Bailey v. Comm'r of Internal Revenue
| Decision Date | 31 March 1988 |
| Docket Number | 21771-81,18288-85,18966-85,Docket Nos. 10193-78,18790-85,19016-85.,18721-85,12885-80,3781-85,4505-82 |
| Citation | 90 T.C. No. 37,90 T.C. 558 |
| Parties | GUY B. BAILEY, JR. AND LOIS M. BAILEY, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
Petitioner-husbands claimed deductions and investment tax credits in connection with motion pictures through their interests as limited partners in either of two partnerships. HELD:
1. The partnerships did not acquire depreciable interests in the motion pictures but purchased contractual rights to payments contingent on the success of the respective motion picture. Durkin v. Commissioner, 87 T.C. 1329 (1986), and Tolwinsky v. Commissioner, 86 T.C. 1009 (1986), followed.
2. The partnerships are entitled to depreciate their bases in the contractual rights and their bases are determined.
3. The partnerships were engaged in their motion picture activities for profit.
4. The partnerships' nonrecourse purchase money notes must be disregarded for tax purposes since the debts had no substance and thus are not includable in depreciable bases.
5. The partnerships are not entitled to interest deductions on payments made with respect to the purchase money notes.
6. The partnerships are entitled to use the income forecast method based on their earnings from their contract rights.
7. The retroactive application of section 48(k) and section 804 of the Tax Reform Act of 1976 is not unconstitutional. Petitioners-husbands are entitled to investment tax credits as lenders or guarantors with respect to the motion pictures under the regulations promulgated pursuant to section 48(k).
8. Determinations are made as to substantial underpayments of tax due to tax motivated transactions within the meaning of section 6621(c). Richard H. Levine, Carlton M. Smith, and Albert Rosenblum, for the petitioners.
Gerald A. Thorpe, for the respondent.
These cases were assigned to and heard by Special Trial Judge John J. Pajak, pursuant to the provisions of section 7456 () of the Code and Rule 180 et seq. 2 The Court agrees with and adopts the Special Trial Judge's opinion which is set forth below.
In these consolidated cases, 3 Respondent determined deficiencies in Federal income taxes due from petitioners as follows:
+------------------------------------------------------+
¦Petitioners ¦Docket No.¦Taxable year¦Deficiency¦
+-------------------+----------+------------+----------¦
¦Bernard B. Neuman ¦3781-85 ¦1973 ¦$7,534.40 ¦
+-------------------+----------+------------+----------¦
¦and Miriam Neuman ¦ ¦1974 ¦3,451.00 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1975 ¦1,365.85 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1976 ¦1,119.50 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1977 ¦30.81 ¦
+-------------------+----------+------------+----------¦
¦Guy B. Bailey, Jr.,¦10193-78 ¦1974 ¦18,342.50 ¦
+-------------------+----------+------------+----------¦
¦and Lois M. Bailey ¦4505-82 ¦1975 ¦222,565.42¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1976 ¦75,325.75 ¦
+-------------------+----------+------------+----------¦
¦Norman B. Levy ¦12885-80 ¦1974 ¦14,096.00 ¦
+-------------------+----------+------------+----------¦
¦and Helene Levy ¦ ¦1975 ¦25,277.00 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1976 ¦46,815.00 ¦
+-------------------+----------+------------+----------¦
¦Henry Milgram ¦21771-81 ¦1971 ¦2,059.00 ¦
+-------------------+----------+------------+----------¦
¦and Toby Milgram ¦ ¦1972 ¦2,059.00 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1974 ¦38,153.00 ¦
+-------------------+----------+------------+----------¦
¦ ¦19016-85 ¦1975 ¦2,447.00 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1976 ¦90,419.00 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1977 ¦1,212.00 ¦
+-------------------+----------+------------+----------¦
¦Henry Milgram ¦18966-85 ¦1978 ¦5,754.00 ¦
+-------------------+----------+------------+----------¦
¦and Carol Milgram ¦ ¦1979 ¦1,210.00 ¦
+-------------------+----------+------------+----------¦
¦William Milgram ¦18721-85 ¦1971 ¦4,975.00 ¦
+-------------------+----------+------------+----------¦
¦and Harriet Milgram¦ ¦1974 ¦25,887.00 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1975 ¦77,872.00 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1976 ¦160,000.00¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1977 ¦2,177.00 ¦
+-------------------+----------+------------+----------¦
¦William Milgram ¦18790-85 ¦1978 ¦7,522.00 ¦
+-------------------+----------+------------+----------¦
¦ ¦ ¦1979 ¦3,146.00 ¦
+-------------------+----------+------------+----------¦
¦William Milgram ¦18288-85 ¦1980 ¦83,823.00 ¦
+-------------------+----------+------------+----------¦
¦and Joyce Milgram ¦ ¦ ¦ ¦
+------------------------------------------------------+
Respondent also determined an addition to tax under section 6651(a)(1) in the amount of $1,834.25 for the year 1974 in docket No. 10193-78.
Certain issues in these cases were severed and consolidated for the purposes of trial, briefing, and opinion. These issues arise out of activities of two partnerships, Persky-Bright Associates (Persky- Bright) and Vista Company (Vista).
After concessions, the issues for decision are: (1) whether the partnerships purchased interests in motion pictures, and, if so, the nature of their purchases; (2) whether the partnerships constituted activities not engaged in for profit within the meaning of section 183; (3) whether the nonrecourse notes should be included in the basis of the partnerships' interests in the motion pictures, and, if not, the determination of the basis of the partnerships' interests; (4) whether the partnerships may deduct interest on the nonrecourse notes; (5) whether the partnerships are entitled to depreciation deductions under the income forecast method; (6) whether each petitioner is entitled to an investment credit; and (7) whether petitioners are subject to an increased rate of interest under section 6621(d) (now section 6621(c)) 4 for substantial underpayments attributable to tax motivated transactions.
Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.
Petitioners Guy B. Bailey, Jr. and Lois H. Bailey resided in Coral Gables, Florida, when their petition was filed. Petitioners Norman B. Levy and Helene Levy resided in Woodland Hills, California, at the time their petition was filed. Petitioners Bernard B. Neuman and Miriam Neuman resided in Skokie, Illinois, when their petition was filed. Petitioners Henry Milgram and Toby Milgram resided in Penn Valley, Pennsylvania, and Bala Cynwyd, Pennsylvania, respectively, at the time their petition was filed. Petitioners Henry Milgram and Carol Milgram resided in Penn Valley, Pennsylvania, at the time their petition was filed. Petitioners William Milgram and Harriet Milgram resided in Boca Raton, Florida, and Elkins Park, Pennsylvania, respectively, at the time their petition was filed. Petitioner William Milgram resided in Boca Raton, Florida, when his petition was filed. Petitioners William Milgram and Joyce Milgram resided in Boca Raton, Florida, when their petition was filed.
On their pertinent Federal income tax returns, petitioner- husbands as partners in Persky-Bright and Vista claimed deductions and investment tax credits. Respondent disallowed the claimed deductions and investment credits on a variety of grounds.
Persky-Bright and Vista are two of a number of film partnerships organized by Lester Persky (Persky) and Richard Bright (Bright). Persky, after an advertising and public relations career, was involved with the production of several motion pictures in the late 1960s. Bright was experienced in the fields of taxation and cash management and was a financial advisor who specialized in agricultural and real estate investments before joining forces with Persky. They met in 1971 when Persky was attempting to find an American distributor for two foreign films. They became the general partners of a limited partnership which purchased the two films. Persky and Bright were not satisfied with the independent distributor of those films.
In 1973, Columbia pictures, Inc. (Columbia), a major distributor, was in desperate financial condition, nearing bankruptcy. It had experienced operating losses in excess of $100 million during the prior three years and had an approximate net worth of only $8 million. Columbia was over $250 million in debt and the banks refused to extend any further credit. The banks insisted on a change of management.
Burton Marcus (Marcus), a tax lawyer, became the vice-president and general counsel of Columbia. He and several other new operating officers determined that Columbia's most potent source of cash was through the distribution of films and that they would not give up the right to distribute their films. They...
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