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T.C. Memo. 1996-392
UNITED STATES TAX COURT
PAUL A. RENDINA AND JANET MAE RENDINA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19223-93. Filed August 21, 1996.
Joseph P. Alexander, J. Timothy Bender, and David G.
Lambert, for petitioners.
Jeffrey J. Erney, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
BEGHE, Judge: Respondent determined a deficiency of $35,934
in petitioners’ 1988 Federal income tax, and additions to tax of
$1,797 and $8,984, under sections 6653(a)(1) and 6661(a),
- 2 -
respectively.1 The deficiency arose from respondent’s
determination that the distribution to petitioner2 of two
condominium units by Wood Street Apartments, Inc. (WSAI) was a
dividend.
We hold that petitioner received the condominium units as a
distribution in de facto liquidation of his shares of WSAI,
thereby reducing his realized gain by the amount of his basis in
the shares and by the amount of certain liabilities to third
parties that he assumed, resulting in a lesser deficiency than
respondent determined. We also hold petitioner liable for the
additions to tax for negligence under section 6653 and
substantial understatement under section 6661, computed on the
reduced deficiency.
FINDINGS OF FACT
Some of the facts have been stipulated, and are so found.
The stipulation of facts and attached exhibits are incorporated
herein.
When petitioners filed their petition, they resided in
Willoughby Hills, Ohio.
1
Unless otherwise identified, section references are to the
Internal Revenue Code in effect for 1988, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
2
Janet Mae Rendina has an interest in this case solely by
virtue of having filed a joint 1988 Federal income tax return
with her husband. Accordingly, all references to “petitioner”
in the singular are to Paul A. Rendina.
- 3 -
Petitioner is a certified public accountant. During the
year at issue, he was an owner-shareholder in a certified public
accounting firm, Rendina & Vitantonio, Inc.
Wood Street Apartments, Inc.
In 1986, petitioner and Thomas J. Ackerman (Ackerman), a
construction contractor, formed WSAI as a general business
corporation under Ohio law, for the purposes of constructing and
selling 18 condominium units in Willoughby, Ohio. WSAI was
operated as a C corporation. Petitioner and Ackerman each paid
WSAI approximately $250 for an equal number of common shares of
WSAI.
In 1987 and 1988, WSAI constructed the 18 condominium units,
known as “South Wood Condominiums” (South Wood). South Wood
consists of two-story townhouses, built in clusters of six units
in each of three buildings.
WSAI financed the construction of South Wood primarily with
borrowed funds. The funds used by WSAI consisted of a loan from
Security Federal Savings and Loan of approximately $740,000,
petitioner’s deposits in WSAI’s checking account of approximately
$41,200,3 and approximately $68,000 in loans from three of
3
Petitioner made three deposits into the account. On
Apr. 11, 1987, petitioner deposited $20,200 into the account. On
Sept. 22, 1987, petitioner deposited $20,000 into the account,
with a notation on the deposit ticket indicating that the deposit
was a “loan”. On Oct. 6, 1987, petitioner deposited $1,000 into
the account.
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petitioner’s accounting clients: William and Mary Foss (the
Fosses), Vito and Adella Navar (the Navars), and Frank and
Benette Posa (the Posas). The principal amounts of the loans
from the Fosses, Navars, and Posas were $53,000, $10,000, and
$5,000, respectively. The loan checks were made to WSAI, and
deposited in WSAI’s checking account at National City Bank. WSAI
issued promissory notes to the lenders, providing that interest
would be paid at a rate of 12 percent per year. The maturity
date of each of the notes was approximately 1 year after
issuance.
On March 9, 1987, the Posas lent $5,000 to WSAI, and
received notes as follows:
Entity Date Amount
WSAI 2/17/87 $5,000
WSAI 3/01/88 5,000
WSAI4 3/01/89 5,000
On May 5, 1987, June 8, 1987, and June 29, 1987, the Fosses
lent $18,000, $10,000, and $25,000, respectively, to WSAI, and
received notes as follows:
Entity Date Amount
WSAI 4/06/87 $28,000
WSAI 6/29/87 25,000
4
In 1989, petitioner replaced the prior note with a note
issued in the name of WSAI, which was by then no longer an active
corporation. When the 1989 notes were typed, petitioner’s office
inadvertently transcribed the information from the client’s old
notes.
- 5 -
WSAI5 4/06/89 53,000
On February 27, 1987, the Navars lent $10,000 to WSAI, and
received the following note:
Entity Date Amount
WSAI 2/26/87 $10,000
With the exception of one of the Foss notes, each new note
reflected a rollover of the obligation on the prior note. For
the months of January, February, March, and April 1989, all
interest payments due on the notes to the Fosses, Navars, and
Posas were made in the name of WSAI.6
In 1988, 16 of the 18 units were sold, two of which were
purchased by Ackerman. The stated purchase prices and dates of
purchase for the 16 units were as follows:
Purchase Purchase
Purchaser Condo Date Price
Thomas J. & Unit A, 9-16-88 $65,9007
Michelle L. Ackerman Bldg. A
5
See supra note 4.
6
The record does not indicate the source of the funds used
to make the first 4 months’ interest payments in 1989.
7
Ackerman borrowed $100,000 to purchase the two condominium
units, and testified that he performed approximately $15,000
worth of work on each of them. While the statutory conveyance
fee for each of the units was $65.90, representing 1 percent of
the purchase price, the way we decide this case does not require
a factual determination of how much Ackerman actually paid for
each of the units. We do find that the stated purchase prices
for the 14 units purchased by the unrelated parties were the
actual purchase prices.
- 6 -
Thomas J. & Unit B, 9-16-88 $65,900
Michelle L. Ackerman Bldg. A
Geza Bihari Unit C, 8-12-88 $66,900
Bldg. A
Larry & Ruth Entis Unit D, 8-19-88 $67,375
Bldg. A
Donald C. & Unit E, 8-04-88 $69,622
Janet T. Matz Bldg. A
Debra J. Stewart Unit F, 8-07-88 $65,900
Bldg. A
Karen Ann Helsel Unit A, 2-03-88 $65,900
Bldg. B
Donald L. Smith Unit C, 6-29-88 $66,900
Bldg. B
Edward N. & Unit D, 10-14-88 $67,900
Barbara J. Snyder Bldg. B
Gia M. Perrico Unit E, 12-08-88 $67,900
Bldg. B
Lauren B. & Unit F, 9-12-88 $65,900
Joseph Wolf Bldg. B
Ronald S. & Unit A, 9-30-88 $65,900
Denise A. Rychel Bldg. C
Gary Ackerman Unit B, 10-18-88 $67,900
Bldg. C
Maria L. Podmore Unit C, 11-21-88 $66,900
Bldg. C
Sharon L. Spei Unit D, 11-30-88 $66,900
Bldg. C
John Viviani & Unit F, 9-26-88 $64,900
Kimberly M. Ficke Bldg. C
Ackerman and petitioner expected a net profit of
approximately $5,000 to $10,000 on each condominium unit sold,
- 7 -
based on a cost estimate of approximately $50,100 per unit.
However, WSAI incurred approximately $3,500 to $4,000 in
commissions and settlement costs for each condominium. In
addition, rebates or building allowances were given to
prospective buyers in amounts ranging from $1,500 to $3,500.
WSAI also incurred financing costs, unanticipated zoning costs,
development fees, $25,000 paid in settlement of a lawsuit by
South Wood Condominium Association related to alleged
construction defects in South Wood and various
misrepresentations, nondisclosures, and failures to perform, and
WSAI’s actual construction costs.
Toward the end of 1988, two of the 18 units remained unsold.
Petitioner and Ackerman orally agreed that WSAI would transfer
title to the two remaining condominium units to petitioner in
consideration of petitioner’s assumption of the Foss, Navar, and
Posa notes, and petitioner’s discharge of WSAI’s “debt” owed to
him.
In December 1988, WSAI transferred South Wood’s two
remaining condominium units to petitioner. Petitioner did not
report any income or gain from the receipt of the two condominium
units on his 1988 Federal income tax return, but did report a
taxable dividend from WSAI in the amount of $90. Although WSAI
had filed U.S. corporation income tax returns for the tax years
1986 and 1987, employing the completed contract method of
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accounting, and showing no gross receipts, sales, or other
income, WSAI filed no U.S. corporation income tax return for
1988, the tax year in which all the condominium units were sold
or transferred.
With the transfer of the last two condominium units to
petitioner in 1988, WSAI no longer held business assets, and
ceased to be a going concern. Upon transfer of all 18
condominium units in 1988, WSAI ceased doing business, but did
not formally dissolve. Its charter was revoked in 1990 for
nonpayment and nonfiling of Ohio franchise tax returns.
In April 1989, petitioner sold one of the units for $67,900.
Transfer of notes from WSAI to Canterbury Construction Co.
Following his receipt of the last two South Wood condominium
units, petitioner gave the Fosses, Navars, and Posas the option
of either having their loans repaid, or of having the loan
obligations taken over by Canterbury Construction Co.
(Canterbury), an S corporation wholly owned by petitioner that is
in the business of real estate construction and development. The
note holders chose to have Canterbury take over the loan
obligations and to continue receiving interest payments. While
petitioner did not, in his individual capacity, issue promissory
notes to any of the note holders, Canterbury issued new notes to
the Fosses, Navars, and Posas sometime after April 1989, and
began making interest payments on the notes.
- 9 -
The loans to the Posas and Navars, in the principal amounts
of $15,000 and $10,000, respectively, have been paid. As of the
date of filing of the petition, the Fosses still held a note
issued by Canterbury on which they were receiving interest
payments.
As a result of the earlier lawsuit, WSAI turned its books
and records over to the South Wood Estates Condominium
Association. Petitioner has not recovered the books and records
of WSAI from the Association.
Corporation tax and transferee issues
On or around March 1, 1994, respondent sent petitioner, as
transferee of WSAI, a 30-day letter, with a report of income tax
examination and explanation of items, asserting for the taxable
year 1988 that WSAI had taxable income of $272,320, resulting
from gross receipts of $1,068,000 from the sale of the South Wood
condominium units,8 based on the retail sales prices as
determined by the transfer taxes paid, less costs and expenses of
$795,680.9 The report took the position that WSAI owed 1988 U.S.
8
Respondent excluded the two units transferred to petitioner
from the calculation of gross receipts.
9
Respondent relied on the Cohan rule to provide what
respondent regarded as a reasonable allowance for costs and other
expenses in lieu of substantiating documents. See Cohan v.
Commissioner, 39 F.2d 540 (2d Cir. 1930). Respondent arrived at
the $795,680 figure for costs and expenses by allowing $715,000
of construction loan proceeds (cf. our findings supra p. 3),
$70,000 as the cost of the land, and $10,680 as expenses of the
(continued...)
- 10 -
corporation income tax of $89,455, and an addition of $22,364 for
failure to file its corporation income tax return. WSAI’s
liability for 1988 U.S. corporation income tax and the failure to
file addition remains unresolved; respondent had issued no
statutory notice of deficiency to WSAI (or to petitioner as
transferee) as of the date of issuance of this report.
OPINION
Because WSAI has never filed a 1988 U.S. corporation income
tax return, the periods of limitation on assessment of WSAI’s
1988 corporation income tax liability and petitioner’s transferee
liability remain open indefinitely. In the course of our
unsuccessful efforts to lead the parties to a comprehensive
settlement or to postpone the submission of this case in order to
allow the related corporation tax and transferee liability cases
to be perfected and consolidated with this case, we observed to
the parties that it would have been preferable, in the interests
of efficient case management and sound judicial administration,
to bring the cases on together, so that the interrelated
questions of corporate taxable income and earnings and profits,
which bear on the transferee liability and dividend questions,
could have been tried together.10 Be that as it may, we decide
9
(...continued)
sale of the condominium units.
10
For an example of a consolidated proceeding dealing with
(continued...)
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this case, on its somewhat unsatisfactory record, in a way that
enables us to avoid making the earnings and profits/dividend
determination, and leave the related corporate taxable income
question for another day, if respondent should decide to pursue
it.
The substantive tax question before us is whether
petitioner’s receipt of two condominium units, during the taxable
year 1988, was a taxable distribution from WSAI. Respondent
determined that petitioner’s receipt of the last two units was a
dividend in the amount of $135,800 during the taxable year 1988.
Petitioner contended that his receipt of the units was not
taxable to him because it was offset by discharge of WSAI’s debt
to him, and his assumption of the Foss, Navar, and Posa notes.
Petitioner also maintained that his receipt of the two units
could not be a dividend because WSAI had no earnings and profits.
Petitioner, in his reply brief, raised the alternative
argument that he received the condominium units in de facto
liquidation of WSAI, which would entitle him to use the basis of
his WSAI stock to compute his gain on the distribution, if we
should determine that his payments into WSAI represented equity
rather than debt. Because it appeared to us that this position
10
(...continued)
related questions of corporation tax and transferee liability,
and shareholder gain on liquidation, see Schneider v.
Commissioner, 65 T.C. 18 (1975).
- 12 -
might have greater merit than the primary position of either of
the parties, we had them address this newly raised issue in
supplemental briefs.
I. Lack of Prejudice to Respondent in Addressing Liquidation
Respondent maintains that petitioner’s delay in raising the
de facto liquidation issue precludes us from addressing it.
Respondent relies on Brown v. Commissioner, T.C. Memo. 1979-443,
to argue that our consideration of the new issue raised on brief
would severely prejudice her case and violate fundamental
fairness.
We have allowed petitioner to raise the de facto liquidation
issue for two reasons. First, just as respondent is not bound by
the theory upon which she relied in determining the deficiency,
Blansett v. United States, 283 F.2d 474 (8th Cir. 1960), so
petitioner is not precluded from raising a new theory on post-
trial brief. Ware v. Commissioner, 906 F.2d 62 (2d Cir. 1990),
affg. 92 T.C. 1267 (1989) and T.C. Memo. 1989-165 (declining to
adopt an ironclad rule that the Tax Court may not consider a
legal theory surfacing in posttrial briefs). Our duty is to
consider all the evidence, and in light thereof, decide whether
or not petitioner has a deficiency. We are therefore entitled to
adopt a new theory of decision, especially where we give both
parties the opportunity to argue its merits. See Brooks v.
Commissioner, 424 F.2d 116 (5th Cir. 1970), revg. 50 T.C. 927
- 13 -
(1968); Gulf Oil Corp. v. Commissioner, 89 T.C. 1010 (1987),
affd. 914 F.2d 396 (3d Cir. 1990).
Where the record contains sufficient facts to permit us to
decide a case on an issue that would dispose of it, we shall do
so, whether or not the parties have pleaded the issue. Barnette
v. Commissioner, T.C. Memo. 1992-595, affd. without published
opinion sub nom. Allied Management Corp. v. Commissioner, 41 F.3d
677 (11th Cir. 1994); see Concord Consumers Housing Coop. v.
Commissioner, 89 T.C. 105, 126 (1987) (Körner, J., concurring);
Park Place, Inc. v. Commissioner, 57 T.C. 767, 768-769 (1972).
In Ohio Clover Leaf Dairy Co. v. Commissioner, 8 B.T.A. 1249
(1927), affd. 34 F.2d 1022 (6th Cir. 1929), the Board decided the
case on the record presented, as we do here. The parties’
failure to plead correctly does not prevent us from deciding this
case on what we consider to be the correct application of the law
to the facts in the record presented. Barnette v. Commissioner,
supra.
Our second reason for allowing petitioner to raise the de
facto liquidation issue is that respondent has not been surprised
or prejudiced by our addressing it. See Riss v. Commissioner, 56
T.C. 388, 400 (1971), affd. 478 F.2d 1160, affd. sub nom.
Commissioner v. Transport Manufacturing & Equip. Co., 478 F.2d
731 (8th Cir. 1973). The rule that a party may not raise a new
issue on brief is not absolute; it is founded upon the exercise
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of judicial discretion in determining whether considerations of
surprise and prejudice require that a party be protected from a
belated confrontation that precludes or limits his opportunity to
present pertinent evidence. Ware v. Commissioner, 92 T.C. 1267
(1989), affg. 906 F.2d 62 (2d Cir. 1990).
Respondent’s reliance on Brown v. Commissioner, T.C. Memo.
1979-443, is misplaced. In Brown, the taxpayer was not given
notice of the Commissioner's change in theory, and was thus
denied the opportunity to prepare an adequate case on the new
issue. Brown is distinguishable from the case at hand. We have
given both petitioner and respondent the same opportunity to make
their arguments on the de facto liquidation issue by way of
supplemental reply brief. Thus, neither party is advantaged or
disadvantaged.
Respondent maintains that, if petitioner had raised the de
facto liquidation issue earlier, respondent would have had the
opportunity to provide evidence on: (1) Whether WSAI was formally
dissolved; (2) whether the corporate records established a plan
by the shareholders to dissolve WSAI; (3) whether WSAI continued
to hold title to the land underlying the condominiums, or any
other property; (4) whether WSAI continued to manage the common
areas of the condominium complex; (5) whether WSAI continued to
file tax returns; (6) whether WSAI continued to comply with
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statutory corporate formalities; and (7) whether WSAI maintained
its corporate identity.
The record adequately addresses these issues, and additional
evidence is not needed to enable us to make a fair determination
of whether de facto liquidation treatment of WSAI is appropriate.
With respect to the observation of corporate and tax formalities,
WSAI was not formally dissolved--its charter was revoked for
nonfiling of Ohio franchise tax returns and nonpayment of Ohio
taxes, and it neither adopted a written plan of liquidation nor
filed the notice of corporate dissolution or liquidation required
by section 6043(a). The record also shows that WSAI filed no
U.S. corporation income tax returns for 1988 or any year
thereafter. The record further shows that WSAI no longer held
business assets after the sale and distribution of the South Wood
units, and that thereafter South Wood was managed by the South
Wood Condominium Association. Finally, the record shows that
WSAI did maintain its corporate identity at least until its
charter was revoked.
Having made findings on the foregoing factual issues, the
majority of which facially would tend to favor respondent’s
position that WSAI was not liquidated in 1988, we see no
prejudice to respondent.
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II. De Facto Liquidation
Applying the three-pronged test of Estate of Maguire v.
Commissioner, 50 T.C. 130, 140 (1968): (1) Whether there is a
manifest intention to liquidate; (2) whether there is a
continuing purpose to terminate corporate affairs; and (3)
whether the activities of the corporation and its shareholders
are directed toward that objective, we are convinced that WSAI
and its shareholders displayed a manifest intention to liquidate
and continuing purpose to terminate corporate affairs, and that
the activities of WSAI and its shareholders were directed to that
end. See Olmsted v. Commissioner, T.C. Memo. 1984-381.
Neither the Code nor the regulations to section 331 define
the term “complete liquidation.” However, as we noted in Olmsted
v. Commissioner, T.C. Memo. 1984-381, the regulations under
section 332 (governing subsidiary liquidations) contain a
definition of “complete liquidation” under section 332 that
applies equally to section 331:
A status of liquidation exists when the corporation
ceases to be a going concern and its activities are
merely for the purpose of winding up its affairs,
paying its debts and distributing any remaining balance
to its shareholders. A liquidation may be completed
prior to the actual dissolution of the liquidating
corporation. However, legal dissolution of the
corporation is not required. Nor will the mere
retention of a nominal amount of assets for the sole
purpose of preserving the corporation’s legal existence
disqualify the transaction. [Sec. 1.332-2(c), Income
Tax Regs.]
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Respondent maintains that petitioner never liquidated WSAI.
In support of her position, respondent relies on Haley Bros.
Constr. Corp. v. Commissioner, 87 T.C. 498, 515-516 (1986). In
Haley Bros. Construction Corp., the corporation at issue,
Marywood Corp., was not dissolved formally in accordance with
State law, and continued to maintain a checking account. We held
that there was no liquidation because there was a business
purpose for the continued existence of Marywood, which continued
to be operated in accordance with that business purpose, holding
and selling real property, maintaining a checking account, paying
expenses, and filing tax returns. Moreover, the continued
corporate existence of Marywood served the purpose of insulating
its parent corporation from liabilities on a mortgage and in
pending litigation.
In the case at hand, there was no business purpose for WSAI
to continue operating. WSAI did not file a corporate tax return
for 1988, and, with the sale or distribution of all of the
condominium units, WSAI had no further assets of any consequence.
We are unpersuaded by respondent’s assertion that, because
WSAI continued some activities through the beginning of 1989, it
did not liquidate. Complete liquidation can occur despite an
extended liquidation process, and several earlier opinions of
this court have upheld liquidations despite protracted time
frames. See, e.g., Estate of Maguire v. Commissioner, supra;
- 18 -
T.T. Word Supply Co. v. Commissioner, 41 B.T.A. 965 (1940);
Olmsted v. Commissioner, supra. In order for complete
liquidation treatment to apply, it is not essential that a formal
plan of liquidation be adopted or that the corporation dissolve,
as long as there is a manifest intention to liquidate that is
carried out. Genecov v. United States, 412 F.2d 556 (5th Cir.
1969); Stamler v. Commissioner, 145 F.2d 37 (3d Cir. 1944), affg.
45 B.T.A. 37 (1941); Kennemer v. Commissioner, 96 F.2d 177, 178
(5th Cir. 1938), affg. 35 B.T.A. 415 (1937); Olmsted v.
Commissioner, supra; Silverman v. Commissioner, T.C. Memo. 1971-
143; see Bittker & Eustice, Federal Income Taxation of
Corporations & Shareholders, par. 10.02, at 10-9 (6th ed. 1994);
11 Mertens, Law of Federal Income Taxation, sec. 42.06, at 53
(1992 rev.).
Respondent maintains that petitioner has failed to provide
the necessary books and records to support his position regarding
the liquidation of WSAI. Although we agree with respondent that
there are gaps in the record, we believe that it contains
sufficient evidence to sustain our conclusion that WSAI was
liquidated in 1988. The intentions of petitioner and Ackerman to
liquidate WSAI at the end of 1988 were apparent from the sales of
WSAI’s assets, its cessation of business, and the agreement of
petitioner and Ackerman that WSAI would distribute the last two
condominium units to petitioner, in consideration of petitioner's
- 19 -
assumption of the corporation's liabilities to its lenders and
his recovery of his investment out of the balance. With that
final distribution, WSAI held title to no further assets of any
substantial consequence. With the exception of interest payments
made through the beginning of 1989,11 WSAI engaged in no further
activities.
Finally, respondent argues that petitioners made no
disclosure of any kind on their 1988 individual income tax return
regarding the receipt of the two condominium units as a
liquidating distribution, as required by section 1.331-1(d),
Income Tax Regs, which states:
In every case in which a shareholder transfers
stock in exchange for property to the corporation which
issued such stock, the facts and circumstances shall be
reported on his return unless the property is part of a
distribution made pursuant to a corporate resolution
reciting that the distribution is made in liquidation
of the corporation and the corporation is completely
liquidated and dissolved within one year after the
distribution. See section 6043 for requirements
relating to returns by corporations.
Section 1.331-1(d), Income Tax Regs., does not impair
our ultimate conclusion that a de facto liquidation did occur
during the taxable year 1988 in the case at hand. Although
section 1.331-1(d), Income Tax Regs., appears to complement
section 6043 and section 1.6043-1, Income Tax Regs., thereunder,
11
The record contains no evidence of the source of the funds
that were apparently used to make interest payments in the name
of WSAI.
- 20 -
providing for the filing of Form 966 (Corporate Dissolution or
Liquidation) by a corporation that adopts any resolution or plan
of liquidation, the filing of Form 966 is not a condition of
liquidation treatment under any provision of the Internal Revenue
Code. Maguire v. Commissioner, 222 F.2d 472, 478 (7th Cir.
1955), revg. 21 T.C. 853 (1954); Murphy v. Commissioner, T.C.
Memo. 1996-59; see also Fowler Hosiery Co. v. Commissioner, 36
T.C. 201 (1961), affd. 301 F.2d 394 (7th Cir. 1962). We are
satisfied that section 1.331-1(d), Income Tax Regs., like the
regulation under section 6043, is directory only. While
compliance with these regulations serves the evidentiary function
of supporting the conclusion that a distribution was received in
a corporate liquidation, and helps to avoid controversies of the
sort we now deal with, we regard them as playing only a
facilitating role. Petitioner's compliance with section 1.331-
1(d), Income Tax Regs., is not a condition precedent to our
treating the distribution of the condominium units to petitioner
as a liquidating distribution.12
We are convinced that the agreement of the WSAI
shareholders, petitioner and Ackerman, for the distribution of
the last two condominium units to petitioner, in consideration of
12
For an example of a mandatory requirement for filing a
form in order to obtain specified tax treatment in a "one month"
liquidation, see former sec. 333, repealed by sec. 631(e)(3) of
the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2273.
- 21 -
his taking care of the corporate liabilities and recovering his
own investment, manifested WSAI’s intention to liquidate, and
that that intention was carried out in the informal winding-up of
WSAI's affairs that followed.
III. Computation of Gain
Having found that WSAI was liquidated in 1988, we turn to
the tax treatment of petitioner’s receipt of the condominium
units. Section 331(a) provides that amounts received by a
shareholder in complete liquidation of a corporation shall be
treated as “full payment in exchange for the stock”, considering
a liquidating distribution, in effect, as a sale by the
shareholder of his stock to the corporation. Bittker & Eustice,
Federal Income Taxation of Corporations & Shareholders, at 10-4,
10-5 (6th ed. 1994); S. Rept. 398, 68th Cong., 1st Sess. 11
(1924), 1939-1 C.B. (pt. 2) 266, 274. As a result, the
shareholder computes gain or loss under section 1001(a) by
subtracting the adjusted basis of his stock from the amount
realized (the fair market value of the distribution), and reports
the difference as capital gain or loss if the stock is a capital
asset in his hands.
To compute petitioner’s gain, we first look at the value of
the condominium units distributed to determine the amount
realized. We then look at whether petitioner’s deposits into the
WSAI checking account were loans or equity investments;
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concluding that they are equity rather than debt, we add them to
petitioner’s basis in his WSAI stock, rather than treating them
as liability offsets to the amount realized. We also look at
whether petitioner assumed, or took subject to, WSAI liabilities,
because the amount realized under section 1001 on the liquidation
exchange is the net value of the distribution, and that amount
must be reduced by the amount of liabilities assumed or taken
subject to. See Ford v. United States, 160 Ct. Cl. 417, 311 F.2d
951 (1963). We then subtract the basis of petitioner’s shares
from the amount realized on the distribution to compute his gain.
A. Value of Condominium Units Distributed
Respondent maintains that petitioner received a taxable
distribution of $135,800, or the value of the two condominium
units received.13 Petitioner maintains that he gave value
equivalent to that of the condominium units. Petitioner’s
position throughout this proceeding has been that the value of
the condominium units was no more than $109,200--the sum of what
he argues were the amount of the WSAI liabilities that he assumed
and his deposits into the WSAI account.
We disagree with petitioner’s estimate of the value of the
condominium units received. The average selling price of the
13
Respondent makes her determination of the value of the
condominiums based on the $66,787 average price of the other 16
units sold, as well as the price petitioner received from the
sale of one of the units transferred to petitioner.
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other 14 condominium units was $66,915.14 Four months after the
distribution, petitioner sold one of his condominium units for
$67,900.
Petitioner has not convinced us that the fair market value
of his condominium units should be less than the average selling
price of the other units sold, or $66,915. Thus, we find the
fair market value of the condominiums transferred to petitioner
to be $133,830.
B. Basis of WSAI Shares: Debt v. Equity
Respondent maintains that no loan or other value was given
by petitioner to WSAI. However, the deposit records of National
City Bank, where WSAI maintained a checking account, indicate
that petitioner deposited $41,200 into WSAI’s account. Because
the books and records of WSAI were not made available, we must
look to such documentary evidence as bank statements, as well as
the testimony of witnesses, in considering whether petitioner
gave value to WSAI. Hagaman v. Commissioner, T.C. Memo. 1987-
549. We are satisfied that petitioner’s deposits into the WSAI
account constitute value that resulted in cost to be taken into
account in determining petitioner’s gain on the receipt of the
condominium units.
14
We exclude from this calculation the purchase price of
Ackerman’s condominium units. See supra note 7.
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While the analysis would vary, depending on whether the
investment in the corporation were debt or equity, the net tax
effect to petitioner would be the same. If petitioner's
investment in the corporation were a loan, WSAI's transfer of
property to petitioner in satisfaction of the loan would not be
governed by section 331 to that extent. This is because the
transfer would not be “in payment for” petitioner's stock. In
such a case, the corporation merely would be repaying the loan,
receiving equal value in exchange for the transfer, resulting in
no taxable event for the transferee. See Citizens Bank & Trust
Co. v. United States, 217 Ct. Cl. 606, 580 F.2d 442 (1978); J.
Hofert Co. v. United States, 23 AFTR 2d 69-845, 69-1 USTC par.
9220 (C.D. Cal. 1969).
If petitioner's investment were equity, petitioner would be
entitled to increase his basis in his WSAI shares by the amount
of the investment. Under this scenario, petitioner would
subtract his basis from the amount of the distribution; if the
distribution should exceed petitioner's basis, the excess would
be treated as capital gain from sale of the stock.
In Donisi v. Commissioner, 405 F.2d 481, 483 (6th Cir.
1968), affg. T.C. Memo. 1967-62, the court noted that, although
the intention of the parties weighs heavily in determining
whether advances are loans, proof of such intent is to be found
in “the arrangements concerning the normal security, interest and
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repayment or efforts to secure the same.” In Austin Village,
Inc. v. United States, 432 F.2d 741, 745 (6th Cir. 1970), the
court relied on the fact that there was no unconditional promise
to repay the loans, no fixed schedule of payments, and no
security given for issuance of the loans.
In the case at hand, none of the factors are present that
would tend to show that petitioner reasonably expected WSAI to
repay the “loan” in accordance with terms in line with those
generally prevailing in the business community. See Nassau Lens
Co. v. Commissioner, 308 F.2d 39 (2d Cir. 1962), remanding 35
T.C. 268 (1960). Moreover, no interest payments to petitioner
were made or provided for. See Texas Farm Bureau v. United
States, 725 F.2d 307, 313-314 (5th Cir. 1984). If petitioner had
been a true lender, he would have provided for interest payments.
Curry v. United States, 396 F.2d 630, 634 (5th Cir. 1968).
We find that petitioner’s $41,200 of deposits into the WSAI
checking account was a contribution to the capital of WSAI.
Because petitioner was a shareholder of WSAI, his $41,200 of
contributions to capital is reflected in an increased basis for
his WSAI stock. Sec. 1.118-1, Income Tax Regs. Thus,
petitioner’s basis in his WSAI stock was $41,450.15
15
At trial, respondent produced copies of WSAI checks to
petitioner and to Camelot Court Development, Inc., and Camelot
Court Development, Inc. II, in the amounts of $5,000, $3,697, and
$57,703, respectively (Petitioner has a 45-percent interest in
(continued...)
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Petitioner’s amount realized from the distribution of the
condominium units should be reduced by the amount of the
corporation's liabilities to the Posas, Fosses, and Navars that
petitioner agreed to assume, and for whose discharge he made the
necessary arrangements. Thus, after subtracting the assumed
liabilities of $68,000 from the $92,380 gain ($133,830 amount
realized minus $41,450 adjusted basis), petitioner’s realized
capital gain is $24,380.
IV. Additions
A. Section 6653(a) negligence addition
Respondent determined that petitioner is liable for an
addition to tax for negligence pursuant to section 6653(a).
Section 6653(a)(1) imposes an addition to tax of 5 percent of the
portion of the underpayment to which section 6653 applies.
15
(...continued)
Camelot Court Development, Inc., and a 50-percent interest in
Camelot Court Development, Inc. II). Petitioner objected to
their introduction into evidence, because they had not been
submitted to petitioner prior to trial, contrary to our Standing
Pretrial Order, for incorporation in the stipulation of facts
under Rule 91. Respondent did not request leave to amend her
answer to assert an additional deficiency for these amounts, and
did not make any argument on brief that we should treat them as
taxable distributions or as reductions in the basis of
petitioner's stock. Respondent maintained at trial that the
documents were offered for impeachment purposes only, under Fed.
R. Evid. 607, as an exception to Rule 91 and the Standing
Pretrial Order, and we so regard them.
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Section 6653(a)(3) defines “negligence” as including any failure
to make a reasonable attempt to comply with the provisions of the
Code. Petitioner has the burden of proving that respondent’s
determination of the addition to tax for negligence is erroneous.
Rule 142(a); Luman v. Commissioner, 79 T.C. 846, 860-861 (1982).
Negligence is defined as the lack of due care or the failure
to do what a reasonable and ordinarily prudent person would do
under similar circumstances. Anderson v. Commissioner, 62 F.3d
1266, 1271 (10th Cir. 1995), affg. T.C. Memo. 1993-607; Norgaard
v. Commissioner, 939 F.2d 874, 880 (9th Cir. 1991), affg. in part
and revg. in part on other grounds T.C. Memo. 1989-390. A
taxpayer’s failure to maintain adequate books and records is
sufficient to establish negligence. Sec. 6001; Zafiratos v.
Commissioner, T.C. Memo. 1992-135, affd. without published
opinion 993 F.2d 880 (3d Cir. 1993); Moran v. Commissioner, T.C.
Memo. 1981-352.
Petitioner has been a certified public accountant for many
years and was aware of the requirement that complete and accurate
books and records be maintained with respect to WSAI’s activities
and any distributions from WSAI to petitioner. As an accountant,
petitioner was also aware of his requirement to verify and
document the value of the condominium units distributed to him.
See Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740
(1973); D’Arcangelo v. Commissioner, T.C. Memo. 1994-572. A
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careful consideration of the evidence, including the selling
price of the other South Wood condominiums and petitioner’s sale
price of his own South Wood Condominium around the time for
filing his 1988 return, should have alerted him, as an
accountant, to the appropriate values for the condominium units
distributed. See deRochemont v. Commissioner, T.C. Memo. 1991-
600.
We sustain respondent’s determination that petitioner was
negligent with respect to the underpayment.
B. Section 6661 substantial understatement addition
Respondent determined that petitioner is liable for an
addition to tax under section 6661 for substantial
understatement. This addition applies when the understatement of
income tax exceeds the greater of (1) 10 percent of the tax
required to be shown on the return for the taxable year, or (2)
$5,000. Sec. 6661(b)(1). The understatement for purposes of
this addition is reduced where there is substantial authority for
the tax treatment of any item or if there was adequate
disclosure, in or attached to the return, of the relevant facts
affecting any item. Sec. 6661(b)(2)(B).
Petitioner made no disclosure of the distribution on his
individual return for 1988 and made no argument against
imposition of this addition. Since the amount of petitioner’s
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understatement for the 1988 taxable year is substantial, we
sustain respondent’s determination on this issue.
Decision will be entered
under Rule 155.