Estate of Kluener v. Commissioner

• Court: U.S. Tax Court
• Writing for the Court: Wells
• Citation: Estate of Kluener v. Commissioner, 72 T.C.M. 1326 (T.C. 1996)
• Decision Date: 25 November 1996
• Docket Number: Docket No. 3867-95.
• Parties: Estate of Robert G. Kluener, Deceased, Donald E. Hathaway, Co-Executor and Charlotte J. Kluener v. Commissioner.

72 T.C.M. 1326

T.C. Memo. 1996-519 Estate of Robert G. Kluener, Deceased, Donald E. Hathaway, Co-Executor and Charlotte J. Kluener v. Commissioner.

Docket No. 3867-95.

United States Tax Court.

Filed November 25, 1996.

David E. Hathaway, Cincinnati, Ohio, for the petitioners. Jeffrey L. Bassin, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WELLS, Judge:

Respondent determined a deficiency of $284,247 in, and an accuracy-related penalty of $56,093 pursuant to section 6662(a) on, Robert G. Kluener's¹ and Charlotte J. Kluener's 1989 Federal income taxes (Robert G. Kluener and Charlotte J. Kluener are sometimes hereinafter referred to as the Klueners, Robert G. Kluener is referred to individually as Mr. Kluener, and Charlotte J. Kluener is referred to individually as Ms. Kluener). Unless otherwise noted, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

After concessions, the issues remaining for decision are whether petitioners are liable for: (1) Income tax on the gain realized from the sales of certain horses that Mr. Kluener transferred² to his wholly owned corporation prior to the sales; and (2) the accuracy-related penalty provided by section 6662(a) for a substantial understatement of income tax.

FINDINGS OF FACT

Some of the facts have been stipulated for trial pursuant to Rule 91. The parties' stipulations of fact are incorporated herein by reference and are found as facts in the instant case.

Mr. Kluener died on October 14, 1991. At the time the petition in the instant case was filed, the executors of Mr. Kluener's estate were Donald E. Hathaway (Mr. Hathaway), who resided in Florida, Vincent H. Beckman, who resided in Ohio, and John W. Kreutzcamp, who resided in Indiana. Mr. Hathaway served as Mr. Kluener's financial and tax adviser prior to Mr. Kluener's death. At the time the petition in the instant case was filed, Ms. Kluener resided in Cincinnati, Ohio.

During relevant times, each of the Klueners maintained an account (agency account) with the Fifth Third Bank (Fifth Third or bank) in which the bank held securities as the account holder's agent. As of July 31, 1989, the market value of the securities held in Mr. Kluener's agency account was $5,081,394.79. As of June 30, 1989, the market value of the securities held in Ms. Kluener's agency account was $7,536,314.33. As of September 30, 1989, Mr. and Ms. Kluener each held securities in separate street accounts with Legg Mason Wood Walker, Inc. (Legg Mason), that were valued at $213,088 and $201,426, respectively.

Additionally, during 1989, Mr. Kluener owned interests in certain highly leveraged real estate ventures, to which he had advanced $12,200,000. Mr. Kluener had borrowed those funds from Fifth Third in the form of personal unsecured loans. The interest that Mr. Kluener collected from the ventures with respect to his loans to them afforded him a source of funds from which to pay the interest on his personal debts to Fifth Third. Due to changes in the tax law by the Tax Reform Act of 1986 and saturation of the real estate market, real estate values fell, and the properties held by the ventures in which Mr. Kluener held an interest could not be sold. During 1986 through 1989, the ability of the ventures to pay interest to Mr. Kluener deteriorated, and, during 1989, (1) the ventures were not generating sufficient cash-flow to afford him an adequate source of funds to pay the interest on his debt to Fifth Third, (2) the real estate held by the ventures could not be sold for an amount sufficient to retire their debts to Mr. Kluener, and (3) Mr. Kluener's loans to the ventures were considered worthless.

During 1989, Mr. Kluener owned stock in ALUCHEM, an aluminum-grinding company. Also, during all times (prior to Mr. Kluener's death) relevant to the instant case, Mr. Kluener was the sole shareholder and chief executive officer of American Power Equipment Co., Inc. (APECO). During 1989 and 1990, Mr. Kluener was also a director of APECO. Mr. Kluener had previously been the principal executive of the Campbell Hausfeld Co. (Campbell Hausfeld), a successful manufacturer of paint-spraying equipment in which Ms. Kluener's family held an interest and which had been sold around 1971. Although APECO had originally produced chain saws, upon the expiration of the covenant not to compete that he had signed when Campbell Hausfeld was sold, Mr. Kluener made APECO into a manufacturer of paint-spraying equipment, which was its business when the events in issue in the instant case occurred. APECO's business activities were conducted at a site in Harrison, Ohio, that had been acquired from Campbell Hausfeld.

APECO had a history of losses. On its Federal income tax return for its fiscal year ending June 30, 1989, it reported that a net operating loss (NOL) of $4,472,915 was available for carryover to its fiscal year ending June 30, 1990, and that NOL was carried over. During relevant times, APECO received loans from Mr. Kluener and Fifth Third to finance its operations. As of January 1, 1989, APECO owed Mr. Kluener $800,000. On or about April 19 and June 12, 1989, he made loans of $700,000 apiece to APECO using funds from his agency account to fund all or a portion of each loan. As of June 30, 1989, APECO owed Fifth Third $3,885,000, and, on or about July 31, 1989, APECO obtained a final loan of $1,500,000 from the bank, bringing its indebtedness to Fifth Third to $5,385,000. Mr. Kluener guaranteed Fifth Third's loans to APECO.

During 1989, APECO's personnel were developing a variety of new or improved products, including more durable sprayer parts, a high-volume, low-pressure spray gun, and a Do-It-Yourself paint sprayer. Mr. Kluener dictated the products that APECO's personnel were to develop. During mid-1989, a project to develop a new type of paint sprayer was just beginning and did not yet have a name. The concept on which the sprayer was based called for a new method of powering the sprayer mechanism and involved a different design than had been used previously. At a June 8, 1989, meeting of APECO's board, the concept of a "turbo airless sprayer" was discussed, but such a product was not mentioned in the minutes of subsequent board meetings on November 20, 1989, and January 16, 1990. Eventually, the sprayer developed from the concept came to be known as the "Planatronic". During mid-1989, APECO's personnel had not allocated a specific amount of money to the development of the Planatronic. APECO experienced continuing difficulties in developing the Planatronic into a reliable product that were not solved as late as July 1991.

Mr. Kluener owned 41 thoroughbred horses, and he had at one time owned as many as 120 to 125 such horses. His horse-related activities were conducted through a sole proprietorship known as Robert G. Kluener Enterprises, which maintained an office in Cincinnati. Mr. Kluener's assistant worked in that office and was responsible for a variety of administrative tasks relating to his personal and business activities, including the paperwork and check-writing connected with the horse-related activities.

As a result of the collapse of the real estate ventures, his obligations to Fifth Third, and the need to fund APECO, Mr. Kluener could no longer afford the losses generated by the horse-related activities, which, for the first 7 months of 1989, amounted to approximately $400,000. Moreover, due to declining health, Mr. Kluener did not enjoy those activities as much as he formerly had enjoyed them, and he began to lose interest in them. Accordingly, Mr. Kluener decided to sell his horses. His tax advisers recommended that the horses be transferred to APECO and sold in its name so as to use APECO's NOL's to shelter any gain realized on their sale. Had Mr. Kluener sold the horses directly, a certain portion of any gain realized would have been taxed as ordinary income pursuant to section 1245, and the balance would have been taxed as capital gain. Consequently, the amount netted from the sale would have been substantially reduced by taxes.

On or about August 1, 1989, Mr. Kluener transferred to APECO title to his entire collection of 41 horses, with an estimated fair market value of $2,428,654. A separate division, APECO Equine, was created to handle the horse-related activities. Only Mr. Kluener, his assistant, and his tax advisers knew of the transfer when it occurred. The other directors and officers of APECO, including its president, Marvin Stock (Mr. Stock), were not informed of the transfer, and Mr. Kluener and his advisers made every effort to ensure that those others did not learn of it. Mr. Stock also was unaware of the existence of APECO Equine. The transfer was not reflected in APECO's monthly financial statements for its year ending June 30, 1990.

After the horses were transferred, Mr. Kluener's assistant continued to perform the same functions with respect to the horses as she had prior thereto, and the functions were performed at Mr. Kluener's office in Cincinnati, rather than at APECO's office in Harrison. Although Mr. Kluener's assistant was nominally an employee of APECO both before and after the transfer, Mr. Kluener personally had reimbursed APECO for the cost of her compensation and continued to do so after the transfer.

Horses of the quality of those transferred by Mr. Kluener are generally sold at open auction, at which the animals offered for sale are displayed and bid upon. It is very unusual for sales to be effected privately. Auctions occur at certain times of the year, including the fall; to be sold at auction, a horse must be registered by a cutoff date so that it may be placed on the auction list. Between August and December 1989, 37 of the horses transferred were sold at auction, realizing net proceeds after deduction of expenses in the amount of $2,177,685, resulting in gain...