Estate of Norris v. Commissioner
| Decision Date | 16 July 1981 |
| Docket Number | Docket No. 1852-78. |
| Citation | 1981 TC Memo 368,42 TCM (CCH) 408 |
| Parties | Estate of Dellora A. Norris, Continental Illinois National Bank and Trust Company of Chicago, George N. Gaynor and Robert C. Norris, Co-executors v. Commissioner. |
| Court | U.S. Tax Court |
John K. O'Connor and Leland E. Hutchinson, 115 S. LaSalle St., Chicago, Ill., for the petitioners. Tom Quinn, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies of $48,918.26 and $72,756.53 in decedent's1 Federal income taxes for 1973 and 1974, respectively. After concessions, the issues remaining for decision are:
(1) Whether decedent incurred or continued indebtedness in order to purchase or carry tax-exempt obligations within the meaning of section 265(2).2
(2) Whether decedent is entitled to an ordinary loss deduction in 1974 on the worthlessness of section 1244 stock.
Some of the facts have been stipulated and are found accordingly.
Decedent Dellora A. Norris resided in St. Charles, Illinois, when she filed her 1973 and 1974 Federal income tax returns with the Internal Revenue Service Center, Kansas City, Missouri, and when she filed her petition in this case.
Issue 1: Section 265(2). During the years at issue, decedent owned a substantial investment portfolio which included corporate stocks as well as debt instruments of various governmental units, the income from which was exempt from Federal income taxation. During those years, decedent also owned assets other than those in her investment portfolio. Decendent's investment advisors considered it prudent to include tax-exempt securities in her portfolio and had purchased such securities on her behalf for over thirty years. The bulk of decedent's portfolio consisted of common stock in Texaco, Inc., which she had inherited, along with other stocks, in 1918. Decedent's adjusted basis in the Texaco stock was less than two dollars per share.
Prior to 1969, decedent's husband, Lester J. Norris, managed her investments while she devoted most of her time raising her family. Although Mr. Norris frequently purchased real estate and often invested decedent's money in business ventures, he generally ignored decedent's portfolio with the result that her holdings remained essentially unchanged for many years. Decedent and Lester Norris separated in 1969.
In 1969, decedent employed an experienced business consultant, George Saum, to manage her investments and business affairs. At that time, decedent owned more than 2,900,000 shares of Texaco stock which represented approximately 85 percent of her total stock and security holdings. Saum believed that such a heavy investment in one company was unduly risky and, therefore, recommended that decedent begin diversifying her portfolio. Saum also examined decedent's potential estate tax liability in view of the fact that she was then 67 years old. After observing the differences at that time between the highest marginal estate tax and gift tax rates, Saum advised decedent to embark upon an extensive and consistent program of family gifts to minimize her eventual estate tax liability. Since decedent had never taken an active interest in managing her financial affairs, she relied heavily upon Saum's expertise in these matters and promptly followed his recommendations.
During 1969 and 1970, decedent made substantial gifts of Texaco stock to her children, their spouses, and to trusts for the benefit of her children and grandchildren. She paid gift taxes of $1,547,565 and $14,195,563, respectively, in those years.
In April 1970, decedent commenced a diversification program by selling 200,000 shares of Texaco common stock and approximately 12,000 shares of other corporate stocks for $5,487,900. One-half of the sales proceeds was immediately turned over to the Continental Illinois National Bank and Trust Co. (hereinafter Continental) and the other half to the investment firm of Stein Roe & Farnham (hereinafter Stein Roe) to be invested on behalf of decedent. The purpose of dividing the proceeds in half was to create a so-called "horse race" between Continental and Stein Roe whereby the more successful investment advisor would eventually be given the entire fund to manage.
Due to her low basis in the Texaco stock, decedent incurred substantial capital gains taxes on the diversification sales. In order to satisfy both her gift tax and income tax liabilities for 1970, decedent sold an additional 100,000 shares of Texaco stock in late 1970 and another 310,000 shares in early 1971. These later sales generated capital gains taxes of approximately $900,000 in 1970 and $3,200,000 in 1971.
In April 1971, decedent's 1970 gift tax and income tax returns were reviewed by George Gorski, a tax manager at the accounting firm of Arthur Anderson & Co. In the course of examining those returns, Gorski recommended to both Saum and decedent's office manager, Norman J. Nelson, that decedent should consider borrowing funds in the future to pay her taxes instead of raising the necessary cash by selling additional low basis Texaco stock and paying enormous capital gains taxes on such sales. Decedent and her advisors unanimously agreed with Gorski's suggestion and asked Lyle F. Veitch, vice-president of Continental, whether the bank would loan decedent funds for this purpose. After discussing the request with several loan officers at the bank, Veitch informed Nelson on May 13, 1971, that Continental would make funds available for decedent to meet her tax obligations. Prior to 1971, decedent had never borrowed any money from a bank.
During the years 1971, 1972, and 1973, decedent borrowed the following amounts from Continental on the dates indicated:
Date Amount
September 16, 1971 .......... $ 400,000
January 14, 1972 ............ 700,000
April 14, 1972 .............. 100,000
February 15, 1973 ........... 3,900,000
The decision to borrow each of those sums was made by decedent's business advisors shortly before the actual loan dates. Following the loan on April 14, 1972, and continuing until late December of that year, neither decedent's advisors nor the officer at Continental believed that additional loans would be needed to meet decedent's Federal tax payments.3 The first three loans were unsecured, but concurrent with the loan of February 15, 1973, decedent pledged 190,000 shares of Texaco common stock as collateral. At the request of Continental, she pledged an additional 60,000 shares on March 21, 1974.
For each of the loans, decedent executed a promissory note payable on demand with interest computed at the prime rate in effect from time to time. In October 1973, decedent executed a single demand note for $5,100,000 covering the previous four loans. Interest on this note was also at a floating prime rate. At that time, decedent also agreed to maintain average monthly compensating balances in her checking account at Continental equal to 15 percent of the outstanding loan balance. Prior to obtaining the four loans in question, decedent had cash balances in that checking account of $153,114.75, $521,827.63, $12,899.46, and $284,315.16, respectively.
The amounts borrowed by decedent were credited to her Continental checking account and immediately transferred, together with some funds already on deposit in that account, to her agency account at the bank (Account No. 39-01474). Bank records and internal memoranda prepared by Continental contemporaneously with these transactions stated that the foregoing amounts were transferred to Account No. 39-01474 to cover payment of decedent's taxes. These funds were then used to pay, in part, the following Federal taxes on the dates indicated:
Date Description Amount
Sept. 15, 1971 1971 estimated Federal
income taxes ........ $1,107,600
Jan. 15, 1972 1971 estimated Federal
income taxes ........ 1,107,600
Apr. 15, 1972 1971 Federal income
tax balance ......... 638,572
Apr. 15, 1972 1972 estimated Federal
income taxes ........ 440,000
Feb. 15, 1973 1972 Federal gift
taxes ............... 4,079,352
The portion of decedent's taxes not satisfied by the transferred funds was paid primarily with the dividends received on taxable securities held in the agency account.
For each of the years 1969 through 1974, decedent paid Federal taxes as follows:
Year Income Tax Gift Tax
1969 .............. $ 2,719,570 $ 1,547,565
1970 .............. 4,430,257 14,195,563
1971 .............. 5,068,972 1,710,852
1972 .............. 1,969,780 4,079,352
1973 .............. 1,480,552 62,220
1974 .............. 1,582,988 —0—
___________ ___________
$17,252,119 $21,595,552
During the years 1973, 1974, and 1975, decedent's payments of Federal income and gift taxes consisted of the following:
Date Description Amount
1/15/73 1972 estimated income tax
installment ............. $ 800,000
2/15/73 1972 gift tax ............. 4,079,352
4/15/73 1972 income tax balance ... 79,780
4/15/73 1973 estimated income tax
installment ............. 432,000
5/15/73 1973 gift tax ............. 62,220
9/15/73 1973 estimated income tax
installment ............. 300,000
1/15/74 1973 estimated income tax
installment ............. 650,000
2/18/74 1970 gift tax deficiency .. 489,864
4/15/74 1973 income tax balance ... 98,552
4/15/74 1974 estimated income tax
installment ............. 370,138
9/15/74 1974 estimated income tax
installment ............. 350,000
1/15/75 1974 estimated income tax...To continue reading
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