Harrison v. Comm'r of Internal Revenue

• Decision Date: 29 January 1973
• Docket Number: Docket Nos. 4027-70— 4030-70,4033-70,6798-70.
• Citation: 59 T.C. 578
• Parties: M. LUCILE HARRISON, ET AL.,1 PETITIONERS V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

59 T.C. 578

M. LUCILE HARRISON, ET AL.,1 PETITIONERS V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket Nos. 4027-70— 4030-70

4033-70

6798-70.

United States Tax Court

Filed January 29, 1973.

Roger C. Cohen, Thomas C. Seawell, and Frank A. Brame III, for the petitioners.

Arthur B. Bleecher, for the respondent.

Petitioners, through their subch. S corporation, Twin Lakes, owned real estate in Colorado. The corporation also owned a note with a face value of $300,000 (basis $220,000) cosigned by Mt. Elbert Plamor Ranch, Inc., and Mason. Mason was the 100-percent shareholder of Mt. Elbert, and his liability on the note was limited to the value of the capital stock owned by him in Mt. Elbert. Mason was an energetic real estate developer and petitioners relied on his ability to increase the value of the area in which Twin Lakes held property and so increase the value of their holdings in Twin Lakes. Twin Lakes purchased a $500,000 ‘key man’ life insurance policy on Mason, who was killed in a plane crash. The insurance company settled the claim for $450,000, which was paid in the nature of an interpleader. Twin Lakes, Mt. Elbert, and Mason's estate then contested their rights to the claim. Prior to trial, a settlement was reached under which Twin Lakes received all of the insurance money, while Mt. Elbert was excused from any further liability on the remaining value of the original $300,000 note. Held, Twin Lakes received the insurance proceeds by reason of the death of the insured and not as income from the compromise and settlement of a lawsuit. Held, further, Twin Lakes did not receive any of the funds in its capacity as a creditor of Mason and there is no discount income by reason of collection of the $300,000 note. Held, further, Twin Lakes is not entitled to a bad debt deduction.

FAY, Judge:

Respondent determined deficiencies in the Federal income taxes of the petitioners, as follows:

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Petitioners                           Docket    Year Deficiency Total
                                                      No
                                                              ( 1965 $17,093.69
                M. Lucile Harrison                    4027-70 ( 1966 71,618.84  $88,712.53
                                                              ( 1965 12,148.32
                Edward G. Panter and Myrtle P. Panter 4028-70 ( 1966 53,184.86  65,333.18
                                                              ( 1965 1   689.31
                Charles A. Roth and Patricia Roth     4029-70 ( 1965 4,595.43
                                                              ( 1967 59.27      5,344.01
                Estate of Everett R. Berglund
                

deceased, Virginia I. Berglund,                 ( 1965 5,436.51
                administratrix                          4030-70 ( 1966 22,155.37 27,591.88
                Henry C. Cleveland and Priscilla A.             ( 1965 9,494.33
                Cleveland                               4033-70 ( 1966 17,412.85 26,907.18
                                                                ( 1963 471.12
                Deward A. Childre and Martha J. Childre 6798-70 ( 1964 28.92
                                                                ( 1966 5,648.93  6,148.97
                Total                                                            220,037.75
                

The issues for decision are whether insurance proceeds were received by reason of the death of the insured and excludable under section 101(a), I.R.C. 1954, ² or as income from the compromise and settlement of a lawsuit; further, whether any amount of such proceeds was received by petitioners' corporation in its capacity as a creditor of the insured; and finally, whether petitioners are entitled to a bad debt deduction.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.

All petitioners, with the exception of Deward A. Childre and Martha J. Childre, resided in Colorado when the petitions were filed. Their Federal income tax returns for all years in controversy were filed on the cash basis of accounting with the district director of internal revenue, Denver, Colo.

Petitioners Deward A. Childre and Martha J. Childre resided in Texas when their petition was filed. Their Federal income tax returns for all years in controversy were filed on the cash basis of accounting with the district director of internal revenue, Dallas, Tex. Petitioners Myrtle P. Panter, Patricia Roth, Priscilla A. Cleveland, and Martha J. Childre are parties only by reason of having filed joint income tax returns with their respective husbands.

In 1961, M. Lucile Harrison, Edward G. Panter, Charles A. Roth, Henry C. Cleveland, and Everett R. Berglund formed a partnership called Debentures Associates (hereinafter referred to as the partnership). The partnership in March 1962 caused to be formed a Colorado corporation named Twin Lakes Land & Cattle Co., Inc., which served solely as a nominee corporation to hold title to various of the partnership's investment properties. In January 1964, Twin Lakes Land & Cattle Co., Inc.‘s, name was changed to Twin Lakes Corp. (hereinafter referred to as Twin Lakes), and at or about the same time the partners of Debentures Associates transferred their partnership interests to Twin Lakes in a tax-free exchange for all the common stock of the corporation. Accordingly, Twin Lakes then ceased to be a nominee corporation and became an operating corporation. The original stockholders continued to own in varying percentages all of the shares of Twin Lakes during all the years in question (except that in 1966 petitioner Deward A. Childre purchased the stock of petitioner Charles A. Roth).

Petitioners were, during one or more of the taxable years in issue, shareholders in Twin Lakes. Their holdings and dates of acquisition and disposition of Twin Lakes' stock are stipulated.

Twin Lakes was a subchapter S corporation pursuant to section 1371 et seq. of the Internal Revenue Code of 1954 throughout 1965 and 1966.

Chester M. Mason (hereinafter referred to as Mason) owned 100 percent of the stock of Mt. Elbert Plamor Ranch, Inc. (hereinafter referred to as Mt. Elbert), from its inception until the time of his death.

On August 15, 1961, Mt. Elbert entered into an agreement to purchase approximately 540 acres, all of which were a part of the Hayden Ranch. The essence of this agreement was that Mason and Mt. Elbert were to deliver a $300,000 promissory note (Mason's note) to the sellers of the aforementioned portion of the Hayden Ranch and then Mason was to develop and subdivide the property in question. The note was to be paid off from the proceeds generated by the subdivision and sale of the property. The agreement originally provided that 50 percent of the total amounts collected from the sale of certain lots would be paid to the sellers.³ Mt. Elbert and Mason cosigned the $300,000 non-interest-bearing promissory note. The note had a maturity date of December 31, 1969. Even though Mason cosigned the note, the agreement specifically provided that Mason's individual liability on the note was limited to the value of the capital stock owned by him in Mt. Elbert.

The agreement in pertinent part reads as follows:

As collateral security for the payment of said note, Mason shall pledge and deliver to first parties all of the capital stock of the corporation issued to him, it being expressly understood and agreed that Mason's individual liability as a co-maker of said note shall be limited to the extent of the value of said stock. When said promissory note has been paid in full according to its terms, then all of said stock shall be returned to Mason free and clear of any and all encumbrances thereon.

It is agreed that in the event the corporation shall fail to pay said promissory note according to its terms, or in the event the corporation shall violate any of the terms or conditions of this agreement, then in that event first parties may, at their option, elect to foreclose said capital stock and retain the same as their sole and separate property. In the event first parties elect to retain said stock, the fair market value of said stock at the time of such default shall be determined by the certified public accountant then retained by the corporation and his determination shall be conclusive. In the event the value of said stock as so determined is not sufficient to satisfy the said promissory note in full, then first parties may, at their option, retain said stock and the said fair market value as determined shall be applied against the unpaid principal balance of said promissory note, and the corporation (but not Mason) shall be liable for any deficiency. * * * (Emphasis added.)

The petitioners' partnership was originally formed in 1961 to purchase stocks and bonds. In 1962 the partners became interested in investing in real estate and the partnership initially acquired four parcels of property in the Leadville, Colo., area. One of the acquired properties was the balance of the Hayden Ranch. On or about June 1, 1962, the partnership acquired the remaining portion of the Hayden Ranch and Mason's $300,000 promissory note both for a total consideration of $450,000. On its books and records, the partnership allocated $220,000 of the purchase price to the promissory note having a face value of $300,000 and $230,000 to the ranchland. The amount of $220,000 is stipulated to be the cost basis of the note.

The partners' original intent in acquiring the ranches was to perfect, by litigation, the water rights attaching to the properties and to sell off the perfected water rights at a profit. The ranches were then to be used for limited agricultural purposes. Three real estate brokers were to participate in the costs of the litigation involved in perfecting title to the water rights. These brokers were unable to pay their share of the expenses, and the partnership bought out the brokers' interests. After this chain of events, the partners, who were aware of Mason's plan to subdivide and develop his half of the ranch, decided to hold their property for sale in...