Hope v. Comm'r of Internal Revenue
| Decision Date | 22 March 1971 |
| Docket Number | 3128-69.,Docket Nos. 2258-65 |
| Citation | 55 T.C. 1020 |
| Parties | KARL HOPE AND HILDA HOPE, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Jules I. Whitman and Richard L. Levy, for the petitioners.
Dennis C. DeBerry and Howard Gordon, for the respondent.
Held: 1. The mere filing of a suit by the seller to rescind the sale of stock did not postpone the realization of taxable gain.
2. Neither the acquisition by the seller of options to purchase a part of the stock sold nor the receipt of the stock on the exercise of the options resulted in a rescission of the sale.
3. The sale did not involve a criminal appropriation of the petitioner's stock.
4. The petitioner did not restore an amount held under a claim of right when he exercised his options.
5. In the absence of a finding of theft or fraud, counsel's fees and other costs incurred by the seller did not give rise to a deduction on account of a ‘theft’ loss.
The respondent determined deficiencies in petitioners income tax as follows:
+----------------------------------------+
¦Docket No. ¦Taxable year ¦Deficiency ¦
+------------+--------------+------------¦
¦ ¦ ¦ ¦
+------------+--------------+------------¦
¦2258-65 ¦1960 ¦$991,127 ¦
+------------+--------------+------------¦
¦3128-69 ¦1961 ¦108,750 ¦
+----------------------------------------+
The deficiencies determined by the respondent in the instant case arose out of the purported sale by Mr. Karl Hope of 206,400 shares of stock of Perfect Photo, Inc., on July 27, 1960, and reflect the fact that the respondent took an inconsistent position with respect to the year of accountability for, as well as the amount of, the income realized on the sale.
The respondent conceded at trial that counsel's fees of $10,000 were deductible in 1960. The questions remaining for decision are:
(1) Whether the petitioner realized taxable gain in 1960 on account of the purported sale of 206,400 shares of stock of Perfect Photo, Inc.
(2) Whether third-party optionees in substance purchased the petitioner's stock subject to a secured loan without recourse, i.e., a mere pledge of the stock.
(3) Whether the petitioner's stock, as a result of its theft, was compulsorily or involuntarily converted.
(4) Whether it was established in a year subsequent to the sale that the petitioner did not have an unrestricted right to the sale proceeds.
(5) Whether counsel's fees and other costs were deductible in 1961.
Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. The facts necessary for our opinion are as follows:
Petitioners Karl and Hilda Hope are husband and wife. At the time of the filing of their petition, the petitioners resided in East Stroudsburg, Pa. For the taxable years here in question, calendar 1960 and 1961, the petitioners filed their joint income tax returns on the cash method of accounting with the district director of internal revenue, Philadelphia, Pa. Inasmuch as Hilda Hope is a petitioner solely as a result of the filing of a joint return, Karl Hope will hereinafter be referred to as the petitioner.
At all times material hereto, Perfect Photo, Inc. (hereinafter Perfect Photo), was a corporation organized under Pennsylvania law and engaged in the business of developing and printing of photographic film. The petitioner purchased a one-half interest in Perfect Photo in 1946. At that time Perfect Photo was engaged in the photofinishing of black and white film. About 1952, the petitioner purchased the remaining 50 percent.
In 1959, Eastman Kodak released the processing of color film. This enabled Perfect Photo to go into the business of photofinishing color film. As a result, the volume of its business increased from several hundred thousand dollars to several million dollars per annum.
The petitioner and his brother, Henry Hope, were the principal officers and directors of Perfect Photo. The petitioner was involved in the financial and management aspects of Perfect Photo's business while Henry Hope confined his activities to the technical aspects of the business.
On or about June 1, 1959, Perfect Photo employed Warren G. Grabb (hereinafter Grabb), a management engineer, as a consulting engineer. In September 1959, Grabb became vice president and director of Perfect Photo. On or about August 1959, Perfect Photo employed Harry J. Sentiff (hereinafter Sentiff), a certified public accountant, as a vice president and director. Sentiff became engaged mainly in the financial affairs of Perfect Photo, and Grabb became engaged not only in the financial affairs but also in the management of Perfect Photo.
In October 1959, a public offering was made of the stock of Perfect Photo at $14 per share. A total of 150,000 shares of the stock of Perfect Photo was sold to the public, of which 60,000 shares were sold by Perfect Photo and 90,000 shares were sold by petitioner.
Following the public sale of the stock of Perfect Photo, the petitioner told Sentiff and Grabb, among others, that he wanted to dispose of the remainder of his stock, and the petitioner did sell 3,600 shares of that stock on January 12,1960, at $37.11 per share. After the petitioner had made an unsuccessful attempt to merge Perfect Photo into another corporation and was otherwise unable to dispose of a large block of his stock, Sentiff discussed the situation with C. Clark Ambrose of Harriman Ripley & Co., Inc., of New York, now doing business as Drexel, Harriman Ripley, Inc. (hereinafter Harriman Ripley Co.). As a result of those discussions, a plan was worked out whereby Harriman Ripley Co. agreed to finance or participate in a purchase of the petitioner's stock interest in Perfect Photo which amounted to 206,400 shares, or approximately 57 percent, of the 360,000 issued and outstanding shares of Perfect Photo stock. However, Ambrose indicated that before Harriman Ripley Co. would proceed with any plan, Sentiff would have to produce written evidence of the petitioner's intention to sell his stock.
At Ambrose's suggestion, Sentiff obtained an agreement from the petitioner granting Sentiff and Grabb the right for a period of 30 days from June 15, 1960, to purchase all of the 206,400 shares of stock of Perfect Photo owned by the Petitioner for the sum of $4 million payable $10,000 upon written notice of exercise of the option on or before July 15, 1960, and the balance in cash on or before August 15, 1960.
On or about June 23, 1960, Ambrose advised Sentiff that Harriman Ripley Co. could not finance a purchase by Sentiff and Grabb because of Federal Reserve Board regulations limiting loans on securities. Ambrose proposed to Sentiff that Harriman Ripley Co. purchase the 206,400 shares of stock from the petitioner at a price of $19.38 per share for a total of $4,000,032 and give Sentiff and Grabb an option until December 31, 1961, to purchase 154,800 shares or 75 percent of the stock so acquired at the same price per share. Sentiff and Grabb also were to be given proxies to vote the 154,800 shares subject to the option.
Harriman Ripley Co. hoped to earn its profit from the 51,600 shares or 25 percent of the purchased stock that was not subject to the option. Sentiff and Grabb intended to sell part of the option to investors or underwriters and to use the net proceeds of that sale to finance the purchase of the stock subject to the remaining part of the option.
Upon reaching this agreement with Harriman Ripley Co., Sentiff thereupon advised the petitioner that Harriman Ripley Co. would purchase his stock for $4,000,032. Sentiff did not tell the petitioner at that time that he and Grabb were going to receive an option to purchase 75 percent of the stock sold to Harriman Ripley Co.
However, on or about June 25, 1960, the details of the sale and option arrangement were made known to Mr. C. Laurence Cushmore, Jr. (hereinafter Cushmore), the attorney who represented the petitioner in the sale and who was also the secretary of and a director of Perfect Photo and a partner in the law firm that was counsel for Perfect Photo. At that time, Sentiff told Cushmore that as the price of the Perfect Photo stock that was listed on the American Stock Exchange had increased substantially over the prior 10 days he and Grabb felt that some readjustment of the sale and option arrangement had to be made in fairness to the petitioner. However, when Cushmore received the first drafts of the documents of sale on July 8, 1960, he noticed that the option to purchase 75 percent of the stock ran from Harriman Ripley Co. to Sentiff and Grabb. When he asked Sentiff about this matter, he was told that the petitioner as the seller of stock could not be included as an optionee without the risk of violating the margin requirements applicable to listed securities under regulations issued by the Federal Reserve Board.
On or about July 11, 1960, Sentiff told Cushmore that Henry Hope would be included as an optionee with respect to 77,400 shares of the 206,400 shares of Perfect Photo stock that were to be sold by the petitioner to Harriman Ripley Co. This notification followed a meeting of the petitioner, Henry Hope, Sentiff, and Grabb at which the petitioner was told that Sentiff and Grabb were to benefit from the transaction and that the petitioner could not share in those benefits because of Government regulations. At that meeting it was also decided that Henry Hope would share any benefits with Sentiff and Grabb. The petitioner first became aware that Sentiff and Grabb were to be issued options to purchase 75 percent of the stock that was to be sold to Harriman Ripley Co. at this meeting which was held on or before July 10, 1960.
On July 14, 1960, stating that he understood that Henry Hope was to receive one-half of the benefits of the agreement under...
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