Horne v. Comm'r of Internal Revenue
| Decision Date | 27 November 1972 |
| Docket Number | Docket No. 2645-70. |
| Citation | 59 T.C. 319 |
| Parties | M. SETH HORNE AND MAURINE D. HORNE, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Hubert E. Kelly and Charles L. Arnold, for the petitioners.
Harold E. Patterson, for the respondent.
Petitioner (husband) was a partner in a three-man firm. The three partners, as individuals, owned all the stock in COINC, which, in turn, owned all the stock in CORP and CO. All three corporations performed construction work. N/A, a bonding company, wrote bonds for all three corporations. All three corporations indemnified N/A on cross-indemnity agreements. In 1960, CO notified N/A that it, N/A, would have to perform on its bond. Because the three corporations were close to insolvency, N/A asked COINC's stockholders to indemnify it. Only petitioner agreed to do so. As a part of the sorting-out process that followed, the partnership was dissolved, the partnership property was distributed, the partners exchanged interests in various properties, and the corporations were reorganized. Concerning the reorganization, petitioner received all the stock in CO— to which substantially all the assets of COINC and CORP had been transferred— in return for all his stock in COINC. At approximately the same time, petitioner entered into an agreement whereby he became jointly and severally liable with CO, for any losses incurred by N/A on its bond. CO continued in existence. COINC and CORP became inactive. Years later the petitioner paid N/A roughly $600,000 and recouped less than half of this amount from CO. Held: On the facts, petitioner's promise to indemnify the bonding company was not part of the purchase price of the CO stock. Estate of McGlothin v. Commissioner, 370 F.2d 729 (C.A. 5, 1967), affirming44 T.C. 611 (1965), distinguished. Nor was petitioner compensated for his losses. Rather the losses on the so-called indemnity agreement must be treated as bad debt losses falling within sec. 166, I.R.C. 1954, and disallowed as such because they were not worthless in the years at issue. Petitioner was as much a guarantor as an indemnitor. Putnam v. Commissioner, 352 U.S. 82 (1956), applicable.
Respondent determined deficiencies in petitioners' Federal income taxes for the taxable years 1966, 1967, and 1968 in the amounts of.$56,280, $23,378, and $66,078, respectively.
Petitioners have conceded one issue. The only issue remaining for decision is whether they are entitled to a deduction for amounts paid in connection with an indemnity agreement entered into by them on behalf of their wholly owned corporation. The issue is argued under sections 162, 165, 166, and 212, I.R.C. 1954.
Some of the facts have been stipulated. The stipulation of facts, the supplemental stipulation of facts, and the exhibits attached to both are incorporated herein by this reference. We have limited our findings to those facts which are pertinent to our decision.
The petitioners, M. Seth Horne and Maurine D. Horne, are husband and wife and, at the time of filing the petition herein, were residents of Phoenix, Ariz. They filed joint Federal income tax returns for the years 1966, 1967, and 1968 with the district director of internal revenue at Phoenix, Ariz.
M. Seth Horne (herein called petitioner) is a real estate developer and investor. He became interested in the field when trying to start up a restaurant in the Washington, D.C., area. Near the end of World War II, he surveyed the real estate business prospects in that area and began development operations on a full-time basis.
In 1947, petitioner was joined by Harold A. Naisbitt, an accountant, in a joint venture for the development of a piece of property in Fairfax County, Va. About 2 years later, W. B. Ingersoll, a practicing dentist, purchased a part of petitioner's interest in the joint venture. On January 5, 1951, Horne, Ingersoll, and Naisbitt formed a general partnership (herein called HIN or the partnership) to engage in the business of real estate development. Petitioner had a 65.6-percent interest in the partnership; Ingersoll had a 20-percent interest; and Naisbitt had a 14.6-percent interest. Petitioner acted as general manager, Naisbitt handled the accounting problems, and Ingersoll was available for consultation. So long as petitioner was a partner in HIN, he did not engage in any other business activities on a strictly individual basis. Although he owned certain rights concerning real property in his own name (as recited in the indemnity agreement detailed below), he owned them in conjunction with his partners. Nevertheless, due to his participation in HIN, he remained in the real estate business.
The business activities of the partnership consisted of acquisition, zoning, financing, and management of real properties. Its first large-scale project was an apartment complex and shopping center situated on 100 acres near Seven Corners, Va.1
James Stewart & Co., Inc. (herein called COINC), is a corporation organized under the laws of the State of New York in 1913. It conducted a general engineering and contracting business; and by 1951 it had acquired a respected international reputation. In 1927, COINC caused James Stewart Corp. (CORP) to be organized pursuant to the laws of the State of Delaware. CORP operated as a wholly owned subsidiary of COINC. It, too, performed general engineering and contracting work.
In 1951, soon after the formation of HIN, the petitioner and his partners became interested in acquiring COINC, thinking that COINC's construction activities would complement the partnership's real estate activities. On January 1, 1952, they purchased all of the common stock of COINC, consisting of 12,168 shares, and 2,055 shares of preferred stock for a total of $150,000. Later, on December 31, 1954, they purchased the remaining 4,533 shares of preferred stock for an additional $150,000. After an adjustment due to taxes assessed against COINC, the total purchase price for both common and preferred stock amounted to $246,406.25. All stock was acquired in the names of the individual partners according to each partner's interest in HIN. Petitioner's basis in the COINC stock was $194,442.50.
On July 28, 1952, COINC— then controlled by petitioner and his partners in HIN— caused James Stewart Co. (CO) to be incorporated under the laws of the State of Texas. Like CORP, CO was COINC's wholly owned subsidiary and performed construction and general contracting work. The plan was for COINC to base its operations in New York and perform contracts in the Eastern States, for CORP to base its operations in Chicago and perform contracts throughout the Midwest, and for CO, based in Texas, to service the western part of the country.
From the start petitioner, Ingersoll, and Naisbitt were active in the management of COINC as members of its board of directors. Also, petitioner was immediately made vice president of COINC. He held that office until 1955, when he was elevated to president and chairman of the board— positions which he held through 1960. Petitioner and Naisbitt were also members of the board of both CORP and CO. In 1953, petitioner was elected vice president of CORP and, in 1954, chairman of its board. Petitioner was president of CO from its inception.
As for the relationship between the partnership and the corporations, HIN was the manager of COINC, and CORP and CO were its operational arms. HIN engaged in all phases of real estate development— though after acquiring COINC, a great deal of the partners' time was devoted to overseeing the parent and its subsidiaries. The corporations only performed construction work, except CO developed some land on the Papago Indian Reservation (Papago Indian Project), near Sells, Ariz., and some mining claims near Tombstone and Camp Verde, Ariz.
For the years 1953 through 1960, the net income of COINC, CORP, and CO, exclusive of any net operating loss deductions, was as follows:
+-------------------------------------------+
¦Year¦COINC ¦CORP ¦CO ¦
+----+------------+------------+------------¦
¦1953¦$32,554.97 ¦$8,707.20 ¦$33,773.99 ¦
+----+------------+------------+------------¦
¦1954¦9,391.29 ¦121,644.15 ¦(52,543.84) ¦
+----+------------+------------+------------¦
¦1955¦36,723.78 ¦19,567.59 ¦(77,982.91) ¦
+----+------------+------------+------------¦
¦1956¦38,379.79 ¦236,126.55 ¦13,621.82 ¦
+----+------------+------------+------------¦
¦1957¦84,020.79 ¦69,316.32 ¦98,356.31 ¦
+----+------------+------------+------------¦
¦1958¦(122,994.30)¦(329,306.37)¦(230,013.29)¦
+----+------------+------------+------------¦
¦1959¦(39,547.41) ¦(10,474.26) ¦(165,019.40)¦
+----+------------+------------+------------¦
¦1960¦(75,967.18) ¦(138,196.22)¦(159,282.89)¦
+-------------------------------------------+
During the years 1952 through 1960, petitioner received no compensation of any kind from COINC, CORP, or CO for services rendered. Nor did Ingersoll or Nesbitt receive any compensation. Also, none of the corporations paid any dividends during those years. CORP and CO did, however, pay management fees to COINC, and COINC in turn paid management fees to the partnership. The following schedule shows the fees paid by COINC to HIN:
+------------------------+
¦Year ¦Management fee ¦
+------+-----------------¦
¦1952 ¦$28,801.63 ¦
+------+-----------------¦
¦1953 ¦33,499.92 ¦
+------+-----------------¦
¦1954 ¦55,500.00 ¦
+------+-----------------¦
¦1955 ¦50,000.00 ¦
+------+-----------------¦
¦1956 ¦50,000.00 ¦
+------+-----------------¦
¦1957 ¦61,303.94 ¦
+------+-----------------¦
¦1958 ¦50,000.00 ¦
+------+-----------------¦
¦1959 ¦55,000.00 ¦
+------+-----------------¦
¦1960 ¦51,001.10 ¦
+------------------------+
The partnership was operated on the accrual basis of accounting and used the calendar year as its taxable year. Its...
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