Farr v. Comm'r of Internal Revenue

• Decision Date: 07 October 1948
• Docket Number: Docket No. 11725.
• Parties: MERTON E. FARR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

11 T.C. 552

MERTON E. FARR, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 11725.

Tax Court of the United States.

Promulgated October 7, 1948.

1. On October 14, 1938, beneficiaries of a liquidating trust of certain realty assigned to petitioner the right to receive all proceeds from the future sale of such realty in excess of $182,947.72, plus interest. The realty was sold on June 21, 1941, and petitioner's share of the proceeds was $114,878.77. He received $84,878.77 of that sum in 1941, but $30,000 was placed in escrow and not released to petitioner until 1942. Upon the facts, held, that the $114,878.77 constitutes compensation to petitioner for services rendered in behalf of the beneficiaries of the trust and is taxable as ordinary income under section 22(a), Internal Revenue Code. Of this amount only the $84,878.77 which petitioner actually received in 1941 is taxable income to him for that year.

2. Held, that it is not shown by the evidence that respondent's disallowance of deductions for certain claimed nonbusiness expenses was erroneous. Fred J. Shumann, Esq., and Robert J. Bird, Esq., for the petitioner.

Cecil H. Haas, Esq., for the respondent.

The Commissioner determined income tax deficiencies against petitioner for the taxable year ended December 31, 1940, in the amount of $31.50 and for the taxable year ended December 31, 1941, in the amount of $48,853.37. The principal question in this case arises from the different tax treatment accorded by petitioner and respondent to the sum of $114,878.77 reported by petitioner in his income tax return for 1941 as a long term capital gain received from the sale of 23 acres of industrial land located in Wyandotte, Michigan. Petitioner now contends this sum represents either a long term capital gain or, in the alternative, compensation for personal services under section 107 of the Internal Revenue Code. In any event petitioner contends that he is entitled to exclude from this income, regardless of its nature, the sum of $85,000 he invested in certain bonds used to acquire the property sold and the sum of $8,070.95 of unreimbursed advances made by him to meet carrying charges on the same property. Respondent determined the sum of $114,878.77 to be ordinary income of petitioner under section 22(a) of the Internal Revenue Code.

In addition to this major issue, an additional issue arises from the fact that the Commissioner disallowed a deduction of $795.19 for 1940 and $1,314.22 for 1941 taken by the petitioner as nonbusiness expenses under section 23(a)(2) of the Internal Revenue Code.

Such of the facts as were stipulated are so found and are incorporated herein by reference.

FINDINGS OF FACT.

Petitioner resides in Grosse Pointe, Michigan. His income tax returns for the years 1940 and 1941 were made on the cash receipts and disbursements basis. They were filed with the collector of internal revenue at Detroit, Michigan.

On January 27, 1926, petitioner secured an option for the purchase from the Detroit Ship Building Co. of certain industrial property consisting of approximately 23 acres in Wyandotte, Michigan (hereinafter referred to as the Wyandotte property).

Biddle Avenue Realty Corporation, the name of which was later changed to Biddle Avenue Corporation (hereinafter referred to as Biddle) was organized as a Michigan corporation on May 27, 1927, by petitioner and three of his sons, namely, Lee M. Farr, L. Rothe Farr, and Everett L. Farr. Petitioner gave partial interests in the above option to these three sons and then joined them in assigning the option to Biddle in exchange for 90,000 shares of capital stock of Biddle.

On June 1, 1927, Biddle exercised the option and acquired the Wyandotte property from the Detroit Ship Building Co. at a price of $350,000. Petitioner had previously advanced $50,000 as down payment on the property on June 1, 1926; the balance of $300,000 was paid by Biddle when it acquired the land.

To finance the purchase of the Wyandotte property, Biddle borrowed $300,000 on its note and issued bonds totaling $50,000. The $300,000 note was endorsed by petitioner and made payable to First National Bank of Detroit, Michigan, which loaned that amount to Biddle, and Biddle paid it to the Detroit Ship Building Co. to be applied on the purchase price. The bonds totaling $50,000 were issued to petitioner for his advance of $50,000 on the purchase price. The 90,000 shares of capital stock constituting consideration for the transfer of the option on the Wyandotte property were issued as follows:

+-------------------------+
                ¦                ¦Shares  ¦
                +----------------+--------¦
                ¦Merton E. Farr  ¦36,00   ¦
                +----------------+--------¦
                ¦Lee M. Farr     ¦18,000  ¦
                +----------------+--------¦
                ¦L. Rothe Farr   ¦18,000  ¦
                +----------------+--------¦
                ¦Everett L. Farr ¦18,000  ¦
                +-------------------------+
                

Petitioner was president and managing officer of Biddle and the above named recipients of the stock continued to be the only shareholders throughout the existence of Biddle.

Biddle financed part of the purchase price and carrying charges for the Wyandotte property by the sale of $265,000 in bonds. Petitioner purchased $85,000 of these bonds for cash. The remaining $180,000 in bonds was purchased at par for cash by members of petitioner's family. The bonds were issued in the following manner:

+------------------------------------------------+
                ¦Name of holder         ¦Date acquired ¦Par value¦
                +-----------------------+--------------+---------¦
                ¦Merton E. Farr         ¦1928-1929     ¦$85,000  ¦
                +-----------------------+--------------+---------¦
                ¦Emma R. Farr           ¦1927-1928-1929¦145,000  ¦
                +-----------------------+--------------+---------¦
                ¦Frederick T. Farr trust¦1929          ¦25,000   ¦
                +-----------------------+--------------+---------¦
                ¦Carolyn Farr Booth     ¦1928-1929     ¦10,000   ¦
                +------------------------------------------------+
                

Of the bonds held by petitioner's wife, Emma R. Farr, $50,000 worth were those bonds received by petitioner for his advance of the down payment on the Wyandotte property, and were thereafter transferred by him to his wife for cash at par. All of the bonds were thereafter held as shown, except those of Carolyn Farr Booth, a daughter of petitioner, which were transferred to petitioner on November 1, 1935, in exchange for other securities of equal value. At the time $150,000 of the $180,000 in bonds were issued to other members of petitioner's family, he made a written guaranty of their payment so long as the bonds were held by the same persons. The last payment of interest on the bonds was made by Biddle on December 15, 1931.

On September 19, 1929, petitioner executed a trust agreement for the benefit of his son, Frederick T. Farr, who was a minor until October 31, 1929, and included in the trust res bonds of Biddle in the principal amount of $25,000. Petitioner and Emma R. Farr were trustees of this trust.

On December 22, 1925, petitioner acquired an option from the Detroit Ship Building Co., for the purchase of certain property known as the Detroit Ship Building Plant. Petitioner gave partial interest in this option to his three sons, Lee M., L. Rothe, and Everett L. Farr. On October 15, 1927, for a nominal consideration of $1, the stockholders of Biddle assigned to it this option. On November 1, 1928, Biddle exercised the option to purchase the Detroit Ship Building Plant and on the same day sold the property to James S. Holden Co., from which transaction Biddle realized income of $215,000. As a part of this transaction, Biddle received notes totaling $150,000 issued by James S. Holden Co.

To provide collateral security for the payment of all its bonds, Biddle executed an ‘Indenture of Trust dated March 15, 1930,‘ to M. E. Farr, L. Rothe Farr, and Ernest Ketcham as trustees, whereby notes of James S. Holden Co. totaling $100,000, which had been delivered to Biddle as part of the purchase price of the Detroit Ship Building Plant, were deposited with the trustees. All of the notes so deposited were released by the trustees from the indenture of trust and disposed of by Biddle between June 9 and October 6, 1930.

Next an ‘Amended Indenture of Trust and Agreement dated January 4, 1934‘ was executed by Biddle and its bondholders, which recited that it modified the ‘Indenture of Trust dated March 15, 1930,‘ and constituted petitioner and his wife as successor trustees. It provided that the bonds of Biddle held by members of petitioner's family other than himself in the amount of $180,000 were to be secured by a trust mortgage on the Wyandotte property. It provided that the bonds of Biddle held by petitioner totaling $85,000 should not participate in the security afforded by such mortgage. The mortgage on the Wyandotte property constituting petitioner and Emma R. Farr as trustees was executed on January 4, 1934, and recorded on January 6, 1934. On November 1, 1935, petitioner acquired secured bonds of Biddle in the amount of $10,000 from Carolyn Farr Booth, and to that extent gained the benefit of the mortgage security.

At some time prior to June 1934 Biddle received notice of the determination of a deficiency of $18,052.68 on its Federal income tax for the fiscal year ended April 30, 1929, in connection with the realization of $215,000 of profit from the aforementioned sale of the Detroit Ship Building Plant. The matter was heard on June 5, 1935, by the Board of Tax Appeals in the case of Biddle Avenue Realty Corporation, 33 B.T.A. 1274. The Board rendered its opinion favorable to the Commissioner on September 10, 1935 (affirmed by the Circuit Court of Appeals for the Sixth Circuit, 94 Fed.(2d) 435). As a result of the Board's decision, the collector of internal revenue filed a lien on April 15, 1936, against Biddle for a deficiency in income taxes for the fiscal year ended April 30, 1929, of $15,110,35 plus interest of $5,915.39, or a total of $21,025.74.

The...