Wallace v. Comm'r of Internal Revenue (In re Estate of Wallace)

• Decision Date: 14 November 1990
• Docket Number: Docket No. 22960-88.
• Citation: 95 T.C. 525,95 T.C. No. 37
• Parties: ESTATE OF GERALD L. WALLACE, DECEASED, CELIA A. WALLACE, EXECUTRIX, AND CELIA A. WALLACE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

95 T.C. 525

95 T.C. No. 37

ESTATE OF GERALD L. WALLACE, DECEASED, CELIA A. WALLACE, EXECUTRIX, AND CELIA A. WALLACE, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22960-88.

United States Tax Court

Filed November 14, 1990.

HELD, Dr. Gerald L. Wallace (petitioner) was a limited entrepreneur who did not actively participate in his cattle feeding business and therefore was entitled under section 464 to deduct only the cost of feed purchased which was actually consumed by the cattle during the year. HELD, FURTHER, the income received by petitioner from a subchapter S corporation in which he owned a 70-percent interest consisted of personal service income, within the meaning of sec. 1348, and dividends. The amount of petitioner's earned income from personal services rendered to the subchapter S corporation is determined from the evidence. Roland J. Mestaver. Jr., G. Tomas Rhodus, Clark S. Willingham, for the petitioners.

Helen C. T. Smith, for the respondent.

SCOTT, JUDGE.

Respondent determined deficiencies in petitioners' income tax for the calendar years 1980 and 1983 in the amounts of $303,129 and $566,236, respectively. Dr. Gerald L. Wallace (Dr. Wallace) died on November 13, 1986, prior to the issuance of the notice of deficiency in this case. However, since the years here involved are 1980 and 1983, we will hereinafter refer to Dr. and Mrs. Wallace as petitioners. Some of the issues raised by the pleadings have been disposed of by agreement of the parties, leaving for our decision the following:

(1) whether the amount of deductions to which Dr. Wallace is entitled for prepaid cattle feed for the years 1980 and 1983 is limited by section 464; ¹ and

(2) to what extent were the payments in 1980 to Dr. Wallace, by a corporation of which he was the major stockholder as well as an officer, earned income within the meaning of section 1348.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly.

At the time of filing the petition in this case Celia A. Wallace (Mrs. Wallace) resided in Mobile, Alabama. Petitioners timely filed a joint Federal income tax return for the calendar year 1980 with the Atlanta, Georgia Service Center. They filed an amended income tax return for 1980 on January 18, 1982, and a second amended income tax return for 1980 on December 31, 1985. On October 15, 1984, petitioners filed a joint Federal income tax return for the calendar year 1983. During the years 1980 through 1985, petitioners were cash basis taxpayers.

Dr. Wallace completed his medical education and various internships in 1964. He entered a family medicine medical practice in that year in Bay Minette, Alabama. Mrs. Wallace has a degree in X-ray technology from the University of Alabama. Dr. and Mrs. Wallace were married in 1966.

By the end of his fifth year of practice, Dr. Wallace was seeing between 75 and 90 patients a day in his office, in addition to seeing approximately 30 hospital patients a day. He began his duties early in the morning and sometimes finished his hospital rounds between midnight and 1 a.m. He spent whatever time he considered necessary with each patient. Dr. Wallace's patient load began to diminish in 1975 as he became more involved in business activities. His hospital admissions also declined.

Although Dr. Wallace's medical practice produced a steady stream of income, petitioners opted to invest their income rather than spend it. Petitioners worked together in their various business undertakings and discussed potential business transactions in detail. Starting in the late 1960s, they examined a number of prospective business ventures with particular emphasis on undeveloped real estate. A brief description of some of the business ventures in which they were involved follows.

Petitioners invested in and developed residential property in St. Thomas, the American Virgin Islands, in 1967 in conjunction with Mrs. Wallace's godfather.

Shortly after commencing the project in St. Thomas, petitioners planned the construction of an apartment complex behind Dr. Wallace's professional office. Dr. Wallace helped to plan the design of the complex, but it was not constructed due to lack of financing.

In 1968, petitioners bought a section of rural land in Mobile County, Alabama. Several years later, a producing oil well was drilled on the property. The area is now referred to as the Chunchula Field. Dr. Wallace negotiated an unusual mineral lease contract on the property under which petitioners received a percentage of the net profit from the refining of the oil produced from their land.

As his medical practice developed, Dr. Wallace became dissatisfied with the availability of hospital beds in Mobile County, Alabama, and the patient care given at existing hospitals. He decided to build a new hospital in order to give his patients the best quality medical care. Dr. Wallace located suitable property for construction of the hospital, obtained a Certificate of Need for the construction of the hospital and began its construction in the early 1970s. Springhill Memorial Hospital opened its doors in January of 1975 as an Acute Care Facility with 150 beds.

In order to attract physicians to use the facilities of Springhill Memorial Hospital, petitioners arranged for the building of a seven-story medical office building adjacent to the hospital.

While the hospital was under construction, petitioners had constructed a 150-bed nursing home adjacent to the hospital. The nursing facility was completed shortly before the hospital opened. Petitioners individually owned, managed, and operated the nursing home for a period of time after it opened, but later turned the management over to a professional administrator.

In 1969, petitioners joined with a Mr. Charles Vann in the Vann Construction Company to build an office building on Hartley Road. After building the office building Vann Construction Company built schools in Baldwin County, Alabama, and some other counties in Alabama. Vann Construction Company became unprofitable and was discontinued.

Dr. and Mrs. Wallace had a number of other business interests during the late 1960s, the 1970s, and early 1980s, including engaging in the commercial fishing business through the ownership of shrimp boats, operating H & W Pipeline Corporation, and owning the Battle House Hotel.

Dr. Wallace was founder, controlling shareholder, president, and chairman of the board of directors of Springhill Medical, Inc.; president, controlling shareholder, and chairman of the board of directors of H & W Pipeline Corporation, a natural gas transmission company; founder, controlling shareholder, and chairman of the board of directors of Springhill Memorial Hospital, Inc., of Mobile, Alabama, which owned and operated the Springhill Memorial Hospital constructed by petitioners; and founder, president, controlling shareholder, and chairman of the board of directors of Chunchula Energy Corporation.

Dr. Wallace had a very high energy level. He required only 3 to 4 hours of sleep per night and would work 14 to 20 hours a day, 7 days a week.

FACTS RELATING TO PREPAID FEED ISSUE

The term ‘cattle feeding‘ applies to the practice of placing cattle in feedlots, feeding the cattle a high protein diet for 3 to 5 months, and then selling the cattle for slaughter. Commercial cattle feeding lots began to develop as an industry in the 1960s. Most of the cattle feeding lots are in Texas, Oklahoma, and New Mexico. Generally the cattle in the lots are not owned by the owners of the feedlots or their employees. Individuals or other entities will purchase cattle, place the cattle at custom feedlots for the required fattening period, and then sell the cattle for slaughter.

The feedlot employees include the feedlot manager, clerical staff, office manager, cowboy-foreman, cowboys, lay doctor, processors, market monitors, and a food mill expert. In addition to employees, a commercial feedlot usually has a nutritionist and a veterinarian as consultants.

The feedlot employees care for the cattle from the moment the cattle are delivered to the feedlot until the moment they are sold for slaughter. Care of the cattle includes daily feeding, maintenance of the cattle's health, treatment of disease, and other activities necessary for the cattle to adequately gain weight during the feeding period. Cattle in the feedlot are segregated into separate pens according to owner, but all cattle in the feedlot at a given time and at a given stage of development are treated exactly the same.

The ultimate authority in a commercial feedlot is the feedlot manager. The feedlot manager and supervisors make all the decisions regarding the hiring and firing of employees on the feedlot. Individual cattle owners have no authority to hire or fire any employees. If an owner is displeased with the treatment his cattle receive at a particular feedlot, he can speak with the feedlot manager or operator in an attempt to work out a solution, take his complaint to arbitration or to court, or simply move his cattle to another feedlot. Generally, if the owner is dissatisfied with a feedlot, when he purchases his next set of cattle he will place those cattle with another feedlot. It is very unusual to move cattle from one feedlot to another during their feeding cycle, because it throws the cattle off feed and adds freight charges.

Commercial feedlots offer cattle owners marketing services. The feedlot will place fat cattle on a show list for viewing by packers/buyers who usually visit the feedlots daily. In many instances, the feedlot manager will negotiate a sale of cattle to the packer/buyer from the cattle owner.

A cattle owner must purchase feed for his cattle to consume during the feeding period. An owner can buy feed directly from a grain or feed mill, or he can buy feed through the feedlot. If the owner buys from a grain or feed mill, he can take physical possession of his pre-purchased feed and store it...