Baldwin v. Commissioner
| Decision Date | 16 September 1993 |
| Docket Number | Docket No. 315-91. |
| Citation | 66 T.C.M. 769 |
| Parties | Jerry C. Baldwin and Patricia A. Baldwin v. Commissioner. |
| Court | U.S. Tax Court |
Respondent determined a deficiency in petitioners' Federal income tax for the year 1985 in the amount of $48,407.89.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable year before the Court, and all Rule references are to the Tax Court Rules of Practice and Procedure.
The issues in this case arise out of a claimed net operating loss carryback from 1987 to 1985. That net operating loss carryback, in the amount of $148,238, is based upon a bad debt deduction, in the amount of $161,483, claimed by petitioner Jerry C. Baldwin on his 1987 individual Federal income tax return. The claimed 1987 bad debt deduction is based upon the alleged worthlessness of a promissory note between petitioner Jerry C. Baldwin and Baldwin Enterprises, Inc. Thus, resolution of the 1985 deficiency depends upon the validity of the claimed 1987 bad debt deduction.1
Specifically, the issues for decision are:
(1) Whether a bona fide debt of Baldwin Enterprises, Inc., was created in favor of petitioner Jerry C. Baldwin;
(2) If a valid debt was created, whether that debt became worthless during the 1987 taxable year; and
(3) If the debt became worthless during 1987, whether that debt was a business or a nonbusiness bad debt.
Some of the facts have been stipulated and are so found. The stipulation of facts and the two supplemental stipulations of facts, together with the exhibits attached thereto, are incorporated herein by this reference.
Petitioners Jerry C. Baldwin and Patricia A. Baldwin were husband and wife during the taxable year at issue and resided in Cabot, Arkansas, at the time they filed their petition in this case. All references to petitioner in the singular will be to petitioner Jerry C. Baldwin.
Petitioners timely filed a 1985 joint U.S. Individual Income Tax Return (Form 1040) with the Internal Revenue Service Center in Memphis, Tennessee.2 That Form 1040 reported, on Schedule E, income from the Baldwin-Odom Enterprises partnership in the amount of $258,752. That Form 1040 reflected tax liability in the amount of $53,866 and total tax payments of $5,795, resulting in tax owed in the amount of $48,071. Petitioners did not pay any of this amount owed with the return.
Petitioner timely filed his U.S. Individual Income Tax Return (Form 1040) for the 1987 taxable year with the Internal Revenue Service Center in Memphis, Tennessee. See supra note 2. That individual return reported a claimed bad debt deduction in the amount of $161,483 on the Schedule C attached thereto. This claimed bad debt deduction resulted from a promissory note, dated September 12, 1985, executed on behalf of Baldwin Enterprises, Inc. (BEI), by petitioner as president of BEI, in favor of petitioner individually.
Petitioners' failure to pay the tax due in 1985 created a Federal tax lien in favor of the United States upon all property and rights to property, real and personal, belonging to petitioners individually in accordance with section 6321. On May 22, 1987, the Internal Revenue Service (the IRS) filed a Notice of Federal Tax Lien against petitioners in Lonoke County, Arkansas, in an effort to collect the 1985 income tax due. On April 15, 1988, an IRS revenue officer advised petitioners' counsel that under the Internal Revenue Code the IRS had legal rights of seizure to satisfy this lien and that said rights could include "locking up" the doors of BEI's place of business since petitioner personally owned the realty and building in which BEI conducted its business.
On April 25, 1988, petitioner filed an Application for Tentative Refund (Form 1045) with the Internal Revenue Service Center in Memphis, Tennessee. That Form 1045 reflected a claimed net operating loss carryback from 1987 to 1985, relating to the claimed 1987 bad debt deduction. At the time the Form 1045 was filed, petitioners still had not paid the remaining tax shown due on petitioners' 1985 joint tax return. The application for tentative refund requested that the tentative refund be applied to the balance due on the 1985 return. On June 20, 1988, respondent issued a credit to the 1985 Federal income tax due from petitioners in the amount of $48,407.89, in accordance with the Form 1045.
On October 3, 1990, the statutory notice of deficiency, on which this case is based, was issued to petitioners for the 1985 taxable year. Respondent determined that the Application for Tentative Refund was without merit and determined a deficiency in an amount equal to the credit amount previously allowed, $48,407.89. On that same date, a statutory notice of deficiency was issued to petitioner for his 1987 taxable year. Respondent determined that the net operating loss claimed by petitioner on his 1987 individual return was not allowable under section 166 and determined a deficiency of $567 due from petitioner for that taxable year. Petitioner did not file a petition with this Court for redetermination of the 1987 deficiency within the time specified by section 6213(a), but he has filed a timely petition for the redetermination of the 1985 tax liability. See supra note 1.
In January of 1985, petitioner and Randall Odom (Odom) pooled their knowledge and certain resources to manufacture and sell satellite dish antennas. Odom provided $20,000 in cash and petitioner provided certain equipment. They formed Baldwin-Odom Enterprises, an Arkansas general partnership (the Partnership). There was no written agreement between petitioner and Odom. Odom had a substantial business in another city and devoted the majority of his time to that business. Petitioner devoted all of his time to the satellite dish antenna business, and the business became an overnight success. That particular area of Arkansas had many skilled welders and was known as the Detroit of satellite dish manufacturers.
In August of 1985, petitioner and Odom informally decided to change their oral agreement. Petitioner desired to acquire Odom's interest in the Partnership. Odom agreed, providing certain conditions were met. First, Odom wished to be released from all liabilities as a partner. Second, he wanted to be repaid his original $20,000 investment in the Partnership plus an additional $50,000. Last, he requested that three of the employees of the business (Wayne Besancon, Jerry Ross, and Steve Lang) receive a combined 25-percent ownership interest in the business. There were no written documents defining the relationships of these men to the business, except for an employment contract between Wayne Besancon and the Partnership. Subsequent to the formation of the Partnership but prior to September 11, 1985, the end of the Partnership's first and only taxable year, 75 percent of the profit, loss, and capital interests in the Partnership was held by petitioner and 15 percent by Wayne Besancon, 5 percent by Jerry Ross, and 5 percent by Steve Lang.
The Partnership timely filed a U.S. Partnership Return of Income (Form 1065) for the period January 1, 1985, through September 11, 1985, with the Internal Revenue Service Center in Memphis, Tennessee. The Partnership had ordinary income of $345,003.01. On the Schedule K-1 for petitioner attached to the Partnership's 1985 return, petitioner's distributive share of partnership ordinary income ($258,752.26) less distributive share of deductions for section 179 recovery property ($557.11) resulted in net earnings from self-employment in the amount of $258,195.15. On petitioners' joint return for 1985, $258,195 was reported as petitioner's net income from the Partnership. Petitioner actually received a cash distribution of about $40,000 to $50,000 of that amount from the Partnership in 1985. In addition, in 1985, petitioners reported income from sources3 other than the partnership distributive share, including $9,721.19 ($6,100 to petitioner and $3,621.19 to Mrs. Baldwin) of salary from the newly formed corporation, to be discussed below.
Incorporation of Baldwin Enterprises, Inc.
In August of 1985, petitioner consulted with his accountant, Calvin K. Aldridge (Aldridge), regarding the business structure of the Partnership. Due to the rapid success of the satellite dish antenna business, petitioner had become concerned about his personal tax liability for undistributed earnings of the Partnership. In a memorandum dated August 7, 1985, Aldridge advised petitioner to consider incorporating the Partnership. He outlined the advantages and disadvantages of incorporation. He specifically suggested two approaches for consideration: one approach would be to transfer all of the assets used in the Partnership to the corporation, while the other approach involved transferring only inventory, receivables, and payables. Before discussing the various options with Aldridge, petitioner asked a lawyer to set up a corporation and that was done.4
On September 12, 1985, petitioner, as the sole incorporator, caused Baldwin Enterprises, Inc. (BEI or the corporation), to be incorporated under the laws of the State of Arkansas. Ultimately, all partnership assets were transferred to BEI, and BEI continued the satellite dish antenna business of the Partnership after incorporation.
At the first meeting of the board of directors, petitioner was elected president of BEI, Wayne Besancon vice president, and Patricia Baldwin secretary/treasurer as of September 12, 1985. At that meeting, the board of directors authorized and directed petitioner, as president, and the corporate secretary to issue $1 par value common stock to the Partnership in exchange for the Partnership's...
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