Harrison v. Commissioner
| Decision Date | 28 April 1981 |
| Docket Number | 1519-78,Docket No. 1518-78,1520-78. |
| Citation | 41 TCM (CCH) 1384,1981 TC Memo 211 |
| Parties | John M. Harrison and Jane M. Harrison, et al. v. Commissioner. |
| Court | U.S. Tax Court |
John T. Suter, for the petitioners. Robyn R. Jones, for the respondent.
Memorandum Findings of Fact and Opinion
The Commissioner determined the following deficiencies in the Federal income tax of the petitioners:
Taxable
Petitioner Year Ending Deficiency
John M. & Jane M.. 12/31/73 $3,886.05
Harrison ....... 12/31/74 876.16
John R. & Carolyn 12/31/73 7,151.84
Harrison ....... 12/31/73 999.75
Harrison Farms, 1/31/74 997.56
Ltd. ........... 1/31/75 3,733.57
The issues are:
(1) whether the assumption by petitioner Harrison Farms, Ltd. (HFL) of two $10,000 notes owed by petitioner John R. Harrison (John) was for a "bona fide business purpose" within the meaning of section 357(b) (1) (B), Internal Revenue Code of 19542;
(2) whether the Harrisons may exclude from their gross incomes, pursuant to section 119, any part of the cost of groceries purchased by HFL for the consumption of themselves and other farm employees;
(3) whether HFL may deduct, pursuant to section 162(a), the cost of the groceries referred to in (2) above;
(4) whether the Harrisons may exclude from their gross incomes, pursuant to section 119, the cost of utilities and telephone service purchased for their personal residences by HFL; and
(5) whether HFL may deduct, pursuant to section 162, the cost of the utilities and telephone service referred to in (4) above.
Findings of Fact
Some of the facts have been stipulated. The stipulation of facts together with the exhibits attached thereto are incorporated herein by this reference.
At the time their petitions herein were filed, the Harrisons resided in, and HFL had its principal place of business at, Nickerson, Kansas.
HFL was organized by the Harrisons under the laws of the State of Kansas on April 26, 1973, to carry on the business of grain and dairy farming. At the time of incorporation, John M. (Mike) and Jane M. (Jane) Harrison transferred property to HFL in exchange for 524 shares of HFL common stock. Mike and Jane also transferred to HFL in this transaction $19,500 in liabilities which HFL assumed. The parties agree that there was a valid business purpose for HFL's assumption of these liabilities and the tax consequences of this assumption are not in issue.
In exchange for her transfer of property to HFL at the time of incorporation, Carolyn Harrison (Carolyn) received 35 shares of HFL common stock and 600 shares of HFL preferred stock. In exchange for his transfer of property to HFL at the time of incorporation, John Harrison (John) received 600 shares of HFL common stock and 1,603.44 shares of HFL preferred stock. He also transferred $20,000 of his personal liabilities to HFL at this time, which HFL assumed. The $20,000 of liabilities arose as described below.
On May 30, 1971, Delvin Randolph (Delvin), John's son-in-law, executed a note payable to John Harrison for $30,000 (hereinafter the Delvin Randolph note). In exchange for this note, John gave Delvin $30,000 in the form of two checks, one dated April 16, 1970, for $3,000, and the second dated May 24, 1971, for $27,000.
In conjunction with the loan to Delvin, John borrowed $27,000 from the Central State Bank in Hutchinson, Kansas, on May 24, 1971 (hereinafter the Central State Bank note). On July 20, 1971, John Harrison paid $5,000 on the principal of this note. He renewed it for $22,000 on November 24, 1971. He made a further principal payment of $12,000 on May 16, 1972, leaving a balance of $10,000. He renewed the note on this date and again on November 16, 1972.
To secure his note to John, Delvin and his wife executed a real estate mortgage to John on March 30, 1973. Delvin purchased the real property subject to the mortgage with the $30,000 he borrowed from John on May 30, 1971, for use in his own farming operation. Delvin was not involved in the operation of HFL. He was not a shareholder, officer, or employee of HFL.
On May 1, 1973, HFL assumed the remaining balance of $10,000 on the Central State Bank note of May 24, 1971. This note represented part of the $20,000 of John Harrison's liabilities which HFL assumed at the time it was incorporated. John did not transfer to HFL the Delvin Randolph note of May 30, 1971, or the mortgage securing it.
On February 21, 1973, Delvin borrowed $10,000 from John by executing a note payable bearing the same date. As security for this note, Delvin gave John a security interest in forty head of cattle which he purchased with the loan proceeds.
In conjunction with the loan to Delvin on February 21, 1973, John borrowed $10,000 from the Nickerson State Bank on February 22, 1973. HFL assumed this note on May 1, 1973. The note represented the remainder of the $20,000 of John's liabilities which HFL assumed at the time of its incorporation. John did not transfer to HFL the note of February 21, 1973, or the security interest in the forty head of cattle.
John transferred the Central and Nickerson State Bank notes to HFL because he was transferring all of his assets to HFL and accordingly was not sure that he would be capable of repaying these notes, and because he thought they belonged there. He failed to transfer the notes receivable from Delvin to HFL because he forgot. He lent Delvin $10,000 in 1973 because the latter was financially overextended and unable to borrow money directly from a bank.
After the transfer of property, liabilities, and stock described above, HFL owned 1,131 acres of farm land on which the two separate residences of John and Carolyn Harrison and Mike and Jane Harrison were and are located.
At all relevant times, the Harrisons were officers of HFL. On July 31, 1973, the board of directors adopted a resolution stating that HFL is authorized to pay for the meals and lodging of its employees who were also its officers. The resolution states that in return the officer/employees are required to maintain their residences on the farm and to remain on call for the convenience of HFL to handle corporate problems and emergencies.
The nature of the operation of HFL during the years in question required constant supervision and availability of personnel on a 24-hour basis to deal with varied and unpredictable farm problems.
During the years in question, HFL had 1,000 acres under cultivation, leased 80 acres, and had 131 acres devoted to raising and maintaining 200 head of cattle, of which 70 to 80 were milk cows.
The scale of its operations was beyond the capabilities of one man and woman to manage adequately.
The Harrisons were all employees of HFL. The men were in charge of the general management of HFL's operation. The women performed farm chores and managed the households. It was part of their duties as corporate employees to purchase groceries, prepare meals, and serve these meals to themselves, their husbands, and the HFL employees who worked on the farm during the summers. During their taxable years 1973 and 1974, the Harrisons received salaries from HFL as follows:
Petitioner Salary Received
1973 1974
John R. Harrison ......... $7,200 $17,500
Carolyn Harrison ......... 800 4,000
Mike Harrison ............ 7,200 17,500
Jane Harrison ............ 800 4,000
During 1973 and 1974, John and Mike started work on a typical day at around 5:30 a.m. and were finished by 6:30 p.m. in the winter and somewhat later in the summer.
In 1973 and 1974, Carolyn Harrison purchased groceries with John's and her own funds and submitted receipts for the groceries to HFL, which reimbursed them. In 1973 and 1974, Jane Harrison purchased groceries by writing checks on HFL's account.
For the year ending January 31, 1974, HFL paid $2,428.22 for groceries purchased by the Harrisons. HFL deducted this amount as a business expense on its corporate income tax return. For the year ending January 31, 1975, HFL paid $4,219.84 for groceries purchased by the Harrisons. HFL deducted this amount as a business expense on its corporate income tax return.
The groceries were prepared into meals by the wives. The meals were consumed both by the Harrisons and by the summer help who, due to the nature of their work, were required to eat some meals at the farm. The meals were all served and consumed on the farm.
HFL paid the electric, gas, and telephone bills for the residences of the Harrisons for 1973 beginning May 26, 1973, and for 1974. No allocation of the telephone cost was made between personal and business use.
HFL paid $1,060.58 for utilities and telephone service for the year ending January 31, 1974, and $1,506.19 for these items for the year ending January 31, 1975. HFL deducted these amounts on its corporate income tax returns for these fiscal taxable years.
Mike and Jane Harrison filed joint Federal income tax returns for their taxable years 1973 and 1974 with the Internal Revenue Service Center, Austin, Texas. They did not report as income any of the costs of groceries, utilities, or telephone service paid by HFL and consumed by them in 1973 and 1974.
John and Carolyn Harrison filed their joint Federal income tax returns for their taxable years 1973 and 1974 with the Internal Revenue Service Center, Austin, Texas. They did not report as income either the $20,000 of John Harrison's liabilities assumed by HFL in 1973 or the cost of groceries, utilities, or telephone service paid for by HFL and consumed by them in 1973 and 1974.
HFL filed its corporate income tax returns for its fiscal years ending January 31, 1974 and 1975 with the Internal Revenue Service Center, Austin, Texas. It claimed on these returns the deductions for groceries, utilities, and telephone service described above.
The Commissioner...
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