Electric & Neon, Inc. v. Comm'r of Internal Revenue
| Citation | 56 T.C. 1324 |
| Decision Date | 21 September 1971 |
| Docket Number | Dockets Nos. 1058-66,3259-70,3220-70.,1059-66 |
| Parties | ELECTRIC & NEON, INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTLUIS AND ALICIA JIMENEZ, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
Towner Leeper, for the petitioners.
Harold Friedman, for the respondent.
1. The corporate petitioner constructed custom-made signs which it leased to customers. Lease durations varied from 1 to 10 years, the most common duration being 5 years. Leases were sometimes not renewed; when renewed, the rental rate was often substantially reduced. The signs were generally of no use to anyone but the original lessees. Held: The costs of constructing the signs must be treated as capital expenditures, depreciable over the term of the original lease in each case. An adjustment under sec. 481, I.R.C. 1954, must be made with respect to the transitional year.
2. The individual petitioner withdrew funds from the corporation on a regular basis throughout the years in issue. Such funds were used for personal purposes, including his ordinary family living expenses. The withdrawals were purportedly loans, but the repayments were relatively few in number and insignificant in amount. Held, such withdrawals were not loans, but were distributions in the nature of dividends.
3. The individual petitioners filed their Federal income tax returns late in 2 successive years. The reason offered for such delay was the wife's alleged willful refusal to divulge certain information which was claimed to be necessary for the preparation of the returns. Held, there has been no showing of reasonable cause for the failure to file the returns timely. SIMPSON, Judge:
In docket Nos. 1058-66 and 3259-70, the respondent determined the following deficiencies in the Federal income tax of the petitioner, Electric & Neon, Inc.:
+-------------------------------------+
¦Year ended Sept. 30— ¦Deficiency ¦
+------------------------+------------¦
¦1961 ¦$29,742.54 ¦
+------------------------+------------¦
¦1962 ¦8,620.72 ¦
+------------------------+------------¦
¦1963 ¦11,150.35 ¦
+------------------------+------------¦
¦1964 ¦20,511.09 ¦
+------------------------+------------¦
¦1965 ¦13,427.87 ¦
+------------------------+------------¦
¦1966 ¦11,343.53 ¦
+-------------------------------------+
The respondent also determined an overassessment in the Federal income tax of such petitioner for the year ended September 30, 1967, in the amount of $2,404.34. In his answer to such petitioner's amended petition, the respondent alleged that if there was to be an adjustment under section 481, I.R.C. 1054, 1 as was proposed in the amended petition, then the deficiency for the year ended September 30, 1961, would be increased to ‘at least $85,141.61’ as a result of such adjustment.
In dockets Nos. 1059-66 and 3220-70, the respondent determined the following deficiencies in, and additions to, the Federal income tax of the petitioners, Luis and Alicia Jimenez:
+----------------------------------+
¦ ¦ ¦Addition ¦
+------+------------+--------------¦
¦Year ¦Deficiency ¦sec. 6651(a) ¦
+------+------------+--------------¦
¦1961 ¦$2,852.60 ¦$713.15 ¦
+------+------------+--------------¦
¦1962 ¦2,381.95 ¦357.29 ¦
+------+------------+--------------¦
¦1963 ¦5,160.32 ¦ ¦
+------+------------+--------------¦
¦1964 ¦1,868.68 ¦ ¦
+------+------------+--------------¦
¦1965 ¦1,171.00 ¦ ¦
+------+------------+--------------¦
¦1966 ¦4,297.00 ¦ ¦
+------+------------+--------------¦
¦1967 ¦4,412.00 ¦ ¦
+----------------------------------+
The primary issues for decision are: (1) Whether the petitioner, Electric & Neon, Inc., may treat as an expense the costs of constructing large electrical signs which it leased; (2) whether the petitioner Luis Jimenez realized additional dividend income or compensation as a result of certain funds and property which he withdrew from such corporation; and (3) whether Mr. and Mr. Jimenez had reasonable cause for the late filing of their Federal income tax returns for 1961 and 1962.
The petitioners, Luis and Alicia Jimenez, resided in El Paso, Tex., when the petitions were filed in this case, and at all times relevant hereto. They filed their joint Federal income tax returns for the years 1961 through 1967 with the district director of internal revenue, Austin, Tex. Mr. Jimenez will sometimes be referred to as the petitioner.
The petitioner, Electric & Neon, Inc. (E & N), is a corporation which had its principal place of business at all times relevant to this case in El Paso, Tex. It filed its Federal income tax returns, using the accrual method of accounting, for the years ended September 30, 1961 through 1967, with the district director of internal revenue, Austin, Tex. Hereafter, a fiscal year of E & N will be identified by the calendar year in which it ends.
During all the years in issue, the petitioner was the president of, and owned substantially all the stock of, E & N. He had been associated with its predecessor company since about 1940. The business was incorporated in 1947; the petitioner became a shareholder at that time and has owned substantially all the stock since 1956. He owned about 97 percent of such stock at the time of trial.
E & N is, and has been during the taxable years here in issue, in the business of manufacturing, installing, and leasing or selling, electric, neon, and plastic signs and displays. The signs, most of which are large, are custom-made to suit the particular needs of the customers and their business premises. Most of such signs are affixed to the property of the customers, either attached to the face of the building or placed on a pole or beam.
Customers could either buy or lease the signs. Many of them preferred to lease; E & N and its predecessor company had been leasing our signs since 1940. When E & N enters into a leasing arrangement, and the lessee defaults in making the payments called for by the lease, E & N removes the sign; but because of its custom-made nature, the sign is rarely usable for any other customer, and thus has virtually no value to E & N. Similarly, when a lease on a sign expires, if the customer does not renew the lease, it is general practice in the sign industry to take the sign down and junk it. The cost of labor usually makes it impractical and uneconomical to alter an existing sign to suit the needs of another customer.
The leased signs which produced income during the years here in issue were constructed between October 1, 1955, and September 30, 1967. The original terms of the leases entered into by E & N with respect to the signs constructed for lease during that period varied in length from 1 to 10 years; the most usual length of such original leases was 5 years. A number of signs constructed before October 1, 1960, were still producing income in the years in issue, some still under the original leases.
E & N treated the entire cost of constructing such signs, including materials, supplies, labor, freight, supervisory salary, workmen's compensation insurance, payroll taxes, licenses, and miscellaneous job costs, as a current expense for Federal income tax purposes, as well as for the corporation's own accounting purposes. When such signs are leased, the lease income was reported on a monthly basis over the life of the lease. The charges billed in a particular month were accrued in that month on the books of the corporation. cost of the leased neon signs as expenses had been followed consistently by that corporation and its predecessor company since 1940 when the latter first started leasing signs.
During the years in issue, E & N received income from repair work that it performed, in addition to the lease revenue. The corporation's expenses for materials and supplies included those consumed with respect to its non- lease-related repair work, as well as those used incident to its responsibilities with respect to the leases.
Over the term of the original lease of a sign, without renewal, E & N generally received in rental payments a total sum which was very substantially in excess of the cost of constructing the sign. Many of the leases on E & N's signs were renewed. However, most of such renewals were at reduced rental rates. Furthermore, even taking the renewals into consideration, very few of the leased signs could be expected to produce income over a 12-year period.
It has been the longstanding and general practice in the electric and neon sign industry to treat the costs of constructing such a sign as capital expenditures to be depreciated over the period of the original lease of the sign. It is a general practice, when a lease is renewed, to charge a substantially reduced rental— merely enough to cover the costs of maintaining the sign and carrying the insurance on it.
The respondent had previously audited E & N with respect to fiscal 1956, 1957, and 1959, but the respondent did not on such occasion require any change in E & N's method of accounting generally, or in its method of treating the cost of the signs as expenses, specifically. In fact, the revenue agent's report dated June 26, 1961, resulting from such audit made no mention of the leasing aspect of E & N's business or the accounting practices used in connection therewith. However, the makeup of E & N's business in the pre-1961 years was not the same as that in the later years; such corporation engaged in a different category of business, electrical contracting, during at least the 5 years prior to September 30, 1960, but not thereafter.
According to the method of reporting income used by E & N during the years in issue, its aggregate taxable income...
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