Estate Of Roger E. Stangeland v. Comm'r Of Internal Revenue

• Decision Date: 16 August 2010
• Docket Number: Docket No. 14402-08.
• Parties: ESTATE OF ROGER E. STANGELAND, DECEASED, LILAH M. STANGELAND, EXECUTOR AND LILAH M. STANGELAND, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

ESTATE OF ROGER E. STANGELAND, DECEASED, LILAH M. STANGELAND, EXECUTOR AND LILAH M. STANGELAND, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14402-08.

United States Tax Court.

Filed August 16, 2010.

Edward M. Robbins, Jr., and Cory Stigile, for petitioners.

Kris H. An and Nathan C. Johnston, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Judge: Respondent determined deficiencies in petitioners' Federal income taxes and penalties as follows:

Year Deficiency Penalty Sec. 6662(a)

2002 $369,406 $73,881

2003 542, 776 108, 555

2004 440, 850 88, 170 The issues for decision are whether petitioners may deduct on Schedule C, Profit or Loss From Business, losses incurred by Roger Stangeland in the course of his consulting activities, whether losses attributable to a partnership owning and operating airplanes are losses from a passive activity, and whether petitioners are liable for accuracy-related penalties under section 6662(a).

The parties also dispute Roger Stangeland's basis in R & L Air, which is relevant because Roger Stangeland died in 2004 and petitioners can deduct from their nonpassive income in 2004 an amount of R & L Air's loss from a passive activity that depends on Roger Stangeland's basis. See sec. 469(g). This issue has been postponed for further proceedings.

All section references are to the Internal Revenue Code for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. Lilah Stangeland resided in California at the time the petition was filed. Roger Stangeland (decedent) died on February 27, 2004.

Petitioners owned numerous companies. Between 2002 and 2004, petitioners had ownership interests in: (1) Casa Encantada, a hotel/motel in Acapulco, Mexico; (2) Wauconda Associates, an entity formed to own and operate the Liberty Square Shopping Center in Wauconda, Illinois; (3) Lido Partners, an entity formed to own and operate the Via Lido Shopping Center in Newport Beach, California; (4) Warehouse Investment Partners, an entity formed to own and operate a warehouse in La Mirada, California; (5) Rancho Encantado, Inc., an S corporation that owns and operates a residential rental property and walnut grove near Santa Barbara, California; (6) Lido Diner, L.L.C., an entity formed to own and operate Lido Diner, a restaurant in Newport Beach, California; (7) New Twist, L.L.C., an entity formed to own and manage two retail stores in Eugene, Oregon; (8) Hawaiian Fruit Specialties, L.L.C., an entity formed to market fruit jam products; and (9) R & L Air, L.L.C., an entity formed to own and lease out two airplanes.

In addition, between 2002 and 2004, petitioners were the sole shareholders of Encantado Enterprises, Inc., an S corporation that held a 99-percent limited partnership interest in the Stangeland Family Limited Partnership. Petitioners held directly a 1-percent general partnership interest in the Stangeland Family Limited Partnership. The Stangeland Family Limited Partnership had ownership interests in the following entities: (1) Indianhead Mountain Enterprises, L.L.C., an entity formed to own and operate the Indianhead Mountain Resort in Michigan; (2) Indianhead Mountain, L.L.C., an entity formed tohold title to the liquor license for the Indianhead Mountain Resort; and (3) Quality Drug Corp., an entity formed to own and operate drug stores in Newport Beach and Laguna Beach, California. In 2003, Quality Drug Holdings Corp. was formed and became the owner of Quality Drug Corp. Petitioners received an ownership interest in Quality Drug Holdings Corp.

We refer collectively to all of the above businesses as the businesses or petitioners' businesses. Except for Casa Encantada, Rancho Encantado, Encantado Enterprises, and R & L Air, petitioners share ownership of the businesses with third parties or their children. Mrs. Stangeland kept track of the books, records, and miscellaneous expenses and wrote the checks for Rancho Encantado.

The businesses each had separate management groups. The pharmacies owned by Quality Drug Corp. sold jams produced by Hawaiian Fruit Specialties, but other than that, there were no products produced by one of petitioners' businesses and used by another.

Aside from his business interests, decedent served on the boards of the Boy Scouts of America, the Los Angeles Chamber of Commerce, the Pasadena Playhouse, the Board of Fellows of Claremont Graduate School, and St. John's Northwestern Military Academy. Decedent was the president of petitioners' private charity, the Roger and Lilah Stangeland Foundation, andpetitioners were also active in fundraising for Methodist Hospital, the Pasadena Playhouse, and St. John's Northwestern Military Academy.

Decedent owned and operated a consulting services business called ResEnt as a sole proprietorship to help him manage petitioners' businesses. Decedent worked approximately 50 hours a week for ResEnt. Petitioners' 2002, 2003, and 2004 Forms 1040, U.S. Individual Income Tax Return, included Schedules C for ResEnt. Petitioners recognized no income from decedent's consulting services, although decedent did report some income on his Schedules C from subletting part of ResEnt's office space. Decedent incurred expenses that were reported on his ResEnt Schedules C and include office rent, supplies, travel, accounting, and legal fees. Decedent also hired Joanne Caccamo as his executive assistant and reported her salary as an expense on the ResEnt Schedules C under "Wages".

In 2003, decedent hired Roger Henn to help find ways to operate petitioners' businesses more profitably and efficiently, and to help decedent identify new business ventures. Henn helped decedent find and acquire businesses in situations where decedent thought he had a particular skill or insight that could help those businesses grow and either make them profitable in the long run or put them in a position where they could be sold for a profit. Henn was compensated by ResEnt in 2003 and 2004, anddecedent reported Henn's compensation as an expense on the ResEnt 2003 and 2004 Schedules C under "Legal and professional services".

Decedent and Henn provided a number of services to petitioners' businesses to sustain or enhance their profitability. For example, decedent oversaw the construction of the Lido Diner and designed the menu. Decedent and Henn also designed the store layout for the second of Quality Drug Corp.'s pharmacies. Henn helped create Quality Drug Corp.'s infrastructure and conducted negotiations to acquire the location for a third store. Henn was also involved in the day-to-day management of Indianhead Mountain. In no case was either decedent or Henn reimbursed for his services by the business he was advising.

When either decedent or Henn traveled to advise the management of petitioners' businesses, he often used R & L Air's airplanes. In 2002, R & L Air owned two airplanes--a King Air and a Canadair Challenger. In December 2002, R & L Air conducted a like-kind exchange, trading the Challenger for a Gulfstream GIII. On its 2002 Form 8824, Like-Kind Exchanges, R & L Air reported that it transferred the Challenger, with a fair market value of $4.5 million, on December 30, 2002, and received the Gulfstream, with a fair market value of $5,808, 236. R & L Air completely refurbished the Gulfstream in 2003, replacing theinterior and painting the exterior. R & L Air included two entries to its 2003 depreciation schedule: "GS3-1031 NEW", with an unadjusted cost or basis of $1,508, 236, and "GS3-REFURBISH", with an unadjusted cost or basis of $1,865, 200. R & L Air continued to operate the King Air and Gulfstream in 2004.

To help manage the airplanes, R & L Air hired Pinnacle Air Group, Inc. In the Aircraft Management Agreement, signed by the parties in September 2000 and again in October 2003, Pinnacle Air Group agreed that

1.2 Manager [Pinnacle Air Group] shall supply to owner [R & L Air] all services and functions customarily provided pursuant to management agreements including, but not limited to:

a. Employment and/or supervision of flight and maintenance personnel assigned to Owner's Aircraft;

b. Maintenance management at contract facilities, and related maintenance support functions;

c. Aircraft insurance through Manager fleet policy,

* * *

d. Liaison with aviation regulatory agencies including the FAA on Owner's behalf and compliance with all statutes, ordinances, rules and regulations enforced by such agencies;

e. Flight and maintenance scheduling, planning, and communications;

f. Record keeping, reporting, budgeting, and other administrative systems;

g. Travel support services for Owner's passengers, as required;h. Miscellaneous support services associated with the daily operation, maintenance, scheduling, and administration of the Aircraft;

i. Management supervision of the operation and maintenance of the Aircraft; and,

j. Provide the necessary FAR Part 91 Aircraft Lease Agreements to Owner and Lessee should such arrangements be required. In addition, Manager will provide Owner with necessary flight time information for Lessee invoicing purposes. Manager will be responsible for invoicing each respective Lessee for Pilot Services and associated expenses. Pilot Service revenue collected from Lessee will be credited to Owners [sic] account accordingly.

When one of the R & L Air airplanes needed maintenance, Curt Pavlicek, the owner of Pinnacle Air Group, would call decedent with bids from various maintenance facilities and would review each item of maintenance with him. Pinnacle Air Group charged R & L Air a monthly management fee for the services listed in the aircraft management agreement.

Both decedent and Pavlicek were involved in the negotiations for the sale of the Challenger and the purchase and refurbishment of the Gulfstream. At times during the sale, purchase, and...