Bledsoe v. Commissioner of Internal Revenue, 103195 FEDTAX, 4572-93

Docket Nº:4572-93
Opinion Judge:GERBER, Judge
Attorney:Ted M. Riseling and Jeff K. Rhodes, for petitioners. Elizabeth Downs, for respondent.
Case Date:October 31, 1995
Court:United States Tax Court

T.C. Memo. 1995-521




No. 4572-93

United States Tax Court

October 31, 1995

Ted M. Riseling and Jeff K. Rhodes, for petitioners.

Elizabeth Downs, for respondent.


GERBER, Judge.

Respondent determined deficiencies in petitioners' Federal income taxes, additions to tax, and a penalty as follows:

Additions to Tax



Sec. 6653(a)(1)(A)









Sec. 6651(a)(1)

Sec. 6653(a)(1)









Sec. 6662 $2

1 50 percent of the interest due on $91,789.

All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.

After concessions, the issues remaining for our consideration are: (1) Whether petitioners are entitled to a bad debt deduction in the amount of $55,000; (2) whether petitioners are entitled to Schedule E deductions for legal fees for 1987 and 1988 in the amounts of $88,199 and $37,419, respectively; (3) whether petitioners are entitled to section 1244 stock loss deductions for 1988 and 1989 in the amounts of $92,500 and $96,503, respectively; (4) whether petitioners received dividend distributions from their S corporation in 1987, 1988, and 1989 in the amounts of $106,212, $66,423, and $48,632, respectively; (5) whether petitioners are liable for additions to tax for 1987 and 1988 and an accuracy-related penalty for 1989 for negligence or intentional disregard of rules or regulations; (6) whether petitioners are liable for an addition to tax for the late filing of their 1988 tax return; and (7) whether petitioners are liable for additions to tax for 1987 and 1988 and an accuracy-related penalty for 1989 for substantially understating their income tax liability.

Petitioners also claim that they had an overpayment of tax for 1989 due to an error made in the notice of deficiency, because, as the parties now agree, petitioners' basis in Resthaven should not be reduced by the amount of dividend distributions.1


Petitioners, who during the years in issue were husband and wife, filed joint Federal income tax returns for the years 1987, 1988, and 1989. Petitioners resided in Wichita, Kansas, at all times relevant to this case.

Harry D. Bledsoe (petitioner), a high school graduate, began his career in the cemetery business in 1950. He started as a salesman and became a sales or division manager, where he learned to hire and train salesmen to sell cemetery plots in advance of need. Eventually, petitioner became a sales manager for four small cemeteries, where he was responsible for all of their sales in advance of need. Desiring to build his own cemetery operation, petitioner saved his earnings and organized/incorporated Resthaven Gardens of Memory, Inc. (Resthaven), in 1958. During the years at issue, petitioner was the sole shareholder, president, and chairman of the board of Resthaven. In 1958, Resthaven entered into certain land option contracts with petitioner and his then wife, Mary Louise Bledsoe (Ms. Bledsoe). Together, they held an undivided three-fourths interest in land adjoining the Resthaven cemetery. Wichita Developers, Inc., an affiliated corporation, held the remaining one-fourth interest. The land option contracts granted petitioner and Ms. Bledsoe an interest in the gross sales of Resthaven.

In 1979, petitioner filed for divorce from Ms. Bledsoe. The two owned considerable property during their marriage. In 1981, petitioner was granted a divorce, and property division was the principal issue in the divorce proceedings. The divorce decree granted Ms. Bledsoe the right to receive payments from Resthaven on the land option contracts which had previously been payable to both petitioner and Ms. Bledsoe, and she was granted the entire three-fourths interest in the adjacent land. She was thus required to assume liability for a note and mortgage on that land which was payable to Resthaven.

In 1983, after Ms. Bledsoe did not make certain payments, Resthaven sued her to recover the $14,250 due on the note and to foreclose the mortgage. She counterclaimed, alleging that Resthaven had not paid her certain amounts to which she was entitled under the land option contracts, and that she was not provided with her annual accounting to which she was entitled. In its 1983 petition with the District Court of Sedgwick County, Kansas, Resthaven based its claim on the 1981 divorce decree and alleged that Ms. Bledsoe had failed to comply with the divorce decree. Resthaven's proceeding was ultimately consolidated with the divorce proceeding; both cases were resolved in 1989. The State appellate proceedings, to which the legal fees relate, concerned the property division between petitioner and Ms. Bledsoe. For instance, the court was to determine the value of certain property awarded to Ms. Bledsoe and her rights under the divorce decree.

During 1987 and 1988, Resthaven paid the consolidated litigation legal costs in the amounts of $88,199 and $37,419, respectively. The legal costs included payments for the divorce case settlement of $66,721 and the Resthaven note case settlement of $14,695.26. The remaining amounts were paid to the attorneys.

In 1986, petitioner, as president and chairman of the board, caused Resthaven to lend $110,000 to Albert Kamas (Kamas), a personal friend. The loan was to help Kamas finance the construction of a gasohol plant. Petitioner, on occasion, asked Kamas to make payments on the loan. In 1987, Kamas informed petitioner that he could not repay/make payments on the loan because the project had lost its government backing. Kamas received a discharge in bankruptcy in approximately 1992.

On May 7, 1987, Diamond Inn Enterprises, Inc. (Diamond), was incorporated. On or about June 1, 1987, Diamond authorized the issuance of 10,000 shares of section 1244 stock, and it received a total of $10,000 from its three incorporators. Seventy-five percent of Diamond's stock was issued to petitioner. Initially, petitioner paid $7,500 to Diamond and, for 1988, deducted a section 1244 loss in the amount of $100,000. In order to support the claimed loss, petitioner relied on each shareholder's postincorporation payments in amounts proportionate to his Diamond stock ownership percentage. From its incorporation through its failure in 1988, Diamond recorded loans from shareholders in the total amount of $252,004. Petitioner's accountant subsequently determined that the $252,004 should not have been reflected on Diamond's books as loans from shareholders. The post in corporation amounts contributed by Diamond shareholders were capital contributions which were not in payment of section 1244 stock.

On February 28, 1987, Resthaven's parent corporation, Developer and Management, Inc. (Developer), ceased operation and merged with Resthaven. On March 1, 1987, Resthaven became an S corporation. During 1987, when S corporation treatment was elected for Resthaven, the deferred gross profits of the prior C corporation were picked up and included in Resthaven's income over the next 4 years. This...

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