Miele v. Comm'r of Internal Revenue
| Decision Date | 09 May 1979 |
| Docket Number | Docket Nos. 6228-75,6230-75. |
| Citation | 72 T.C. 284 |
| Parties | ANTHONY D. MIELE and MATILDA F. MIELE, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENTPATRICK H. FIERRO and EVELYN FIERRO, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Pursuant to Pennsylvania's Code of Professional Responsibility, petitioners' cash method calendar year law partnership transferred client advances to a special bank account. Held, the law firm is in constructive receipt of the earned portion of the advances held in the account at the end of 1972. Held, further: Respondent's change in the firm's method of accounting under sec. 481, I.R.C. 1954, approved. Petitioner Fierro deducted a business bad debt in 1971 resulting from a stock sale. Held, he is entitled only to capital loss treatment in 1971 for his adjusted basis of the stock. Patrick H. Fierro and Anthony D. Miele, pro se.
Alan E. Cobb, for the respondent.
Respondent determined the following deficiencies in petitioners' income taxes:
After concessions, the three remaining issues are:
(1) Whether petitioners' law firm, which utilizes a cash receipts and disbursements method of accounting, may defer recognition of client advances from 1972 to 1973 where the advances were received and held, in part, in a special bank account in 1972 and transferred to its general account in 1973;
(2) Whether the amount of $23,572, excluded from the law firm's income in 1971 and not included by respondent in the firm's 1972 income as an amount received in 1972, should be taken into account under sections 481(a) 1 and 481(b)(1) in computing the law firm's gross income for 1972; and
(3) Whether petitioner Fierro suffered a business bad debt in 1971.
Some facts were stipulated and are found accordingly.
Patrick H. Fierro (hereinafter Fierro) and Evelyn Fierro, husband and wife, and Anthony D. Miele (hereinafter Miele) and Matilda F. Miele, husband and wife, resided in Williamsport, Pa., when they timely filed their 1971 and 1972 Federal income tax returns and when they filed their petitions in this case.
Fierro and Miele, attorneys, were the sole practitioners in their own law partnership in 1971 and 1972. They shared partnership profits on a two-thirds and one-third basis, respectively.
Petitioners maintained their books and filed their Federal income tax returns under the calendar year cash receipts and disbursements method of accounting. The law firm maintained its partnership books and filed its Federal partnership income tax returns under the calendar year cash receipts and disbursements method of accounting, except that it included in gross income only that portion of client advances held in a special bank account which were actually transferred to its general partnership account.
In compliance with Pennsylvania's Code of Professional Responsibility, the law firm preserved the identity of their client's funds and property through segregation and accounting measures. First, the law firm transferred all client advances, including advances for both future client costs and future legal services, to the Fierro and Miele Trustee Account (hereinafter trustee account). Second, the law firm provided an accounting of each client's funds by maintaining a ledger card reflecting all client transactions. When a case was closed, the firm would transfer the earned portion of the prepaid legal fees held in the trustee account to the general partnership account; the unearned portion was refunded to the client.
The law firm, operating under a cash receipts and disbursements method of accounting, would include the prepaid legal fees in income only when the funds were transferred to its general account. For administrative purposes, the firm would transfer funds from the trustee account only about four times a year, and it generally never made any transfers in November or December. Consequently, fees were not always included in income in the year earned and therefore otherwise available to the firm. In fact, $35,623.75 of the $68,199 held in the trustee account at the end of 1972 was earned and available to the firm in 1972 but not transferred to the general account, and not included in income, until 1973. In 1972, the trustee account had a beginning balance of $23,572, which was not included in the firm's 1971 gross income, and an ending balance of $68,199; $35,623.75 of that ending balance was earned in 1972 and the remaining balance was earned in 1973. In addition, the law firm had $4,337 in client advances on hand at the end of 1972 which had not yet been deposited in the trustee account; $2,000 of this amount specifically belonged to a client on the settlement of a case.
Respondent changed the law firm's method of accounting for client advances by placing it on a strict cash receipts and disbursements method. This created a three-part adjustment. First, respondent increased the firm's 1972 gross income by the difference between the 1972 ending and opening balances in the trustee account, an amount representing the amount of client advances received in 1972. Second, under section 481, respondent increased the firm's 1972 gross income by the 1972 opening balance in the trustee account. Third, respondent increased the firm's 1972 gross income by the amount of client funds received but not yet deposited less $2,000, the amount belonging to a client. This calculation is reflected as follows:
Based upon this adjustment, respondent increased Fierro's 1972 taxable income by $47,024, his two-thirds partnership share, and increased Miele's 1972 taxable income by $23,512, his one-third partnership share.
Issue 3. Fierro Bad Debt
In May 1969, Elijah Pringle, then an employee of Frank Hayes Pontiac, Inc., of Williamsport, Pa., approached Fierro with a business proposition to finance Pringle's acquisition of the Hayes Pontiac dealership. On October 6, 1969, following negotiations with Fierro, Pringle executed an agreement to purchase all the stock of Frank Hayes Pontiac Inc. Fierro, a silent investing partner with Pringle, was not consulted in the actual signing of this agreement. After Fierro had reviewed the document, Pringle executed a supplemental agreement with Frank Hayes Pontiac, Inc., pursuant to which Fierro and Pringle placed $62,500 in an escrow account in their names and agreed to give the sellers a joint note for $22,500. Fierro contributed $42,500 of the $62,500 to the escrow account and Pringle contributed $20,000.
On March 12, 1970, Fierro granted Pringle an option to purchase his interest in the business in 7 years for $85,000. The option grant was required by General Motors Corp. who would not grant Pringle the right to sell Pontiacs without Fierro's agreement to terminate his interest in no longer than 7 years. General Motors wanted Fierro out of the dealership since he intended to operate only as an investor taking no active role in the business.
Following the option agreement, Pringle was granted the right to sell Pontiacs. The dealership was operated under the name of Pringle Pontiac, Inc.; 400 shares of stock were issued to both Pringle and Fierro.
An undisclosed tax liability of Frank Hayes Pontiac, Inc., discovered in May 1970, precipitated a Federal tax levy on Pringle Pontiac's corporate bank account. To obtain working capital, Pringle sought an SBA loan which was denied on the ground that a then-current stockholder, Fierro, was financially able to assist Pringle. Pringle could qualify for the loan only if Fierro was no longer a stockholder. To allow Pringle to obtain the SBA loan, Fierro granted Pringle the following option on June 9, 1970:
PATRICK H. FIERRO gives to ELIJAH PRINGLE, III, the option to purchase all of the Fierro's FRANK HAYES PONTIAC, INC. stock for the sum of $42,500.00; this sum to be deferred until the S.B.A. loan is first repaid. This option is granted on Pringle's representation that this is required by the S.B.A. in order that he may obtain a loan from the S.B.A.
Pringle exercised this option and, on June 30, 1970, Fierro transferred his 400 shares to Pringle. Fierro did not report the sale of his stock in 1970. Pringle obtained the SBA loan but in October 1971, the business still failed. Pringle never repaid the SBA loan or paid Fierro for the stock.
Fierro deducted...
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