Raich v. Comm'r of Internal Revenue
| Decision Date | 12 August 1966 |
| Docket Number | Docket No. 5651-64. |
| Citation | 46 T.C. 604 |
| Parties | PETER RAICH AND WANDA J. RAICH, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
46 T.C. 604
PETER RAICH AND WANDA J. RAICH, PETITIONERS,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 5651-64.
Tax Court of the United States.
Filed August 12, 1966.
[46 T.C. 604]
Clarence J. Ferrari, Jr., for the petitioners.
Harry M. Asch, for the respondent.
In 1961, petitioners, pursuant to section 351, I.R.C. 1954, transferred all the assets and liabilities of their sole proprietorship to their controlled corporation in exchange for its entire capital stock and a promissory note payable on demand. The principal asset transferred was trade accounts receivable, having a book value of $77,361.66. Held:
1. Section 357(c) is applicable and petitioners are taxable on the excess of liabilities assumed by the corporation over petitioners' adjusted basis of property transferred.
2. Trade accounts receivable in hands of cash basis taxpayer have zero basis and are includable in ‘adjusted basis of property transferred,‘ under a section 357(c) computation at that figure.
3. Upon receipt of promissory note, petitioners received taxable income under section 351(b)(1)(B) in the amount of $12,755.50.
Respondent determined deficiencies in petitioners' income tax for the calendar years 1961 and 1962 in the amounts of $12,840.49 and $221.84, respectively. Petitioners have conceded some of the issues raised by their petition, leaving the following issues to be decided:
(1) Whether the transfer by petitioners in 1961 of the assets and liabilities of their sole proprietorship to their controlled corporation constituted a taxable exchange under sections 351 and 357(c) of the Internal Revenue Code of 1954.
(2) Whether petitioners' receipt from the corporation of a promissory note in the adjusted amount of $12,755.50, as partial payment for the assets and liabilities transferred to it, resulted in gain to petitioners in that amount.
All of the facts have been stipulated and are so found.
Petitioners Peter Raich and Wanda J. Raich are husband and wife residing in San Jose, Calif. For the years in question, 1961 and 1962, they filed joint Federal income tax returns with the district director at San Francisco, Calif. Petitioners filed said returns on the cash receipts and disbursements method of accounting.
Prior to January 3, 1961, petitioner Peter Raich conducted, as a sole proprietorship, a sheetrock and drywall contracting business under the name of Pete Raich Sheetrock Taping Service. For accounting purposes, the business had as its taxable year the calendar year and operated on a cash basis method of accounting.
[46 T.C. 605]
On or about January 3, 1961, petitioners transferred to the Pete Raich Sheetrock Taping Service, Inc. (hereinafter the corporation), and the corporation accepted all of the assets and liabilities of the sole proprietorship business previously conducted by petitioners. The transfer of the business was intended to qualify as a nontaxable exchange under the provisions of section 351 of the Internal Revenue Code of 1954.1 In accordance with the transfer of the business of the sole proprietorship to the corporation, the corporation received the following assets and liabilities, listed on the books and records of the transferor in the following amounts:
+-------------------------------------------------------+
¦Assets ¦
+-------------------------------------------------------¦
¦Cash ¦ ¦$1,045.40 ¦
+------------------------------+----------+-------------¦
¦Trade accounts receivable ¦ ¦1 77,361.66¦
+------------------------------+----------+-------------¦
¦Receivables ¦ ¦1,833.97 ¦
+------------------------------+----------+-------------¦
¦Prepaid rent ¦ ¦125.00 ¦
+------------------------------+----------+-------------¦
¦Equipment ¦$13,626.30¦ ¦
+------------------------------+----------+-------------¦
¦Less: Accumulated depreciation¦5,378.94 ¦8,247.36 ¦
+------------------------------+----------+-------------¦
¦Total ¦ ¦88,613.39 ¦
+------------------------------+----------+-------------¦
¦ ¦ ¦ ¦
+-------------------------------------------------------+
Liabilities
Trade accounts payable 37,719.78
Notes payable 2 8,273.03
Total 45,992.81
--------
Notes:
1 No amount of these receivables was reported as income on the returns of the transferor, but rather, was reported as income by the corporation in the fiscal periods in which they were collected. The petitioners personally guaranteed payment of all trade receivables transferred in the exchange.
2 Of this amount, $3,273.03 constituted a specific encumbrance on equipment transferred to the corporation. The remaining $5,000 of this item represented the unpaid balance on a bank loan.
All the trade accounts payable were in existence as of January 3, 1961, the date of the transfer. None of these accounts were deducted for income tax purposes by the transferors but were deducted by the corporation, an accrual basis taxpayer, in its initial taxable period, the short fiscal year beginning January 1, 1961, and ending May 31, 1961. The capital stock received by the petitioners from the corporation consisted of 2,500 shares of $10 par value common stock which constituted all the issued stock of the corporation. The stock received by petitioners was listed on the books and records of the corporation at a total valuation of $25,000. As additional consideration, petitioners received a short-term unsecured promissory note in the face amount of $16,280.58. The note was payable on demand and carried interest at the rate of 6 percent per annum. Because of uncollectible accounts receivable in the amount of $3,525.08, whose collection had been guaranteed by petitioners, the face amount of the demand note
[46 T.C. 606]
was reduced by an equal amount, to $12,755.50. The balance of the note was reduced, by payment thereon, to $4,150.54 by the close of the corporation's fiscal period ended May 31, 1961. It was further reduced to $1,780.51 by the close of the corporation's fiscal year ended May 31, 1962, and was paid off in full by the close of the corporation's fiscal year ended May 31, 1964.
The principal issue is whether the transfer of petitioners' sole proprietorship to their wholly owned corporation constituted a non-taxable exchange pursuant to section 351,4 or constituted a taxable event under section 357(c).5 Both parties agree that the transfer qualifies as a section 351 exchange. The parties disagree with respect...
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