Falsetti v. Comm'r of Internal Revenue
| Decision Date | 21 August 1985 |
| Docket Number | 5438-83,7111-83,5437-83,20833-83.,Docket Nos. 7013-82 |
| Citation | 85 T.C. 332,85 T.C. No. 19 |
| Parties | MICHAEL S. AND MARILYN H. FALSETTI, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Ps were limited partners in M, a California limited partnership. M purportedly purchased an apartment complex (the Property) from W, a Cayman Islands corporation, which purportedly purchased the Property from H. M purportedly made interest payments to W. Ps were subsequently ‘cashed out‘ by H for the amount of their capital contributions plus 10 percent per annum simple interest. HELD, the totality of the facts and circumstances surrounding the alleged sale transactions demonstrates that the purported sales were shams in substance, as defined for purposes of this case, and therefore M was not engaged in a bona fide business activity sufficient to pass through any deductions to Ps. HELD FURTHER, since the purported interest payments by M were in reality the mere shifting by H of funds under his dominion and control, and were not paid to W, M is not liable for the 30 percent withholding tax under section 1442, I.R.C. 1954, or the addition to tax under section 6651(a), I.R.C. 1954, for failure to file a return.
Fs owned all of the stock of C. C paid certain amounts relating to auto, boat, travel, insurance and other unidentified expenses for the benefit of Fs. HELD, amount of constructive dividends from C to Fs determined. THOMAS W. HARRIS, Jr., for the petitioners.
THEODORE GARELIS, for the respondent.
Respondent determined the following deficiencies and additions to tax in petitioners' income taxes for the taxable years ending December 31:
+----------------------------------------------------------+
¦ ¦ ¦ ¦ ¦Additions to tax¦
+--------------+----------+----+----------+----------------¦
¦Case ¦Docket No.¦Year¦Deficiency¦sec. 6651(a)2 ¦
+--------------+----------+----+----------+----------------¦
¦Falsetti ¦7013-82 ¦1976¦$3,590 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦ ¦ ¦1977¦5,383 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦ ¦ ¦1978¦12,546 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦Cuttone ¦5437-83 ¦1976¦1,925 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦ ¦ ¦1977¦16,013 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦Bittner ¦5438-83 ¦1976¦2,335 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦ ¦ ¦1977¦12,420 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦Medefind ¦7111-83 ¦1974¦3,404 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦ ¦ ¦1976¦5,337 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦ ¦ ¦1977¦9,885 ¦ ¦
+--------------+----------+----+----------+----------------¦
¦Monterey Pines¦20833-83 ¦1976¦14,250 ¦$3,563 ¦
+--------------+----------+----+----------+----------------¦
¦Investors ¦ ¦1977¦123,279 ¦30,820 ¦
+----------------------------------------------------------+
After concessions, the issues for decision are: (1) whether Monterey Pines Investors was engaged in a bona fide business activity during 1976 and 1977; (2) the amount, if any, of depreciation expenses petitioners are entitled to claim; (3) whether petitioners are entitled to interest expense deductions; (4) whether petitioners are entitled to deduct certain legal expenses; (5) whether petitioner, Monterey Pines Investors, actually or constructively paid interest to a foreign corporation; (6) whether section 1461 (relating to ‘Liability for Withheld Tax‘) required Monterey Pines Investors to file a return and pay the tax imposed by section 1442 (); (7) whether a section 1442 tax of 30 percent of such interest payments should have been withheld at the source by Monterey Pines Investors; (8) and if so, whether Monterey Pines Investors is liable for the section 6651(a) addition to tax for the non-filing of form 1042 (U.S. annual return of income tax to be paid at source) for the years 1976 and 1977; and (9) whether petitioners Michael and Marilyn Falsetti received constructive dividends from their wholly-owned corporation, Mikomar, Inc., in the years 1977 and 1978.
Certain facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.
The following petitioners are individuals who resided in California at the time of filing of the petitions herein:
Petitioner Monterey Pines Investors (also known as Monterey Pines Investors I, a California limited partnership, hereinafter referred to as Monterey Pines Investors), is a California limited partnership with its principal place of business in California.
Monterey Pines Investors was formed in March, 1977, with Lloyd V. Biggs (Biggs) as the general partner and the individual petitioners (as well as others who are not petitioners in this case) as limited partners. The Certificate of Limited Partnership was signed on behalf of the limited partners by Biggs on March 15, 1977, and was recorded in the official records of Fresno County, California, on March 16, 1977.
The individual petitioners contributed the following amounts of cash at the time of their investment in Monterey Pines Investors:
+----------------+
¦Falsetti ¦$7,500¦
+---------+------¦
¦Cuttone ¦7,500 ¦
+---------+------¦
¦Bittner ¦7,500 ¦
+---------+------¦
¦Medefind ¦10,000¦
+----------------+
All individual petitioners made their contributions in December, 1976.
Monterey Pines Apartments (the Property) is an apartment complex located at 445 West Bullard Avenue, Fresno, California. Prior to October 21, 1976, the Property was owned jointly by Gardner Motors, Inc., Sunnyside Volkswagen, Inc. and Fresno Economy Import Used Cars (collectively referred to as the Gardner Group). The fair market value of the property on November 1, 1976, was no greater than $1,960,000.
In May, 1976, the Gardner Group entered into negotiations to sell the Property to G & G Investors for $1,880,000. G & G Investors is a California limited partnership with Daniel Grayson, Richard A. Denman and John E. Sims as general partners. A proposed purchase price of $1,869,500 was also seriously discussed as late as September, 1976. The sale of the Property to G & G Investors was never consummated.
On October 21, 1976, Thomas W. Harris, Jr. (Harris) and Donald L. Jackson formed a general partnership called ‘Jackson-Harris, Monterey Pines Investors‘ (hereinafter Jackson-Harris). One or both of the partners in Jackson-Harris borrowed $250,000 from the Bank of America (the Bank of America loan). The proceeds of this loan were contributed to Jackson-Harris as the capital contribution of one or both of the partners.
On October 21, 1976, the Gardner Group sold the Property to Jackson-Harris for $1,880,000. The Bank of America loan proceeds were used as a down payment on the Agreement of Purchase and Sale Land Contract to acquire the Property. Harris located the Property and negotiated the terms of purchase on behalf of Jackson-Harris. Jackson-Harris, the Gardner Group and G & G Investors were all unrelated parties, and negotiations were conducted at arm's length.
The Agreement of Purchase and Sale Land Contract provides for the payment of the purchase price as follows:
2. PURCHASE PRICE. Vendor agrees to sell, and Vendee agrees to buy the Project for the sum of ONE MILLION EIGHT HUNDRED AND EIGHTY THOUSAND DOLLARS ($1,880,000.00) (hereinafter ‘Purchase Price‘) lawful money of the United States, which shall be payable or evidenced as follows:
(a) The sum of TWO HUNDRED FORTY-FOUR THOUSAND AND FOUR HUNDRED DOLLARS ($244,400.00) hereinafter ‘Down Payment‘) in the form of cash, cashier's check or certified check through and at close of TITLE INSURANCE AND TRUST Escrow Number 241701-T.
(b) The sum ONE MILLION SIX HUNDRED THIRTY-FIVE THOUSAND SIX HUNDRED DOLLARS ($1,635,600.00) (hereinafter ‘Balance of Purchase Price‘) as follows:
(1) The sum of ELEVEN THOUSAND NINE HUNDRED NINETY-FOUR and 40/100 DOLLARS ($11,994.40) in monthly installments beginning December 1, 1976 and on the first (lst) day of each and every month thereafter for sixty (60) consecutive calendar months. Said sum represents interest only at eight and eight-tenths percent (8.8%) per annum on the principal balance of ONE MILLION SIX HUNDRED THIRTY-FIVE THOUSAND SIX HUNDRED DOLLARS ($1,635,600.00); and
(2) The full amount of the balance of the Purchase Price shall be paid on or before November 1, 1981 or by that date the Underlying Note (as hereinafter described) shall be assumed and the difference between the principal amount of that note and the Purchase Price shall be paid to Vendor. Vendee will assume liability for the commission to be paid to GERALD R. RODDER or nominee.
(c) In addition to the monthly payment as hereinabove provided, Vendee assumes and agrees to pay before delinquency all real property taxes and assessments, and Vendee shall reserve each...
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