Seaman v. Comm'r of Internal Revenue
| Decision Date | 02 April 1985 |
| Docket Number | 1239-81,1238-81,1236-81,1598-81.,Docket Nos. 1235-81,1237-81,1596-81 |
| Citation | 84 T.C. No. 38,84 T.C. 564 |
| Parties | JOHN W. SEAMAN, JR. AND BETTYE H. SEAMAN, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioners deducted their distributive shares of the losses claimed during the years in question by the Knox County Partners, Ltd., a limited partnership organized and operated for the avowed purpose of exploiting certain coal rights. The partnership's loss for 1976 was attributable to deductions for advanced royalties, which the partnership ‘paid‘ in the form of cash and a nonrecourse note. Respondent disallowed petitioners' distributive shares of the partnership's loss for 1976. Respondent also disallowed certain of petitioners' distributive shares of the partnership's loss for 1977 attributable to the partnership's claimed deductions for accrued interest and ‘costs of goods—development costs.‘ HELD, petitioners have not carried their burden of proving that Knox County Partners, Ltd., was organized and operated with the primary and predominant objective of realizing an economic profit. Therefore, the advanced royalties are not deductible by the partnership under sec. 162(a), I.R.C. 1954, and petitioners are not entitled to deduct their distributive shares of the claimed partnership loss for 1976. HELD FURTHER, respondent's disallowance of certain of petitioners' distributive shares of the partnership's loss for 1977 attributable to the partnership's claimed deduction for accrued interest is sustained, since the partnership's nonrecourse note did not constitute true indebtedness. HELD FURTHER, respondent's disallowance of certain of petitioners' distributive shares of the partnership's loss for 1977 attributable to the partnership's claimed deduction for ‘costs of goods—development costs‘ is sustained, since petitioners have failed to carry their burden of proving that respondent's determination with respect to the issue was erroneous. PATRICIA A. DONAHUE and JOHN FERRANTE for the respondent.
ELLIOT I. MILLER and RICHARD S. KESTENBAUM, for the petitioners.
Respondent issued statutory notices of deficiency in these consolidated cases that determined deficiencies in petitioners' Federal income taxes as follows:
+----------------------------------------------------+
¦Docket No.¦Petitioner ¦Year¦Deficiency ¦
+----------+-----------------------+----+------------¦
¦1235-81 ¦John W. Seaman, Jr., ¦1976¦$43,451.00 ¦
+----------+-----------------------+----+------------¦
¦ ¦and Bettye H. Seaman ¦1977¦3,342.98 ¦
+----------+-----------------------+----+------------¦
¦1236-81 ¦Bruce A. Samson ¦1976¦130,035.80 ¦
+----------+-----------------------+----+------------¦
¦ ¦and Adajean L. Samson ¦1977¦7,874.98 ¦
+----------+-----------------------+----+------------¦
¦1237-81 ¦Harold G. Nix ¦1976¦43,343.00 ¦
+----------+-----------------------+----+------------¦
¦ ¦ ¦1977¦2,624.16 ¦
+----------+-----------------------+----+------------¦
¦1238-81 ¦Richard F. Lockey ¦1976¦29,682.70 ¦
+----------+-----------------------+----+------------¦
¦ ¦and Anne S. Lockey ¦ ¦ ¦
+----------+-----------------------+----+------------¦
¦1239-81 ¦William J. Schifino ¦1976¦28,062.70 ¦
+----------+-----------------------+----+------------¦
¦ ¦and Lois A. Schifino ¦ ¦ ¦
+----------+-----------------------+----+------------¦
¦1596-81 ¦Edward Hoornstra ¦1976¦29,346.19 ¦
+----------+-----------------------+----+------------¦
¦ ¦and Mildred Hoornstra ¦ ¦ ¦
+----------+-----------------------+----+------------¦
¦1598-81 ¦Charles A. Kottmeier ¦1976¦2 20,908.25¦
+----------+-----------------------+----+------------¦
¦ ¦and Eloise L. Kottmeier¦ ¦ ¦
+----------------------------------------------------+
The ultimate issue for decision is the amount, if any, that petitioners, as limited partners, are entitled to deduct as their distributive shares of the losses claimed during the years in question by the Knox County Partners, Ltd. (the partnership). Specific issues posed by the parties include the following:
(1) Whether the coal mining activity of the partnership was an activity engaged in for profit;
(2) Whether, and if so to what extent, are the advanced royalties claimed by the partnership deductible for the 1976 taxable year;
(3) Whether petitioners in docket Nos. 1235-81, 1236-81, and 1237-81 are entitled to deduct their distributive shares of interest expense claimed by the partnership for the 1977 taxable year; and
(4) Whether petitioners in docket Nos. 1235-81, 1236-81, and 1237-81 are entitled to deduct their distributive shares of ‘cost of goods—development costs‘ claimed by the partnership for the 1977 taxable year.
Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.
All of the petitioners herein were residents of Florida at the time their petitions were filed. The income tax returns for the periods involved were filed by each of the petitioners with the Office of the Internal Revenue Service at Chamblee, Georgia. All of the determined deficiencies in these cases are attributable to petitioners' participation, as limited partners, in the Knox County Partners, Ltd., a limited partnership organized and operated for the avowed purpose of exploiting certain coal rights.
Knox County Partners, Ltd., was organized through the joint efforts of Ralph Musicant, Michael Glantz, Carl Anderson, and Samuel Winer. Ralph Musicant is a graduate of Northwestern University, from which he received his Bachelor of Arts degree in 1968, and of Harvard Law School, from which he received his Juris Doctorate in 1971. After he graduated from law school, Musicant practiced tax and securities law, first with a firm in Illinois and later with a firm in Florida. Subsequently, he became a vice president of acquisitions and general counsel of a real estate investment firm. He then became a visiting professor of finance at the Northwestern University Graduate School of Management. In the spring of 1976 Musicant began working, as director of real estate and assistant general counsel, for Financial Analytics Corporation (Finalco), an equipment leasing firm. Prior to that time, Musicant could boast of no background in the coal mining industry. By his own admission, his prior work history largely involved the structuring of tax shelters.
It was as an employee of Finalco that Musicant first became involved in the transactions that eventually led to this litigation. During the early summer of 1976, Musicant began to investigate the coal industry as an area for expansion by Finalco. In his efforts to learn about the industry, Musicant talked to an accountant in Florida who informed him that one Michael Glantz had been involved in the coal business. Glantz's experience in the coal industry began in 1975 or 1976 when some people he knew approached him with respect to joining them in a strip mining venture. In late August or early September 1976, Musicant contacted Glantz and set up a meeting to discuss the coal mining business. The meeting was held the following day in Finalco's offices in Vienna, Virginia and was attended by Musicant, Jack Olmstead, who was vice president of Finalco, Glantz, and Carl Anderson. Anderson was Glantz's partner in at least one coal mining venture in Kentucky. Glantz indicated that American Coal and Coke, Inc. (American Coal and Coke), of Nashville, Tennessee had a substantial number of coal leases, and the parties agreed to a mutual meeting with the principals of that corporation.
Thereafter, Glantz set up the meeting with American Coal and Coke. The meeting was held at the offices of American Coal and Coke in early September 1976 and was attended by Musicant, Olmstead, Glantz, Anderson, and various officers of American Coal and Coke, Cliff E. Hooper, Reginald Keene, Raymond Rhodes, and John Ozier. During the meeting, which lasted the better part of the day, the attendees discussed such matters as the nature of American Coal and Coke's involvement in the coal mining business, the sums necessary to open up a mine, the type of mining equipment that should be used, and the manner in which a possible deal might be structured. The name ‘American Blue Gem Coal Co., Inc. ‘ (American Blue Gem) was mentioned in the course of the conversation as a mining corporation that performed functions for American Coal and Coke.
Shortly after the meeting in Nashville, Musicant resigned from Finalco. The reason for the resignation was a dispute with Olmstead, who allegedly wanted to cut Glantz and Anderson out of any forthcoming deal that might be reached between Finalco and American Coal and Coke. Musicant then got in touch with Glantz to inform the latter that he had resigned from Finalco. It was agreed that Musicant would join Glantz and Anderson in an effort to structure a deal with American Coal and Coke.
In early October, Musicant and Glantz flew to Nashville to meet again with the principals of American Coal and Coke for purposes of discussing a possible sublease of mineral property. 3 The lease under inquiry was known as the Detherage lease. At this juncture the property in question was described by American Coal and Coke as an approximately 2,600-acre piece of property located in Knox County, Kentucky and containing Blue Gem coal, the highest quality coal available. It was represented that the property was worth $2 million and that it would cost $400,000 to open a mine. The parties pursued discussions regarding the structuring of the deal, particularly the use of an advanced royalty. Musicant believed that use of an advanced...
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