Bolnick v. Comm'r of Internal Revenue, Docket No. 3503-62.

• Decision Date: 28 May 1965
• Docket Number: Docket No. 3503-62.
• Parties: TED BOLNICK AND BERTHA BOLNICK, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

44 T.C. 245

TED BOLNICK AND BERTHA BOLNICK, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 3503-62.

Tax Court of the United States.

Filed May 28, 1965.

Samuel P. Halpern and Joseph L. Abrahamson, for the petitioners.

Paul G. Wilson, for the respondent.

1. Gain realized by petitioners on redemption prior to maturity at face amount of debentures issued to petitioners in 1953 at an original issue discount is taxable in part as ordinary income and in part as capital gain, where there was no specific intent on the part of the issuers at the date of issue to redeem the debentures prior to maturity and no understanding between the issuers and petitioners that the bonds would be redeemed prior to maturity.

2. Petitioners are entitled to have amount claimed on their return as an overpayment taken into consideration in determining a deficiency or overpayment of tax for that year where, despite the fact that respondent's records indicated that a check for the amount had been issued, the evidence indicated that petitioners had never received the check or the proceeds thereof. Petitioners' claim not barred by statute of limitations relating to claims on Government checks. 31 U.S.C.sec. 122, as amended Pub. L. 85-183, sec. 3(a), 71 Stat. 465 (August 28, 1957).

DRENNEN, Judge:

Respondent determined a deficiency in income tax for the taxable year 1954 in the amount of $3,535.89.

There are two issues for decision:

(1) Whether gain realized in 1954 by petitioner Ted Bolnick upon the redemption at face value, by the issuers prior to maturity, of debentures issued in registered form by certain corporations to petitioner at an original issue discount in 1953, constitutes long-term capital gain or ordinary income.

(2) Whether petitioners are entitled to an overpayment of income tax paid for the taxable year 1954 in the amount of $778.90, which overpayment they claimed on their Federal Income tax return for that year.

FINDINGS OF FACT

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

Petitioners were husband and wife residing in Los Angeles, Calif., during the taxable year 1954 with the district director of internal revenue, Los Angeles, Calif. They reported taxable income by the cash method of accounting. Hereafter, Ted Bolnick will be referred to as petitioner.

During 1954, petitioner was an employee of West Valley Publishing Co., Tarzana, Calif. He was also a self-employed investment counselor and an investor.

On April 8, 1953, petitioner purchased from Alto Building Corp. (hereafter referred to as Alto), for the sum of $21,770, 61 debentures, numbered 1 through 61, each having a face value of $500, and each bearing stated interest at the rate of 2 percent per annum, payable in semiannual installments commencing October 15, 1953. The debentures were due and payable at face value on April 15, 1959, and were in registered form. On or about April 15, 1953 (the date of issue), all of the debentures were registered in the records of Alto in the name of petitioner.

On April 10, 1953, petitioner purchased from Black Construction Co. (hereafter referred to as Black), the issuer thereof, for the sum of $9,282,26 debentures, numbered 1 through 26, each having a face value of $500, and each bearing stated interest at the rate of 2 percent per annum, payable in semiannual installments commencing October 15, 1953. The debentures were due and payable at face value on April 15, 1959. On or about April 15, 1953 (the date of issue), all of the debentures were registered in the records of Black in the name of petitioner.

On May 15, 1953, petitioner purchased From de Soto Park Estates (hereafter referred to as De Soto) the issuer thereof, for the sum of $9,000, 30 debentures, numbered 31 through 60, each having a face value of $500, and each bearing stated interest at the rate of 2 percent per annum, payable in semiannual installments commencing November 15, 1953. The debentures were due and payable at face value on May 15, 1961, and were in registered form. On or about May 15, 1953 (the date of issue thereof), all of the debentures were registered in the records of De Soto in the name of petitioner.

Alto, Black, and De Soto were incorporated under the laws of California in March or April 1953. Daniel E. Cohn (hereafter referred to as Cohn) and his brother were the principal stockholders, officers, and directors of the three corporations which were formed to develop subdivisions and to construct and sell houses. Cohn, who was engaged in the business of building and selling homes, formed other corporations to build houses in the same subdivisions where Alto, Black, and De Soto were engaged in building and selling houses. These other corporations, as did Alto, Black, and De Soto, issued debentures at original issue discount, to K. Light (hereafter referred to as Light), or who were known to Light's clients.

Light made a study of what he deemed to be the relevant law and determined that if Cohn's corporations issued registered debentures at an original issue discount, any gain realized by holders of the debentures upon maturity would constitute capital gain to them.

Petitioner heard through a friend that Alto, Black, and De Soto were to issue debentures at an original issue discount and that the debentures would bear interest to maturity at the rate of 2 percent per annum on the principal amount. Petitioner's friend, who was also investing in debentures of Cohn's corporations, put petitioner in touch with Light. Petitioner was advised by Light that any gain which he might realize upon maturity of such debentures, issued at an original issue discount, would constitute capital gain to him. He considered that the stated interest rate would not compensate him for the risks inherent in investing in such debentures of corporations engaged in the business of building and selling houses, but he felt that the discount, which he would realize upon maturity as capital gain, plus the stated interest, would justify the risks. On one occasion, petitioner and Light visited the subdivision where Alto, Black, and De Soto were to build houses. Petitioner discussed the debentures generally with Light, but neither Light nor Cohn indicated to petitioner that any debentures which petitioner might purchase from Alto, Black, and De Soto would be redeemed prior to maturity. Petitioner hoped that the debentures might be redeemed prior to maturity, but he did not expect or anticipate that they would be, and no representations were made to him in this regard. There was no understanding between petitioner and any representative of Alto, Black, or De Soto that the debentures would be redeemed prior to the dates of maturity as stated.

Each of the debentures issued by Alto, Black, and De Soto provided that no salaries or compensation of any kind was to be paid to officers, directors, or stockholders of the corporations without the prior written consent of the registered holders of 100 percent of the outstanding debentures.

Alto, Black, and De Soto paid interest at the rate of 2 percent per annum on the face amounts of the debentures as called for therein. Petitioner reported such interest as ordinary income, and the amounts thereof are not involved herein.

Except as the holder of debentures, acquir3d as set forth above, petitioner was at no time financially interested in Alto, Black, or De Soto. Petitioner was not acquainted with Cohn prior to his purchase of these debentures.

Cohn's corporations, including Alto, Black, and De Soto, were successful, and Cohn, who desired to be paid compensation by his corporations and to cause the corporations to be dissolved, decided to have the corporations offer to redeem the outstanding debentures from the holders thereof.

On July 7, 1954, Light, on behalf of Alto, made a written offer to redeem petitioner's debentures of Alto as of August 1, 1954, at face amount; on July 8, 1954, he made a written offer on behalf of Black to redeem petitioner's debentures of Black as of August 1, 1954, at face amount; and on August 5, 1954, he made a written offer on behalf of De Soto to redeem petitioner's debentures of De Soto as of September 1, 1954, at face amount. In each of these written offers, petitioner was advised that he had the privilege of holding the debentures until stated maturity. Petitioner accepted each of the offers, and the corporations redeemed at face amount the debentures which he held.

In petitioner's Federal income tax return for 1954, petitioner reported the gains realized upon redemption of the debentures of Alto, Black, and De Soto as long-term capital gain in the total amount of $18,441. He reported that the gains upon redemption of the Alto, Black, and De Soto debentures were in the amounts of $8,723, $3,718, and $6,000, respectively. In the determination of the deficiency here involved, respondent determined such gains to be ordinary income.

Petitioner's Federal income tax return for 1954 reported tax due for the year (including self-employment tax) to be in the amount of $2,451.10; income tax withheld by his employer to be in the amount of $480; and payments on 1954 declaration of estimated tax to be in the amount of $2,750. He therefore reported an overpayment of income tax for the taxable year in the amount of $778.90. Petitioner indicated in the return for 1954 that this amount of $778.90 was to be refunded to petitioners.

Upon examination of petitioner's 1954 return, the examining officer made certain adjustments to petitioners' taxable income as reported. Petitioners agreed to these adjustments, which are not involved in the present controversy, and paid the amount of $1,064.43 as additional income tax for the year 1954.

In the statutory notice which respondent issued to petitioners herein, dated on or about June 8, 1962, respondent determined that petitioners' income tax liability for the taxable year 1954 was in the amount of $7,051.42, that the income tax...