Cerone v. Comm'r of Internal Revenue, Docket Nos. 1683-80
| Decision Date | 01 July 1986 |
| Docket Number | 27979-82.,Docket Nos. 1683-80,1684-80,28696-81 |
| Parties | MICHAEL N. CERONE AND HELEN E. CERONE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSTOCKADE CAFE, INC., Petitioner v. COMMISISIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
P and his son were each 50 percent shareholders in C. Because of hostility between father and son, C redeemed all of P's stock therein. After the redemption, P continued to work as an employee of C for several years, but he retained no control over, and was not involved in the management of, the corporation after the redemption.
HELD, family hostility does not nullify the family attribution rules of sec. 318(a)(1), I.R.C. 1954, in determining whether the redemption satisfies the dividend equivalency test of sec. 302(b)(1), I.R.C. 1954, or the complete redemption test of sec. 302(b)(3), I.R.C. 1954. David Metzger Trust v. Commissioner, 76 T.C. 42 (1981) (Court Reviewed), affd. 693 F.2d 459 (5th Cir. 1982), cert. denied463 U.S. 1207 (1983) followed.
HELD FURTHER, under the attribution rules of sec. 318(a)(1)(A)(ii), I.R.C. 1954, P actually and/or constructively owned 100 percent of C's stock both before and after the redemption, and the redemption was thus essentially equivalent to a dividend within the meaning of sec. 302(b)(1), I.R.C. 1954. United States v. Davis, 397 U.S. 301, 307 (1970).
HELD FURTHER, P's position as an employee of C after the redemption is a prohibited interest within the meaning of sec. 302(c)(2)(A)(i), I.R.C. 1954, so that sec. 302(c)(2), I.R.C. 1954, does not prevent the application of the attribution rules of sec. 318(a)(1), I.R.C. 1954, in testing the redemption under sec. 302(b)(3), I.R.C. 1954. Seda v. Commissioner, 82 T.C. 484 (1984) (Court Reviewed) followed. Consequently, the redemption is not a complete redemption within the meaning of sec. 302(b)(3), I.R.C. 1954, and thus is taxable as a dividend under sec. 301, I.R.C. 1954, rather than as a payment in exchange for stock under sec. 302(a), I.R.C. 1954. David E. Pavel, for the petitioners.
Leonard A. Hammes, for the respondent.
In these consolidated cases, respondent determined deficiencies in petitioners' Federal income taxes as follows:
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¦ ¦ ¦Taxable year(s)¦ ¦
+----------+--------------------------------------+---------------+----------¦
¦Docket No.¦Petitioners(s) ¦ending ¦Deficiency¦
+----------+--------------------------------------+---------------+----------¦
¦1683-80 ¦Michael N. Cerone ¦Dec. 31, 1974 ¦$12,742.00¦
+----------+--------------------------------------+---------------+----------¦
¦ ¦and Helen E. Cerone ¦Dec. 31, 1976 ¦2,436.00 ¦
+----------+--------------------------------------+---------------+----------¦
¦1684-80 ¦Stockade Cafe, Inc. ¦Sept. 30, 1975 ¦2,595.36 ¦
+----------+--------------------------------------+---------------+----------¦
¦ ¦ ¦Sept. 30, 1976 ¦2,711.47 ¦
+----------+--------------------------------------+---------------+----------¦
¦28696-81 ¦Michael N. Cerone and Helene E. Cerone¦Dec. 31, 1975 ¦9,502.00 ¦
+----------+--------------------------------------+---------------+----------¦
¦27979-82 ¦Michael N. Cerone ¦Dec. 31, 1977 ¦2,726.00 ¦
+----------+--------------------------------------+---------------+----------¦
¦ ¦and Helen E. Cerone ¦Dec. 31, 1978 ¦2,934.00 ¦
+----------+--------------------------------------+---------------+----------¦
¦ ¦ ¦Dec. 31, 1979 ¦3,195.00 ¦
+----------------------------------------------------------------------------+
After concessions, 1 the issues for decision are as follows:
(1) Whether distributions received by petitioner Michael N. Cerone from petitioner Stockade Cafe, Inc., in redemption of his stock in the corporation should be treated as being received in exchange for such stock under section 302(a) 2 or as dividends under sections 302(d), 301, and 316. Resolution of this issue depends on whether the redemption qualifies as being not essentially equivalent to a dividend under section 302(b)(1) or, alternatively, as a complete redemption of all of his stock under section 302(b)(3). These determinations in turn involve the family attribution rules of section 318(a)(1) in a context of family hostility.
(2) Whether petitioner Stockade Cafe, Inc., can deduct the portion of such distributions it designated as interest as such under section 163. The parties agree that resolution of the first issue is determinative of this issue.
Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Petitioners Michael N. Cerone and Helen E. Cerone (collectively, the individual petitioners) resided in Omaha, Nebraska at the time they filed their petitions in this case, except that petitioner Michael N. Cerone resided in Gretna, Nebraska at the time they filed the petition in docket No. 27979-82. Petitioner Stockade Cafe, Inc. (the corporation), a Nebraska corporation, had its principal office at 13325 Millard Avenue, Omaha, Nebraska at the time it filed its petition in this case. The individual petitioners filed joint Federal individual income tax returns (Forms 1040) for the years 1974 through 1979 with the Internal Revenue Service Center in Ogden, Utah. The corporation filed Federal corporation income tax returns (Forms 1120) for its taxable years ending September 30, 1975 and 1976, with the Internal Revenue Service Center in Ogden, Utah.
In the years prior to 1963, petitioner Michael N. Cerone (petitioner or ‘Mike ‘) and his son (Michael L. Cerone or ‘Mick‘) worked together as painting and decorating contractors. 3 In March of 1963, petitioner, his son, and their acquaintance, Dan Malone, purchased the assets (including appurtenant real estate and liquor license) 4 of a restaurant and bar (individually, the restaurant or the bar; collectively, the business) known as the Stockade Cafe. The business was located at 13325 Millard Avenue, in what was then Millard and is now part of Omaha, Nebraska. The three men operated the business as equal partners for approximately one year until Dan Malone withdrew from the partnership. Thereafter, petitioner and his son operated the business as equal partners.
On or about October 1, 1964, petitioner and his son organized petitioner Stockade Cafe, Inc. (the corporation), and transferred thereto the assets of the business (including appurtenant real estate and liquor license). They each purchased 50 shares of the corporation's common stock for $5,000. These shares were the only outstanding shares of stock in the corporation. Petitioner and his son also became the directors and the president and secretary/treasurer, respectively, of the corporation. They maintained their respective ownership interests in and positions with the corporation until at least November 7, 1974.
Throughout the period of joint ownership, petitioner and his son were both very actively involved in managing the business. Petitioner ran the cash register and supervised the waitresses in the restaurant. He had authority to sign the corporation's checks. For awhile, petitioner also ordered supplies for the business, but his son soon assumed that responsibility. Petitioner's son ran the restaurant's kitchen and the bar. He also kept the corporation's books. Petitioner and his son shared responsibility for major management decisions and for hiring and firing personnel.
During the years 1971 through 1974, the corporation paid petitioner an annual salary and bonus as follows:
+--------------------+
¦Year¦Salary ¦Bonus ¦
+----+-------+-------¦
¦1971¦$13,800¦$21,156¦
+----+-------+-------¦
¦1972¦13,200 ¦23,452 ¦
+----+-------+-------¦
¦1973¦14,400 ¦27,758 ¦
+----+-------+-------¦
¦1974¦14,400 ¦27,660 ¦
+--------------------+
The corporation paid petitioner's son an annual salary and bonus during those years in amounts equal to those it paid petitioner.
Under the joint management of petitioner and his son, the business steadily grew. They expanded the facilities to accommodate this growth. Petitioner and his son completely remodeled the restaurant and the bar and also put in a new kitchen. By 1974, the corporation employed between 50 and 60 employees. Approximately 175 patrons could be seated in the restaurant. Between 60 and 70 patrons could be seated in the bar. The restaurant and the bar were usually open from 10:00 a.m. in the morning until 1:00 a.m. at night.
Despite their success, petitioner and his son disagreed about the management and operation of the business. As the years went by, the conflicts between the two increased in frequency and intensity. They disagreed about a number of matters. Petitioner refused to follow operating rules for employees that his son had established and that the son and the other managers were trying to enforce. Petitioner frequently reinstated employees that Mick or another manager had dismissed or reprimanded. Since a large number of the corporation's employees worked only part-time, Mick and the other managers thought it extremely important to establish well-defined rules for the employees and to rigidly adhere to those rules. Petitioner's failure to follow the rules in such circumstances increased the growing hostility between him and his son.
Petitioner and his son also argued over expanding the business' facilities. Mike wanted to go slow on expansion. Mick favored expansion on a much larger scale than did his father. In particular, they disagreed about the new kitchen they put in. After petitioner's son became the sole...
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