Focht v. Comm'r of Internal Revenue
| Decision Date | 24 May 1977 |
| Docket Number | Docket No. 7807—73. |
| Citation | 68 T.C. 223 |
| Parties | DONALD D. FOCHT, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner transferred all of the assets and liabilities of his sole proprietorship to a corporation in exchange for all the stock of such corporation. The sum of the liabilities assumed by the corporation exceeded the total adjusted basis of the proprietorship's assets transferred. Held, an obligation to the extent that its payment would have been deductible if made by petitioner shall not, for purposes of secs. 357 and 358, be treated as a liability. Held, further, the amount of unreported rental income and various unsubstantiated deductions determined. Donald D. Focht, pro se.
Lowell F. Raeder, for the respondent.
Respondent determined a deficiency in petitioner's Federal income tax for the calendar year 1970 in the amount of $22,699.
The issues presented for decision are: (1) Whether gain is recognized under section 357(c), I.R.C. 1954, upon the transfer by petitioner, in 1970, of the assets and liabilities of his sole proprietorship to his controlled corporation; (2) whether petitioner failed to include, for his 1970 taxable year, $2,094 of receipts as rental income; and (3) whether petitioner is entitled to various deductions in excess of the amounts allowed by respondent.
Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.
Petitioner Donald D. Focht resided in Bethlehem, Pa., at the time the petition herein was filed. Prior to December 23, 1969, petitioner owned and operated a plumbing and heating service under the name of Don Focht Plumbing & Heating. This business was conducted as a sole proprietorship (the proprietorship) and operated on the cash receipts and disbursements method of accounting. On December 23, 1969, Don Focht Plumbing & Heating, Inc. (the corporation), was incorporated under the laws of the Commonwealth of Pennsylvania. During the taxable year 1970 petitioner transferred to Don Focht Plumbing & Heating, Inc., all of the assets of the sole proprietorship in exchange for all of the stock of the corporation,1 plus the assumption by the corporation of all of the liabilities of the sole proprietorship. The primary reason for the incorporation of the business was to provide petitioner with limited liability against future business hazards.
The assets transferred to, petitioner's adjusted basis therein, and the liabilities assumed by the corporation are as follows:
+-----------------------------------------------------------------------------+
¦Assets ¦ ¦ ¦Adjusted basis ¦
+-----------------------------------------+-------+----------+----------------¦
¦ ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Accounts receivable ¦ ¦$42,237.10¦0 ¦
+-----------------------------------------+-------+----------+----------------¦
¦Cash ¦ ¦959.00 ¦$959 ¦
+-----------------------------------------+-------+----------+----------------¦
¦Inventory ¦ ¦18,320.00 ¦18,320 ¦
+-----------------------------------------+-------+----------+----------------¦
¦ ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Fixed assets: ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Cost of assets ¦$39,741¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Less accelerated depreciation as of 12/31¦23,533 ¦16,188.00 ¦16,188 ¦
¦/69 ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦ ¦ ¦77,704.10 ¦2 35,467 ¦
+-----------------------------------------+-------+----------+----------------¦
¦ ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Liabilities ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦ ¦ ¦ ¦ ¦
+-------------------------------------------------+----------+----------------¦
¦Liabilities assumed by the corporation: ¦ ¦ ¦
+-------------------------------------------------+----------+----------------¦
¦Accounts payable ¦ ¦$73,729.00¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Salaries and wages paid by the ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦corporation ¦ ¦1,746.00 ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Federal income taxes payable on payroll ¦ ¦8,168.00 ¦ ¦
¦return ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦ ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Property subject to liabilities which ¦ ¦ ¦ ¦
¦were transferred to the corporation: ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Truck (Clark Sandt) ¦ ¦1,857.00 ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Auto loan (Merchant's National Bank) ¦ ¦3,479.00 ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦Total liabilities assumed by the ¦ ¦ ¦ ¦
+-----------------------------------------+-------+----------+----------------¦
¦corporation ¦ ¦88,979.00 ¦ ¦
+-----------------------------------------------------------------------------+
Therefore, the sum of the liabilities assumed by the corporation exceeded the total adjusted basis of the proprietorship's assets transferred to the corporation by $53,512. For his taxable year ended December 31, 1970, petitioner did not report any gain pursuant to the aforementioned exchange. Respondent, in his notice of deficiency dated July 27, 1973, determined that the petitioner recognized an ordinary gain in 1970 of $53,512 under section 357(c), such amount representing the excess of liabilities assumed over the adjusted basis of the assets transferred.
On his 1970 return, petitioner reported gross rental income3 of $16,694.25. Gross receipts for the year, per petitioner's rental receipt book, total $19,873.25 of which petitioner paid, to himself, $1,200. The receipts indicate petitioner's payments were for rent on apartment 5, 506 W.3d Street, petitioner's address on his 1970 return. The statutory notice increased petitioner's rental income by $2,094. We find the correct computation of unreported rental income to be $1,979 arrived at as follows:
$19,873.25-$16,694.25-$1,200=4$1,979
Petitioner took various deductions on his 1970 return which have been disallowed, in part, by respondent as follows:
+------------------------------------------------------------+
¦Deduction ¦Amount claimed ¦Disallowed 5 ¦
+---------------------------+----------------+---------------¦
¦ ¦ ¦ ¦
+---------------------------+----------------+---------------¦
¦Auto expense ¦$2,098.01 ¦$497 ¦
+---------------------------+----------------+---------------¦
¦Legal expense ¦589.63 ¦330 ¦
+---------------------------+----------------+---------------¦
¦Insurance expense ¦1,503.00 ¦703 ¦
+---------------------------+----------------+---------------¦
¦Interest expense ¦4,547.67 ¦705 ¦
+---------------------------+----------------+---------------¦
¦Open house and show expense¦910.00 ¦422 ¦
+---------------------------+----------------+---------------¦
¦Depreciation ¦2,150.00 ¦2,150 ¦
+------------------------------------------------------------+
OPINION
The primary issue for our consideration is whether the transfer of the assets and liabilities of petitioner's sole proprietorship to his wholly owned corporation constituted a taxable exchange under section 357(c).6 We have heretofore held, in a multitude of cases, that the term ‘liabilities' as used in section 357 should be given an all-inclusive meaning. These holdings have required an extremely literal interpretation of the statute and the adoption of a mechanical test. Raich v. Commissioner, 46 T.C. 604 (1966); Thatcher v. Commissioner, 61 T.C. 28 (1973), revd. in part and affd. in part 533 F.2d 1114 (9th Cir. 1976).
In Raich v. Commissioner, supra, we held that the sum of the liabilities assumed, including the accounts payable, by the corporation exceeded the basis of the assets transferred because of our conclusion that trade account receivables of the cash basis pet...
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