59 T.C. 791 (1973), 5602-69, Johnson v. C.I.R.

Docket Nº:5602-69, 5638-69, 5639-69.
Citation:59 T.C. 791
Opinion Judge:BRUCE, Judge:
Party Name:JOSEPH W. JOHNSON, JR., AND MARGARET A. JOHNSON, ET AL.,[1] PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Attorney:William L. Taylor, Jr., and T. A. Caldwell, Jr., for the petitioner. John M. Wylie, for the respondent.
Case Date:March 12, 1973
Court:United States Tax Court
 
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Page 791

59 T.C. 791 (1973)

JOSEPH W. JOHNSON, JR., AND MARGARET A. JOHNSON, ET AL.,[1] PETITIONERS

v.

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Nos. 5602-69, 5638-69, 5639-69.

United States Tax Court

March 12, 1973

Page 792

William L. Taylor, Jr., and T. A. Caldwell, Jr., for the petitioner.

John M. Wylie, for the respondent.

1. Petitioners Joseph Johnson, David Johnson, and Clay Johnson borrowed $200,000, $200,000, and $175,000, respectively, from a bank, signing 30-day notes therefor. The words ‘ without personal liability’ were written after their signatures. At the same time each petitioner transferred to the bank as collateral security for his loan 50,000 shares of stock having a basis of $10,812.50 and a fair market value exceeding $500,000. Immediately thereafter each of these petitioners established an irrevocable trust for his children, transferring thereto, as the corpus, his ownership in the stock pledged to the bank. The wife of each petitioner and the bank that made the loans served as cotrustees of each such trust. The trustees replaced the promissory notes of the petitioners with their own notes, which were also secured by the same shares of stock held by the bank, the ownership of which had been transferred to each of the trusts. The petitioners used the proceeds of the loans which they had obtained from the bank for their own personal purposes. Held: The transactions resulted, in substance, in a part sale to the extent of the loan proceeds received by each petitioner and a part gift of the excess fair market value of the stock. Accordingly, petitioners are liable for capital gains tax on the difference between the amount of the loan proceeds received and their adjusted basis in the stock.

2. Petitioner Clay Johnson and his wife purchased a cottage on Sea Island, Ga., in 1961. Previously, they and their children had spent vacations on the island, renting a place to stay. After the purchase, petitioners used the cottage for their personal pleasure and it was also held out for rent. Petitioners' expenses of maintaining the property exceeded rental income in every year. In 1965 they expended $26,000 in remodeling and installing air conditioning and new furniture and furnishings. In the years 1965 and 1966 petitioners reported losses of $10,312.34 and $8,286.14 on their tax returns from the maintenance of this cottage. Held, further, such losses were not incurred in a transaction carried on for profit or for the production of income, and are not deductible.

BRUCE, Judge:

Respondent determined deficiencies in the income taxes of the petitioners for the taxable years and in amounts as follows:

Docket No. Petitioner Taxable Deficiency
year
5602-69 Johnson, Joseph W., Jr., and Margaret A 1965 $47,660.02
5638-69 Johnson, H. Clay Evans and Betty Mead ( 1965 42,774.26
( 1966 9,440.64
5639-69 Johnson, David F. S. and Elise E 1965 50,832.04
Certain adjustments contained in the statutory notices of deficiency have been conceded by the respective petitioners. The principal issue, common to each of the cases, is whether the respective petitioners realized taxable income in 1965 upon the transfer of 50,000 shares of stock, having a basis of $10,812.50 and a fair market value of $500,000, to a trust for the benefit of their children, where such stock had been pledged as collateral security for bank loans, obtained 1 or 2 days prior to such transfer, in the amount of $200,000 (in two of the cases) and $175,000 (in the other case), the notes evidencing the loans were endorsed ‘ without personal liability,‘ the trustees assumed payment of the loans by substituting their notes for those of the petitioners which were then stamped as paid, and the petitioners used the proceeds of the loans for their own personal purposes. Page 793 A second issue in the case of H. Clay Evans Johnson and Betty Mead Johnson is whether the petitioners therein are entitled to deduct as losses in 1965 and 1966 the cost of maintaining and operating a residence in Sea Island, Ga., in excess of rentals received. FINDINGS OF FACT Joseph W. Johnson, Jr., David F. S. Johnson, and H. Clay Evans Johnson are brothers. During the years in issue, all three were active in the management of Interstate Life & Accident Insurance Co. (Interstate), located in Chattanooga, Tenn., serving as officers and members of the board of directors. H. Clay Evans Johnson was president, Joseph W. Johnson, Jr., was vice president and medical director, and David F. S. Johnson was executive vice president. Joseph W. Johnson, Jr., and his wife, Margaret A. Johnson, filed a joint Federal income tax return for the calendar year 1965 with the district director of internal revenue, Nashville, Tenn. David F. S. Johnson and his wife, Elise E. Johnson, filed a joint Federal income tax return for the calendar year 1965 with the district director of internal revenue, Nashville, TenN.H. Clay Evans Johnson and his wife, Betty Mead Johnson, filed joint Federal income tax returns for the calendar years 1965 and 1966 with the district director of internal revenue, Atlanta, Ga. At the time the petitions herein were filed, H. Clay Evans Johnson and Betty Mead Johnson resided in Dade County, Ga., and the other petitioners resided in Hamilton County, Tenn. On March 9, 1965, Dr. Joseph W. Johnson, Jr., borrowed $200,000 from the Hamilton National Bank in Chattanooga, Tenn. As security for such loan, Dr. Johnson signed a 30-day note dated March 9, 1965, in the amount of $200,000. On the note immediately after the signature of Dr. Johnson the words ‘ without personal liability’ were written. Such note also provided that 50,000 shares of Interstate stock were being pledged as collateral security for payment of the note. At the same time the $200,000 note was signed, Dr. Johnson delivered to the bank as collateral security for such note two stock certificates, Nos. A-1044 and A-1046, representing 50,000 shares of Interstate stock. The two certificates were endorsed by Dr. Johnson and the space provided for the designation of the person who was entitled to have such stock transferred on Interstate's books was left blank. On March 9, 1965, the bank established a ‘ Direct Liability’ account for Joseph W. Johnson, Jr., and made a debit to such account in the amount of $200,750. This amount represented the principal amount of the loan for $200,000 plus interest of $750 for 30 days. Page 794 On March 11, 1965, Joseph W. Johnson, Jr., created an irrevocable trust for the benefit of his children and transferred to it, as the corpus of the trust, all his right, title, and interest in the 50,000 shares of Interstate stock pledged to the bank as collateral security for the payment of the note of March 9. The trustees under the trust instrument were Dr. Joseph W. Johnson's wife, Margaret Austin Johnson, and the bank. The trust agreement provided, in part: ARTICLE 6 DISTRIBUTION OF INCOME AND CORPUS 6-a. Distribution of Income. So much of the share of the Income of the Fund as shall be apportioned to a separate trust that is continued in trust for the benefit of a child or other descendant of Joseph W. Johnson, Jr., of David F. S. Johnson or of H. Clay Evans Johnson, as the trustees (in their sole discretion) shall deem necessary or advisable, and in the best interests of the beneficiary, shall be distributed to or used for the benefit of the beneficiary, or of the then living children of such beneficiary at such times and in such amounts as the trustees shall determine. 6-b. Treatment of Accumulated Income. Any income not distributed or used as above provided shall be invested by the trustees to the extent they shall seem advisable, and such accumulated income shall, at the election of the trustees, either continue to constitute income of the trust from which discretionary distribution of income may be made by the trustees, or may be transferred to corpus for handling and distribution as such. 6-c. Distribution of Corpus. The trustees may encroach upon the corpus of any trust hereunder, if deemed advisable for the proper support, maintenance or education of any income beneficiary thereof. Any such encroachment shall be considered an advancement and shall be charged, without interest, against such beneficiary upon any subsequent apportionment or against those beneficiaries taking such beneficiary's share of such trust. ARTICLE 7 GENERAL POWERS, DUTIES AND OBLIGATIONS OF TRUSTEES AND MISCELLANEOUS PROVISIONS 7-a. General Discretionary Powers. The trustees shall, except as herein otherwise expressly provided, be fully empowered to lend money at interest and to receive, hold, control, manage, collect, rent, lease, sell, exchange, transfer, convey, invest and reinvest, any and every item of money and other property owned by any trust. In making any investments or reinvestments, the trustees shall not be restricted to those authorized or prescribed by any present or future law governing trust investments in the State of Tennessee or any other State. 7-b. Specific Discretionary Powers. In addition to the powers of the trustees under Paragraph 7-a, the trustees shall have the following specific discretionary powers, duties and obligations: (1) Diversification. To acquire, receive and retain investments for any trust, without regard to principles of diversification, and without regard to the predominance Page 795 of common stocks (or stocks in close corporations) in the trust. The trustees are specifically authorized to retain in the trusts any stock in Interstate Life & Accident Insurance Company of Chattanooga, Tennessee. (9)...

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