Dean v. Comm'r of Internal Revenue
| Decision Date | 19 July 1984 |
| Docket Number | Docket No. 22565–80. |
| Citation | 83 T.C. No. 6,83 T.C. 56 |
| Parties | JOHN R. DEAN AND FLORENCE DEAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioners claimed losses in connection with a limited partnership which obtained all the rights to an original paperback book for a stated amount of $877,500.00 of which $742,500.00 was a nonrecourse note, payable solely from proceeds from these rights and due in seven years. When obtained by the partnership, estimated receipts from all the rights to the paperback book did not exceed $58,500.00, and the value of such rights was significantly less than that amount. The partnership was syndicated by a brokerage house which controlled it. The amount of the nonrecourse note was determined by a formula used by the brokerage house to inflate depreciation deductions. Held, none of the claimed losses are deductible because the partnership's activities were not engaged in for profit within the meaning of sec. 183, I.R.C. 1954, and interest paid on the $742,500.00 nonrecourse note is not deductible because there was no genuine indebtedness due to the fact that both the purchase price and the note unreasonably exceeded the value of the property acquired. Marvin S. Lieber, Charles B. Gibbons, and Harry F. Klodowski, Jr., for the petitioners.
Francis J. Emmons and Robert B. Marino, for the respondent.
This case was assigned to and heard by Special Trial Judge John J. Pajak, pursuant to the provisions of section 7456(c) of the Code and Rules 180 and 181.1 The Court agrees with and adopts the Special Trial Judge's opinion which is set forth below.
PAJAK, Special Trial Judge:
Respondent determined deficiencies in petitioners' Federal income taxes for 1976 and 1977 in the amounts of $9,042.00 and $4,051.00, respectively. Respondent disallowed the distributable share of losses from a limited partnership, The Season Company, claimed on petitioners' returns.
The issues for decision are: (1) whether the partnership was engaged in for profit; (2) whether the partnership may deduct interest on certain nonrecourse indebtedness; (3) whether the partnership was a sham organized to create artificial tax deductions; (4) whether the nonrecourse indebtedness should be included in the bases of the partnership and the partners; (5) whether the partnership properly depreciated rights in an original paperback book, The Season; (6) whether the partnership was entitled to deduct various miscellaneous items under either section 162 or section 212; and (7) whether the agreement between the partnership and Pinnacle Books, Inc.,constituted a sale of the partnership's interest in the manuscript or a “lease of section 1245 property” within the meaning of section 465(c)(1)(C).2
This case is one of two groups of cases which were heard pursuant to test case procedures for purposes of judicial economy of benefit to petitioners, respondent and the Court. For the same reason, since most of the witnesses had testimony relevant to each of the groups, the test cases of Fuchs, Docket No. 18961–81 and Genstein, Docket No. 18962–81 both decided this day in Fuchs v. Commissioner, 83 T.C.——, were consolidated for trial at the same Special Session of the Court as was this case. The Fuchs case pertains to a limited partnership involving the Chinese ultimatum original paperback book and right thereto. This case pertains to a limited partnership involving the Season original paperback book and rights thereto.3.
Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.
Petitioners John R. Dean and Florence Dean resided in Wexford, Pennsylvania, when their petition was filed. On their 1976 and 1977 Federal income tax returns, petitioners deducted losses of $16,501.00 and $7,408.00, respectively, in connection with The Season Company (Season Co.), a limited partnership formed under the laws of Pennsylvania. Respondent disallowed these loss deductions.
Patricia Hornung (Hornung) was the former spouse of the star halfback of the Vince Lombardi Green Bay Packers, Paul Hornung. Apparently in 1975, she contacted Robin Moore (Moore) to seek assistance in writing a book about professional football as seen through the eyes of the wives and girlfriends of the players. Moore is the author or co-author of such best selling books as The Green Berets, The French Connection (co-author), and The Happy Hooker (co-author), all three of which became highly successful motion pictures. Moore often used co-authors or ghost-writers to write books. Moore contacted Howard Liss (Liss) for his opinion and assistance. Liss is a professional writer who was the ghostwriter of several books for Moore.
Liss found Hornung's initial draft unpublishable, Liss and Hornung met in the summer of 1975 so that Liss could write an original paperback book, The Season. Liss kept Hornung and Moore appraised of the progress being made on the draft, provided them with copies of work completed, and discussed with Moore future work on the paperback book. Moore did little, if any, of the actual writing. The cover of The Season lists as authors “Patricia Hornung & Robin Moore”.
During early 1976 Liss accompanied Moore to the office of Jack Klein (Klein), Moore's accountant, where a discussion occurred involving tax shelters. In February 1976, Moore contacted Liss and requested that Liss complete the book as fast as he could do so. Liss finished the book in about two weeks and gave it to Moore toward the end of February 1976.
Moore had copyrighted 14 books in the five years 1971 through 1975. The Season was one of 24 books subject to copyright in Moore's name in 1976. Many more books were subject to copyright under Moore's name in subsequent years.
Babbitt, Meyers and Company (Babbitt) was a regional member firm of the New York Stock Exchange, with its headquarters in Pittsburgh, Pennsylvania, and with branch offices located throughout western Pennsylvania. During 1976, Robert E. Rose (Rose) was the manager of Babbitt's tax shelter department. His function was to seek out, review and coordinate the distribution of tax advantaged investments to Babbitt's customers.
Babbitt's practice was to enter into an agreement on behalf of a partnership to be formed. If the offering was successful, the legal formalities of organizing a partnership would be followed.
In late 1975 or early 1976 Babbitt began the development of tax shelter programs using books. Since neither Rose nor anyone else at Babbitt had any expertise in the publishing industry, Rose discussed the development of this program with George Mack (Mack) and others. Mack introduced Babbitt to the law firm of Regan, Goldfarb, Heller, Wetzler & Quinn (Regan Goldfarb), New York, New York. Marty Heller of Regan Goldfarb represented Moore. Heller introduced Rose to Moore in January or February 1976. Babbitt used Regan Goldfarb in developing book tax shelter programs. In 1976, Babbitt syndicated at least three limited partnerships which utilized paperback books bearing the name of Moore and different co-authors.
Babbitt offered $200,000.00 of limited partnership interests in the Season Co. by a private placement Memorandum dated March 2, 1976. The Season Co. was established in the manner described in this memorandum. The memorandum stated in pertinent part that:
THIS INVESTMENT IS AVAILABLE ONLY TO THOSE OFFEREES WHOSE NET WORTH EXCLUSIVE OF HOME AND PERSONAL EFFECTS IS AT LEAST $200,000 OR SOME PORTION OF WHOSE CURRENT ANNUAL GROSS INCOME WOULD BE SUBJECT TO FEDERAL INCOME TAX AT A RATE OF 50% OR HIGHER AND WHOSE NET WORTH IS $100,000 OR MORE. * * *
Offering: $200,000 of Limited Partnership Interests to be offered by Babbitt, Meyers & Co. as exclusive agent for the Partnership; 25 Limited Partnership Interests of $8,000 each. Minimum purchase is one Limited Partnership Interest [which] requires (i) the payment of $2,000 in cash at the time of subscription, and (ii) the execution of a negotiable promissory note in the principal amount of $6,000 due in installments on September 1, 1976 and January 31, 1977. * * *
Partnership Business: The acquisition, publication and other exploitation of the copyright to and the manuscript entitled THE SEASON written by
ROBIN MOORE with PATRICIA (MRS. PAUL) HORNUNG (“THE WORK”) * * *
Compensation to General Partner: The General Partner will be paid a guaranteed initial management fee of $2,000 in 1977 which he will contribute to the capital of the Partnership, * * *
Purchase Price and Leverage: The Partnership will purchase the Work for $877,500, of which an aggregate of $135,000 is payable in cash and a short-term nonrecourse promissory note and the balance of $742,500 by delivery of the Partnership's 7-year, 8% nonrecourse purchase money note with required prepayments (i) to December 31, 1976 out of 1008 of Partnership receipts attributable to the publication or other exploitation of the copyright and the Work associated therewith after the first $2,000 of such Partnership receipts to pay accrued interest to December 31, 1976 and out of 50% of Partnership receipts in excess thereof to pay principal on the Partnership's 7-year nonrecourse note, (ii) from January 1, 1977 to March 31, 1977 (assuming a closing on April 1, 1977) out of 100% of such Partnership receipts to the extent of accrued interest on such 7year nonrecourse note for such period and out of 50% of such Partnership receipts to pay principal on such note and (iii) thereafter out of 50% of such Partnership receipts to be applied first to the payment of interest on such 7-year nonrecourse note and then to the principal thereof. In addition, the Partnership may prepay interest in the amount of $5,050 * * *.
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