Borkowski v. Commissioner, Docket No. 14957-79.
| Decision Date | 18 February 1982 |
| Docket Number | Docket No. 14957-79. |
| Citation | 43 TCM (CCH) 593,1982 TC Memo 87 |
| Parties | M. John Borkowski and Lorraine Borkowski v. Commissioner. |
| Court | U.S. Tax Court |
Robert E. Johnson, One Indiana Square, Indianapolis, Ind., for the petitioners. Michael J. Rusnak, for the respondent.
Memorandum Findings of Fact and Opinion
The Commissioner determined deficiencies in the petitioners' Federal income taxes of $8,418.16 for 1976 and $8,890.48 for 1977. After concessions by the parties, the issues for decision are: (1) Whether, when Dr. Borkowski transferred some of the stock in an electing small business corporation to his children, they became the beneficial owners of such stock so that Dr. Borkowski was not required to report the income thereon; (2) whether such corporation is entitled to deductions for depreciation of an automobile which was owned by the petitioners and which was used, in part, by such corporation; and (3) whether certain initial management fees paid in connection with the petitioners' purchase of breeding cattle are currently deductible or must be capitalized.
Some of the facts have been stipulated, and those facts are so found.
The petitioners, M. John and Lorraine Borkowski, husband and wife, resided in Indianapolis, Ind., at the time they filed their petition in this case. They filed joint Federal income tax returns for 1976 and 1977 with the Internal Revenue Service Center, Memphis, Tenn.
The petitioner M. John Borkowski is a dentist. During 1976 and 1977, Dr. Borkowski practiced dentistry in Indianapolis, specializing in crown and bridgework. Such practice required the use of a dental laboratory. Prior to December 1974, Dr. Borkowski maintained a dental laboratory as part of his dental practice and employed a laboratory technician. He discussed with his family the incorporation of such laboratory, and on December 6, 1974, at his suggestion, Avalon Laboratories, Inc. (Avalon), was organized as a corporation under Indiana law. Avalon's paid-in capital consisted of $1,000 in cash and equipment, which had been previously used in Dr. Borkowski's dental laboratory, with a value of $3,085. Such cash and equipment were contributed by Dr. Borkowski.
At the time of Avalon's incorporation, 100 shares of common stock were issued to the following individuals:
Dr. Borkowski .......... 60 shares
Robert Borkowski ....... 20 shares
Christine Borkowski .... 20 shares
Robert Borkowski and Christine Borkowski are children of the petitioners. Robert's date of birth is February 26, 1956, and Christine's date of birth is April 12, 1960. Neither Robert nor Christine contributed anything to Avalon or to Dr. Borkowski in exchange for the shares issued to them. At the time Avalon was incorporated, Dr. Borkowski discussed with his family and his attorney whether a custodian should be appointed for the shares issued to Robert and Christine. Although his attorney advised him to do so, Dr. Borkowski decided that a custodian should not be appointed. Through 1977, all of the stock certificates were kept with Avalon's corporate records, which were maintained at various times by Dr. Borkowski, his attorney, or his accountant.
From the time of Avalon's incorporation through 1977, Dr. Borkowski, Mrs. Borkowski, Robert, and Christine were the directors of Avalon. During such period, Dr. Borkowski held the offices of president and treasurer, as well as chairman of the board of directors, and Mrs. Borkowski held the office of secretary. At the initial meeting of the board of directors, a fiscal year ending November 30 was chosen for Avalon, and it was decided that Avalon should elect to be taxed as a small business corporation, as defined in section 1371(b) of the Internal Revenue Code of 1954.1 Such election and fiscal year remained in effect during 1976 and 1977.
Avalon's place of business was in a dental building, which was constructed by Dr. Borkowski in 1974. Such building was used by Dr. Borkowski and other dentists and consisted of various dental operating rooms, a common reception area, and a dental laboratory occupied by Avalon. Avalon did not have a lease, nor did it pay rent to Dr. Borkowski for its use of such space. However, Avalon charged Dr. Borkowski, who was one of the principal users of its services, fees which were approximately 20 percent less than those charged by another dental laboratory in Indianapolis. During 1976 and 1977, approximately 6 other dentists, who worked in Dr. Borkowski's building or were otherwise associated with him, used Avalon's services, and they all paid fees similar to those charged Dr. Borkowski.
In 1976 and 1977, Avalon employed a lab manager, who managed the day-to-day operations of the lab. He ordered supplies, recommended the employees to be hired and dismissed, and recommended the fees to be charged. However, Dr. and Mrs. Borkowski were the only persons with the authority to sign checks on behalf of Avalon; Dr. Borkowski supervised the operations of the lab; he hired and dismissed employees; and he made the final decision as to the fees to be charged, including those charged him.
On November 13, 1976, Dr. Borkowski transferred 40 of his shares of Avalon to two of his other children, Catherine and David. Catherine's date of birth is March 26, 1963, and David's date of birth is January 29, 1965. After such transfer, Avalon's stock was held as follows:
Dr. Borkowski ....... 20 shares
Robert .............. 20 shares
Christine ........... 20 shares
Catherine ........... 20 shares
David ............... 20 shares
__________
100 shares
Dr. Borkowski made a concerted effort to encourage his family's interest in dentistry. Mrs. Borkowski worked on almost a full-time basis in the reception area of Dr. Borkowski's dental building. Christine and Catherine, who were students during 1976 and 1977, worked, at times, on weekends or during their vactions as chairside assistants for Dr. Borkowski and the other dentists in the dental building. Although they occasionally observed work in the laboratory, neither Christine nor Catherine ever worked in the laboratory nor was an employee of Avalon. David, who was also a student during 1976 and 1977, did some work on the maintenance of the dental building. During 1976 and 1977, Robert was a full-time college student; he lived at college and commuted home most weekends. While he was at home, including the summer of 1976 and two summers while he was in high school, Robert worked in the laboratory, primarily maintaining its equipment, and also did maintenance work around the dental building.
In December of each year, Avalon had regular annual meetings of its board of directors and shareholders. The corporate counsel and accountant also attended such meetings. In addition, the family had many informal meetings around the dinner table. At both the formal and informal meetings, Dr. Borkowski discussed the operations of his dental practice and the business of Avalon. However, he did not discuss with them the fees to be charged him and the other dentists for the services of Avalon. In November 1975, Dr. Borkowski purchased a medical reimbursement plan for Avalon's officers and employees. He did not discuss the purchase of such plan with his children or seek their approval for such purchase. Yet, in 1977, Dr. Borkowski decided to change medical reimbursement plans and sought his children's approval for such change.
Christine did not know that Dr. Borkowski was treasurer of Avalon. Also, she did not understand the function of a director, nor did she know the difference between a shareholder, an officer, and a director; she was unaware that during 1976 and 1977 she was a director of Avalon. Although at the time of trial Robert understood the role of a shareholder, he erroneously believed that he was vice president of Avalon at the time of its formation.
At the meeting of Avalon's shareholders held on December 13, 1976, a distribution of $2,500 per shareholder was authorized from Avalon's earnings for the year ended November 30, 1976. Checks, each in the amount of $2,500 and dated February 8, 1977, were drawn payable to Dr. Borkowski, Robert, Christine, Catherine, and David. On the same day, or soon thereafter, Dr. Borkowski handed the checks to his children and requested that they endorse them over to Avalon. In exchange for such endorsements, Dr. Borkowski offered his children his demand notes, which provided for annual compound interest at the rate of 6 percent. All of Dr. Borkowski's children complied with such requests. Dr. Borkowski had previously prepared such notes with his children's names. Neither at the time that he requested his children to endorse the distribution checks over to Avalon, nor previously, did Dr. Borkowski discuss with his children when he would repay such notes. Also, Dr. Borkowski unilaterally determined the interest rate on such notes; he did not discuss such interest rate with his children. At such time, the children were obtaining a 4½- or 5-percent return on their savings accounts, and Dr. Borkowski could have borrowed money at an interest rate of 8 or 9 percent. After the children endorsed such checks, Dr. Borkowski retained custody and control over the demand notes.
In late 1976 or early 1977, but prior to February 8, 1977, Dr. Borkowski borrowed $10,000 from Avalon. He did not discuss such loan with his wife or children, nor did he seek his children's approval; and he did not give a note or security to Avalon. Dr. Borkowski's children first became aware that he borrowed money from Avalon when he requested that they endorse the distribution checks to Avalon in order for him to repay such loan. Dr. Borkowski borrowed such $10,000 from Avalon because he needed funds for personal reasons, including the payment of taxes, the making of Christmas gifts to his employees, and the purchase of a boat...
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