Carlson v. Commissioner
| Decision Date | 23 June 1987 |
| Docket Number | 35742-84.,Docket No. 29273-83 |
| Citation | 1987 TC Memo 306,53 TCM (CCH) 1176 |
| Parties | Robert O. Carlson and Eileen E. Carlson v. Commissioner. |
| Court | U.S. Tax Court |
Robert A. Trevisani and Arthur B. Crozier, for the petitioners. Anne Hintermeister and Dennis M. Bresnan, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioners' Federal income tax in these consolidated cases as follows:
Year Amount
1976 .................. 13,166.62
1977 .................. 37,455.17
1979 .................. 40,340.00
After concessions, the issues presented for decision are: (1) Whether petitioners are entitled to deductions claimed as their distributive share of the losses of Benton Harbor Associates, a New Jersey Limited Partnership, for the years in issue; (2) whether petitioners are entitled to an investment tax credit, representing their distributive share of the investment tax credit claimed by Benton Harbor Associates; and (3) whether the transactions at issue were tax motivated so that increased interest under section 6621(c) is required.1
Some of the facts have been stipulated and are so found. The stipulation of facts, supplemental stipulations of facts, and exhibits attached thereto are incorporated herein by this reference.
Eileen E. Carlson (Eileen or petitioner) and Robert O. Carlson (Robert) were husband and wife and residents of Tuxedo Park, New York, at all times relevant to this case. Eileen and Robert (collectively petitioners) timely filed joint Federal income tax returns for their taxable years 1976, 1977, 1978, 1979 and 1984, using the cash receipts and disbursements method of accounting. Eileen is a graduate of Yale Law School and New York University's Graduate School of Business Administration. Currently, she is President and Chief Executive Officer of Arthur J. Evers Corporation, whose business is manufacturing printing presses, cutters, creasers and related machines for converting of paper. Robert holds a Ph.D. from Columbia University and is a professor of Marketing and Business Policy.
In 1973, the City Commission of the city of Benton Harbor (Benton Harbor or City), Michigan, granted a cable television franchise to Earl Drake.2 In various forms, Drake held the franchise until 1976. On May 7, 1976, Benton Harbor Cable TV, Inc. (BHCT, Inc.), entered into a cable television franchise agreement with the City. (Drake was then president and sole shareholder of BHCT, Inc.) This franchise agreement granted to BHCT, Inc. a 15-year nonexclusive franchise to construct, maintain and operate a cable television transmission system in the City.3 BHCT, Inc. as franchise holder was authorized to charge subscribers the following rates: monthly service charge $5.95 or $7.95, an additional outlet charge of $1.50, an installation charge of $20, and a frequency modulation charge of $1.00. BHCT, Inc. could not increase the rates without prior City approval. If BHCT, Inc. failed to follow any specifications of the franchise agreement, the City had a right to terminate the franchise. The City is the only area covered by the above franchise. A separate franchise exists with respect to Benton Township, which was built by another entity. See n. 24, infra.
On July 20, 1976, BFM Constructors Inc. (BFM) purchased all of the stock of BHCT, Inc. from Drake for $5,000. On September 22, 1976, BFM sold the stock to Benton Harbor Associates (BHA or Partnership) for $25,000.4
In 1976, Jack Isaacson (Isaacson) was searching for potential purchases of BFM cable television systems. Isaacson met Richard Siegal (Siegal) through one of Siegal's clients, Konigsberg & Wolf, an accounting firm. Isaacson proposed to Siegal that Siegal become involved and help structure the deals that BFM was putting together. Isaacson also suggested that Siegal become the general partner in two of the limited partnerships that BFM was affiliated with — BHA and La Junta.5
Siegal and Isaacson visited BFM's offices in Connecticut together. There Siegal met Frank Pitassi (Pitassi),6 John Galanis (Galanis), and others. Siegal also talked with a partner of his former law firm about risks and exposures involved with being a general partner.7 Siegal then agreed to become the sole general partner of BHA.
Prior to 1976, Siegal had no prior experience in the cable television industry. Siegal's experience and education largely were in law and business. He is a practicing attorney with a masters in taxation degree and a certified public accountant.
Jack Scheinman (Scheinman) of Alron Communications, Inc. (Alron) was recommended to Isaacson and Siegal by Paul Konigsberg (Konigsberg) as an expert in cable television. Siegal retained Scheinman on behalf of the partnership to see if the proposed system was workable and if BFM was capable of putting the system together. Siegal worked out an arrangement with Scheinman whereby Scheinman would be a consultant to the partnership for a period of years. Scheinman's role was to monitor construction and to evaluate management and management's performance. Scheinman was to visit the site annually; his fees were to be paid by the partnership, unless it failed to be funded, in which event Isaacson would pay the bill.
Scheinman submitted a 3-page report, dated September 20, 1976, concerning the economic viability of the partnership. The report assumed that the contemplated system would have 60 miles of plant and would pass 8,500 homes (i.e., possible customers), and stated that the price of construction of $990,000 "while at the top of the scale of parameters for such a build, is acceptable, bearing in mind the fact that the builder `BFM Construction, Inc.' is being subject to delayed payments makes for a unique but understandable extra consideration." The report also stated that "When the projected subscriber and revenue is reached, $400 as a basis for sales price falls within the lower level of estimates by expert opinion among the more cognizant members of the Cable Industry community." The report did not otherwise state the basis for its conclusions, nor did it contain any projections of revenues, income, expenses, or profits.
Scheinman was Alron's only employee. He prepared appraisal reports only for BFM partnerships. Scheinman worked for Alron through March 1978, and in April 1978, died of cancer.
A private offering memorandum (memorandum), dated August 16, 1976, explaining the transactions to be entered into by BHA and a legal opinion explaining the tax consequences of the transactions were prepared and used to obtain limited partners. The memorandum stated that upon completion of the offering, BHA was to enter into simultaneous agreements: (1) with BFM (a) to acquire a franchise, and (b) to construct the community antenna television system (system) in the City; and (2) with Benton Harbor Cable Management Company (BCM) to operate and maintain the system for the initial term of the franchise. The memorandum also provided the BHA would enter into financing agreements: (1) with BFM for the construction of the system, at a total price of $990,000 ($80,000 to be paid in cash on the commencement of construction; the balance by execution of a non-recourse promissory note to BFM); and (2) with North Country Financial Corporation (an affiliate company of Pitassi), for a total amount of $548,000 (over a 3-year period), to be used by BHA in its business activities.
The memorandum provided that Siegal (as general partner) would receive a management fee of $90,000 during 1976; $1,000 in 1977; and $3,500 per year starting in 1978. Siegal was also required to make a $1,000 contribution to capital, for which he would receive a 2-percent interest in the partnership. In the event of a sale or refinancing of the system, the agreement provided that Siegal would be entitled to 40 percent of any profit, after the limited partners recouped their initial capital contributions.
The private offering memorandum specifically listed as a risk factor that Siegal did not have "any prior experience in the CATV industry and will be required to depend upon the advice of independent consultants for technical background to evaluate the construction of the system and the performance of BCM." The memorandum further states that "BHA will seek the services of qualified consultants, but no assurance can be given relative to the ability of BHA to locate and retain such consultants and the level of their performance." Additionally, the memorandum warned that Siegal would devote only a limited amount of time to BHA, that he may be a general partner in other BFM deals, and that BCM may be involved in other CATV systems as well.
Assuming the sale of the limited partnership units and the contribution of the general partner ($1,000), the gross contributions to be received by the partnership would amount to $551,000. Sales of limited partnership units were to be made only to persons of at least 21 years of age meeting certain minimum standards of income and net worth,8 who were in a position to benefit from the applicable tax laws with respect to such investments, who had prior investment experience or had consulted a professional advisor, and who understood the speculative nature of the investment.
The memorandum disclosed that BCM was to manage the system, and was to be organized as a limited partnership with BFM as the general partner and S.C. Orlicki, Inc.,9 as the limited partner. The memorandum represented that Frank J. Pitassi was president and founder of BFM; that BFM and its affiliated companies were engaged in real estate construction and acquisition and management consulting activities; that Pitassi had a lot of experience in the construction and cable industries; that BFM had been involved in utilities installation; and that currently it had 75 full-time...
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