Fuchs v. Comm'r of Internal Revenue
| Decision Date | 19 July 1984 |
| Docket Number | Docket Nos. 18961–81 and 18962–81. |
| Citation | 83 T.C. No. 7,83 T.C. 79 |
| Parties | WILLIAM R. FUCHS AND ALICE S. FUCHS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentJOSEPH GENSTEIN AND DOROTHY GENSTEIN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioners claimed losses in connection with a limited partnership which obtained all the rights to an original paperback book for a stated amount of $812,500.00 of which $687,500.00 was a nonrecourse note, payable solely from proceeds from these rights and due in seven years. When obtained by the partnership, estimated receipts from all the rights to the paperback book did not exceed $42,000.00, and the value of such rights was significantly less than that amount. The partnership was syndicated by a brokerage house which controlled it. The amount of the nonrecourse note was determined by a formula used by the brokerage house to inflate depreciation deductions. Held, none of the claimed losses are deductible because the partnership's activities were not engaged in for profit within the meaning of sec. 183, I.R.C. 1954, and interest paid on the $687,500.00 nonrecourse note is not deductible because there was no genuine indebtedness due to the fact that both the purchase price and the note unreasonably exceeded the value of the property acquired. Marvin S. Lieber, Charles B. Gibbons, and Harry F. Klodowski, Jr., for the petitioners.
Francis J. Emmons and Robert B. Marino, for the respondent.
These consolidated cases were assigned to and heard by Special Trial Judge John J. Pajak, pursuant to the provisions of section 7456(c) of the Code and Rules 180 and 181.1 The Court agrees with and adopts the Special Trial Judge's opinion which is set forth below.
PAJAK, Special Trial Judge:
In these consolidated cases, respondent determined the following deficiencies in petitioners' Federal income taxes for the respective years:
+------------------------------------------------------+
¦Docket No. ¦Petitioners ¦Years ¦Deficiency ¦
+------------+--------------------+-------+------------¦
¦ ¦ ¦ ¦ ¦
+------------+--------------------+-------+------------¦
¦18961-81 ¦William R. Fuchs ¦1977 ¦$2,789 ¦
+------------+--------------------+-------+------------¦
¦ ¦and Alice S. Fuchs ¦1978 ¦2,453 ¦
+------------+--------------------+-------+------------¦
¦ ¦ ¦ ¦ ¦
+------------+--------------------+-------+------------¦
¦18962-81 ¦Joseph Genstein ¦1976 ¦7,119 ¦
+------------+--------------------+-------+------------¦
¦ ¦and Dorothy Genstein¦1977 ¦2,994 ¦
+------------+--------------------+-------+------------¦
¦ ¦ ¦1978 ¦2,643 ¦
+------------------------------------------------------+
In each case, respondent disallowed the distributable share of losses from a limited partnership, The Chinese Ultimatum Company, claimed on petitioners' returns.
The issues for decision are: (1) whether the partnership was engaged in for profit; (2) whether the partnership may deduct interest on certain nonrecourse indebtedness; (3) whether the partnership was a sham organized to create artificial tax deductions; (4) whether the nonrecourse indebtedness should be included in the bases of the partnership and the partners; (5) whether the partnership properly depreciated rights in an original paperback book, The Chinese Ultimatum; (6) whether the partnership was entitled to deduct various miscellaneous items under either section 162 or section 212; and (7) whether the agreement between the partnership and Pinnacle Books, Inc., constituted a sale of the partnership's interest in the manuscript or a “lease of section 1245 property” within the meaning of section 465(c)(1)(C).
This case is one of two groups of cases which were heard pursuant to test case procedures for purposes of judicial economy of benefit to petitioners, respondent and the Court. For the same reason, since most of the witnesses had testimony relevant to each of the groups, the test case of Dean, Docket No. 22565–80 decided this day in Dean v. Commissioner, 83 T.C. ——, was consolidated for trial at the same Special Session of the Court as were these cases. The Dean case pertains to a limited partnership involving The Season original paperback book and rights thereto. This case pertains to a limited partnership involving The Chinese Ultimatum original paperback book and rights thereto.2
Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.
Petitioners William R. Fuchs and Alice S. Fuchs resided in Lock Haven, Pennsylvania, when their petition was filed. Petitioners Joseph Genstein and Dorothy Genstein resided in Pittsburgh, Pennsylvania, when their petition was filed. For ease of reference, we will refer to petitioners William R. Fuchs and Alice S. Fuchs as “petitioner” or “petitioner Fuchs,” to petitioners Joseph Genstein and Dorothy Genstein as “petitioner” or “petitioner Genstein,” and to both sets of petitioners as “petitioners.” On their pertinent Federal income tax returns petitioners deducted losses in connection with The Chinese Ultimatum Company (Chinese Ultimatum Co.), a limited partnership formed under the laws of Delaware. Respondent disallowed these loss deductions.
The original paperback book, The Chinese Ultimatum, concerns the outbreak of war amongst the world's superpowers. It tells the story of the explosion of world political forces during a one-week period as seen through the eyes of the two principal characters, a high-ranking United States diplomat and his news-broadcaster girl friend.
Edward M. Harper (Harper), using the pen name Edward McGhee, was the author of The Chinese Ultimatum. The cover of this original paperback lists as authors, “Edward McGhee & Robin Moore”. Robin Moore (Moore) is the author or co-author of such best selling books as The Green Berets, The French Connection (co-author), and The Happy Hooker (co-author), all three of which became highly successful motion pictures. Moore often used co-authors and ghostwriters to write books.
During early 1976 Howard Liss (Liss), a ghostwriter used by Moore, accompanied Moore to the office of Jack Klein (Klein), Moore's accountant, where a discussion occurred involving tax shelters.
Moore had copyrighted 14 books in the five years 1971 through 1975. The Chinese Ultimatum was one of 24 books subject to copyright in Moore's name in 1976. Many more books were subject to copyright under Moore's name in subsequent years.
Babbitt, Meyers and Company (Babbitt) was a regional member firm of the New York Stock Exchange with its headquarters in Pittsburgh, Pennsylvania, and with branch offices located throughout western Pennsylvania. During 1976, Robert E. Rose (Rose) was the manager of Babbitt's tax shelter department. His function was to seek out, review and coordinate the distribution of tax advantaged investments to Babbitt's customers.
Babbitt's practice was to enter into an agreement on behalf of a partnership to be formed. If the offering was successful, the legal formalities of organizing a partnership would be followed.
In late 1975 or early 1976 Babbitt began the development of tax shelter programs using books. Since neither Rose nor anyone else at Babbitt had any expertise in the publishing industry,Rose discussed the development of this program with George Mack (Mack) and others. Mack introduced Babbitt to the law firm of Regan, Goldfarb, Heller, Wetzler & Quinn (Regan Goldfarb), New York, New York. Marty Keller of Regan Goldfarb, represented Moore. Heller introduced Rose to Moore in January or February 1976. Babbitt used Regan Goldfarb in developing book tax shelter programs. In 1976, Babbitt syndicated at least three limited partnerships which utilized paperback books bearing the names of Moore and different co-authors.
Babbitt offered $200,000.00 of limited partnership interests in the Chinese Ultimatum Co. by a private placement memorandum dated April 1, 1976. The Chinese Ultimatum Co. was established in the manner described in this memorandum. The memorandum stated in pertinent part that:
THIS INVESTMENT IS AVAILABLE ONLY TO THOSE OFFEREES (i) WHOSE NET WORTH, EXCLUSIVE OF HOME AND PERSONAL EFFECTS, IS AT LEAST $200,000, OR (ii) SOME PORTION OF WHOSE CURRENT ANNUAL GROSS INCOME WOULD BE SUBJECT TO FEDERAL INCOME TAX AT A RATE OF 50% OR HIGHER AND WHOSE NET WORTH, EXCLUSIVE OF HOME AND PERSONAL EFFECTS, IS $100,000 OR MORE. * * *
Offering: $200,000 of Limited Partnership Interests to be offered by Babbitt, Meyers & Co. as exclusive agent for the Partnership; 25 Limited Partnership Interests of $8,000 each. Minimum purchase is one Limited Partnership Interest and requires (i) the payment of $3,000 in cash at the time of subscription, and (ii) the execution of a negotiable promissory note in the principal amount of $5,000 due on January 15, 1977. * * * Partnership Business: The acquisition, publication and other exploitation of the copyright to and the manuscript entitled THE CHINESE ULTIMATUM written by ROBIN MOORE with EDWARD MAINGET HARPER * * *.
Compensation to General Partner: The General Partner will be paid a guaranteed initial management fee of $2,000 in 1977 which he will contribute to the capital of the Partnership. * * *
Purchase Price and Leverage: The Partnership will purchase the Work for $812,500, of which an aggregate of $125,000 is payable in cash and a short-term nonrecourse promissory note and the balance of $687,500 by delivery of the Partnership's 7-year, 8% nonrecourse purchase money...
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