FALKOFF v. Commissioner
| Decision Date | 31 March 1977 |
| Docket Number | Docket No. 6709-74. |
| Citation | 36 TCM (CCH) 417,1977 TC Memo 93 |
| Parties | Milton Falkoff and Jeannette L. Falkaoff v. Commissioner. |
| Court | U.S. Tax Court |
Byron S. Miller, Alan L. Reinstein and Geoffrey F. Grossman, 33 N. LaSalle St., Chicago, Ill., for the petitioners. Seymour I. Sherman, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined a deficiency in petitioners' Federal income tax for the calendar year 1969 in the amount of $164, 425.52.
The remaining issue for decision is whether a series of transactions, whereby the indebtedness of the partnership in which the petitioner had an interest to the First National Bank of Chicago was repaid, resulted in a distribution of earnings and profits by Henry Crown and Company, a corporation, the stock of which was owned by the partnership.
Some of the facts have been stipulated and are so found. The stipulation of facts together with exhibits attached thereto are incorporated herein by this reference.
Milton Falkoff and Jeannette L. Falkoff, husband and wife, resided at the time this petition was filed in Lincolnwood, Illinois. They filed their joint Federal income tax return for the calendar year 1969 on the cash receipts and disbursements basis with the District Director of Internal Revenue at Chicago, Illinois. Milton Falkoff will sometimes be referred to hereafter as petitioner.
The petitioner was the beneficial owner of a 2.5 percent interest in a partnership doing business as Henry Crown and Company, Not Incorporated, hereinafter referred to as the partnership. At all times since its formation, the partnership has reported its income and kept its books and records on the cash basis and has used the calendar year as its taxable and fiscal year.
Henry Crown and Company (hereinafter sometimes referred to as the corporation) is an Illinois corporation originally organized under the name of Exchange Building Corporation. At all times material herein, the corporation and its subsidiaries kept their books and records and filed consolidated Federal income tax returns on the accrual basis for the fiscal year ending September 30. No election was made under the consolidated return regulations for the consolidated group to adjust earnings and profits currently.1
On December 24, 1959, the partnership acquired all of the issued and outstanding stock of Henry Crown and Company, together with a promissory note, dated December 15, 1959, made by the corporation in the principal amount of $7,500,000 payable December 31, 1969, with interest at the rate of 7 percent per annum owing only after such date. At the same time and in the same transaction, the partnership also acquired all of the issued and outstanding stock of the LaSalle Corporation (hereinafter referred to as LaSalle), Arrowhead Venture, Inc. (hereinafter referred to as Arrowhead), and Mascar Corporation (hereinafter referred to as Mascar), and promissory notes made by each of them, each dated, maturing and bearing interest under the same terms and conditions as the note of Henry Crown and Company referred to above, and having respective principal amounts payable as follows: $1,650,000 by LaSalle, $3,250,000 by Arrowhead and $900,000 by Mascar.
On January 1, 1964, the partnership contributed the stock and notes of LaSalle, Arrowhead and Mascar to the capital of Henry Crown and Company, so that from that date henceforth, LaSalle, Arrowhead and Mascar were wholly owned subsidiaries of the corporation. The principal balance due on the Arrowhead note had by then been reduced to $2,290,000. The principal balances due on the notes of LaSalle and Mascar were unchanged from December 24, 1959.
On April 1, 1967, Henry Crown and Company caused to be organized under the laws of Illinois, the Exchange Building Corporation (hereinafter referred to as Exchange), to which the corporation contributed certain property located in Contra Costa County, California, known as the San Ramon Ranch.
For some months prior to September 30, 1969, there were intermittent negotiations for the sale of the San Ramon Ranch by Exchange to an undisclosed buyer, acting through one Willis Hannawalt, an attorney. Such negotiations resulted in an agreement in substance with respect to such sale on or before September 30, 1969.
By October 1, 1969, the attorneys for Exchange and the attorneys for Western Electric Company (hereinafter referred to as Western Electric), the undisclosed purchaser, had completed all the documents which would be required to consummate the sale. An escrow agent had been selected by the parties and an agreement had been entered into with respect to the instructions and procedures to be followed.
On October 1, 1969, the attorney for Exchange traveled from Chicago, Illinois, to San Francisco, California, and deposited with the escrow agent the various documents which had duly been executed by or on behalf of Exchange. On October 2, 1969, the documents were delivered by the escrow agent to the attorney for the purchaser and, in accordance with the prior agreements, the sum of $12,191,709.39 was transmitted to the First National Bank of Chicago (hereinafter referred to as the First National Bank), as of the opening of business on that date, for the account of Exchange.
In accordance with the foregoing procedure, the San Ramon property was sold to Western Electric for a price of $12,250,000 subject to adjustments for taxes, assessments and transfer tax. The transaction was reflected in the consolidated Federal income tax return of Henry Crown and Company and subsidiaries for the fiscal year ending September 30, 1970, as a long-term capital gain of $11,002,410.02, resulting from the sales price of $12,250,000 less basis and costs and expenses of sale of $1,247,589.98.
Prior to September 29, 1969, the partnership was indebted to the First National Bank in the amount of $15,900,000. This indebtedness was represented by the balance due on various notes, as follows:
Executed Date Due Balance Due
12/18/68 12/31/69 $ 4,000,000
1/22/69 12/31/69 500,000
5/20/69 1/02/70 11,000,000
5/20/69 1/02/70 400,000
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Total .................. $15,900,000
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The indebtedness to the First National Bank had been guaranteed by Robert Crown and Lester Crown, general partners. Robert Crown died on July 6, 1969. Thereafter, the First National Bank released the decedent's guarantee of the partnership's indebtedness.
In anticipation of the sale of the San Ramon property by Exchange, a plan was evolved whereby the indebtedness of the partnership to the First National Bank would be repaid or refinanced using, in part, the proceeds from the contemplated sale of such property. Pursuant thereto, the following transactions took place:
(1) On September 29, 1969, the First National Bank made a loan of $18 million to Henry Crown and Company as the borrower of record, payable on demand. The loan was secured by a pledge of certain assets belonging to either the partnership or Henry Crown and Company, including all of the issued and outstanding stock of Henry Crown and Company. First National Bank valued the pledged collateral at $30,213,365, consisting of the following:2
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Shares Corporation Value
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25,000 s/s Henry Crown and Company |
10 s/s Thomas B. Bishop Co. > $ 6,414,000
100 s/s The Park-Grey Corp. |
500 s/s Arrowhead Venture, Inc. ....... 6,000,000
6,000 s/s The LaSalle Corp. ............. 1,453,123
400 s/s Mascar Corp. .................. 308,017
50,000 s/s Exchange Bldg. Corp. .......... 15,600,000
5,000 s/s Lindrick Service Corp. ........ 33,688
5,000 s/s Lindrick Corp. ................ 5,000
1,000 s/s Mile 300 Company .............. 99,537
200 s/s DPV Corporation ............... 300,000
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$30,213,365
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(2) On September 29, 1969, Henry Crown and Company discharged its promissory note held by the partnership by payment of the sum of $7.5 million. At the same time the corporation made a distribution to the partnership with respect to the stock of Henry Crown and Company in the amount of $400 per share, for a total of $10 million.
(3) On September 29, 1969, the partnership paid First National Bank the sum of $15,500,000, which was credited as full payment of three of the four notes held by the bank. After this payment, the partnership remained indebted to First National Bank for $400,000 on the remaining note and $628,034.23 for interest due on the prior indebtedness, for which the partnership gave its note.
(4) On October 2, 1969, LaSalle paid $1.5 million and Arrowhead paid $1.4 million to Henry Crown and Company as partial payment of the respective notes held by the corporation. On that same day, the corporation paid $3 million to the First National Bank as partial payment of its $18 million loan.
(5) On October 3, 1969, Exchange transferred the sum of $10 million to Henry Crown and Company, receiving the corporation's note for $10 million due September 30, 1970.
(6) On October 3, 1969, Henry Crown and Company paid $10 million to the First National Bank as an additional payment on account of the corporation's indebtedness to the bank. This payment reduced the outstanding principal amount of the $18 million loan to $5 million.
In a memorandum dated October 3, 1969, James Bourke, the loan officer of First National Bank who...
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