Davenport v. Comm'r of Internal Revenue

• Decision Date: 14 September 1978
• Docket Number: Docket No. 5317-76.
• Citation: 70 T.C. 922
• Parties: H. L. DAVENPORT and NEYSA C. DAVENPORT, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

70 T.C. 922

H. L. DAVENPORT and NEYSA C. DAVENPORT, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 5317-76.

United States Tax Court

Filed September 14, 1978.

Greenbelt derived more than 50 percent of its gross receipts from interest. Held: Greenbelt was not largely an operating company. Its stock is therefore not sec. 1244, I.R.C. 1954, stock, and losses thereon are not sec. 1244, I.R.C. 1954, losses. Sec. 1.1244(c)-1(g)(2), Income Tax Regs., followed. Petitioner's purchases of Greenbelt stock and loans to Greenbelt were motivated by investment reasons. Held, petitioners were not entitled to ordinary loss treatment when the stock and loans became worthless. J. Howard Hayden, for the petitioners.

William T. Overton, for the respondent.

WILES, Judge:

Respondent determined the following deficiencies in petitioners' income taxes:

+--------------------+
                ¦Year  ¦Deficiency   ¦
                +------+-------------¦
                ¦      ¦             ¦
                +------+-------------¦
                ¦1968  ¦$1,710.99    ¦
                +------+-------------¦
                ¦1969  ¦2,836.71     ¦
                +------+-------------¦
                ¦1970  ¦8,584.39     ¦
                +------+-------------¦
                ¦1972  ¦1,515.45     ¦
                +--------------------+
                

There are three issues: whether petitioners' loss on Greenbelt Finance, Inc. (hereinafter Greenbelt), stock, purchased in 1959, was a loss on section 1244 ¹ stock; whether petitioners are entitled to an ordinary loss deduction under section 165(a) for Greenbelt stock purchased in 1968; and whether petitioners are entitled to a bad debt deduction under section 166(a) for loans made to Greenbelt.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly.

Petitioners H. L. and Neysa C. Davenport, husband and wife, were residents of Pflugerville, Tex., when they filed their petition herein. They filed their joint income tax returns for the years in question with the Internal Revenue Service Center, Austin, Tex.

In 1940, after completing 21;2 years of college, H. L. Davenport (hereinafter petitioner) started working for Ray Green Finance Co. in Childress, Tex. In his employment, petitioner made loans and handled insurance on automobiles. In 1959, because he felt he was undercompensated, petitioner ended his employment with Ray Green Finance Co. and organized Greenbelt, a Texas corporation, for the purpose of operating a small loan business. Greenbelt was authorized and had issued 100,000 shares of $1 par common stock that was intended to qualify as section 1244 stock. Petitioner purchased 20,000 shares; 15 other investors purchased the remaining 80,000 shares. Petitioner was made president of the company and thereafter remained in that capacity. His initial salary as president was $7,200 per year. In 1969 his salary was raised to $10,800 per year and thereafter it was raised to $12,000 per year.

Following Greenbelt's incorporation, petitioner purchased additional amounts of stock from other stockholders at various prices. By 1971 petitioner owned 76,272 shares of stock purchased at the following time and amounts:

+---------------------------------------------+
                ¦Year acquired  ¦Number of shares  ¦Cost      ¦
                +---------------+------------------+----------¦
                ¦               ¦                  ¦          ¦
                +---------------+------------------+----------¦
                ¦1959           ¦20,000            ¦$20,000.00¦
                +---------------+------------------+----------¦
                ¦1964           ¦2,062             ¦1,855.80  ¦
                +---------------+------------------+----------¦
                ¦1965           ¦1,063             ¦1,063.00  ¦
                +---------------+------------------+----------¦
                ¦1968           ¦52,147            ¦59,841.90 ¦
                +---------------+------------------+----------¦
                ¦1971           ¦1,000             ¦1,226.84  ¦
                +---------------+------------------+----------¦
                ¦Total          ¦76,272            ¦83,987.54 ¦
                +---------------------------------------------+
                

During the years before us, the remaining authorized shares were held by petitioner's daughter and by Greenbelt as treasury stock.

Petitioner's large purchase of stock in 1968 was a result of a directors meeting held October 17, 1968. At that meeting the directors discussed financing problems the corporation was having with two lending banks. The banks had presented Greenbelt with three options under which they would continue to lend money to Greenbelt. The option decided on by Greenbelt's board of directors required petitioner to personally endorse all loans made to Greenbelt. Since petitioner was going to personally guarantee all loans made to Greenbelt, all the stockholders agreed that in fairness he should be allowed to purchase their stock.

From 1969 through 1971 petitioner made the following loans to Greenbelt:

+-----------------+
                ¦Year  ¦Amount    ¦
                +------+----------¦
                ¦      ¦          ¦
                +------+----------¦
                ¦1969  ¦$6,041.14 ¦
                +------+----------¦
                ¦1970  ¦12,500.00 ¦
                +------+----------¦
                ¦1971  ¦50,861.34 ¦
                +------+----------¦
                ¦Total ¦69,402.48 ¦
                +-----------------+
                

In March 1971, Greenbelt distributed corporate property to petitioner in partial payment of these loans. After this distribution, Greenbelt owed petitioner $35,410.35. During 1971 Greenbelt's stock and debts held by petitioner became worthless.

Throughout its existence Greenbelt derived more than 50 percent of its gross receipts from interest. Also, during its last 5 years of existence, Greenbelt's deductions (other than those claimed under sections 172, 242, 243, 244, and 245) exceeded its gross income.

OPINION

There are three issues for our resolution: whether petitioners' loss on 20,000 shares of Greenbelt stock purchased in 1959 was a loss on section 1244 stock; whether petitioners are entitled to an ordinary loss deduction under section 165(a) for the remainder of their Greenbelt stock; and whether petitioners are entitled to claim an ordinary loss under section 166(a) for the loans to Greenbelt.

Section 1244 generally provides that a loss on section 1244 stock shall be treated to a limited extent as an ordinary loss. Section 1244(c) defines the term “section 1244 stock” by establishing certain requirements, only one of which is in issue. That requirement, found in paragraph (1)(E) of section 1244(c), provides that “section 1244 stock” means common stock in a domestic corporation if—-

such corporation, during the period of its 5 most recent taxable years ending before the date the loss on such stock is sustained * * *, derived more than 50 percent of its aggregate gross receipts from sources other than royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities * * *; except that this subparagraph shall not apply with respect to any corporation if, for the period referred to, the amount of the deductions allowed by this chapter (other than by sections 172, 242, 243, 244, and 245) exceed the amount of gross income. (Emphasis added.)

The parties agree that Greenbelt, during the 5 most recent taxable years ending before petitioner sustained his loss, derived more than 50 percent of its aggregate gross receipts from interest. Petitioner nevertheless contends that his Greenbelt stock qualifies as section 1244 stock, because the amount of Greenbelt's deductions (other than sections 172, 242, 243, 244, and 245 deductions) during Greenbelt's preceding 5 taxable years exceeded the amount of its gross income. In sum, petitioner alleges that the gross receipts test of section 1244(c)(1)(E) does not apply to his Greenbelt stock because of the exception emphasized in the above-quoted statute.

Respondent, in contrast, contends Greenbelt does not fall within the exception in section 1244(c)(1)(E). Respondent's argument, briefly summarized, is that the purpose of the gross receipts test in section 1244(c)(1)(E) is to limit section 1244 benefits to “largely operating companies.” The exception to the gross receipts test is to preserve section 1244 benefits for largely operating companies that “never get off the ground.” Without this exception, respondent notes, a corporation that was intended to be largely an operating corporation, yet was unsuccessful in its business, could be disqualified by the 50-percent gross receipts test if it received a small amount of passive income.

After considering both parties' arguments as well as the facts before us, we agree with respondent that petitioner's Greenbelt stock, purchased in 1959, was not section 1244 stock. Therefore, petitioners are not entitled to treat their loss on the Greenbelt stock as an ordinary loss under section 1244.

Section 1244(c)(1)(E) establishes a gross receipts test under which more than 50 percent of a corporation's gross receipts must be derived from sources other than passive income. Section 1.1244(c)-1(g)(2), Income Tax Regs., notes that the gross receipts test need not be complied with “if for the applicable period the aggregate amount of deductions allowed to the corporation exceeds the aggregate amount of its gross income.” The parties have agreed that during the applicable period Greenbelt's properly allowed deductions exceeded its gross income. Because Greenbelt's deductions exceeded its gross income, petitioners contend the gross receipts requirement, on its face, does not apply to Greenbelt. We disagree.

Section 1.1244(c)-1(g)(2), Income Tax Regs., continues with a qualification of the exception to the gross receipts test:

Notwithstanding * * * (the exception to the gross receipts test), pursuant to the specific delegation of authority granted in section 1244(e) to prescribe such regulations as may be necessary to carry out the purposes of section 1244, ordinary loss treatment will not be available with respect to stock of a corporation which is not largely an operating company within the five most recent taxable years * * * ending before the date of the loss. (Emphasis added.)

Respondent contends this regulation was properly authorized by section 1244(e), and further, the regulation prohibits any Greenbelt stock from qualifying as section 1244 stock. Petitio...