Frentz v. Comm'r of Internal Revenue, Docket Nos. 4650-63— 4652-63.

• Decision Date: 28 June 1965
• Docket Number: Docket Nos. 4650-63— 4652-63.
• Citation: 44 T.C. 485
• Parties: J. WILLIAM FRENTZ AND BARBARA B. FRENTZ, ET AL.,1 PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

44 T.C. 485

J. WILLIAM FRENTZ AND BARBARA B. FRENTZ, ET AL.,1 PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket Nos. 4650-63— 4652-63.

Tax Court of the United States.

Filed June 28, 1965.

Frank E. Haddad, Jr., and Arthur Clark, Jr., for the petitioners.

Dennis M. Feeley, for the respondent.

Petitioners acquired all the stock of an Indiana corporation which was an electing small business corporation under subchapter S, I.R.C. 1954, having a fiscal year ending October 31. Intending to form a new corporation under Kentucky law to operate the business from November 1, 1959, as an electing small business corporation, they filed a purported election on November 30, 1959. The new corporation was not chartered until January 11, 1960. The new corporation operated at a loss in the fiscal period ending October 31, 1960, and the petitioners claimed deductions for their pro rata shares of the loss. Held, the new corporation not being in existence at the time of the filing of the election, the requirements of section 1372 as to filing were not met, the purported election was invalid, the corporation was not an electing small business corporation, and the losses claimed by the petitioners are not allowable as deductions.

BRUCE, Judge:

The respondent determined deficiencies in the income taxes of the respective petitioners for the year 1960 as follows:

+-------------------------------------------------------------+
                ¦Docket No.¦Petitoner                              ¦Deficiency¦
                +----------+---------------------------------------+----------¦
                ¦          ¦                                       ¦          ¦
                +----------+---------------------------------------+----------¦
                ¦4650-63   ¦J. William Frentz and Barbara B. Frentz¦$620.33   ¦
                +----------+---------------------------------------+----------¦
                ¦4651-63   ¦Orville Brown and Alice Brown          ¦3,750.45  ¦
                +----------+---------------------------------------+----------¦
                ¦4652-63   ¦Morris Brown and Judy Brown            ¦3,626.61  ¦
                +----------+---------------------------------------+----------¦
                ¦          ¦                                       ¦          ¦
                +-------------------------------------------------------------+
                

The sole issue is whether the petitioners are entitled to deduct net losses claimed on their returns for 1960. Some facts are stipulated.

FINDINGS OF FACT

The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.

The above-named petitioners are husbands and wives. Each couple resides in Louisville, Ky., and each filed a joint Federal income tax return for the calendar year 1960 with the district director of internal revenue at Louisville. References to the petitioners hereinafter relate to J. William Frentz, Orville Brown, and Morris Brown.

On or about October 7, 1959, the petitioners purchased the entire outstanding capital stock of Ohio Valley Broadcasting, Inc., hereinafter referred to as Ohio Valley, an Indiana corporation engaged in the operation of a radio station under the call letters WLRP. Ohio Valley was licensed by the Federal Communications Commission, hereinafter referred to as the FCC, to operate a radio station at New Albany, Ind. Its license was renewed under date of July 2, 1958, for a term ending August 1, 1961.

Ohio Valley was an electing small business corporation, having made a valid election under section 1372 of the Internal Revenue Code of 1954 in 1958. Petitioners filed timely and valid consents to this election.

On September 30, 1959, the FCC issued its consent to the transfer of control of Ohio Valley to the petitioners.

Prior to November 1, 1959, Ohio Valley requested the FCC to authorize a change of call letters, and effective November 1, 1959, the call letters were changed by the FCC from WLRP to WOWI.

A new checking account in the name of Ohio Valley Broadcasting, Inc., doing business as WOWI, was opened on November 3, 1959, at Royal Bank & Trust Co., louisville.

Kentuckiana Broadcasting, Inc., hereinafter referred to as Kentuckiana, is a corporation formed under the laws of the State of Kentucky. The articles of incorporation were executed by the petitioners on December 31, 1959, and were filed with the secretary of state of Kentucky on January 11, 1960, on which date the corporation charter was issued.

Petitioners had employed counsel to prepare the articles of incorporation for Kentuckiana. Counsel sought advice from an attorney in Washington, D.C., versed in FCC practice, concerning the wording of a ‘purpose’ clause acceptable to the FCC. This clause was received in December 1959, and the prepared articles were sent to the petitioners December 17, 1959, for execution.

The petitioners originally attempted to purchase the assets of Ohio Valley, but the sellers insisted on a sale of stock. The petitioners intended to dissolve Ohio Valley and form a new corporation to operate the radio station. The intent of the petitioners was to effect the transfer as of the close of Ohio Valley's fiscal year, October 31, 1959, and new call letters assigned by the FCC were made effective as of November 1, 1959. A new set of books was opened as of November 1 under the letters WOWI, and all the assets and liabilities of Ohio Valley were entered thereon. Quarterly returns of employment taxes and withholding of income taxes were made in the name of Ohio Valley covering wages paid in October and in the name of Kentuckiana for wages paid in November and December to the employees of the station. A new employer's identification number was secured in the name of Kentuckiana.

On November 30, 1959, there was filed with the district director of internal revenue at Louisville a Form 2553, ‘Election by Small Business Corporation,‘ as to taxable status under subchapter S of the Internal Revenue Code. This purported to be an election by Kentuckiana under section 1372(a) to be treated as a ‘small business corporation’ for income tax purposes. The form was signed by Frentz, as president, under date of November 26, 1959, and attached was a statement signed by the petitioners, as the stockholders, consenting to such election. The form represented that the corporation's predecessor was Ohio Valley and that such predecessor was in existence from September 7, 1949, to October 31, 1959; that Kentuckiana was incorporated November 1, 1959, in Kentucky; that the first taxable year for which the election was effective was the year ending October 31, 1960; and that the petitioners were the only shareholders. The number of shares outstanding was stated to be 170, held 13.6 by Frentz, 78.2 by Morris Brown, and 78.2 by Orville R. Brown.

Ohio Valley was dissolved in 1960. Notice of intent to dissolve was given January 26, 1960. Articles of dissolution were executed February 1, 1960, and a certificate of dissolution was executed by the Indiana secretary of state on August 8, 1960.

Kentuckiana, on July 22, 1960, filed an application with the FCC for consent to an assignment of the broadcasting license from Ohio Valley to Kentuckiana, which application was approved August 23, 1960.

Kentuckiana filed a timely Form 1120-S, ‘U.S. Small Business Corporation Return of Income,‘ for the fiscal period November 1, 1959, to October 31, 1960. The return reported income of $138,562.72, expenses of $166,812.53, and a net loss of $28,249.81. The balance sheet as of October 31, 1960, showed assets of $176,582.39, liabilities of $34,259.64, common stock $170,000, capital surplus $792.24, and a deficit of $28,469.49. The return gave the date of incorporation as January 11, 1960, and scheduled the distribution of the loss $2,259.99 to Frentz, $12,994.91 to Morris Brown, and $12,994.91 to Orville Brown.

On the Federal income tax return filed by each of the petitioners for the calendar year 1960 a deduction was claimed for the loss from the business of Kentuckiana in the amount shown in the preceding paragraph. Respondent determined in each case that the loss so claimed was not allowable under section 1374 of the Code as Kentuckiana failed to meet the requirements of section 1372.

OPINION

Subchapter S of chapter 1 of the Internal Revenue Code of 1954, secs. 1371 to 1377, provides for elections by certain small business corporations as to taxable status. In general, where a qualified corporation has so elected, it is not subject to income tax, and its undistributed taxable income is taxed to the shareholders pro rata or its net operating loss is allowable to the shareholders pro rata as a deduction from gross income.

When the petitioners acquired the stock of Ohio Valley it was an electing small business corporation pursuant to an election made in 1958. The petitioners consented to that election, as was required of new shareholders by section 1372(e)(1),² to keep the election in effect. The petitioners, in forming a new corporation, Kentuckiana, to take over the operation of the radio station, intended to have it qualified as an electing small business corporation. Their intention was to have it commence operations as of November 1, 1959, and they filed the required election in the name of Kentuckiana, together with their consents as shareholders, within the first month of the intended fiscal year, November 1, 1959, to October 31, 1960, as required by section 1372(a) and (c)(1).³ The difficulty with their attempt to have Kentuckiana qualify was that the corporation's articles were not filed and the charter was not issued until January 11, 1960.

Respondent takes the position that since Kentuckiana became a corporation on January 11, 1960, it could not, prior to such date, have stockholders, own assets, or do business; that the purported election on...