Welle v. Commissioner

U.S. Tax Court6/27/2013

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TERRY J. WELLE AND CHRISSE J. WELLE, PETITIONERS v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 156–11. Filed June 27, 2013.

P–H is the sole shareholder of TWC, a subch. C corporation.
Ps used TWC to facilitate the construction of their lakefront
home in that TWC kept track of construction costs and TWC’s
framing crew framed the home. Ps, however, personally hired
the subcontractors and ordered building supplies from the
vendors in TWC’s name. Ps reimbursed TWC for its costs,
including overhead, but did not pay TWC an amount equal to
the profit margin of 6% to 7% that TWC normally charged its
customers (forgone profit). R determined that P–H received a
constructive dividend from TWC in an amount equal to TWC’s
forgone profit. Held: P–H did not receive a constructive divi-
dend equal to TWC’s forgone profit from services that TWC
provided during the building of Ps’ home because the trans-
actions did not result in the distribution of current or accumu-
lated earnings and profits.

Jon J. Jensen, for petitioners.
Christina L. Cook, for respondent.
MARVEL, Judge: Respondent determined a deficiency of
$10,620 in petitioners’ Federal income tax and an accuracy-
related penalty under section 6662(a) 1 of $2,124 for 2006.
The issues for decision are: (1) whether petitioner Terry J.
Welle received a constructive dividend of $48,275 from his
wholly owned subchapter C corporation, Terry Welle
Construction, Inc. (TWC), in 2006; and (2) whether peti-
tioners are liable for the accuracy-related penalty under sec-
tion 6662(a).

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of
facts is incorporated herein by this reference. Petitioners
resided in North Dakota when they petitioned this Court.
TWC is a construction company specializing in multifamily
housing projects. For most jobs that closed during 2006 TWC
had profit margins of 6% to 7%. Mr. Welle is the president
and sole shareholder of TWC.
1 Unless otherwise indicated, section references are to the Internal Rev-

enue Code (Code) in effect for the year at issue, and Rule references are
to the Tax Court Rules of Practice and Procedure.

420

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(420) WELLE v. COMMISSIONER 421

Petitioners owned lakefront property in Detroit Lakes,
Minnesota, on which they planned to build a second home
(lakefront home). In 2004 petitioners began construction of
the lakefront home. To keep track of material and other
construction costs, Mr. Welle caused TWC to open a ‘‘cost
plus’’ job account on its books. Petitioners, however, person-
ally contacted all of the subcontractors and building supply
vendors that built or supplied materials for the lakefront
home and acted as their own general contractors during its
construction.
During the construction TWC paid the subcontractors and
vendors directly, and its framing crew framed the lakefront
home. Petitioners repaid TWC for all amounts paid to the
subcontractors and also reimbursed TWC for its labor and
overhead costs. TWC, however, did not charge petitioners,
and petitioners did not pay to TWC, an amount equal to the
customary profit margin that TWC used to calculate the con-
tract price that it charged its unrelated clients (forgone
profit).
Respondent determined that Mr. Welle received a qualified
dividend of $48,275 from TWC in 2006, equal to the forgone
profit.

OPINION

Respondent contends that Mr. Welle received a construc-
tive dividend from TWC when TWC built petitioners’ lake-
front home without charging them an amount equal to its
customary profit margin of 6% to 7%.
Petitioners contend that (1) Mr. Welle did not receive a
constructive dividend because a shareholder does not receive
a constructive dividend when a corporation provides services
to the shareholder at cost; and (2) respondent’s determina-
tion of the measure of any constructive dividend that Mr.
Welle may have received was erroneous because the services
that TWC provided to Mr. Welle were not comparable to the
services that it provided to its unrelated clients. Because we
decide on this record that Mr. Welle did not receive a

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422 140 UNITED STATES TAX COURT REPORTS (420)

constructive dividend, 2 we need not address petitioners’
second contention. 3
I. Constructive Dividends Generally
Section 61(a)(7) includes dividends in a taxpayer’s gross
income. Section 316(a) defines a dividend as any distribution
of property that a corporation makes to its shareholders out
of its earnings and profits accumulated after February 28,
1913, or out of its earnings and profits for the taxable year.
Section 317(a) defines property as money, securities, and any
other property except stock in the distributing corporation.
We have held that, under some circumstances, the provision
of services by a corporation to its shareholders constitutes
‘‘property’’ within the meaning of section 317(a). See Magnon
v. Commissioner, 73 T.C. 980, 993 (1980) (citing Loftin &
Woodard, Inc. v. United States, 577 F.2d 1206, 1214 (5th Cir.
1978), and Benes v. Commissioner, 42 T.C. 358, 379 (1964),
aff ’d, 355 F.2d 929 (6th Cir. 1966)).
‘‘A constructive dividend arises ‘[w]here a corporation con-
fers an economic benefit on a shareholder without the
expectation of repayment, * * * even though neither the cor-
poration nor the shareholder intended a dividend.’ ’’ Hood v.
Commissioner, 115 T.C. 172, 179 (2000) (quoting Magnon v.
Commissioner, 73 T.C. at 993–994). ‘‘ ‘The crucial concept in
a finding that there is a constructive dividend is that the cor-
poration has conferred a benefit on the shareholder in order
2 Wedecide this case without regard to the allocation of the burden of
proof. We therefore need not decide whether petitioners satisfied the re-
quirements of sec. 7491(a). See Blodgett v. Commissioner, 394 F.3d 1030,
1039 (8th Cir. 2005), aff ’g T.C. Memo. 2003–212; Knudsen v. Commis-
sioner, 131 T.C. 185, 188–189 (2008).
3 We question the timing of respondent’s constructive dividend adjust-

ment. TWC advanced payment of the expenses relating to the construction
of petitioners’ lakefront home during 2004 and 2005. Additionally, Mr.
Welle credibly testified that he and petitioner Chrisse J. Welle moved into
the lakefront home during Memorial Day weekend of 2005. Accordingly, it
appears that a credible argument could have been made that any construc-
tive dividend arose in 2004 and/or 2005. See sec. 1.451–1(a), Income Tax
Regs. However, we deem this issue waived by petitioners because they
never raised it. See Muhich v. Commissioner, 238 F.3d 860, 864 n.10 (7th
Cir. 2001) (issues not addressed or developed are deemed waived—it is not
the Court’s obligation to research and construct the parties’ arguments),
aff ’g T.C. Memo. 1999–192.

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(420) WELLE v. COMMISSIONER 423

to distribute available earnings and profits without expecta-
tion of repayment.’ ’’ Truesdell v. Commissioner, 89 T.C. 1280,
1295 (1987) (quoting Noble v. Commissioner, 368 F.2d 439,
443 (9th Cir. 1966), aff ’g T.C. Memo. 1965–84); see also
Palmer v. Commissioner, 302 U.S. 63, 70 (1937) (stating that,
for a transaction to be treated as a deemed dividend, ‘‘it is
at least necessary to make some showing that the trans-
action is in purpose or effect used as an implement for the
distribution of corporate earnings to stockholders’’); CTM
Constr., Inc. v. Commissioner, T.C. Memo. 1988–590, 56
T.C.M. (CCH) 971, 974 (1988) (‘‘Generally, a constructive dis-
tribution occurs when corporate assets are diverted to or for
the benefit of a shareholder without adequate consideration
for the diversion.’’ (citing Sammons v. Commissioner, 472
F.2d 449 (5th Cir. 1972), aff ’g in part, rev’g in part T.C.
Memo. 1971–145)). However, ‘‘ ‘[n]ot every corporate expendi-
ture [that] incidentally confer[s] economic benefit on a share-
holder is a constructive dividend.’ ’’ Loftin & Woodard, 577
F.2d at 1215 (quoting Crosby v. United States, 496 F.2d 1384,
1388 (5th Cir. 1974)).
Where a corporation constructively distributes property to
a shareholder, the constructive dividend received by the
shareholder is ordinarily measured by the fair market value
of the benefit conferred. See Ireland v. United States, 621
F.2d 731, 737 (1980) (citing Loftin & Woodard, 577 F.2d at
1223); Melvin v. Commissioner, 88 T.C. 63, 80–81 (1987),
aff ’d, 894 F.2d 1072 (9th Cir. 1990). However, where fair
market value cannot be reliably ascertained or there is evi-
dence that fair market value is an inappropriate mode of
measurement, the constructive dividend can be measured by
the cost to the corporation of the benefit conferred. See Loftin
& Woodard, 577 F.2d at 1223 (citing Commissioner v. Riss,
374 F.2d 161, 170 (8th Cir. 1967), aff ’g in part, rev’g in part
T.C. Memo. 1964–190).
The Code does not define the term ‘‘earnings and profits’’.
See sec. 316(a); Henry C. Beck Co. v. Commissioner, 52 T.C.
1, 6 (1969), aff ’d per curiam, 433 F.2d 309 (5th Cir. 1970).
As we have previously observed, the calculation of earnings
and profits is not easy or obvious. See, e.g., Anderson v.
Commissioner, 67 T.C. 522, 527 (1976), aff ’d, 583 F.2d 953
(7th Cir. 1978); Juha v. Commissioner, T.C. Memo. 2012–68,
103 T.C.M. (CCH) 1338, 1341 (2012). For example, although

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424 140 UNITED STATES TAX COURT REPORTS (420)

section 1.312–6(a), Income Tax Regs., provides that a cor-
poration must compute earnings and profits using the same
method of accounting employed in computing taxable income,
earnings and profits are not equivalent to taxable income.
See Commissioner v. Wheeler, 324 U.S. 542, 546 (1945);
Jaques v. Commissioner, 935 F.2d 104, 107–108 (6th Cir.
1991), aff ’g T.C. Memo. 1989–673. The reason for this
distinction is that earnings and profits is a broad concept
‘‘which the tax law has utilized ‘to approximate a corpora-
tion’s power to make distributions which are more than just
a return of investment.’ ’’ Henry C. Beck Co. v. Commissioner,
52 T.C. at 6 (quoting Arthur R. Albrecht, ‘‘ ‘Dividends’ and
‘Earnings or Profits’ ’’, 7 Tax L. Rev. 157, 183 (1952)).
II. Services Provided by a Corporation to a Shareholder at
Cost
Respondent contends that Magnon v. Commissioner, 73
T.C. 980, stands for the proposition that a shareholder
receives a constructive dividend equal to the cost of the serv-
ices provided to the shareholder by a corporation plus the
corporation’s customary profit margin. In Magnon v.
Commissioner, 73 T.C. at 994–996, we held that the amount
of the costs and overhead for electrical services provided by
a corporation to a shareholder without expectation of repay-
ment was a constructive dividend. But we did not hold, and
the Commissioner did not assert, that the constructive divi-
dend the shareholder received included an amount cor-
responding to the corporation’s forgone profit.
Similarly, in cases such as Benes v. Commissioner, 42 T.C.
at 379, Nahikian v. Commissioner, T.C. Memo. 1995–161, 69
T.C.M. (CCH) 2370, 2372–2375 (1995), CTM Constr., Inc. v.
Commissioner, 56 T.C.M. (CCH) at 974, and Clevenger v.
Commissioner, T.C. Memo. 1986–149, 51 T.C.M. (CCH) 835,
839–840 (1986), aff ’d, 826 F.2d 1379 (4th Cir. 1987), we held
that amounts expended by the respective corporations in con-
structing homes for their shareholders constituted construc-
tive dividends. But we did not hold, and the Commissioner
did not assert, that the constructive dividends in those cases
each included an amount corresponding to the respective cor-
porations’ forgone profit.

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(420) WELLE v. COMMISSIONER 425

Respondent does not explain how a corporation’s decision
not to make a profit on services provided to a shareholder
who fully reimburses the corporation for the cost of the serv-
ices (including overhead) constitutes a distribution of prop-
erty that reduces the corporation’s earnings and profits
under section 316(a), nor does respondent cite any cases sup-
porting such a position. Respondent argues that his position
follows from the general rule that constructive dividends are
ordinarily measured by the fair market value of the benefit
conferred. See Ireland, 621 F.2d at 737; Melvin v. Commis-
sioner, 88 T.C. at 80–81. It appears to us, however, that
respondent’s argument skips an important analytical step
required by section 316(a)—we must first find that there has
been a distribution of property to the shareholder that
reduces the corporation’s current or accumulated earnings
and profits. A finding that a shareholder received a construc-
tive dividend from a corporation is only appropriate where
‘‘corporate assets are diverted to or for the benefit of a share-
holder’’, CTM Constr., Inc. v. Commissioner, 56 T.C.M. (CCH)
at 974, ‘‘in order to distribute available earnings and profits
without expectation of repayment’’, Truesdell v. Commis-
sioner, 89 T.C. at 1295; see also Palmer v. Commissioner, 302
U.S. at 69 (‘‘While a sale of corporate assets to stockholders
is, in a literal sense, a distribution of its property, such a
transaction does not necessarily fall within the statutory
definition of a dividend. For a sale to stockholders may not
result in any diminution of its net worth and in that case
cannot result in any distribution of its profits.’’); Honigman
v. Commissioner, 466 F.2d 69, 74 (6th Cir. 1972) (noting that
the below-market sale of corporate assets at issue diminished
the net worth of the corporation), aff ’g in part, rev’g in part,
and remanding 55 T.C. 1067 (1971); Goldstein v. Commis-
sioner, 298 F.2d 562, 568 (9th Cir. 1962) (noting that cor-
porate assets were reduced in the amount held to be a dis-
guised dividend), aff ’g T.C. Memo. 1960–276; McCabe
Packing Co. v. United States, 809 F. Supp. 614, 617 (C.D. Ill.
1992) (holding that a shareholder’s use of a discarded
slaughterhouse byproduct was not a constructive dividend to
the shareholder because corporate assets were not distrib-
uted or expended).
We cannot see how TWC’s provision of services to Mr.
Welle at cost resulted in the diversion of corporate assets or

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426 140 UNITED STATES TAX COURT REPORTS (420)

the distribution of its earnings and profits. Moreover, we do
not think that TWC’s provision of services to Mr. Welle at
cost was ‘‘in purpose or effect * * * an implement for the dis-
tribution of corporate earnings’’ and profits. See Palmer v.
Commissioner, 302 U.S. at 70.
By contrast, in cases involving the bargain sale of property
to a shareholder, we have held that the shareholder receives
a constructive dividend equal to the excess of the fair market
value over the sale price, see, e.g., Dellinger v. Commissioner,
32 T.C. 1178, 1182–1183 (1959); Nelson v. Commissioner,
T.C. Memo. 1982–361, 44 T.C.M. (CCH) 277, 281 (1982),
aff ’d, 767 F.2d 667 (10th Cir. 1985); see also sec. 1.301–1(j),
Income Tax Regs., because the property being sold is an
asset of the corporation and its sale for less than fair market
value diverts actual value otherwise available to the corpora-
tion to or for the benefit of a shareholder, see Honigman v.
Commissioner, 466 F.2d at 74; Goldstein v. Commissioner,
298 F.2d at 568. Similarly, we have held that, where a cor-
poration provides a shareholder with the use of corporate
property and the shareholder does not fully and reasonably
reimburse the corporation for its use, the shareholder has
received a constructive dividend equal to the fair market
value of the use of the property. See Melvin v. Commissioner,
88 T.C. at 80–81. In Melvin, however, we observed that inci-
dental or insignificant use of corporate property may not jus-
tify a finding of a constructive dividend, id. at 82 (citing
United Aniline Co. v. Commissioner, 316 F.2d 701, 703 (1st
Cir. 1963), aff ’g T.C. Memo. 1962–60); see also Loftin &
Woodard, 577 F.2d at 1214, and we specifically found that
the taxpayer’s personal use of the property was not inci-
dental to the taxpayer’s business use of the property, Melvin
v. Commissioner, 88 T.C. at 82–83.
TWC maintained its corporate infrastucture and workforce
for business purposes. Mr. Welle’s use of TWC during the
construction of petitioners’ lakefront home was at most inci-
dental to those purposes. The most that can be said about
Mr. Welle’s use of TWC is that he used the corporation as
a conduit in paying subcontractors and vendors and that he
obtained some limited services from corporate employees. Mr.
Welle fully reimbursed the corporation for all costs, including
overhead, associated with those services, and TWC did not
divert actual value otherwise available to it by failing to

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(420) WELLE v. COMMISSIONER 427

apply its customary profit margin in determining the amount
Mr. Welle had to reimburse the corporation. We therefore
conclude that this arrangement did not operate as a vehicle
for the distribution of TWC’s current or accumulated
earnings and profits within the meaning of section 316(a).
III. Conclusion
We hold that Mr. Welle did not receive constructive divi-
dend income when TWC provided services to him at cost and
for which he timely paid. Accordingly, we do not sustain
respondent’s deficiency determination, and we thus need not
decide whether an accuracy-related penalty under section
6662(a) would be appropriate.
We have considered the parties’ remaining arguments, and
to the extent not discussed above, conclude those arguments
are irrelevant, moot, or without merit.
To reflect the foregoing,
Decision will be entered for petitioners.

f

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Welle v. Commissioner

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