Brutsche v. Comm'r of Internal Revenue

• Citation: 65 T.C. 1034
• Decision Date: 02 March 1976
• Docket Number: Docket Nos. 6818-73,6819-73.
• Parties: RALPH L. BRUTSCHE AND INGRID BRUTSCHE, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTRUTH L. FARLEY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

65 T.C. 1034

RALPH L. BRUTSCHE AND INGRID BRUTSCHE, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENTRUTH L. FARLEY, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket Nos. 6818-73

6819-73.

United States Tax Court

Filed March 2, 1976.

Held: 1. On the basis of the facts in this record, advances by one of the stockholders of a corporation (T.M.) to that corporation were loans and not contributions to capital and these advances did not constitute a second class of stock under sec. 1371, I.R.C. 1954;

2. Under sec. 1372(c)(1), I.R.C. 1954, T.M.‘s election on June 26, 1961, to be taxed as an electing small business corporation was not timely with respect to its first taxable year ending on June 30, 1961, but was timely with respect to its second taxable year beginning on July 1, 1961, and ending June 30, 1962;

3. Under the facts here present the statement of shareholders' consent required by sec. 1372(a), I.R.C. 1954, and the regulations issued pursuant thereto was properly made within an extended period of time granted by respondent;

4. T.M. may not properly accrue in income for the years ended June 30, 1965, 1966, 1967, and 1968 any amount for a claim against the bank which it was suing for lost profits;

5. T.M. is not entitled under sec. 165, I.R.C. 1954, to any deduction for its fiscal year ended June 30, 1969, for any profits it failed to realize prior to July 1, 1968;

6. T.M. realized income of $162,500 for its taxable year ended June 30, 1969, from settlement of its claim for lost profits;

7. T.M. realized forgiveness of indebtedness income of $88,550.33 for its taxable year ended June 30, 1969, since after an overall settlement of its suit against the bank and the bank's counterclaim it was solvent to that extent;

8. Petitioner Ruth Farley must include in her income for the calendar years 1969 and 1969 her community one-half interest in the dividends received by her husband;

9. Petitioners Ralph and Ingrid Brutsche as shareholders of T.M. must include in their income for the calendar year 1969 their proportionate share of the amount of T.M.‘s undistributed income for its taxable year ending June 30, 1969, and petitioner Ruth Farley must include in her income for the calendar year 1969 her one-half community property interest of the proportionate share of hers and her husband in this undistributed income. Joseph A. Sommer, for the petitioners.

SCOTT, Judge:

Respondent determined a deficiency in Federal income tax of petitioners Ralph L. and Ingrid Brutsche for the calendar year 1969 in the amount of $65,615.48. Respondent determined a deficiency in the Federal income tax of Ruth L. Farley for the calendar years 1968 and 1969 in the amounts of $1,289 and $11,621, respectively. The issues for decision are (1) whether petitioner Ruth L. Farley received taxable income in the calendar years 1968 and 1969 under the New Mexico community property law by reason of dividend distributions made to her husband in those years, and (2) whether petitioners Ralph L. and Ingrid Brutsche and petitioner Ruth L. Farley are each required under section 1373, I.R.C. 1954,¹ to include in their taxable income in the calendar year 1969 a pro rata part of an amount received by a corporation of which they were shareholders in settlement of litigation initiated by that corporation and of amounts of indebtedness of that corporation which were canceled.

FINDINGS OF FACT

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

Ralph L. Brutsche and Ingrid Brutsche were residents of Santa Fe, N. Mex., at the time of the filing of their petition in this case. They filed a joint Federal income tax return on the cash basis of accounting for the calendar year 1969 with the District Director of Internal Revenue, Albuquerque, N. Mex.

Ruth L. Farley was a resident of Albuquerque, N. Mex., at the time of the filing of her petition in this case. She filed on the cash basis of accounting separate Federal income tax returns for each of the calendar years 1968 and 1969 with the District Director of Internal Revenue, Albuquerque, N. Mex.

Ruth L. Farley (hereinafter Ruth) and Phillip A. Farley (hereinafter Phillip) were married during the calendar years 1968 and 1969. In 1971 they were divorced and in 1972 Phillip Farley died.

During 1960 and until October 1961, Ralph L. Brutsche (hereinafter Ralph) and Phillip were engaged as partners under the name of Thunder Mountain Construction Co. (hereinafter the partnership) in the business of building residential homes in Santa Fe, N. Mex. Ralph had been engaged in the building business for some time prior to 1960 and Phillip was a lawyer. During July 1960 the partnership executed an agreement to purchase some real property from Stamm Development Co. (hereinafter Stamm).

On March 29, 1961, Thunder Mountain Land Co., Inc. (hereinafter the corporation or Thunder Mountain), was incorporated under the laws of the State of New Mexico. On July 12, 1961, its certificate was amended to change the name of the corporation to Thunder Mountain Construction Co.

The certificate of incorporation provided that the total authorized capital stock was one class of common stock, numbering 250,000 shares, that the holders of common stock were entitled to one vote per share, that Ralph, Phillip, and an attorney (hereinafter the attorney) responsible for forming the corporation subscribed to 666 shares, 333 shares, and 1 share of common stock, respectively, and that Ralph, Phillip, and the attorney were members of the corporation's board of directors and were the president, vice president, and secretary-treasurer of the corporation, respectively, until successors were elected. Between March 29 and May 1, 1961, stock certificates were issued to Ralph, Phillip, and the attorney, representing the number of shares to which each subscribed in the certificate of incorporation. The attorney was a nominal shareholder to have three incorporators and three stockholders.

During March 1961 Phillip and Ralph in anticipation of the formation of the corporation negotiated on its behalf for the purchase of land from C. H. Carder Construction Co. The negotiations resulted in a proposed agreement dated in March 1961. Although negotiations continued during April 1961, the purchase agreement was never consummated.

Ralph and Phillip on behalf of the corporation negotiated for the purchase of land with Stamm during April and May 1961. These negotiations culminated in the execution of a purchase agreement dated May 26, 1961. This agreement provided that the corporation would acquire certain parcels of land that the partnership had previously agreed to buy from Stamm. The purchase agreement recited that certain of the parcels of land described therein had been conveyed by Stamm to the corporation and that the sum of $30,341.25 had been paid on the purchase price of those parcels. It further provided that the corporation was to pay at the time of the execution of the agreement an additional amount of $6,708.43 on the purchase price of the land. Paragraph 9 of the purchase agreement provided a release of Stamm for any previous obligation it had to sell the land involved to the partnership.

Phillip and Ralph executed the agreement on behalf of the corporation in their capacities as officers of the corporation and as partners of the partnership executed a consent to paragraph 9 of the agreement.

On July 1, 1961, the corporation had a total of 9,000 shares of $1 par value common stock issued and outstanding of which Ralph and Phillip owned 6,000 shares and 3,000 shares, respectively. At that time the assets of the partnership were transferred to the corporation. Ralph's partnership capital account in the amount of $38,570.47 was entered on the corporation's accounting records as of June 30, 1962, as paid-in capital to the extent of $32,570.47. Phillip's subscription to 3,000 shares of common stock was entered on the corporation's accounting records as a stock subscription receivable in the amount of $3,000. Phillip never paid for his stock subscription.

The minutes of Thunder Mountain Construction Co. recite that the first meeting of its board of directors was held July 1, 1961.

Phillip and the corporation's accountant prepared a Form 2553, Election by Small Business Corporation, and a statement of shareholders' consent to the election. The statement was in the form of a letter dated June 23, 1961, signed by Ralph and his wife, Phillip and his wife, and the attorney and his wife. The letter read: ‘We, the undersigned shareholders, do hereby consent to the election of Thunder Mountain Land Company, Inc. to be taxed as a small business corporation under Section 1372, Internal Revenue Code.’ By his signature and by the signature of Ralph and his wife, Phillip made the notation ‘6/23/61’ and by the signatures of his wife and the attorney and his wife, Phillip made the notation ‘6/24/61.’ At the bottom of the letter below all the signatures there was the following statement:

Note:

First assets acquired May 26, 1961; no transactions of business or issuance of stock until after May 26, 1961.

The prepared Form 2553, Election by Small Business Corporation, which Ralph signed in his capacity as president of the corporation on June 23, 1961, stated the name, Thunder Mountain Land Co., Inc., the address of the corporation, its place of incorporation, its business activity, the names and addresses of each of its six shareholders, Ralph, Phillip, and the attorney and their respective spouses, and the Internal Revenue District in which each such shareholder's return was filed. Further the Form 2553 represented that the corporation was not an outgrowth of any predecessor organization, that Ralph and his wife owned 6 shares, Phillip and Ruth owned 3 shares, and the attorney and his wife owned 1 share, that the number of shares issued and outstanding was 10 and that the first taxable year for which the election was effective...