73 T.C. 370 (1979), 2103-76, Danenberg v. C.I.R.

Docket Nº:2103-76.
Citation:73 T.C. 370
Opinion Judge:SIMPSON, Judge:
Attorney:Charles A. Pinney, Jr., and Clifford C. Caldwell, for the petitioners. Charles W. Jeglikowski, for the respondent.
Case Date:November 27, 1979
Court:United States Tax Court

Page 370

73 T.C. 370 (1979)




No. 2103-76.

United States Tax Court

November 27, 1979

         1. P was heavily in debt to B. As part of the settlement of such debt, P sold various items of collateral to third parties and transferred his stock in his wholly owned subch. S corporation to a nominee of B. He arranged that the proceeds of such dispositions be forwarded directly to B and applied to reduce his debt. After the liquidation of all P's collateral, B discharged P from any further liability on his indebtedness. P was insolvent at the time of such discharge. Held: The dispositions of the collateral by P were sales of such collateral, and P realized gain or loss on such sales measured by the difference between the amount realized and his basis in such collateral. The entire amount of such gain or loss is recognizable, subject to the provisions relating to capital gains and losses. Held, further, P did not realize income on the discharge of his remaining debt since he was insolvent at such time.

         2. Before the end of the taxable year of his subch. S corporation, M, P executed documents to transfer title to his stock. However, such documents were to take effect after the end of the taxable year of M. Held, P was still the owner of the stock of M on the last day of its taxable year, and therefore, he must include the undistributed taxable income of M in his gross income in accordance with sec. 1373, I.R.C. 1954.

         3. The Commissioner determined that part of the underpayment of tax during the year in issue was due to P's fraud with intent to evade tax within the meaning of sec. 6653(b), I.R.C. 1954. Held, due to the complexity of the facts and issues involved, fraud penalty not imposed.

          Charles A. Pinney, Jr., and Clifford C. Caldwell, for the petitioners.

         Charles W. Jeglikowski, for the respondent.

          SIMPSON, Judge:

         The Commissioner determined a deficiency of $64,683.60 in the petitioners' Federal income tax for 1971 and an

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addition to tax of $32,341.80 under section 6653(b) of the Internal Revenue Code of 1954.[1] The Commissioner has conceded certain issues, and the issues remaining for decision are: (1) Whether the petitioners must recognize gain or loss as a result of the disposition of certain of their properties which had been given as collateral for their indebtedness even though they were insolvent at the time of such disposition; (2) whether the petitioner's transfer of his stock in a subchapter S corporation before the end of the taxable year of such corporation to take effect after the end of such taxable year relieves him of the requirement of section 1373 of including the undistributed taxable income of the corporation in his gross income; and (3) whether any part of the underpayment of tax for the year in issue was due to fraud with the intent to evade tax within the meaning of section 6653(b).


         Some of the facts have been stipulated, and those facts are so found.

         The petitioners, Julian S. Danenberg and Mabel S. Danenberg, husband and wife, maintained their legal residence in Holtville, Calif., at the time they filed their petition in this case. They filed their joint Federal income tax return for 1971 with the Internal Revenue Service, Fresno, Calif. The petitioners maintained their books and records on the cash method of accounting, and they filed their income tax return on a calendar year basis. Mr. Danenberg will sometimes be referred to as the petitioner.

         The petitioner was a farmer in the Imperial Valley of California. During the period from October 1963 through June 1971, he obtained financing for his farming and cattle operations from the United California Bank (UCB or the bank). UCB made loans to the petitioner on real estate, farm equipment, and 37 separate crops, and it held certain property of the petitioner as collateral for the loans. Such collateral included the crops of the petitioner, certain farm equipment, the petitioner's stock in the Farmer's Tractor Co., his accounts receivable, an assignment of rents, and all the stock in the Meloland Cattle Co. (Meloland). The bank also held as collateral and had trust deeds for certain

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real property owned by the petitioner, including six commercial lots located in El Centro, Calif. (the six lots), improved real estate consisting of an onion shed, a labor camp, and approximately 35 acres of land (the onion shed property), and the petitioner's residence in El Centro, Calif. None of the collateral held by the bank constituted security for " purchase-money" obligations, and in none of the loans to the petitioner did the bank assign a specific value to any of the items of collateral at the time of making the loan. However, subsequently, the bank did make appraisals of the collateral for the purpose of estimating the amounts that could be realized in the event of a foreclosure. The petitioner and Meloland also executed cross-collateralization and cross-guarantee agreements to support the bank's extension of credit to him. Meloland provided UCB with a continuing guarantee up to $4 million for the petitioner's personal debt, and the petitioner provided UCB with a personal guarantee for Meloland's corporate loans.

         Sometime in May 1970, the petitioner met with officials of UCB to discuss his financing with the bank. At that time, UCB informed him that it would no longer finance his farming operations because his accumulated debts were so great that they no longer constituted a bankable loan. At another meeting with the bank officials in July 1970, the petitioner stated that he was forming a new corporation to take over his farming operations, and he proposed that such corporation be allowed to purchase for $150,000 the farm equipment which the bank held as collateral. The new corporation, California Farm Exchange, Inc. (CFE), was subsequently incorporated on August 11, 1970, and was funded by various third parties. The petitioner offered to negotiate with CFE for a lump-sum sale of all the farm equipment so that UCB would get more money than if it sold the equipment on a piece-meal basis at auction. Although the bank considered the purchase price to be reasonable, it was hesitant to accept the petitioner's proposal because it wanted more information regarding the capitalization of CFE. Subsequently, UCB acquiesced in the proposed sale to CFE, and CFE purchased the farm equipment from the petitioner for $157,500 on October 1, 1970. The bank had not instituted foreclosure proceedings against the farm equipment at the time of such sale to CFE. Under the terms of the sales arrangement, CFE made payments directly to the bank, and the bank applied such proceeds to

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reduce the petitioner's debt. The petitioners reported a gain of $19,506.60 from the sale of the farm equipment on their 1970 income tax return.

         In July 1970, the petitioner informed the bank that he was negotiating with seven other creditors to whom he owed approximately $300,200 for the purpose of arranging a settlement of their claims. He proposed to make them an immediate payment of $45,000 and additional payments at later dates. The petitioner informed the bank that such $45,000 would be provided by CFE and that the principals of CFE had agreed to such action. In late September 1970, a loan officer of UCB reviewed the petitioner's account and estimated that after all the petitioner's collateral had been liquidated and the proceeds were applied to his account, the bank would have a final loss of $800,000.

         In December of 1970, John R. Fitch, a vice president of Associated Desert Newspapers, Inc. (the newspaper), called an official at UCB to inquire about purchasing the six lots for the newspaper. UCB told Mr. Fitch to get in touch with the petitioner, and Mr. Fitch met with the petitioner sometime in early January 1971 to discuss a possible sale agreement. All negotiations regarding the sale of the property were subject to the approval of UCB since it wanted to insure that the selling price of the six lots was reasonable and that it received all moneys realized from such sale. The bank also had control over the minimum price at which the lots could be sold. At that time, one of the petitioner's other creditors, Arizona Agro Chemical, had a lien on the property junior to UCB's lien. Before the petitioner could complete negotiations with Mr. Fitch, he made an arrangement with such company whereby they released its lien for no consideration. The petitioner and Mr. Fitch eventually agreed on a sales price of $58,500 for the six lots, and the bank considered such amount a reasonable selling price.

         On or about January 25, 1971, an escrow account was opened with a title insurance company to carry out the sale of the six lots. On January 28, 1971, UCB executed a notice of default and election to sell the six lots and the onion shed property, and it recorded such notice on February 2, 1971. However, before the bank took any formal action to foreclose on the six lots, the sale arrangement with Mr. Fitch was consummated, and title to the property passed from Mr. and Mrs. Danenberg to the newspaper

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on April 30, 1971. The title insurance company paid the proceeds of the sale, consisting of the $58,500 selling price less $960.84 selling costs, directly to UCB. The petitioner's basis in the six lots was $34,719.76; however, the petitioners did not report any gain from the sale of the six lots on their 1971 income tax return.

         On March 24, 1971, the petitioner met with the officials of UCB to discuss the transfer of his interest in Meloland to the bank. The bank regarded the Meloland feedlot as the petitioner's...

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