91 T.C. 874 (1988), 24351-84, Recklitis v. C.I.R.

Docket Nº:24351-84
Citation:91 T.C. 874
Opinion Judge:NIMS, CHIEF JUDGE:
Attorney:Albert F. Cullen, Jr., for the petitioner. Lewis R. Mandel, for the respondent.
Case Date:November 07, 1988
Court:United States Tax Court

Page 874

91 T.C. 874 (1988)




No. 24351-84

United States Tax Court

November 7, 1988

R determined deficiencies in P's taxable income resulting from adjustments related to P's dealings with his own closely- held corporation and with another publicly-held corporation of which he was both an officer and a director.

Held, P's misappropriation of funds through means of several land sales was properly includible in gross income. HELD FURTHER, P failed to adequately account under I.R.C. section 274 to his employer regarding business expenses which were reimbursed. HELD FURTHER, P's transfer of title to appreciated stock to a closely-held corporation immediately before completing a negotiated sale is not respected for tax purposes. The capital gain from the sale of the stock is properly attributed to P under principles established in Commissioner v. Court Holding Co., 324 U.S. 331 (1945). HELD FURTHER, P's advances to his closely-held corporation constitute contributions to capital to the corporation. No bad debt deduction under I.R.C. section 166(a) is allowed. HELD FURTHER, the deductibility of interest expenditures incurred on personal loans incurred to procure cash subsequently advanced to a closely-held corporation is subject to limitation under I.R.C. section 163(d). HELD FURTHER, P is liable for additions to tax for fraud under I.R.C. section 6653(b). R need not establish that tax evasion was a primary motive of P, but may (and did) satisfy his burden of proof on this issue by showing that a tax evasion motive played some part in P's conduct, including conduct designed to conceal another crime. Worcester v. Commissioner, 370 F.2d 713 (1st Cir. 1966), affg. in part and vacating in part (on another issue) T.C. Memo. 1965-199, followed. HELD FURTHER, P is liable for additions to tax under I.R.C. section 6654 for underpayment of estimated income tax.

Albert F. Cullen, Jr., for the petitioner.

Lewis R. Mandel, for the respondent.


Respondent determined the following deficiencies and additions to tax in petitioner's 1974 and 1975 Federal income tax:

Additions to tax
Year Deficiency 1Sec. 6653(b) Sec. 6654
1974 $1,023,854.30 $511,927.15 $32,684.76
1975 1,532,711.14 766,355.57 66,053.40
Page 875 Petitioner admits tax liability for the following items of gross income: $57,250 (1974) and $27,500 (1975) received from SCA as wages; $40,000 received or paid annually on his behalf during 1974 and 1975 by Trans World Services, Inc. pursuant to the terms of a 15- year consulting and noncompetition agreement; $400,000 of gain from the 1974 Cyrano land transaction; and unexplained bank deposits in the amounts of $26,152 and $37,561 during the respective 1974 and 1975 tax years. After concessions, the issues for decision are: (1) whether the various land sales directed by petitioner caused him to recognize gross income; (2) whether cash payments made to petitioner by his corporate employer, SCA Services, Inc., may be excluded from gross income as reimbursed business expenses; (3) whether petitioner contributed his TWS stock to Carlton House Corporation prior to the sale of the TWS stock to third parties; (4) whether cash advances made by petitioner to Carlton House Corporation constituted bona fide loans which gave rise to bad debt deductions; (5) whether petitioner is liable for additions to tax under section 6653(b) for 1974 and 1975, or, in the alternative, whether petitioner is liable for additions to tax under sections 6651(a)(1) and 6653(a); and (6) whether petitioner is liable for additions to tax under section 6654 for 1974 and 1975. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by reference. Petitioner resided at Boxford, Massachusetts, at the time he filed his petition. Petitioner is a well educated and highly successful businessman. Many of the issues before us arise out of transactions entered into by petitioner and three businesses Page 876 he either founded or significantly developed. In the interest of understanding these transactions, we deem it appropriate to summarize petitioner's involvement in SCA, TWS and Carlton prior to 1974, the first taxable year in issue. GENERAL BACKGROUND While pursuing combined studies at Massachusetts Institute of Technology and Amherst College, petitioner became involved in a six- person maintenance company. He gradually progressed in the company and was given a one-third ownership interest. Sometime later, petitioner acquired the other two-thirds of the maintenance company stock and renamed the company Consolidated Service Corporation (CSC). Over the next few years, under petitioner's direction CSC effected several acquisitions and greatly expanded its operations. By 1971, CSC had become a full-scale maintenance business with janitorial services, window cleaning services, security services and disposal services. It employed a work force of 2,000 persons and generated annual revenues in excess of $7 million. Overseeing the activities of CSC occupied the major portion of petitioner's time. During 1963, petitioner joined with a couple of classmates and two others to form Trans World Services (TWS), a company which subsequently developed the sandwich wrap utilized in vending equipment. Petitioner owned approximately 62 percent of the TWS stock, but was not a salaried employee. His activities were limited to those of a company director. In 1964, petitioner and another individual acquired a hotel and started Carlton Hotel Corporation as a hotel holding company (Carlton). Petitioner initially owned approximately 80 percent of Carlton. Petitioner assumed the role of Carlton's president for a period of time following its formation, but soon turned the management responsibilities over to Alfred Weiner, son of the former owner and operator of the Ritz Carlton. Weiner operated Carlton until late 1973 or early 1974 when petitioner reassumed the position of president and increased his ownership to approximately 93 percent. From formation in 1964 through 1971, Carlton acquired six additional hotels, four being acquired during 1971. Each Page 877 of the seven hotels was operated as a separate subsidiary of Carlton. The rapid expansion of Carlton often created temporary cash flow problems, particularly following the 1971 acquisitions which more than doubled the number of operating hotels. Petitioner would often advance Carlton the cash it needed to meet its operating needs. Petitioner also on occasion advanced funds to his other business interests. Prior to 1971, petitioner regularly received repayment of his advances. CSC also loaned cash to Carlton. The advances made by CSC and its successor SCA were bona fide loans. However, during 1971 Carlton attempted to acquire independent and more permanent sources of funds through refinancing the appreciated real estate of its subsidiaries. It simultaneously entered into merger negotiations with several established hotel chains. Neither the refinancing nor the merger negotiations were completed. During 1971, the operations of CSC and Carlton became increasingly entwined. Petitioner purchased a building within which to house centralized accounting and administrative functions for the two firms. The two companies also began rendering services to one another, and intercompany transfers of cash became common. As of the end of 1971, CSC had advanced approximately $400,000 to Carlton. Sometime during 1971, petitioner arranged for CSC to be acquired by S.C.A. Services, Inc. (SCA), this combination being the first of several steps in a plan to operate a publicly-owned conglomerate in the waste service industry. Under the terms of the acquisition, petitioner became president, director and treasurer of SCA with an annual salary of approximately $50,000 plus expenses. As president, he was responsible for directing acquisitions and integrating the acquired assets into SCA's waste management business. Petitioner also received assurances that SCA would continue to provide goods, services and short-term cash advances to Carlton. However, because SCA was publicly traded, it was agreed that petitioner would not assume the position of president of the public company until the CSC loan to Carlton (which was transferred to SCA) was repaid. To provide Carlton with funds to repay its loan, SCA caused the First National Bank of Boston to lend petitioner Page 878 $1 million (the Boston loan) on a demand note bearing interest at one percentage point over prime. The demand note was secured by 65,000 shares of petitioner's SCA stock. In about February, 1972, petitioner transferred essentially all of the Boston loan proceeds to Carlton. The transferred funds were recorded on Carlton's books in the ‘ due to/due from‘ current liability account. No note or other writing was executed by Carlton in connection with petitioner's advance. Likewise, Carlton made no commitment regarding repayment terms or interest. Shortly after petitioner's advance, Carlton repaid the CSC loan and petitioner assumed his role as president of SCA. After taking the reins of SCA in early 1972, petitioner was ‘ swept away‘ in an acquisition frenzy that brought over 50 companies into the SCA family within a short six-month period. This rapid expansion vaulted SCA onto the New York Stock Exchange by the end of 1972. The expansion continued during 1973, growing to 127 acquisitions, approximately 100 of which were personally handled by petitioner. Understandably, directing and approving the expansion of SCA...

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