Chesapeake Outdoor Enterprises, Inc. v. Commissioner
| Decision Date | 12 May 1998 |
| Docket Number | Docket No. 21830-96. |
| Citation | 75 T.C.M. 2279 |
| Parties | Chesapeake Outdoor Enterprises, Inc., Abel Trust, John E. Magee, Jr., Trustee, Tax Matters Person v. Commissioner. |
| Court | U.S. Tax Court |
James R. O'Neill and John B. Spirtos, Washington, D.C., for the petitioner.* Bettie N. Ricca and Kathleen E. Whatley, for the respondent.
By Notice of Final S Corporation Administrative Adjustment (FSAA), respondent determined a $317,583 adjustment to the S corporation return of income filed by Chesapeake Outdoor Enterprises, Inc. (Chesapeake) for its taxable year ending (TYE) March 19, 1992. Respondent further determined an adjustment to Chesapeake's shareholders' aggregate stock basis in the amount of $995,000.
Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the year at issue. All Rule references are to the Tax Court Rules of Practice and-Procedure.
After concessions, the remaining issues for decision are: (1) Whether we have jurisdiction in this case, and, if so, (2) whether cancellation of debt (COD) income excluded from the gross income of an S corporation pursuant to section 108(a) qualifies as a separately stated item of tax-exempt income for purposes of section 1366(a)(1)(A).
This case was submitted fully stipulated. The Stipulation of Facts and attached exhibits, and the Stipulation of Agreed Adjustments, are incorporated herein by this reference. Chesapeake maintained its principal place of business at 519 West Pratt Street, Baltimore, Maryland, at the time the petition for readjustment was filed.
Chesapeake was incorporated on February 9, 1989, under Delaware law. During the relevant period, Chesapeake was engaged in the business of maintaining and renting outdoor billboards. Chesapeake filed its income tax returns on a calendar year basis. During the year at issue, Chesapeake was an S corporation within the meaning of section 1362(a), with three shareholders, including Abel Trust (petitioner), the tax matters person.
On March 23, 1989, Chesapeake entered into a credit agreement with Chase Manhattan Bank, N.A. (Chase Manhattan), pursuant to which Chase Manhattan agreed to make loans to Chesapeake from time to time in an aggregate principal amount not to exceed $14,100,000. A general security agreement and a promissory note were also executed on that date between Chesapeake and Chase Manhattan in connection with the borrowings under the credit agreement. Chesapeake borrowed a total of $13,424,443.37 from Chase Manhattan under the credit agreement.
During 1989, Chesapeake acquired certain assets of Tec Media, Inc. (Tec Media). As Part of the consideration for this purchase, Chesapeake issued a note to Tec Media in the amount of $506,000.
Chesapeake subsequently defaulted on its debt to both Chase Manhattan and Tec Media. The defaults occurred prior to, and were continuing on, August 7, 1991. On that date, Chase Manhattan terminated its commitment under the terms of the credit agreement and demanded that Chesapeake immediately pay the outstanding principal amount of $13,424,443, together with all interest thereon, as well as any other amounts payable under the credit agreement and promissory note.
On January 14, 1992, a judgment in favor of Chase Manhattan as plaintiff, and against Chesapeake as defendant, was entered by the Supreme Court of the State of New York, New York County, in the amount of $15,513,914.87. As of March 19, 1992, Chesapeake was indebted to Chase Manhattan for $13,424,443.37 in principal and $2,481,720.46 in interest, for a total of $15,906,163.83.
Pursuant to an Amended and Restated Credit Agreement (amended agreement) dated March 19, 1992, between Chesapeake, Chase Manhattan, and Tec Media, Chesapeake's indebtedness to Chase Manhattan and Tec Media was restructured. Chesapeake was released from indebtedness to Chase Manhattan in the amount of $906,163.83. In addition, Chesapeake was released from indebtedness to Tec Media in the amount of $6,000, plus accrued and unpaid interest, for a total of approximately $88,815.
As of January 1, 1992, Chesapeake had total assets of $10,858,689, and total liabilities of $16,139,334. Chesapeake was insolvent, within the meaning of section 108(d)(3), immediately prior to the discharge of its indebtedness pursuant to the amended agreement. The total amount of Chesapeake's discharged indebtedness (approximately $995,000) did not exceed the amount by which Chesapeake was insolvent.
On March 20, 1992, Chase Manhattan acquired ownership of Chesapeake in accordance with the terms of the amended agreement, and Chesapeake's status as an S corporation was thereafter terminated. Accordingly, Chesapeake filed a short-year Form 1120S, U.S. Income Tax Return for an S Corporation, for the period ending March 19, 1992.
Chesapeake reported its excluded COD income on line 18, Other tax-exempt income, of the Schedule K, Shareholders' Share of Income, Credits, Deductions, Etc., and Schedules K-I, Shareholder's Share of Income, Credits, Deductions, Etc., attached to its return for the year in issue.
On July 15, 1996, respondent issued an FSAA with respect to Chesapeake's TYE March 19, 1992. Respondent disallowed deductions for accrued interest expenses in the amount of $317,583 forgiven by Chase Manhattan and Tec Media in the same year as the accrual. Furthermore, under the heading "Other Adjustment: Basis of Shareholders", respondent determined an adjustment to the shareholders' aggregate basis in Chesapeake stock in the amount of $995,000. In "Remarks" included on the Schedule of Adjustments, respondent stated that
The discharge of indebtedness income that is excluded from gross income under section 108(a) * * * does not pass through to the Subchapter S Corporation's shareholders as a separately stated item of tax-exempt income under section 1366(a)(1). Accordingly, the shareholders' stock basis under Section 1367 is not increased.
Petitioner timely filed a petition for readjustment of subchapter S items on October 9, 1996.
Pursuant to a Stipulation of Agreed Adjustments filed on September 29, 1997, petitioner conceded the correctness of respondent's adjustment relating to the disallowed deductions for accrued interest expenses. On brief, respondent conceded that the proposed adjustment to Chesapeake's shareholders' stock basis was inappropriate at the corporate level.
As previously stated, respondent has conceded that the adjustment to shareholder basis was inappropriate at the shareholder level. Consequently, the remaining issues are: (1) Whether we have jurisdiction to decide this case, and, if so, (2) whether COD income excluded from the gross income of an S corporation pursuant to section 108(a) qualifies as a separately stated item of tax-exempt income for purposes of section 1366(a)(1)(A).
The question of jurisdiction is fundamental and can be raised at any time by either party or by the Court. Naftel v. Commissioner [Dec. 42,414], 85 T.C. 527, 530 (1985); Estate of Young v. Commissioner [Dec. 40,602], 81 T.C. 879, 880-881 (1983). We have jurisdiction to determine whether we have jurisdiction. Pyo v. Commissioner [Dec. 41,573], 83 T.C. 626, 632 (1984); Kluger v. Commissioner [Dec. 41,480], 83 T.C. 309, 314 (1984).
In the instant case, our jurisdiction turns on whether the unified subchapter S audit and litigation provisions in effect for the year at issue, set forth at sections 6241 through 6245, are applicable. (Sections 6241 through 6245 were repealed by the Small Business Job Protection Act of 1996, Pub. L. 104-188, sec. 1307(c)(1), 110 Stat. 1755, 1781, for tax years beginning after December 31, 1996.) If not, we must dismiss this case for lack of jurisdiction. See Albatrick Inc. v. Commissioner [Dec. 50,534(M)], T.C. Memo. 1995-119.
The S corporation audit and litigation procedures were enacted by Congress in 1982 in order to provide a method for the unified treatment of subchapter S items among shareholders. Subchapter S Revision Act of 1982, Pub. L. 97-354, sec. 4(a), 96 Stat. 1691-1692; see Dial USA, Inc. v. Commissioner [Dec. 46,686], 95 T.C. 1, 3 (1990). A subchapter S item is defined as "any item of an S corporation to the extent regulations prescribed by the Secretary provide that, for purposes of * * * [subtitle F of the Code (Procedure and Administration)], such item is more appropriately determined at the corporate level than at the shareholder level." Sec. 6245. Pursuant to section 301.6245-1T(a), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 3003 (Jan. 30, 1987), subchapter S items are those "items which are required to be taken into account for the taxable year of an S corporation under subtitle A of the Code". See University Heights at Hamilton Corp. v. Commissioner [Dec. 47,569], 97 T.C. 278, 281 (1991). Section 301.6245-1T(a)(1) and (b), Temporary Proced. & Admin. Regs., supra, more specifically defines subchapter S items, in part, as follows:
(1) The S corporation aggregate and each shareholder's share of, and any factor necessary to determine, each of the following:
* * * * * * *
(iv) Items of income of the corporation that are exempt from tax;
* * * * * * *
(b) Factors that affect the determination of subchapter S items. The term "subchapter S item" includes the accounting practices and the legal and factual determinations that underlie the determination of the existence, amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc. * * *
Except as otherwise provided by regulations, the tax treatment of subchapter S items must be determined in one unified proceeding at the corporate level as opposed to individual proceedings at the shareholder level. Sec. 6241; Eastern States Cas. Agency, Inc. v. Commissioner [Dec. 47,379], 96 T.C. 773, 775 (1991).
The Subchapter S Revision Act of 1982 was enacted shortly after the Tax Equity and Fiscal...
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