Beaton v. Commissioner

• Decision Date: 22 September 1980
• Docket Number: Docket No. 1884-77.
• Citation: 1980 TC Memo 413,40 TCM (CCH) 1324
• Parties: Colin F. and Eleanor M. Beaton v. Commissioner.
• Court: U.S. Tax Court

40 TCM (CCH) 1324

1980 TC Memo 413

T.C. Memo. 1980-413.

Colin F. and Eleanor M. Beaton v. Commissioner.

Docket No. 1884-77.

United States Tax Court.

Filed September 22, 1980.

Kenneth F. Kane, for the petitioners. Thomas P. Dougherty, Jr., for the respondent.

Memorandum Findings of Fact and Opinion

SIMPSON, Judge:

The Commissioner determined a deficiency of $50,821.03 in the petitioners' Federal income tax for 1973 and additions to tax for such year of $12,705.26 under section 6651(a) of the Internal Revenue Code of 1954¹ and $2,541.05 under section 6653(a). After concessions by the petitioners, the issues to be decided are: (1) Whether Mr. Beaton is taxable in 1973 on certain funds misappropriated by him in that year as ordinary income; (2) whether Mr. Beaton is taxable on imputed interest as a result of the receipt of an interest-free loan from his employer; and (3) whether the petitioners were liable for additions to tax under section 6651(a), relating to late filing of returns, and under section 6653(a), relating to underpayments of tax due to negligence or intentional disregard of rules and regulations.

Findings of Fact

Some of the facts have been stipulated, and those facts are so found.

The petitioners, Colin F. and Eleanor M. Beaton, husband and wife, resided in Bridgewater, Mass., when they filed their petition in this case. They filed untimely their joint Federal income tax return for 1973 with the Internal Revenue Service. Mr. Beaton will sometimes be referred to as the petitioner.

Sometime prior to the 1960s, the petitioner became the president and sole stockholder of the Brockton Ice and Coal Company, Inc. (Brockton). Brockton had been formed by the petitioner's grandfather and was engaged principally in the sale and distribution of heating oil in the 1960s and 1970s.

During such years, Brockton's primary supplier of oil was The Quincy Oil Company (Quinoil).² Quinoil sold to Brockton on open account and thereby extended credit to Brockton for the purchases of oil. In late 1964, Brockton's debt to Quinoil totaled approximately $400,000 and Quinoil officials began to fear default. Consequently, they sought security for the debt, and in 1966, they received such security from the petitioner in the form of his personal guarantee of the debt together with a pledge of his stock in Brockton and a mortgage on his residence.

By the summer of 1968, Brockton's debt to Quinoil had risen to more than $500,000, and Quinoil contemplated foreclosing upon the security. There was a conference between the petitioner and his counsel and the counsel and officials of Quinoil, and at such conference, the petitioner was presented a proposed agreement for his consideration. After considering the agreement for several days and receiving the advice of his counsel, the petitioner executed the proposed agreement on July 17, 1968. In pertinent part, the agreement provided:

the undersigned the petitioner does hereby irrevocably assign and transfer to * * * Quinoil 875 shares of the Class A Common Stock * * * and 115 shares of the Class B Common Stock * * * of the Brockton Ice and Coal Company, representing all of the issued and outstanding stock of said company as of this date.

In return for the petitioner's assignment of his stock, Quinoil promised to "temporarily forebear" collecting under the petitioner's guarantee and mortgage. The agreement also stated that $1 was received as consideration for the transfer of the stock.

After the assignment of the petitioner's stock, Quinoil elected the majority of the board of directors of Brockton. The petitioner continued to serve as the president of Brockton, but his powers over financial matters were restricted. For 1969 and later years, Brockton filed consolidated returns with Quinoil, and the petitioner executed such returns as the principal officer of Brockton. The board of directors of Brockton selected a different accounting firm to perform the accounting work of Brockton.

In late 1972, the petitioner attempted to repurchase the Brockton stock. He and his counsel and counsel for Quinoil held a meeting in December of that year to negotiate a purchase agreement; however, Quinoil would not sell on the terms proposed by the petitioner, and the meeting was fruitless.

Prior to 1973, the petitioner had established B & B Spring Water Company (B & B), which he wholly owned. B & B was unrelated to Brockton, but in opening its bank account, the petitioner represented to the bank that B & B was a division of Brockton. Between the beginning of 1973 and August of that year, the petitioner had checks payable to Brockton deposited in the B & B account.

In the spring of 1973, the petitioner's counsel renewed negotiations for the repurchase of the stock. Another meeting was held with the counsel for Quinoil, but again, the negotiations failed. Thereafter, the petitioner became openly hostile toward Quinoil. When accountants hired by the Brockton board of directors arrived at the company offices to perform their regular audit of the books of Brockton for the fiscal year ending June 30, 1973, the petitioner refused to allow them to enter and told them that he had hired others to replace them. Because of the petitioner's refusal to permit the accountants to conduct their audit, Quinoil decided that he had to be removed, and in late August 1973, the Quinoil counsel, together with local authorities, appeared at the offices of Brockton and announced that the petitioner had been removed from office. During 1973, the petitioner deposited in the B & B account a total of $96,803.33 of the funds belonging to Brockton, and he withdrew $48,585.69 from such account for his personal use.

On September 5, 1973, the petitioner filed suit against Brockton, Quinoil, and Quinoil's counsel to recover the Brockton stock. He alleged that the 1968 assignment was not supported by consideration and was fraudulently induced. In November 1973, Brockton brought suit against the petitioner to recover the misappropriataed funds. In addition, 2 years later, the petitioner and his son-in-law, who was a signatory on the B & B account and an employee of Brockton, were indicted for stealing and for conspiracy to steal.

In June 1977, the litigation was settled. The petitioner relinquished all claims to the Brockton stock and to any property of Brockton; Brockton relinquished all claims against the petitioner, including the claim to the misappropriated funds; and Quinoil relinquished all claims against the petitioner, including those arising under his guarantee of Brockton's debts to Quinoil. Also, Quinoil agreed to discharge the mortgage executed by the petitioner in 1966 and to pay $15,000 to the petitioner. In addition, in September of that year, the criminal charges against the petitioner were dropped.

In his notice of deficiency, the Commissioner determined that the Brockton funds misappropriated by the petitioner in 1973 represented additional ordinary income received by him in that year. The Commissioner also determined that the petitioner received an interest-free loan of $123,361.86 from Brockton in 1973 and that since he was not charged interest on such loan, he received additional income of $9,868.95, representing interest at the rate of 8 percent on such loan. In addition, the Commissioner determined that the petitioners were liable for additions to tax under section 6651(a), for filing their return late, and under section 6653(a), for an underpayment of tax due to negligence or intentional disregard of rules and regulations.

Opinion

The principal issue to be decided is whether the Brockton funds misappropriated by the petitioner in 1973 are taxable to him in that year as ordinary income. The petitioner takes the position that the funds represented partial consideration for his assignment of the Brockton stock, that as such, they are taxable as capital gain, and that such gain was not includable in his income until 1977, when the litigation was settled and he was absolved of any obligation to repay the funds. In support of his position, he contends that his assignment of the stock in 1968 was obtained by fraud and without adequate consideration and that as a result, the transfer was ineffective. He insists that his contention is corroborated by the fact that in settling the litigation, Quinoil permitted him to retain the funds taken by him.

Initially, it is clear that the petitioner received income in 1973 when the Brockton funds were misappropriated by him. It is axiomatic that when an individual receives money without the recognition of an obligation to repay and without restriction as to its disposition, he has taxable income in the year it is received, even though he may be required to restore the money later. James v. United States 61-1 USTC ¶ 9449, 366 U.S. 213, 219-220 (1961); North American Oil Consolidated v. Burnet 3 USTC ¶ 943, 286 U.S. 417, 424 (1931); Mais v. Commissioner Dec. 29,288, 51 T.C. 494, 498-499 (1968). Whether the individual receives the money lawfully or unlawfully is irrelevant. James v. United States, supra. This case falls clearly within these principles. First, the record contains no evidence that in 1973 the petitioner recognized an obligation to repay Brockton. Indeed, the petitioner steadfastly maintains that he had a legitimate claim to the funds misappropriated by him. Second, there is no evidence that after the petitioner took the funds and deposited them in the B & B account, he was under any restrictions as to the disposition and use of the funds. In fact, he has admitted that during 1973 he withdrew about half of such funds and that he used them for personal purposes. On the record, we hold that the petitioner is taxable in 1973 on the funds misappropriated by him in that year.

There remains the question of whether the funds misappropriated by the petitioner constituted a capital gain or ordinary income. The petitioner recognizes that for the funds to qualify...