Chapman v. Commissioner, Docket No. 20342-94.
| Decision Date | 20 March 1997 |
| Docket Number | Docket No. 20560-94.,Docket No. 20363-94.,Docket No. 20342-94. |
| Citation | 73 T.C.M. 2405 |
| Parties | Milo G. and Sarah E. Chapman, et al.<SMALL><SUP>1</SUP></SMALL> v. Commissioner. |
| Court | U.S. Tax Court |
Joann K. Beck, for the petitioners. Kathey I. Shaw, for the respondent.
By four separate notices of deficiency, respondent determined deficiencies, additions to tax, and penalties in regard to petitioners' Federal income tax as follows:
Milo G. and Sarah E. Chapman—docket No. 20342-94
Additions to Tax and Penalties
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Year Deficiency Sec. 6653(a)(1) Sec. 6662(a)
1988 ........................................ $25,424 $1,237 --
1989 ........................................ 12,429 -- $2,357
1990 ........................................ 1,574 -- 315
David E. and Gladys A. Christie—docket No. 20363-94
Addition to Tax and Penalties
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Year Deficiency Sec. 6653(a)(1) Sec. 6662(a)
1988 ........................................ $19,469 $973 --
1989 ........................................ 10,846 -- $2,040
1990 ........................................ 962 -- 192
Dura-Craft, Inc.—docket No. 20560-94
Addition to Tax an Penalty
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Taxable Year Ending Deficiency Sec. 6653(a)(1) Sec. 6662(a)
10/31/88 .................................... $15,968 $798 --
10/31/89 .................................... 93,410 -- $3,591
Unless otherwise indicated, all section references are to the Internal Revenue Code as in effect for the years at issue, and Rule references are to the Tax Court Rules of Practice and Procedure.
After concessions, the issues for decision are:
(1) Whether petitioners Milo and Sarah Chapman and David and Gladys Christie received distributions from the Dura-Craft profit-sharing plan (Plan) in 1988 and 1989 pursuant to section 72(p);
(2) whether petitioners Milo and Sarah Chapman and David and Gladys Christie received early distributions from the Plan in 1988 and 1989 and therefore are liable under section 72(t) for the 10-percent additional tax for early distributions;
(3) whether petitioners Milo and Sarah Chapman and David and Gladys Christie constructively received interest income in 1989 from the payments by Dura-Craft, Inc. (Dura-Craft), and Springbrook Marketing (Springbrook) to the Plan;
(4) whether petitioners David and Gladys Christie received constructive dividends in 1989 from the loan repayments by both Dura-Craft and Springbrook to the Plan in amounts greater than those actually owed to the individual petitioners; and
(5) whether the 5-percent processing fees charged by Northwest Purchasing, Inc., were allowable as a part of Dura-Craft's cost of goods sold for fiscal years ending October 31, 1988 and 1989.
These consolidated cases were submitted without a trial pursuant to Rule 122. The stipulation of facts and the attached exhibits are incorporated by this reference, and the facts contained therein are found accordingly. Petitioners Milo Chapman and Sarah Chapman (collectively hereinafter referred to as the Chapmans) resided in Newberg, Oregon, at the time the petition was filed in Docket No. 20342-94, and petitioners David Christie and Gladys Christie (collectively hereinafter referred to as the Christies) resided in Aurora, Oregon, at the time the petition was filed in Docket No. 20363-94. Dura-Craft, Inc., is a C corporation which maintained its principal place of business in Newberg, Oregon, at the time the petition was filed in docket No. 20560-94. During the years at issue, the Chapmans and the Christies prepared their respective joint Federal individual income tax returns using the cash receipts and disbursements method of accounting, and Dura-Craft prepared its Federal corporate income tax returns using an accrual method of accounting.
This case involves three closely held corporations and their shareholders. Northwest Purchasing, Inc. (Northwest), is a subchapter S corporation which is owned equally by David Christie and Milo Chapman. Northwest sells raw materials to Dura-Craft at Northwest's cost, plus a 5-percent processing fee. During the years at issue, Dura-Craft was owned by Milo Chapman (25 percent) and David Christie (75 percent). Dura-Craft manufactures doll house kits and sells these kits exclusively to Springbrook. During the years at issue, Springbrook was owned by Milo Chapman (75 percent) and David Christie (25 percent). Springbrook markets the doll house kits to various outside retailers such as Fred Meyer and Payless.
During the years at issue, Milo Chapman was an employee of Springbrook, and David Christie was both an officer and an employee of Dura-Craft. Milo Chapman controlled all of the financial decisions of Springbrook. His responsibilities included signing checks, hiring employees, and establishing new markets for the Dura-Craft kits. David Christie controlled all of the financial decisions of Dura-Craft. His responsibilities included signing checks, hiring employees, and making all major decisions concerning production and new kit designs. Office management and bookkeeping for both Dura-Craft and Springbrook were performed at the office of Dura-Craft by employees of Dura-Craft.
On February 10, 1983, the Chapmans and the Christies each requested a loan in the amount of $37,500 from the Dura-Craft Profit-Sharing Plan (Plan) to meet unspecified "emergency financial requirements". On February 22, 1983, the Chapmans and the Christies each signed separate notes agreeing to pay $37,500 to the plan, plus 12 percent interest, accruing from February 22, 1983, until the principal was paid. On April 22, 1983, the Plan agreed to lend $37,500 to the Chapmans and $37,500 to the Christies at 12 percent interest, with a repayment date of December 31, 1984 (collectively hereinafter referred to as plan loans).2
Although the Plan agreed to these loans, the Plan instead paid $50,000 to Dura-Craft on February 22, 1983, and $25,000 to Springbrook on April 27, 1983. On February 22, 1983, Dura-Craft signed a note agreeing to pay David Christie and Milo Chapman a total of $50,000 plus 12 percent interest, and, on April 27, 1983, Springbrook signed a note agreeing to pay David Christie and Milo Chapman $25,000 plus 12 percent interest (collectively referred to as corporate loans).
In 1985, Dura-Craft paid David Christie $10,000 on its $50,000 corporate loan, and Springbrook paid Milo Chapman $10,000 on its $25,000 corporate loan. At that time, Dura-Craft reduced its loan payable balance reflected in its accounting records by the $10,000 it paid to David Christie. Springbrook also reduced its loan payable balance reflected in its accounting records by the $10,000 it paid to Milo Chapman. Due to an error, Springbrook included the 1985 $10,000 loan repayment to Milo Chapman on his 1985 Form W-2. Neither David Christie nor Milo Chapman reduced his loan balance with the Plan in 1985.
As of January 1, 1986, the accounting records of Dura-Craft had a loan payable balance to David Christie and Milo Chapman of $40,000, and the accounting records of Springbrook had a loan payable balance of $15,000.
On April 25, 1989, Springbrook paid the balance of its corporate loan by issuing a check to the Plan in the amount of $43,315 with the notation "princ $25,000—int $18,315". On the same day, Dura-Craft also paid the balance of its corporate loan by issuing a check to the Plan for $87,185 with the notation "princ $50,000, int $37,185". Dura-Craft's check register for the $87,185 check to the Plan bears the notation "Loan Payback from Milo-Dave-pd directly to Dura-Craft profit Share Trust."
Springbrook recorded the payment on its accounting records as follows:
Wage expense ............................. $10,000
Interest expense ......................... 18,315
Loan payment ............................. 15,000
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Paid to profit-sharing plan .............. 43,315
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At the time of the payment, Springbrook's accounting records reflected a loan payable balance of $33,315. Springbrook computed and paid interest to the Plan on the full amount of its corporate loan despite the $10,000 loan payment which Springbrook made to Milo Chapman in 1985. Accordingly, as of the date of its payment, Springbrook owed to Milo Chapman and David Christie a total of $14,000 in interest rather than the $18,315 which was paid.
Dura-Craft recorded the $87,185 repayment on the same date in its accounting records as follows:
Wage expense ............................. $10,000
Interest expense ......................... 37,185
Loan payment ............................. 40,000
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Paid to profit-sharing trust ............. 87,185
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At the time of the payment, Dura-Craft's accounting records reflected a remaining loan payable balance of $40,000. Nonetheless, Dura-Craft computed the interest owed based upon an outstanding loan balance of $50,000 despite the $10,000 loan payment which Dura-Craft made to David Christie in 1985. Accordingly, as of the date of its payment,...
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