Gamman v. Comm'r of Internal Revenue, Docket Nos. 5268-64
| Decision Date | 04 April 1966 |
| Docket Number | 3763-65,5270-64,3877-65.,Docket Nos. 5268-64 |
| Citation | 46 T.C. 1 |
| Parties | W. C. GAMMAN AND HARRIETT GAMMAN, ET. AL.,1 PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Roger E. Lageschulte, Warren V. Clodfelter, and Richard F. Kroetch, for the petitioners.
Richard G. Daly, for the respondent.
Held, prorata advances by the two equal stockholders of a corporation far in excess of their contributions to the corporation for stock were placed at the risk of the business and had the characteristics of equity capital. Held, further, the notes issued by the corporation to the stockholders as evidence of their advances to the corporation did not constitute a second class of stock so as to disqualify the corporation as an electing ‘small business corporation’ under subchapter S of the 1954 Code.
Respondent determined deficiencies in petitioners' income taxes and an addition to tax, as follows:
+-----------------------------------------------------------------------------+
¦Docket ¦Petitioner ¦Year ¦Deficiency¦Addition to ¦
+-------+----------------------------------+-----+----------+-----------------¦
¦No. ¦ ¦ ¦ ¦tax, sec. 6651 ¦
¦ ¦ ¦ ¦ ¦2 ¦
+-------+----------------------------------+-----+----------+-----------------¦
¦ ¦ ¦( ¦$2,997.29 ¦ ¦
¦ ¦ ¦1958 ¦ ¦ ¦
+-------+----------------------------------+-----+----------+-----------------¦
¦5268-64¦W.C. Gamman and Harriett Gamman ¦( ¦3,238.11 ¦ ¦
¦ ¦ ¦1959 ¦ ¦ ¦
+-------+----------------------------------+-----+----------+-----------------¦
¦ ¦ ¦( ¦1,271.55 ¦ ¦
¦ ¦ ¦1962 ¦ ¦ ¦
+-------+----------------------------------+-----+----------+-----------------¦
¦3763-65¦W.C. Gamman and Harriett Gamman ¦1961 ¦6,800.00 ¦ ¦
+-------+----------------------------------+-----+----------+-----------------¦
¦5270-64¦David M. Reese and Dorothy Ione ¦( ¦3,127.18 ¦ ¦
¦ ¦Reese ¦1960 ¦ ¦ ¦
+-------+----------------------------------+-----+----------+-----------------¦
¦ ¦ ¦( ¦5,971.24 ¦$1,492.81 ¦
¦ ¦ ¦1961 ¦ ¦ ¦
+-------+----------------------------------+-----+----------+-----------------¦
¦3877-65¦David M. Reese and Dorothy Ione ¦1962 ¦8,240.81 ¦ ¦
¦ ¦Reese ¦ ¦ ¦ ¦
+-----------------------------------------------------------------------------+
In his answer filed in docket No. 5268-64 respondent claimed increased deficiencies for the years 1958 and 1962 in the amounts of $3,600.44 and $11,579.35, respectively. In his answer filed in docket No. 5270-64 respondent claimed an increased deficiency in tax and addition to tax for the year 1961 in the amounts of $18,402.52 and $4,600.63, respectively.
All issues in all docket numbers have been agreed upon by the parties except one, common to all docket numbers, which is whether Century House, Inc., a corporation in which Gamman and Reese were equal owners of all the outstanding stock, qualified as a ‘small business corporation’ under subchapter S (secs. 1371-1377), I.R.C. 1954, the underlying issue being whether purported loans to the corporation by the stockholders constituted a second class of stock. Respondent raised this issue in his answers filed in docket No. 5268-64 () and docket No. 5270-64 (), and in his notices of deficiency in docket No. 3763-65 (Gamman for 1961) and docket No. 3877-65 (Reese for 1962). All because of the posture of the pleadings and its effect on the burden of proof the Court agreed to decide the issue without reliance on the burden of proof.
W. C. Gamman (referred to herein as Gamman) and Harriett Gamman, husband and wife residing in Seattle, Wash., filed joint income tax returns for the years 1958, 1959, 1961, and 1962 with the district director of internal revenue, Tacoma, Wash.
David M. Reese (referred to herein as Reese) and Dorothy Ione Reese were husband and wife residing in Seattle, Wash., during the years here involved, and filed joint income tax returns for the years 1960, 1961, and 1962 with the district director of internal revenue, Tacoma, Wash.
Century House, Inc. (referred to herein as Century House), filed U.S. Small Business Corporation returns for the years 1961 and 1962 with the district director of internal revenue, Tacoma, Wash.
In 1959 plans were under discussion to hold a World's Fair in Seattle. The discussions indicated that the fair would open in the spring of 1961 and continue throughout the warm weather seasons of both 1961 and 1962. One concern was whether there were adequate lodging facilities in Seattle for the anticipated tourists. This gave Gamman, Reese, and William L. Hiller the idea of building a motel near the proposed site of the fair. A contract to purchase land for this purpose was entered into in April 1959. Century House was incorporated under the laws of the State of Washington as the vehicle to build and operate this motel.
The articles of incorporation for Century House were filed with the secretary of state of Washington on October 15, 1959, and were general in nature. The authorized capital stock of the corporation was 500 shares of stock having no-par-value, and the amount of paid-in capital with which the corporation was to begin business was stated to be $500. The articles of incorporation had not been amended prior to the end of the years here involved and the corporation was not authorized to issue a second class of stock.
On October 21, 1959, each of the three original stockholders, Gamman, Reese, and Hiller, paid $200 to the corporation for capital stock and also advanced the corporation $5,333.33 in return for demand notes bearing 6-percent interest. Each of the three stockholders also advanced to the corporation $2,500 in cash on November 13, 1959, and $1,500 in cash on December 11, 1959, and received in return demand notes of the corporation in like amounts bearing 6-percent interest. By the close of 1959 the advances of the stockholders totaled $28,000.
In January 1960 the corporation bought the stock owned by Hiller for $200 and paid off his advances without interest. Since that time Gamman and Reese each owned one-half of the outstanding stock of Century House and were its principal officers and directors.
The expense of organizing the corporation was $1,404.05. On October 21, 1959, Century House acquired the land for the motel for $114,400 under a real estate contract which provided for $20,000 to be paid in cash by closing and the balance to be paid on or before November 1, 1962. The sellers agreed that if buyer obtained a first mortgage construction loan for building an apartment motel on the property they would subordinate their real estate contract to the construction loan and take a second mortgage on the property as security for the unpaid balance of the purchase price. All three original stockholders and their wives guaranteed performance of the real estate contract and the second mortgage. Soon thereafter construction of a motel was commenced on the property with funds advanced by the stockholders.
On February 25, 1960, Century House received a construction loan from Securities Mortgage Co. in the amount of $412,000, secured by a first mortgage on the property. A commitment for a take-out loan in the amount of $400,000 had been arranged with a life insurance company for permanent financing of the project. However, this proved to be insufficient in amount and the loan was never consummated. On January 12, 1961, Century House borrowed $175,000 from an outside lender, secured by a third mortgage on the property, on which petitioners became personally liable. On January 1, 1962, Century House borrowed $95,000 from Securities Mortgage Co. to partially refinance the construction loan. The petitioners were personally liable on this loan and it was secured by mortgages on their personal residences.
On January 16, 1962, Century House borrowed $600,000 from Fidelity Savings & Loan Association which was used to pay off the construction loan and the second mortgage. This loan, which was intended to be the permanent financing of the project, was secured by a first mortgage on the property and, in accordance with the standard policy of the lender in lending money to closely held corporations, the petitioners were personally liable for payment of the loan. The loan was conditioned upon the borrower adding a restaurant, laundry, and bar to the motel, which was done by the end of 1962.
Petitioners originally intended and hoped to obtain 100-percent permanent financing of the project from outside sources, and hoped to recover their advances to the corporation from such financing and the anticipated profits from operation of the motel. When petitioners first conceived the idea of building the motel construction funds were readily available in the Seattle area at a reasonable cost and, because of the usual increment in value of property after it was improved and anticipated high earnings from operations during the fair, some builders were able to finance their housing projects to the extent of 100 percent of cost. Petitioners originally hoped to operate the motel profitably for the 2 years the fair was supposed to be in operation and then sell out at a profit. The...
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