42 T.C. 114 (1964), 94162, Ach v. C. I. R.

Docket Nº:94162-94164.
Citation:42 T.C. 114
Opinion Judge:RAUM, Judge:
Attorney:William R. Seaman and Ronald E. Heinlen, for the petitioners. Gerald W. Fuller, for the respondent.
Case Date:April 15, 1964
Court:United States Tax Court

Page 114

42 T.C. 114 (1964)




Nos. 94162-94164.

United States Tax Court.

April 15, 1964

William R. Seaman and Ronald E. Heinlen, for the petitioners.

Gerald W. Fuller, for the respondent.

1. Held: The Commissioner was warranted in allocating income of corporate petitioner to individual petitioner under section 482, I.R.C. 1954. Allocation approved as revised herein.

2. Held, individual petitioner acquired control of corporate petitioner for purpose of avoiding tax within meaning of section 269, I.R.C. 1954, and section 129, I.R.C. 1939.

Respondent determined deficiencies in income tax in these consolidated proceedings as follows:

Estate of Ernest
M. Ach, Deceased,
Year The Ach Corp. Pauline W. Pauline W. Ach,
Ach Sole Legatte,
Pauline W. Ach,
Surviving Wife
1954 $19,695.24
1955 $14,576.30 22,161.34
1956 16,591.44 22,268.76
1957 15,155.52 $23,562.53
1958 16,309.54 26,894.31

Page 115 The principal issues for decision are (1) whether income reflected in the corporation's returns from the operation of a dress business during the taxable years may be ascribed to petitioner Pauline W. Ach; and (2) whether net operating losses incurred prior to 1954 in the operation of a dairy business may be carried forward as deductions against corporate earnings realized in the conduct of a dress and apparel business. FINDINGS OF FACT Some of the facts have been stipulated; the stipulation of facts and all exhibits identified therein are incorporated by this reference. Pauline W. Ach and her husband, Ernest M. Ach, resided in Hamilton, Ohio. He died on February 14, 1956. Pauline timely filed joint income tax returns with her husband, or his estate, for the years 1954, 1955, and 1956. She filed separate individual returns for 1957 and 1958. The Ach Corp., an Ohio corporation with its principal place of business in Cincinnati, Ohio, timely filed its corporate income tax returns for the years 1955-58. All of the foregoing returns were filed with the district director of internal revenue at Cincinnati. Pauline was the executrix of Ernest's will and his sole beneficiary. Roger W. Ach is the son of Pauline and Ernest. During 1945 or early 1946 Roger and his father purchased the assets of a dairy business in Indiana and conducted a dairy business with those assets as a partnership in Rising Sun, Ind. The business was incorporated under the laws of Ohio in December 1946 as ‘ Indiana Ideal Creamery Company,‘ but shortly thereafter, in January 1947, its name was changed to ‘ Rising Sun Creamery Company.’ The statement of purpose or purposes for which the corporation was formed reads in its entirety as follows: To buy, sell, manufacture, purchase, distribute and deal in milk, cream, butter, cheese, eggs, and all other products and derivatives of milk, cream and other dairy products of any kind, and the doing of all things incidental and necessary to carry out the purposes of this corporation.DP The only shares of stock issued were 300 shares of common to Roger and 200 shares of 4-percent noncumulative preferred to his father. The shares of preferred stock were transferred to someone else on December 31, 1951, and were surrendered for cancellation during the following year. All of the common stock was held continuously by Roger until July 14, 1953, when changes occurred, as hereinafter set forth. Throughout the years 1947 through 1952 the Rising Sun Creamery Co.‘ s principal business was the operation of a creamery plant in Rising Sun, Ind. Roger was its president and chief executive officer in charge of its daily operations. Neither of his parents participated Page 116 in the management of the corporation. The business was unsuccessful, and the corporation's net operating losses during the years 1950-53 were as follows:

Year Net operating loss
1950 $34,057.60
1951 49,836.76
1952 61,807.12
1953 87,492.60

In an effort to help sustain his son's faltering enterprise, Ernest from time to time made loans to the corporation, evidenced by interest-bearing notes. The amount due on those notes as of the end of each of the years 1950-53 was as follows:

Year Net operating loss
1950 $103,000
1951 252,000
1952 281,000
1953 282,700

The corporation's balance sheet, as of December 31, 1952, reflected the following:

Cash ($3,007.19)
Notes and accounts receivable
Less: Reserve for bad debts 18,375.21
Inventories 59,919.84
Capital assets:
Depreciable assets $183,180.33
Less: Reserve for depreciation 52,676.44 130,503.89
Land 1,600.00
Other assets
Deferred charges 7,565.34
Cash surrender value-
life insurance 2,953.21 10,518.55
Total assets 217,910.30
Accounts payable $38,862.48
Bonds, notes, and mortgages payable:
With original maturity of less
than 1 year $45,140.00
With original maturity of 1 year
or more 282,315.45 327,455.45
Accrued expenses
Taxes $998.48
Interest 439.25 $1,437.73
Other liabilities
Employee's payroll deductions 1,319.24
Capital stock:
Common stock 20,000.00
Paid or capital surplus 26,508.47
Earned surplus and undivided profits (197,673.07)
Total liabilities 217,910.30

Page 117 During the latter part of 1952, Roger went to his father and told him that it was time to give up the dairy and creamery business; Roger felt his father was too old to have to worry about continued losses and the continued backing of a losing cause. It was at approximately this time that it was decided to quit this business. The corporation ceased operating the dairy and creamery business at some undisclosed time prior to August 1, 1953, and sold its dairy and creamery equipment. Its principal remaining assets consisted of land and buildings in Rising Sun, Ind., which were being rented to persons not connected with the corporation. On April 23, 1953, the corporation changed its name to the Ach Corp. and changed its stated corporate purposes from the operation of a creamery plant and related dairy business to broad, general purposes which would permit it to conduct a wide range of businesses authorized under the statutes in the State of Ohio. On or about July 14, 1953, Roger, pursuant to his parents' suggestion, transferred to his brother, S. Laurence Ach, 149 shares of the corporation's common stock; there was no consideration for this transfer. For approximately 29 years prior to August 1, 1953, Pauline had owned and operated a sole proprietorship known as ‘ Vogues and Vanities,‘ a successful retail dress and apparel business located in Cincinnati, Ohio. During this period there was never a year when the business lost money, even during the depression. Prior to August 1, 1953, the profits approximated $25,000-$30,000 per year; the trend of these profits was upward. Vogues and Vanities employed approximately 9 to 12 persons. On August 1, 1953, the net book value of its assets was $30,705.57. Page 118 The balance sheet of Vogues and Vanities, as of July 31, 1953, reflected the following:

Cash on hand and in banks $2,901.49
Accounts receivable-customers 26,347.43
Note receivable 2,210.00
Inventory-merchandise 4,220.13
Sales tax stamps on hand 11.43
Furniture and fixtures $5,351.10
Less-Reserve for
depreciation 4,716.30
Depreciated cost 634.80
Leasehold improvements 7,733.15
Less-Reserve for
amortization 5,799.84
Amortized cost 1,933.31
TOTAL FIXED ASSETS-Depreciated cost
DEFERRED CHARGES: Unexpired insurance
TOTAL ASSETS 38,420.02
Notes payable-bank $2,000.00
Accounts payable 4,399.13
Accrued taxes 428.27
Employees payroll deductions 887.05
INVESTMENT 30,705.57

On or about August 1, 1953, Pauline, who was at that date almost 60 years of age, became president, treasurer, and chairman of the board of directors of the Ach Corp.; she was not, however, a shareholder of record at that time. At a ‘ Special Meeting of the Board of Directors' of the corporation, on August 1, 1953, at which Pauline presided, she made the following written offer to the corporation: As sole proprietor of Vogues and Vanities, a shop engaged in selling women's apparel at retail and presently located at 27 Garfield Place, Cincinnati, Ohio, Page 119 I hereby offer to sell to you all the business merchandise and other assets thereof, less the liabilities, at the book value of $30,705.57 as shown by balance sheet of Vogues and Vanities of July 31, 1953, prepared by J.D. Cloud & Co., Certified Public Accountants, payment to be made by the corporation's demand note payable to me, without interest, in the sum of $30,705.57. The minutes reveal that the offer was accepted. No formal contract or other written instrument reflecting an agreement between Pauline and the corporation, other than the foregoing, is...

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