86 T.C. 492 (1986), 15789-82, Jackson v. C.I.R.

Docket Nº:15789-82, 32889-83, 32890-83.
Citation:86 T.C. 492
Opinion Judge:GOFFE, JUDGE:
Party Name:JOHN L. JACKSON and YVONNE JACKSON, ET AL., [1] Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:R. LaMar Bishop, for the petitioners. Richard W. Kennedy, for the respondent.
Case Date:March 27, 1986
Court:United States Tax Court
 
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Page 492

86 T.C. 492 (1986)

JOHN L. JACKSON and YVONNE JACKSON, ET AL., [1] Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Nos. 15789-82, 32889-83, 32890-83.

United States Tax Court

March 27, 1986

         1. Petitioners and their partnership acquired territorial sublicenses to distribute specially designed tape recorders from petitioners' wholly owned corporate licensee. Petitioners and the partnership obligated themselves to contribute to an advertising cooperative with other sublicensees. The purchase price of the sublicenses and the advertising cooperative obligation were paid primarily with recourse and nonrecourse notes. The Commissioner disallowed the deductions for amortization and advertising expense because petitioners and the partnership were not in the trade or business of distributing tape recorders during 1978. HELD, the tax treatment of the territorial sublicenses is governed by sec. 1253(d)(2), I.R.C. 1954. HELD FURTHER, satisfaction of the trade or business requirement of sec. 162, I.R.C. 1954, is a prerequisite to any deduction under sec. 1253(d)(2), I.R.C. 1954. HELD FURTHER, neither petitioners nor the partnership were engaged in the trade or business of distributing the tape recorders in 1978 within the meaning of sec. 162, I.R.C. 1954.

         2. The Commissioner determined that amortization of the sublicenses based, in part, upon nonrecourse notes was not allowable because sec. 1253(d)(2), I.R.C. 1954, requires ‘ actual payment.‘ HELD, delivery of nonrecourse promissory notes constitutes ‘ payment‘ under sec. 1253(d)(2), I.R.C. 1954.

         3. The Commissioner determined that the nonrecourse notes used by petitioners and partnership to acquire the sublicenses to distribute tape recorders were not bona fide within the meaning of Estate of Franklin v. Commissioner, 544 F.2d 1045 (9th Cir. 1976), affg. 64 T.C. 752 (1975), and, therefore, could not support the license amortization deductions claimed. HELD, unlike the notes given in Estate of Franklin v. Commissioner, the nonrecourse notes given by petitioners and the partnership represented bona fide debt.

         4. The Commissioner determined that the nonrecourse notes used by petitioners and partnership to acquire the sublicenses to distribute tape recorders and also used to contribute to the advertising cooperative were too contingent to support license amortization and advertising expense deductions. HELD, the notes in issue had definite due dates and were not excessively contingent.

         5. The Commissioner determined that license amortization and advertising expense deductions were not allowable in excess of petitioners' cash investment under sec. 465, I.R.C. 1954. HELD, recourse notes executed by petitioners and partnership, and payable to the corporation are not includable in petitioners' amounts at risk because these amounts were borrowed from a person who has a relationship to petitioners specified in sec. 267(b), I.R.C. 1954. Sec. 465(b)(3), I.R.C. 1954. HELD FURTHER, the nonrecourse notes are not at risk by petitioners under sec. 465(b)(4). HELD FURTHER, in calculating petitioners' amount at risk from partnership interest, each trade or business of the partnership constitutes a separate activity. Sec. 465(c)(3), I.R.C. 1954.

         6. The Commissioner, in his answer, determined an increased deficiency based upon petitioners' distributive share of partnership income, which determination was made more than 3 years after the partnership return was filed. Petitioners alleged that the increased deficiency was barred by the statute of limitations. HELD, because a partnership is not a tax-paying entity, because the statute of limitations applies only to determinations of deficiency in tax liability, and because the running of the period of limitations as to petitioners was suspended by the issuance of the statutory notice of deficiency, the increased deficiency determined by the Commissioner was not barred. Sec. 6501(a), I.R.C. 1954.

         7. The Commissioner determined additions to tax under section 6651(a), I.R.C. 1954. Petitioners' tax advisor informed them that although timely filing of their Federal income tax returns was required, no additions to tax would be incurred because petitioners would not have any deficiencies in tax for the years in issue. HELD, the reliance of petitioners upon the erroneous advice of their tax advisor was not reasonable cause for failure to file timely income tax returns and the additions to tax under section 6651(a), I.R.C. 1954, were proper.

         8. The Commissioner also determined additions to tax for negligence or intentional disregard of rules or regulations under sec. 6653(a), I.R.C. 1954, against petitioners. HELD, because petitioners relied upon the tax opinion of an attorney regarding the tax treatment of the sublicense agreements, the additions to tax under sec. 6653(a), I.R.C. 1954, are not imposed.

Page 494

          R. LaMar Bishop, for the petitioners.

         Richard W. Kennedy, for the respondent.

          GOFFE, JUDGE:

         The Commissioner determined deficiencies in, and additions to, petitioners' Federal income tax as follows:

Additions to tax
Taxable
Petitioners year Deficiency Sec. 6651(a)2 Sec. 6653(a)
John L. and 1978 $18,879.05
Yvonne Jackson 1979 38,910.28 $1,945.51
1980 74,804.85 3,740.24
Gregory M. and 1978 50,906.70 $7,096.00 2,545.34
Timsey Barrow 1979 29,889.90 7,422.48 1,494.50
1980 57,518.00 14,379.50 2,875.90
1981 3,350.00 837.50 167.50
         The Commissioner also asserted in his answer to this action that petitioners John L. and Yvonne Jackson failed to report income on their return for 1978 in the amount of $85,000 as John L. Jackson's distributive share of partnership income. The unreported partnership income increases the deficiency determined by the Commissioner for the taxable year 1978 from $18,879.05 to $61,379.03.          The issues for decision concern whether deductions for license amortization and advertising expense claimed by petitioners and a partnership in which petitioners were the only partners were properly disallowed. More specifically, we must determine (1) whether Barrow, Jackson, and J & G were engaged in the trade or business of distributing Norwood products during 1978; (2) whether actual payment is prerequisite to a deduction under section 1253(d)(2); (3) whether the notes given under the sublicense agreements by Page 495 Barrow, Jackson, and J & G are bona fide under Estate of Franklin v. Commissioner, 544 F.2d 1045 (9th Cir. 1976), affg. 64 T.C. 752 (1975); (4) whether the notes given under the sublicense agreements and the advertising cooperative notes are excessively contingent; (5) whether the at-risk rules of section 465 limit the losses deducted by the Barrows and the Jacksons with respect to the sublicenses; (6) the amount at-risk of Barrow and Jackson at the end of the taxable years 1979, 1980, and 1981; (7) whether the statute of limitations bars assessment against petitioners Jackson for the distributive share of partnership income for the taxable year 1978; and (8) whether petitioners are subject to the additions to tax determined by the Commissioner.          FINDINGS OF FACT          Some of the facts in this case have been stipulated by the parties. The stipulation of facts and the exhibits attached thereto are incorporated by this reference.          All of the petitioners resided in Salt Lake City, Utah, at the time they filed their petitions in this case. Petitioners John L. and Yvonne Jackson, husband and wife, timely filed joint Federal income tax returns for the taxable years 1978, 1979, and 1980. [3] Petitioners Gregory M. and Timsey Barrow, husband and wife, filed joint Federal income tax returns for the taxable years 1978, 1979, 1980, and 1981. [4]          The issues before us are derived from the enterprise undertaken by petitioners Jackson and Barrow to manufacture and distribute a specially designed cassette tape player/recorder. Jackson and Barrow (also collectively referred to as petitioners) became aware of the special characteristics of the tape player/ recorder, and the potential business opportunity it presented, at about the time that they met the inventor of the device, Elwood G. Norris (Norris), during the summer of 1978. Page 496           Norris represented that the device, known as the Norris XLP, was capable of playing 24 hours of material on a specially recorded cassette tape that would only afford 3 hours of playing time on a normal player/recorder. The extra long playing capability of the Norris XLP was achieved by playing back cassette tapes at one-quarter of the normal speed. Because reducing the speed to one-quarter of normal would only quadruple the length of playing time, the additional two-fold increase was to be achieved by special circuitry that allowed the player/recorder to play back tapes recorded in the quarter track format, instead of the normal one-half track. Norris also represented that the Norris XLP was capable of recording at quarter speed and in the quarter track format. Norris applied for a U.S. patent on certain portions of his invention in 1978. The application for patent was eventually granted.          Jackson and Barrow were intrigued with the market potential that they perceived for the Norris XLP and so began negotiating to acquire the rights to the device. The negotiations led to an informal letter agreement dated October 13, 1978, in which Norris agreed to grant Barrow and Jackson an exclusive license to manufacture, distribute, and sell the Norris XLP. [5] The agreement between Jackson, Barrow, and Norris was finally formalized in a document denominated ‘ License Agreement,‘ which was dated December...

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