Gill v. Commissioner
| Decision Date | 01 March 1994 |
| Docket Number | Docket No. 20188-91.,Docket No. 20100-91. |
| Parties | Larry O. Gill v. Commissioner. Quilting Creations by D. J., Inc. v. Commissioner. |
| Court | U.S. Tax Court |
David J. Lewis and Mark J. Skakun, 50 S. Main St., Akron, Ohio, for the petitioners. Dawn Marie Krause, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined the following deficiencies in, and additions to, petitioners' Federal income tax for the taxable years indicated:
Additions to Tax
---------------------------------------------------------------
Year Section Section Section Section Section
Petitioner Ended Deficiency 6651(a)1 6653(a)(1) 6653(a)(1)(A) 6653(a)(1)(B) 6661(a)
Larry O. Gill 12/31/86 $15,617 $ -- $-- $ 781 * $ 3,904
12/31/87 26,841 1,401 -- 2,144 * 6,710
12/31/88 9,109 -- 455 -- -- 2,277
Quilting
Creations by
D.J., Inc. 4/30/86 8,371 393 -- 4,649 * --
4/30/87 34,443 8,611 -- 8,148 * 8,611
4/30/88 76,867 -- -- 3,843 * 19,217
* 50% of the interest due on the portion of the underpayment
attributable to negligence. Respondent determined that the
entire amount of each underpayment was due to negligence
The issues for decision in these consolidated cases are:
(1) Is Quilting Creations by D.J., Inc. (Quilting) entitled to certain depreciation deductions with respect to a house in Dundee, Ohio, and do certain amounts Quilting expended for that house constitute constructive dividends to Larry O. Gill (Gill)? We hold that Quilting is not entitled to those depreciation deductions and that those expenditures constitute constructive dividends to Gill.
(2) Is Quilting entitled to claim certain deductions relating to a house in Bolivar, Ohio, in excess of those allowed by respondent? We hold it is not.
(3) a. Is Quilting entitled to deduct as additional compensation certain contributions it made to Gill's individual retirement account and certain premiums it paid for life insurance policies on the lives of Gill and Debra Bell (Bell)? We hold that Quilting is entitled to deduct those amounts.
b. Are Quilting's payments of premiums on a policy insuring Bell's life includible in Gill's income as constructive dividends or additional compensation to him? We hold that they are not.
(4) Is Quilting entitled to deduct certain expenses it incurred relating to various race cars, and do those expenses constitute constructive dividends to Gill? We hold that Quilting is entitled to deduct those expenses to the extent allowed herein and that they do not constitute constructive dividends to Gill to the extent stated herein.
(5) Are petitioners liable for the additions to tax for negligence for each of the years at issue? We hold that they are to the extent stated herein.
(6) Are petitioners liable for the addition to tax for substantial understatement of income tax for each of the years at issue except Quilting's taxable year ended April 30, 1986? We hold that they are to the extent stated herein.
Some of the facts have been stipulated and are so found.
Petitioner Gill resided in Bolivar, Ohio, at the time he filed his petition. The principal place of business of petitioner Quilting at the time it filed its petition was Zoar, Ohio.
Gill married Bell in 1978. Gill and Bell separated in 1985 and divorced on January 17, 1986.
Gill has an eleventh grade education and no training or work experience in income tax matters. After Gill and Bell separated, Gill took some business classes.
Petitioners' accountant, Harry Shaw (Shaw), prepared, or at least worked on and reviewed, each of the returns filed by Gill and Quilting for each of the years at issue. Bell performed the bookkeeping for Quilting until sometime in 1986. Thereafter, Quilting hired an employee to take over the bookkeeping. During the years at issue, Gill had no role in Quilting's bookkeeping and accounting, having relied on Bell, the employee of Quilting who replaced Bell as bookkeeper, and Shaw with respect to these matters.
Bell started Quilting as a sole proprietorship in 1979. Gill originally worked in the business on a part-time basis, but was fully involved in the business by 1982. Quilting was incorporated under the laws of Ohio on August 6, 1984.
At all material times, Quilting was engaged in the design and manufacture of stencils. The stencils designed and manufactured by Quilting are used for quilts, arts and crafts, and clothing.
Prior to the time Bell and Gill separated in 1985, Bell owned the majority of the Quilting stock and made most of the business decisions relating to Quilting's operations.2 Following their separation, Gill became, and remained throughout the years at issue, the sole shareholder of Quilting. During those years, Gill was the sole officer of Quilting and was in charge of running the business.
In the early years of its operations, Quilting marketed its products directly to consumers through retail trade shows throughout the United States. By 1985, Quilting had phased out marketing its products at retail trade shows and was marketing only at wholesale trade shows where it sold its products to retailers and large corporations. During the years 1986 through 1988, Quilting attended wholesale trade shows on a worldwide basis. During those years, about 10 percent of Quilting's customers were located in Ohio.
For the years indicated, Quilting had the following amounts of total gross receipts and gross receipts from Ohio that were included in total gross receipts:
Taxable Year Gross Receipts
Ended Gross Receipts From Ohio
April 30, 1986 ...... $1,087.314 $48,000
April 30, 1987 ...... 1,423,357 60,000
April 30, 1988 ...... 1,506,630 72,000
In September 1978, Gill and Bell purchased a house in Dundee, Ohio (the Dundee house), on which they made the mortgage loan and real estate tax payments. The purchase price was $32,000. The title to, and the mortgage loan for, the Dundee house were in the name of Ruby Hostetler, Gill's mother-in-law.
When Quilting began operations in 1979, it operated out of the Dundee house. In 1983, it moved its operations to a manufacturing facility in Zoar, Ohio (the manufacturing facility). The manufacturing facility is located about 20 miles from the Dundee house. Gill found it difficult to live 20 miles away from Quilting's operations because there was a frequent breakdown of equipment at the manufacturing facility that needed repair. Consequently, in 1983, Gill and Bell moved their residence to an unused portion of the manufacturing facility.
From 1983 until its sale in April 1989, the Dundee house was used by Quilting to store materials such as cardboard and plastic. The materials stored at the Dundee house were placed on skids on the floor.
On August 13, 1986, Gill and Quilting executed a written agreement (Dundee lease), which was retroactive to December 1, 1984, under which Gill agreed to rent the Dundee house to Quilting for three years at $100 per month. The Dundee lease required Gill, as the lessor, to pay the property taxes and cost of electricity for the house. In addition, it provided that Quilting, as the lessee, was required to pay "Any damages done to building and property from any person employed by lessee". Shaw drafted and set the terms of the Dundee lease.
During Quilting's use of the Dundee house, a skylight in the house was leaking which caused a lot of damage to the house. In addition, a leak in the porch resulted in damage to the lower level of the house. During the years 1986 through 1988, Quilting incurred expenses to (1) replace the roof on the house, (2) repair the heating and plumbing systems, (3) put in new dry wall and trim molding, and (4) remove the skylight. Quilting's expenditures with respect to the Dundee house during those years were $4,710.05 $13,532.57, and $2,821.67, respectively. Quilting claimed depreciation deductions relating to those expenditures in its returns for its taxable years ended April 30, 1987, and April 30, 1988, in the amounts of $374 and $1,819, respectively.
Under the separation agreement between Gill and Bell, Gill received Bell's interest in the Dundee house. In April 1989, the Dundee house was sold for $34,000. Gill received all sales proceeds remaining after payment of closing costs and the outstanding mortgage loan balance.
On October 10, 1985, Quilting purchased a house in Bolivar, Ohio (the Bolivar house), from Freeman Hostetler, Gill's father-in-law. The purchase price was $69,000. At the time of its purchase, the Bolivar house, which is located two to three miles from the manufacturing facility, had a finished first floor and an unfinished second floor.
Sometime in 1985, Gill moved from the manufacturing facility into the Bolivar house. On August 13, 1986, Gill and Quilting executed a written agreement (Bolivar lease), which was made retroactive to October 1, 1985, under which Quilting agreed to lease the house to Gill for two years at $200 per month. The Bolivar lease required Quilting, as the lessor, to pay the property taxes and cost of electricity for the house. In addition, it provided that Gill, as the lessee, was required to pay for any damage to the property from any person he employed. Shaw drafted and set the terms of the Bolivar lease.
Gill did not pay the rent due under the Bolivar lease for any of the years at issue. For its taxable year ended April 30, 1987,...
To continue reading
Request your trial