Kerry v. Comm'r of Internal Revenue
| Decision Date | 24 August 1987 |
| Docket Number | 24443-81,Docket Nos. 24442-81 |
| Citation | 89 T.C. 327,89 T.C. No. 29 |
| Parties | VERNON Y. KERRY AND MARY ANN KERRY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentGAIL C. KERRY AND CAROL E. KERRY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
For the years 1974, 1975, and 1976, petitioners claimed an investment credit for their distributive share of Kerry Brothers' basis in qualified investment property. Respondent disallowed the claimed credit based on the section 46(e)(3) prohibition against the claiming of investment credits by noncorporate lessors. Petitioners subsequently amended Kerry Brothers' and Kerry Coal's returns to reflect a section 48(d) pass-through election of the qualified property from Kerry Brothers as lessor to Kerry Coal as lessee. HELD, petitioners are not entitled to make a late section 48(d) election based upon the statute, regulations, and administrative burdens involved therein. HELD FURTHER, petitioners failed to substantially comply with the election provisions of section 48(d). HELD FURTHER, petitioners are not entitled to an extension of time for making a late section 48(d) election. John W. Schmehl and Thomas E. Doran, for the petitioners.
James P. Clancy, for the respondent.
Respondent determined a deficiency in petitioners' Federal income tax for the years and in the amounts indicated:
After concessions by petitioners, the sole issue for decision is whether petitioners are entitled to investment tax credits (investment credits) relating to equipment purchased by the Kerry Brothers partnership in 1974, 1975, and 1976.
Some of the facts have been stipulated and are found accordingly. The Stipulation of Facts and attached exhibits are incorporated herein by this reference.
Petitioners Vernon Y. Kerry (Vernon Kerry) and Mary Ann Kerry, husband and wife throughout the years at issue,1 and petitioners Gail C. Kerry (Gail Kerry) and Carol E. Kerry, husband and wife, resided in Portersville, Pennsylvania, at the time their petitions herein were filed. 2 Petitioners and their spouses filed joint individual income tax returns for each of the years at issue.
Vernon Kerry was president, and Gail Kerry was secretary- treasurer, of the Kerry Coal Company (Kerry Coal), a small business corporation. Kerry Coal was incorporated on January 5, 1953, and elected to file as an S Corporation on October 24, 1960. Kerry Coal was actively engaged in strip mining for coal in western Pennsylvania during the years in issue. In the early 1960's petitioners and a third brother began to acquire stock in Kerry Coal from their father. Upon their brother's death in 1969, petitioners each acquired a 50-percent interest in Kerry Coal, which they owned through the time of trial. Kerry Coal reports its taxable income based on a fiscal year ending September 30.
In early 1974, petitioners formed Kerry Brothers, a general partnership whose principal business was the buying, selling, and leasing of heavy equipment and land. Pursuant to the partnership agreement, petitioners transferred title to equipment and land owned jointly by them to the partnership, and the partnership's net profits and losses were allocated to the partners in proportion to their ownership interests therein. At the time of its formation, Kerry Brothers was owned equally by petitioners. On December 29, 1975, petitioners each transferred by gift a 16- 2/3-percent interest in Kerry Brothers to separate but identical irrevocable inter vivos trusts (Trusts) established for the benefit of their respective children. As a result of the transfer, and pursuant to the partnership agreement, each Trust was allocated 16- 2/3 percent of Kerry Brothers' net profits and losses. 3
Kerry Brothers was formed to hold legal title to equipment used by Kerry Coal in its mining operations. Kerry Coal had been engaged in deep mining for ‘quite a few years,‘ and was unable to obtain insurance covering its potential liability under recently enacted Black Lung legislation. Additionally, the volatility of the coal mining industry and the cost of complying with pollution control requirements made the minimizing of assets held by Kerry Coal imperative. Consequently, petitioners were advised to form a separate entity as a repository for the title to assets utilized by Kerry Coal. Allocation of the investment credit resulting from the purchase of qualified property by either Kerry Coal or Kerry Brothers was not discussed at the time Kerry Brothers was formed, and did not impact on the decision to purchase and own equipment through the partnership.
During 1974, 1975, and 1976 Kerry Brothers purchased draglines, bulldozers, and other heavy equipment used to remove overburden and mine coal. The following amounts of new and used equipment were purchased by Kerry Brothers and leased to Kerry Coal in the years indicated:
+----------------------------------------------------+
¦ ¦Amount ¦New or used¦ ¦
+----+---------+-----------+-------------------------¦
¦Year¦purchased¦property ¦Useful life years ¦
+----+---------+-----------+-------------------------¦
¦1974¦147,872 ¦New ¦7 or more ¦
+----+---------+-----------+-------------------------¦
¦1974¦17,334 ¦Used ¦5 or more but less than 7¦
+----+---------+-----------+-------------------------¦
¦1974¦118,899 ¦Used ¦7 or more ¦
+----+---------+-----------+-------------------------¦
¦1975¦217,091 ¦New ¦7 or more ¦
+----+---------+-----------+-------------------------¦
¦1975¦91,380 ¦Used ¦5 or more but less than 7¦
+----+---------+-----------+-------------------------¦
¦1976¦219,010 ¦New ¦7 or more years ¦
+----+---------+-----------+-------------------------¦
¦1976¦43,000 ¦Used ¦7 or more years ¦
+----------------------------------------------------+
Kerry Brothers reported both the new and used equipment as property qualifying for the investment credit on its original return for the year in which the property was purchased. Consequently, petitioners claimed as a distributive share from Kerry Brothers an investment credit based upon their pro rata interest in the qualified investment property. 4
Petitioners retained the accounting firm of Carbis Walker and Associates (Carbis Walker) of New Castle, Pennsylvania, as tax counsel. Petitioners relied upon Thomas J. Donovan (Donovan), a certified public accountant and senior partner with Carbis Walker, for the preparation of their personal, partnership, and corporate returns. Donovan was first employed by Carbis Walker in 1947, and had worked with petitioners' father and Kerry Coal since the late 1940's. The returns were prepared by a manager at Carbis Walker prior to being reviewed and signed by Donovan. Donovan would then submit the returns to petitioners for their signature. At the time he reviewed Kerry Brothers' 1974, 1975, and 1976 returns, Donovan believed that the investment credit resulting from the purchase of qualified property could be passed from the partnership to petitioners as partners. 5 Petitioners did not know that claiming the investment credit as partners of Kerry Brothers rather than as shareholders of Kerry Coal was impermissible until informed of this by Donovan subsequent to the commencement of the audit.
An audit of petitioners, Kerry Coal, and Kerry Brothers was begun by respondent no later than July 12, 1977. Pursuant to the audit, respondent disallowed petitioners' distributive share of Kerry Brothers' investment in property qualifying for the investment credit. Petitioners concede that they were not entitled to the reported distributive share of investment credit from Kerry Brothers for the years in issue by operation of the restrictions imposed upon noncorporate lessors of property by section 46(e)(3). 6
Subsequent to commencement of the audit, Donovan contacted the law firm of Kirkpatrick, Lockhart, Johnson & Hutchison regarding the feasibility of making an untimely investment credit pass-through election. Donovan was advised by the firm to file amended partnership and corporate returns reflecting the election. Consequently, Donovan contacted petitioners and informed them that Kerry Brothers and Kerry Coal would have to file amended returns for 1974, 1975, and 1976. It was at this time that petitioners first learned of the prohibition against claiming investment credits by noncorporate lessors.
Kerry Brothers' and Kerry Coal's amended returns for the years in issue were prepared by Carbis Walker and signed by Donovan in January 1978. Donovan then submitted the returns to petitioners, who filed them with respondent on or about February 13, 1978. The amended returns included a general election to transfer the investment credit from Kerry Brothers as lessor to Kerry Coal as lessee. In the amended returns, Kerry Coal claimed a credit for both new and used equipment purchased by Kerry Brothers. Petitioners concede that they are not entitled to...
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