Chester v. Commissioner
| Decision Date | 06 August 1986 |
| Docket Number | 20675-84,15240-84,15916-84,Docket No. 14299-84,14325-84,15932-84,15933-84,15228-84,15227-84,15915-84,14328-84,22336-84.,14329-84,22153-84,14324-84 |
| Parties | Robert L. and Leona M. Chester, et al. v. Commissioner. |
| Court | U.S. Tax Court |
Robert F. Hatfield, for the petitioners. Rebecca W. Wolfe and Deborah A. Butler, for the respondent.
Memorandum Findings of Fact and Opinion
These cases were consolidated for purposes of trial, briefing, and opinion. Appendix A sets forth petitioners by name and docket numbers, the tax years involved, the deficiencies for each year, and the place of residence of each individual petitioner. Each of the petitions includes, among other issues, the common issue of the tax consequences of the investment by petitioners in video tapes with religious themes claimed to have been produced by Jesus Is Lord Ministries (JLM), sold to petitioners by DanKryst, a corporation, formed and owned by Dan Chester, and marketed by SWEET, a corporation formed and operated by Ron Davis. In his statutory notice, respondent disallowed each petitioner's depreciation deductions,1 interest deductions, and investment tax credits incurred as a result of their investments in the JLM tapes.2
Some of the facts have been stipulated and are so found. The stipulation of facts along with the supplemental stipulations of facts and attached exhibits are incorporated herein by this reference. The pertinent facts are summarized below.
Jesus Is Lord Ministries (JLM) is a non-profit organization incorporated in the state of Arkansas in February 1977 as the result of a merger between Jesus Is Lord Foundation and the Charles Thompson Evangelistic Association. The principal place of business of JLM was listed in the merger documents as Hardy, Arkansas. The stated purpose or purposes for which JLM was formed were described as "charitable, benevolent, educational, religious, missionary, evangelistic and other religious activities." Charles W. Thompson (Thompson), was listed as the president and resident agent of JLM. Rena Walters (Walters), was the secretary/treasurer of JLM and Bernice Thompson was the vice president.
Thompson had worked as a Methodist minister for about 15 years in northern Arkansas. He was ordained as an elder in the Methodist Church. After organizing JLM, Thompson conducted tent crusades3 from May through October in Arkansas, and also in Kentucky, Louisiana, Illinois, Tennessee, Alabama, Mississippi, Georgia and Missouri. In addition to its tent crusades, JLM operated a thrift shop, a Christian bookstore, a Christian school, and held religious seminars in Hardy, Arkansas. From 200 to 600 people would attend each tent crusade and from 800 to 1,000 would attend the seminars held twice a year. JLM compiled a mailing list of seven to eight thousand persons based upon those individuals who attended the tent crusades and seminars.
Petitioner Daniel Chester (Chester) served as Associate Director for JLM from 1978 to the spring of 1984. Sometime in the late summer or early fall of 1980 Thompson asked Chester to contact John Williams (Wiliams). Williams was described to Chester as a Christian financial consultant. Thompson had learned of a tax shelter program marketed by Williams in Arizona involving audio cassettes and wanted Williams to discuss this program with JLM.4 Chester contacted Williams and invited him to come to Arkansas to speak with JLM representatives. A meeting with Williams was held in the fall of 1980 attended by Thompson, Walters, Ron Davis (Davis), and Gary Chester (Gary), Daniel's son. Williams explained to those present his concept of marketing audio cassettes to utilize investment tax credits.
After meeting with Williams, several JLM representatives met with several representatives of the Internal Revenue Service (IRS), in Little Rock, Arkansas. The JLM representatives discussed with the IRS the possibility of obtaining investment tax credits on religious master video recordings ("MVR" or "tapes"). Specific details of JLM's plan were not discussed and no tapes were shown to the IRS. The meeting lasted about 20 minutes. The JLM representatives left the meeting with the belief that their proposal qualified for an investment tax credit. The IRS, however, refused to give the JLM representatives written approval of their plan. Gary testified that a verbal legal opinion approving JLM's plan was later obtained from C.P. Christian (Christian), an attorney from Jacksonville, Florida, who specialized in criminal law.
JLM then developed a tax shelter plan similar to the one described to them by Williams but utilizing MVR. JLM wanted to make Christian programming available to low power television stations for family entertainment and education. To prepare for this endeavor, JLM members read articles and magazines but felt that their investment was in a "pioneering, virgin field." Prior to this time, JLM had never been involved in the production of MVR. On November 5, 1980, a special meeting of the JLM Board of Directors was called to approve the video program which JLM called "The Video Ministry." JLM set a goal of producing 30 tapes in 1980. Thompson was to be hired as one of the artists to make the tapes. For his services, Thompson was to receive royalties of 20 percent of the selling price of each tape. The royalties were to be paid5 at the rate of 10 percent of the income received from the sale of the tapes up to a maximum of $50,000 per year. JLM then sold the tapes to DanKryst, an organization established by Gary Chester to sell the tapes to individual investors. Names of potential investors were obtained from JLM's mailing list. Parkin Printing Co. was first approached to market the tapes. After Parkin Printing Co. declined, Ron Davis, who worked for Parkin Printing Co., was recommended to market the tapes. Davis formed SWEET, Inc. (SWEET), to market the tapes. The tapes were produced sometime subsequent to October 1980.6 One of JLM's employees, Dave Keylor (Keylor), operated the video equipment used to make the tapes.
Formation of DanKryst, Inc. Gary was a high school graduate with one year of college courses. While in college he took two accounting courses. During the time he was associated with JLM, he was working as a tax return preparer in Hardy, Arkansas. Prior to that time he had worked as a bookkeeper for Plough Corp., an industrial corporation, reconciling corporate bank accounts. He also worked at one time for an accounting firm.
DanKryst was an Arizona corporation incorporated under the name Don Lyon, Inc. on September 22, 1980. Gary purchased the corporate shell of Don Lyon, Inc. from Williams. On July 13, 1981, an "Amendment to the Articles of Incorporation" was filed with the State of Arizona changing the name of Don Lyon, Inc. to DanKryst, Inc.7 A "Statement of Foreign Corporation Seeking Authorization to Do Business in Arkansas" was filed with the Secretary of the State of Arkansas on June 15, 1982. Gary was listed as the corporate president and resident agent. Gary held 51 percent of the DanKryst stock while his wife held the other 49 percent. Gary and his wife were the only members of DanKryst's Board of Directors but they did not hold any meetings.
During the fall of 1980, DanKryst (or Lyon), entered into agreements with JLM for the purchase of 30 tapes.8 Each tape was purchased for $95,000. None of these tapes were copyrighted. The purchase price of $95,000 was suggested by Williams; Gary did not attempt to negotiate with JLM concerning the price. The agreements called for cash downpayments of $5,000 and a $90,000 note at 7.5 percent annual interest for each tape. DanKryst paid JLM a $100 downpayment for each tape with the remainder of the downpayment due within one year of execution of the note. Gary signed the notes for DanKryst. When the notes were signed DanKryst had no assets except for a minimal amount of cash. The total purchase price for the 30 tapes was $2,850,000. Prior to purchasing the tapes from JLM, Gary did not contact anyone involved in the production, or marketing of religious video tapes to determine the costs to produce such tapes, or whether there was a market for the tapes. Neither did he seek an appraisal with respect to the tapes.
In December of 1980, DanKryst began selling the tapes to investors. The price for each tape was $100,000. Prospective investors learned about the tapes through Thompson who discussed the tapes at JLM's tent crusades, or through Gary, Daniel, or Everett Croslow, who acted as sales representatives for DanKryst. Prospective investors were shown a copy of section 38,9 and were advised that the tapes qualified for investment tax credits. They were also asked to make their tax returns for the three prior years available so that the amount of investment tax credit they could earn, and utilize, by investing in a tape could be computed. Using these prior tax returns, the total amount of Federal income taxes paid and recoverable through use of the investment credit and carrybacks was calculated for each potential investor. This amount was determined to be the investor's 10 percent cash downpayment, which was then multiplied by 10 to determine the total amount of the investor's investment in the tapes. If the investment was to be less than $100,000, the investor was sold a percentage of one tape. If it was more than $100,000, the investor was sold one tape and a percentage interest in an additional tape. None of the investors was asked to present a financial statement.
Davis was present at meetings with prospective investors and discussed with them his strategy for marketing the tapes which included pooling all the income from exploiting all the tapes so that all investors would share in the income from the tapes based upon their respective percentages of ownership. None of the investors attempted to negotiate...
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