Gleason v. Commissioner
| Decision Date | 11 September 2006 |
| Docket Number | Docket No. 18377-04. |
| Citation | 92 T.C.M. 250 |
| Parties | Thomas and Janice Gleason, v. Commissioner. |
| Court | U.S. Tax Court |
John W. Stevens, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiencies and penalties with respect to petitioners' Federal income taxes:
Year Deficiency Penalty Sec. 6662, I.R.C
1994 $18,583 $3,717
1995 663,679 132,736
After concessions, the principal issues for decision are:
(1) Whether petitioners' income for 1995 and 1996 should be increased on account of (a) their pro rata share of ordinary income from various S corporations and/or (b) property distributions from certain of the S corporations.
(2) Whether losses claimed by petitioners with respect to their interests in two of the S corporations, Alofs Manufacturing Co. (Alofs) and Target Components, Inc. (Target), should be adjusted for the years 1994 and 1995. Subsumed in this question is the proper computation of petitioners' bases in their Alofs and Target stock.
(3) Whether petitioners are liable for the section 6662 accuracy-related penalty for 1994 and 1995.1 Certain additional adjustments, e.g., to itemized deductions and exemption amounts, are computational in nature and will be resolved by our holdings on the foregoing issues.
Some of the facts have been stipulated and are so found. The stipulations of the parties, with accompanying exhibits, are incorporated herein by this reference. To facilitate disposition of the above issues, we shall first set forth general findings of fact and then, where appropriate, make additional findings in conjunction with our analysis of and opinion on discrete issues.
Petitioners Thomas and Janice Gleason (individually referred to as Mr. Gleason and Mrs. Gleason, respectively) are husband and wife. On the petition filed in this case, petitioners stated that their mailing address was in Kentwood, Michigan, and their legal residence was in Long Beach, Mississippi.
The principal issues in this case revolve around Mr. Gleason's involvement with various S corporations.2 In 1987, Mr. Gleason purchased 35 percent of Target, a metal-stamping business, for an initial investment of $35,000. Then, in 1992, Mr. Gleason invested $50,000 in each of two related S corporations, Alofs and Excellence Manufacturing, Inc. (Excellence), in exchange for interests of 20 percent. Alofs, like Target, was a metal-stamping business, and Excellence was a seat assembly business. All three companies were engaged in supplying components to major automobile manufacturers. Mr. Gleason served as president of each of these corporations and dealt with operational aspects. A common group of investors and/or officers was involved with each of the three companies (as well as with other entities not directly relevant to the instant litigation), operating to an extent not clearly explained by the record under the name M/IC Partnership.
During late 1994, some shareholders in the companies became interested in restructuring or monetizing their interests to take advantage of anticipated consolidation in the automotive supply industry. Ernst & Young LLP (E&Y) was engaged to advise on possible transactions. Based on cashflow statements and projections prepared by E&Y, Mr. Gleason ultimately agreed to participate in a leveraged buyout (LBO) transaction whereby through exchange of his Excellence shares and the assistance of outside financing, he purchased all or most of Alofs and Target from the other investors. The transaction closed in late 1995.
In connection with this transaction, Mr. Gleason as "Borrower" on December 20, 1995, executed an agreement for a term loan or loans (hereinafter referred to in the singular) from Comerica Bank (Comerica) in the aggregate amount of $6 million. The agreement contained a statement that "The proceeds of the Loan will be used for the following business purpose or purposes and no other: TO PURCHASE COMMON STOCK OF ALOFS MANUFACTURING COMPANY AND TARGET COMPONENTS, INC." On the same date, Mr. Gleason as "Pledgor" also executed a pledge agreement in favor of Comerica to secure the $6 million loan. He therein pledged as collateral 770.528 shares of Alofs and 350 shares of Target. The pledge agreement entitled petitioner to receive cash dividends and distributions arising from the collateral so long as no default on the attendant loan had occurred. In the event of a default, the pledge agreement afforded Comerica broad rights with respect to the collateral and any proceeds thereof.
The previous day, on December 19, 1995, Comerica had issued an irrevocable standby letter of credit addressed to named beneficiary M/IC Partnership and stating as follows: "WE HEREBY OPEN OUR IRREVOCABLE STANDBY LETTER OF CREDIT NO. 531075 IN YOUR FAVOR, FOR ACCOUNT OF THOMAS E. GLEASON, * * * FOR A SUM NOT EXCEEDING SIX MILLION AND 00/100'S U.S. DOLLARS AVAILABLE BY YOUR DRAFT AT SIGHT ON COMERICA BANK".
By January of 1996, neither Alofs nor Target could make their debt payments and payroll. E&Y's asset accounting and cashflow analysis had incorporated substantial errors. Mr. Gleason informed Comerica of these developments in mid-January, and Comerica at that time began sweeping accounts held at the bank for payments on notes relating to the entities, including the $6 million note executed by Mr. Gleason and referenced above.
Both Alofs and Target filed for bankruptcy on October 30, 1996, and were completely liquidated in May of 1997. During the course of the bankruptcy proceedings, in late 1997, Comerica agreed to settle "any and all claims for avoidable transfers, whether based upon allegations of fraudulent conveyance, preferential transfer or otherwise" by paying a lump sum of $1,125,000 and funding an "LBO Litigation Fund" in an amount not to exceed $500,000. Thereafter, in May of 1999, Mr. Gleason and the bankruptcy trustee for Alofs and Target executed a settlement agreement and mutual release of claims related to the bankruptcy, wherein Mr. Gleason also released to the trustee all potential claims against other former shareholders in the entities.
Prior to the foregoing settlement, beginning in December of 1997, Mr. Gleason had communicated with the law firm of Miller, Canfield, Paddock and Stone, P.L.C. (Miller, Canfield), with respect to possible representation of Mr. Gleason on any claims that he might have had against E&Y and other former shareholders in connection with the LBO transaction. In a letter dated December 15, 1997, the firm expressed a willingness to explore the possibility of representing Mr. Gleason but noted that the firm's provision of legal services to Comerica in the LBO transaction could present conflict issues. A series of meetings and discussions between Mr. Gleason and attorneys from Miller, Canfield took place over at least the next several months and were documented by Mr. Gleason in contemporaneous notes. The final entry, dated March 10, 1998, read:
TALKING W/ COMERICA ABOUT PARTNERING & NOT GETTING
For tax reporting purposes, Target, Alofs, and Excellence utilized a fiscal year running from October 1 through September 30. The record contains copies of Schedules K-1, Shareholder's Share of Income, Credits, Deductions, etc., prepared for Mr. Gleason by Target for the fiscal years ending (FYE) 1990 through 1994 and 1996, by Alofs for FYE 1995 and 1996, and by Excellence for FYE 1994 through 1996. The Schedules K-1 reflect the following amounts as Mr. Gleason's pro rata share of ordinary income (loss), of interest income, and of "Property distributions (including cash) other than dividend distributions reported to you on Form 1099-DIV":
TARGET
Ordinary Income Property
FYE (Loss) Interest Income Distributions
1990 $5,675 $3,366 --
1991 101,485 2,670 --
1992 (42,242) 2,694 $36,400
1993 113,311 7,035 --
1994 245,886 14,825 206,663
1995 -- -- --
1996 (2,893,326) -- --
ALOFS
Ordinary Income Property
FYE (Loss) Interest Income Distributions
1995 $470,814 -- $237,000
1996 (2,518,616) -- 344,082
EXCELLENCE
Ordinary Income Property
FYE (Loss) Interest Income Distributions
1994 $312,699 $ 5,260 $140,000
1995 807,012 19,725 360,200
1996 257,328 7,043 196,000
The Schedules K-1 for Target and Alofs for 1996 contain handwritten notations suggesting that these schedules are amended documents and that originals reflected ordinary income (loss) of ($800,000) and zero, respectively. Likewise, on certain copies of the Schedule K-1 from Excellence for FYE 1996, the property distribution amount of $196,000 is circled and marked with the handwritten notation "NEVER PAID".
Petitioners filed original joint Forms 1040, U.S. Individual Income Tax Return, for their 1993, 1994, 1995, and 1996 taxable (calendar) years in August of 1994, October of 1995, May of 1998, and October of 1997, respectively. They reported thereon adjusted gross income, taxable income, and total tax as set forth below:
Adjusted Gross
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