Flowers v. Comm'r of Internal Revenue
| Citation | 80 T.C. 914 |
| Decision Date | 16 May 1983 |
| Docket Number | Docket Nos. 8315-80,8336-80,8417-80—-8419-80. |
| Parties | GEORGE T. FLOWERS and DONNA FLOWERS, et al. v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
Petitioners were limited partners in a Florida limited partnership called Levon Records. In a simultaneous transaction, Chiodo-Scott sold four master recordings to Common Sense for $85,000 and an $840,000 nonrecourse promissory note, Common Sense sold the recordings to Levon Records for $136,500 in cash and a $940,000 nonrecourse note, and Levon Records leased the recordings to SRS, which was owned by the same individuals who owned Chiodo-Scott, by way of a distribution agreement that obligated SRS to use its best efforts to promote and distribute the records pressed from the master recordings.
SRS expended minimal efforts to promote and distribute the records pressed from the master recordings. In so doing, it violated the distribution agreement in a number of ways. Levon Records did not exercise its ownership or contractual rights with respect to the master recordings consistent with its alleged objective of making a profit. Accordingly, there were no sales of records pressed from the master recordings and, therefore, Levon Records received no income during the years in question. No amounts were paid on the nonrecourse indebtedness used in the double acquisition. Held, the activities of Levon Records with respect to the master recordings were not engaged in with the predominant purpose and intention of making a profit. Held, further, the nonrecourse promissory note given by Levon Records to Common Sense does not constitute “genuine indebtedness” and therefore petitioners' deductions for accrued interest on such note must be denied. Held, further, petitioners are not entitled to deductions under sec. 212(3), I.R.C. 1954, since they have failed to prove that the amounts paid for tax advice in 1976 were not capital expenditures and since they failed to prove that any amounts were expended for tax advice in 1977. William Randolph Klein, for the petitioners.
Robert J. Shilliday, Jr., for the respondent.
In these consolidated cases, respondent determined deficiencies in petitioners' Federal income taxes as follows:
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¦Docket No. ¦Petitioner ¦TYE Dec. 31— ¦Deficiency ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦ ¦ ¦ ¦
+------------+----------------------------------+----------------+------------¦
¦8315-80 ¦George T. Flowers ¦1974 ¦$1,078.00 ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦and Donna Flowers ¦1976 ¦5,629.00 ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦ ¦1977 ¦828.00 ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦ ¦ ¦ ¦
+------------+----------------------------------+----------------+------------¦
¦8336-80 ¦Cary A. Williams ¦1976 ¦7,101.62 ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦and Suzanne M. Williams ¦1977 ¦10,773.18 ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦ ¦ ¦ ¦
+------------+----------------------------------+----------------+------------¦
¦8417-80 ¦Charles J. Crist and Nancy L. ¦1977 ¦4,072.75 ¦
¦ ¦Crist ¦ ¦ ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦ ¦ ¦ ¦
+------------+----------------------------------+----------------+------------¦
¦8418-80 ¦William J. McCallie ¦1976 ¦7,177.00 ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦and Charlotte W. McCallie ¦1977 ¦6,503.00 ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦ ¦ ¦ ¦
+------------+----------------------------------+----------------+------------¦
¦8419-80 ¦Richard L. Peck ¦1976 ¦7,330.41 ¦
+------------+----------------------------------+----------------+------------¦
¦ ¦and Evelyn K. Peck ¦1977 ¦6,347.01 ¦
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After various concessions, the issues for decision are (1) whether the master recording acquisition and leaseback arrangement constituted a genuine multiparty transaction with economic substance; (2) whether the activities conducted by Levon Records, Ltd., were engaged in for profit; (3) whether certain nonrecourse indebtedness should be included in the bases of petitioners' partnership interests; (4) the time that the master recordings here at issue were placed in service; (5) whether such recordings constitute tangible personal property; (6) the useful lives of the recordings; and (7) whether petitioners are entitled to accrued interest deductions generated by the nonrecourse indebtedness.
Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Petitioners George T. and Donna Flowers resided in Sarasota, Fla., at the time of filing the petition herein. Petitioners Cary A. and Suzanne M. Williams resided in Tampa, Fla., at the time of filing the petition herein. Petitioners Charles J. and Nancy L. Crist resided in St. Petersburg, Fla., at the time of filing the petition herein. Petitioners William J. and Charlotte W. McCallie resided in Tampa, Fla., at the time of filing the petition herein. Petitioners Richard L. and Evelyn K. Peck resided in Odessa, Fla., at the time of filing the petition herein. All petitioners filed their respective returns for the years in issue with the Office of the Internal Revenue Service, Chamblee, Ga.
On July 25, 1976, Robert S. Spencer (Mr. Spencer) and Ralph P. Lebkuecher (Mr. Lebkuecher) began promotional efforts to secure at least six limited partners in a proposed Florida limited partnership to be known as Levon Records, Ltd. (hereinafter Levon Records). The confidential descriptive memorandum supplied by Mr. Spencer and Mr. Lebkuecher to potential limited partners between July 24, 1976, and September 13, 1976, stated that they intended to sell an aggregate of $160,000 of limited partnership interests in Levon Records. The memorandum further provided that, unless $96,000 in limited partnership interests were sold by November 30, 1976, Levon Records would not be created and the moneys paid to Mr. Spencer and Mr. Lebkuecher would be refunded. Levon Records was to acquire four master tape recordings, and distribute and sell the records pressed from the master tapes. As proposed, the master recordings were to cost the partnership $269,125 each, for a total of $1,076,500. Of this amount, Levon Records was required to pay only $34,125 in cash for each master tape, or a total cash downpayment of $136,500. The remainder of the purchase price was to be satisfied with a 12-year nonrecourse note in the face amount of $940,000. The note was to be secured by a first lien security interest in the records and payable only out of profits derived from the sale of records. The $160,000 to be collected from the limited partners of Levon Records was to be used as follows:
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¦Cash payment for master tapes¦$136,500¦
+-----------------------------+--------¦
¦Working capital ¦10,000 ¦
+-----------------------------+--------¦
¦Legal fee ¦12,500 ¦
+-----------------------------+--------¦
¦Accounting fee ¦1,000 ¦
+-----------------------------+--------¦
¦Total ¦160,000 ¦
+--------------------------------------+
The confidential descriptive memorandum warned that there was “no assurance that the distributor will fulfill his obligation under the Distribution Agreement.” Even if such obligation were fulfilled, there was “no representation or warranty as to the marketability of the Records.” In addition, the memorandum provided that The memorandum further stated that “Neither the Partnership, the General Partners, nor any affiliates of a General Partner * * * or any advisor or representative of any of the foregoing assumes any responsibility for the tax consequences of this transaction to a Limited Partner.” Finally the memorandum provided:
Proposed investors considering investing in this Partnership should understand there is a risk that the information tax return of the Partnership and the tax returns of the Limited Partners may be audited by the Internal Revenue Service, and that upon such audit all or a substantial part of the deductions may be disallowed. Such a result would substantially reduce the tax benefits, if any, of investing in the Partnership. Contesting any Internal Revenue Service challenge may impose significant legal expense on Limited Partners, which expenses will be the responsibility of the individual Limited Partner.
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