax Regs. Respondent contends that petitioner has failed to demonstrate1994 Tax Ct. Memo LEXIS 261">275 that Mrs. Simpson's receipt of an elective share in decedent's estate was a bona fide recognition of her enforceable rights in decedent's estate as required by section 20.2056(e)-2(d)(2), Estate Tax Regs. We agree. In Commissioner v. Estate of Bosch, 387 U.S. 456">387 U.S. 456 (1967), the Supreme Court held that a Federal court deciding the estate tax consequences of an attempted disclaimer was not bound by the State trial court's adjudication of the property rights involved. Citing Erie R. Co. v. Tompkins, 304 U.S. 64">304 U.S. 64 (1938), the Court noted that "state law as announced by the highest court of the State is to be followed." 387 U.S. 456">Commissioner v. Estate of Bosch, supra at 465. The Court explained that the State's intermediate appellate court decisions should be considered in deciding State law unless the Federal court is convinced that the highest court of the State would rule otherwise. Therefore, the Court concluded that a Federal court may not always be bound by the decision of the intermediate appellate court and that "when the application of a federal statute is involved, the decision of a state trial1994 Tax Ct. Memo LEXIS 261">276 court as to an underlying issue of state law should a fortiori not be controlling." 387 U.S. 456">Commissioner v. Estate of Bosch, supra at 465; 101 T.C. 314">Estate of Hubert v. Commissioner, supra at 319. Finally, the Court explained: the underlying substantive rule involved is based on state law and the State's highest court is the best authority on its own law. If there be no decision by that court then federal authorities must apply what they find to be the state law after giving "proper regard" to relevant rulings of other courts of the State. In this respect, it may be said to be, in effect, sitting as a state court. [387 U.S. 456">Commissioner v. Estate of Bosch, supra at 465; emphasis added; citation omitted.]In light of the Supreme Court's decision in Estate of Bosch, courts have concluded that if the decision of a State trial court on a matter of State law is not binding for estate tax purposes, a good faith settlement of such an issue cannot be either. Ahmanson Found. v. United States, 674 F.2d 761">674 F.2d 761, 674 F.2d 761">774 (9th Cir. 1981); 101 T.C. 314">Estate of Hubert v. Commissioner, supra at 319.1994 Tax Ct. Memo LEXIS 261">277 Even under "the most narrow reading of Bosch, either a good faith settlement or a judgment of a lower state court must be based on an enforceable right, under state law properly interpreted, in order to qualify as 'passing' pursuant to the estate tax marital deduction." 674 F.2d 761">Ahmanson Found. v. United States, supra at 775. Not every State court probate proceeding represents bona fide, adversary litigation, and a decree rendered therefrom is not conclusive as to property interests for Federal estate tax purposes. Estate of Rowan v. Commissioner, 54 T.C. 633">54 T.C. 633, 54 T.C. 633">638 (1970). There are a number of aspects to a State court proceeding which can raise questions and cast doubt upon its bona fide, adversary character, including whether all persons interested in the estate were aware of the proceedings so as to participate, and whether there is a hearing transcript or other record of how the court reached its decision. Id.Taxpayers can achieve favorable but collusive results from State court proceedings in which the Commissioner has not been made a party or which appear to have been pursued for the purpose of affecting a Federal1994 Tax Ct. Memo LEXIS 261">278 tax liability. Collusion does not imply fraudulent or improper conduct; rather, it implies that the parties have joined in submission of the issues such that there was no genuine issue of law or fact as to a beneficiary's rights to or property interest in an estate. Estate of Peyton v. Commissioner, 323 F.2d 438">323 F.2d 438, 323 F.2d 438">444 (8th Cir. 1963) (citing Saulsbury v. United States, 199 F.2d 578">199 F.2d 578, 199 F.2d 578">580 (5th Cir. 1952)), affg. T.C. Memo. 1962-205. In determining that a State court proceeding is not an adversary proceeding, we do not assume "any lack of competence or disinterestedness among state judges; no more would be needed than a complex issue of law, a crowded calendar, and the presentation to a busy judge of but essentially a single viewpoint." 387 U.S. 456">Commissioner v. Estate of Bosch, supra at 478 (Harlan, J., dissenting). The outcome of such a proceeding would be an explication of State law that is not necessarily "either a reasoned adjudication of the issues or a consistent application of the rules adopted by the State's appellate courts." Id.We first observe that the estate1994 Tax Ct. Memo LEXIS 261">279 claimed a deduction for the amount of the elective share on its return filed before Mrs. Simpson filed her claim and long before the circuit court entered its decision. In its response to Mrs. Simpson's claim, First American, as decedent's personal representative, represented to the circuit court that decedent intended to set aside the antenuptial agreement. The estate and beneficiaries most likely had arrived at an agreement before initiation of the proceeding in the circuit court. Furthermore, although one charitable beneficiary objected to the admissibility of Mrs. Simpson's affidavit, the record does not indicate that such objection was pursued. The pleadings before the circuit court contained allegations regarding decedent's revocation of the antenuptial agreement but no evidence to support them. Neither Minot, who prepared the antenuptial agreement and amended decedent's estate plan, nor Lintz, who prepared decedent's will and trust agreement, participated in the proceeding. There was thus no opposition to Mrs. Simpson's claim. We conclude that the circuit court was not presented with any unresolved factual issues. No hearing was held, and the circuit court entered an1994 Tax Ct. Memo LEXIS 261">280 order giving the parties to the matter, including the charitable beneficiaries, the result they sought. The circuit court proceeding was neither a genuine and active contest nor adversarial in nature. We conclude that the circuit court did not pass upon the facts upon which the marital deduction depends. The settlement agreement was similarly not a good faith compromise of a bona fide dispute. Consequently, Mrs. Simpson's receipt of her elective share in decedent's estate was not a bona fide recognition of her right to it. In deciding whether the surviving spouse has enforceable rights in decedent's estate, we must make an independent determination as to the enforceability of Mrs. Simpson's claim to a spouse's elective share under Florida State law. Estate of Brandon v. Commissioner, 828 F.2d 493">828 F.2d 493, 828 F.2d 493">499 (8th Cir. 1987), revg. and remanding 86 T.C. 327">86 T.C. 327 (1986); Estate of Hubert v. Commissioner, 101 T.C. 314">101 T.C. 319-320. The surviving spouse of a person who dies domiciled in Florida has a right to an elective share of the decedent's estate. Fla. Stat. Ann. sec. 732.201 (West 1976). The right to1994 Tax Ct. Memo LEXIS 261">281 an elective share may be waived before or after marriage by agreement. Fla. Stat. Ann. sec. 732.702 (West 1976). Antenuptial agreements waiving such rights are to be construed like other types of contracts and are generally presumed valid in Florida. Del Vecchio v. Del Vecchio, 143 So. 2d 17">143 So. 2d 17 (Fla. 1962); Cantor v. Palmer, 166 So. 2d 466">166 So. 2d 466 (Fla. Dist. Ct. App. 1964). Furthermore, antenuptial agreements do not preclude either spouse from making a bequest to the surviving spouse. 97 C.J.S., Wills, sec. 1266 (1957). An antenuptial agreement may be abandoned by mutual consent without consideration. McMullen v. McMullen, 185 So. 2d 191">185 So. 2d 191 (Fla. Dist. Ct. App. 1966). Petitioner presented the expert report and testimony of Judge Stanley Wolfman, a former circuit court judge in Florida. Judge Wolfman merely stated that in his opinion, the circuit court's declaratory judgment order setting aside the antenuptial agreement was within the judge's discretion and likely would have been upheld on appeal. He did not attempt to pass judgment on the merits. Although we accepted Judge Wolfman's testimony, 1994 Tax Ct. Memo LEXIS 261">282 his opinion cannot usurp this Court's function in determining the issues before us. See Estate of Carpenter v. Commissioner, T.C. Memo. 1993-97. Our independent inquiry into Florida law does not result from a determination that the circuit court's order was not within its discretion. We conclude that we are not bound by the order for Federal estate tax purposes because it was not the result of an adversary proceeding and, therefore, not a pronouncement upon which deductibility of the surviving spouse's property interest can rest. Commissioner v. Estate of Bosch, 387 U.S. 456">387 U.S. 456 (1967); sec. 20.2056(e)-2(d)(2), Estate Tax Regs. Petitioner has not presented any persuasive evidence supporting a finding that Mrs. Simpson had an enforceable right in decedent's estate. There is no testimony or record regarding decedent's alleged revocation of the antenuptial agreement. Mrs. Simpson did not testify. Rather, petitioner proffered the statements of Whittaker, the successor personal representative of decedent's estate, that the previous personal representative believed decedent intended to abandon the antenuptial agreement. 1994 Tax Ct. Memo LEXIS 261">283 Decedent never indicated his intent to abandon the antenuptial agreement to Minot, who prepared the antenuptial agreement and participated in developing decedent's estate plan and amendments thereto. Minot testified that decedent wished to make only minimal provisions for Mrs. Simpson's care in his estate plan. Petitioner's case appears to rest solely on the circuit court's order setting aside the antenuptial agreement and the agreement of the parties to that proceeding. We have concluded that neither the proceeding nor the settlement agreement was adversarial in nature. There is consequently a total lack of evidence in the record before us that would permit a conclusion as a matter of Florida law that the antenuptial agreement was abandoned. Petitioner has failed to satisfy its burden of proof as to the factual matters upon which it relies. DePaoli v. Commissioner, T.C. Memo. 1993-577. The source and nature of the property interest received by Mrs. Simpson derived from the circuit court's order and the agreement with the charitable beneficiaries, not from an enforceable right under Florida law. See Estate of Nachimson v. Commissioner, 50 T.C. 452">50 T.C. 452, 50 T.C. 452">454-456 (1968).1994 Tax Ct. Memo LEXIS 261">284 Further, the existence of a good faith settlement agreement is not enough to find that Mrs. Simpson had an enforceable right. 828 F.2d 493">Estate of Brandon v. Commissioner, supra at 499; Ahmanson Found. v. United States, 674 F.2d 761">674 F.2d at 774; 101 T.C. 314">Estate of Hubert v. Commissioner, supra at 319. We conclude that Mrs. Simpson's receipt of an elective share in decedent's estate was not a bona fide recognition of an enforceable right and, therefore, petitioner is not entitled to a marital deduction under section 20.2056(e)-2(d)(2), Estate Tax Regs. Charitable DeductionA deduction is allowed for transfers of property otherwise includable in the gross estate for bequests to certain charitable organizations. Sec. 2055(a). A charitable bequest of a remainder interest in a trust will qualify for deduction only if it is made in one of three specified forms: A charitable remainder annuity trust, a charitable remainder unitrust, or a pooled income fund. Sec. 2055(e)(2)(A). Reformation of an instrument to meet the above requirements is permitted under section 2055(e)(3). A deduction is allowed for any reformation1994 Tax Ct. Memo LEXIS 261">285 that changes a reformable interest into a qualified interest within the limitations set forth in section 2055(e)(3)(B) and (C). Petitioner has not sought such a reformation of the trust instrument in this case. Respondent concedes that all five charities named in decedent's will are qualified charitable organizations under section 2055(a), and that the distribution of 1 percent of the balance of the remaining trust estate to the charities qualifies for a charitable deduction under section 2055. Respondent argues, however, that the provisions of the trust created a split-interest trust that did not qualify for a deduction under section 2055, and that the post-death actions by the estate and the State court decisions are not binding for Federal estate tax purposes. We agree. Petitioner does not argue that the charitable remainder in decedent's pourover trust qualified for the deduction under section 2055 as it existed on the date of decedent's death. Rather, petitioner argues that the estate is entitled to a deduction on the basis of the actions of the circuit court and the beneficiaries giving Mrs. Simpson an elective share outright such that the charities could take their remainder1994 Tax Ct. Memo LEXIS 261">286 immediately. As discussed above, these actions were nonadversarial in nature and, therefore, we are not bound by them. 387 U.S. 456">Commissioner v. Estate of Bosch, supra;Estate of Hubert v. Commissioner, 101 T.C. 314">101 T.C. 314 (1993). An order or judgment of a State trial court cannot operate to change the Federal tax consequences of a completed transaction. To hold otherwise would allow opportunity for collusive State court actions having the sole purpose of reducing Federal tax liabilities. Van Den Wymelenberg v. United States, 397 F.2d 443">397 F.2d 443, 397 F.2d 443">445 (7th Cir. 1968). Furthermore, the reformation of an instrument may have retroactive effect as between the beneficiaries but not as to nonparties such as the Federal Government. Id.; Estate of Bennett v. Commissioner, 100 T.C. 42">100 T.C. 60; Estate of Nicholson v. Commissioner, 94 T.C. 666">94 T.C. 674. Petitioner has therefore failed to establish its entitlement to a charitable deduction in excess of the amount allowed by respondent. Addition to TaxSection 6075(a) provides that a Federal estate tax return must 1994 Tax Ct. Memo LEXIS 261">287 be filed within 9 months after the date of a decedent's death. Section 6651(a)(1) provides for an addition to tax of 5 percent of the tax for each month during which a failure to file continues, not exceeding 25 percent in the aggregate, unless it is shown that a failure to file any return on its due date is due to reasonable cause and not due to willful neglect. Petitioner's Federal estate tax return was filed December 8, 1988, more than 3 months after its September 3, 1988, due date, as extended by a timely obtained extension of time to file. Petitioner did not proffer any argument or explanation for the delay and is, therefore, deemed to concede the addition to tax. In accordance with the foregoing, Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625649/	ABRAHAM SCHEER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Scheer v. CommissionerDocket No. 10857.United States Board of Tax Appeals11 B.T.A. 836; 1928 BTA LEXIS 3709; April 26, 1928, Promulgated 1928 BTA LEXIS 3709">3709 1. FRAUD. - Petitioner maintained an inadequate set of books of accounts but did not wilfully file a false and fraudulent return with intent to evade tax. 2. STATUTE OF LIMITATIONS. - There having been no fraud and, the statute having run, there is no deficiency for the year under review. Ralph W. Smith, Esq., Claude I. Parker, Esq., and E. L. Barrette, Esq., for the petitioner. John W. Fisher, Esq., for the respondent. TRUSSELL 11 B.T.A. 836">836 Respondent's deficiency letter dated December 9, 1925, asserted against the petitioner for the fiscal year ended January 31, 1919, an additional income tax in the amount of $700.79, to which there was added a 50 per cent fraud penalty in the amount of $350.40, total tax and penalty, $1,051.19. The said letter also asserted additional taxes for periods between February 1, 1916, and January 31, 1918, in the amount of $88.86. Counsel for the respondent conceded at the trial that there was no deficiency for said periods. The petitioner pleaded the bar of the statute of limitations as a complete defense while the respondent's answer contained the following affirmative allegations: That this taxpayer1928 BTA LEXIS 3709">3710 fraudulently omitted to report as income for the fiscal year ended January 31, 1919, salaries in the amount of $4,471.56; income of minor child in the amount of $1,110; and income from sale of bonds in the amount of $20.20. 11 B.T.A. 836">837 At the trial the petitioner produced evidence tending to show that his return for the year ended January 31, 1919, was not subject to the charge of being false or fraudulent with the intent to evade taxes. The respondent produced no direct evidence and relied entirely upon cross-examination of petitioner's witnesses. FINDINGS OF FACT. At the time of the trial petitioner was residing at Los Angeles, Calif. During the year ended January 31, 1919, and for a considerable number of years prior thereto, he had been a resident of the City of New York, and had been engaged in the business of manufacturing ladies' muslin underwear, in which business he was engaged for about 20 years. During the period here under consideration his factory plant comprised about 75 sewing machines and the employees therein numbered between 50 and 60 people. For the year here under consideration the closing entries on the taxpayer's journal made as of January 31, 1919, were1928 BTA LEXIS 3709">3711 as follows: January 31, 1919. Dr.Cr. $2,958.76Discount on purchases. 76.97Bank interest.120,432.41Sales. 120.00Interest on investments. 1.47Interest and discount: To discount on sales$6,115.07 To rent1,810.00 To insurance567.17 To general expense5,363.92 To manufacturing and indirect1,016.48 To purchases66,665.33 To merchandise inventory (old)6,208.36 To claims and allowance25.57 To labor24,563.68 To commission4,700.82 To charity125.00 To profit and loss6,428.21123,589.61 To close out all nominal accounts to last account123,589.61Profit and loss: 6,428.21 To A. Scheer, capital6,428.21 To transfer.In the petitioner's ledger pertaining to the accounts of his business there appears a personal account with petitioner for the fiscal year ending January 31, 1919, which account indicates a net debit of $2,356.81. In that account there are many debit items aggregating $4,656.81, and among other credit items, collections of what appear 11 B.T.A. 836">838 to be interest or dividends upon bonds or stocks aggregating $1,110, and an entry indicating that certain1928 BTA LEXIS 3709">3712 bonds or stocks had been sold at a gain of $20.20. On March 8, 1919, petitioner made and verified an income-tax return on Form 1040, which was filed with the Collector of Internal Revenue for the Second District of New York on March 14, 1919. In Block A of this return petitioner showed income from his business as follows: Total sales and income from business or professional services$123,589.61COST OF GOODS SOLD:Labor$25,580.16Merchandise bought for sale66,665.33Plus inventories at beginning of year20,275.68TOTAL112,521.17Less inventories at end of year14,067.32Net cost of goods sold98,453.85OTHER BUSINESS DEDUCTIONS:Salaries and wages not reported as "Labor" under "Cost of goods sold"4,700.82Rent1,810.00Other expenses (submit schedule of principal items at foot of page or on separate sheet)12,196.73TOTAL OTHER BUSINESS DEDUCTIONS98,453.85NET COST OF GOODS SOLD PLUS OTHER BUSINESS DEDUCTIONS117,161.40NET INCOME FROM BUSINESS OR PROFESSION$6,428.21From the income of the business so shown he deducted in Block I, under the head of taxes paid, $60, and returned his net income as $6,368.21, upon which1928 BTA LEXIS 3709">3713 he computed a tax of $277.55. The respondent's deficiency letter shows modifications of income and tax liability as follows: Fiscal year ended January 31, 1919.Net income originally reported$6,368.21Add:Salaries not reported$4,471.56Income of minor child1,110.00Income from sale of bonds20.205,601.7611,969.97Less:Depreciation$746.52746.52Net income as corrected11,223.45Summary of tax.Tax applicable to 1918$918.27Tax applicable to 191960.07Total tax assessable978.34Tax originally assessed277.55Additional tax due700.7950% penalty as provided in section 250(b), Revenue Act of 1918350.40Additional tax and penalty due1,051.1911 B.T.A. 836">839 The item of salaries not reported, $4,471.56, which the respondent added to petitioner's income, resulted from an examination of petitioner's books of account by a revenue agent whose report, among other things, contained the following data: Salaries paid andSalaries paid and charged to laborcharged to general expense.To Abraham Scheer$2,796.56$1,220.00To Lottie Scheer405.0050.003,201.561,270.001,270.00Total salary not reported as income4,471.561928 BTA LEXIS 3709">3714 During the year here under consideration and also during the years prior and subsequent thereto, petitioner paid bonuses to 12 or 15 of his skilled employees who demanded higher wages, but he paid such bonuses secretly so that the other employees would not know of the special agreement. Petitioner's bookkeeper had entire charge of the books of account, made out the pay roll and each week she drew a check for the total amount of the regular pay roll plus any amount requested by petitioner or his wife, Lottie Scheer. The bookkeeper paid off the employees and gave the balance of the money drawn from the bank to petitioner, or in his absence, to Lottie Scheer, and she charged such amounts either to labor account or to general expense account. Such amounts were used by petitioner to pay the secret bonuses; to pay varying sums as salary for Lottie Scheer, who was regularly employed in assisting in the management of petitioner's factory, and also for the payment of little incidental expenses. Prior to the year in question petitioner had acquired from the profits and savings of his business approximately $20,000 of bonds which he gave to his two daughters, respectively 19 and 17 years1928 BTA LEXIS 3709">3715 of age in 1918. During the taxable year under review the interest upon the bonds amounted to $1,110, which was credited to petitioner's 11 B.T.A. 836">840 personal account as collected, but it was put into the hands of Lottie Scheer who spent it for necessities for the two daughters. Petitioner had no knowledge of bookkeeping and depended entirely upon his bookkeeper to keep accurate accounts of his business, and each month he employed an accountant to check over and balance the accounts. The accountant also made up petitioner's income-tax return which was made in accordance with his books and which petitioner accepted, signed, and filed as a correct return of his income. Petitioner was ignorant of any errors in his books of account or in his income-tax return. The period of five years from the date of the filing of the return for the fiscal year ended January 31, 1919, had expired at the date in 1925 when respondent determined the deficiency here in question. OPINION. TRUSSELL: Assessment and collection of the deficiency here in question is barred by the statute of limitations, unless it be found that petitioner wilfully filed a false and fraudulent return with intent to evade1928 BTA LEXIS 3709">3716 tax. The facts establish that petitioner's return was made in accordance with his books of account; that he had no knowledge of accounting; that he depended entirely upon his bookkeeper for an accurate set of accounts, and that he accepted as correct an accountant's audit of his books and preparation of his income-tax return. Petitioner was ignorant of any error in his accounts or in his return for the year under review. We can not find as a fact that petitioner wilfully filed a false and fraudulent return with the intent to evade tax. It is true that petitioner's books of accounts were inadequate and contained mistakes but such fact does not establish fraud as asserted by respondent's answer filed in this proceeding. Cf. ; ; ; and . There was no fraud on the part of this petitioner and the running of the statute of limitations has barred the assessment and collection of a deficiency in tax, if any, for the fiscal year ended January 31, 1919. Judgment of no deficiency1928 BTA LEXIS 3709">3717 will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625656/	James T. Castle v. Commissioner.Castle v. CommissionerDocket No. 10508.United States Tax Court1947 Tax Ct. Memo LEXIS 138; 6 T.C.M. (CCH) 863; T.C.M. (RIA) 47205; July 16, 1947138 William G. Heiner, Esq., 1321 Park Blvd., Pittsburgh 22, Pa., for the petitioner. Brooks Fullerton, Esq., for the respondent. OPPERMemorandum Findings of Fact and Opinion OPPER, Judge: A deficiency in income and victory tax for the year 1943 of $94.39 is in controversy in this proceeding. The issue is the deductibility as a bad debt of an amount of $5,598 (reduced to $1,000 by reason of Internal Revenue Code, section 117 (d) (2)) of an advance originally made in 1903 and claimed to have become worthless in the present year. Findings of Fact Petitioner filed his tax return with the collector for the twenty-third district of Pennsylvania. As a result of various prior advances totaling $5,598, a consolidated promissory note was endorsed on May 4, 1909, by Henry H. Seabrook, a long-time personal friend of petitioner. The note also included some interest theretofore due. In 1914 Seabrook's mother, the original primary obligor, became ill, and Seabrook assumed the liability and gave his note to petitioner. The note was renewed from time to time, and in 1937, most of the interest was eliminated and an acknowledgment of the indebtedness was given139 in the amount of $7,000. A new acknowledgment in the same amount was substituted on May 10, 1943. Seabrook was employed by Westinghouse Electric and Manufacturing Company for 43 years. His highest salary was $10,000 a year. About 1939 Seabrook, who was then 65 years of age, arranged with his employer for his continuation in an active duty status for the three years intervening before he became 68, at compensation based upon what he would receive when he retired. On January 30, 1942, Seabrook retired on a pension of $218.50 a month, and received in addition $42.40 a month as Social Security Old Age pension. His income from 1939 on has been approximately $3,000 a year. Up to 1943 Seabrook continued to seek other employment and expected to be able to obtain it. In 1943, after a final interview with the head of the United States Employment Service, Seabrook became convinced that he was unable to find employment and ceased his efforts in that direction. Seabrook's personal living expenses exceed his income. He has no other transferable property or other source of income. In 1943, because of the imminent expiration of the period of limitation, petitioner employed an attorney to collect*140 the Seabrook account. The attorney was unsuccessful and in December, 1943, he advised petitioner to treat the indebtedness as worthless, which petitioner did in the same year. The indebtedness due petitioner from Seabrook in the amount of $5,598 became worthless in 1943. Opinion The sole question is whether petitioner's debt from Seabrook became worthless in the year 1943. Respondent has filed no brief and requested no findings of fact contrary to those submitted by petitioner. On the record it is evident that there was some prospect of collecting the debt until the year 1943, when both petitioner and the debtor concluded that the debt was uncollectible, and the prospect of the debtor's acquisition of assets out of which at least some part of the debt could have been paid finally disappeared. We are satisfied from the evidence that the debt became worthless in 1943, and hence was deductible in that year as a bad debt. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625657/	THE MERCHANTS NATIONAL BANK OF TOPEKA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMerchants Nat'l Bank v. CommissionerDocket No. 382-73.United States Tax CourtT.C. Memo 1975-238; 1975 Tax Ct. Memo LEXIS 136; 34 T.C.M. (CCH) 1030; T.C.M. (RIA) 750238; July 17, 1975, Filed Murray F. Hardesty and Bryon R. Schlosser, for the petitioner. Joe K. Gordon, for the respondent. FORRESTERMEMORANDUM FINDINGS OF FACT AND OPINION FORRESTER, Judge: Respondent has determined the following deficiencies in petitioner's Federal income taxes: TYEDeficiency12/31/69$23,301.1412/31/7038,861.98Petitioner claims that it is entitled to refunds in the amounts of $10,107.56 and $3,360.45, respectively, of its 1969 and 1970 taxes. Because of concessions by both parties, the only matters remaining for our decision are the useful lives, for depreciation purposes, of certain components of an office building which petitioner constructed in 1969 and 1970. FINDINGS OF FACT Some of137 the facts have been stipulated and are so found. At the time of the filing of the petition herein, The Merchants National Bank of Topeka (petitioner) had its principal place of business in Topeka, Kansas. It filed its 1969 and 1970 corporate income tax returns with the Director, Internal Revenue Service Center, Austin, Texas. On July 1, 1969, petitioner completed the construction of a 16-story office building in the downtown business area of Topeka, Kansas, at a cost of $5,545,079. Certain additions to the building were completed in the following year at a cost of $133,943.21. The parties agree that the above-described total cost figures are allocable to the various component parts of the building as follows: 19701969AdditionsCostCost1. Structure3,107,928.212. Addition-197060,705.893. Precast Concrete750,574.884. Sprinkler13,211.225. Plumbing - pIping14,355.126. Plumbing-Fixtures53,831.717. Plumbing-Equipment16,183.218. Plumbing-Title52,840.119. Plumbing-Addition2,763.9510. Electrical46,361.6811. Electrical-Addition6,296.7512. Electrical-Lamps&Fixtures133,892.2313. Electrical-Tranf. & Panels95,660.5514. Ceilings18,743.2915. Addition4,025.0016. Partitions & Doors145,144.2317. Addition49,173.4318. Roof89,728.5019. Elevators294,440.1420. Switches & Gears 44,678.1221. Htg.&Air Conditioning165,011.4222. Sheet Metal208,190.2123. Temperature Controls57,267.4424. Hot & Chill Tower39,326.5525. Painting & Decorating72,746.6226. Addition7,271.0927. After Hour Depository3,430.1428. Vault Doors41,907.8729. Asphalt Paving5,184.3130. Resilient Floors10,368.6331. Vacuum System9,922.5232. IBM Piping1,742.0333. Generator10,069.5334. Sign13,681.0035. Window-Washing Scaf26,400.0036. Decorating2,257.5337. Furniture&Fixtures3,707.105,545,079.00133,943.21138 The building has a frame of structural steel with masonry and precast panel walls. Of its 16 stories, floors two through five provide customer and tenant parking for the bank and office areas, but the record does not establish how many of the other floors are bank occupied, and how many are occupied by tenants leasing office space from petitioner. The building is fireproofed throughout by a sprinkler system designed to last for the life of the structure. Air-conditioning and heating are central, with zoned humidity and temperature control. The air-conditioning units, together with temperature controls, will probably have to be replaced in approximately 20 years due to physical deterioration. The heat and chill towers deteriorate more rapidly, and replacement in 15 years will likely be dictated. The ducts of the current air-conditioning system will only have to be replaced if a new type of system is introduced, and the likelihood of such occurring before the actual structure of the building has been replaced has not been established139 in the record. Space on the office floors is segregated by dry-wall partitions, which, in some areas of the building, are movable. The location of such partitions is normally a function of the changing demands of the various tenants. They will normally have to be replaced within about 20 years, together with doors and ceilings, because of the deterioration in their appearance, and a replacement of the ceiling will also normally call for replacement of appurtenant lighting fixtures. Such a major remodeling may demand replacement of the building's switches and gears system. The ceilings on each floor are acoustical, and the building is carpeted throughout the office areas. Windows are fixed and double paned, set in neoprene, and a service core in the building houses all elevators, stairwells, washrooms (which are ceramically tiled), and service ducts. The building's plumbing fixtures, which are of a standard type, will demand replacement in approximately 20 years due to their physical deterioration. As noted above, the building is located in the downtown central business district of Topeka, Kansas. That area contains professional offices, retail stores, financial institutions, 140 communication and transportation facilities, government buildings, hotels, and similar facilities, and is considered the "hub" of activity in Metropolitan Topeka. The building was constructed on a 29,000 square-foot plot of land, but each floor in the office tower takes up only 8000 square feet of space. On its 1969 corporate income tax return petitioner claimed a half year's depreciation for that portion of the building completed on July 1, 1969. On its 1970 return petitioner claimed a full year's depreciation on that portion of the building completed on July 1, 1969, and a half year's depreciation for the 1970 additions. In computing its depreciation deductions for each of these years, petitioner utilized the component method of depreciation. Each asset account of the building was assigned a separate useful life, and depreciation was calculated thereon. Each asset account was depreciated on the basis of the double declining balance method of depreciation. In his statutory notice of deficiency, respondent determined that certain of the asset accounts had been assigned improper useful lives by petitioner. The following table presents the useful lives utilized by petitioner in its141 return, together with respondent's determinations in the statutory notice: PetitionerRespondentStructure (including pre-cast concrete)50651970 Additions5065Sprinkler3065Plumbing-Piping30AllowedPlumbing-Fixtures1030Plumbing-Equipment1030Plumbing-Tile30Allowed1970 Additions30AllowedElectrical25Allowed1970 Additions25AllowedElectrical-Lamps & Fixtures1525Electrical-Transformers & Panels2025Ceilings25Allowed1970 Additions25AllowedPartitions & Doors20251970 Additions2025Roof25AllowedElevators2025Switches & Gears2025Heating & Air-Conditioning20AllowedSheet Metal (Ducts)2565Temperature Controls1020Hot & Chill Tower1020Painting & Decorating8Allowed1970 Additions8AllowedAfter-Hour Depository30AllowedVault Doors30AllowedAsphalt Paving25AllowedResilient Floors20AllowedVacuum System10AllowedIBM Piping10AllowedGenerator10AllowedSign10AllowedWindow Washing Scaffold10AllowedDecorations8AllowedFurniture & Fixtures (1970)10AllowedOPINION We are called upon in142 the instant case to decide, for depreciation purposes, the useful lives of various components of an office building constructed by petitioner in Topeka, Kansas, in 1969. Certain additions to such building were completed in the following year, and the useful lives of numerous components of such additions are also in dispute.1 The issue of an asset's useful life is inherently one of fact, and it is petitioner's burden to demonstrate that the useful lives determined by respondent are erroneous. Dielectric Materials Co.,57 T.C. 587">57 T.C. 587, 592 (1972); Rule 142(a), Tax Court Rules of Practice and Procedure.An asset's "useful life" is to be distinguished from its potential "physical life." As stated by the Supreme Court, it has long been held that the useful life of an asset is "the number of years the asset is expected to function profitably in use." Massey Motors v. United States,364 U.S. 92">364 U.S. 92, 96 (1960). In M. Pauline Casey,38 T.C. 357">38 T.C. 357 (1962), we expressed our understanding of the above test: This test logically assumes that when an asset can no longer be profitably used by the owner, it will be disposed of. While the physical life of143 the asset is certainly important in ascertaining economic life, it cannot be used as the sole criterion in determining useful life for depreciation purposes if it is shown that the asset will have a shorter economic life than physical life. 144 In his regulations, respondent has listed those other factors, in addition to physical life, commonly taken into account in fixing an asset's useful life for purposes of depreciation: Sec. 1.167(a)-1(b) Useful life. * * (2) the normal progress of the art, economic changes, inventions, and current developments within the industry and the taxpayer's trade or business, (3) the climatic and other local conditions peculiar to the taxpayer's trade or business, and (4) the taxpayer's policy as to repairs, renewals, and replacements. * * * In making outrfindings as to useful life in the instant case, we have relied heavily on the testimony of the expert witnesses produced by both parties during the trial. Petitioner's experts, who included the general contractor of the building and an engineer, impressed us with their obvious qualifications and experience. These two witnesses, especially, demonstrated an intimate familiarity with the building, and their testimony as to the maintenance and deterioration aspects of many of the building's components was thus entitled to, and given careful consideration. See Kerr-Cochran, Inc.,30 T.C. 69">30 T.C. 69, 79 (1958); Laura Massaglia,33 T.C. 379">33 T.C. 379, 388 (1959),145 affd. 286 F. 2d 258 (10th Cir. 1961). Also helpful were their opinions as to the future changes and remodelings of the building which would be required of the petitioner-lessor in order that the building might continue to attract tenants and be operated profitably. Respondent's expert witness, while not as experienced and as familiar with the structure as petitioner's witnesses, made a study of office buildings in downtown Kansas City, Missouri. Of 15 such buildings in that City, ranging in height from 8 stories to 20 stories, respondent's expert found that 5 of the structures had been in existence for over 65 years, 9 for over 60 years, and 10 for over 50 years. Unfortunately, the expert testified in only the most general manner concerning any changes and remodelings which these buildings had undergone. Only as to four of the structures which had been in existence for over 65 years did he testify with any specificity as to remodelings. Of such four buildings, three had undergone major remodelings approximately 60 years after initial construction and one had undergone such remodeling after only 41 years. However, the expert did not indicate--except as to one of the146 buildings, the exterior of which was remodeled 61 years after initial construction--whether these major remodelings included work on the actual structures of the buildings, information which would certainly have been quite helpful to us in making our findings herein. This Court professes no special expertise in the areas in which we are called upon to render a decision in the instant case. As we noted at trial, agreement between the parties would have been a far more satisfactory method for settling the issues now before us, issues which are simply not susceptible to any precise formula treatment. On the basis of all the facts in the record before us, including the testimony of the expert witnesses called by both parties, we hold that the useful lives of those components of petitioner's building as to which the parties were unable to reach agreement are as follows: ComponentUseful LifeStructure (including pre-cast cement)551970 Additions55Sprinkler55Plumbing-Fixtures20Plumbing-Equipment20Electrical-Lamps & Fixtures20Electrical-Transformers & Panels25Partitions & Doors201970 Additions20Elevators25Switches & Gears20Sheet Metal (Ducts)55Temperature Controls20Hot and Chill Tower15147 Decision will be entered under Rule 155.Footnotes. The cost allocable to "Switches & Gears" has been increased by a $4,400 item improperly included by petitioner as a part of a plumbing account.↩1. Respondent does not dispute that petitioner was entitled to utilize the component method of depreciation. See Herbert Shainberg,33 T.C. 241">33 T.C. 241, 254 (1959), acq. 1960-1 C.B 5; sec. 1.167(a)-7(a), Income Tax Regs.; Rev. Rul. 68-4, 1 C.B. 77">1968-1 C.B. 77. That petitioner would have been entitled to a greater or lesser annual depreciation deduction in the year before us had it decided to avail itself of the composite method of depreciation and had it chosen one useful life for its entire building from the guideline useful lives presented in Rev. Proc. 62-21, 2 C.B. 418">1962-2 C.B. 418, is not significant in the instant case because we are convinced that the record before us establishes the proper useful lives for purposes of the component method and that a "reasonable allowance for exhaustion, wear and tear" (sec. 167(a)) is calculable therefrom. Any such difference in the annual amounts of depreciation to which petitioner would have been entitled only suggests to us that respondent's guidelines in Rev. Proc. 62-21↩ might not be entirely accurate for the instant case.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625658/	CRESCENT LEATHER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Crescent Leather Co. v. CommissionerDocket No. 13933.United States Board of Tax Appeals13 B.T.A. 940; 1928 BTA LEXIS 3149; October 11, 1928, Promulgated 3149 Affiliation allowed. A. L. Newton, Esq., for the petitioner. Harold Allen, Esq., and W. R. Lansford, Esq., for the respondent. ARUNDELL940 In this proceeding the petitioner seeks a redetermination of income and profits taxes for the year 1920, for which the Commissioner has determined a deficiency of $60,453.65. The petitioner alleges error on the part of the Commissioner in failing to hold that the Crescent Leather Co. and the Buckman Tanning Co. were affiliated during the year 1920 and entitled to file consolidated returns. The original petition was based upon a deficiency for the calendar year 1920 of $46,063.09, and a deficiency for the calendar year 1921 of $9,777.68. By stipulation of the parties it was agreed that there was no deficiency for the year 1921, and that the true deficiency based upon the determination by the Commissioner for the year 1920 was $60,453.65. It was further stipulated that the alleged deficiency for 1920 of $60,453.65 was predicated upon an alleged taxable consolidated net income of the Crescent Leather Co. and the Haverhill Strand Theatre of $151,441.82 for the year 1920. It was further stipulated3150 that an alleged loss of $118,408.63 of the Buckman Tanning Co. for the year 1920 was disallowed by the respondent in arriving at said income of $151,441.82, by reason of the respondent's denial of affiliation between the petitioner and the said Buckman Tanning Co. FINDINGS OF FACT. The petitioner is a corporation organized under the laws of the Commonwealth of Massachusetts, with principal place of business at Number 96 South Street, Boston, Mass.Benjamin J. Kaplan owned 99 per cent of the stock of petitioner during the years 1919 and 1920. In 1919 petitioner had hides that it desired to have tanned by the Buckman Leather Co. The latter company was in financial difficulties and it was feared that it might be unable to complete the tanning of the hides. Thereupon Kaplan 941 entered into an arrangement with Alvah Buckman, who owned the Buckman Leather Co., whereby Kaplan paid the debts of the Leather Company up to the first mortgage. A new company was then organized, known as the Buckman Tanning Co., which took over the assets of the Buckman Leather Co. The entire stock of the Buckman Tanning Co. was issued to Kaplan and Buckman in equal amounts. Kaplan loaned3151 the new company about $175,000 and in addition advanced money to Buckman for his own private use since Buckman was without funds. At the time of the organization of the Buckman Tanning Co. several contracts were executed. One contract between Kaplan and the Buckman Tanning Co. provided that Kaplan would be employed for a term of five years from August 1, 1919, as general manager of the company; that no act should be done by said Buckman Tanning Co. affecting its general policy except with the approval of said Kaplan or the Crescent Leather Co., it being understood, however, that so far as matters of general policy are concerned neither this term nor the powers of said Kaplan as general manager shall be deemed to include the matter of determining who shall be the officers of such corporation nor matters connected with or affecting the contracts of said corporation and the Crescent Leather Co., nor the matter of terminating the contract of Alvan Buckman, nor defining the duties of said Buckman. A second agreement provided that in the event of the death or incapacity of Kaplan, the Crescent Leather Co., acting by such person or persons as it may from time to time select, shall3152 determine the general policy of said Buckman Tanning Co. for the period of five years from August 1, 1919, subject to the following limitations: (1) such determinations shall be in good faith and shall be made by said Crescent Leather Co. with a view to the vest interests of said Buckman Tanning Co., (2) the control of the Crescent Leather Co. of the general policy of said Buckman Tanning Co. shall not be deemed to include the matter of determining who shall be the officers of said Buckman Tanning Co. nor matters connected with or affecting the contract between Buckman Tanning Co. and said Crescent Leather Co., nor the matter of terminating the contract of employment between the Buckman Tanning Co. and Buckman, nor of defining the duties of said Buckman. A third agreement between the Buckman Tanning Co. and Buckman provided that Buckman should be employed for five years from August 1, 1919, as manager of the actual operation of tanning and finishing at the plant with no authority to buy or sell hides, skins or leather or to make agreements for tanning or finishing except with the approval of Kaplan or his successors in interest. 942 A fourth agreement was entered into3153 between the Buckman Tanning Co. and the Crescent Leather Co., covering a period of five years from August 1, 1919, and providing for the work to be performed by the Buckman Tanning Co. and the price to be paid for such work. On August 1, 1919, Kaplan signed a statement wherein he declared that "he held for the benefit of the Crescent Leather Company all shares or benefits derived or obtained and to be derived or obtained by him from the Buckman Tanning Company or Alvah Buckman, particularly under the agreements heretofore cited, and that the Crescent Leather Company agreed to indemnify Benjamin J. Kaplan of and from any liability or loss on account of said agreements." On August 6, 1919, an agreement was signed by Buckman, which provided that he would pay the debts of the Buckman Leather Co. in excess of certain specified obligations and amounts, out of the first profits of the Buckman Tanning Co., otherwise payable to him, and that his stock would stand as security for the performance thereof. During the year 1920 the Buckman Tanning Co. suffered a loss from operations, amounting to $118,408.63. OPINION. ARUNDELL: The petitioner claims that it is affiliated with the3154 Buckman Tanning Co. on the ground that it controlled through Kaplan substantially all of the stock of the Buckman Tanning Co. The two companies were operated as one enterprise. The office manager of petitioner acted as bookkeeper and general financial man for the Buckman Tanning Co.; the books and records of both companies were kept in the office of petitioner and the evidence discloses that Kaplan exercised actual control over the business. The interests of Buckman were so dependent upon the support of Kaplan and the business of the petitioner and Buckman's rights and activities were so controlled by the agreements to which he was a party, that in effect he became no more than an employee of the Buckman Tanning Co. who was entitled to share in the profits of the business that remained after certain liabilities were paid on his account. The stock standing in Buckman's name was voted in accordance with Kaplan's directions and in every substantial way Kaplan and petitioner controlled the stock. See ; 3155 ; . We believe that the requirements of section 240 of the Revenue Act of 1918 have been fully met and that petitioner and the Buckman Tanning Co. were for the year 1920 entitled to file consolidated returns. 943 The operating loss of the Buckman Tanning Co. for 1920 of $118,408.63 was denied by the respondent, but the respondent did not introduce any testimony as to the profit or loss of that company for 1920, showing a different amount. The petitioner having established that the books of account were destroyed, called as a witness the officer who had charge of the books of account of the Buckman Tanning Co. in 1920 and who made up the tax return of the petitioner for 1920. This witness testified that the books of account of the Buckman Tanning Co. suppported the figures contained in schedules attached to the return of petitioner, showing the net loss for the Buckman Tanning Co. to be $118,408.63 for the year 1920. In the absence of any evidence to the contrary, we must hold that the Buckman Tanning Co. suffered a loss of $118,408.63 in 1920. Judgment3156 will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625659/	BAMBERG COTTON MILLS CO., DISSOLVED, BY SANTEE MILLS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Bamberg Cotton Mills Co. v. CommissionerDocket Nos. 9445, 10104.United States Board of Tax Appeals8 B.T.A. 1236; 1927 BTA LEXIS 2705; November 5, 1927, Promulgated 2705 More than 5 years having expired since the filing of income and excess-profits-tax returns for the fiscal years 1917 and 1920 and no valid consent to an extension of the period of limitation having been entered into between respondent and taxpayer, held, the assessment of tax for the fiscal years 1917 and 1920 is barred by the statute of limitations. G.E.H. Goodner, Esq., for the petitioner. J. E. Marshall, Esq., for the respondent. MORRIS1237 This is a proceeding for the redetermination of deficiencies in income and profits taxes for the fiscal years ended August 31, 1917, and June 30, 1920, in the amounts of $2,440.83 and $9,273.09, respectively. The questions raised by the pleadings are: (1) Whether the proposed assessments for the periods ended August 31, 1917, and June 30, 1920, are barred by the statute of limitations. (2) Whether the respondent has erroneously understated the invested capital of the petitioner for the fiscal periods ended August 31, 1917, and June 30, 1920. (3) Whether the respondent has erroneously computed the 4 per cent additional income tax levied under section 4 of the Revenue Act of 1917 in determining2706 the tax for the fiscal year ended August 31, 1917. This case came on for hearing on February 7, 1927, at which time it was on motion of counsel ordered that the appeals for the years 1917 and 1920, Docket Nos. 9445 and 10104, be consolidated for hearing. No oral testimony was offered at the hearing by either the petitioner or the respondent. The case was submitted on documentary evidence and stipulations entered into by counsel. FINDINGS OF FACT; Petitioner (Bamberg Cotton Mills Co.) was organized and incorporated under the laws of the State of South Carolina in 1903, to engaged in the cotton-mill business at Bamberg. It was dissolved on May 14, 1920, in accordance with the laws of the that State and its assets were distributed to the Santee Mills, a corporation then existing under the laws of the State of South Carolina, which corporation owned all of the stock of the petitioner at the time of said dissolution. Upon acquisition of the assets of the petitioner, the Santee Mills at the same time assumed all of its liabilities and obligations. The Bamberg Cotton Mills, predecessor of the petitioner, also engaged in the cotton-mill business, petitioned the court on December 2, 1902, for2707 the appointment of a receiver and in 1903 said receiver was appointed. The balance sheet of that company at that time was as follows: Assets:Machinery, buildings and real estate$182,076.01Other assets26,281.95Deficit11,531.02219,888.98Liabilities:Capital stock137,990.00Bills payable and interest78,277.02Accounts payable3,621.96219,888.981238 In 1903, when the petitioner was organized, the stockholders thereof were composed in part of the stockholders and creditors of the old company. At the receiver's sale either the petitioner or the subscribers to its stock purchased the entire assets of the old company for the sum of $50,000, of which sum $38,982.21 represented machinery, buildings, etc. In 1906, petitioner experienced a disastrous fire which destroyed its records. Petitioner filed its income-tax return for the year ended August 31, 1917, with the collector of internal revenue, district of South Carolina, on October 11, 1917. Petitioner filed its income and profits-tax return for the fiscal period July 1, 1919, to May 14, 1920, with the collector of internal revenue, district of South Carolina, on September 7, 1920. 2708 The following consents in writing were filed in connection with this case for the years 1917 and 1920, as follows: New York, January , 1923. Special Assignment Section. INCOME AND PROFITS TAX WAIVER In pursuance of the provisions of subdivision (d) of Section 250 of the Revenue Act of 1921, SANTEE MILLS, the successor to Bamberg Cotton Mills Co., of Bamberg,South Carolina, and the COMMISSIONER OF INTERNAL REVENUE hereby consent to a determination, assessment and collection of the amount of income, excess profits or war profits taxes due under any return made by or on behalf of said Bamberg Cotton Mills Co., of which said Santee Mills is the successor, for the year 1917 under the Revenue Act of 1921 or under prior income, excess profits or war profits tax Acts or under Section 38 of the Act entitled "An Act to provide revenue, equalize duties and encourage the industries of the United States, and for other purposes", approved August 5, 1909, irrespective of any period of limitations. SANTEE MILLS (Successor to Bamberg Cotton Mills Co.), Tax-Payer.by (Sgd) FRANK E. WHITMAN, Treasurer. ,Commissioner(SEAL) SANTEE MILLS Incorporated2709 1917 Orangeburg, S.C. APPROVED FEB. 12, 1923. (Date) (Sgd) D. H. BLAIR, a. Commissioner of Internal Revenue.1239 As amended 1924 IT:CA 2336-6 NOVEMBER 10, 1924. (Date) Received Nov. 19, 1924 Special Assessment Section Section 23 INCOME AND PROFITS TAX WAIVER In pursuance of the provisions of existing Internal Revenue Laws, Bamberg Cotton Mills (now Santee Mills) a taxpayer, of Bamberg, S.C., and the Commissioner of Internal Revenue, hereby consent to extend the period prescribed by law for a determination, assessment, and collection of the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of said taxpayer for the years ended August 31, 1917, under the Revenue Act of 1924, or under prior income, excess-profits, or war-profits tax Acts, or under Section 38 of the Act entitled "An Act to provide revenue, equalize duties, and encourage the industries of the United States, and for other purposes", approved August 5, 1909. This waiver is in effect from the date it is signed by the taxpayer and will remain in effect for a period of one year after the expiration of the statutory period2710 of limitation within which assessments of taxes may be made for the year or years mentioned, or the statutory period of limitation as extended by Section 277(b) of the Revenue Act of 1924, or by any waivers already on file with the Bureau. SANTEE MILLS, Taxpayer.BY FRANK E. WHITMAN (Sgd), Treasurer.D. H. BLAIR (Sgd), Commissioner.(SEAL) SANTEE MILLS Incorporated 1917 Orangeburg, S.C. If this waiver is executed on behalf of a corporation, it must be signed by such officer or officers of the corporation as are empowered under the laws of the State in which the corporation is located to sign for the corporation, in addition to which, the seal, if any, of the corporation must be affixed. (A 5) IT:E:SM HAL-18848 A-18849 JANUARY, 28, 1925. Received Jan. 31, 1925 Special Assessment Section INCOME AND PROFITS TAX WAIVER (For taxable years ended prior to March 1, 1921) In pursuance of the provisions of existing Internal Revenue Laws Bamberg Cotton Mill, (Now Santee Mills), taxpayer of Bamberg,SoughCarolina, and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of2711 the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of said taxpayer for the fiscal year 1917 under existing revenue acts, or under prior revenue acts. 1240 This waiver of the time for making any assessment as aforesaid shall remain in effect until December 31, 1925, and shall then expire except that if a notice of deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax Appeals then said date shall be extended sixty days, or (2) if an appeal is filed with said Board then said date shall be extended by the number of days between the date of mailing of said notice of deficiency and the date of final decision by said Board. BAMBERG COTTON MILL (Now Santee mills)Taxpayer.BY MARTIN J. KEOGH, JR. (Sgd) Vice-President.J. E. FULLAGAR, Secty.D. H. BLAIR, W.B. Commissioner.(SEAL) SANTEE MILLS Incorporated 1917 Orangeburg, S.C. If this waiver is executed on behalf of a corporation, it must be signed by such officer or officers of the corporation as are empowered under the laws of the2712 State in which the corporation is located to sign for the corporation, in addition to which, the seal, if any, of the corporation must be affixed. (A 3) INCOME AND PROFITS TAX WAIVER For taxable years ended prior to January 1, 1922 IT. E. SM HWG-C-21500-2 Received August 26, 1925 Special Assessment Section AUGUST 22, 1925. In pursuance of the provisions of existing Internal Revenue Laws, SANTEE MILLS, Successors to Bamberg Cotton Mills Company, a taxpayer of Bamberg, South Carolina, and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of said taxpayer for the fiscal year ended June 30, 1920 under existing revenue acts, or under prior revenue acts. This waiver of the time for making any assessments as aforesaid shall remain in effect until December 31, 1926, and shall then expire except that if a notice of a deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax Appeals then said date shall be2713 extended sixty days, or (2) if an appeal is filed with said Board then said date shall be extended by the number of days between the date of mailing of said notice of deficiency and the date of final decision by said Board. SANTEE MILLS, (Successors to Bamberg Cotton Mills Company) Taxpayer.By MARTIN J. KEOGH, Jr. (Sgd) Vice-President.D. H. BLAIR, W.B. Commissioner.(SEAL) SANTEE MILLS Incorporated 1917 Orangeburg, S.C.1241 If this waiver is executed on behalf of a corporation, it must be signed by such officer or officers of the corporation as are empowered under the laws of the State in which the corporation is located to sign for the corporation, in addition to which, the seal, if any, of the corporation must be affixed. J.C. b 12. On October 20, 1925, the respondent mailed a deficiency notice to the petitioner with respect to the fiscal year ended August 31, 1917, and on September 29, 1925, the respondent mailed a deficiency notice to the petitioner with respect to the fiscal period ended June 30, 1920, showing in said deficiency notices the amounts here in controversy. In auditing the return of the petitioner for the2714 fiscal year ended August 31, 1917, the respondent determined the income to be $23,719.56 and the invested capital to be $123,600, the total tax liability to be $2,491.21, and the deficiency to be $2,440.83. In auditing the return of the petitioner for the fiscal period ended June 30, 1920, the respondent has determined the income to be $42,158.95, the invested capital to be $181,209.56, the total tax liability to be $9,520.16, and the deficiency to be $9,273.09. The respondent computed the deficiency in tax for the year 1917 as follows: Excess profits tax$1,452.06Total net income$23,719.56Less: Profits tax1,452.06Amount taxable at 2%22,267.50445.35Amount taxable at 4% (8/12 of year)22,267.50593.80Total tax assessable2,491.21Original tax:Original return$13.89Amended return36.4950.38Additional tax2,440.83OPINION. MORRIS: The petitioner contends that the proposed assessments for the fiscal periods ended August 31, 1917, and June 30, 1920, are barred by the statute of limitations, there being no valid consents extending the period of time provided for in the statute. The evidence shows that the petitioner2715 filed its return for the fiscal year ended August 31, 1917, with the collector of internal revenue on October 11, 1917, and that its return for the portion of the fiscal period ended June 30, 1920, during which it was operating, was filed on September 7, 1920; that in January, 1923, November, 1924, and January, 1925, three consents were filed with, and duly accepted by the respondent, with respect to the fiscal year ended August 31, 1917; that in August, 1925, an income and profits-tax consent with respect to the fiscal period ended June 30, 1920, was filed with and duly 1242 accepted by the respondent. All of these consents are set forth verbatim in the findings of fact herein. The evidence further discloses that deficiency letters were mailed to the petitioner for the fiscal years ended August 31, 1917, and June 30, 1920, on October 20, 1925, and September 29, 1925, respectively, setting forth the deficiencies herein contested. The provisions of the Revenue Acts of 1921 and 1924 applicable to this issue are as follows: SEC. 250. (d) The amount of income, excess-profits, or war-profits taxes due under any return made under this Act for the taxable year 1921 or succeeding2716 taxable years shall be determined and assessed by the Commissioner within four years after the return was filed, and the amount of any such taxes due under any return made under this Act for prior taxable years or under prior income, excess-profits, or war-profits tax Acts, or under section 38 of the Act entitled "An Act to provide revenue, equalize duties, and encourage the industries of the United States, and for other purposes," approved August 5, 1909, shall be determined and assessed within five years after the return was filed, unless both the Commissioner and the taxpayer consent in writing to a later determination, assessment, and collection of the tax; * * * SEC. 277. (a) Except as provided in section 278 and in subdivision (b) of section 274 and in subdivision (b) of section 279 - * * * (2) The amount of income, excess-profits, and war-profits taxes imposed by the Act entitled "An Act to provide revenue, equalize duties, and encourage the industries of the United States, and for other purposes," approved August 5, 1909, the Act entitled "An Act to reduce tariff duties and to provide revenue for the Government, and for other purposes," approved October 3, 1913, the Revenue2717 Act of 1916, the Revenue Act of 1917, the Revenue Act of 1918, and by any such Act as amended, shall be assessed within five years after the return was filed, and no proceeding in court for the collection of such taxes shall be begun after the expiration of such period. SEC. 278. (c) Where both the Commissioner and the taxpayer have consented in writing to the assessment of the tax after the time prescribed in section 277 for its assessment the tax may be assessed at any time prior to the expiration of the period agreed upon. SEC. 277. (b) The period within which an assessment is required to be made by subdivision (a) of this section in respect of any deficiency shall be extended (1) by 60 days if a notice of such deficiency has been mailed to the taxpayer under subdivision (a) of section 274 and no appeal has been filed with the Board of Tax Appeals, or, (2) if an appeal has been filed, then by the number of days between the date of the mailing of such notice and the date of the final decision by the Board. Obviously, if the consents herein were validly executed there can be no question but that under the provisions of the statute herein-above recited, the respondent is authorized2718 to make the assessments in question but it is equally as obvious if the consents were not validly executed, and therefore of no effect, the statute of limitations has long since expired and consequently no assessment can now be levied by the respondent. 1243 The petitioner contends that under the laws of the State of South Carolina, upon the dissolution of a corporation, the trustees who are the directors of the dissolved corporation, and they only, have authority to bind the corporation, and, therefore, these consents signed by an office of the Santee Mills, a separate and distinct corporation, and bearing the seal of that corporation, are invalid and of no effect. Sections 4281, 4282, and 4283 of the Code of Laws of South Carolina provide: 4281. Art. 32. Continuance of Corporations for Closing Affairs After Expiration, Annulment, Etc., of Charter. - All corporations, whether they expire by their own limitation or be annulled by the Legislature, or otherwise dissolved, shall be continued bodies corporate for the purpose of prosecuting and defending suits by or against them and of enabling them to settle and close their affairs, to dispose of and convey their property2719 and to divide their capital, but not for the purpose of continuing the business for which they were established. 4282. Art. 33. Powers of Directors after Dissolution of Corporation. - Upon the dissolution in any manner of any corporation, the directors shall be trustees thereof, with full power to settle the affairs, collect the outstanding debts, sell and convey the property and divide the moneys and other property among the stockholders after paying its debts, as far as such moneys and property shall enable them; they shall have power to meet and act under the by-laws of the corporation and under regulations to be made by a majority of said trustees, to prescribe the terms and conditions of the sale of such property, and may sell all or any part for cash, or partly on credit, or take mortgages and bonds for part of the purchase price for all or any part of said property. 4283. Art. 34. Power to Sue and Liability to Suit of Directors After Dissolution. - The Directors constituted trustees as aforesaid shall have authority to sue for and recover the aforesaid debts and property by the name of the corporation, and shall be suable by the same name or in their own names or individual2720 capacities for the debts owing by such corporation, and shall be jointly and severally responsible for such debts to the amount of the moneys and property of the corporation which shall come to their hands or possession as such trustees. The statute of limitations is generally regarded as a personal privilege and may be waived by defendant or asserted at its election. It has been held by some courts that where the defendant has parted with interest in property, the grantees, mortgagees, or other persons standing in his place are entitled to avail themselves of all the advantages of this plea. See Wood on Limitations, vol. 1, p. 142. The respondent not having taken issue on the subject of the Santee Mills filing the petition in this case and pleading the statute of limitations, apparently concedes that it has such an interest in the subject matter as would give it the right to avail itself of that plea. It will be observed that the consents, except the one dated January, 1923, bore the following provision: If this waiver is executed on behalf of a corporation, it must be signed by such officer or officers of the corporation as are empowered under the laws 1244 of2721 the State in which the corporation is located to sign for the corporation, in addition to which, the seal, if any, of the corporation must be affixed. The consent of January, 1923, was signed "Santee Mills (Successor to Bamberg Cotton Mills Co.) Taxpayer by Frank E. Whitman, Treasurer." The consent of November 1924, was signed "Santee Mills, Taxpayer, by Frank E. Whitman, Treasurer." The consent of January 1925, was signed "Bamberg Cotton Mill (Now Santee Mills) Taxpayer by Martin J. Keogh, Jr., Vice-President, J. E. Fullager, Secty." The consent of August, 1925, was signed "Santee Mills, Successors to Bamberg Cotton Mills Company, Taxpayer, Martin J. Keogh, Jr., Vice-President." All of these consents bore the corporate seal of "Santee Mills." The directors of the petitioner, as disclosed by the Certificate of Dissolution of Charter of May 14, 1920, were: Wm. Elliot J. M. Albergotti Jno. H. Cope R. J. Brown It appears, therefore, that none of the men whose signatures appear in the consents filed with the respondent were directors or officers of the petitioner at the time of dissolution. On what theory of law would the Board be justified in holding that a consent executed2722 by an officer of a separate and distinct corporation from that of the petitioner constituted a consent executed by the petitioner itself and binding thereon? We can not say that the petitioner or the Santee Mills is estopped from denying the validity of these consents because they show clearly and unmistakably that they were executed by an officer of the Santee Mills, in his capacity as such, and that they bore the corporate seal of the Santee Mills. We have no reason to doubt the good faith of the officer executing them. The respondent was, or should have been, put on notice, and should have demanded that proper consents be filed, or the taxes should have been assessed in the event of refusal or failure to comply with his demands. The Board is powerless to apply the theory of equitable estoppel, for the reason that estoppels to be available on the trial must be affirmatively pleaded and proved. . The respondent has nowhere in the record raised the question of estoppel either against the petitioner itself or the Santee Mills. The respondent's counsel apparently attaches some significance to the fact that the Santee2723 Mills assumed all of the liabilities and obligations of the petitioner. The Santee Mills has not disputed the fact that it assumed the liabilities and obligations of the petitioner, but we are of the opinion that the fact that the Santee Mills was liable for the debts and obligations of the petitioner does not give it the right to execute consents without the express sanction of the state legislature in such cases, or some authorized delegation of power 1245 from the trustees in dissolution. The Santee Mills, even though it was the sole stockholder of the petitioner, has no more right to execute a consent for the petitioner than a stockholder has to bind a corporation by any other form of agreement or contract. In the case , handed down by the Circuit Court of Appeals, Fifth Circuit, wherein the validity of certain consents signed by former officers of the dissolved corporation was under consideration, the court held that these consents, filed within the statutory period and executed by men who were officers and directors of the dissolved corporation, were valid. In that case, the court cited the provisions of the2724 law of Texas, which are similar to section 4281 of the Civil Code of South Carolina, to the effect that the president and directors at the time of dissolution shall be trustees, etc. After considering the State law and finding that the men whose names appeared in the consents there under consideration had been officers and directors of the corporation, it found that they were valid. While the court does not so state, it appears clearly from the context that if the parties who signed them had not been the parties authorized by the State statute, they would have been held to be invalid. The law of South Carolina, by which we are bound in this matter, places absolute control and power over the affairs of a corporation in dissolution in the directors of the corporation, who are made trustees by express statutory provision. Consequently, it is our opinion that they, and they only, could enter into agreements which would be binding on the corporation. These consents which do not bear the seal of the petitioner, which are not executed by an officer empowered under the laws of the State to act for the company have no binding effect upon the taxpayer. The statutes provide that the taxes2725 in controversy shall be assessed within five years after the return was filed, unless the Commissioner and the "taxpayer" shall have consented in writing to an assessment after the time prescribed. The term "taxpayer" as used in the statute is clearly confined to the Bamberg Cotton Mills. The deficiencies for the fiscal years ended August 31, 1917, and June 30, 1920, not having been assessed within five years after the filing of the return by the petitioner and no valid consent in writing having been entered into between the respondent and the "taxpayer," the assessment of the deficiencies for these years is barred by the statute of limitations. Having so held with respect to the first issue, it is obviously unnecessary for us to consider the two remaining allegations of error urged by the petitioner. Reviewed by the Board. Judgment will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625660/	John W. Pearsall and Laila W. Pearsall v. Commissioner.Pearsall v. CommissionerDocket No. 3524-73. T.C. Memo. 1977-230.United States Tax CourtT.C. Memo 1977-230; 1977 Tax Ct. Memo LEXIS 212; 36 T.C.M. (CCH) 956; T.C.M. (RIA) 770230; July 25, 1977, Filed John W. Pearsall, III, 320 Mutual Bldg., Richmond, Va., for the petitioners. Robert T. Hollohan, for the respondent. STERRETTMemorandum Findings of Fact and Opinion STERRETT, Judge: Respondent determined deficiencies in petitioners' Federal income taxes for the calendar years as follows: YearDeficiency1969$ 5,305.4219703,154.51197113,580.63Due to concessions by respondent, the sole issue for our decision concerns the determination of the fair market value of certain property claimed as a charitable contribution under section 170, I.R.C. 1954. Findings of Fact Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. John W. Pearsall (hereinafter petitioner) and Laila W. Pearsall, husband and wife, resided in Richmond, Virginia at the time they filed their petition herein. Petitioners filed joint Federal income tax214 returns for the calendar years 1969, 1970 and 1971, with the internal revenue service center, Philadelphia, Pennsylvania and the internal revenue service center, Memphis, Tennessee. Petitioners for some period of time prior to 1969 owned 47 pieces of low income housing in Fulton, a black residential area of the city of Richmond, Virginia. These houses were approximately 40 to 60 years old, had no indoor plumbing and provided little more than shelter. In 1968 black leadership among residents in the Fulton community opposed destruction of residences as proposed as part of an urban renewal project planned for the area. This opposition took the form of an ad hoc committee backed with community funds. During this same period a storm of criticism of substandard housing in Richmond had erupted and petitioner was subjected to severe social pressures because of his ownership of housing stated to be substandard. These social pressures included a local newspaper devoting a full page to derogatory comments about petitioner, a nationally syndicated article branding petitioner a "slumlord" and expressions of concern by petitioner's church. In response to this social pressure petitioner, 215 in June 1969, directed his real estate agent to cause his Fulton properties, all of which were scheduled for demolition as part of the urban renewal plan, to be vacated and to advise the tenants to take the next 2 months' rent to relocate. Petitioner testified that he concluded such action was essential to avoid further controversy attaching to his name and destroying his effectiveness as a lawyer. The chairman of the Fulton ad hoc committee urged petitioner to reconsider because during the urban renewal period Fulton residents had a real need for this housing. Petitioner offered to donate the houses, which carried the right to income therefrom, to a charitable organization. A committee was formed which developed information looking to an appropriate response to this offer. When it was reported that no existing community organization had been found to assume the role of landlord, petitioner proceeded with the incorporation on June 23, 1969, of the Fulton Foundation as a tax exempt organization. Respondent has conceded that the Fulton Foundation was organized and operated as an organization described in section 501 (c)(3) and is therefore exempt from taxation under section216 501(a) for the years in issue. By deed of gift dated June 27, 1969, petitioners conveyed to Fulton Foundation the 47 houses together with the right for such houses to occupy the land on which they were situated and to enjoy all easements and appurtenances thereto for a period of 3 years. The deed specified that the houses were deemed severed from the land and could never revert to petitioners, the Fulton Foundation being required to remove the houses within 60 days of termination of its right to occupancy. The deed of gift further provided that, if an eminent domain proceeding was instituted during the term of the gift, the Foundation's right to occupy the dwellings ceased on the day of the institution of such proceeding. Respondent has conceded that the foregoing constitutes a completed gift and that petitioners had no further interest in the houses. At the time petitioner decided to vacate the property in April, 1969, 31 of the 47 houses were occupied, producing a total monthly rental of $865 or an annual rental of $10,380. Those unoccupied had as of their last occupancy produced an annual rental of $5,790. No evidence was presented with respect to the rentals immediately217 prior to the gift in June, 1969 because petitioner had waived the last 2 months' rent in his notice to the tenants and did not know how many of the 31 houses which had been rented in April, 1969 were still occupied on the date of the gift: As houses became vacant they were boarded up in compliance with a local ordinance prohibiting the rental of housing without indoor plumbing. Real estate taxes on the houses, separately stated by the City of Richmond from taxes on the land, amounted to $1,106.21. The local real estate assessment for the 47 houses equaled $60,120. Petitioner, for the years 1970 and 1971, made cash contributions to the Fulton Foundation for the real estate taxes due on the property. 1At trial petitioner placed a value of $60,516 on these 47 properties for purposes of computing the charitable contribution here in issue. Petitioner assumed a total annual rental in the amount of $16,170 for the 47 pieces of property. This figure included annual rentals based218 on the actual monthly rentals for April, 1969 plus the annual rent that the unoccupied houses had produced as of their last occupancy. He determined the value of the properties by multiplying this sum by the factors furnished in section 25.2512-5(b) and (c), Gift Tax Regs., which provides a method for valuing a gift of a stream of income for a given period. Petitioner's computations used, as the time factor, a period of 4 years. Petitioner's computation did not take into account projected vacancies during the period, taxes, commissions, maintenance, or expenses of vandalism. His computation of the fair market value of the gift also did not take into account Fulton's assumption of the obligation to demolish the houses at the end of the term of the gift. 2Respondent disallowed petitioner's charitable contribution deduction for the donated houses in the amount of $60,120. By reason of the charitable contribution percentage limitation petitioner's charitable contributions were thereby reduced by $10,407.18 in 1969, $17,384.86219 in 1970 and $26,818.46 in 1971. Opinion At the outset we must dispose of a procedural issue raised by petitioner at trial and on brief concerning respondent's pleadings. Petitioner contends that the issue with respect to the fair market value of the property contributed was new matter pleaded by the respondent, and under Rule 142(a) of the Court's Rules of Practice and Procedure he has the burden of proof with respect thereto. Petitioner has cited several cases in support of his contention, but after careful study we have found that none substantiates his position. Respondent in his statutory notice dated February 28, 1973, stated: (a) It is determined that the deductions claimed for charitable contributions in the amount of $22,496.34 and $25,125.60 for the taxable years 1969 and 1970 respectively are not allowed in any amount in excess of $12,089.16 and $7,740.74 respectively, since it has not been established that any greater amounts constitute charitable contributions in accordance with section 170 of the Internal Revenue Code. * * * In his statutory notice dated May 7, 1973, respondent used the same language in disallowing charitable contributions220 in the amount of $26,818.46 for the taxable year 1971. As can be seen the determinations made by respondent were very broad. Petitioner contends that respondent's notice of deficiency can only be read as a determination that no completed gifts were made to the Fulton Foundation in any years because in the same notice petitioners were allowed deductions for real estate taxes and demolition expense that would have been available to them only if they continued to own the houses. In his answer, however, respondent stated that his determination was not based on the premise that there was no gift by petitioners but rather upon the fact that the Fulton Foundation was never operated as required by section 501(c)(3) and "that at the time of the gift it had not been established that the fair market value of the property contributed equaled the $60,120 claimed by petitioners on their return." Respondent subsequently conceded that the Fulton Foundation did qualify as a section 501(c)(3) organization and that petitioners were entitled to deduct as charitable contributions the amounts paid for demolition expenses and real estate taxes. It is readily apparent that respondent merely narrowed221 the issue after taking a broad position in the statutory notices. The specific reason for the purported deficiencies, as asserted by respondent in his answer, his opening brief and remarks before the Court, is consistent with and inherent in the determination set forth in the notices of deficiency. Proceeding from the broad to the specific, as the respondent has in this case, does not destroy the presumptive correctness of the respondent's determination of deficiency and shift the burden of proof to him. Spangler v. Commissioner, 32 T.C. 782">32 T.C. 782, 793 (1959), affd. 278 F. 2d 665 (4th Cir. 1960), cert. den. 364 U.S. 825">364 U.S. 825; Cf. Sorin v. Commissioner, 29 T.C. 959">29 T.C. 959, 969, affd. 271 F. 2d 741 (2d Cir. 1959). It would be otherwise where respondent's determination is narrowly drawn and, after the matter has been petitioned to the Court, he advances a new position not within the ambit of the determination made in the notices of deficiency. McSpadden v. Commissioner, 50 T.C. 478">50 T.C. 478, 493 (1968). Since respondent has not raised222 a new issue, we hold that his determination remains presumptively correct, and the burden of proof remains on petitioners. We now turn to the principal issue of what is the fair market value of the 47 houses donated by petitioner to the Fulton Foundation in 1969. In general section 170 sets forth detailed rules which, if adhered to, provide a deduction for charitable contributions. If property other than money is contributed the amount of the deduction is determined by the fair market value of the property so contributed. Goldman v. Commissioner, 46 T.C. 136">46 T.C. 136, 137 (1966), affd. 388 F. 2d 476 (6th Cir. 1967); section 1.170A-1(c), Income Tax Regs.The issue at bar arose because petitioner claimed a deduction for the contribution of property which he alleges was worth $60,516. It is respondent's position that the property had no value. The question is purely factual, Kaplan v. Commissioner, 43 T.C. 663">43 T.C. 663, 665 (1965), and the223 petitioner has the burden of proof. Goldman v. Commissioner, supra at 137. We are of the opinion that the petitioner has failed to fully carry this burden. The generally accepted definition of fair market value as set forth in respondent's regulations is: The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts * * . In the case at bar petitioner did not establish that a willing buyer would pay anything for the houses. In fact, it is highly unlikely that a willing buyer could be found. This is true because of the age and condition of the property, the fact that more than a third of the houses could not be rented due to a local ordinance prohibiting the rerenting of houses without indoor plumbing, and the fact that the property was scheduled to be demolished as part of a plan of urban renewal. In the absence of such proof, one reliable guide to fair market value is the property's earning capacity. Jerecki Manufacturing Co. v. Commissioner, 12 B.T.A. 1165">12 B.T.A. 1165, 1178 (1928).224 Petitioner testified that the $60,516 charitable deduction represented his computation of a 4-year interest in the gross rents from the 47 properties. Such value was determined by the application of Table II of Regs. section 25.2512-5(f) and the payment factor provided in section 25.2512(b) of the Gift Tax Regulations to the gross rental value which included the sum of the annual rental value of those houses occupied in April, 1969, and annual rental of unoccupied houses as determined by the rent received on the dates of their last occupancy. Although petitioner's reliance on these tables under the circumstances of this case may be correct, see Hipp v. United States, 215 F. Supp. 222">215 F. Supp. 222 (W.D.S.C. 1962), we believe that his computations were entirely too optimistic. In the first place, the petitioner used a 4 year time period. By its terms, however, the gift was to terminate at the earlier of 3 years or the institution of eminent domain proceedings. Additionally, petitioner's computation did not account for the obligation assumed by Fulton Foundation to demolish the buildings at the completion of the term of the gift. Scott v. Commissioner, 61 T.C. 654">61 T.C. 654, 662 (1974).225 Further, petitioner's computation did not take into account any vacancies that might have occurred between the time he had decided to dispose of the property in April, 1969 and June 27, 1969, the date of the gift. His computation also made no provisions for the loss of rental income resulting from vacancies occurring during the term of the gift. 3Additionally, petitioner made no provision for expenditures for maintenance, repairs, taxes or costs of vandalism. Finally, he did not factor into his computation the possibility that the term of the gift would be less than 3 years due to the institution of eminent domain proceedings. After a careful study of the evidence presented, we conclude that the fair market value of the 47 buildings was $25,000 at the time of the donation. In view of the foregoing, 226 Decision will be entered under Rule 155. Footnotes1. In 1969 petitioner paid the taxes prior to the gift to the Fulton Foundation. In 1970 and 1971 he paid to Fulton $872.80 and $247.09, respectively, for the real estate taxes assessed on the houses.↩2. Petitioner made a cash contribution in the amount of $4,500 in 1970 to the Fulton Foundation to assist in the payment of the demolition expense.↩3. Because of a local ordinance prohibiting the rerenting of houses without indoor plumbing, petitioner boarded up each house as it became vacant. This Court does not accept the unsupported contention by petitioner that he could have persuaded the City of Richmond to give the Fulton Foundation permission to rent those houses that were prohibited from being rerented.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625661/	CAROLINE MILLS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Caroline Mills v. CommissionerDocket No. 100343.United States Board of Tax Appeals44 B.T.A. 379; 1941 BTA LEXIS 1340; May 1, 1941, Promulgated 1340 Committees representing bondholders and shareholders of petitioner entered into an oral agreement that the bondholders would not foreclose on a deed of trust and that the shareholders would not pay dividends until past due bond interest had been paid. At a shareholders' meeting a resolution in which the agreement was recited was adopted. The minutes of the shareholders' meeting were approved by the board of directors of petitioner. Held, the minutes of the meeting of the shareholders did not constitute a "written contract executed by the corporation" and petitioner is not entitled to a credit under section 26(c)(1) of the Revenue Act of 1936. W. A. Sutherland, Esq., and B. F. Boykin, Esq, for the petitioner. J. Marvin Kelley, Esq., for the respondent. VAN FOSSAN 379 Respondent determined a deficiency in petitioner's income tax for the fiscal year ended June 30, 1937, in the sum of $2,839.74. The sole issue before the Board is whether or not petitioner is entitled to a credit under section 26(c)(1) of the Revenue Act of 1936. FINDINGS OF FACT. Petitioner is a corporation, organized and existing under the laws of the State1341 of Georgia, and is engaged in the operation of a cotton mill. Its principal office is located at Carrollton, Georgia. Under date of May 1, 1928, petitioner entered into an indenture with the Trust Co. of Georgia whereby petitioner executed a deed of trust covering all of petitioner's real property, improvements thereon, machinery, equipment, rights, franchises, and patents to secure the issue of $50,000 first mortgage bonds. During the fiscal year ended June 30, 1937, and for some time prior thereto, bonds of petitioner secured by the deed of trust of May 1, 1928, were outstanding in the principal amount of $43,800. At the end of the taxable year interest in the sum of $12,648.86 had accrued on these bonds. During the period from 1928 through the fiscal year ended June 30, 1936, petitioner had a net operating deficit of $39,266.71. At the end of the taxable year the operating deficit of petitioner had been reduced to $22,201.20. There was no change in petitioner's outstanding capital stock during the period in which there was a net operating deficit. Due to adverse business conditions petitioner's mill ceased operation for several months in 1933. Petitioner was unable1342 to pay interest on the bonds outstanding and was continually pressed by the bondholders for payment. 380 On March 22, 1933, the bondholders of petitioner held a meeting for the consideration of petitioner's financial condition and for discussion of the advisability of payment by petitioner of bond interest due May 1, 1933. After discussion the bondholders appointed a bondholders' committee with full power to act for their protection and for the best interests of petitioner's shareholders and bondholders. At a called meeting of petitioner's board of directors held May 22, 1933, the board voted to incorporate the minutes of the bondholders' meeting of March 22, 1933, into the regular minutes of the board of directors. The board voted to accept a report of the bondholders' committee in which it was stated that the committee had secured authority from the bondholders to withhold requests for bond interest due May 1, 1933. The committee reported that it had been decided that the bondholders request the Trust Co. of Georgin to resign as trustee under the deed of trust of May 1, 1928, so that a local trustee or trustees might be appointed to work out petitioner's affairs1343 to the best interests of the community. The report also stated that all of the bondholders of petitioner, with the exception of owners of approximately $2,000 of bonds, had acceded to the plan. The board of directors voted to join with the bondholders in requesting that the Trust Co. of Georgia resign as trustee. On August 18, 1933, the Trust Co. of Georgia resigned as trustee under the deed of trust of May 1, 1928, "in order to cooperate fully with certain plans the bondholders have worked out in conjunction with the Caroline mills, Inc. * * ." At a meeting of the stockholders of petitioner, held January 19, 1934, at which a majority of the outstanding shares was represented, E. T. Steed, L. J. Brock, and S. C. Boykin were elected trustees in lieu of the Trust Co. of Georgia, with all the powers set forth in the deed of trust dated May 1, 1928. A resolution was carried that the trustees: * * be further empowered to carry out the agreement made with the stockholders and the bondholders, between the Committee representing the bondholders and the Committee representing the stockholders, to-wit: That the bondholders agree that a deed may be executed to these Trustees, creating1344 them Trustees for the bondholders. The bondholders agree that these Trustees not push at the present time for the interest due on said bonds, nor to foreclose the same on the mill until further order to do so by a majority of the bondholders, in writing, given to these Trustees named above. The stockholders agree with these Trustees and the bondholders, that in consideration of this agreement made by the bondholders to them, that neither the stockholders nor the directors of the mill will pay out any dividends, nor employ any additional officers, at any salary, until authorized to do so by the Trustees, and that in no event shall any dividends be paid in any manner, until the past due interest on the bonds has been fully paid. These minutes were signed, "E. T. Steed, Chairman" (of the meeting) and "P. L. Shaefer, Secretary." Contracts entered into by 381 petitioner are usually signed by both the president and secretary of petitioner. The agreement referred to in the resolution quoted above was oral. On January 19, 1934, Steed, Brock, and Boykin entered into a written agreement with petitioner whereby petitioner conveyed, transferred, and assigned to them as trustees1345 all the powers, rights, privileges, and title to the property held by the original trustee under the deed of trust of May 1, 1928. This agreement was signed in behalf of petitioner by "B. F. Boykin, President" and "P. L. Shaefer. Secretary." At a regular monthly meeting of the board of directors of petitioner, held February 8, 1934, the minutes of the stockholders' meeting of January 19, 1934, were read and approved by the directors. Respondent determined petitioner's adjusted net income and undistributed net income for the taxable year to be in the amount of $17,065.51. After allowance of the specific credit granted by section 14(c) of the Revenue Act of 1936, respondent determined that petitioner's undistributed net income subject to surtax was in the sum of $13,772.06. On its return for the taxable year petitioner claimed a credit on account of an alleged contract restricting payment of dividends in the sum of $17,065.51. Respondent disallowed the credit. At the date of hearing the bondholders and stockholders had not violated the terms of the agreement set forth in the resolution adopted by the shareholders on January 19, 1934. OPINION. VAN FOSSAN: The only issue1346 for our determination is whether or not petitioner is entitled to a credit under section 26(c)(1) of the Revenue Act of 1936 1 for purposes of the surtax on undistributed profits. Petitioner contends that it was restricted in payment of dividends in the taxable year because of limitations imposed by its charter and by the agreement set forth in the minutes of the shareholders' meeting held January 19, 1934. It maintains that the shareholders' resolution was a written contract executed by petitioner within the purview of the statute. Respondent's position is that the minutes of the shareholders' meeting indicate a mere authorization to the elected trustees to carry into effect the oral agreement which 382 had been reached by the committee representing the bondholders and the shareholders. 1347 Since the date of hearing of this proceeding the Supreme Court handed down its decisions in , and . In those cases the Supreme Court held that a corporate charter was not a contract within the meaning of section 26(c)(1) of the Revenue Act of 1936. Petitioner's charter, therefore, is not a contract restricting payment of dividends and does not entitle petitioner to the credit granted by the statute. It thus becomes necessary that we consider petitioner's contention that the resolution adopted by the shareholders on January 19, 1934, was a written contract executed by petitioner. In , we held that a corporate bylaw is not a "written contract executed by the corporation" within the meaning of section 26(c)(1). We reiterated our position in that case in . Recently, we held that an agreement between preferred and common stockholders which was recorded in the minutes of a shareholders' meeting was not a contract executed by the1348 corporation. . We are of the opinion that the agreement among stockholders, bondholders, and trustees which is recited in the corporate minutes of the shareholders' meeting of January 19, 1934, is not a written contract executed by petitioner. It does not appear that there was any intention that a contract be executed by petitioner at that time. The embodiment of the agreement in the minutes seems a mere recitation for the purpose of corporate records. Moreover, although petitioner's contracts were customarily signed by its president and secretary, these minutes were signed by the secretary and by the chairman of the meeting. Nor does the fact that petitioner's board of directors, on February 8, 1934, approved the minutes of the shareholders' meeting of January 19, 1934, make the agreement a written contract executed by petitioner. The directors approved the minutes of the meeting which included the resolution here under consideration, but that approval can not transmute an oral agreement into a written one. The agreement among the bondholders, shareholders, and trustees was not a written contract. We hold that the1349 facts do not show a written contract executed by petitioner which restricted payment of dividends in the taxable year. Reviewed by the Board. Decision will be entered for the respondent.TYSON 383 TYSON, dissenting: I agree with the majority opinion in its holding that petitioner's charter is not a contract restricting the payment of dividends within the purview of section 26(c)(1) of the Revenue Act of 1936. However, I disagree with the holding in that opinion that the resolution adopted at the stockholders' meeting and thereafter approved by the board of directors did not constitute a written contract executed by petitioner restricting the payment of dividends under the cited section. The majority opinion predicates its latter holding primarily upon the conclusion that the agreement between the petitioner and its bondholders was oral and that the embodiment of that oral agreement in the resolution set out in the minutes of the stockholders' meeting was a mere recitation for the purpose of corporate records; and the opinion seems also to imply that the latter holding might also be additionally based upon the fact that the minutes of the stockholders' 1350 meeting at which the resolution was adopted were signed by the chairman of that meeting rather than by the president of the corporation. In my opinion, the embodiment in the resolution of the only oral agreement shown by the record, i.e., that between the bondholders' committee and the stockholders' committee, was not a mere recitation for the purpose of the corporate records, but constituted the only contract between the parties after its adoption; and I do not think that at the time of the adoption of the resolution it is correct to state, as is done in the majority opinion, that "it does not appear that there was any intention that a contract be executed by petitioner at that time." The undisputed evidence, not all of which is shown in the majority opinion, discloses: That the bondholders' committee, with full authority to act for the bondholders, and a committee of the stockholders met together and made an oral agreement containing the same terms and provisions as are set out in the resolution in question; that after this oral agreement was made the bondholders' committee appeared in person at the meeting of the stockholders on January 19, 1934, for the purposes of making1351 a report of the petitioner's defaults in payment of interest on its bonds and of requesting the stockholders to confirm the oral agreement made by the two committees for the protection of the bondholders; and that after the report of the bondholders' committee to the stockholders' meeting, and while that committee was present, the resolution in question was adopted in response to the request of that committee. Under the facts as above stated it seems clear that at the time of the adoption of the resolution it was the intention of the bondholders' committee and the stockholders to execute the contract here in question and it seems equally clear that the contract was so executed by incorporating in the written resolution the terms of the precedent oral 384 agreement between the bondholders' committee and the stockholders' committee. From all the facts and attendant circumstances, I can reach no conclusion other than that the oral agreement previously made by the two committees became merged in the written resolution under the elementary principle stated in 17 Corpus Juris Secundum, p. 872, § 381, as follows: "* * * in the absence of fraud, a written contract merges all1352 prior and contemporaneous negotiations on the subject, together with all prior oral contracts * ." In concluding that the oral agreement made by the two committees was merged in like provisions of the resolution, I do so by applying the principle that a resolution embracing the terms of an oral request or proposal made by the other party to an agreement, or embracing terms orally accepted by or acquiesced in by such other party, constitutes a binding obligation and a written contract of the corporation when adopted by it and spread in writing upon its minutes. This principle is established by the following authorities: (Md.); (Mass.); (Iowa); (Pa.); (Pa.); (Ala.); cf. 1353 , (Va.); (Mass.); (Colo.). The implication in the majority opinion that its holding might be additionally based upon the fact that the minutes of the meeting of the stockholders were signed by "E. T. Steed, Chairman" of that meeting rather than by the president of the corporation is, in my opinion, unsound. The minutes show that Steed was duly selected as chairman thereof and in signing the minutes with the secretary was properly performing the functions of such a position. The minutes were binding on the corporation, under the controlling principle as stated in 18 Corpus Juris Secundum, pp. 1233, 1234, § 545: "While provision is frequently made that the president shall preside at stockholders' meetings, where no provision is made, a chairman may be selected by the stockholders." In my opinion the resolution in question constituted a written contract executed by the petitioner1354 corporation which restricted payment by it of dividends in the taxable year. ARUNDELL, MURDOCK, BLACK, LEECH, and HARRON agree with this dissent. Footnotes1. SEC. 26. CREDITS OF CORPORATIONS. In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax - * * (c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. - (1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. * * * ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625663/	STATE SAFETY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.State Safety Co. v. CommissionerDocket No. 12641.United States Board of Tax Appeals13 B.T.A. 1385; 1928 BTA LEXIS 3056; November 2, 1928, Promulgated 3056 March 1, 1913, value of leasehold interest determined. Raymond H. Schultz, Esq., and David Bluford, Esq., for the petitioner. Brice Toole, Esq., for the respondent. SIEFKIN1386 This is a proceeding for the redetermination of deficiencies in respective amounts of $3,519.64 and $3,699.06. The error alleged is respective amounts of $3,519.64 and $3,699.06. The error alleged is that the respondent erred in refusing to allow depreciation sustained on a leasehold owned by the petitioner on the basis of its March 1, 1913, value. FINDINGS OF FACT. Petitioner is an Illinois corporation with its principal place of business at Chicago. On January 26, 1926, the deficiency letter on which this appeal was taken was mailed to the taxpayer stating a deficiency of $3,519.64 for the calendar year 1920, and $3,699.06 for the calendar year 1921. In its returns for said years, the petitioner deducted the amount of $8,416.57 for amortization of ground lease and building. In his determination of the deficiency the respondent disallowed $6,528.35 of such amount in each year and allowed $1,888.22 in each year. In 1894 the petitioner acquired a lease3057 for 97 years and three months (expiring July 31, 1991) on the premises known as: Sub-lots 1 and 2 of lot 10 in block 7 in fractional section 15 addition to Chicago in Cook County, Illinois, except the west 27 feet of said lots taken for the widening of State Street, at an annual rental of $30,000. On October 10, 1905, the premises were sublet by the petitioner to Rothschild & Co. from October 10, 1905, to February 28, 1986, a term of 80 years and 5 months, at an annual rental of $63,000. The sublease provided for the payment by the sublessees of all taxes, special assessments, repairs, insurance, etc. The leased premises comprise a ground area of 11,041 square feet, being 144.8 feet on Van Buren Street, by 76.42 on State Street, and were on March 1, 1913, improved with a steel skeleton fireproof department store building equipped with sprinkler system on concrete caissons going down to bedrock. The building contained 10 stories, an attic, and two basements and was designed to carry 7 additional stories. The cubic content of the building was 2,500,000 feet. The value of the land under the building on March 1, 1913, was approximately $3,000,000. The value of petitioner's3058 leasehold as of March 1, 1913, was $528,000. OPINION. SIEFKIN: The position of the respondent on which the deficiencies asserted in this proceeding were based was that exhaustion of the 1387 petitioner's leasehold interest must be based upon cost. That position was abandoned and at the hearing respondent's counsel admitted that the petitioner was entitled to an exhaustion allowance based upon the March 1, 1913, value. The respondent further admitted at the hearing that the petitioner's leasehold interest had a value on March 1, 1913, of $528,000, and in his brief, therefore, reduces the deficiencies to $1,290.89 for 1920 and $1,395.89 for 1921. The petitioner, however, contends for a value of $721,965, basing such amount on the testimony of the two real estate experts who testified at the hearing and who placed that value upon the petitioner's interest as of March 1, 1913. The petitioner, also, at the close of the hearing, filed a motion asking the Board to enter judgment upon the basis of such a value based upon the theory that such testimony was uncontradicted and must be adopted verbatim. This position is not sound. In the hearing of fact cases we concede that3059 it is our province to act as a jury, and, while we have no right arbitrarily to ignore or discredit the testimony of unimpeached witnesses, it is still our province, when the question is purely one of value, to exercise our own judgment on the facts as to which the experts give their opinions. In this proceeding the experts, in reviewing the basis for the value which they placed on the property, listed a large number of sales or leases of property within the loop district in Chicago. Two of these leases and sales were as late as 1923 and 1926. Nor were the transactions proved independently of the testimony of the experts whose testimony with respect to such transactions was pure hearsay. It further appears that the value obtained by the two experts for the petitioner was obtained by capitalizing the annual return of $33,000 over a period of 78 years and 5 months upon a straight discount formula, using 4 1/2 per cent compound interest. Such a method takes no account of the speculative possibilities over the long period which the lease had to run. It may be true, as testified by the experts, that the buildings upon the property standing back of the payments as security minimized*3060 that risk. Considering all the circumstances, we are inclined to the view that a method which makes provision for a safe interest rate and a speculative rate more nearly reflects the value than a method which makes no provision for the element of risk. The respondent's calculation used such a method and results in a value of $528,000. The petitioner has not satisfied us that the amount should be larger. Judgment will be entered for the respondent for a deficiency of $1,290.89 for the year 1920, and $1,395.89 for the year 1921.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625664/	MANUEL CEBOLLERO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCebollero v. CommissionerDocket No. 9396-88United States Tax CourtT.C. Memo 1990-618; 1990 Tax Ct. Memo LEXIS 693; 60 T.C.M. (CCH) 1379; T.C.M. (RIA) 90618; December 6, 1990, Filed 693 Decision will be entered under Rule 155. Stephen P. Kauffman, for the petitioner. Deborah Y. Clark and William T. Lyons, for the respondent. COLVIN, Judge. COLVIN1996 MEMORANDUM FINDINGS OF FACT AND OPINION Petitioner owned a beer and wine retail store which had two cash registers. Petitioner did not report all of the receipts from one of the cash registers694 during 1982 - 1984, the taxable years at issue here. Respondent used a cost percentage markup method to reconstruct petitioner's income for 1982 through 1984, and determined petitioner's deficiencies in and additions to Federal individual income tax as follows: 11997 Additions to TaxSectionSectionSectionYearDeficiency6653(b)(1)6653(b)(2)66611982$ 18,287.64$ 9,143.82 $ 6,767.14198316,914.238,457.67 5,702.52198417,630.018,815.51 4,397.60 50 percent of the interest due on the underpayment caused by fraud. At trial, petitioner conceded that his failure to report all receipts from the second cash register was fraudulent. 695 The issues to be decided are: 1. Whether respondent's use of the cost percentage markup method to reconstruct petitioner's income is reasonable. We hold that it is, with minor modifications. 2. Whether respondent's agent may base her analysis of petitioner's income in part on information which would be hearsay if offered to prove its truth through respondent's agent's testimony. We hold that she may. 3. Whether petitioner's expert witness is permitted to testify where there was no notification to respondent that he would testify until after the calendar call of the case and shortly before trial, and no expert report was prepared. We hold he is not. 4. Whether the addition to tax under section 6661 for substantial understatement of income tax is applicable to petitioner. We hold that it is. Unless otherwise provided, 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. FINDINGS OF FACT Some of the facts have been stipulated and are so found. 1. PetitionerPetitioner resided in Silver Spring, Maryland, when the696 petition was filed. He has Bachelor of Science degrees in mechanical engineering and electrical engineering. He had no training in accounting or bookkeeping. In December 1955, petitioner married June Cebollero, now know as June Flory (Ms. Flory). They were married during all of the years at issue. Petitioner was also a 50-percent partner with Ms. Flory in a partnership called Belby Discount Beer and Wine (Belby) during these years. Petitioner and Ms. Flory were divorced in 1985. Petitioner's filing status was married filing separately for his 1982 and 1983 Federal income tax returns, and single for his 1984 return. The parties have stipulated that petitioner's correct filing status for 1984 is married filing separately. Petitioner prepared his personal 1982, 1983, and 1984 returns. Petitioner knowingly failed to report all of his partnership income. Petitioner skimmed unrecorded cash from Belby during the years at issue. On April 11, 1988, he pled guilty to a charge of willfully subscribing to a false return for 1983 under section 7206(1). 2. Belby Discount Beer and WinePetitioner and his former wife, Ms. Flory, acquired Belby in December 1976. Belby697 is a retail beer and wine sales store. It was owned and operated as a partnership, with petitioner and Ms. Flory its only partners. Petitioner and Ms. Flory worked at Belby, along with several part-time employees. Petitioner also hired a part-time bookkeeper. The bookkeeper was unaware of the understatement of gross income. Belby was located in Montgomery County, Maryland, and licensed by the Montgomery County Liquor Control Board (the Board). All of Belby's beer and wine purchases were from the Board. Petitioner's primary duties at Belby were to make inventories of beer and wine and order those items from the Board. Petitioner also set the price of beer and wine for sale. Typically, he would make a physical inventory of both beer and wine and compare the result with the previous week's inventory to determine the amount sold during the week. He would then order the 1998 difference. He made adjustments for holidays and local temperature or weather. Petitioner also hired, fired, and trained employees. Ms. Flory ordered sundries such as cigarettes and candy, closed out the cash registers, and posted the books and records. Belby was open 365 days a year. The698 hours were 10 a.m. to 10 p.m. in winter, 10 a.m. to 11 p.m. in summer, and 10 a.m. until midnight on Friday and Saturday nights. Friday was the busiest day. Belby operated with two shifts, one from 10 a.m. to 5 p.m., and the second from 5 p.m. until closing. Sales were summarized twice a day. At the end of each shift, the total receipts for the shift were summarized when the register produced a Z-tape. Usually Ms. Flory totaled the cash receipts and reconciled the cash collected with the Z-tape. During the years 1982, 1983, and 1984, petitioner's practice was to mark up beer and wine by a certain percentage. Petitioner's markup of his inventory remained generally constant throughout the years at issue and 1985. Petitioner's sales mix was generally consistent during the years 1982, 1983, and 1984. About 75 percent of Belby's sales were from beer. Six-pack sales accounted for 40 percent of beer sales, and cases accounted for 60 percent. Beer purchases constituted 73.9, 72.7, and 72.1 percent of Belby's purchases from the Board in 1982, 1983, and 1984, respectively. For the years at issue and 1985, Belby's markup was 22 percent on beer sold by the case, and 35 percent699 on six-packs. From time to time, the Board offered beer to retail beer and wine licensees at lower than cost. The retailer could set any price for the beer. Belby sold some beer at prices below the usual markup every week. During sales, Belby offered between two and four brands of beer at discounted prices. Petitioner placed a large number cases of beer on sale with a big bull's-eye advertisement in front of the store. During sales, petitioner sold beer a few pennies above or below cost. Although Belby advertised at the outset, petitioner found it to be more effective to simply stack the sales-priced beer on sale in front of the store. For the years at issue, Belby's wine inventory was classified in two categories, wine regulars and wine specials. Approximately 90 percent of sales were regular wines and 10 percent were special order wines. Petitioner's markup for regular wines was 25 percent for the years at issue and 1985. Wine specials were sold at a higher markup than wine regulars. For the years at issue, the markup for special order wines was between 25 and 60 percent, and averaged about 50 percent. Sundry items accounted for 10 percent of petitioner's overall700 sales. The markup for sundries averaged the same as the markups on beer and wine. Belby experienced some breakage of beer and wine purchased from Montgomery County. Petitioner filed suit against the Board in an effort to force the Board to modify its breakage refund policy. Petitioner kept no records of breakage or spoilage. Belby experienced some problems with theft. Some of the thefts were by employees. Petitioner and Ms. Flory once caught an employee taking $ 150 in cash. On another occasion, petitioner apprehended an employee stealing merchandise worth more than $ 100. Belby used two cash registers to collect and record cash receipts. Only one was used daily, while the other was used only on busy days such as weekends and holidays. Petitioner instructed Belby cashiers to ring up all sales. Petitioner kept a handwritten cash receipts journal, a handwritten disbursements journal, cash register tapes, standard payroll records, sales tax records, and general business records, such as excise tax forms. Belby's cash disbursement journal separately listed checks to Montgomery County for beer and wine purchases. Books and records were maintained and the income tax returns701 were filed for the years at issue using the cash method of accounting. Petitioner and Ms. Flory devised a scheme to understate Belby's gross receipts. Under their scheme, most of the receipts from the second register were not recorded in the Belby cash receipts journal. At times petitioner and Ms. Flory became concerned that the amount of unreported income was excessive, and so some of the sales from the second register were re-rung on the first register. Petitioner and Ms. Flory agreed to divide the unrecorded receipts equally. The unrecorded receipts were not reported on Belby's partnership returns. The partnership filed a partnership income tax return for each of the three years at issue. During the years at issue, the partnership underreported gross receipts. Petitioner helped prepare those returns. At the time Belby's 1985 partnership tax return was due to be filed, the business was being operated by Ms. Flory as a court appointed trustee. Belby's operated in a competitive environment. Jumbo, a competitor, was located six to eight blocks from Belby. Jumbo placed big advertisements in the newspaper for beer and wine. Rodman's Discount Beer & Wine was located one block702 from Belby. The Board stores 1999 also sold regular wines in direct competition with stores such as Belby. Before July 1, 1982, licensed retailers in Maryland were permitted to sell beer and light wine to any person over the age of 18 years. Beginning July 1, 1982, licensed retailers were permitted to sell beer and light wine to any person who was over the age of 21 or to any person who was 18 before July 1, 1982. The partnership was dissolved in 1985 and the store was sold in 1986. 3. The IRS Audit and Respondent's Determinationa. The AuditRevenue Agent Laura Sencer examined the returns of Belby and petitioner. She had seven years' experience in private industry as an accountant followed by seven years of public accounting. She received her bachelor's degree from the Peabody Institute of John Hopkins University and is a certified public accountant in the State of Maryland. In the course of the audit, Ms. Sencer sent petitioner a letter for an appointment to examine his tax liability. He responded by telephone to confirm it. Ms. Sencer kept the appointment, visiting petitioner at Belby on a Friday in March 1985. Ms. Sencer took notes at that703 meeting. She and petitioner discussed the manner in which petitioner's books and records were kept, the kind of books and records that he had, how sales and expenses were recorded, his hours of operations, and other background facts in preparation for the examination of the books and records. They discussed what he sold, his markup policy, and sales mix. Petitioner told Ms. Sencer that he had one cash register which he used to ring up all of his sales. Ms. Sencer took the Belby books and records back to her office to reconcile Belby's bank deposits, sales, and cash register tapes with either the books and records or the returns. She was unable to reconcile the records. Ms. Sencer then attempted to verify the percentage markups provided by petitioner. During the interview in March 1985, petitioner had told Ms. Sencer the amount of his markups, and that his markups had been constant from year to year. Petitioner gave Ms. Sencer a copy of a price list. Ms. Sencer verified the prices with prices on the walls. She then telephoned the Board to verify petitioner's cost of goods sold. She compared the Montgomery County prices with petitioner's price list and discovered that petitioner's704 markup was exactly what he had said it was. It was 35 percent for six-packs and 22 percent for cases of beer. Ms. Sencer verified petitioner's markup figures by dividing the sales price obtained from the price list by the cost and arrived at 22 percent for beer six-packs. She verified the markup for each of the listed beers using this method. Her independent verification procedures confirmed that the markup figures provided to her by petitioner were correct. Ms. Sencer then verified petitioner's purchases. Petitioner had told Ms. Sencer that all Belby purchases were made by check. She then compared all check purchases in excess of $ 50 with petitioner's cash disbursements journal or check journal. She took his bank statements and verified that the checks written on his bank account matched that in his journal. She also verified that the checks were made payable to Montgomery County. Ms. Sencer then applied petitioner's markup to his purchases and discovered a very large understatement of gross income. She showed petitioner the figures. When petitioner was asked if there could be anything wrong with her figures, he mentioned employee theft and that some beer was sold at a705 discount. Petitioner said that on a quarterly basis Montgomery County inspected his wine to ensure that all wine on his shelves was good, and that he was required to break some bottles. Ms. Sencer asked petitioner what he thought of the figure of $ 5,000 for spoilage and theft. Petitioner said that it was okay. Petitioner was unable to explain the large understatement of gross income. Ms. Sencer then concluded that the situation was fraudulent. She referred the case for criminal investigation. Ms. Sencer acknowledged that petitioner sold some products at sale prices, but she did not know how much he was selling below his regular prices or below cost. She made no adjustments for sales. Petitioner told the revenue agent during the audit in February or March 1985 that his markup remained constant in the years at issue. On August 2, 1985, during a criminal interview with the revenue agent also present, petitioner told a special agent that he increased his markup within recent years, but he didn't remember when. However, during the August 2, 1985, interview, petitioner reiterated the same markups that he had told the revenue agent that he used during the years at issue. OPINION706 Respondent reconstructed petitioner's gross receipts from petitioner's retail beer and wine business for taxable years 1982, 1983, and 1984, using the percentage markup method. Under this method, gross sales are determined by adding a predetermined percentage to cost of goods sold. Bernstein v. Commissioner, 267 F.2d 879">267 F.2d 879, 880 (5th Cir. 1959), affirming a Memorandum Opinion of this Court. The predetermined percentage 2000 markups were obtained in interviews with petitioner, and verified by respondent's revenue agent. Petitioner concedes that he participated in a plan to conceal income from the second cash register at his beer and wine retail store. However, petitioner contends that respondent's notice of deficiency is not entitled to a presumption of correctness because the determination set forth in the notice of deficiency is arbitrary and excessive under the rationale of Helvering v. Taylor, 293 U.S. 507 (1935). 1. Percentage Markup MethodWhere a taxpayer's records are inadequate, the Commissioner is authorized to compute income by any other reasonable method, Webb v. Commissioner, 394 F.2d 366">394 F.2d 366, 373 (5th Cir. 1968);707 Burka v. Commissioner, 179 F.2d 483">179 F.2d 483 (4th Cir. 1950); Harbin v. Commissioner, 40 T.C. 373">40 T.C. 373, 377 (1963); Hutcherson v. Commissioner, T.C. Memo. 1984-165; Wright v. Commissioner; T.C. Memo. 1967-86. Where reconstruction of a taxpayer's income is necessary, respondent has great latitude in the method used. The method, however, must produce a result that is reasonable and substantially correct. Mendelson v. Commissioner, 305 F.2d 519">305 F.2d 519, 523 (7th Cir. 1962). Although respondent's reconstruction of income need not be exact, it must be "reasonable in light of all surrounding facts and circumstances." Schroeder v. Commissioner, 40 T.C. 30">40 T.C. 30, 33 (1963). The percentage markup method is well recognized as an appropriate means of reconstructing income where a taxpayer's records are incomplete or inaccurate. Bollella v. Commissioner, 374 F.2d 96 (6th Cir. 1967), affirming a Memorandum Opinion of this Court, upholding the percentage markup method; Kurnick v. Commissioner, 232 F.2d 678 (6th Cir. 1956), affirming a Memorandum Opinion of this Court; Western Supply & Furnace Co. v. Commissioner, 295 F.2d 341 (7th Cir. 1961);708 Bernstein v. Commissioner, supra; Stone v. Commissioner, 22 T.C. 893">22 T.C. 893, 905-906 (1954). Taxpayers are required to keep records which are sufficient to enable respondent to determine their correct Federal income tax liability. Sec. 6001. Petitioner does not claim that his books and records for the years in question were adequate. Respondent's revenue agent attempted to reconcile petitioner's records with his returns, but was unable to do so. Accordingly, she chose to reconstruct petitioner's gross receipts by applying the percentage markup method to petitioner's costs. Petitioner argues that respondent's application of the percentage markup method here is arbitrary and excessive. Petitioner argues: a. The revenue agent failed to adjust for Belby's sales of beer at lower-than-advertised prices. b. The revenue agent allowed only $ 5,000 per year for broken, spoiled, and stolen inventory. c. The revenue agent applied a markup percentage derived by applying 1985 prices to 1982, 1983, and 1984. d. The revenue agent did not follow Internal Revenue Manual procedures considering industry averages when examining beer and wine stores. 709 e. Petitioner produced competent and convincing evidence of respondent's errors, while respondent failed to produce evidence to refute petitioner's testimony. We will first examine respondent's application of the percentage markup method. Respondent's agent verified the markups used by petitioner during the years at issue. Petitioner told her that his markup was 22 percent for beer cases, 35 percent for beer six-packs, 25 percent on wine regulars, and an 25 to 60 percent for wine specials. To verify this, she obtained the costs of the other brands of beer from the Board. She compared that information with the prices for which petitioner had sold beer and verified the percentage markup as being 22 percent for cases and 35 percent for six-packs. She also verified that wine regulars were marked up 25 percent. She found that the markup for wine specials varied greatly, but found the average to be about 50 percent. Thus, petitioner's own statements as to his markups were verified. Petitioner denies that he told the revenue agent that his markups were constant, pointing to his statement to an IRS criminal investigation division special agent. The special agent asked petitioner710 if Belby's prices were constant during the period 1982 through 1984. Petitioner replied that Belby's markups had been increasing, but he couldn't recall when. We believe that petitioner's statement initially made to the revenue agent was more credible. We note also that petitioner conceded that his markup on wine regulars remained constant. He provided no reason that wine regulars would be treated differently from his other merchandise. Respondent's revenue agent also confirmed the sales mix between wine and beer which had been supplied by petitioner. The agent compared Belby's wine and beer purchases in the cash disbursement journal to confirm the sales mix. She found that the average over the three years at issue was 72.9 percent for beer sales. 2001 This is close to the estimate made by petitioner during the audit of 75 percent for beer sales. Thus, the sales mix that petitioner supplied to the agent was confirmed. Petitioner kept no records of breakage, theft, spoilage, discounts, or sales mix. However, the revenue agent allowed $ 5,000 for broken, spoiled, or stolen inventory. When breakage and spoilage was discussed during the examination, petitioner agreed711 with the revenue agent's allowance for it. Petitioner described two incidents of employee theft, but did not indicate whether they occurred during the years at issue. Petitioner testified that he filed a lawsuit against the Board because of breakage and that he estimated breakage to be one and one-half to two percent. He provided no basis for this estimate. He also testified that he sued because Montgomery County suspended beer delivery that left him without beer for a week. The record does not contain any documents or corroborating evidence supporting an allowance for broken, spoiled, or stolen inventory in excess of the $ 5,000 allowed by respondent's agent. Petitioner argues that the change in legal drinking age in 1982 from 18 to 21 years of age was not properly considered by respondent. Petitioner argues that the change in the legal drinking age in Maryland in July 1982 reduced the number of his customers. Petitioner argues that his response was to raise the markup to compensate for lost volume. Regardless of the drinking age change, petitioner has not convinced us that he did raise the markup, or that respondent's estimate of petitioner's markup or sales volumes712 was defective. Petitioner also contends that respondent's markup for sundry items was incorrect and that it should have been lower than that on beer and wine. Ms. Sencer testified that petitioner told her that the markup for sundry items was generally the same as beer and wine. Petitioner has not convinced us that his statement to Ms. Sencer was wrong. On occasion, Belby sold beer at sales prices, including some at and near cost. Ms. Sencer agrees that petitioner probably did sell below cost at times, but petitioner provided no evidence as to how much was sold below cost. We believe that sales were sufficiently significant that an adjustment should be made for them. However, petitioner's testimony that he placed one- seventh of the beer cases on sale was uncorroborated and unsupported by business records. On brief petitioner argues that the sale amount should be marked up at 2.2 percent. Taking into account all of the facts and circumstances, we believe that petitioner should be entitled to adjustments to gross income allowing 10 percent of the beer cases per year to be marked up 2.2 percent. See Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540, 543-544 (2d Cir. 1930).713 In an earlier liquor store unreported income case using the percentage markup method, we noted: From the record, it appears to us that the Commissioner computed the liquor markup from the only available evidence; the obligation to keep records that might more accurately reflect the liquor income was [the taxpayer's]. Sec. 6001. Having neglected his duty to do so, he cannot now condemn the Commissioner's computation * * Hutcherson v. Commissioner, T.C. Memo. 1984-165, 47 T.C.M. (CCH) 1421">47 T.C.M. 1421, 1425, 53 P-H Memo T.C. par. 84,165 at 84. Petitioner's argument about respondent's alleged failure to follow the Internal Revenue Manual provisions is also unpersuasive. Petitioner has not referred us to a specific section of the Manual. Further, regardless of any reference the manual may make to consideration of industry data, we believe respondent's agent's reconstruction of petitioner's income is entitled to greater weight. Having found respondent's reconstruction of petitioner's income to be reasonable, we disagree with petitioner's argument that the notice of deficiency is arbitrary and excessive such that the burden of going forward with evidence is714 on respondent. In light of the foregoing, respondent's determination is sustained as adjusted.2. Presumption of Correctness and the Burden of Going Forward With Evidence Generally, respondent's determinations are entitled to a presumption of correctness, and petitioner bears the burden of rebutting that presumption by a preponderance of the evidence. Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933); United States v. Pomponio, 635 F.2d 293">635 F.2d 293, 296-297 (4th Cir. 1980). We do not generally look behind a notice of deficiency to examine the basis for the determination of a deficiency. Riland v. Commissioner, 79 T.C. 185">79 T.C. 185, 201 (1982); Jackson v. Commissioner, 73 T.C. 394">73 T.C. 394, 403 (1979); Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324">62 T.C. 324, 327 (1974). However, where the notice of deficiency is found to be arbitrary, the burden of going forward with the evidence is shifted to respondent. Helvering v. Taylor, 293 U.S. 507">293 U.S. 507 (1935); Weimerskirch v. Commissioner, 596 F.2d 358">596 F.2d 358, 362 (9th Cir. 1979); Jackson v. Commissioner, supra, at 403. Petitioner715 contends that the notice of deficiency in this case is arbitrary, and that, as a result, respondent bears the burden of going 2002 forward to establish the existence and amount of the deficiency. Fraud was determined and alleged in the notice of deficiency, but petitioner has now conceded fraud. The burden of going forward as to the underlying deficiency does not shift to respondent merely because fraud is determined. Zack v. Commissioner, 692 F.2d 28 (6th Cir. 1982); Drieborg v. Commissioner, 225 F.2d 216">225 F.2d 216 (6th Cir. 1955). Petitioner has the burden of going forward as well as of proving that respondent's determination is arbitrary and excessive. Coomes v. Commissioner, 572 F.2d 554">572 F.2d 554 (6th Cir. 1978). Petitioner cites Foster v. Commissioner, 391 F.2d 727">391 F.2d 727 (4th Cir. 1968), an unreported income case from the Fourth Circuit Court of Appeals, the court to which appeal lies in this case, which stated: The burden of proof is on the Commissioner to show that the taxpayer received income. This burden is initially satisfied, however, by the fact that the Commissioner's deficiency determination is presumed correct. 716 The burden is thus on the taxpayer to prove the incorrectness of the deficiency determination . [Fn. ref. omitted.] This burden is procedural and is met if the taxpayer produces competent and relevant evidence from which it could be found that he did not receive the income alleged in the deficiency notice. In other words, the taxpayer at this point has the burden of producing evidence or of going forward with the evidence. If this burden is met, the burden of proof shifts back to the Commissioner to prove the existence and amount of the deficiency. Foster v. Commissioner, supra at 735. Petitioner alleges that he has produced competent evidence which establishes that he did not receive the amount of income alleged in the notice of deficiency, and which establishes that respondent's notice of deficiency is arbitrary, excessive, and incorrect, thereby negating the presumption of correctness. We disagree. We do not agree that petitioner has produced evidence establishing the incorrectness of respondent's determination. The only evidence before the Court to establish that petitioner did not receive the income determined by respondent is petitioner's717 testimony. He provided no business records or other corroboration for his testimony. Petitioner argues that respondent had named his ex-wife and former partner, Ms. Flory, as a witness who could have corroborated his testimony or the testimony of the revenue agent. However, respondent was under no duty to call Ms. Flory as a witness. After considering all of the evidence in this case, we hold that the burden of going forward is not shifted to respondent. The burden of going forward as well as the burden of proof is on petitioner. Rule 142. Under these circumstances, we hold that respondent's application of the percentage markup method was a reasonable method to reconstruct petitioner's income. Respondent's determination of deficiencies for 1982, 1983, and 1984, are sustained with adjustments for below normal markup sales. 3. Evidentiary Issuesa. Revenue Agent Telephone Conversation with the Montgomery County Liquor Control Board During trial, respondent's revenue agent, Laura Sencer, testified that she telephoned the Board to verify petitioner's costs. Petitioner objected to her testimony describing the cost information given to her during the telephone call718 as hearsay. The objection was overruled. Ms. Sencer needed to obtain cost information from the Board to determine markup and gross profit. It is true that if respondent testified as to what she was told during telephone calls about these prices in Court to establish the truth of the matter, it would be hearsay. However, her testimony about the prices is not hearsay here because it was not offered to prove the truth of the matter, but to show that respondent's technique used to apply the cost percentage markup method to petitioner was reasonable. We note that because petitioner conceded fraud and because of the facts and circumstances of this case, we are not faced with the issue of whether respondent must offer admissible evidence to establish that petitioner had any connection to the unreported income. See Anastasato v. Commissioner, 794 F.2d 884">794 F.2d 884, 887 (3d Cir. 1986). b. Petitioner's Expert WitnessAt trial petitioner called Peter C. Santoni as a witness. Respondent objected because Mr. Santoni was not identified 15 days before the trial session as a witness for petitioner as required by the Court's pretrial order. The pretrial order applicable to719 this case states that witnesses who are not so identified will not be permitted to testify at trial without leave of the Court upon sufficient showing of cause. Respondent was not informed that Mr. Santoni would be called as a witness until the morning of trial. Respondent also objected to Mr. Santoni's testimony on grounds that it was to be expert testimony, but no expert witness report had been presented 15 days in advance, as required by Rule 143(f) as in effect at the time. Petitioner argued that he had not received the revenue agent's work papers in sufficient time to identify Mr. Santoni as his witness. However, petitioner knew respondent's methodology for a considerable period of time. The statutory notice of deficiency includes a 15-page explanation of the adjustments fully setting 2003 forth the basis for adjustments including the markup method. Petitioner's claim of insufficient time to provide notice that Mr. Santoni would be a witness did not convince the Court of good cause for the lack of notice. We have enforced the 15-day rule of our pretrial order by excluding evidence. E.g., Gray v. Commissioner, T.C. Memo 1990-283">T.C. Memo. 1990-283; see Facuseh v. Commissioner, T.C. Memo. 1988-10.720 Accordingly, we believe respondent's objection was appropriately sustained. c. The Dunn & Bradstreet Industry Profile for Liquor Stores At trial, petitioner argued that a Dunn & Bradstreet Industry Profile for Liquor Stores (profile) was admissible under Federal Rules of Evidence 803(18). Because Mr. Santoni was precluded from testifying in this case, and petitioner offered no other foundation for introduction of the profile under Federal Rules of Evidence 803(18), the profile is inadmissible, and was not considered in deciding this case. However, we would not have reached a different result if we had considered the Dunn & Bradstreet profile. It shows average profit margins for 476 liquor stores in 1983. Here, we would give little or no weight to industry averages because respondent's analysis provides better information. d. Petitioner's Version of the 1985 ReturnDuring trial, petitioner offered into evidence a document purporting to be the Belby 1985 Partnership Return. However, petitioner was unable to authenticate the document. Ms. Sencer and petitioner were asked to identify it, but neither could. The document bears the signature of Lawrence Keane, CPA. Petitioner721 contends that the only way to authenticate the document is through the Internal Revenue Service. We disagree. It appears that Mr. Keane could have identified the document for purposes of Federal Rules of Evidence 901. The Court's pretrial order required that the parties exchange all documents which they intend to use at trial. Rule 91 requires the parties to stipulate to documents to the fullest extent possible. There is no showing of compliance with either the pretrial order or Rule 91. One purpose of these procedural rules is to allow the parties to address and resolve evidentiary matters such as this before trial. For these reasons, and because of petitioner's failure to authenticate the document, it was not admitted into evidence. 4. Substantial Understatement of Income Tax Under Section 6661Section 6661 authorizes an addition to tax when there is a substantial understatement of income tax in any given taxable year. Sec. 6661(a). The addition to tax is equal to 25 percent of the amount of any underpayment attributable to the substantial understatement. Sec. 6661(a). A substantial understatement exists if in any year the amount of the understatement exceeds*722 the greater of 10 percent of the amount required to be shown on the return, or $ 5,000. Sec. 6661(b)(1). An understatement, for purposes of this addition to tax, is the amount by which the amount required to be shown on the return exceeds the amount actually shown on the return. Sec. 6661(b)(2); Tweeddale v. Commissioner, 92 T.C. 501">92 T.C. 501 (1989); Woods v. Commissioner, 91 T.C. 88">91 T.C. 88 (1988). The addition to tax under section 6661 for each of the years at issue is applicable to petitioner if the understatement as adjusted by this opinion is substantial. Decision will be entered under Rule 155. Footnotes1. These amounts are as determined by a statutory notice of deficiency dated March 20, 1988, reduced by jeopardy assessments made on August 25, 1985. On October 21, 1985, respondent issued to petitioner with respect to a jeopardy assessment a statutory notice of deficiency for 1982, 1983, and 1984, determining income tax deficiencies in the amounts of $ 18,894, $ 15,043, and $ 5,633, additions to tax under section 6653(b)(1) in the amounts of $ 9,447, $ 7,521, and $ 2,816, additions to tax under section 6653(b)(2), and additions to tax under section 6661 in the amounts of $ 1,889, $ 1,504, and $ 5,636, respectively. Petitioner did not file a petition with respect to the October 21, 1985, notice of deficiency. On March 30, 1988, respondent issued a second statutory notice of deficiency to petitioner for 1982, 1983, and 1984, determining income tax deficiencies in the amounts of $ 37,181.64, 31,957.23, and 23,263.01, additions to tax under section 6653(b)(1) in the amounts of $ 18,590.02, $ 15,978.67, and $ 11,631.51, additions to tax under section 6653(b)(2), and additions to tax under section 6661 in the amounts of $ 8,656.14, $ 7,206.52, and $ 4,960.60, respectively. This notice of deficiency, however, did not account for prior jeopardy assessments made on August 25, 1985. The deficiencies set forth in this opinion take into account the prior jeopardy assessments. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625667/	JAMES R. WALSH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWalsh v. CommissionerDocket No. 7411-73.United States Tax CourtT.C. Memo 1977-392; 1977 Tax Ct. Memo LEXIS 49; 36 T.C.M. (CCH) 1587; T.C.M. (RIA) 770392; November 14, 1977; as amended, Filed Pipp Marshall Boyls and Peter R. Stromer, for the50 petitioner. Fredrick B. Strothman, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined the following deficiencies and additions to tax in petitioner's Federal income tax: YearDeficiencySec. 6653(b) 1Sec. 66541963$269,063.45$134,531.73$7,533.76196417,357.898,678.95486.0219662,455.441,227.7257.3819679,301.704,650.85297.66The issues for decision are: (1) Whether $365,000 under the management and control of petitioner during 1963 and 1964 was misappropriated and converted by him for his personal benefit and is therefore taxable income to him; (2) Whether the payment to petitioner of $1,000 in 1966 by J. Alton Lauren is taxable income to him; (3) Whether payments during 1966 and 1967 by the Sargent Foundation to or on behalf of petitioner are taxable income to him; (4) Whether payments during 1966 and 1967 by Americans Building Constitutionally to or on behalf of petitioner are taxable income to him; (5) Whether the fraud penalty51 provided by section 6653(b) is applicable for 1963, 1964, 1966 and 1967; and (6) Whether the addition to tax pursuant to section 6654 for failure to pay estimated tax is applicable for 1963, 1964, 1966 and 1967. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. At the time he filed his petition, petitioner was a resident of Aurora, Colorado. Petitioner is in the "educational business," instructing laymen in techniques to "conserve assets." Petitioner is knowledgeable in the law in general and tax law in particular. In 1947 petitioner created the National Committee on Alcoholism and transferred the "rights" to all his services to that Committee. Subsequently, in 1964 he formed the Walsh Family Estate, a Trust, to carry on the work of the National Committee on Alcoholism and transferred his "intellectual property" to the trust. Petitioner, his wife and his mother were the trustees of the Walsh Family Estate. The primary beneficiary of the Walsh Family Estate was the Walsh Family Foundation. Neither the Walsh Family Estate nor the Walsh Family Foundation was a qualified tax exempt organization pursuant to section 501(c). 1. One52 Prospect Corporation.Petitioner was employed as general manager of the Boxwood properties ("Boxwood") from approximately March 1963 until January or February 1964. Boxwood consisted of some 23 to 25 structures which were composed of four, six or eight townhouses apiece. There was a total of 163 units, 159 of which were rentable. Four of the units were to be converted into a community recreation center and a large swimming pool was to be constructed adjacent to this center. Boxwood was owned by One Prospect Corporation ("Prospect which was formed for the purpose of managing Boxwood. Prospect acquired Boxwood by taking over the existing mortgage and then refinancing the loan. Prospect had, as a result of the refinancing, a surplus of $358,000. This surplus was placed in an escrow account for the furnishing and operation of Boxwood as well as completion of the recreation center. Legal title to Boxwood was held by a land trust of which the sole beneficiaries were the principals of Prospect. Petitioner was neither an officer nor director of Prospect and he owned no equity in either prospect or Boxwood. 253 As general manager of Boxwood, petitioner promoted the concept behind the project, namely, obtaining young, single (often transient) tenants for furnished apartments. His other duties included: preparing apartments for occupancy, securing tenants, collecting rents, paying bills, hiring and firing employees. In sum, he had complete control over the management of Boxwood. During the period that petitioner was general manager of Boxwood, many of its expenses, particularly utility bills, were not paid, and some furniture was misappropriated. In addition, a check on Prospect's account, dated August 4, 1963, in the amount of $500 was made payable to a law firm which represented petitioner in a lawsuit. 3 This lawsuit did not involve Prospect in any manner whatsoever. Petitioner never accounted to Prospect or any of its principals for any of the monies that were under his management and control, despite demands for such accountings. Petitioner's position as general manager was terminated in early 1964 at the direction of Prospect's vice-president. After petitioner was terminated as general manager,54 no records concerning the income or expenses of Boxwood were found. Since petitioner left behind no records, the principals of Prospect had to reconstruct the income and expenses for the period during which petitioner was general manager. An accountant was employed for this purpose. The accountant's audit revealed the disappearance of rental income in the amount of $100,000, construction loans in the amount of $140,000, and other conversions of monies and personal property in the amount of $125,000, for a total of $365,000, during the period that petitioner was manager of Boxwood. Petitioner had these monies under his management and control while he was manager of Boxwood. In 1964 a complaint was filed in the Circuit Court of Cook County against petitioner and others by the principals of Prospect for misappropriation and conversion of corporate funds. A summons was served on petitioner on October 31, 1964, and he filed an answer to the complaint. However, neither petitioner nor his attorney appeared at the trial, and a default judgment in the amount of $365,000 was entered against petitioner and the other defendants. 4 The amount of the judgment was based upon the accountant's55 audit and the testimony of Prospect's vicepresident. Of this $365,000, $140,000 (the construction loans) was misappropriated by one of petitioner's co-defendants in the lawsuit. No part of the remaining $225,000 ($365,000 less $140,000) was used for the benefit of Prospect nor was any part of the $225,000 either a loan or a gift to petitioner. None of the $225,000 has been repaid to Prospect, its officers and shareholders or Boxwood. Of this $225,000 under petitioner's management and control, 8/9 ($200,000) is allocable to 1963 and 1/9 ($25,000) is allocable to 1964. 56 2. J. Alton LaurenPetitioner received a $1,000 check from J. Alton Lauren dated February 18, 1966, as a finder's fee for referring an appraisal to Mr. Lauren. 3. Sargent FoundationPetitioner met Dr. Harold Lee Sargent in 1965 at a meeting where petitioner stated he had an "idea" that could possibly be of benefit to Dr. Sargent and several of his colleagues and other professional people. The "idea" was that under constitutional law there were provisions whereby Dr. Sargent and others could conserve and preserve their funds. Petitioner talked in terms of tax savings through the creation of a not-for-profit corporation (foundation) to which an individual could transfer his assets and the contract for his services. 5 On the basis of petitioner's advice, Dr. Sargent established the Sargent Foundation. There were no contractual arrangements between Dr. Sargent or the Sargent Foundation and petitioner, or between Dr. Sargent or the Sargent Foundation and the Walsh Family Estate or the Walsh Family Foundation. 6 However, petitioner57 devoted a considerable amount of time to the activities of the Sargent Foundation. The Sargent Foundation's activities consisted of spreading the "idea" of using not-for-profit corporations to save taxes. Presentations of the "idea" were made to groups of individuals, and if an individual actually employed the "idea" a fee of $1,750 was charged. During 1966 approximately $65,000 was collected by the Sargent Foundation through these activities. Presentations of the Sargent Foundation's "idea" were made by petitioner and Dr. Sargent. Expenses incurred by either individual in connection with these presentations were paid by the Sargent Foundation. However, petitioner was not an employee of the Sargent Foundation, and he did not receive a salary for his services. Dr. Sargent signed on behalf of the Sargent Foundation58 the following checks payable to petitioner during 1966: DateAmount1/21/66$ 3501/22/666503/17/661,1004/23/661,0006/14/661,0009/14/66500$ 4,600 The following checks, written to cash, were signed by Dr. Sargent on behalf of the Sargent Foundation and cashed by Mrs. Walsh, who acted as a courier for petitioner; Mrs. Walsh was not an employee of either Dr. Sargent or the Sargent Foundation: DateAmount7/24/66$ 6407/25/663508/ 2/662508/ 2/663008/18/665008/31/663509/30/66500$2,890On June 30, 1966, Dr. Sargent signed on behalf of the Sargent Foundation a check payable to cash in the amount of $400. Petitioner received $200 when this check was cashed. On September 14, 1966, Dr. Sargent signed on behalf of the Sargent Foundation a check payable to the Walsh Family Estate in the amount of $1,500. Neither Dr. Sargent nor the Sargent Foundation had any business dealings with the Walsh Family Estate. Dr. Sargent paid the Walsh Family Estate at petitioner's direction. The total of the above payments from the Sargent Foundation to petitioner during 1966 is $9,190, which petitioner had under59 his management and control in 1966. Petitioner never gave Dr. Sargent or the Sargent Foundation an accounting for these monies, although such an accounting was requested. No part of this amount was used to pay expenses of the Sargent Foundation. In addition, none of these monies was ever returned to the Sargent Foundation by petitioner, nor were these monies intended to be either gifts or loans to petitioner. 4. Americans Building ConstitutionallyIn 1965 petitioner met Mr. Robert Hayes. Mr. Hayes and petitioner together established Americans Building Constitutionally ("ABC"). The purpose of ABC was, like the Sargent Foundation, to spread the "idea" of saving taxes through the usage of tax-exempt, not-for-profit corporations or foundations. Petitioner was not an employee of ABC. However, he acted as a consultant to ABC in 1966 and 1967. Pursuant to his advice, ABC did not seek a determination letter regarding its tax-exempt status from the Internal Revenue Service. Petitioner was provided office space by ABC, and several young attorneys at ABC were selected by him to work under his direction and control. Petitioner's activities as a consultant to ABC during the60 years in question took up most of his time during this period. During 1966 and 1967 petitioner had under his management and control the following amounts: DateAmountPayee9/13/66$1,000Saul Gaynes11/11/661,500Walsh Family Estate$2,5001/6/675,000CashFoundation3/1/672,500James Walsh andSaul Gaynes3/1/671,500Walsh Family Estate4/10/672,000Walsh Family Estate5/5/673,000Walsh Family Estate6/5/672,000Walsh Family Estate6/21/673,000Cash6/30/673,000Walsh Family Estate7/24/671,000Sofietti and Johnson9/5/671,500Walsh Family Estate9/11/672,600John B. M. Goetz, Jr.12/1/671,500Walsh FamilyFoundation12/1/671,500Clarice R. McWilliams$31,600Neither the Walsh Family Estate nor the Walsh Family Foundation had any contractual arrangement with ABC. Petitioner asked Mr. Hayes that any compensation due him be paid to the Walsh Family Estate or the Walsh Family Foundation. There was no reason other than to compensate petitioner that ABC would have paid either the Walsh Family Estate or the Walsh Family Foundation. The check to Soffietti and Johnson was posted61 on ABC's ledger under the caption "legal fees." Mr. Hayes did not engage the services of Soffietti and Johnson, and the law firm did no work on behalf of ABC. Rather, Soffietti and Johnson performed legal services for petitioner personally. All of the above-listed checks were written pursuant to the directions of petitioner and were for his benefit. None of these payments was for expenses on behalf of ABC, nor were these monies loans or gifts by ABC to petitioner. During 1967 petitioner occupied Apartment 5-F at the Fontana Shores Condominiums in Fontana, Wisconsin. He was not required by ABC to live in that apartment. Title to the apartment was in ABC, which paid the mortgage on the apartment and its upkeep and maintenance costs. The realtor in charge of the Fontana Shores thought that petitioner was the owner of the apartment and that ABC was "his" corporation. The apartment sold for $39,000 in 1967, and the fair rental value of the apartment on an annual basis was $5,025. In the fall of 1966, petitioner was questioned about ABC by a revenue agent. Petitioner told the agent that ABC was exempt and that a Form 990 had been filed; neither statement was true. Subsequently, 62 in 1971, this same agent was assigned to investigate petitioner. At a meeting in March of 1971, petitioner appeared but refused to produce any records. Petitioner did not file Federal income tax returns for the years in issue, nor has he ever filed Federal tax returns or paid any Federal income tax. In 1969 petitioner was convicted in California of conspiracy to commit grand theft by false pretenses; he is also under injunction in Colorado to refrain from employing deceptive business practices. In his statutory notice respondent determined deficiencies and additions to tax for the years in issue as set forth at the outset of this opinion. ULTIMATE FINDINGS OF FACT Petitioner was knowledgeable in tax law and knew of his obligation to file income tax returns. Petitioner received income for the years in issue as follows: Source1963196419661967Prospect$200,00025,000$ 0$ 0J. Alton Lauren1,000Sargent Foundation9,190ABC2,50032,125$200,000$25,000$12,690$32,125 7/63 Petitioner failed to file income tax returns for the years in issue and failed to pay any portion of his income tax liability for those years, and refused to produce records of his income or expenditures for the Internal Revenue Service. OPINION The first issue is whether petitioner received unreported taxable income during the years in question. Respondent's determination is presumptively correct. Petitioner, on whom the burden of proof rests ( Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933), Rule 142, Tax Court Rules of Practice and Procedure), has failed to carry his burden in this case. 1. Funds Misappropriated From One Prospect CorporationRespondent determined that $365,000 misappropriated from One Prospect Corporation ("Prospect"), which was under the management and control of petitioner, was taxable income to him during 1963 and 1964. Prospect owned Boxwood, a housing development outside Chicago. During the years in question, petitioner was general manager of the Boxwood project; petitioner's duties covered complete management of the project, including the collection of rent, payment of bills, hiring and firing of employees, and furthering the64 success of the project. Prospect had obtained $358,000 by refinancing the mortgages on the condominiums, which funds were placed in an escrow account for the purpose of furnishing the condominiums and completing a recreation center. In addition, during the time that petitioner was general manager of Boxwood approximately $100,000 in rent was collected. When petitioner was terminated as general manager of Boxwood in early 1964, an audit of the project revealed that $365,000 was missing. This sum included $100,000 rental income, $140,000 from escrow set aside for construction, and $125,000 of other monies and property. In order to audit Boxwood, the owners had to reconstruct its income since petitioner left no records of either the income or expenses of the project. Prospect and the principals thereof subsequently sued petitioner and others for misappropriation and conversion of these funds and obtained a default judgment for $365,000.Respondent relied on this default judgment in determining petitioner's deficiencies for 1963 and 1964. At trial petitioner made several assertions denying that he had ever misappropriated funds. Petitioner claimed (a) that he had paid all the65 bills with the rental income and some of the loan proceeds, (b) that he had used the loan proceeds to purchase furniture which was subsequently converted by other individuals, and (c) that the $140,000 from escrow had been misappropriated by another individual. With the exception of the last assertion, we find no evidence to support petitioner's claims. Petitioner relied at trial only on his own testimony; he had no records for the years in question. However, petitioner was not a credible witness. He gave vague, inconsistent and evasive answers throughout the trial. Moreover, petitioner has recently been convicted in California of conspiracy to commit grand theft by false pretenses. The sole witness on his behalf, a Chicago attorney, was similarly not a credible witness, especially in light of his recent disciplinary suspension from the practice of law. At trial respondent's witnesses and petitioner did agree that another individual had misappropriated $140,000 from the escrow funds set aside for construction. Although the parties stipulated before trial that these monies had been under petitioner's management and control during the years in question, we find that petitioner66 did not misappropriate or convert the $140,000.Petitioner has carried his burden of proof as to this amount, and respondent's determination of the deficiency must be reduced accordingly. As to the remaining $225,000 ($365,000 less $140,000) it is unclear whether petitioner alone misappropriated all these funds, especially since petitioner was only one of several defendants against whom a default judgment was entered for these monies. However, petitioner failed to carry his burden of proving that he did not misappropriate monies which he conceded were under his management and control. Since respondent's determination was not arbitrary or capricious (cf. Helvering v. Taylor,293 U.S. 507">293 U.S. 507 (1935)), we must sustain the remainder of respondent's determination. Accordingly, we find that petitioner had taxable income of $200,000 in 1963 and $25,000 in 1964. 2. J. Alton LaurenPetitioner received a $1,000 check from J. Alton Lauren in 1966. The parties have stipulated that this check was a finder's fee for referring an appraisal to Mr. Lauren and represents taxable67 income to petitioner. Accordingly, respondent's determination of a deficiency as to this income is sustained. 3. Sargent FoundationPetitioner admits having received $9,190 from the Sargent Foundation during 1966, but disputes respondent's determination that these monies were taxable income to him. Petitioner argues that these monies were used to pay expenses of the Sargent Foundation. Respondent has determined that $9,190 received by petitioner in 1966 was compensation to him. During 1966 petitioner worked for or on behalf of the Sargent Foundation, which was established by Dr. Harold Lee Sargent on petitioner's recommendation in order to spread the "idea" of using foundations to lower taxes. Petitioner was not an employee of the Sargent Foundation, and he received no regular salary therefrom. Petitioner has failed to produce records verifying his assertion that the $9,190 he received from the Sargent Foundation was used on behalf of the Sargent Foundation. He refused to account for his expenditures to Dr. Sargent during the years in question. In the absence of records we have only his unsupported testimony as evidence, and we do not find petitioner to be a credible68 witness. 8 Since petitioner has produced no credible proof, respondent's determination must be sustained. 4. Americans Building ConstitutionallyPetitioner admits that he had under his management and control $2,500 for 1966 and $32,125 for 1967 received from ABC, but he disputes respondent's determination that these monies were taxable income to him. Petitioner argues, to the contrary, that these monies were used to pay expenses of ABC. ABC was formed in 1966 by Mr. Robert Hayes at the advice of petitioner. The purpose of ABC was to promote the "idea" of saving taxes through the use of not-for-profit foundations. During 1966 and 1967 petitioner spent a considerable amount of his time working on behalf of ABC promoting the "idea." Although ABC provided him with an office, he was not an employee of ABC and did not receive any salary.During 1966 ABC paid to petitioner69 or on his behalf $2,500, and during 1967 $30,100. 8a Respondent has determined that these monies were compensation to petitioner. Petitioner failed to produce any records establishing that the monies received by him or on his behalf were expenses of ABC. He asserted that none of the monies received from ABC were spent on his own behalf, but we have found that one check in the amount of $500 was paid to a law firm which performed legal services for petitioner personally and not for ABC. In the absence of records we have only petitioner's unsupported testimony, and we do not find him to be a credible witness. Petitioner did not challenge respondent's assertion that the apartment which he occupied in Fontana Shores, Wisconsin, was paid for by ABC and that petitioner was not required to live in the apartment as a condition of his employment. Accordingly, respondent's determination that $2,025 for the rental value of the apartment (which was considerably less than the fair market rental value of $5,025) was compensation to petitioner is sustained. Since petitioner has presented no credible evidence contrary to respondent's determinations, 70 respondent's determination is sustained. 5. Section 6653(b) Addition to Tax (Fraud Penalty)The next issue is whether petitioner is liable for the fraud penalty under section 6653(b). Section 6653(b) provides that if any part of an underpayment of tax is due to fraud, an addition to tax equal to 50 percent of the total underpayment may be imposed. Respondent has determined such additions to tax for each of the years in question. Respondent has the burden of proving that all or part of petitioner's underpayment for each year in issue was due to fraud (section 7454(a)). Fraud must be proved by clear and convincing evidence. Rule 142(b), Tax Court Rules of Practice and Procedure; Otsuki v. Commissioner,53 T.C. 96">53 T.C. 96, 105 (1969). Respondent must establish fraud for each individual year in issue. Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 220 (1971). For fraud to be present, we must find that petitioner acted with the specific intent to evade a tax believed to be owing. Estate of Temple v. Commissioner,67 T.C. 143">67 T.C. 143, 159 (1976). The71 issue of fraud poses a factual question which is to be decided upon an examination of all the evidence in the record. Stratton v. Commissioner,54 T.C. 255">54 T.C. 255, 284 (1970). Respondent may meet his burden of proof through circumstantial evidence. Powell v. Granquist,252 F.2d 56">252 F. 2d 56, 61 (9th Cir. 1958). Well-established indicia of fraud provide benchmarks for weighing petitioner's conduct. See Tooke v. Commissioner, 1977 P-H Memo. T.C. par. 77,091 (1977). See also H. Balter, Tax Fraud and Evasion, sec. 8, p. 54 (3d ed. 1963). In this case respondent has met his burden of proving fraud by clear and convincing evidence on the record as a whole, and for three of the years in question respondent has established specific instances of petitioner's fraudulent conduct. On the basis of the following indicia of fraud we sustain respondent's fraud penalty: Failure to file. Petitioner either received compensation or misappropriated funds from Prospect, J. Alton Lauren, the Sargent Foundation and ABC during the years in question but failed to file income tax returns for each of these years. In fact, petitioner has never filed an income72 tax return. He is a knowledgeable businessman and knew of the filing requirements. Petitioner claimed at trial that he had never filed Federal income tax returns since he believed that he was within the ambit of the "Nun's Exception." 9 During the years in question, section 170 provided that charitable deductions are not subject to a percentage limitation if during the taxable year and in each of 8 out of the 10 preceding years a taxpayer's charitable contributions plus income taxes exceed 90 percent of his taxable income. Petitioner's contention that he did not have to file a return is without merit for two reasons: (1) This exception allows increased charitable deductions but does not excuse an individual from filing a return; and (2) petitioner's "contributions" were to the Walsh Family Estate or the Walsh Family Foundation, neither of which was organized and operated exclusively for charitable purposes or had sought to obtain an exemption ruling. On the basis of petitioner's background, we find that petitioner knew that he had no valid or reasonable excuse for his failure to file Federal income tax returns for the years in issue. Such 73 continuous, willful failure to file is not conclusive evidence of fraud, but it is one of the facts which is indicative that an underpayment of tax is due to fraud. Gajewski v. Commissioner, 67 T.C. 181">67 T.C. 181, 200 (1976), on appeal (8th Cir., May 23, 1977); Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85, 93 (1970). Failure to produce records. Petitioner failed to produce any records for the years in issue. Petitioner claimed that all his records had been destoryed in a plane crash in 1973; we find this contention incredible. Although failure to produce records is not conclusive evidence of fraud, such behavior is a further indication of petitioner's fraudulent intent. See Webb v. Commissioner, 394 F. 2d 366, 379-380 (5th Cir. 1968), affg. a Memorandum Opinion of this Court. Causing monies to be paid to third parties. Petitioner had his compensation paid to third parties during 1966 and 1967. This action also indicates74 petitioner's intent to fraudulently avoid payment of taxes. Gajewski v. Commissioner, 67 T.C. 181">67 T.C. 181, 200 (1976), on appeal (8th Cir., May 23, 1977). Petitioner's background. One relevant factor in an inquiry into fraud is petitioner's legal and business background. According to the testimony of several witnesses, petitioner was knowledgeable about income tax laws and presented himself as a promoter in tax-related ventures. Petitioner claimed to have attended law school and spent much of his life studying tax law. In light of this background, petitioner's failure to report taxable income is an additional indicium of fraud. Irolla v. United States, 390 F. 2d 951, 954 (Ct. Cl. 1968). See Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85, 93 (1970).Credibility. We have found petitioner to be almost completely lacking in credibility. His testimony was vague and contradictory. His petition to this Court claimed that the monies from Prospect were a loan to him, but at trial petitioner denied ever receiving any of the monies. In addition, petitioner has recently been convicted of conspiracy to commit grand theft by false pretenses in75 California and is under injunction in Colorado to refrain from false and deceptive business practices. Petitioner's sole witness on his behalf was also not credible. The lack of petitioner's credibility does not establish fraud, but leads us to discount his explanation of his business affairs for the years in question. In addition to these indicia of fraud, we have the following specific instances of petitioner's fraudulent failure to report taxable income: Use of Prospect funds to pay petitioner's law firm. On August 4, 1963, Prospect paid the amount of $200 to a law firm for petitioner's personal benefit. The law firm had no relationship, business or otherwise, with Prospect but was defending petitioner personally.Payment of petitioner's expenses by Prospect was clearly compensation to him, Old Colony Trust Co. v. Commissioner, 279 U.S. 716 (1929), which he failed to report without justification. Payment from J. Alton Lauren. On February 18, 1966, J. Alton Lauren paid petitioner $1,000 as a finder's fee for petitioner's services. He failed to report this compensation, which was clearly taxable income to him. We find this failure to report76 taxable income to be fraudulent. Payment of petitioner's lawyers by ABC. On July 24, 1967, ABC paid a law firm $1,000. This payment was on behalf of petitioner personally; ABC had no dealings, business or otherwise, with the law firm. This payment constituted compensation to petitioner, which he fraudulently failed to report.In light of these specific instances of petitioner's fraudulent failure to report income, as well as the other general indicia of fraud for all the years in question, we hold that respondent has shown by clear and convincing evidence that petitioner is liable for additions to tax for fraud under section 6653(b) for each of the years in issue. 6. Section 6654 Addition to TaxThe final issue for decision is whether petitioner is liable for an addition to tax due to underpayment of estimated income taxet pursuant to section 6654. Petitioner agreed that he paid no income taxes during the years in issue, and we have determined that petitioner had taxable income during those years. The addition to tax is mandatory if respondent can establish underpayment77 of estimated tax, Estate of Roe v. Commissioner, 36 T.C. 939">36 T.C. 939, 952 (1961), and respondent has established such underpayment in this case. Accordingly, an addition to tax pursuant to section 6654 is applicable for the underpayments of tax by petitioner in 1963, 1964, 1966 and 1967. Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the years in issue.↩2. Petitioner asserted at trial that he, Mr. Buchanan and Mr. Stanaszek were the true owners of Boxwood, and that Mr. Debes and Drs. Pfeiffer and Dommers were merely nominees seeking tax shelters. As proof of this contention, petitioner introduced a quit-claim deed signed by Dr. Pfeiffer. However, the testimony of Mr. Debes and Dr. Pfeiffer contradicts petitioner, and we find the former witnesses to be more credible. In any event, the actual ownership of Boxwood is immaterial to the issues in this case.↩3. McEwen v. Walsh,↩ Nineteenth Judicial Circuit (Ill.), General No. 76305.4. Civil Action 64 CH 6077↩. Petitioner claims his default was due to the death of his trial counsel and threats received against his life should he prosecute the case. The reliability of the default judgment is relevant because respondent admits that the deficiency determination was based upon the default judgment. We find it difficult to believe, however, that petitioner and his regular (as opposed to trial) attorney would allow a default judgment of this magnitude to be entered without a contest, if petitioner had any evidence to support his present assertions of lack of misconduct. Furthermore, petitioner failed at trial to produce any evidence (other than the fact that one of his co-defendants misappropriated $140,000 of the total amount) which is contrary to the default judgment.5. Apparently, petitioner believed that usage of foundations would minimize taxes since the individual would have no direct income.↩6. Dr. Sargent stated there was no contractual arrangement between the various foundations; petitioner stated that the Walsh Family Estate contracted to sell Mr. Walsh's services to the Sargent Foundation. We find the former's testimony more persuasive, especially since there was only one check from the Sargent Foundation to the Walsh Family Estate during 1966.↩7. /↩ We have determined that petitioner received $36,625 ($31,600 received plus $5,025 rental value of the apartment) from ABC during 1967. The parties stipulated that petitioner had $32,125 ($30,100 received plus $2,025 rental value) under his management and control for 1967, and this figure was also the basis of the deficiency determined by respondent. For purposes of this opinion, we adopt the stipulated figure.8. Dr. Sargent stated that possibly some of these monies were for petitioner's expenses on behalf of the Sargent Foundation. Dr. Sargent was not certain, however, of the extent of such expenses. Since petitioner failed to verify any expenses whatsoever, we must sustain respondent's determination.↩8a. See footnote 7 supra↩.9. Apparently petitioner was referring to section 170(b)(1)(C).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625668/	KENNETH G. LIND, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentLind v. CommissionerDocket No. 8471-91United States Tax CourtT.C. Memo 1993-286; 1993 Tax Ct. Memo LEXIS 288; 65 T.C.M. (CCH) 3043; June 30, 1993, Filed 288 Decision will be entered under Rule 155. Kenneth G. Lind, pro se. For respondent: J. Paul Knap. GERBERGERBERMEMORANDUM FINDINGS OF FACT AND OPINION GERBER, Judge: Respondent determined a $ 54,121 income tax deficiency for petitioner's 1987 taxable year. Respondent also determined additions to tax under sections 6653(a)(1)(A) and 66611 in the amounts of $ 2,706 and $ 13,530, respectively. Additionally, respondent determined that section 6653(a)(1)(B), which provides for 50 percent additional interest on the portion of any deficiency redetermined that is attributable to negligence, is also applicable. The deficiency is attributable to a single adjustment in the amount of $ 161,799. That amount represents the total of funds loaned by a corporation controlled by petitioner to a family partnership operated by petitioner. The main issue for our consideration concerns whether that indebtedness was discharged and if it resulted in income taxable to petitioner. 289 FINDINGS OF FACT 2Petitioner's legal residence was in Wayzata, Minnesota, at the time of the filing of his petition in this case. Midwest Elevator, Inc. (Midwest), was incorporated in 1971 and was controlled by petitioner and his family and operated by petitioner at all times relevant to the issue in this case. Midwest was engaged in the elevator repair business and never declared a cash dividend. Lind Enterprises (Lind) was a family partnership established in 1979 and was comprised of petitioner and his two adult children, as partners. Petitioner acquired his children's interest in Lind in 1986. Although petitioner purchased his children's interest in Lind, Schedules K-1 were issued to the children for 1987. After petitioner bought the children's interest in Lind, the children formed Lind Enterprises, Inc. (Enterprises), for the purpose of holding their shares of stock or ownership interest in Midwest. At some point after290 1986, the real estate of Lind was also transferred to Enterprises, and at the end of 1987 Lind had one obligation (a loan payable to Midwest) and one asset (a lease or rental arrangement with Midwest as lessee). Lind was used for Midwest's real property needs because petitioner's accountant had advised that Midwest should not own any real property. Lind was in the business of leasing buildings. All capital used in connection with Lind was loaned from Midwest. From 1979 through 1987, Midwest had loaned Lind a total of $ 161,799. The loans were recorded in Midwest's books. No repayments were made on these loans. Midwest did not demand payment or attempt to collect any part of the loans. Lind, for consideration of $ 26,007.50, acquired unimproved realty near Hill City, South Dakota. During 1986 and 1987 a building was erected on the Hill City land. At that time Lind already leased realty in Minneapolis to Midwest for its business premises. The newly acquired property was used to erect a warehouse for Midwest in South Dakota. This property had been zoned for residential use since 1984. There is no indication that the Hill City property was used by Midwest in the elevator 291 business. Beginning in 1991 the building was used to store classic and antique automobiles and motorcycles. Late in 1988, one of respondent's agents examined Midwest's 1986 taxable year. The agent raised the question of whether the loans reflected from Midwest to Lind were actually constructive dividends to petitioner. Petitioner advised the agent that the loans were valid and that Lind intended to repay the loans with the rent paid to it from Midwest and that rental payments had been made from August through December 1986. The agent checked Lind's 1986 partnership return and no rental income had been reported from Midwest, and petitioner's accountant advised that Lind's return would be amended to include the rental income. Based upon these representations, respondent's agent dropped the constructive dividend issue. Petitioner drafted notes, dated February 8, 1989, in the amounts of $ 50,000 and $ 86,074.07 to himself from Midwest, which were allegedly for unpaid wages from Midwest. Petitioner caused an additional note for unpaid wages from Midwest to issue in the amount of $ 17,500, dated April 17, 1990. None of these notes were paid by Midwest. No accrued salary obligation292 appeared on Midwest's books. Late in 1989 another agent of respondent examined the 1987 tax year of Midwest. Respondent's agent inquired of petitioner about the loan from Midwest to Lind and more specifically why the loan was reflected on Midwest's balance sheet for 1987 and not for 1988. Respondent's agent also inquired whether Midwest was paying rent, and petitioner stated that Midwest had not paid rent and that it had broken the lease with Lind. Petitioner, without indicating when, stated that the loan from Midwest was uncollectible. In connection with the examination by respondent's agent, petitioner did not mention or discuss any unpaid wages due to him from Midwest. No income was reflected on Lind's 1987 partnership return. Petitioner filed for bankruptcy during March 1990 and was discharged from the proceeding on June 18, 1990. The bankruptcy case was closed December 1, 1990. OPINION Respondent determined that petitioner had $ 161,799 of additional income for 1987 attributable to Lind, a partnership. Respondent explains that the $ 161,799 is income from the discharge of indebtedness due from Lind to Midwest. Petitioner bears the burden of showing that respondent's293 determination is in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). For reasons substantially unexplained in the record, petitioner's elevator service business was operated through a corporation (Midwest), and various real estate transactions and lease arrangements were handled through a partnership and other corporations. The ownership interests in these entities changed on a regular basis, depending upon the needs of the moment. Although the interest holders of the various entities may have changed, they were limited to petitioner and members of his immediate family. It is clear that petitioner was in control and that his family was involved, to the extent permitted by petitioner, as possible beneficiaries of any business success that petitioner and his entities may have experienced. The record is sketchy as to which entity, at any particular time, owned various of the assets, and it appears that these entities were created and used at petitioner's whim depending upon advice received or petitioner's own perception, depending upon the occasion. There is very little documentation supporting any of petitioner's claims. The record, 294 however, does reflect the following: (1) Midwest, over a period of years, loaned funds to Lind, which in 1987 totaled $ 161,799; (2) the loan was reflected on the business balance sheet of Midwest for 1987 but was not reflected for 1988; (3) petitioner advised respondent's agent that the $ 161,799 was uncollectible; (4) no payments were made on the loan; and (5) Midwest did not make rental payments for 1987 and never paid a dividend. The discharge of debt constitutes income to the debtor. Sec. 61(a)(12). The named debtor was Lind, a partnership. We find it peculiar that petitioner was the only partner of Lind at the conclusion of 1987. Although there is some indication that petitioner's children may have been partners at some time during 1987, neither petitioner nor respondent argues that the children should be considered partners at the time of the forgiveness or discharge of indebtedness, which appears to have been at yearend. Also neither party questions respondent's determination that petitioner had income from the Lind partnership, at a time when he was the only partner. In any event, it does not appear that the result would differ depending upon the existence of a partnership295 entity. Petitioner does not deny any of the documented facts listed above, but instead argues that Midwest owed him for unpaid and accrued salary approximating the amount of the loans outstanding between Midwest and Lind. Although petitioner's position on this point seems somewhat unclear, the essence of his position appears to be that the obligations due him from Midwest should cancel out any debt from Lind to Midwest whether that debt was forgiven or not. It should be remembered that the majority of the alleged unpaid salary from Midwest was purportedly evidenced by Midwest notes drafted by petitioner shortly after respondent's agent examined Midwest's 1986 tax return. More importantly, petitioner has not reported the alleged income due as salary from Midwest and has no basis in same. If petitioner is owed salary as he alleges, it would not shield Lind or him from discharge of indebtedness income. Petitioner also contends that he was insolvent or in bankruptcy and that any income from discharge of indebtedness would be excludable from his gross income under section 108. Section 108(a) excludes from gross income amounts which would have been includable due to discharge of 296 indebtedness if the discharge occurs in a bankruptcy case, the discharge occurred when the debtor was insolvent, or the indebtedness is qualified farm indebtedness. Petitioner has failed to show he or Lind was insolvent during 1987, the time of the discharge. Additionally, the parties have agreed that petitioner's bankruptcy and discharge from same did not occur until 1990. Finally, petitioner was in control of the situation during the period under consideration, and he attempted to counter the inquiries of respondent's agents by various approaches. We do not find any of petitioner's attempts to be successful. Petitioner has failed to show error in respondent's determination that the forgiveness or discharge of indebtedness is taxable to petitioner for 1987. Respondent also determined that petitioner was liable for additions to tax under sections 6653(a)(1)(A) and (B) and 6661(a). Petitioner bears the burden of proof with respect to such determinations. Rule 142(a); Clayden v. Commissioner, 90 T.C. 656">90 T.C. 656, 677 (1988); Abramo v. Commissioner, 78 T.C. 154">78 T.C. 154, 162-164 (1982); Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791-792 (1972).297 Negligence, within the meaning of section 6653(a), has been defined as the failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Respondent determined a single adjustment in connection with petitioner's reporting of his 1987 income and deductions. That determination was made in connection with a technical matter under which debt between two related entities controlled by petitioner was considered to be income attributable to the discharge of indebtedness. We also note that respondent had conducted an examination in connection with the 1986 tax year of petitioner's business entities. In connection with that examination, petitioner had convinced respondent's agents that the very transaction in question was not a constructive dividend to him in an earlier year. Accordingly, we find that petitioner is not liable for additions to tax under section 6653(a)(1)(A) and (B) on the entire underpayment of tax for the taxable year 1987. Respondent also determined an addition to tax for substantial understatement of tax under section 6661 for the 1987 taxable year. Section*298 6661(a) provides for a 25-percent addition to tax if there is a substantial understatement of tax. An understatement is "substantial" if it exceeds the greater of 10 percent of the tax required to be shown for the taxable year or $ 5,000. An "understatement" does not include an amount attributable to "the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment". Sec. 6661(b)(2)(B)(i). Additionally, an understatement does not include any item for which there was adequate disclosure. Sec. 6661(b)(2)(B)(ii). Petitioner has presented no evidence or argument concerning this addition to tax. Accordingly, the substantial understatement addition is applicable for the 1987 taxable year if the threshold understatement is exceeded. That determination will be made in connection with the Rule 155 computations. To reflect the foregoing, Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code in effect for the year under consideration, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The parties' stipulation of facts and exhibits are incorporated by this reference.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625669/	Concord Consumers Housing Cooperative, Petitioner v. Commissioner of Internal Revenue, RespondentConcord Consumers Hous. Coop. v. CommissionerDocket No. 31365-81United States Tax Court89 T.C. 105; 1987 U.S. Tax Ct. LEXIS 101; 89 T.C. No. 12; July 16, 1987July 16, 1987, Filed 101 Decision will be entered under Rule 155. P is a federally subsidized, nonexempt, nonprofit corporation organized to provide housing for persons of low and moderate incomes. P earned interest income on two reserve accounts and on an escrow account it was required to maintain under its agreements with the Federal Housing Administration (FHA) and the Michigan State Housing Development Authority (MSHDA). Held, interest income earned on those accounts is not "income derived * * from members or transactions with members" within the meaning of sec. 277(a), I.R.C. 1954, and constitutes nonmembership income. Held, further, expenses attributable to and deductible against such nonmembership income determined. Robert W. Siegel, for the petitioner.D. Marcus Carr, for the respondent. Parker, Judge. Sterrett, Simpson, Chabot, Nims, Whitaker, Hamblen, Cohen, Swift, Gerber, Wright, Parr, and Wells, JJ., agree with the majority opinion. Korner, J., concurring. Whitaker, Hamblen, Jacobs, Wright, Parr, and Williams, JJ., agree with this concurring opinion. PARKER105 Respondent determined deficiencies in petitioner's Federal income tax as follows:TYE Mar. 31 --Deficiency1976$ 4,39919773,03619783,865102 106 After concessions 1 the issues remaining for decision are:(1) Whether the interest petitioner earned on two reserve accounts and a mortgage escrow account required to be established pursuant to regulatory agreements with the Federal Housing Administration and the Michigan State Housing Development Authority constitutes income "derived * * from members or transactions with members" (membership income) within the meaning of section 277(a); 2 and(2) If not, and if such interest constitutes instead nonmembership income, whether any deductions are properly attributable to the production of such nonmembership income.FINDINGS103 OF FACTSome of the facts have been stipulated and are so found. The stipulation of facts, as orally supplemented at trial, and the exhibits attached thereto are incorporated herein by this reference.Petitioner Concord Consumers Housing Cooperative (hereinafter sometimes referred to as Concord) is a nonprofit, nonstock corporation incorporated on January 16, 1970, in accordance with the laws of the State of Michigan. 3 At the 107 time the petition was filed in this case, petitioner's principal business office was located in Trenton, Michigan. Petitioner reports its income under the accrual method of accounting and on a fiscal year basis ending March 31. During the years in issue, petitioner filed its U.S. Corporation Income Tax Returns (Forms 1120) with the Internal Revenue Service Center at Cincinnati, Ohio.104 Concord is a federally subsidized, nonprofit corporation organized exclusively to provide housing facilities for persons of low and moderate incomes and such social, recreational, commercial, and communal facilities as may be incidental or appurtenant thereto and, in general, to carry on any business in connection therewith and incidental thereto, with all powers conferred upon corporations by the laws of the State of Michigan but not inconsistent with Act No. 346 of Public Acts of 1966 of the State of Michigan, as amended.Concord obtained mortgages from the Michigan State Housing Development Authority (MSHDA) and obtained mortgage insurance and the benefits of special financing through the Federal Housing Administration (FHA), Department of Housing and Urban Development (HUD), in accordance with section 236 of the National Housing Act, as amended. 4 MSHDA is the mortgagee on all the real property 108 owned by petitioner. In order to obtain these mortgages from MSHDA and to qualify under section 236 of the National Housing Act for Federal assistance, petitioner was required to enter into regulatory agreements with FHA. The regulatory agreements set forth extensive rules105 and regulations governing virtually every aspect of petitioner's activities. In the event petitioner fails to comply with the terms of the regulatory agreements, FHA, among other things, can institute mortgage foreclosure proceedings or any other appropriate legal proceeding and assume management of petitioner. Petitioner's members, who will be described below, elect their own boards of directors to conduct corporate activities. Corporate activity, however, is restricted by the terms and conditions of the regulatory agreements, which effectively provide FHA and MSHDA with the ultimate authority to regulate petitioner.106 Concord was constructed in eight phases or sections. Seven sections contain 50 dwelling units each and the eighth section contains 41 units, for a total of 391 units. Separate mortgages were obtained from MSHDA for each section, and petitioner, and FHA executed separate regulatory agreements with respect to each section. These eight regulatory agreements were executed in the period from March 20, 1970, through June 9, 1971. The terms and conditions set forth in each of these regulatory agreements are essentially identical.Occupancy in Concord is limited to those families whose incomes do not exceed the limits prescribed by the Federal Housing Commissioner (hereinafter referred to as the Housing Commissioner) with the exception of those occupants who agree to pay fair market rental value. However, preference is given to those families displaced from an urban renewal area, or as a result of governmental action, or as a result of a disaster determined by the President to be a major disaster, and to those families whose incomes are within the lowest practicable limits for obtaining membership in the project.Membership in petitioner is limited to 391 members, i.e., one per unit. 107 Each applicant for membership submits a certification of income and written evidence substantiating the information given on the certification. Memberships in 109 petitioner are sold at a cost of approximately $ 900 to $ 1,000. 5 After becoming a member, the individual is assigned a unit and pays rent for that unit commonly referred to as a "carrying charge."108 With the prior approval of the Housing Commissioner, petitioner established for each dwelling unit a basic carrying charge and a fair market carrying charge. The basic carrying charge was determined on the basis of operating Concord with payments of principal and interest under a mortgage bearing interest at 1 percent. See note 4 supra. The fair market carrying charge was determined on the basis of operating Concord with payments of principal, interest, and mortgage insurance premiums due under the insured mortgage on the project. The amount of the basic carrying charges and the fair market carrying charges can be changed only with the approval of the Housing Commissioner.Generally, the actual carrying charge to be collected for each unit is the greater of either the basic carrying charge or 25 percent of the member's income. However, in no event is the actual carrying charge collected greater than the fair market carrying charge. The regulatory agreements require petitioner to make a monthly report of any excess income and remit to the Housing Commissioner on a monthly basis the difference, if any, between the total carrying charges collected and the approved basic carrying109 charge per unit for all occupied units.Sixty days prior to the beginning of each fiscal year, petitioner is required to prepare and submit a proposed operating budget to FHA for approval. This proposed operating budget is required to set forth the anticipated income of the project and a detailed estimate of expenses, including separate estimates for administration expense, operating expense, maintenance expense, utilities, hazard insurance, taxes and assessments, ground rent, interest and 110 amortization, mortgage insurance premium, replacement reserve, and operating reserve.Most members of Concord also receive additional Federal assistance. As of the date of trial, 244 members of Concord were receiving a Federal subsidy under section 8, and 41 members of Concord were receiving a Federal subsidy under a rent supplement program. 6 The remaining 106 members were paying the basic carrying charge or rent. Section 8 is a subsidy provided by the Federal Government where the member pays a portion of the basic carrying charge, with the balance of the carrying charge paid by the Federal Government, specifically, HUD. The rent supplement program is similar to the section 8 subsidy110 in that the Federal Government, specifically, HUD, pays a portion of the member's basic carrying charge.111 Members paying less than the fair market carrying charge are required to submit a recertification of income to petitioner at various intervals. Written evidence substantiating the information given on these recertifications is also required.In accordance with the terms and conditions of the regulatory agreements, petitioner is required to establish two reserve funds, namely, a replacement reserve fund and a general operating reserve fund. The purpose of the replacement reserve fund is to make funds available to petitioner to replace structural elements and mechanical equipment of the project, such as stoves and refrigerators, roofing, or street repairs, and for other items of expense not specifically included in petitioner's annual budget. However, disbursements from this fund are permitted only after receiving the consent in writing from the Housing Commissioner.111 The replacement reserve is funded by petitioner on a monthly basis in various amounts specified in each of the eight regulatory agreements. Each regulatory agreement provides a specific dollar amount that must be placed in the replacement reserve each month. The total annual payments required to be deposited112 into this fund for all eight regulatory agreements was $ 27,364.08 at the time the project began and had increased by the time of trial to $ 41,436. There is nothing in the record indicating that petitioner ever deposited any amount in excess of the required monthly payments.Pursuant to the regulatory agreements, the mortgagee (MSHDA) managed and controlled the replacement reserve fund at all times. The regulatory agreements require this fund to be maintained either in the form of a cash deposit or invested in obligations of, or fully guaranteed as to principal by, the United States of America. Any interest earned on these funds is credited to the replacement reserve account for petitioner's subsequent use in that petitioner submits bills it has paid for replacements and is reimbursed from the replacement reserve.The regulatory agreements also require petitioner to establish and maintain a general operating reserve fund. Petitioner is required to contribute monthly to this fund in an amount not less than 3 percent of the monthly amounts otherwise chargeable to the members pursuant to their occupancy agreements. Three percent of the chargeable monthly amounts totals approximately113 $ 65,000 annually. Upon accrual in this fund of 15 percent of the current annual chargeable amounts, petitioner is permitted to reduce its contributions from 3 percent to 2 percent of the monthly chargeable amounts. However, in the event withdrawals from the general operating reserve reduce it below the 15-percent level, the rate of monthly deposits immediately reverts to the 3-percent rate. Upon accrual in this fund of 25 percent of the current annual chargeable amounts, petitioner is permitted to discontinue all deposits into this fund so long as the 25-percent level is maintained. There is nothing in the record indicating that petitioner ever deposited into this account any amount in excess of the required monthly payments or that the fund had ever 112 accrued the appropriate amounts to permit either a reduction in the monthly payments or to discontinue the payments entirely. Indeed, at the time of trial, petitioner's general operating reserve fund had a deficit in the amount of $ 51,800.The purpose of the general operating reserve fund is to provide a measure of financial stability during periods of special stress and to meet deficiencies from time to time as a result114 of delinquent member payments. In addition, the fund is used to repurchase membership certificates of withdrawing members, and for other contingencies. Disbursements totaling in excess of 20 percent of the total balance in the reserve as of the close of the preceding annual period may not be made during any annual period without the consent of the Housing Commissioner. Upon payment of tenants' delinquencies or the sale of membership certificates for which funds were withdrawn, such amounts are required to be redeposited in the general operating reserve fund.Unlike the replacement reserve fund, the general operating reserve fund was under petitioner's control (or the control of its management company) at all times. However, similar to the replacement reserve fund, the regulatory agreements require this fund to be maintained either in the form of a cash deposit or invested in obligations of, or fully guaranteed as to principal by, the United States of America.Petitioner's management company actually runs the housing project. As part of its many responsibilities, that company manages the general operating reserve for petitioner, maintaining the funds in the form of insured bank115 deposits, Treasury bonds, and Treasury bills in accordance with the regulatory agreements. Any interest earned on these funds is credited to the general operating reserve for petitioner's subsequent use. However, part of the interest is used to pay the management company's annual fee.Petitioner's management company also makes monthly mortgage payments to MSHDA on petitioner's behalf. Part of each payment is placed in a mortgage escrow account established and maintained by MSHDA for the subsequent payment of petitioner's real estate taxes and insurance. The 113 mortgage escrow account is an interest-bearing account and the interest earned is credited to the account and used solely to pay petitioner's real estate taxes and insurance. No part of this interest is accessible to petitioner for its general operating expense and no part is used to pay the management company's annual fee. The management company's annual fee is related to the replacement reserve fund and the general operating reserve fund in the sense that the company's fee includes a certain percentage of the interest earned on those reserve funds, but does not include a percentage of the interest earned on the116 mortgage escrow account.Petitioner's present management company began managing petitioner in April of 1978, subsequent to the years before the Court. 7 In addition to Concord, this company manages approximately nine other housing organizations such as Concord. The company performs various services for Concord including collecting and posting the monthly rent payments to member's cards, depositing funds, preparing monthly cash-flow statements for HUD and MSHDA, and maintaining petitioner's books. The company also invests funds on petitioner's behalf, assures that the general operating reserve is properly maintained, attends board meetings, obtains bids on repairs, supervises the maintenance department and supervises membership resales and recertifications. In addition, a property manager visits the premises twice a week.117 In total, the management company devotes approximately 980 hours each year to managing Concord. About 100 hours of this time is related to the interest income generated by the escrow and reserve accounts, particularly the general operating reserve fund. These services include preparing the cash-flow statements, making reports to the board of 114 directors, reviewing investments, making requests to withdraw moneys, reconciling interest, checking interest rates at various banks, and on occasion, changing banks and making requests for reimbursement from the replacement reserve fund. Petitioner's management company receives annually, as part of its management fee, an amount equal to 4.5 percent of the interest earned on petitioner's two reserve accounts.For its taxable years ended March 31, 1976, 1977, and 1978, petitioner claimed deductions for management fees in the amounts of $ 41,005, $ 43,293, and $ 52,457, respectively. Petitioner also incurred audit fees of $ 2,800 in each of those years.In obtaining its eight mortgages, petitioner incurred a financing cost totaling $ 277,645 which it is amortizing over 40 years, in the amount of $ 6,941 per year. In addition, petitioner118 incurred organizational costs at its inception totaling $ 213,049 for legal and accounting fees and is amortizing this amount over 40 years also, in the amount of $ 5,326 per year.During petitioner's taxable years ended March 31, 1976, 1977, and 1978, interest earned on the two reserve funds and the mortgage escrow account totaled $ 21,997, $ 15,181, and $ 19,324, respectively. For the taxable year ended March 31, 1976, the record does not provide a breakdown of the interest earned with respect to these individual accounts. For the other two years, the breakdown is as follows:GeneralMortgageReplacementoperatingescrowTYE Mar. 31 --reservereserveaccountTotal1977$ 7,9911 ($ 602)$ 7,792$ 15,18119788,0164,432 6,87619,324Petitioner reported these amounts of interest as income in these years. On its U.S. Corporation Income Tax Returns (Forms 1120) for its taxable years ended March 31, 1976 and 1977, petitioner reported total gross income of $ 686,773 and $ 753,021 and total deductions of $ 854,672 and $ 925,857, respectively, resulting in a substantial119 loss each year. Petitioner did not specifically allocate any of the deductions to its interest income. On its U.S. Corporation 115 Income Tax Return (Form 1120) for its taxable year ended March 31, 1978, petitioner reported interest income of $ 19,324 as outside (nonmember) income and specifically allocated deductions totaling $ 29,639 to this income resulting in a loss of $ 10,315 for such year. Petitioner allocated the entire annual amortization for finance cost ($ 6,941) and for organization cost ($ 5,326), for a total of $ 12,267 to the interest income. Petitioner also allocated $ 10,491 of the management fee, $ 3,811 of the legal fee, and $ 3,070 of the audit and tax appeal fee, for a total of $ 17,372, to the interest income.In a statutory notice of deficiency dated September 30, 1981, respondent determined that the interest on the replacement reserve fund, the general operating reserve fund, and the mortgage escrow account during each of the years in issue constituted nonmember or nonmembership income within the meaning of section 277. Respondent further determined that petitioner failed to establish that its expenses, or any portions thereof, deducted on its tax120 returns were attributable to this nonmembership interest income. Respondent thus increased petitioner's taxable income for each of the years in issue by the amounts of this interest income, $ 21,997, $ 15,181, and $ 19,324, respectively. 8OPINIONPetitioner is a nonexempt, nonprofit corporation organized exclusively to provide housing for persons of low and moderate incomes. As such, petitioner qualifies for and receives the benefits of special mortgage financing afforded by section 236 of the National Housing Act, as amended. During the years in issue, petitioner earned and reported as income interest on two reserve accounts and a mortgage escrow account. However, each year petitioner's expenses exceeded its income (including121 this interest income). Thus, petitioner reported a loss in each year and paid no tax with respect to the interest earned on these accounts.116 We must determine whether the interest earned on those three accounts constitutes "income derived * * from members or transactions with members" (hereinafter sometimes referred to as member income or membership income) within the meaning of section 277. If we conclude that such interest constitutes nonmember or nonmembership income (income not derived from members or transactions with members), then we must determine what deductions, if any, are properly attributable thereto.Section 277(a) provides: 9SEC. 277(a). General Rule. -- 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 (including income derived during such year from institutes and trade shows which are 122 primarily for the education of 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. The deductions provided by sections 243, 244, and 245 (relating to dividends received by corporations) shall not be allowed to any organization to which this section applies for the taxable year. [Emphasis added.]Section 277(a) is a deduction deferral, not a deduction disallowance provision. Generally, this section applies to nonexempt membership organizations which are operated primarily to furnish services or goods to their members. 10 This provision limits deductions (attributable to furnishing services, goods, or other items of value to members) to the extent of membership income. However, those deductions disallowed in one year can be used in the succeeding year to offset membership income. The effect of section 277 is to prevent taxable membership organizations from avoiding tax on nonmembership income by operating membership activities at a loss and using this loss to offset the 117 123 nonmembership income. Associated Barbers & Beauticians v. Commissioner, 69 T.C. 53">69 T.C. 53, 70-75 (1977).Respondent essentially takes the position that interest earned by an organization described in section 277 necessarily constitutes investment income and is properly characterized as nonmembership income. Petitioner contends that Congress never intended such a blanket rule to apply to section 277 organizations. 124 Rather, relying on the legislative history, petitioner argues that we should construe nonmembership income under section 277 similar to "unrelated business taxable income" as that term is construed under section 513 and the regulations thereunder. As such, membership income should be defined, according to petitioner, to include all income received from sources substantially related to the function of the organization. Petitioner points to the fact that the interest in this case was earned on accounts required to be maintained pursuant to the terms of the FHA and MSHDA regulatory agreements. Thus, petitioner contends the income on those accounts was derived from sources substantially related to its function and is therefore properly characterized as membership income under section 277.Unfortunately, the term "income derived * * * from members or transactions with members" is not defined in the Code, and regulations under section 277 have yet to be promulgated. 11126 Moreover, the parties have not cited and we have not found any case wholly dispositive of the issue herein. 12 Our opinion in Associated Barbers & Beauticians v. Commissioner, supra,125 concluded that interest income on United States Savings Bonds and Treasury Notes was nonmembership income, but the main thrust of that opinion was the status of the taxpayer as a membership organization 118 vel non. Also, petitioner tries to distinguish that case on the ground that the investments therein were voluntary, whereas, in this case, they were compelled by the regulatory agreements. We think that factor is not determinative. In any event, we will look to the language of the statute and its legislative history to construe the term so as to give effect to congressional intent. United States v. American Trucking Association, 310 U.S. 534">310 U.S. 534, 542-544, rehearing denied 311 U.S. 724">311 U.S. 724 (1940).Section 277 was enacted into law by section 121 of the Tax Reform Act of 1969 (TRA 69), Pub. L. 91-172, 83 Stat. 537, in connection with the extensive revisions made to the unrelated business income tax provisions. Generally, the unrelated business income tax is a tax imposed on the income of a tax-exempt organization, which is generated by a trade or business, regularly carried on, and not substantially related to the organization's tax-exempt purpose. United States v. American College of Physicians, 475 U.S. 834">475 U.S. 834 (1986), (57 AFTR 2d 86-1182, 86-1 USTC par. 9339); United States v. American Bar Endowment, 477 U.S. 105 (1986), (58 AFTR 2d 86-5190, 86-1 USTC par. 9482).127 Prior to 1969, many tax-exempt organizations were not subject to the unrelated business income tax. However, with few exceptions TRA 69 extended the unrelated business income tax to virtually all tax-exempt organizations since these organizations, which were previously entirely exempt from tax, were "equally apt to engage in unrelated business." H. Rept. 91-413 (Part 1) (1969), 3 C.B. 230">1969-3 C.B. 230.Simply extending the coverage of the "unrelated business income tax" did not address the particular problem with respect to investment income of "organizations which are exempt on the grounds of mutuality or common membership." H. Rept. 91-413, supra, 1969-3 C.B. at 231. Since investment income generally is not derived from a trade or business and thus not subject to the unrelated business income tax, the investment income generated by various tax-exempt membership organizations was generally exempt from tax. Congress reasoned that the tax exemption provided for these organizations, such as social clubs, was originally "designed to allow individuals to join together to provide recreational or social facilities or other benefits on128 a 119 mutual basis, without tax consequences." H. Rept. 91-413, supra; S. Rept. 91-552 (1969), 3 C.B. 469">1969-3 C.B. 469. As such, "the tax exemption operates properly only when the sources of income of the organization are limited to receipts from the membership * * * where the organization receives income from sources outside the membership, such as income from investments, upon which no tax is paid, the membership receives a benefit not contemplated by the exemption in that untaxed dollars can be used * * * to provide pleasure or recreation to its membership." H. Rept. 91-413, supra; S. Rept. 91-552, supra, 1969-3 C.B. at 469-470.In order to prevent certain tax-exempt membership organizations from escaping tax on their investment and other nonmember income, Congress added section 512(a)(3). Sec. 121 of the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 537. Section 512(a)(3) extends the definition of "unrelated business taxable income" to include all income that is not "exempt function income." As originally enacted, 13 section 512(a)(3) provided as follows:(3) Special rules applicable to organizations described129 in section 501(c)(7) or (9). -- (A) General rule. -- In the case of an organization described in section 501(c)(7) or (9), the term "unrelated business taxable income" means the gross income (excluding any exempt function income), less the deductions allowed by this chapter which are directly connected with the production of the gross income (excluding exempt function income), both computed with the modifications provided in paragraphs (6), (10), (11), and (12) of section (b).(B) Exempt function income. -- For purposes of subparagraph (A), the term "exempt function income" means the gross income from dues, fees, charges, or similar amounts paid by members of the organization as consideration for providing such members or their dependents or guests goods, facilities, or services in furtherance of the purposes constituting the basis for the exemption of the organization to which such income is paid. Such term also means all income (other than an amount equal to the gross income derived from any unrelated trade or business regularly carried on by such organization computed as if the organization were subject to paragraph (1)), which is set aside -- (i) for a purpose specified130 in section 170(c)(4), or(ii) in the case of an organization described in section 501(c)(9), to provide for the payment of life, sick, accident, or other benefits,120 including reasonable costs of administration directly connected with a purpose described in clause (i) or (ii). If during the taxable year, an amount which is attributable to income so set aside is used for a purpose other than that described in clause (i) or (ii), such amount shall be included, under subparagraph (A), in unrelated business taxable income for the taxable year.Organizations described in section 512(a)(3) are thus taxed on all income other than that received from members in exchange for goods and services and other than that income specifically exempted by section 512(a)(3)(B)(i) or (ii). Thus, to be taxable, the income of these organizations need not be generated by a "trade or business." Consequently, interest earned on investments, unless specifically exempted by section 512(a)(3)(B)(i) or (ii), is "unrelated business taxable income" within the meaning of section 512(a)(3), regardless of whether such income is substantially related to the organization's exempt purpose. In addition, 131 deductions attributable to the organization's exempt-function income cannot be used to offset its unrelated business taxable income.The enactment of section 512(a)(3) prompted Congress to enact section 277. Congress was aware that certain nonexempt membership organizations were using their investment income and nonmember income to offset the cost of providing services to their members, which in some instances rendered their investment income totally nontaxable:Certain nonexempt corporations organized to provide services to members on a nonprofit basis realize investment income, or income from providing services to nonmembers, which is used to defray all or part of the cost of providing services to members. The courts have upheld this treatment in certain cases, although the effect132 is to render the investment income nontaxable, and therefore to permit untaxed dollars to be used by the organization to provide services for its members. [H. Rept. 91-413 (Part 1) (1969), 3 C.B. 232">1969-3 C.B. 232.]Virtually identical concerns were expressed in the Senate Report. S. Rept. 91-552 (1969), 3 C.B. 471">1969-3 C.B. 471. In addition, the concern was also expressed that without a specific provision to deal with investment and nonmember income of nonexempt membership organizations, those tax-exempt organizations governed under newly enacted section 512(a)(3) might attempt to avoid its effect "in treating 121 investment income and income received from nonmembers as unrelated business income by giving up their exempt status and deducting the cost of providing services for members against this income." H. Rept. 91-413, supra, 1969-3 C.B. at 232. 14133 In response, Congress enacted section 277. The purpose of section 277 was "to prevent [taxable] membership organizations from escaping tax on business or investment income by using this income to serve its members at less than cost and then deducting the book 'loss.'" S. Rept. 91-552 (1969), 3 C.B. 471">1969-3 C.B. 471.The effect of section 277 for nonexempt organizations is essentially the same as the effect of section 512(a)(3) for exempt organizations. Both sections prevent their respective organizations from escaping tax on their investment income and nonmember income by offsetting such income with losses incurred in providing goods and services to members. 15 The purpose of section 512(a)(3) is accomplished by defining unrelated business taxable income to mean all income that is not "exempt function income," less the deductions allowed which are directly connected with the production of such income (excluding exempt-function income). The purpose of section 277 is accomplished by simply limiting deductions in any taxable year for expenses incurred in providing goods and services to members to the extent of the "income derived during such year from members134 or transactions with members." We have found nothing to indicate that Congress intended that phrase to include all income from sources substantially related to the function of the organization, as petitioner contends. Indeed, 122 the plain language of section 277 precludes us from reaching such a conclusion. Petitioner has not cited and we have not found any authority for deviating from the plain language of the statute.In addition, because of the nexus between section 277 and section 512(a)(3) 135 and the similar concerns Congress expressed with respect to investment income and other nonmember income of both tax-exempt and taxable membership organizations, we conclude that Congress did not intend taxable organizations described in section 277 to be treated more favorably than tax-exempt organizations described in section 512(a)(3). 16137 For purposes of section 512(a)(3), "unrelated business taxable income" includes all investment income except limited amounts specifically excluded by section 512(a)(3)(B)(i) or (ii), and investment income cannot be offset by expenses of providing goods and services to members. We think it necessarily follows that all investment income constitutes nonmembership income within the meaning of section 277. It would indeed be anomalous to hold investment income constitutes "unrelated business taxable income" for purposes of section 512(a)(3), but in some instances constitutes membership income for purposes of section 277. Such an interpretation would thwart the underlying congressional intent of both section 512(a)(3) and section 277. Accordingly, based on the plain language of section 277 and its legislative purpose, we conclude that since the136 interest income earned and credited to petitioner's replacement reserve, general operating reserve, and mortgage escrow account was not received from members or transactions with members, such income constitutes 123 nonmembership income within the meaning of section 277. 17138 Having concluded that the interest petitioner earned on the replacement reserve, the general operating reserve, and the mortgage escrow account is nonmembership income, we must now determine what deductions, if any, are attributable to this nonmembership income.Petitioner incurred the following expenses during the years in issue and the parties agree that a portion of each expense is attributable to the interest generated on the above accounts:AmortizedAmortizedTYEManagementmortgage financeorganizationalAuditMar. 31 --feecostscostsfeeTotal1976$ 41,005$ 6,94118 $ 5,069$ 2,800$ 55,815197743,2936,9415,0692,80058,103197852,4576,9415,32619 2,80067,524139 The portion of each expense properly allocable to the nonmembership income each year naturally is in dispute. Petitioner argues that 10 percent of the management fee, the amortized mortgage finance costs and organizational costs, and 20 percent of the audit fee are properly allocable 124 to the nonmembership interest income. 20 Respondent requested the Court to find that only 3 percent of management and auditing fees and 2 percent of organizational and financing cost are properly allocable to such income, but on brief respondent contended for a range of 1 to 5 percent of each expense.Unfortunately, neither the management company nor petitioner's accountant maintained a separate accounting of the expenses attributable to petitioner's nonmembership interest income. 140 Petitioner's allocation of these expenses is primarily based upon the testimony of Alphonse Marcus, a principal of the management firm, and John Gwizdala, petitioner's accountant.At trial, Mr. Marcus gave his best estimate of the time his company devoted to the three interest-bearing accounts. However, his company did not work for petitioner during the years before the Court. See note 7 supra. Mr. Gwizdala gave his opinion with respect to the organizational costs, the finance costs, and the auditing fee, that he considered properly allocable to the three interest-bearing accounts. While both witnesses appeared credible, 21 petitioner did not offer and there is nothing in the record setting forth the underlying factual data that each witness relied upon. Consequently, we are reluctant to make an allocation based solely on their unsupported conclusions.141 However, when a taxpayer proves that some part of an expenditure was made for deductible purposes and when the record contains sufficient evidence for us to make some reasonable approximation, we will do so. Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (2d Cir. 1930). Although the evidence is less than satisfactory for this purpose, we will do our best with the materials at hand "bearing heavily * * * upon the 125 taxpayer whose inexactitude is of his own making." Cohan v. Commissioner, 39 F.2d at 543-544.There is no dispute in this case as to the amounts that petitioner expended during the years in issue with respect to its amortized organizational costs and finance costs, management fees, and auditing fees. Moreover, there is no dispute in this case that some portion of each expense is allocable to the nonmembership interest income. Accordingly, based on all the facts and circumstances, but bearing heavily against petitioner for the inexactitude of its evidence, we conclude that 5 percent of each of the above expenses is properly allocable to the nonmembership income and petitioner is entitled to deduct such amounts 142 in each of the years in issue.To reflect the parties' stipulation and our holdings, 22143 Decision will be entered under Rule 155. KORNERKorner, J., concurring: I concur in the result which the majority has reached in this case, based upon the facts as 126 found, but I think it desirable to add a few comments so that the majority opinion herein will not be misinterpreted.The majority opinion, in footnote 3, refuses to find that this petitioner either is a cooperative organization within the meaning of section 216, or within the meaning of subchapter T of the Code, and therefore does not consider the applicability of those provisions of law to this case. I agree that section 216 has no application to this case, not because the record will not support a holding that this petitioner is a section 216 cooperative (it may or may not be), but because it is irrelevant. Section 216 deals only with certain taxes, interest, and depreciation expense which may be deducted by a tenant stockholder of a housing cooperative. None of those persons are before us as petitioners, and none of those items are in dispute in this case. Thus, this case can be decided without any reference to section 216, or petitioner's qualification thereunder.The application of subchapter144 T to this case, however, is a different matter. If this petitioner was being operated on the cooperative basis, within the meaning of section 1381(a)(2), then the provisions of subchapter T attach, and petitioner's liability is to be determined under those provisions as a matter of law. The application of subchapter T is not elective on the part of either petitioner or respondent. Neither party can avoid the application of the correct law to the facts of the case by failing to plead or argue it. That is the province of the Court. See Park Place, Inc. v. Commissioner, 57 T.C. 767">57 T.C. 767, 769 (1972). We have previously held that low income nonprofit housing corporations, which concededly were cooperatives, are governed by subchapter T, and that those Code provisions preempt other more general Code provisions which otherwise might be applicable. Concord Village, Inc. v. Commissioner, 65 T.C. 142 (1975); Park Place, Inc. v. Commissioner, supra.Here, the majority avoids the question of the applicability of subchapter T by specifically refusing to find that petitioner was operated on the145 cooperative basis, for lack of adequate facts. There is certainly some support for the proposition that this petitioner was not operated on the cooperative basis, in that the findings of fact would suggest that there is no possibility that any margins or savings 127 which petitioner might realize could ever be rebated to the tenant members of the corporation as patronage refunds. The obligation of the organization to rebate to the patron member, on a patronage basis, the excess of its charges collected from the member over its actual costs of operation, and the right of the patron member to receive such distributions, is the principal factor which distinguishes cooperatives from other forms of business organization, and is the sine qua non of operating on the cooperative basis. See I. Packel, The Organization and Operation of Cooperatives 186-187, 252 (4th ed. 1970). 1146 Giving proper deference to the trial judge as the finder of facts in this case, I thus concur in the result reached by the majority here, as long as it is clear, as I think it should be, that we are not holding that the provisions of section 277 supersede the provisions of subchapter T in a case where the latter provisions apply. In such a case, I think a different analysis would be required, with at least the possibility that a different result might be reached. Compare Certified Grocers of California, Ltd. v. Commissioner, 88 T.C. 238 (1987); Illinois Grain Corp. v. Commissioner, 87 T.C. 435">87 T.C. 435 (1986), on appeal (7th Cir., Mar. 2, 1987). Footnotes1. Respondent concedes that petitioner is entitled to the investment tax credit claimed for the taxable years ended Mar. 31,1976, and Mar. 31, 1978.↩2. 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.↩3. The parties stipulated that petitioner "was incorporated on Jan. 16, 1970 as a cooperative housing corporation and was organized exclusively to provide housing facilities." However, petitioner has not contended that it is a "cooperative housing corporation" within the meaning of sec. 216, and the record does not contain the facts necessary for us to determine whether, during the years before the Court, petitioner satisfied the statutory requirements of sec. 216(b)(1) and the pertinent regulations. See Eckstein v. United States, 452 F.2d 1036">452 F.2d 1036 (Ct. Cl. 1971). Indeed, from the evidence in the record and from the parties' briefs, we cannot find that the parties attached any significance to the above-stipulated language. Since neither party contends that petitioner is a "cooperative" to which sec. 216 or subch. T applies, and since the facts in the record are not sufficient for us to conclude that petitioner is a "cooperative housing corporation" within the meaning of sec. 216(b)(1) or that petitioner is "operating on a cooperative basis" within the meaning of sec. 1381(a)(2), we attach no significance to the above-stipulated language in this case. In other cases, we have held that those provisions can apply to cooperative housing corporations. Concord Village, Inc. v. Commissioner, 65 T.C. 142 (1975); Park Place, Inc. v. Commissioner, 57 T.C. 767 (1972). The parties have neither cited nor relied upon those cases, possibly because the issues therein are not involved here. All the taxable years in those two cases preceded the enactment of sec. 277, and so neither of those cases involved the applicability of sec. 277 to cooperative housing corporations or to cooperatives generally. Both of those cases involved various forfeitures and payments from and "overassessments" as to members and whether such forfeitures, payments, and overassessments constituted contributions to capital, income to the corporation, or amounts available to be distributed to patrons and deducted as patronage dividends. Here, there is no question that the disputed interest constitutes income to petitioner, and here art. XII of petitioner's articles of incorporation expressly provides that "No dividend shall be paid at any time upon any membership issued by this corporation." Accordingly, our opinion below will be limited to sec. 277↩ and its application to the facts of this case, i.e., to the only issue pleaded, tried, and briefed by the parties. We leave to another day any exploration of the possible interrelationship and full sweep of secs. 216, 277, and subch. T.4. Sec. 236 was added to the National Housing Act by sec. 201 of the Housing and Urban Development Act of 1968, Pub. L. 90-448, 82 Stat. 498, 12 U.S.C. sec. 1715Z-1 (1982).Sec. 236 was enacted to assist low and moderate income families in obtaining suitable rental and cooperative housing. Generally sec. 236 authorizes the Department of Housing and Urban Development (HUD) to issue mortgage insurance on mortgage loans for qualified sec. 236 projects and to pay, on behalf of the mortgagors, the mortgage insurance premiums and the interest on the mortgage loan over 1 percent. These interest payments, commonly referred to as interest reduction payments, reduce the total operating costs of a sec. 236 project by lowering, in effect, the rate of interest on the mortgage loan to 1 percent. The reduced operating costs enable the sec. 236 project to charge lower rents to its tenants. For a good overview of sec. 236, see Graff v. Commissioner, 743">74 T.C. 743 (1980), affd. 673 F.2d 784">673 F.2d 784 (5th Cir. 1982). See also "Low Income Housing: Section 236 of the National Housing Act and the Tax Reform Act of 1969," 31 U. Pitt. L. Rev. 443">31 U. Pitt. L. Rev. 443↩ (1970).5. The articles of incorporation provide for 391 memberships at the initial cost of $ 100 each. However, sec. 8(d) of petitioner's bylaws provides a formula in determining transfer values of membership certificates with respect to subsequent purchasers. This formula takes into account the original purchase price, improvements made by previous tenants with the prior approval of the directors, and the amount of principal amortized by petitioner on its mortgage indebtedness and attributable at the discretion of the directors to the dwelling unit involved as paid by all holders, past and present, of the same membership. However, the first 3 years of principal payments on its mortgage indebtedness are not included in this computation.↩6. The record does not fully explain the particulars of either the sec. 8 program or the rent supplement program. We assume that the sec. 8 program refers to the housing assistance program provided by sec. 8 of the United States Housing Act of 1937 as amended by the Housing and Community Development Act of 1974, Pub. L. 93-383, 88 Stat. 653, 662, 42 U.S.C. sec. 1437(f) (1982). We also assume that the rent supplement program refers to the housing assistance program provided by sec. 101 of the Housing and Urban Development Act of 1965, as amended by sec. 202 of Pub. L. 90-448, 82 Stat. 503 (1968), 12 U.S.C. 1701(s) (1982).Detailing the specifics of the rent supplement program and the sec. 8 program is not necessary for purposes of this case. Suffice it to say that each program provides additional Federal funds to certain families unable to pay the basic carrying charge for housing. At the time of trial, 285 of petitioner's 391 members were receiving assistance from HUD in paying the basic carrying charge established under the regulatory agreements.↩7. Mr. and Mrs. Alphonse Marcus are the principals of the present management company. Mr. Marcus testified at the trial, but there was no testimony by anyone connected with the management company that served in that capacity during the years before the Court. While Mr. Marcus testified that he thought his company's activities and the time his company spent on Concord's work were representative of that of the predecessor company, he had no personal knowledge as to the earlier years. We have made findings based on Mr. Marcus' testimony, but the weight that can properly be accorded to it is lessened by his lack of personal knowledge. However, since Mr. Marcus performs similar services for nine other housing organizations such as Concord and since the State and Federal regulatory requirements give some assurance of reasonable consistency in administrative practices, we think his testimony is entitled to some weight.↩1. Negative figure because overstated by $ 3,500 in the preceding year.↩8. Respondent also determined that petitioner failed to establish that the net operating losses (NOL's) in prior years or any portions thereof were attributable to nonmembership income. Accordingly, respondent determined this nonmembership interest income could not be reduced by those NOL's.↩9. Sec. 277(b)↩ excepts certain organizations from the general rule under subsec. (a). None of those exceptions are applicable herein.10. No issue has been raised in this case as to petitioner's status as a membership organization operated primarily to furnish services or goods to its members within the meaning of sec. 277. Indeed, petitioner has never contended otherwise, and the record does not suggest that petitioner is other than an organization described in sec. 277. See Associated Barbers & Beauticians v. Commissioner, 69 T.C. 53">69 T.C. 53, 70-75↩ (1977).11. Proposed regulations under sec. 277 were issued in May of 1972. However, respondent announced in a News Release dated Dec. 9, 1986, the closing of 133 regulation projects. One of the projects listed was project No. LR 721-71 pertaining to sec. 277. Thus, whether the proposed regulations under this section will ever be promulgated in final form is uncertain.In any event, proposed regulations carry no more weight than a position or argument advanced on brief. See Freesen v. Commissioner, 84 T.C. 920">84 T.C. 920, 939 (1985), revd. on other grounds 798 F.2d 195">798 F.2d 195 (7th Cir. 1986), quoting F.W. Woolworth Co. v. Commissioner, 54 T.C. 1233">54 T.C. 1233, 1265-1266↩ (1970). Moreover, the proposed regulations provided no assistance in the resolution of the instant case.12. We note that in Shore Drive Apartments, Inc. v. United States, an unreported case ( M.D. Fla. 1976, 38 AFTR 2d 76-5916, 76-2 USTC par. 9808), the District Court on cross-motions for summary judgment held without discussion or analysis that interest earned on investments in United States obligations was not membership income within the meaning of sec. 277(a)↩.13. Sec. 512(a)(3) remains substantially the same today, except for expansion to include organizations described in sec. 501(c)(17) and (20), and a new sentence at the end of sec. 512(a)(3) relating to dividends received by corporations.↩14. The same concern was reiterated as an argument in favor of the enactment of sec. 277 in the 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 (Comm. Print 1969):(2) This provision is necessary to prevent exempt membership organizations from attempting to avoid the effect of the unrelated business income rule by giving up their exempt status and deducting the cost of providing services for members from its investment or nonmembership income.↩15. The 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 (Comm. Print 1969), provides the following argument in support of sec. 277:(1) To permit a membership organization to offset investment or business income against a loss arising from services provided to members is the same as if an individual were allowed to offset his personal or recreational expenses against his investment income.↩16. The nexus between sec. 512(a)(3) and sec. 277 is seen again in 1976 when Congress added essentially identical amendments to each section.In 1976, Congress amended sec. 512(a)(3)(A) to prevent the use of the deductions provided by secs. 243, 244, and 245 (relating to dividends received by corporations) in computing unrelated business taxable income as defined in that section. Pub. L. 94-568, sec. 1(b), 90 Stat. 2697 (Oct. 20, 1976). See note 13 supra. Congress also enacted a similar amendment to sec. 277(a) which stated "The deductions provided by sections 243, 244 and 245 (relating to dividends received by corporations) shall not be allowed to any organization to which this section applies for the taxable year." Pub. L. 94-568, sec. 1(c), 90 Stat. 2697 (Oct. 20, 1976). See Rolling Rock Club v. United States, 785 F.2d 93">785 F.2d 93 (3d Cir. 1986).Congress was concerned that without a similar provision in sec. 277↩, tax-exempt organizations defined in sec. 512(a)(3) could avoid tax on this dividend income by simply giving up their tax-exempt status. H. Rept. 94-1353, to accompany H.R. 1144 (Pub. L. 94-568), 94th Cong., 2d Sess. 7 (1976), S. Rept. 94-1318, to accompany H.R. 1144 (Pub. L. 94-568), 94th Cong., 2d Sess. 7 (1976).17. Citing Land O'Lakes, Inc. v. United States, 675 F.2d 988">675 F.2d 988 (8th Cir. 1982), petitioner invites us to consider cases under subch. T in defining "membership income" for purposes of sec. 277. We decline the invitation. Recently we have had occasion to explore thoroughly the matter of patronage sourced income for cooperatives, i.e., income "from business done with or for its patrons" under sec. 1388(a). Illinois Grain Corp. v. Commissioner, 87 T.C. 435">87 T.C. 435 (1986), on appeal (7th Cir., Mar. 2, 1987); Certified Grocers of California, Ltd. and Subsidiaries v. Commissioner, 88 T.C. 238">88 T.C. 238 (1987). Subch. T provides a comprehensive framework for taxation of cooperatives. Petitioner does not contend that it comes within subch. T. Suffice it to say that we are not prepared to say that "income derived * * * from members or transactions with members" under sec. 277 has the same meaning as income "from business done with or for its patrons" under sec. 1388(a). See Washington-Oregon Shippers Cooperative, Inc. v. Commissioner, T.C. Memo. 1987-32, n. 13.Petitioner also cites Farm Service Cooperative v. Commissioner, 70 T.C. 145">70 T.C. 145, 156 (1978), revd. on cooperative issue 619 F.2d 718">619 F.2d 718 (8th Cir. 1980), and overruled by this Court on that point in Certified Grocers of California, Ltd. v. Commissioner, supra.Relying on our passing comment on sec. 277 in that case, petitioner insists it does not come within the purpose of sec. 277 to disallow only intentional and sham losses. The sec. 277 issue in Farm Service Cooperative was decided on respondent's failure of proof, and our brief reference to sec. 277 therein did not purport to analyze the full range of sec. 277↩ in its proper sphere.18. The record is unclear as to why petitioner claimed $ 5,069 for amortized organizational costs in 1976 and 1977 when the total cost of $ 213,049 amortized over 40 years results in annual allowances of $ 5,326 as claimed in 1978. In any event, we have used the amounts petitioner reported.↩19. In 1978, petitioner incurred an expense in excess of $ 12,000 relating to a tax appeal. However, since this tax appeal involved local property taxes, we conclude that no part of this expense is properly allocable to nonmembership income.↩20. Petitioner understandably no longer seeks 20 percent of the management fee and 100 percent of the finance cost, organizational cost, and audit fee, as claimed on the 1978 tax return. We agree with respondent that those amounts were unreasonable.↩21. Here, as is generally the case with opinion evidence, credibility is not the issue. As we have had occasion to note:"The Court's task is to determine the credibility of any lay or expert witness based upon objective facts, the reasonableness of the testimony, the consistency of the statements made by the witness, and, in some cases, the demeanor of the witness. In the present case, as in the ordinary case, any doubts about the reliability of an expert's testimony are based on the failure of the facts to support his assumptions and his ultimate opinion rather than any doubt as to whether the expert is expressing a truthful opinion. [Estate of Fittl v. Commissioner, T.C. Memo. 1986-452, 52 T.C.M. (CCH) 567">52 T.C.M. 567↩, 571, 55 P-H Memo T.C. par. 86,452 at 2097-2098.]"22. We are satisfied that our treatment of investment income under sec. 277 is compelled by the statutory language, congressional intent, and the underlying legislative history. However, the interest generated by the various accounts in this case appears to have benefited HUD more than petitioner's members. The interest was used to defray a portion of petitioner's overall operating costs. Since HUD pays part of the basic carrying charges ("rent") for 285 of petitioner's members, that portion of the defrayed operating costs attributable to these members would appear to lower the financial assistance payments from HUD with respect to these members. On the other hand, the tax liability resulting from our holding necessarily increases petitioner's operating costs, and the increase attributable to the 285 members receiving Federal assistance in paying their basic charges will apparently be paid by HUD.At least one commentator takes the position that for purposes of sec. 277, investment income is nonmember income, regardless of whether the generating funds are member contributions. However, he also suggests an exception might be made with respect to interest earned on cash reserves required by the FHA as a condition of obtaining mortgage insurance. See Miller, "Section 277: Guardsman or Marauder?" 10 J. Real Est. Tax. 370, 374 (1983). While good policy reasons may exist for creating such an exception, it is not the function of a court to rewrite or amend a statute in the guise of construing it. David Metzger Trust v. Commissioner, 76 T.C. 42">76 T.C. 42, 59-60 (1981), affd. 693 F.2d 459">693 F.2d 459 (5th Cir. 1982), cert. denied 463 U.S. 1207">463 U.S. 1207↩ (1983). If Congress sees a need to exempt the interest earned by housing organizations such as petitioner, it can do so.1. Art. XII of petitioner's articles of incorporation, quoted in note 3 of the majority opinion, is not relevant to a determination of this question, since patronage refunds made by a cooperative to its members are not "dividends" at all, either under general law or under sec. 316.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625670/	DENNIS M. SEIGLER and PAULA M. SEIGLER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSeigler v. CommissionerDocket No. 2418-77.United States Tax CourtT.C. Memo 1979-326; 1979 Tax Ct. Memo LEXIS 194; 38 T.C.M. (CCH) 1265; T.C.M. (RIA) 79326; August 22, 1979, Filed Robert M. Fowler, for the respondent. WILBURMEMORANDUM OPINION WILBUR, Judge: This matter is before the Court on respondent's Motion for Summary Judgement filed February 16, 1979, pursuant to Rule 121, Tax Court Rules of Practice and Procedure.Respondent determined a deficiency in petitioners' Federal income tax for the taxable year 1975 in the amount of $1,268 and an addition to tax under section 6653(a) 1 in the amount of $63. Petitioners were residents of Donahue, Iowa at the time they filed their petition in this case. Petitioners filed their individual Federal income tax return for the taxable year 1975 with the Internal Revenue Service, Kansas City, Missouri. 195 Respondent's adjustments in the notice of deficiency are based primarily upon petitioners' failure to report properly the amount of their wages. In their petition to the Court, petitioners contend that Federal Reserve notes are not dollars and therefore must be valued at fair market value; that their rights to a jury trial have been violated; and that respondent has violated section 7214. On their 1975 tax return, petitioners reduced the amount of their reportable income based upon their estimation of the difference between the fair market value of the Federal Reserve notes they received in taxable wages and the face value of those notes. In essence, petitioners are specifically attacking the legality of the American monetary system by arguing that they did not receive "dollars" in the sense of gold and silver coin. Thus, they contend that their Federal Reserve notes are taxable only to the extent that they can be redeemed in gold and silver. This contention, which we have considered extensively in recent years, has uniformly been held to be without merit. Hatfield v. Commissioner,68 T.C. 895">68 T.C. 895 (1977), Sibla v. Commissioner,68 T.C. 422">68 T.C. 422 (1977);196 Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181 (1976), affd, without opinion 578 F. 2d 1383 (8th Cir. 1978). In their petition, petitioners assert that the Constitution forbids a "legislative act which would inflict penalties upon the citizen without a judicial trial." The law, however, is clear that petitioners have no right under the Seventh Amendment or under statutory law to a trial by jury in this Court. Swanson v. Commissioner,65 T.C. 1180">65 T.C. 1180 (1976); Cupp v. Commissioner,65 T.C. 68">65 T.C. 68 (1975), affd. 559 F. 2d 1207 (3d Cir. 1977). Petitioners also assert that respondent violated section 7214 by issuing to petitioners the statutory notice of deficiency. Something more than petitioners' bare assertion of an impropriety is required for with certain exceptions not pertinent here, the manner in which respondent makes his determination of the deficiency is not an issue properly before this Court and cannot invalidate a deficiency notice. See Greenberg's Express, Inc. v. Commissioner,62 T.C. 324">62 T.C. 324, 328 (1974); Suarez v. Commissioner,58 T.C. 792">58 T.C. 792 (1972). We must also sustain respondent's197 determination that a penalty should be imposed under section 6653(a). Section 6653(a) imposes an addition to tax whenever "any underpayment * * is due to negligence or intentional disregard of rules and regulations." Petitioners' argument that their earnings should be taxed based upon the fair market value of Federal Reserve notes borders on frivolous. We believe they were aware that no such deduction is provided for or authorized. Even if petitioners felt in good faith that they were entitled to such a deduction, which we do not believe, good faith alone will not relieve them from liability for the penalty imposed by section 6653(a). See United States v. Malinowski,472 F. 2d 850 (3d Cir. 1973), cert. denied 411 U.S. 970">411 U.S. 970 (1973). Accordingly, respondent's motion is granted and, An appropriate order will be issued.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise stated.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625671/	EMIL STEIN AND JULIA STEIN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. BERTHA ZUCKER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. WILLIAM B. STEIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. JACOB STEIN AND FRANCES STEIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Stein v. CommissionerDocket Nos. 104553, 104554, 104555, 104556.United States Board of Tax Appeals46 B.T.A. 135; 1942 BTA LEXIS 904; January 21, 1942, Promulgated 904 The petitioners are stockholders of a corporation which on January 1, 1933, had a book deficit of $70,971.52 as a result of having made distributions to the stockholders in excess of earnings. To correct that deficit the corporation recapitalized in 1933, executing as a part of the recapitalization plan a noninterest-bearing note for $80,000 to certain stockholders as trustees for all the stockholders, payments on the note to be distributed pro rata to the stockholders according to stockholdings. In 1934 payments upon the note were made out of current earnings. Held, such payments constitute in the hands of the stockholders ordinary taxable dividends (sec. 115 (a), Revenue Act of 1934), or distributions essentially equivalent to taxable dividends (sec. 115(g), Revenue Act of 1934). John A. Conlin, C.P.A., for the petitioners. Albert H. Monacelli, Esq., for the respondent. SMITH 135 OPINION. SMITH: These proceedings, consolidated for hearing, involve income tax deficiencies for 1934 as follows: PetitionerDocket No.DeficiencyEmil Stein and Julia Stein104553$677.18Bertha Zucker104554389.89William B. Stein104555104.47Jacob Stein and Frances Stein104556104.84905 The sole question presented in each proceeding is whether certain distributions received by the petitioners in 1934 from the Elizabeth Amusement Co., a New Jersey corporation, of which the petitioners were stockholders, constituted taxable dividends. Petitioners' returns for 1934 were filed with the collector of internal revenue at Newark, New Jersey. The proceedings were submitted on a written stipulation of facts filed at the hearing, which we adopt as our findings of fact. During 1933 and 1934 the petitioners were the majority stockholders of the Elizabeth Amusement Co., a New Jersey corporation 136 organized in 1920, which was from 1924 through 1934 the lessor of the Motion Picture Theatre. The authorized capital stock of the Elizabeth Amusement Co., hereinafter sometimes referred to as the corporation, consisted originally of 10,000 common shares of a par value of $100 each, of which 2,400 shares were outstanding as of June 30, 1933. At January 1, 1933, the corporation had a deficit of $70,971.52, which resulted from distributions having been made to its stockholders in excess of earnings during the years 1928 to 1932, inclusive, as follows: YearBook earningsDividends paid which were considered 100% taxable by the stockholdersExcess amounts taxed to stockholdersSurplus Jan. 1, 1928$6,246.54192845,948.09$67,200$15,005.37192946,429.3167,20020,770.69193045,944.4767,20021,255.53193153,473.4669,20015,726.54193251,798.6752,8001,001.33Total73,759.46Less surplus adjustments 1929 and 19322,787.94Deficit Jan. 1, 193370,971.52906 On July 28, 1933, the certificate of incorporation of the Elizabeth Amusement Co. was amended to provide for the changing of the authorized capital stock from 10,000 shares of $100 par value to 5,000 shares of no par value. On July 28, 1933, the corporation's board of directors passed the following resolution: Mr. William B. Stein thereupon moved that immediately upon the completion of legal formalities changing and amending the certificate of incorporation in the mode and manner aforesaid, that the present outstanding stock of the corporation be called in for exchange and surrender, and in lieu of each one-eighth interest now outstanding there be issued two hundred (200) shares of no par value stock and that as an added consideration for the surrender of the present outstanding stock by each of the stockholders and his acceptance of the new stock, that there be created for the benefit of the present stockholders of record, a provisional interest in a note to be executed by this Corporation to William B. Stein and Emil Zucker, as Trustees, which note is to be in the sum of Eighty Thousand ($80,000.,) Dollars, and to run for Twenty (20) months, and is to be amortized in the sum907 of Four Thousand ($4,000.,) Dollars per month, said amortization payments to be distributed by the Trustees, as, when and if received, to each of the present stockholders, in the proportion which their present holdings bear to the entire capital stock issued and outstanding, it being further understood, however, that default in the payment of said amortization payments, or in the payment of the entire note, shall not be charged against the Elizabeth Amusement Company and no suit thereon be brought, unless and until the Trustees shall have received a written demand in that 137 behalf executed by two-thirds of the holders in interest of the beneficial proceeds of said note at the time of said default. On July 28, 1933, the corporation recapitalized and canceled its par capital stock, consisting of 2,400 shares, par value $100 per share, by issuing 1,600 common shares of no value stock and also issuing is note for $80,000 payable at the rate of $4,000 per month. Those payments in liquidation of note indebtedness were made out of earnings for the year in which paid to the trustees and distributed to the stockholders. The value per share of the new stock was stated on the corporation's908 books to be the same as the old stock, namely, $100 per share. Before the recapitalization the total stock account as shown by the books was $240,000; thereafter, $160,000, a reduction of $80,000. The purpose of the recapitalization was to ultimately eliminate the book deficit caused by distributions in excess of earnings in prior years. The corporation created upon its books of account in 1933 an account headed "Note Payable" and stated liability thereunder $80,000. Petitioners in 1933 surrendered to the corporation their par shares of capital stock in the corporation, which had cost them par, and received in lieu thereof their proportionate shares in 1,600 shares of no par stock plus their proportionate beneficial interest in a note of $80,000 issued by the corporation to William B. Stein and Emil Zucker as trustees. Pursuant to the resolution of the corporation's board of directors on July 28, 1933, a trust indenture dated August 7, 1933, was executed, under the terms of which the corporation agreed to pay to the trustees the $80,000 note referred to in the resolution in accordance with the terms thereof. The records of the corporation reflect a deficit as of January 1, 1934, of909 $48,556.18, and as of December 31, 1934, of $58.10, shown as follows: Book deficit January 1, 1933$70,971.52Less Surplus adjustments of prior years1,800.3369,171.191933 book earnings44,615.0124,556.18Dividends paid 193324,000.00Book deficit January 1, 193448,556.18Surplus adjustment of prior years382.5248,938.701934 book earnings48,880.60Book deficit December 31, 193458.10138 The following schedule indicates payments made by the corporation from July 1, 1933, until December 31, 1936: YearBook earningsPayments made on note payableDistributions held to represent ordinary dividends1933$44,615.01$24,000$24,000193448,880.6044,500none193549,897.1511,50040,000193656,202.67none56,000Total199,595.4380,000120,000It has been the practice of the corporation for a number of years before the taxable year to distribute rentals collected by it without declaring formal dividends. The corporation did not in 1934 declare dividends to its stockholders. Petitioners in 1934 received the following amounts as their shares of payments made on the $80,000 note: Julia Stein$12,000Bertha Zucker6,000William B. Stein6,000Jacob Stein6,000910 These amounts the corporation charged in its books of account against "Note Payable" and they are included in the totals stated above as having been paid in the year 1934 on the note. During the period from July 29, 1933, to March 5, 1935, when payments were made upon the $80,000 note, no other distributions were made by the corporation. On March 14, 1935, a resolution was passed by the corporation's board of directors directing that dividends of $30 per annum be resumed upon each of the 1,600 shares outstanding, the payments to be made monthly. The distributions in payment of the $80,000 note were made in direct proportion to the stockholdings of the several stockholders. In their income tax returns for 1934 the petitioners did not report as taxable income the amounts received by them from the corporation in part payment of the note. In the determination of the deficiencies the respondent has included in the petitioners' gross incomes such payments received by the petitioners. In each of the deficiency notices attached to the several petitions the respondent says: "The distributions received by you from the Elizabeth Amusement Company are held to constitute ordinary911 taxable dividends." The petitioners submit that the amounts received by them from the corporation in 1934 "did not constitue in 1934 taxazle [dividends] to these petitioners." 139 The respondent submits that the amounts received by the petitioners from the corporation in 1934 are taxable either under section 115(a) of the Revenue Act of 1934 as taxable dividends, or under section 115(g) of the same act as being amounts "essentially equivalent to the distribution of a taxable dividend." The applicable provisions of the Revenue Act of 1934 are as follows: SEC. 115. DISTRIBUTIONS BY CORPORATIONS. (a) DEFINITION OF DIVIDEND. - The term "dividend" when used in this title (except in section 203(a)(4) and section 207(c)(1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913. * * (d) OTHER DISTRIBUTIONS FROM CAPITAL. - If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not out of912 earnings or profits, then the amount of such distribution shall be applied against and reduce the adjusted basis of the stock provided in section 113, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale or exchange of property. * * (g) REDEMPTION OF STOCK. - If a corporation cancies or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. In support of their contentions that the amounts received by them in 1934 from the corporation do not constitute taxable income, the petitioners cite ; ; 913 Elton Hoyt, 2nd,; ; and . Those cases merely stand for the proposition that in computing the amount of earnings accumlated by a corporation subsequent to March 1, 1933. for the purpose of determining whether a taxable distribution had been made by a corporation, operating losses and dividends paid must be deducted from the gross earnings in determining whether there are any available earnings in the corporation's treasury for payment of a dividend. The cases are obviously inapposite in these proceedings. The record here does not show that the corporation, Elizabeth Amusement Co., had any operating losses for any year. The facts are simply that the corporation in years prior to 1934 had distributed to its stockholders more than the earnings available for distribution. To the extent that those distributions were in excess of earnings available for the making of the distributions there was an invasion of capital. 140 The excess distributions in prior years did not constitute taxable income of the recipients. 914 ; ; The stipulated facts are that these distributions out of capital received in years prior to 1934 were returned as taxable income of the petitioners. We think it plain that it is immaterial in these proceedings that they were so returned. Petitioners can not for 1934 obtain a benefit for the erroneous inclusion in taxable income of prior years of amounts which in point of fact were not taxable income of the years in which received. Apparently the principal purpose of the recapitalization effected by the corporation in 1933 was to correct the erroneous report made by the stockholders of these distributions in prior years. Such purpose can have no material bearing upon the issue which is before us. The question for decision is whether petitioners derived taxable income from the receipt in 1934 of payments made by the corporation upon its note pursuant to the indenture of trust of August 7, 1933. There is no evidence that the petitioners reported as taxable income of 1933 the value of their interest in the $80,000 note. They received no distribution915 from the corporation in 1933 and if they were on the cash basis they clearly were not required to include in their taxable incomes any value for their interests in the note. We do not think that it is material whether the distributions received by the petitioners in 1934 were considered by the taxpayers as taxable dividends or not. In any event, they received the distributions in 1934 and we think they constituted taxable income of that year. But we do not think that the respondent erred in treating the distributions of 1934 as taxable dividends. The stipulated facts are that the corporation had earnings in 1934 of $48,880.60 and the payments made on the note were in the amount of $44,500. Since under the statute distributions made by a corporation are to be regarded as paid out of the most recently accumulated earnings, it must be held that the payments on the note were out of the earnings of 1934. Cf. . In , the Board held that a distribution made by a corporation in 1929 of an amount not in excess of surplus accumulated after February 28, 1913, is taxable to the shareholders916 as an ordinary dividend, notwithstanding it occurs at the same time as an exchange of shares as a part of recapitalization. See also . Furthermore, it is not material that there was no formal declaration of the dividend made by the corporation in 1934. A declaration of a dividend is not essential to a taxable dividend distribution. ; . 141 Even if the distribution made by the corporation does not fall under section 115(a) of the Revenue Act of 1934, we think that it must be held a taxable distribution under section 115(g) of that act, for the distributions were essentially equivalent to the distribution of a taxable dividend. See ; ; affd., ; ; affd. (C.C.A., 6th Cir.), ; 917 . It is not material that there was no "artifice, subterfuge, or bad faith" on the part of the corporation or its stockholders. . The important factor is the result. ; ; affd., ; certiorari denied, . In , the court said: * * However, it is our opinion that the bona fides in a company's capitalization of its earnings is immaterial to the applicability of Section 115(g). * * * The statute is aimed at the result. [Citations]. The basic criterion for the application of Section 115(g) is "the net effect of the distribution rather than the motives and plans of the taxpayer or his corporation." , (Ct. of App., D.C.) * * . The respondent's determination that the distributions received by the petitioners in 1934 from the Elizabeth Amusement Co. constituted taxable dividends918 is approved. Decisions will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625672/	Antoinette M. Faraco, Petitioner, v. Commissioner of Internal Revenue, RespondentFaraco v. CommissionerDocket No. 65034United States Tax Court29 T.C. 674; 1958 U.S. Tax Ct. LEXIS 274; January 23, 1958, Filed 274 Decision will be entered for the respondent. Petitioner and her late husband owned a parcel of real estate as tenants by the entirety with the common law right of survivorship. Held, the basis for depreciation for petitioner in 1954 was the cost at the time the property was acquired and not the fair market value at the time of the husband's death in 1953. Held, further, the constitutionality of section 2, I. R. C. 1954, was not properly raised by a petition that failed to state the specific constitutional provision alleged to have been violated. David R.275 Shelton, Esq., for the petitioner.George H. Becker, Esq., for the respondent. Mulroney, Judge. MULRONEY 674 OPINION.The respondent determined a deficiency in the income tax of petitioner for the year 1954 in the amount of $ 364.20. Petitioner either does not contest or concedes the correctness of the adjustments upon which the deficiency is based and the only question for determination is whether the basis for depreciation of certain real estate should be the cost of such property at the time it was acquired by the petitioner and her late husband, Joseph L. Arnold, as tenants by the entirety with the common law right of survivorship, or whether the basis of such property should be its fair market value at the time of the death of the said Joseph L. Arnold. A second question, whether section 2 of the Internal Revenue Code of 1954 is unconstitutional, is argued by the parties but it is not presented by the pleadings.All of the facts were stipulated and are found accordingly.Petitioner and Joseph L. Arnold were married in 1933 and remained husband and wife until Joseph L. Arnold died December 26, 1953. Petitioner did not remarry until February 1955. Petitioner's276 Federal income tax return was filed for the calendar year 1954 with the district director of internal revenue at Richmond, Virginia. There was a clause in the will of Joseph L. Arnold which gave, devised, and bequeathed all of his estate, both real and personal, to petitioner.By deed dated November 4, 1947, certain bus terminal real estate located at 707 North Randolph Street, Arlington, Virginia, was transferred to Joseph L. Arnold and his wife, Antoinette M. Arnold, as tenants by the entirety with the common law right of survivorship. The petitioner and her husband, Joseph L. Arnold, continued to hold the aforementioned property as tenants by the entirety with 675 the common law right of survivorship until the death of Joseph L. Arnold on December 26, 1953. The original cost of this bus terminal real estate was $ 159,029.33 with 68.55 per cent ($ 109,029.33) of such cost being allocated to depreciable improvements and the remaining 31.45 per cent thereof ($ 50,000) being allocated to nondepreciable land. No improvements with respect to which petitioner is entitled to depreciation allowances were added to the property from the date of acquisition to and including the taxable277 year.Petitioner, as executrix of the Estate of Joseph L. Arnold, deceased, reported the bus terminal property for Federal estate tax purposes as having a total value of $ 650,000 at the date of the death of the said Joseph L. Arnold. The parties agreed that the fair market value of the bus terminal property at the date of the death of Joseph L. Arnold was $ 650,000 and the parties also agreed that petitioner's basis for depreciation shall be 68.55 per cent of petitioner's total basis.In petitioner's 1954 income tax return she claimed depreciation for 1954 with respect to said bus terminal real estate on the basis of original cost rather than the fair market value of said real estate at the date of the death of said Joseph L. Arnold. On or about November 23, 1956, petitioner filed claim for refund in the amount of $ 2,920.01 on the ground that she had mistakenly claimed depreciation for 1954 on the basis of the original cost of the bus terminal real estate, whereas she was entitled to claim depreciation for 1954 on the basis of the value of said real estate at the date of the death of the said Joseph L. Arnold.The first issue is as to the correct basis of the bus terminal property278 for depreciation purposes. It is the contention of the petitioner that she is entitled to the stepped-up basis provided in section 113 (a) (5) of the Internal Revenue Code of 1939. The cited section provides, in part, "If the property was acquired by bequest, devise, or inheritance, * * the basis shall be the fair market value of such property at the time of such acquisition."Respondent contends that petitioner is not entitled to the basis provided in section 113 (a) (5), supra, because the bus terminal real estate was held by petitioner and her late husband, Joseph L. Arnold, as tenants by the entirety with the common law right of survivorship. Therefore, said property was not acquired by petitioner "by bequest, devise, or inheritance." It is respondent's argument that upon the death of her husband, petitioner did not take such property as a new acquisition, but instead took under the terms of the original conveyance, petitioner's estate being simply freed from the participation of her deceased husband.676 With admirable candor petitioner admits the case of Lang v. Commissioner, 289 U.S. 109">289 U.S. 109, holds against her contention. In the279 Lang case it was held (at p. 111):An estate by the entirety is held by the husband and wife in single ownership, by a single title. They do not take by moieties, but both and each take the whole estate, that is to say, the entirety. The tenancy results from the common law principle of marital unity; and is said to be sui generis. Upon the death of one of the tenants "the survivor does not take as a new acquisition, but under the original limitation, his estate being simply freed from participation by the other; * * "Petitioner argues that the Lang case is wrongly decided. The only argument advanced is that hardship results here by following the Lang decision and confiscation could result in a hypothetical case set forth in the brief by application of the doctrine of the Lang case and the Federal estate tax statutes. We followed the Lang case in Edward V. Schiesser, Executor, 28 B. T. A. 640, and we deem it controlling here. The Supreme Court in the Lang case was aware that hardship could result from the conclusion reached but as the opinion states "the remedy is with the Congress and not with the courts." 1280 The second issue is also a claim for refund which petitioner alleges is in the sum of $ 2,936.79. According to the petition, the refund claim seems to be computed in an unusual manner.Petitioner paid her income tax on her income for the year 1954 as an unmarried person. She was unmarried during all of that year, but if she had been married she would have had the right under section 2 of the Internal Revenue Code of 1954 to split her income in two parts and pay only twice the normal tax and surtax. She computes what her tax would have been if she had been married and section 2 of the Internal Revenue Code of 1954 had applied, and she subtracts that from what she paid and the difference is the amount of her refund claim. She alleges she is entitled to this refund because section 2, I. R. C. 1954, is unconstitutional. It would seem she is claiming the benefit of a section of the Internal Revenue Code that she claims is unconstitutional. But, in any event, her petition presents no issue of law with respect to the constitutionality of section 2 of the Internal Revenue Code of 1954. She fails to allege any specific constitutional challenge. She alleges in general terms that the281 said section of the Internal Revenue Code constitutes the taking of property without due process of law and the denial of equal protection of the law; that it amounts to the arbitrary confiscation of property; and that the classifications for taxation therein are unreasonable, arbitrary, capricious, and discriminatory. Nowhere in the petition 677 is there any reference to any specific provision of the Constitution that denies the power to enact such legislation.Constitutional questions are of great importance and it is the duty of the party raising the question to state the specific clause of the Constitution that is alleged to have been violated. The constitutionality of a taxing statute is not drawn in question by a pleading which is defective in that it fails to point out the particular provision of the Constitution that is violated. Coca-Cola Bottling Co., 22 B. T. A. 686, 702; Frederick N. Dillon, 20 B. T. A. 690; Muriel Dodge Neeman, 13 T. C. 397; and Calvert Iron Works, Inc., 26 T.C. 770">26 T. C. 770. In the Dillon case, supra, where the pleading282 situation was the same as here, we said (at p. 691):The pleadings do not raise any issue of law. In order to raise a question of law with respect to the constitutionality of a particular section of any one of the revenue acts, it is not sufficient to allege in general terms that Congress does not have the power to enact the section complained of. The specific constitutional provision alleged to be violated must be pointed out. * *Decision will be entered for the respondent. Footnotes1. Some relief is granted to taxpayers in petitioner's situation by section 1014 (b) (9), I. R. C. 1954↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625673/	JOSEPH VESSIO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentVessio v. CommissionerDocket No. 21946-87United States Tax CourtT.C. Memo 1990-218; 1990 Tax Ct. Memo LEXIS 237; 59 T.C.M. (CCH) 495; T.C.M. (RIA) 90218; April 30, 1990, Filed 237 Decision will be entered under Rule 155. Jared J. Scharf, for the petitioner. George H. Soba, for the respondent. WELLS, Judge. WELLS713 MEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined the following deficiencies in and additions to petitioner's Federal income tax: Addition Under Section 1YearDeficiency6653(b)(1)6653(b)(2)66611983$ 65,103$ 32,552$ 16,72619847,7833,891 1,946238 The instant case presents the following issues: (1) whether respondent's determination that petitioner had specified amounts of unreported income from loansharking and bookmaking in 1983 and 1984 is entitled to a presumption of correctness; (2) whether petitioner had unreported income from those sources in the amounts of $ 133,498 and $ 19,071 in 1983 and 1984, respectively; (3) whether the foregoing amounts of income are subject to the self-employment tax under section 1401(a); (4) whether petitioner failed to report $ 390 of interest income in 1984; (5) whether petitioner is liable for additions to tax for fraud under section 6653(b)(1) and (2); and (6) whether petitioner is liable for additions to tax for substantial239 understatements of tax under section 6661. 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 reference. Petitioner resided in Carmel, New York, when he filed his petition. On February 2, 1984, Suffolk County Police ("the police") searched petitioner's home in Centereach, New York, pursuant to a warrant. Among the items discovered by the police were a black notebook and a blue notebook, $ 152,569 in cash, $ 151,372 of which was located in a safe and the remainder of which was on a dresser, numerous "policy slips" (slips of paper containing names and numbers and used in bookmaking), several envelopes containing such slips of paper, and two firearms, a Smith and Wesson .38 caliber revolver and a Baretta .38 caliber automatic, both of which were located in the ceiling of petitioner's basement. The search of petitioner's home followed an investigation that began in October 1983 and included wiretapping petitioner's telephone and surveillance. Detective Vincent F. Lowe, who headed the investigation, had been with the Suffolk County District Attorney Rackets Bureau for 12240 years and had investigated 75 to 100 cases, half of which had involved loansharking. Loansharking is the practice of lending money at a usurious rate of interest. During surveillance, the police saw petitioner carry envelopes of the sort containing the policy slips from the trunk of his car to a restaurant in the Bronx called "The Corner Restaurant." Following the search of petitioner's home, a Suffolk County Grand Jury issued an indictment charging petitioner with making usurious loans in concert with other individuals, possession of usurious loan records, possession of gambling records, and two counts of possession of a weapon. Petitioner pleaded guilty to one count of attempted usury and to one count of criminal possession of a weapon. At the hearing at which petitioner entered his pleas, petitioner testified (1) that he met Dennis Szwech in October 1983 and loaned him $ 7,500 at an interest rate of five percent per week, (2) that he and others collected weekly interest payments on the loan, (3) that he directed someone to collect the principal balance of the loan, and (4) that he made similar loans to others at illegal interest rates. 714 Raymond Jermyn, Assistant District241 Attorney for Suffolk County, advised respondent of petitioner's conviction. Respondent subsequently determined that petitioner had income from loansharking and bookmaking equal to the $ 152,569 in cash seized at his home, that seven-eighths of such amount was attributable to 1983, and that the remaining one-eighth constituted income for 1984. Respondent based his allocation on the black notebook seized from petitioner's home on February 2, 1984. That black notebook evidences loansharking from June 1983 through February 1984. 2Petitioner filed Federal income tax returns for 1983 and 1984 and reported taxable income of $ 15,915 and $ 6,167, respectively. Petitioner's mother died on December 29, 1983. Petitioner's father was a loan shark. Prior to the death of petitioner's mother, petitioner's father had been ill, and petitioner242 had occasionally helped his father collect loans. Petitioner, petitioner's sisters Mildred Russo Vessio and Lisa Vessio, petitioner's nephew Michael Russo, and the Estate of Sue Vessio (petitioner's mother) all made separate claims against Suffolk County for the seized items, including the cash. The claims were waived as part of petitioner's plea agreement. A New York State estate tax return signed by Lisa Vessio, as executrix, on April 21, 1988, lists among the assets of the estate "Cash on Hand" of $ 153,000. The return discloses no estate tax liability. OPINION I. ILLEGAL INCOME Burden of Going ForwardWe must first decide whether respondent's determination that petitioner had the determined amounts of unreported illegal income in 1983 and 1984 is entitled to a presumption of correctness. As a general rule, respondent's determination is presumed correct, and a taxpayer bears the burden of proof and the burden of going forward. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933). When a determination is based on unreported illegal income, however, 243 it will not be presumed correct and the burden of going forward with the evidence will be shifted to respondent who must adduce "substantive evidence" linking the taxpayer to the illegal, income-producing activity. Llorente v. Commissioner, 649 F.2d 152">649 F.2d 152, 156 (2d Cir. 1981); Petzoldt v. Commissioner, 92 T.C. 661">92 T.C. 661, 688 (1989); Berkery v. Commissioner, 91 T.C. 179">91 T.C. 179, 195 (1988), affd. without published opinion 872 F.2d 411">872 F.2d 411 (3d Cir. 1989). Since an appeal in this case lies in the Second Circuit, which we are bound to follow, see Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940 (1971), we look to the cases decided therein for guidance here. In Llorente, the court held that respondent had failed to adduce the necessary proof, reasoning that evidence of "mere peripheral contact with illegal conduct" does not suffice. 649 F.2d at 156. In the trial of that case, respondent relied upon the testimony of an undercover agent that he had seen or heard cocaine dealers speaking with the taxpayer about cocaine244 shipments, the taxpayer's indictment for conspiracy to possess and sell a controlled substance, and the taxpayer's guilty plea to attempted conspiracy to possess a controlled substance. 649 F.2d at 153. In preparing the notice of deficiency, respondent also relied upon the undercover agent's claim that an informant had seen the taxpayer inspect six kilos of cocaine worth at least $ 54,000. 649 F.2d at 154. The court held that the informant's statement that the taxpayer had inspected heroin was hearsay and, therefore, could not be used to support respondent's determination. 649 F.2d at 157. We so interpreted Llorente in Dellacroce v. Commissioner, 83 T.C. 269">83 T.C. 269 (1984), and further held that any negative inferences to be drawn from the taxpayer's invocation of the Fifth Amendment privilege against self-incrimination did not constitute substantive evidence under the situation of that case. 83 T.C. at 283-284, 286. In Pizzarello v. United States, 408 F.2d 579">408 F.2d 579 (2d Cir. 1969), the court held that the government had improperly estimated a taxpayer's income from illegal wagering and that, 245 therefore, a jeopardy assessment based upon the estimate was excessive. The government had estimated income for a five-year period by using average receipts for a three-day period within one of the five years, without offering any evidence that the activity had in fact been conducted over the full five-year period. 408 F.2d at 583. The court remanded the case for a determination as to whether the denial of injunctive relief would subject the taxpayer to "irreparable harm." 408 F.2d at 587. The foregoing exception to the general rule regarding the burden of going forward does not apply where a determination is based upon seized cash. Such a determination is entitled to a presumption of correctness, even in the absence 715 of substantive proof linking the taxpayer to illegal income. Schad v. Commissioner, 87 T.C. 609">87 T.C. 609, 618-619 (1986). In Schad, we explained, "We think connecting petitioner to the funds that form the basis of the deficiency is sufficient to give him the burden of proving the deficiency determination erroneous." 87 T.C. at 620.246 Cash had been seized from the taxpayer in 1983 and formed the basis for respondent's deficiency determination for that year. Despite the fact that $ 152,569 was seized from petitioner's possession and respondent has determined that such amount represents income to petitioner, we do not rely upon those cases holding that determinations based upon seized cash are entitled to a presumption of correctness. Our review of such cases discloses that respondent invariably determined that the seized cash represented income in the year of seizure. 3 Here, by contrast, respondent's determination is that the seized cash represents income for two taxable periods, i.e., 1983 and 1984. Respondent has allocated the income between the two years on the basis of evidence other than the cash itself, specifically, the black notebook. Consequently, we cannot say that the determination is based on the seized cash. It is based, rather, on both the seized cash and other evidence. 247 In Jackson v. Commissioner , 73 T.C. 394">73 T.C. 394, 402 (1979), we held that a determination was not entitled to a presumption of correctness because respondent had failed to produce evidence linking the taxpayer to illegal, income-producing activity for the period in issue. In that case, respondent's determination was not based upon cash seized from the taxpayer in 1971 (the year in issue was 1970). 73 T.C. at 399. See Tokarski v. Commissioner, 87 T.C. 74">87 T.C. 74, 76 n. 4 (1986). Thus, respondent's determination in the instant case will not be presumed correct in the absence of substantive evidence linking petitioner to illegal income in 1983 and 1984. Respondent contends that substantive evidence links petitioner to loansharking in both 1983 and 1984. We agree with respondent. When entering his guilty plea to attempted criminal usury, petitioner admitted that in late 1983 he lent Mr. Szwech $ 7,500 at five-percent interest per week and collected weekly interest payments. Petitioner also admitted making usurious loans to others. Although petitioner's counsel has objected to the admissability of petitioner's statements on relevancy248 and hearsay grounds, we consider such objections meritless. The Federal Rules of Evidence generally apply in proceedings before this Court. Petzoldt v. Commissioner, supra at 671. That the statements are relevant does not require discussion. Further, admissions of a party opponent are not hearsay. Fed. R. Evid. 801(d)(2). The black notebook is also substantive evidence that petitioner was a loan shark in 1983 and 1984. Detective Lowe, who had extensive experience in the investigation of loansharking, identified the notebook as a record of loansharking. Petitioner does not appear to contest Detective Lowe's characterization, but does argue that respondent has failed to authenticate the notebook as petitioner's record. We disagree. Rule 901(a) of the Federal Rules of Evidence provides as follows: The requirement of authentication or identification as a condition precedent to admissibility is satisfied by evidence sufficient to support a finding that the matter in question is what its proponent claims. Rule 901(b) of the Federal Rules of Evidence lists249 a number of methods by which evidence may by authenticated or identified. Rule 901(b)(4) of the Federal Rules of Evidence specifically provides that authenticity may be established through "Appearance, contents, substance, internal patterns, or other distinctive characteristics, taken in conjunction with circumstances." Authorities interpreting the foregoing rule provide that a document may be ascribed to a particular individual by proof that it was discovered someplace that that person would have kept it and that its contents suggest that the individual prepared it. United States v. Calbas, 821 F.2d 887">821 F.2d 887, 893 (2d Cir. 1987) (notebook recording drug transactions identified as belonging to co-conspirator where notebook found in hotel room abandoned by co-conspirator and contained name appearing in co-conspirator's personal telephone book); United States v. De Gudino, 722 F.2d 1351">722 F.2d 1351, 1355-1356 (7th Cir. 1983). In the instant case, circumstances support the notebook's authenticity. The notebook was found in petitioner's home, where petitioner resided with250 a wife and two children. The police, in fact, found the notebook in petitioner's desk. The name "Dennis" appears in various parts of the notebook, accompanied by entries indicating that loans were made to Dennis in October at an interest rate of five percent per week, with interest payable weekly. For example, the following information appears on one page of the notebook: 716 10/13- Dennis 15,000 750 VIG 10/20-750 VIG 10/25-750 VIG 11/3 -- 750 VIG 11/9 -- 750 VIG 11/17-750 VIG 11/23-750 VIG 5250 12/1 -- 750 VIG Both Detective Lowe and petitioner testified that "VIG" refers to interest in the business of loansharking. The quoted portions of the notebook suggest a $ 15,000 loan to Dennis and interest payments of five percent of this amount, i.e., $ 750, paid approximately once a week. We do not view as coincidence that petitioner met Dennis Szwech in October 1983 and lent him money at terms the same as those disclosed by the notebook. Finally, Detective Lowe testified that during the search of petitioner's home, petitioner identified the notebook as his record. Petitioner's statement is not hearsay, but an admission by a party opponent. Fed. R. Evid. 801(d)(2). 251 4Respondent has also adduced substantive evidence linking petitioner to bookmaking in 1983 and 1984. Detective Lowe testified that three or four times between October 1983 and February 1984 he saw petitioner carry brown envelopes of the sort which contained the policy slips from the trunk of his car to The Corner Restaurant. Detective Lowe also testified that during the search of petitioner's home, he asked petitioner about The Corner Restaurant. According to Detective Lowe, petitioner replied, "That's just a numbers joint; we don't serve any food in there and haven't in years." The policy slips found in petitioner's252 home are further evidence of bookmaking. Detective Lowe identified the papers as bookmaking records; they contained names and numbers and were placed in envelopes. We do not agree with petitioner's assertion that evidence of the contents of the papers violates the best evidence rule. The Federal Rules of Evidence have codified the rule thus: "To prove the content of a writing, * * the original writing, * * * is required, except as otherwise provided in these rules or by Act of Congress." Fed. R. Evid. 1002. An exception to the foregoing rule permits other evidence of the contents of a writing, e.g., testimony, when "All originals are lost or have been destroyed, unless the proponent lost or destroyed them in bad faith." Fed. R. Evid. 1004(1). The record discloses that the Suffolk County Police Department destroyed the policy slips after petitioner entered his guilty plea. Because the policy slips have been destroyed, testimony regarding their content does not violate the best evidence rule. We need not decide whether petitioner is correct in asserting that the police destroyed the253 policy slips in bad faith. The applicable rule bars secondary evidence of lost or destroyed writings only when the proponent of the evidence has lost or destroyed the writings in bad faith. Respondent is the proponent of secondary evidence here, not Suffolk County, New York, and we see no basis for imputing the alleged bad faith conduct of the police to respondent. Our holding that respondent has adduced sufficient evidence linking the taxpayer with illegal, income-producing activities comports with our precedents. In Petzoldt, respondent supported deficiency determinations for 1983 and 1984 by producing an informant who testified about the taxpayer's drug transactions from 1980 through 1982, a notebook which implicated the taxpayer in transactions for the years in issue, and evidence of a substantial cash seizure in 1984. 92 T.C. at 690-691. Respondent reconstructed the taxpayer's income for 1983 and 1984 by adding the purchases of marijuana reflected in the notebook. For 1984, respondent also added the amount of cash seized and estimated living costs. 92 T.C. at 669. We held that the taxpayer had failed to rebut the presumption of correctness254 that attached to the statutory notice because of the proof adduced by respondent. 92 T.C. at 691. DeficiencyBecause respondent has adduced substantive evidence linking petitioner to loansharking and bookmaking in 1983 and 1984, petitioner bears the burden of going forward as well as the burden of proving that respondent's determination is incorrect. As noted, respondent determined that the $ 152,569 found in petitioner's safe represented income for 1983 and 1984 from illegal activities. Petitioner contends, however, that the money was not his, but belonged to his mother. Petitioner's mother apparently died on December 29, 1983. Petitioner contends that shortly after his mother's death, he and his sisters removed approximately $ 112,000 from beneath a step in his mother's home in Scarsdale, New York, and that he then placed the money in his safe. Petitioner's account is confirmed by his sisters, Mildred and Lisa, who testified that they gave the money to petitioner because they feared that Mildred's son, Michael, would otherwise steal it. The account is also confirmed by Stanley Behar, who testified that he was present when petitioner's 717 sisters counted the255 money recovered from under the step, and by Warren Martin and Ines Vessio, petitioner's wife, who both testified that petitioner told them that he was holding money belonging to his deceased mother. Petitioner denies that the remainder of the money found in his safe represents income. For a number of reasons, we do not accept petitioner's account of the money found in his safe. First, we note that none of the witnesses who confirmed the account fairly may be characterized as unbiased. The witnesses who confirmed petitioner's story are his sisters, his wife, Mr. Behar and Mr. Martin. Petitioner's sisters and wife are, of course, close relatives. We observed Mr. Behar and Mr. Martin on the witness stand and do not consider their testimony credible. Additionally, both Mr. Behar and Mr. Martin are business associates of petitioner who were named in the indictment against petitioner and have been convicted of criminal usury. 5256 Petitioner's mother kept and used safe deposit boxes in a bank. Given that fact, we find it unlikely that she would have kept a large sum of cash under a step. Even assuming that petitioner's mother harbored some distrust of banks that caused her to keep a cash hoard, we fail to understand why petitioner's sisters would have given the cash to petitioner instead of placing the funds in some income-producing account. We believe Lisa Vessio, as executrix of her mother's estate, would have exercised better judgment. Another reason for disbelieving petitioner's account is that it contradicts his statement to Detective Lowe on the day of the search that the seized cash had come from his mother's safe deposit box. The account also varies from a statement made by an accountant representing petitioner that the cash belonged to petitioner's father. The accountant possessed a power of attorney empowering him to represent petitioner before respondent with respect to petitioner's Federal income tax liability for 1983. Evidence of the accountant's statement is admissible as that of a party opponent's agent. Fed. R. Evid. 801(d)(2)(C). The state estate tax return for petitioner's257 mother's estate does not, in our view, supply sufficient corroboration of petitioner's account. The return claims that the estate includes $ 153,000 in cash, but such statement was made during the pendency of the instant proceeding and did not result in tax liability. Additionally, we properly may infer from petitioner's repeated invocation of the privilege against self-incrimination that his account of the discovered funds is false. Petzoldt v. Commissioner, supra at 685-686 (although negative inference from invocation of privilege does not supply "substantive proof" of illegal activity that respondent must produce, once substantive evidence has been produced, the negative inference may discredit taxpayer's rebuttal). Petitioner produced no credible evidence that the remainder of the seized funds, $ 40,569, were other than income for the periods in issue. His wife testified that the money was held for petitioner's father, but we do not find her testimony credible. In support of his position that respondent's determination is incorrect, petitioner also argues258 that the black notebook discloses a negative cash flow. Respondent's determination, however, is that petitioner had income from gambling and loansharking for the years in issue. Even if the loansharking produced a negative cash flow because petitioner's operation was shut down before loans were repaid, bookmaking could have generated the money respondent contends represents income. In fact, we view as reasonable respondent's conclusion that loansharking and bookmaking were simultaneously conducted, with cash flow from the latter activity supplying the capital with which to conduct the former activity. Respondent's determination that the seized cash represents income received during the period such activities were conducted appears equally reasonable. We do not deem it significant that the indictment charging petitioner with criminal usury states that petitioner acted in concert with other individuals. The record contains no evidence that petitioner held cash belonging to the others. Self-Employment TaxPetitioner's only objection to the determination respecting self-employment tax under section 1401(a) is that respondent's determination of unreported illegal income259 is incorrect. Since we have held to the contrary, we also hold that petitioner is liable for self-employment tax as determined by respondent. II. UNREPORTED INTEREST INCOME Respondent determined that petitioner received but failed to report $ 390 of interest income from Manufacturer's Hanover Trust in 1984. 6 On brief and at trial, petitioner's counsel represented that petitioner's mother and her 718 grandson, and not petitioner, had an account at the bank but used petitioner's social security number. At trial, however, petitioner offered no evidence to support such contention. As noted, the taxpayer normally bears the burden of going forward as well as the burden of proving respondent's determination incorrect. Rule 142(a); Welch v. Halvering, 290 U.S. at 115.260 We have already discussed one exception to this general rule, i.e., that which provides that determinations of unreported illegal income are not presumed correct unless respondent has adduced substantive evidence linking the taxpayer to the illegal, income-producing activity. Some courts have extended the exception to determinations of unreported legal income, reasoning that "the obvious difficulties in proving the nonreceipt of income" necessitate a rule requiring respondent to make an initial showing. Anastasato v. Commissioner, 794 F.2d 884">794 F.2d 884, 887 (3d Cir. 1986). In LaBow v. Commissioner, 763 F.2d 125 (2d Cir. 1985), affg. in part, revg. in part, and remanding in part a Memorandum Opinion of this Court, a determination that a taxpayer had received alimony payments was supported solely by the unsubstantiated testimony of an ex-spouse who claimed to have made the payments. The Second Circuit Court of Appeals, which would hear an appeal of the instant case, held that the determination was not entitled to a presumption of correctness. 763 F.2d at 132. The court reasoned as follows: SBut 261 while "the burden of proof may be said technically to rest" on Myrna, a taxpayer contesting the IRS's determination of income received, United States v. Janis, 428 U.S. 433">428 U.S. 433, 441, 96 S. Ct. 3021">96 S.Ct. 3021, 3026, 49 L. Ed. 2d 1046">49 L.Ed. 2d 1046 (1976), Myrna, unlike Ronald [ex-spouse], need not prove the IRS wrong; if Myrna can show the IRS made "a 'naked' assessment without any foundation whatsoever," id. (emphasis in original), then the burden shifts back to the IRS to prove her receipt of alimony income. * I 763 F.2d at 132. See also Schaffer v. Commissioner, 779 F.2d 849">779 F.2d 849, 858 (2d Cir. 1985), affg. in part and remanding in part a Memorandum Opinion of this Court. In the instant case, petitioner has conceded his link to the determined interest income. His counsel represented that the interest-bearing account bore petitioner's social security number. Given this concession, we cannot characterize the determination as lacking "any factual basis." LaBow v. Commissioner, supra at 132. Because petitioner offered no evidence, not even his own testimony, refuting respondent's262 determination of interest income, we must uphold the determination. III. FRAUD ADDITIONS Respondent seeks additions to tax for fraud under section 6653(b)(1) and (2) for 1983 and 1984. Respondent bears the burden of proving, by clear and convincing evidence, some underpayment attributable to fraud for each year. Petzoldt v. Commissioner, supra at 699; sec. 7454(a); Rule 142(b). Fraud must never be presumed or decided on the basis of suspicion. Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85, 92 (1970). Respondent does not meet his burden by relying upon a taxpayer's failure to disprove respondent's determination of a deficiency. Habersham-Bey v. Commissioner, 78 T.C. 304">78 T.C. 304, 312 (1982); Otsuki v. Commissioner, 53 T.C. 96">53 T.C. 96, 106 (1969); Pigman v. Commissioner, 31 T.C. 356">31 T.C. 356, 370 (1958). We hold that respondent has failed to prove, by clear and convincing evidence, underpayments attributable to fraud for the years in issue. Although respondent has linked petitioner to loansharking and bookmaking in those263 years and petitioner has not disproved respondent's determination of income for those years, respondent has not adduced clear and convincing evidence that the activities were indeed profitable in either of those years. While it is reasonable to infer that the money found in the safe represented income from the activities for the period in which the activities were conducted, we believe that such an inference falls short of clear and convincing evidence of income. 7 We cannot simply presume that petitioner's activities produced income in the years in issue and apply the fraud additions on that basis. 8264 719 Although we hold that, due to certain circumstances described above, petitioner's explanation for the seized cash does not satisfy his burden of refuting respondent's deficiency determination, petitioner's explanation does raise sufficient doubt to prevent respondent from meeting his burden of proving fraud by clear and convincing evidence in the instant case, considering his failure to present any accepted method of reconstructing petitioner's income 9 and the fact that petitioner's records from his loansharking activities showed a loss. In Jones v. Commissioner, 29 T.C. 601">29 T.C. 601, 619 (1957), we were presented with an analogous situation and reasoned: just as the petitioner failed to show that the deposits in controversy did not in some substantial part represent income, the respondent has similarly failed to prove that the amounts in question were income, and the mere showing on his part that there was a failure to report as income items which insofar as shown by the evidence could in some part have been either income or nonincome items does not establish that, by reason of the omission of such items, the returns were false and fraudulent with intent to evade tax. 265 * * * See also Anastasato v. Commissioner, supra at 888-889. We take seriously the statutory admonition that clear and convincing evidence support a finding of fraud. We therefore decline to find fraud on the basis of inferences in the instant case. IV. SECTION 6661 ADDITIONS Respondent seeks additions to tax under section 6661. That provision imposes an addition to tax for the "substantial understatement" of tax liability. Section 6661(b) defines a substantial understatement as one exceeding the greater of 10 percent of the correct tax or $ 5,000. Petitioner offers no argument as to why additions under section 6661 should not be imposed in the event we uphold deficiencies meeting the statutory threshold. Consequently, we hold that the additions apply if the Rule 155 computation which we will direct discloses deficiencies that warrant imposition of266 the addition. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended and in effect 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 $ 65,103 ** 50 percent of the interest on $ 7,783↩2. Respondent does not contend that the blue notebook also evidences petitioner's loansharking, perhaps because police believed that the notebook belonged to petitioner's father.↩3. E.g., Segers v. Commissioner, T.C. Memo. 1990-28; Constable v. Commissioner, T.C. Memo. 1989-554; Pring v. Commissioner, T.C. Memo. 1989-340↩.4. At trial, petitioner invoked the Fifth Amendment privilege against self-incrimination in response to questions regarding the black notebook. We do not, however, rely upon any negative inference from such invocation in holding that respondent has met his burden of linking petitioner to illegal, income-generating activity. Petzoldt v. Commissioner, 92 T.C. 661">92 T.C. 661, 685-686↩ (1989).5. We consider respondent's motion to have the testimony of Mr. Behar and Mr. Martin stricken as moot, because we lend no credence to the testimony of either witness.↩6. Respondent also determined that petitioner received but failed to report dividend and interest income from Dreyfus Liquid Assets and Ridgewood Savings Bank, respectively, but respondent conceded these items in his opening brief.↩7. Respondent cites no authority for the proposition that the burden of proving an underpayment is satisfied solely by evidence of seized cash, nor has our own research disclosed any such authority. In cases in which respondent has based a deficiency on seized cash, respondent has not determined the fraud addition. E.g., Segers v. Commissioner, T.C. Memo. 1990-28; Constable v. Commissioner, T.C. Memo. 1989-554; Pring v. Commissioner, T.C. Memo. 1989-340; Graham v. Commissioner, T.C. Memo 1987-410">T.C. Memo. 1987-410. Moreover, in cases involving seized cash in which we have held that the fraud addition applies, respondent used some accepted indirect method of proving income. Petzoldt v. Commissioner, 92 T.C. at 694 (cash expenditures method used); Mack v. Commissioner, T.C. Memo. 1989-490 (cash expenditures method used); Bonacci v. Commissioner, T.C. Memo. 1989-289↩ (net worth method used). By citing the foregoing examples we do not mean to decide that respondent can never meet his burden of proving an underpayment by relying solely on evidence of seized cash. 8. While it may be reasonable to presume that bank deposits represent income for the period during which the deposits are made (see Marghzar v. Commissioner, T.C. Memo. 1989-609↩), in the instant case, the connection between the seized cash and the years in issue is not as clear.9. See footnote 7, supra↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625676/	John W. Ground and Charlotte Ground v. Commissioner.John W. Ground v. CommissionerDocket No. 31717.United States Tax Court1952 Tax Ct. Memo LEXIS 219; 11 T.C.M. (CCH) 484; T.C.M. (RIA) 52144; May 15, 1952Harry F. Russell, Esq., 205 City Nat'l Bk. Bldg., Hastings, Neb., for the petitioners. William B. Springer, Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: This proceeding involves deficiencies in income tax for the years 1947 and 1948 in the amounts of $186.71 and $379.24, respectively. An increased deficiency for 1947 claimed by respondent in an amended answer has been abandoned. The only issue is whether petitioner, John W. Ground, is entitled to claimed deductions in the taxable years for meals, lodging, laundry, and tools "while away from home". Other adjustments involving claimed exemptions for 1948 are not contested by petitioners. Findings of Fact Petitioners are husband and220 wife and reside at Hastings, Nebraska. They filed their joint income tax returns for the years 1947 and 1948 with the collector of internal revenue for the district of Nebraska. Petitioner, John W. Ground, hereinafter referred to as the petitioner, has maintained a residence in Hastings since 1935 or 1936. Since the later year he has been a carpenter, usually selling his services, but contracting occasionally for odd jobs. He did no contracting during the years in issue. Maxon Construction Company, hereinafter called Maxon, had its principal office in Dayton, Ohio, in 1947 and 1948. In 1942 Maxon had been engaged in the construction of a naval ammunition depot at Hastings and had employed petitioner during that year on the project as a carpenter. During 1943 and 1944 petitioner performed small jobs as a carpenter for another contractor in Hastings. During 1945 and part of 1946 Maxon did additional work at the naval depot in Hastings and again employed petitioner. This employment terminated about September 1946. When Maxon left Hastings in 1946 after completion of the naval depot it invited petitioner to go to Miamisburg, Ohio, as a carpenter since Maxon was going to construct221 an atomic energy research plant there. Miamisburg is about 800 miles distant from Hastings, and about 15 miles from Dayton, Ohio. Petitioner did not immediately go to Miamisburg, but worked during the remainder of 1946 and until January 1947 for a local construction company in Hastings and engaged in a few small jobs on his own. In February 1947 petitioner went to Miamisburg and began working for Maxon as a carpenter on the atomic energy research plant. He continued his employment with Maxon from February 1947 until December 21, 1948. During that time petitioner had no business of his own. He was paid an hourly wage, worked eight hours a day, and received a weekly paycheck. Petitioner's wife lived in Hastings during 1947 and 1948, except for four or five weeks during 1948 when she went to Miamisburg to stay with petitioner. During those years petitioner visited in Hastings on one or two occasions for short periods of time. In addition to his wife, petitioner's family consisted of a son and two daughters. Petitioner's wife was not employed and the two girls lived with her at the family residence. Their son lived there too until he was married in 1948. While in Miamisburg petitioner222 lived in a room in a private home most of the time and part of the time in a trailer camp. He purchased his meals in restaurants where the prices were moderate. He furnished his own tools. Maxon did not pay any of petitioner's traveling expenses between Hastings and Miamisburg. There was no understanding that Maxon would pay any of petitioner's living expenses in Miamisburg and it did not do so. Maxon did not require petitioner to do any traveling while he was in Miamisburg. During 1947 petitioner paid $300 for room rent, $750 for meals, and $43 for laundry. During 1948 petitioner paid $355 for room rent, $877.50 for meals, and $51 for laundry. These expenditures were made while petitioner was at Miamisburg, Ohio. Opinion Petitioner thus puts his argument: " * * His employment as carpenter was not temporary, but definite and applicable to the time required for completion of carpenter work on the several projects upon which he was employed. The expenses were necessary, reasonable and appropriate to his occupation. He owned and maintained his family home at Hastings, Nebraska and the definite posts of temporary employment were in cities other than those of his home residence. 223 "The expenses were normal and usual to the type of occupation engaged in; they were required in the conduct of and in connection with the business in which the taxpayer was engaged; they were incurred while he was away from home. The law contemplates and permits the deduction of such expenses." We think petitioner has reached an erroneous conclusion. Ordinarily, expenses for items such as meals, laundry, and lodging would be "personal, living, or family expenses" and hence nondeductible under section 24 (a) (1) of the Internal Revenue Code. They would become deductible only if property brought within the classification of "traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business" provided for in section 23 (a) (1) (A). Petitioner's contention apparently is that his employment as Miamisburg was "temporary" and "away from home" and that this put him in travel status and expenses that would otherwise be nondeductible thus became deductible. This argument misses the primary tests set up in Commissioner v. Flowers, 326 U.S. 465">326 U.S. 465. To be deductible the expenses not224 only must be incurred in traveling for business purposes, but also must have a direct connection with carrying on the business of petitioner's employer. Here, petitioner had no business of his own - he was an employee of Maxon. Maxon did not require him to travel to Miamisburg on its business. In his own words, "they gave me an invitation" when they left Hastings and he accepted that invitation to go to work for them in 1947. As a result of accepting the "invitation" petitioner traveled from Hastings to Miamisburg, entered again the employ of Maxon, and stayed in Miamisburg almost all of 1947 and 1948. This move was made for personal reasons. The expenses sought to be deducted were incurred during the time petitioner stayed in Miamisburg. They were of no different a character than such expenses would have been had petitioner stayed in Hastings. We can reach no other conclusion but that the cost of his food, lodging, and laundry were personal expenses of petitioner and that they had no connection whatsoever with Maxon's construction business. Petitioner had no right to deduct them and respondent's action in disallowing these deductions is sustained. Henry C. Warren, 13 T.C. 205">13 T.C. 205;*225 Willard S. Jones, 13 T.C. 880">13 T.C. 880. As far as the small amounts claimed to be deductible as expenses for tools are concerned, we find the proof to be insufficient to make findings thereon. We do not decide whether the amounts claimed, if proven, would be deductible. Accordingly, respondent's disallowance is approved. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625677/	GLENN WINFORD RYAN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRyan v. CommissionerDocket No. 10053-82.United States Tax CourtT.C. Memo 1984-482; 1984 Tax Ct. Memo LEXIS 195; 48 T.C.M. (CCH) 1073; T.C.M. (RIA) 84482; September 10, 1984. Glenn Winford Ryan, pro se. Mark A. Pridgeon, for the respondent. CLAPPMEMORANDUM FINDINGS OF FACT AND OPINION CLAPP, Judge: Respondent determined deficiencies in the income tax of petitioner Glenn Ryan and his wife of $2,062 for 1978 and $484 for 1979. With regard to both years, we must determine the amount of traveling expenses petitioner may deduct. With regard to 1978 only, we must determine whether petitioner received income which was not reported. FINDINGS OF FACT 196 Some of the facts have been stipulated. The stipulation and attached exhibits are incorporated herein by this reference. Petitioner is a pipe fitter. At the beginning of 1978 he resided in Milwaukee, Wisconsin. From February 1978 until April 1980 he was employed by A.W. Kuettel & Sons, Inc. (Kuettel) on a construction project in and and near Siler Bay, Minnesota. The project involved the construction of a disposal site for taconite tailings from the Reserve Mining Company's processing plant at Silver Bay. Some time in 1978 after petitioner accepted employment with Kuettel, he and his wife moved to Two Harbors, Minnesota, which is near Silver Bay. They did not maintain a home in Milwaukee while petitioner was employed by Kuettel. Petitioner received $3,135 in subsistence pay from Kuettel during 1978. Petitioner and his wife filed joint returns for 1978 and 1979. On the return for 1978, petitioner deducted $2,360 in mileage, representing travel to and from the Silver Bay project work site. He also deducted $1,213 in meals and lodging expenses related to his employment with Kuettel. For 1979, petitioner deducted mileage expenses of $2,072, again representing travel to and197 from the Silver Bay work site. On February 9, 1982, respondent mailed a notice of deficiency to petitioner and his wife. The notice disallowed the deductions mentioned above and added $3,300 in unreported income for 1978. On May 12, 1982, Mr. Ryan's petition was filed. His wife did not join him in filing the petition and she is not a party in this case. Petitioner resided in Two Harbors, Minnesota, when his petition was filed. OPINION Petitioner contends his employment with Kuettel was temporary. He apparently believes his mileage, food, and lodging expenses are therefore deductible under section 162. 1 See, e.g., Tucker v. Commissioner,55 T.C. 783">55 T.C. 783, 786 (1971). 2 Respondent contends petitioner's expenses are nondeductible personal expenditures within the meaning of section 262.198 Petitioner's testimony shows that he believes all construction work is temporary since employment at any particular site ceases when the construction at that site is completed. However, this Court has rejected the view that construction work is inherently temporary. Garlock v. Commissioner,34 T.C. 611">34 T.C. 611, 615-616 (1960). 3 We regard employment as temporary if its termination within a short time can be foreseen. Mitchell v. Commissioner,74 T.C. 578">74 T.C. 578, 581 (1980). Petitioner's contention that his employment with Kuettel was temporary is based on his testimony that he had no assurance that he would not be laid off. This, however, is not determinative. McCallister v. Commissioner,70 T.C. 505">70 T.C. 505, 510 (1978). It does not establish that petitioner would be laid off within a short time. Unfortunately for petitioner, there simply is no evidence concerning how long his employment with Kuettel was expected to last. There is no evidence about whether the Silver Bay project might have been abandoned before it was completed or whether petitioner expected to be laid199 off during harsh Minnesota winters. Cf. Frederick v. United States,603 F.2d 1292">603 F.2d 1292, 1296 (8th Cir. 1979). Furthermore, even if petitioner expected that he might have been laid off, there is no evidence that he would not have been rehired after a short period. Cf. Weiberg v. Commissioner,639 F.2d 434">639 F.2d 434, 437 (8th Cir. 1981), affg. a Memorandum Opinion of this Court. A short work stoppage, alone, does not establish that a job is temporary. Frederick v. United States,supra at 1296; Blatnick v. Commissioner,56 T.C. 1344">56 T.C. 1344, 1348 (1971). Petitioner has the burden of proving that his employment with Kuettel was temporary. Welch v. Helvering,290 U.S. 111">290 U.S. 111, 115 (1933); Tax Court Rule 142(a).On this record, petitioner has not carried that burden and respondent's determination on this issue must be sustained.4*200 With regard to the unreported income, respondent determined in the notice of deficiency petitioner received $3,300 in subsistence pay from Kuettel during 1978 which was not reported. Respondent conceded, and testimony by the payroll supervisor of Kuettel established, that the amount of the subsistence pay petitioner received was $3,135. Petitioner contends only that he reported the amount shown on the Form W-2, Wage and Tax Statement, he received from Kuettel. Petitioner has not adduced any evidence which shows that the subsistence pay was included on the Form W-2. Accordingly, we must find that petitioner did not report the $3,135 in subsistence pay. Decision will be entered under Rule 155.Footnotes1. All references to sections are to the Internal Revenue Code of 1954 as amended and in effect during the years in issue. ↩2. Tucker and other similar cases usually determine whether such expenses are deductible with reference to section 162(a)(2). However, the Court of Appeals for the Eighth Circuit, the circuit to which this case may be appealed, has held such expense may also be deducted under section 162(a). Frederick v. United States,603 F.2d 1292">603 F.2d 1292, 1295↩, n.5 (1979).3. See Brown v. Commissioner,T.C. Memo. 1982-189↩.4. Even if petitioner's employment with Kuettel were temporary, he would not be entitled to deduct mileage, food, and lodging after he moved to Minnesota. He did not have duplicate living expenses after he moved. See, e.g., Thomas v. Commissioner,T.C. Memo. 1976-394↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625678/	THOMAS J. MCLAUGHLIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.McLaughlin v. CommissionerDocket No. 59788.United States Board of Tax Appeals29 B.T.A. 247; 1933 BTA LEXIS 974; October 31, 1933, Promulgated 974 FRAUD PENALTIES - EVIDENCE. - Respondent's proof that petitioner was indicted for willful failure to file returns and evasion of taxes, to which he pleaded guilty and was sentenced, is sufficient, in the absence of any explanation by petitioner, to sustain the imposition of fraud penalties for those years covered by the plea and sentence. Fraud penalties disallowed for other years for which it appears petitioner was indicted but the evidence shows no record of any plea by petitioner of disposition by the court. Robert W. Smith, Esq., and J. M. Horn, Esq., for the petitioner. C. H. Curl, Esq., for the respondent. ARUNDELL247 The respondent's assertion of 50 percent fraud penalties is the only matter at issue in this proceeding. The penalties asserted are as follows: 1924$657.66192567.211926282.251927$1,257.121928760.861929387.46FINDINGS OF FACT. Petitioner, during the period 1924 to 1929, inclusive, was a resident of Greensburg, Pennsylvania, and was a member of the police force of that commonwealth. For each of the years involved petitioner failed to file an income tax return at the times975 prescribed by the revenue acts and regulations then in force. Subsequently, upon an investigation by a revenue agent, it was discovered that petitioner had received taxable net income. Thereupon, on or about August 21, 1930, the revenue agent prepared returns which were executed by petitioner, showing income tax for each year, to which was added and assessed a 25 percent penalty. The taxes and penalties, together with interest, were paid by petitioner in August 1930. The amounts of the taxes and 25 percent penalties are as follows: YearTax25% penalty1924$1,315.32$328.831925134.4233.611926564.50141.121927$2,514.23$628.5619281,521.72380.431929774.91193.73On November 14, 1930, petitioner was indicted in the District Court of the United States for the Western District of Pennsylvania, for unlawfully, willfully, knowingly, and feloniously attempting 248 to evade income tax for each of the years 1924 to 1929, inclusive, and also for unlawfully, willfully, knowingly, and feloniously failing to file income tax returns for each of the years 1927, 1928 and 1929. On January 22, 1931, petitioner pleaded guilty to the indictment976 in so far as it pertained to the years 1927, 1928 and 1929, whereupon he was sentenced by the court to pay a fine of $1,000 and costs and to serve three months imprisonment in the Westmoreland County jail. The notice of deficiency asserting the fraud penalties was mailed by respondent on July 2, 1931. The deficiencies in tax for the years 1927, 1928 and 1929 were due to fraud with intent to evade tax. OPINION. ARUNDELL: Petitioner denies fraud, but the main attack upon the assertion of the penalties is that the penalties imposed by section 275(b) of the Revenue Act of 1926 and section 293(b) of the Revenue Act of 1928 are an integral part of the deficiency in tax and there is no authority in law for the assertion of such penalties after the basic tax and delinquency penalties have been assessed and collected. The portions of the revenue acts applicable here are alike and provide as follows: ADDITIONS TO THE TAX IN CASE OF DEFICIENCY SEC. 275. (a) If any part of any deficiency is due to negligence, or intentional disregard of rules and regulations but without intent to defraud, five per centum of the total amount of the deficiency (in addition to such deficiency) 977 shall be so assessed, collected, and paid, in the same manner as if it were a deficiency * * . (b) If any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be so assessed, collected, and paid, in lieu of the 50 per centum addition to the tax provided in section 3176 of the Revised Statutes, as amended. These provisions, on their face, contain nothing that would require respondent to enforce penalties simultaneously with the assertion of a tax liability or forever after prevent him from asserting a penalty liability. The statute treats the penalties as "additions to the tax" and the only requirement as to enforcement proceedings is that they shall be "assessed, collected, and paid, in the same manner" as if they were deficiencies. We have no occasion here to question the statement in , that: The normal tax and the [50 per cent] penalty were constitutent parts of the whole deficiency tax, which under the statute constituted a single liability and not an aggregation of separate items978 of liability. 249 Undoubtedly income tax liability for any year constitutes a "single liability", yet if the taxpayer reports only a portion of it the respondent not only may, but is required by law, to proceed to collect the balance. This is the usual situation giving rise to a deficiency. True, the respondent is prohibited from asserting a deficiency piecemeal, with certain exceptions (sec. 272(f), Revenue Act of 1928), but that is not involved here, as the only amount claimed is that determined to be due in excess of the amounts "previously assessed (or collected without assessment)." Sec. 273, Revenue Act of 1926; sec. 271, Revenue Act of 1928. So in the present case, if, as contended, the taxes and penalties constitute a "single liability", the respondent was entirely within his statutory rights in proceeding, through the sending of a deficiency notice, to collect the unpaid portion of the liability. The question of the sufficiency of respondent's proof - he having the burden - is raised, though not seriously pressed. This consisted solely of an exemplified copy of the record of the United States District Court, showing the indictment of petitioner, his plea979 of guilty, sentence of the court, and commitment. The record of a plea of guilty in a criminal case and the conviction thereon may be received in evidence in a civil suit arising out of the same matter. Such evidence is not conclusive in the civil proceedings, but is receivable as an admission to be given weight according to the circumstances. Like other admissions, they may be explained and the circumstances given under which they were made, in order to throw light upon the force that should be given to them. ; ; ; . In this case petitioner made no attempt to explain in any way the circumstances surrounding his plea and his conviction in the criminal proceeding against him. As this was the only evidence offered, we are constrained to accept it as establishing, sufficiently to support the respondent's burden, the elements necessary to prove "fraud with intent to evade tax." As stated in the findings of fact, petitioner was indicted for all the years from 1924 to 1929. Counsel for respondent980 states in his brief that the plea of guilty went to the years 1927, 1928 and 1929, although this does not appear elsewhere in the record. Respondent contends that this is "presumptive evidence" of petitioner's guilt for the earlier years in which income was not reported. Whatever the presumption may be, proof of fraud for one year will not sustain the respondent's burden of proving fraud in another year. We accordingly sustain the fraud penalty only for the years 1927, 1928 and 1929. 250 The respondent, by appropriate pleading, asks that the 5 percent penalty be asserted in the event that the Board does not sustain the charge of fraud but finds that there was negligence or intentional disregard of rules and regulations. The record contains nothing to support the assertion of a negligence penalty for the years prior to 1927, which are the only years to which this penalty could apply under the pleadings and our holding as to the other years. While petitioner was delinquent in filing returns for the earlier years there is no evidence of the reason for the delinquency. The burden of proof on this point is on the respondent and he has not sustained it. Decision will*981 be entered for the petitioner for the years 1924, 1925 and 1926, and for the respondent for the years 1927, 1928 and 1929.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625679/	JOHN E. RODGERS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRodgers v. CommissionerDocket No. 26765-81.United States Tax CourtT.C. Memo 1986-335; 1986 Tax Ct. Memo LEXIS 276; 51 T.C.M. (CCH) 1669; T.C.M. (RIA) 86335; July 31, 1986. John M. McCauley, for the petitioner. John C. McDougal, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent determined the following deficiency in, and additions to, petitioner's Federal income taxes: Additions to taxYearDeficiencySec. 6653(b) 1Sec. 66541980$672,646.40$336,323.20$42,946.17The issues for decision are: (1) whether petitioner received unreported income from the sale of illegal drugs during the taxable year 1980; (2) whether part of the underpayment of petitioner's income tax for that year was due to fraud; and (3) whether petitioner underpaid his estimated tax for that277 year. FINDINGS OF FACT Some of the facts are stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. John E. Rogers (petitioner) resided in Colonial Heights, Virginia, when he filed his petition in this case. Petitioner did not file a Federal income tax return for his taxable year 1980 within the period prescribed by law, nor had he filed such a return as of October 17, 1983. On December 3, 1982, petitioner entered a plea of guilty in the Circuit Court of the City of Colonial Heights, Virginia, to charges of conspiracy to possess with intent to distribute marijuana, cocaine, and methaqualone (quaalude), and attempted bribery. Indictment of petitioner on the drug charges related to his activities between May 7, 1980 and June 1, 1980. Opha Winston Peden was indicted on similar charges as petitioner's co-conspirator, but the charges against Peden were latter nol prossed pursuant to an order of the Circuit Court. During the period January 1980 through April 1980 (approximately 15 weeks), petitioner sold at least 5 pounds of marijuana per week to Peden, at a price of $325 per pound. During 1980, petitioner also278 sold one 42-pound bale of marijuana to Peden at a price of $295 per pound. Petitioner paid no more than $265 per pound for this marijuana. Petitioner also made sales of marijuana to other persons during this period. During his taxable year 1980, petitioner had gross receipts from the sale of marijauna to Peden in the amount of $36,765, and a cost of goods sold on these sales in an amount no greater than $31,005. During the year 1980, petitioner made a bulk purchase of 1,000,000 quaaludes at a cost of $0.19 per quaalude. The street price of a quaalude in 1980 was $2 to $4. Petitioner sold Peden small quantities of quaaludes for $1.15 each, but sold the bulk of his quaaludes in lots of 10,000 at a price per pill of $0.85 to $0.95. Petitioner had gross receipts from the sale of quaaludes of at least $850,000 during his taxable year 1980, and a cost of goods sold on these sales of $190,000. During the year 1980, petitioner sold 12 ounces of cocaine to Peden, 8 ounces at a price of $1,800 per ounce, and 4 ounces at a price of $2,300 per ounce. During 1980, petitioner purchased cocaine at a cost of no more than $30,000 per pound. Petitioner was also selling cocaine to persons other279 than Peden during 1980. Petitioner had gross receipts from the sale of cocaine of at least $23,600 during his taxable year 1980, and a cost of goods sold on these sales of $20,000. 2During Peden's association with petitioner, from November 1977 through April 1980, petitioner dealt with large amounts of each. On one occasion during280 this period, Peden observed a large sum of currency in a brief case in petitioner's possession. Petitioner told his wife, in Peden's presence, that the brief case contained $250,000 in cash. On a number of other occasions, petitioner sent large amounts of each from Richmond, Virginia, to other cities via air express. These packages were mailed in the name of one or the other of petitioner's two daughters. Petitioner told Peden that he owned real estate in Florida, as well as elsewhere on the East Coast, but that the property was not kept in his own name. He also told Peden that he kept most of his money with his daughters because he knew that if he were arrested, the Internal Revenue Service would follow up on any convictions the Government obtained. OPINION 1. Unreported IncomeThe first issue for decision is whether petitioner had unreported income from the sale of illegal drugs for the taxable year 1980. Respondent now asserts that a deficiency is due based on petitioner having underreported his income for 1980 by the amount of $678,695. 3 Petitioner asserts that respondent's determination of the deficiency should not be allowed to stand on the basis of the testimony281 of Peden because such testimony was the product of bias and self-interest. Petitioner contends that because Peden's testimony was the only evidence offered by respondent as proof of a deficiency, we should not find petitioner liable for any part of the determined deficiency. Respondent's determination of a deficiency is presumptively correct and petitioner has the burden of proving error in such determination. Welch v. Helvering,290 U.S. 111">290 U.S. 111, 115 (1933); Rule 142(a). 4 Petitioner has failed to offer any evidence casting doubt on the deficiency determined by respondent. Based on the testimony of Peden at trial, however, we find that respondent erred in calculating petitioner's cost of goods sold for his sales of cocaine in 1980. Accordingly, we hold that petitioner is liable for a deficiency in tax based282 on his having underreported his income for 1980 by the amount of $669,945. 52. FraudWe next consider whether any part of the underpayment of petitioner's income tax for the taxable year 1980 was due to fraud. Section 6653(b) imposes an addition to tax if any part of an underpayment of tax is due to fraud. Respondent bears the burden of proving fraud by clear and convincing evidence. Section 7454(a); Rule 142(b); Otsuki v. Commissioner,53 T.C. 96">53 T.C. 96, 105 (1969). Respondent must show that the taxpayer intended to evade taxes which he knew or believed that he owed, by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. Webb v. Commissioner,394 F.2d 366">394 F.2d 366, 377-378 (5th Cir. 1968),283 affg. a Memorandum Opinion of this Court; Acker v. Commissioner,26 T.C. 107">26 T.C. 107, 111-112 (1956). Respondent contends that he has clearly proven fraud by establishing that: (1) petitioner failed to file an income tax return for 1980; (2) the amount of petitioner's unreported income was substantial; (3) petitioner's income earning activities were of an illegal nature; (4) petitioner dealt in large amounts of cash and conducted many business transactions; and (5) petitioner held assets in the names of his daughters. The only evidence offered by respondent to prove these facts, other than petitioner's criminal conviction and failure to file a return, was the testimony of Peden. Petitioner chose to offer no evidence with respect to the issue. Instead, he asserts that respondent cannot satisfy his burden of proof by relying solely on petitioner's failure to file a return, his criminal conviction and Peden's testimony. We are not bound to accept uncontradicted testimony if it is found to be improbable, unreasonable, or the likely product of self-interest. Wood v. Commissioner,338 F.2d 602">338 F.2d 602, 605 (9th Cir. 1964), affg. 41 T.C. 593">41 T.C. 593 (1964); 284 Demkowicz v. Commissioner,551 F.2d 929">551 F.2d 929, 931 (3d Cir. 1977). However, Peden's testimony in this case was consistent, reasonable and not inherently improbable. In attempting to establish that Peden's testimony was based on self-interest, petitioner has done nothing more than to allege that the Commonwealth of Virginia was not barred from reinstating the charges against Peden and that the State authorities might have done so if Peden had not given testimony favorable to respondent in this case. Without any evidence to show that State officials might be inclined to take such action, we find this allegation to be highly unlikely and clearly insufficient to impeach Peden's testimony. The facts established by Peden's testimony, in conjunction with petitioner's failure to file a return, are sufficient to satisfy respondent's burden of proof. 6 Accordingly, we hold that respondent has proved by clear and convincing evidence that part of petitioner's underpayment of tax for 1980 was due to fraud. *285 3. Section 6654 Addition to TaxFinally, we must decide whether respondent correctly determined that petitioner underpaid his estimated tax for his taxable year 1980. Petitioner has the burden of proving error in respondent's determination. Welch v. Helvering,supra at 115; rule 142(a). Petitioner presented no evidence on this issue. Accordingly, we sustain respondent's determination. To reflect our conclusions on the disputed issues, Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue.↩2. Respondent asserts that petitioner's cost of goods sold for cocaine should be based on petitioner cutting the purity of the cocaine by 50 percent prior to resale. Peden testified at trial, however, that the cocaine purchased by petitioner was 90 percent pure and that petitioner only cut the cocaine to 80 or 85 percent purity before resale. We will assume that the purity of the cocaine was cut from 90 percent to 80 percent based on petitioner's failure to prove the cocaine sold was more than 80 percent pure. Rule 142(a), Tax Court Rules of Practice and Procedure. The cost of goods sold of the cocaine is, therefore, $20,000, computed as follows: ↩16 ounces at $30,000/pound=$1,875.00per ounceCut from 90 to 80 percentX8/9 Cost per ounce sold$1,666.67Ounces soldX12Total cost of goods sold$20,000.003. Respondent calculates this amount as follows: ↩Gross Receipts:Marijuana$36,765Quaaludes850,000Cocaine23,600Total Gross Receipts$910,365Cost of Goods Sold:Marijuana$30,420Quaaludes190,000Cocaine11,250Total Cost of Goods Sold$231,670Total Amount Underreported$678,6954. Unless otherwise indicated, all rule references are to the Tax Court Rules of Practice and Procedure. ↩5. This amount is calculated as follows: ↩Gross Receipts:Marijuana$36,765Quaaludes850,000Cocaine23,600Total Gross Receipts$910,365Cost of Goods Sold:Marijuana$30,420Quaaludes190,000Cocaine20,000Total Cost of Goods Sold240,420Total Amount Underreported$669,9456. See Yocum v. Commissioner,T.C. Memo. 1985-447 (finding of fraud where taxpayer failed to report substantial illegal income from transportation of marijuana during 2 years and engaged in large cash transactions); Bender v. Commissioner,T.C. Memo. 1985-375 (where taxpayer failed to report income from sale of hashish in 1 year, we stated that a dual motive in failing to file and other acts of concealment did not relieve taxpayer of addition to tax for fraud); Piazza v. Commissioner,T.C. Memo. 1985-222 (finding of fraud where taxpayer omitted substantial amounts of income from extortion); DeVaughn v. Commissioner,T.C. Memo. 1983-712↩ (finding of fraud where taxpayer failed to report illegal bribes and kickbacks during 2 years and deposited money in bank accounts opened under fictitious names).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625680/	ESTATE OF MRS. CORNELIA ADAIR, DECEASED, MONTGOMERY H. W. RITCHIE, ADMINISTRATOR, DE BONIS NON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Adair v. CommissionerDocket No. 95451.United States Board of Tax Appeals43 B.T.A. 384; 1941 BTA LEXIS 1509; January 22, 1941, Promulgated 1509 1. For the years 1925 through 1935 the petitioner valued its inventories of live stock by the constant price method. Such basis was consistently accepted by the respondent for all years except 1935. For 1935 the respondent accepted such basis with respect to three of the petitioner's herds, but as to the other herd determined that the farm price method should be used. Held that the constant price method is not a proper basis for valuing the petitioner's inventories; held, further, that the use of the farm price method is optional with the taxpayer; held, further, that the petitioner, so requesting and showing that cost may be ascertained from its books, is entitled to value its inventories on the basis of cost. 2. The petitioner operates its ranch primarily for the production of calves and for that purpose maintains breeding and growing animals and certain horses and mules in the operation of the ranch. Held, that in computing cost, for inventory purposes, it is proper to apportion to animals born during the year the cost for the year of maintaining the breeding animals; held, further, that death losses during the year (a) on breeding animals may not be1510 apportioned to animals born during the year, (b) on growing animals may not be apportioned to growing animals surviving the year, and (c) on horses and mules may not be apportioned to breeding and growing animals. 3. Where pursuant to the terms of the will the administration of the estate apparently has not been completed, though 14 years have elapsed since the decedent's death, but the activities of the estate have consisted of carrying on a ranch business and not the preparation of the estate for settlement and distribution, held, that the annual premium paid on the bond of the administrator, appointed subsequent to the death of the executors, is an allowable deduction in computing the net income of the estate. George Thompson, Esq., and Albert G. Moss, C.P.A., for the petitioner. James H. Yeatman, Esq., for the respondent. TURNER 385 The Commissioner determined a deficiency of $37,412.37 in the petitioner's income tax for 1935. The issues presented for decision are (1) what the proper basis is for valuing the petitioner's inventories of live stock, and (2) whether the petitioner is entitled to a deduction from income for the1511 amount paid by it during the taxable year as the annual premium on the bond of the administrator. FINDINGS OF FACT. The petitioner, the estate of Mrs. Cornelia Adair, deceased, is being administered under the jurisdiction of the County Court of Armstrong County, Texas, and Montgomery H. W. Ritchie is the duly qualified and acting administrator de bonis non with the will annexed, having been appointed as such by the said court in 1935. The principal office and business address of petitioner is Paloduro, Armstrong County, Texas. The petitioner filed an income tax return for 1935 with the collector of internal revenue at Dallas, Texas, which showed no income tax liability. Cornelia Adair died September 22, 1921. At the date of her death her principal properties were a large cattle ranch, known as the J. A. Ranch, and a herd of live stock, consisting chiefly of cattle. The ranch comprises 425,590 acres of land situated in the Texas Panhandle, and its headquarters, which are at Paloduro, are approximately 54 miles southeast of Amarillo. The ranch was acquired about 1870 by Mrs. Adair and her husband and originally comprised about 1,000,000 acres of land. Practically all of1512 the land is fenced off into pastures. It is divided into what is known as the winter range and the summer range. The winter range, which comprises slightly more than one-half of the total acreage, is rough land and lies in the Paloduro Canyon, which runs north and south and divides the ranch into eastern and western portions. The summer range lies to the east of the canyon and the live stock are grazed there during the summer months. 386 Continuously since the death of Mrs. Adair the estate has been engaged in raising live stock on the ranch. The chief purpose of the business is the production of calves. The estate maintains and operates four herds of live stock; namely, the main cattle herd known as the J.A. herd, the brood cattle herd known as the JJ. herd, the main horse herd, and the brood horse herd. The main cattle herd, composed of white-faced Hereford cattle, is maintained for the purpose of producing calves. The brood cattle herd is a small herd of pure blood Hereford cattle maintained primarily to supply pure bred bulls for the main herd. The estate raises all of its cows. In order to prevent inbreeding in its brood cattle herd one or two bulls are bought1513 each year for that herd. Occasionally a car load of bulls is bought for the main herd. The estate is known and referred to by the cattle industry as a cattle breeder, as distinguished from a feeder who purchases cattle and fattens them for sale as beef cattle. The petitioner has an average of about 10,800 head of cows in the main cattle herd. The cows produce an average of approximately 7,700 calves annually of which about 52 percent are heifers and 48 percent are bulls. The main calving months are March, April, and May, with about two-thirds of the annual calf crop being born prior to June 1 of each year. The petitioner has two round-up periods each year. The first starts in May and is completed by the first week of July. The second starts in September and continues until November. At these round-ups the calves born during the year are segregated from the rest of the cattle. The bull calves are branded, castrated, and turned back on the range and held for sale. The heifer calves are segregated and kept apart from the steer calves, branded, inspected, and turned loose on the range. Those which appear suitable for breeders are retained for that purpose. Those not considered1514 suitable for that purpose are held for sale with the steer calves. Most of the steer calves born prior to June 1 of each year, together with such heifer calves born prior to such date as it is deemed inadvisable to keep for breeding purposes, are generally sold in November of the year in which they are born. The calves which are not of sufficient size and growth to market in November of the year in which they are born are held on the range and sold as soon as expedient in the following year. From the time heifers are branded until they become two years old they are subjected to inspection to determine their future usefulness for breeding purposes. At the age of one year they are carefully examined and those that it is deemed inadvisable to keep are sold. The same kind of examination is given them when they are two years old. The heifers that are thus culled out are not, therefore, included in the following December 31 annual inventory. It is not 387 possible to gather all the steer calves in a round-up and as a result the petitioner's cattle inventory contains one-year, two-year, and three-year old steers. However as soon as these strays are gathered and gotten to the1515 delivery point they are sold. In 1935, sometime after July, an actual count was made of the number of cattle on hand and it disclosed about 1,500 head, principally cows and steers, which were not included by the petitioner in its closing inventory for 1934 and which the petitioner did not know that it had. In determining the number of cattle in the inventory at the beginning of 1935, the respondent included said 1,500 head. A heifer born in a given year is classified as a calf in the closing inventory for that year, as a one-year heifer in the closing inventory for the following year and as a two-year heifer in the closing inventory of the next year. The first two years following the year of birth of a calf are the growing period. A heifer is classified as a breeder at the end of two years following the year of birth and generally produces its first calf at the age of three years, after which time it is classified as a cow. The average life of the cows in the main cattle herd for producing calves is six years. About 1,500 head of the cows in the main cattle herd reach the limit of their productivity each year and are sold and replaced by a like number of young cows which have1516 been raised on the ranch. Every year there are a few cattle in the brood herd which are not considered good enough to retain in that herd and they are transferred to the main cattle herd. The main horse herd consists of horses and a few mules maintained for the use of the cowboys and other employees in their daily work. During the spring and fall round-ups a cowboy generally uses three or four horses a day and each cowboy has a mount of approximately 12 horses. The brood horse herd consists of brood mares and stallions and young growing horses born of such mares. The brood horse herd is maintained to produce horses for the main horse herd. Mare colts born to the brood horse herd are culled over in much the same way as heifer calves in the main cattle herd to select and retain a few that will grow up into good brood mares. Those not selected for retention are sold. The horse colts are made geldings and when they are three years old are broken to ride, after which time they become a part of the main horse herd. The petitioner does not raise, but purchases, stallions for the brood horse herd. The area in which the petitioner's ranch is situated suffered a severe drought1517 which began in 1932 and did not break until the spring of 1935. As a result of the drought range conditions became bad, the grass was partially destroyed, and the springs and rivers dried up. In addition dust storms continually occurred in the area. These conditions had a disastrous effect on the petitioner's cattle, 388 increasing the number of deaths, reducing the number of calves produced, and reducing the cattle in weight. On January 1, 1935, the cows in the main cattle herd had an estimated average weight of 650 pounds per head and on December 31, 1935, of 675 pounds per head, whereas in a normal year these cows would have averaged about 750 pounds per head. On December 31, 1935, the estimated average weight of heifer calves was about 320 pounds per head and of the steer calves carried over into 1936 was about 260 pounds. The average weight of steer calves sold during 1935 was 340 pounds per head. Some breeding and growing animals die each year. For the 10-year period ended December 31, 1935, the average annual amount of losses resulting from the deaths of breeding animals was $24,119.31 and from the deaths of growing animals was $2,773.41. In the main cattle1518 herd death losses amounted in value to approximately $15,000 in 1933, $29,000 in 1934, $47,000 in 1935, and $19,000 in 1936. Forage and grain consumed in feeding the cattle cost $26,000 in 1933, $29,000 in 1934, $44,000 in 1935, and $19,900 in 1936. The number of calves born was 8,655 in 1933, 8,003 in 1934, 6,311 in 1935, and 9,556 in 1936. The total expenses of operating the ranch during 1935 amounted to $163,020.23. The various items of expense constituting the foregoing total are apportionable between the breeding and raising activities on the one hand and selling and administrative activities on the other hand as follows: Percentages to breeding and raisingPercentages to selling and administrativePercentPercentSalary, ranch superintendent8020Salary, cashier100Salary, trustee (administrator)4060Salary, cowboys and helpers9010Maintenance of commissary9010Fuel and light6040Forage and grain, property repairs, depreciation, and taxes100Interest100General expenses and suppliesAAMrs. 1519 Adair, from November 30, 1910, to the date of her death in 1921, and her estate since 1921, have continuously maintained books and records relating to the operation of the ranch and its live stock business. Such books have been kept on an accrual basis of accounting and Federal income tax returns have been prepared on that basis since 1916. In the first income tax return filed by the estate, which covered the period from September 22, 1921 (the date of Mrs. Adair's death), 389 through December 31, 1921, all live stock included in the opening and closing inventories were valued at the following flat prices: Cattle in the main cattle herd, $20 per head; cattle in the brood cattle herd, $27.50 per head; animals in the main horse herd, $40 per head; and animals in the brood horse herd, $30 per head. During the years 1922 through 1924 the cattle were inventoried according to classes and ages at their estimated values for Federal estate tax as of the date of Mrs. Adair's death. When the final values for Federal estate tax of the several classes and ages of cattle belonging to the estate were determined and fixed, these values were consistently used in both the opening and closing1520 inventories by the petitioner in making its income tax returns for the years 1925 through 1935, with certain exceptions indicated in the footnotes to the following table, which shows the per head values used by the petitioner in computing its opening and closing inventories for the periods indicated: [Table omitted] The respondent consistently accepted the basis of inventory values used by petitioner in its returns for 1934 and prior years. Following a revenue agent's investigation of petitioner's return for 1935 the respondent accepted petitioner's constant price method of valuing its inventory of the main horse herd, the brood horse herd, and the 390 brood cattle herd but rejected the use of that basis with respect to the inventory of the main cattle herd, holding that the constant price method of valuing inventories does not clearly reflect income and that its use is prohibited by article 22(c)-2 of Regulations 86, relating to the Revenue Act of 1934. The respondent determined that the farm price method, which provides for the valuation of inventories at market price less cost of disposition, should be used in valuing the various classes of cattle in the inventory1521 of the main cattle herd. Using the farm price method for valuing cattle in the inventory of the main cattle herd, but accepting the constant price method as used by the petitioner in valuing the livestock in the other three herds of petitioner, the respondent determined the total value of the petitioner's inventory of live stock at December 31, 1934, and December 31, 1935, as follows: [Table omitted] 391 By the use of the values of the inventories determined by him, the respondent increased the petitioner's income reported from the cattle business for 1935 by $143,234.04, which was determined as follows: Inventory, December 31, 1935, determined by Commissioner$593,170.52Inventory, December 31, 1935, reported in return439,400.00153,770.52IncreaseInventory, December 31, 1934, determined by Commissioner* $454,399.98Inventory, December 31, 1934, reported in return* 443,863.5010,536.48Net increase in income143,234.041522 Some cattlemen in the Southwest report their income on the cash receipts and disbursements basis and do not employ inventories. Of those that use inventories in reporting their income, some employ the farm price method in valuing their inventories, while others employ various other methods and at least one uses the cost basis. The will of Mrs. Adair named Henry C. Coke and T. D. Hobart as independent executors thereof and provided that they should not be required to give bond. In due course the will was admitted to probate by the County Court of Armstrong County, Texas, where the principal part of Mrs. Adair's estate was situated and letters testamentary were issued to said Coke and Hobart. By the will the executors were directed to dispose of all properties as soon after the death of the decedent as they were able to obtain prices deemed by them to be satisfactory, but they were expressly authorized to retain all or any part of the properties until satisfactory prices could be obtained, and while holding the ranch properties they were authorized to manage the ranch and estate and conduct the ranching business as had the decedent during her lifetime. Under the authority contained1523 in the will, the operation of the ranch has been continued since the death of Mrs. Adair. On July 10, 1933, Coke died and on May 19, 1935, Hobart, the surviving executor, died, and, there being no provision in the will for a successor executor, Montgomery H. W. Ritchie, on June 6, 1935, was appointed and qualified as temporary administrator and on September 12, 1935, was named and qualified as permanent administrator de bonis non, with the will annexed. Before taking charge of the estate's property and the conduct of its affairs in 1935, Ritchie was required to give bond. Ritchie, a grandson of Mrs. Adair, first went to the ranch in 1932, when he became employed there. After taking charge of the estate of Mrs. Adair in 1935, he employed an experienced ranchman by the name of Kent as ranch superintendent. After his appointment as administrator 392 Ritchie devoted approximately 60 percent of his time to matters relating to the sale of cattle and the general conduct and administration of the estate's business and 40 percent to matters relating to the breeding and raising of cattle. Of the total ranch expenses for 1935 of $163,020.23, $1,500 represented the salary of the1524 administrator of the estate and $3,888.52 represented the salary of the ranch superintendent. Both of said salary items were allowed by the respondent as deductions. During 1935 the income of the estate consisted of $126,599.29 from the sale of cattle (the gross selling price less shipping expenses), $7,501.48 from lease and crop rentals, $45 from interest, and $34.20 from miscellaneous sources. During 1935 the estate paid an annual premium of $2,484.66 on Ritchie's bond as administrator of the estate and in its income tax return for that year took that amount as a deduction from income. In determining the deficiency the respondent disallowed the deduction on the ground that the amount was applicable to the corpus of the estate and was not a proper deduction against the ranch income. OPINION. TURNER: There is no controversy between the parties as to whether the use of inventories of live stock is necessary to the correct determination of the petitioner's income, but they are in disagreement as to the method to be used in valuing such inventories. The respondent contends that the farm price method is the proper method and that his action in using it should be sustained. 1525 The petitioner concedes that it is not entitled to use the constant price method which it employed in filing its return. However it contends now, as prior to the determination of the deficiency, that it is entitled to use cost and that the true cost of its live stock can be ascertained through the use of a method or formula proposed by it and explained as follows: (1) The cost of a breeding animal, born on the ranch and raised to maturity, is its cost when born plus the cost to raise it during a two year period of growth into maturity as a breeder. (2) The cost of all calves born during the year is the sum of (1) the cost of maintaining the breeding cattle during the year and (2) the cost value of such number of said cattle as die during the year. The cost of a single calf is the said sum divided by the number of calves born during said year. (3) The cost of all colts born during the year is the sum of (1) the cost of maintaining the breeding horses during the year and (2) the cost value of such number of said horses as die during the year. The cost of a single colt is said sum divided by the number of colts born during said year. (4) The cost of raising calves and colts1526 (sometimes referred to as growing animals) after they are born, and during the two year period before they mature into breeders, constitutes an additional cost of these animals. The cost to be added to said animals each year is the sum of (1) the ranch expenses applicable to said animals and (2) the cost value of such number of 393 said animals as die during the year. The cost to be added to each such growing animal each year is said sum divided by the number of growing animals which survive. (5) The cost of raising steers after they are born, and during the period they remain unsold, constitutes an additional cost of these animals. The cost to be added to said animals each year is the sum of (1) the ranch expenses applicable to said animals and (2) the cost value of such number of said animals as die during the year. The cost to be added to each such steer each year is said sum divided by the number of steers which survive. (6) The cost of a growing animal purchased is the actual purchase price plus raising cost. The cost of a grown animal purchased is the actual purchase price. (7) All ranch expenses, other than selling, general and administrative expenses, 1527 are apportionable on a per head basis each year to the breeding and growing animals. In addition, the cost value of such number of main herd horses (saddle and work horses and mules) as die during the year is so apportionable also. (8) Ranch expenses constitute two general classes, viz: (1) Breeding and raising expenses and (2) Selling, general and administrative expenses. Class (1) expenses are chargeable to the cost of animals produced and raised in determining gross income from live stock sales. Class (2) expenses are deductible from gross income in determining net income. Certain ranch expenses are direct expenses of breeding and raising animals. Under this class falls forage and grain, repairs to properties, depreciation and taxes. Other ranch expenses are applicable to both said general classes (1) and (2). * * * The table following shows such expenses as are incurred annually and the bases of apportionment: Percentages apportion to -Nature of ExpensesBreeding and Raising ExpensesSelling General and Administrative ExpensesSalaries and wages:Ranch superintendent80%20%Cashier100%Trustees and administrator40%60%Cowboys and helpers90%10%Commissary90%10%Fuel and lights60%40%Forage and grain100%Repairs to properties100%Depreciation100%Taxes100%Interest100%General expenses and suppliesAA1528 The method or formula of the petitioner provides for the application of the "first in, first out" rule authorized in article 22(c)-2 of Regulations 86 for identifying goods in an inventory where they have become so intermingled as to lose their identity. The parties have stipulated that if it should be determined that the petitioner is entitled to value its inventories of live stock upon the basis of cost and that the petitioner's method or formula for determining 394 cost is correct, the amounts of $493,173.50 and $525,728.24 shall be accepted as correctly reflecting the values of the petitioner's inventories of live stock at the beginning and end of 1935, respectively. Section 22(c) of the Revenue Act of 1934 provides as follows: (c) INVENTORIES. - Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting1529 practice in the trade or business and as most clearly reflecting the income. Regulations 86, relating to the Revenue Act of 1934, provides in part as follows: ART. 22(c)-2. Valuation of inventories. - Section 22(c) provides two tests to which each inventory must conform: (1) It must conform as nearly as may be to the best accounting practice in the trade or business, and (2) It must clearly reflect the income. It follows, therefore, that inventory rules cannot be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order clearly to reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income. The bases of valuation most commonly used by business1530 concerns and which meet the requirements of section 22(c) are (a) cost and (b) cost or market, whichever is lower. * * * In respect of normal goods, whichever basis is adopted must be applied with reasonable consistency to the entire inventory. * * * Goods taken in the inventory which have been so intermingled that they can not be identified with specific invoices will be deemed to be the goods most recently purchased or produced, and the cost thereof will be the actual cost of the goods purchased or produced during the period in which the quantity of goods in the inventory has been acquired. * * * The following methods, among others, are sometimes used in taking or valuing inventories, but are not in accord with these regulations, viz: * * * (4) Using a constant price or nominal value for so-called normal quantity of materials or goods in stock. * * * ART. 22(c)-3. Inventories at cost. - Cost means: (1) In the case of merchandise on hand at the beginning of the taxable year, the inventory price of such goods. (2) In the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash1531 discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods. 395 (3) In the case of merchandise produced by the taxpayer since the beginning of the taxable year, (a) the cost of raw materials and supplies entering into or consumed in connection with the product, (b) expenditures for direct labor, (c) indirect expenses incident to and necessary for the production of the particular article, including in such indirect expenses a reasonable proportion of management expenses, but not including any cost of selling or return on capital, whether by way of interest or profit. (4) In any industry in which the usual rules for computation of cost of production are inapplicable, costs may be approximated upon such basis as may be reasonable and in conformity with established trade practice in the particular industry. Among such cases are (a) farmers and raisers of live stock (see article 22(c)-6), (b) miners and manufacturers who by a single process or uniform series1532 of processes derive a product of two or more kinds, sizes, or grades, the unit cost of which is substantially alike (see article 22(c)-7), and (c) retail merchants who use what is known as the "retail method" in ascertaining approximate cost (see article 22(c)-8). * * ART. 22(c)-6. Inventories of livestock raisers and other farmers. - * * * Because of the difficulty of ascertaining actual cost of live stock and other farm products, farmers who render their returns upon an inventory basis may value their inventories according to the "farm-price method," which provides for the valuation of inventories at market price less direct cost of disposition. If the use of the "farm-price method" of valuing inventories for any taxable year involves a change in method of valuing inventories from that employed in prior years, permission for such change shall first be secured from the Commissioner as provided in article 41-2. In such case the opening inventory for the taxable year in which the change is made should be brought in at the same value as the closing inventory for the preceding taxable year. If such valuation of the opening inventory for the taxable year in which the1533 change is made results in an abnormally large income for that year, there may be submitted with the return for such taxable year an adjustment statement for the preceding year. This statement shall be based on the "farm-price method" of valuing inventories, upon the amount of which adjustments the tax, if any be due, shall be assessed and paid at the rate of tax in effect for such preceding year. If an adjustment for the preceding year is not, in the opinion of the Commissioner, sufficient clearly to reflect income, adjustment sheets for prior years may be accepted or required. [Emphasis supplied.] In filing its return petitioner valued its inventories by the constant price method, which concededly is condemned by the respondent in his regulations and by decided cases, Lucas v. Kansas City Structural Steel Co.,281 U.S. 264">281 U.S. 264; Reynolds Cattle Co.,31 B.T.A. 206">31 B.T.A. 206. Rejecting the constant price method with respect to the main cattle herd and rejecting the contention of the petitioner that it should be permitted to value its entire inventory on the basis of cost, computed according to its formula, the respondent valued the live stock in the main1534 cattle herd by the farm price method but accepted the petitioner's constant price method for valuing the live stock in the three other herds as used in filing its return. While not conceding error, the respondent offers no explanation of his action in employing such a hybrid method for making his valuation and points to nothing in 396 the record in support of its propriety. It is therefore apparent that consistency was not observed in making the respondent's valuations and that the use of such valuations does not tend to properly reflect income. In the light of the foregoing situation the first question for decision is what basis or method should be used in valuing petitioner's live stock inventories at the beginning and end of 1935. Obviously the constant price method may not be used. Under the provisions of article 22(c)-6 the use of the farm price method by a taxpayer is not compulsory but is only optional in case he desires to employ it. Here the petitioner does not desire to employ such method and we find nothing in the statute or the regulations which requires that the petitioner should accept its use because of the fact that in prior years, with the respondent's1535 apparent approval, the petitioner had used a proscribed basis. As stated in article 22(c)-2, supra, the bases of valuation most commonly used by business concerns which meet the requirements of section 22(c) of the act, supra, respecting conformity to the best accounting practice in the business or trade and the clear reflection of income are (a) cost and (b) cost or market, whichever is lower. From the evidence it appears that there is some diversity of method by which taxpayers engaged in the livestock business in the Southwest value their inventories. While it appears that a substantial number of operators use the farm price method, doubtless due to the fact that it is permitted by the regulations and relieves them of the keeping of cost records, and it further appears that the use of the cost basis is exceptional, probably due to the fact that in the case of the small operators the keeping of the necessary cost records would be unduly burdensome, we do not find anything in the law or regulations which makes that a bar to the use of that basis by those who desire to use it and who are in a position to keept the records necessary for the determination of cost. No contention1536 is made by the respondent that the bookkeeping system of the petitioner does not contain adequate data from which to determine cost. Since the use of the constant price method of valuing inventories will not correctly reflect income and since the method of valuing inventories at cost is approved by the regulations as being one which will clearly reflect income, we find nothing in the statute or regulations which would prevent a taxpayer who has been using the constant price method from changing to the cost basis if he so desires. Cf. Chicago Frog & Switch Co. v. United States,68 Ct.Cls. 186. Being of the opinion that the petitioner is entitled to value its inventories on the basis of cost, the next question for determination is whether the use of the petitioner's formula will correctly reflect cost. 397 The respondent contends that the use of the petitioner's formula in computing cost of its livestock is objectionable for two reasons: (1) Because it apportions to animals born during the year the cost of maintaining the breeding animals, and (2) because it apportions death losses to surviving animals, that is it apportions the cost value, (a) of1537 breeding animals dying during the year to the animals born during the year, (b) of growing animals dying during the year to the growing animals which survive the year, and (c) of saddle and work horses and mules dying during the year to breeding and growing animals. Respecting the first objection of the Commissioner, it is to be observed that the petitioner's ranch is operated primarily for the production of calves. The breeding animals therefore are the instruments of production and the animals they produce are the products. The principle contended for by the respondent in his objection would require the maintenance expenses each year of an animal, after reaching the productive state, to be treated as part of its cost so long as it remained in the herd, which would mean until it was worn out or no longer useful as a breeding animal. Proper consideration of the purpose for which the ranch is operated leads, we think, to the conclusion that after a breeding animal reaches the productive state the cost of its maintenance should not be treated as part of and added to its cost, but should fall on the animal which it produces and be treated as a part of the cost of the animal so produced. 1538 In our opinion, after an animal reaches the productive state, expenditures for its maintenance bear a similar relationship to the animals it produces as the expenditures set forth in paragraph (3) of article 22(c)-3, supra, bear to the merchandise there referred to as being produced. The expenditures there mentioned are regarded as constituting part of the cost of the merchandise so produced and we think that here expenditures for the maintenance of the breeding animals are likewise to be treated as a part of the cost of the animals produced. The respondent's other objection to the use of the formula, because of the manner in which it apportions to surviving animals death losses occurring during the year, is sound. While the evidence shows that death losses are losses recurring year after year in substantial amounts, we fail to see why that fact makes them apportionable to surviving animals as a part of the cost of such animals. While it is true that the breeding animals are maintained as instruments of production and that the animals they produce are the products thereof, yet when a breeding animal dies its usefulness is terminated. The petitioner sustains its loss thereon1539 at that time and under the statute such loss is deductible in the year in which 398 sustained. Relative to the manner in which such losses are to be deducted, regulations 86 provides as follows: ART. 23(e)-5. Losses of farmers. - Losses incurred in the operation of farms as business enterprises are deductible from gross income. * * * A farmer engaged in raising and selling stock, such as cattle, sheep, horses, etc., is not entitled to claim as a loss the value of animals that perish from among those animals that were raised on the farm, except as such loss is reflected in an inventory if used. * * * If gross income is ascertained by inventories, no deduction can be made for live stock or products lost during the year, whether purchased for resale or produced on the farm, as such losses will be reflected in the inventory by reducing the amount of live stock or products on hand at the close of the year. * * * The petitioner has not directed our attention to any authority and we know of none which warrants a holding that death losses from breeding animals in a given year are to be regarded as a part of the cost of the animals born in that year and as such are to be1540 carried forward and used as an offset against income for a later year or years in which such animals are sold. The petitioner's apportionment of death losses on growing animals, saddle and work horses and mules is objectionable for the same reason. In a recomputation of the petitioner's tax liability under Rule 50 the inventories will be valued at cost, computed by the petitioner's formula, but so modified as to eliminate from such cost all death losses. While conceding that he has allowed as a deduction against ranch income the amount paid Ritchie as salary for his services, the respondent contends that Ritchie's bond was given to guarantee his good faith, honesty, and integrity in administering the estate and that the premium paid by the petitioner on such bond is as much an administration expense as are court costs, attorneys' fees, or executors' commissions which are not allowable deductions in determining income and that his action in disallowing a deduction from income of the amount of such premium therefore should be sustained. The petitioner concedes that the bond was a fidelity bond but contends that the premium thereon is just as much a business expense as insurance1541 premiums against fire, storm, theft, accident, or other similar losses, which are expressly classed as business expenses in the respondent's regulations. Since the will directed that all properties of the decedent be disposed of as soon as possible after her death but only at prices deemed satisfactory to the executors, and since the ranch was still held and operated in 1935 under the terms of the will, no sale thereof having been made, and since Ritchie was appointed administrator in that year, it appears that administration of the estate had not been fully completed even after the lapse of 14 years. So far as the record shows, nothing was being done during 1935 to prepare the estate for 399 settlement and distribution. Such activities as are disclosed for that year, with the possible exception of the appointment of Ritchie as administrator, indicate that nothing was done except carry on the business. This being the situation, we think the following statements made in George W. Oldham et al., Executors,36 B.T.A. 523">36 B.T.A. 523, 529, are applicable: * * Where, however, such fees or commissions [of executors, administrators, attorneys, and other representatives1542 of estates] are paid for services rendered exclusively in carrying on the affairs of the estate as a business, rather than in preparing it for settlement and distribution, such payments constitute ordinary and necessary expenses and may be deducted for income tax purposes. Grace M. Knox et al., Executors,3 B.T.A. 143">3 B.T.A. 143; William W. Mead et al., Executors, supra; George W. Seligman, Executor,10 B.T.A. 840">10 B.T.A. 840; Henrietta Bendheim,8 B.T.A. 158">8 B.T.A. 158; Charles Lesley Ames, Executor,14 B.T.A. 1067">14 B.T.A. 1067; Margaret B. Sparrow,18 B.T.A. 1">18 B.T.A. 1; Florence Grandin,16 B.T.A. 515">16 B.T.A. 515; Estate of William G. Peckham,19 B.T.A. 1020">19 B.T.A. 1020, 1023; Chicago Title & Trust Co. et al., Trustees,18 B.T.A. 395">18 B.T.A. 395; H. Alfred Hansen, Executor,6 B.T.A. 860">6 B.T.A. 860. * * * * * On the other hand, in cases where, according to the provisions of the will or testamentary trust, it is necessary to continue the estate intact over a period of years, and to carry on its affairs as a business in the interim, the fees and commissions paid to representatives of the estate for such services constitute1543 expenses, deductible for income tax purposes. William W. Mead et al., Executors, supra; H. Alfred Hansen, executor, supra; Florence Grandin, supra; * * The respondent having allowed as a deduction from income the salary paid Ritchie in 1935 as administrator, we fail to see why the premium paid for his bond, the furnishing of which was a prerequisite to his acting as administrator, is not also allowable. Both the salary and the bond premium were incurred primarily in connection with the conduct of the petitioner's business. We accordingly hold that the bond premium constitutes an allowable deduction for income tax purposes. Decision will be entered under Rule 50.FootnotesA. Actual allocation based on the nature of each item of expense included under this heading. ↩*. The parties have stipulated that the correct amount of the petitioner's inventory of live stock at December 31, 1934, upon the basis of the constant price method used by it in valuing its inventory on that date was $493,173.50 instead of $443,863.50 as reported in the return. ↩A. Actual allocation based upon the nature of each item of expense included under this heading. ↩	01-04-2023	11-21-2020

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