Broz v. Commissioner
| Decision Date | 01 September 2011 |
| Docket Number | Docket No. 21629-06. |
| Citation | 137 T.C. 46 |
| Parties | ROBERT AND KIMBERLY BROZ, Petitioners<BR>v.<BR>COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
ROBERT AND KIMBERLY BROZ, Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.
Docket No. 21629-06.
09-01-2011
Stephen M. Feldman and Eric T. Weiss, for petitioners.
Meso T. Hammoud, Elizabeth Rebecca Edberg, and Steven G. Cappellino, for respondent.
KROUPA, Judge:
Respondent determined over $16 million of deficiencies[1] in petitioners' Federal income tax for 1996, 1998, 1999, 2000 and 2001 (years at issue). Respondent also determined that petitioners were liable for accuracy-related penalties of $563,042 for 1998, $386,489 for 1999, and $591,213 for 2000.
After concessions,[2] we are asked to decide several issues, many of which present questions of first impression as they relate to the ever-evolving cellular phone industry. We must
[137 T.C. 47]
first decide a procedural issue, whether respondent is bound by equitable estoppel to a settlement offer made and subsequently withdrawn by respondent's Appeals Office before the deficiency notice was issued. We find that respondent is not bound by the settlement offer. Second, we must decide whether petitioners properly allocated $2.5 million of the $7.2 million purchase price to depreciable equipment when the allocation in the purchase agreement remained unchanged despite a 2-year delay in closing the transaction. We find that petitioners' allocation was improper. Third, we must determine whether petitioners had sufficient debt basis under section 1366 in stock of Alpine PCS, Inc. (Alpine), an S corporation, to claim flowthrough losses. We find that petitioners had insufficient debt basis and therefore cannot claim the flowthrough losses. Fourth, we must determine whether petitioners were at risk under section 465[3] and can therefore claim flowthrough losses from Alpine and related holding companies. We must decide whether petitioners' pledge of stock in a related S corporation is excluded from the at-risk amount because it was "property used in the business." This issue presents a question of first impression. We find that petitioners were not sufficiently at risk and therefore cannot claim the flowthrough losses because the stock they pledged was related to the business. Fifth, we must decide whether Alpine and Alpine PCS-Operating, LLC (Alpine Operating), an equipment holding company, were engaged in an active trade or business permitting them to deduct business expenses. We find that neither entity was engaged in an active trade or business and therefore may not deduct the expenses. Finally, we must decide whether the related license holding companies are entitled to amortization deductions for cellular licenses from the FCC upon the grant of the license or upon commencement of an active trade or business. This issue presents a question of first impression. We hold that they are not entitled to any amortization deductions upon the license grant because they were not engaged in an active trade or business during the years at issue.
[137 T.C. 48]
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. We incorporate the stipulation of facts and the accompanying exhibits by this reference. Petitioners resided in Gaylord, Michigan, at the time they filed the petition.
I. RFB Cellular, Inc. (RFB)
Robert Broz (petitioner) began his career as a banker before becoming involved with the cellular phone industry. He was president of Cellular Information Systems (CIS), a cellular company, for approximately seven or eight years in the 1980s.
Petitioner decided to invest personally in the development of cellular networks in rural statistical areas (RSAs) in the 1990s. Most large cellular service providers, like CIS, were focused on developing cellular networks in major statistical areas (MSA) and were less interested in RSA networks. The FCC began offering RSA licenses by lottery to any interested person to encourage development of cellular networks in rural areas. The RSA lotteries attracted an average of 500 participants nationwide.
Petitioner participated in approximately 400 lotteries for RSAs across the country. He won and purchased an RSA license for Northern Michigan (the Michigan 4 license) in 1991.
A. The Organization of RFB
Petitioner organized RFB Cellular, Inc. (RFB), an S corporation, in 1991, the year he acquired the license. He contributed the Michigan 4 license and received in exchange 100 percent of RFB's issued and outstanding stock. Petitioner did not contribute any other money or property, nor did he make any loans to RFB from its inception through 2001. Petitioner was CEO of RFB and his brother, James Broz, served as CFO. Petitioner wife was involved in marketing.
RFB received between $4 and $4.2 million in vendor financing from Motorola to cover startup expenses. Approximately two-thirds of the financing went to construct and install the cellular equipment. When Motorola constructed and installed the equipment, petitioner began operating the network and used the remaining funds for working capital.
[137 T.C. 49]
The Michigan 4 license that petitioner contributed to RFB serviced the northern portion of the lower Michigan peninsula by providing analog cellular service during the years at issue. RFB acquired a second license, the Michigan 2 license, which serviced the eastern upper Michigan peninsula. Most of RFB's revenue came from roaming charges for the use of two networks in Michigan. RFB also sold cellular phones to people to generate airtime.
RFB made $241,500 of cash distributions to petitioner in 1996, $613,673 in 2000 and $342,455 in 2001. RFB made Federal income tax payments on petitioners' behalf in 1995 and 1996. These tax payments were reflected as shareholder loans on RFB's tax returns. No promissory notes were issued for the tax payments RFB made on petitioners' behalf.
B. The Michigan 2 Acquisition
RFB entered into a purchase agreement with Mackinac Cellular to acquire the Michigan 2 license and related equipment in 1994 (1994 purchase agreement). Mackinac Cellular had paid $1.6 million for the equipment in 1994. RFB arranged to purchase the license and equipment by issuing promissory notes and assuming debt.
The Michigan 2 acquisition by RFB was stalled for two years. It was stalled for various reasons but primarily because of a lawsuit petitioner's former employer, CIS, filed against petitioner for usurpation of a corporate opportunity. The license and equipment were transferred to Pebbles Cellular Corporation (Pebbles), a wholly owned subsidiary of CIS, through the negotiations. Pebbles did not change or improve the equipment during these two intervening years. Pebbles sold the Michigan 2 assets to RFB.
RFB and Pebbles entered into a purchase agreement in 1996 (1996 purchase agreement) after the lawsuit was resolved. The parties again undertook a series of negotiations and made some adjustments to the transaction. Nevertheless, the purchase price and the allocations in the 1996 purchase agreement were the same as those in the 1994 agreement. Both purchase agreements allocated $2.5 million of the $7.2 million purchase price to the equipment. Approximately $909,000 of the purchase price was allocated to costs
[137 T.C. 50]
incurred by Pebbles between 1994 and 1996. Yet there was no allocation for these costs.
II. The Alpine Entities
Petitioners sought to expand RFB's existing cellular business to new license areas. RFB's lenders agreed to fund the expansion. The lenders required, however, that RFB form a new entity to isolate the liabilities to the thinly capitalized new business entities RFB would form to hold title only to the licenses. Petitioners formed various entities (the Alpine entities) to further this expansion.
A. Alpine
Petitioners organized Alpine, an S corporation, to bid on FCC licenses in RSA lotteries and to construct and operate digital networks to service the new license areas. Petitioner held a 99-percent interest in Alpine and his brother held the remaining one percent.
Alpine bid on licenses for geographic areas with demographics similar to those of RFB's existing network areas, and Alpine bid on licenses for areas in Michigan where RFB was already providing analog service. The FCC financed the purchase of most of the licenses Alpine won at auction. The FCC required, however, as a condition for financing, that the license holder make services available to at least 25 percent of the population in the geographic license area within five years of the grant (build out requirement). The FCC licenses were issued for a period of ten years from the date of the grant. RFB and commercial lenders funded the bidding and constructed and operated the new networks.
B. The Alpine License Holding Entities
Alpine successfully bid on 12 licenses during the years at issue. Alpine made downpayments on the licenses and issued notes payable to the FCC for the balance of the purchase prices. Alpine then transferred the licenses to various single-member limited liability companies (collectively, the license holding companies) formed to hold the licenses and lease them to Alpine.[4] Petitioner held a 99-percent interest in each
[137 T.C. 51]
license holding entity and his brother owned the remaining one percent. Each Alpine license holding entity assumed the FCC debt in exchange for receiving the license. Alpine continued to make payments on the FCC debt even after the licenses were transferred to the Alpine license holding entities. Alpine maintained the books and records of Alpine, the Alpine entities and the Alpine license holding entities.
No Alpine entities operated any on-air networks during the years at issue. RFB operated the only on-air networks. RFB used Alpine's licenses to provide digital service in geographic areas RFB's analog licenses already covered. RFB provided digital service by adding digital equipment onto RFB's existing cellular towers. RFB owned the equipment that serviced the Michigan licenses. RFB allocated income and expenses related to the licenses...
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