Betson v. C.I.R., 85-7053

Citation802 F.2d 365
Decision Date17 October 1986
Docket NumberNo. 85-7053,85-7053
Parties-5870, 86-2 USTC P 9712, 86-2 USTC P 9826 J.R. BETSON, Jr. and Joan Sue Betson, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Respondent-Appellee.
CourtUnited States Courts of Appeals. United States Court of Appeals (9th Circuit)

Ronald K. Van Wert, Newport Beach, Cal., for petitioner-appellant.

Martha B. Brissette, William Whitledge, Dept. of Justice, Washington, D.C., for respondent-appellee.

Appeal from a Decision of the United States Tax Court.

Before KENNEDY, SKOPIL, and ALARCON, Circuit Judges.

KENNEDY, Circuit Judge:

Taxpayers J.R. Betson, Jr. and Joan Sue Betson (collectively "Betson") appeal the Tax Court's disallowance of deductions for 1970-1972 claimed under I.R.C. Secs. 162, 165, and 212 in connection with the operation of certain retail liquor stores in New Mexico. The Tax Court found that the stores were in fact operated by Bethinol, Inc., a New Mexico corporation wholly owned by the taxpayers and formed "[t]o engage in the retail and wholesale sale of alcoholic beverages of all types throughout the State of New Mexico and to own and operate bars, lounges and package stores throughout the State of New Mexico." The Tax Court held that the expenses giving rise to the deductions arose in the course of the corporation's trade or business, and that any allowable deductions therefore belonged to the corporation and not to the individual taxpayers. The court also upheld imposition of a negligence penalty against the taxpayers under I.R.C. Sec. 6653(a). We affirm in part and reverse in part.

The deductions claimed are attributable to the operation of four stores: Winrock Economy Liquors (also known as Western Wine and Liquor Marts, No. I), an outlet in the Bellas Hess Department Store (also known as Western Wine and Liquor Marts, No. III), Western Liquors (also known as Western Wine and Liquor Marts, No. IV), and an outlet at a Pizza Hut (also known as Western Wine and Liquor Marts, No. II). The first two businesses were acquired by Betson prior to the formation of Bethinol in January 1970. While the Tax Court found that all four stores were in fact operated by Bethinol after its formation, the licenses for the two original stores remained at all times in Betson's name. The other two outlets were acquired after the formation of Bethinol, with the corporation as licensee.

The liquor stores were less than successful. The parties stipulated in the Tax Court that the four stores had combined operating losses of $37,000 in 1970 and $25,000 in 1971. The parties also stipulated that Betson expended $175,365.89 in connection with the stores in 1972, of which $138,478.68 was deductible by either Betson or Bethinol depending on the outcome of this case. Of the $175,365.89, the single largest expenditure by the taxpayer was $62,292 paid to settle suits against himself and Bethinol filed or threatened by wholesale liquor distributors through 1971. A few of Betson's checks bore the notation "Loan to Corp.," while others were reflected on Bethinol's books as notes payable to Betson.

In reviewing the Tax Court's findings that neither the losses associated with the stores nor the sums expended on the liquor operations by Betson were deductible, this court reviews de novo questions of law, namely the construction of provisions of the statute itself. See Roemer v. Commissioner, 716 F.2d 693, 696 (9th Cir.1983) (considering propriety of distinguishing personal and professional reputation under I.R.C. Sec. 104(a)(2)). The taxpayer, however, bears the burden of showing that he is entitled to a particular deduction, and the determination that he has failed to produce sufficient evidence to support a deduction is one of fact subject to reversal only if clearly erroneous. Zmuda v. Commissioner, 731 F.2d 1417, 1421 (9th Cir.1984).

Betson does not contest on appeal, as he did below, that Bethinol exists as a separate taxable entity. A corporation exists for tax purposes if formed for a business purpose or if it carries on business after incorporation. Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 438-39, 63 S.Ct. 1132, 1133-34, 87 L.Ed. 1499 (1943). In this case the Tax Court found that following its founding in 1970 Bethinol in fact operated all four liquor stores as part of a unified enterprise, a finding clearly supported by the record. The court observed, among other things, that Bethinol operated the stores under a common trade name (Western Wine and Liquor Marts); that all bank accounts were in Bethinol's name, and gross receipts from all stores were deposited in these accounts; that Bethinol purchased the beverages for all four stores; that Bethinol's inventory included merchandise on hand in all four stores; and that Bethinol's corporate tax returns were based on income and expenses from all four stores. Consequently, this appeal focuses on whether Betson is entitled to the claimed deductions even though he chose to operate his liquor stores through a corporation recognized for tax purposes.

Betson does not clearly distinguish between his claims under I.R.C. Sec. 162(a), I.R.C. Sec. 165, and I.R.C. Sec. 212. He argues, however, that he should be able to deduct all expenditures by him in 1972, on the ground that the payments were necessary to protect the businesses and licenses. He also argues that he should be able to deduct all payments to creditors of the Winrock and Bellas Hess stores, as well as the 1970 and 1971 losses attributable to those stores, because he believed himself personally liable for their debts as the record licensee of those stores. He also suggests that he, rather than Bethinol, is entitled to deduct expenditures to pay expenses and cover losses associated with the stores because Bethinol operated the stores only as his agent. The Commissioner contends that no deduction is permissible under I.R.C. Sec. 162(a) because the expenses paid by Betson arose in connection with Bethinol's trade or business. The Commissioner characterizes Betson's payments on behalf of the liquor stores as either contributions to the capital of Bethinol or loans to the corporation, neither of which give rise to a current deduction. The Commissioner argues, moreover, that since the expenditures were capital and not ordinary and necessary, they are also not deductible under I.R.C. Sec. 212.

I.R.C. Sec. 162(a) provides a deduction for "ordinary and necessary" expenses incurred "in carrying on any trade or business...." As a general rule, the trade or business of a corporation is not that of its shareholders. See Whipple v. Commissioner, 373 U.S. 193, 202, 83 S.Ct. 1168, 1174, 10 L.Ed.2d 288 (1963). Shareholders, unless they are traders, do not engage in a trade or business when they invest in the stock of a corporation. Id. Consequently, shareholders are generally not permitted to deduct under section 162(a) sums advanced to a corporation to meet its expenses or pay its debts. See, e.g., Grauman v. Commissioner, 357 F.2d 504, 505-06 (9th Cir.1966); 7 Mertens, Law of Federal Income Taxation Sec. 38.22, at 50 (1985). Such expenditures, if not loans, are generally considered capital contributions. See I.R.C. Sec. 263; Treas.Reg. Sec. 1.263(a)-2(f) (voluntary contributions by shareholders for any corporate purpose are nondeductible capital expenditures).

These rules are consistent with the principle that if a taxpayer chooses to conduct business through a corporation, he will not subsequently be permitted to deny the existence of the corporation if it suits him for tax purposes. See, e.g., Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 438-39, 63 S.Ct. 1132, 1133-34, 87 L.Ed. 1499 (1943) (individuals adopting corporate form must accept tax disadvantages); O'Neill v. Commissioner, 271 F.2d 44, 49 (9th Cir.1959) (declining to ignore corporate entity). In particular corporate shareholders will not be permitted to claim deductions for ordinary and necessary expenses incurred by the corporation even though paid by the shareholders. See Elot H. Raffety Farms, Inc. v. United States, 511 F.2d 1234, 1239 (8th Cir.), cert. denied, 423 U.S. 834, 96 S.Ct. 57, 46 L.Ed.2d 52 (1975); Dodd v. Commissioner, 298 F.2d 570, 577-78 (4th Cir.1962); Ihrig v. Commissioner, 26 T.C. 73, 76 (1956); cf. O'Neill, 271 F.2d at 48-49 (no loss deduction allowed).

There are exceptions to these principles. If Betson paid corporate expenses in the ordinary and necessary course of some trade or business of his own, a deduction would be permitted. See, e.g., Madden v. Commissioner, 40 T.C.M. (CCH) 1103, 1111 (1980); Lohrke v. Commissioner, 48 T.C. 679, 688-89 (1967); cf. O'Neill, 271 F.2d at 48 (considering loss deduction). Payments made, however, with the purpose of keeping in business a corporation in which the taxpayer holds an interest are not deductible. Madden, 40 T.C.M. at 1111. Cf. Dodd, 298 F.2d at 576-77 (deduction disallowed where expenses of corporation are only "incidentally related" to taxpayer's own trade or business).

In this case the Tax Court found that Betson's dominant motive in paying the expenses of the liquor stores "was to provide operating capital and perpetuate or revitalize the liquor operations carried on by Bethinol." This conclusion is not clearly erroneous, in light of Betson's own representations that he acted to protect the corporation and hoped for repayment in the future. The Tax Court also found that any connection between paying the expenses of the liquor operations and Betson's own trade or business as a medical doctor was too attenuated to support the deduction. This finding, too, is not clearly erroneous. Compare Dinardo v. Commissioner, 22 T.C. 430 (1954) (medical partnership permitted to deduct expenses of hospital they organized and in which they practiced because of close business connection between hospital and their medical practice), with Dodd, 298 F.2d at 576-77 (deduction disallowed...

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