In re Estate of Johnson

• Decision Date: 29 January 1987
• Docket Number: Docket No. 18799-85.
• Citation: 88 T.C. 225,88 T.C. No. 14
• Parties: ESTATE OF KEITH WOLD JOHNSON, DECEASED, SEYMOUR M. KLEIN, BETTY W. JOHNSON, AND ROBERT J. MORTIMER, EXECUTORS, Petitioner
• Court: U.S. Tax Court

88 T.C. 225

88 T.C. No. 14

ESTATE OF KEITH WOLD JOHNSON, DECEASED, SEYMOUR M. KLEIN, BETTY W. JOHNSON, AND ROBERT J. MORTIMER, EXECUTORS, Petitioner

Docket No. 18799-85.

United States Tax Court

Filed January 29, 1987.

1. Decedent guaranteed a loan from a Bank to a corporation of which he was majority shareholder and assigned insurance policies on his life as collateral. Decedent died before the notes were repaid; the bank collected $4.2 million in insurance proceeds, and assigned the notes to P (decedent's estate). P and R entered into a Closing Agreement pursuant to section 7121 setting the value for estate tax purposes and the unadjusted basis for income tax purposes of P's subordinated rights in the notes as of the date of decedent's death at $600,000.00. The notes were repaid in full in 1980 and 1981 and P reported capital gains. P subsequently claimed an increased basis in the notes of $4.2 million, claiming that it constructively received the insurance proceeds and transferred them to the Bank in exchange for the notes. P filed amended returns for 1980 and 1981 claiming refunds of capital gains taxes paid. HELD, P's claim of increased basis in the notes contradicts the position P agreed to in entering into the Closing Agreement and, having entered into that agreement, P is bound by it. P, therefore, correctly reported capital gains on its 1980 and 1981 income tax returns.

2. P has five beneficiaries, each entitled to 20 percent of the residuary estate. One beneficiary is the estate of decedent's brother Willard. Willard's estate and P have the same executors and accountants. Due to numerous contingent liabilities and other contingencies, P was not prepared to distribute its assets as of the close of 1981. The executors of P and Willard's estate decided, however, that they could transfer a 20 percent share of P's income to Willard's estate each year by making book entries, but without any actual transfer of funds. P claimed deductions for distributions to Willard's estate in the amounts credited on the accountants' work papers, for the estates' fiduciary income tax returns. HELD, the funds credited on the accountants' work papers were not allocated to Willard's estate beyond P's recall and P, therefore, is not entitled to deductions for them. Milton Gould and Allan Parker, for the petitioner.

Lawrence Blaskopf and John Becker, for the respondent.

WILLIAMS, JUDGE:

The Commissioner determined deficiencies in petitioner's Federal income tax for the taxable years 1980 and 1981 as follows:

+----------------+
                ¦Year¦Deficiency ¦
                +----+-----------¦
                ¦1980¦$269,963   ¦
                +----+-----------¦
                ¦1981¦109,165    ¦
                +----------------+
                

Petitioner claims an overpayment in Federal income tax in the amounts of $712,045.00 for 1980 and $93,198.00 for 1981. The issues for decision are (1) whether petitioner correctly reported capital gains realized from its collection on certain notes in 1980 and 1981; and (2) whether petitioner properly deducted as income distributions in 1980 and 1981 amounts credited to the Estate of Willard T.C. Johnson.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. Petitioner is the Estate of Keith Wold Johnson (sometimes hereinafter referred to as ‘decedent's estate‘). Petitioner's address was New York, New York at the time its petition was filed. Petitioner timely filed fiduciary income tax returns for the taxable years 1980 and 1981.

Decedent, Keith Wold Johnson, was majority shareholder of American Video Corporation (‘AVC‘) at the time of his death. Toward the end of 1974, AVC required additional funding and sought a loan from the Union Commerce Bank of Cleveland (the ‘Bank‘). The Bank agreed to loan the money to AVC only if decedent personally guaranteed the loan and assigned a life insurance policy on his life to the bank as collateral.

To induce decedent to enter into a guarantee agreement with the Bank, AVC entered into an indemnity agreement with decedent on December 6, 1974. Decedent subsequently entered into a guarantee agreement with the Bank. In accordance with the terms of the guarantee agreement decedent purchased two adjustable term life insurance policies on his life from the Occidental Life Insurance Company of California (Occidental) in the total amount of $7,000,000.00. Decedent designated the Bank as beneficiary on the policies ‘as their interest may appear, balance, if any to the Estate of the insured.‘ Both policies were issued on February 1, 1975, and assigned to the Bank as collateral security for the loans to AVC. If decedent were to die before the AVC notes were repaid, the guarantee agreement provided that the Bank would receive the proceeds from the insurance policies and assign its interest in the AVC notes to decedent's estate to the extent the proceeds satisfied the notes.

Decedent died on March 28, 1975 of acute cocaine poisoning. Because of the circumstances of his death, Occidental claimed that it had a complete defense to payment on the insurance policies and a dispute arose between Occidental on one side and the Bank and petitioner on the other. On January 29, 1976, the Bank and petitioner entered into an agreement under which the Bank would release petitioner from liability on the loan to AVC and the parties would work together to collect the insurance proceeds. On June 14, 1976, Occidental and the Bank settled their dispute. Pursuant to their agreement, Occidental paid the Bank a net amount of $4,200,000.00. The Bank then assigned to petitioner an interest in the AVC notes to the extent of $4,200,000.00.

Petitioner filed an estate tax return on or about June 17, 1976. On the return petitioner attributed no value to the life insurance policies on decedent's life. In a statement attached to the return petitioner explained:

Since the $4,200,000 of net insurance proceeds ultimately receivable was pledged as security for the AVC indebtedness to Union Commerce and was paid to the latter, the only right of the decedent or his estate at the date of death was a possible right to a subordinated participation in Union Commerce's loans to AVC.

The value as of the date of decedent's death of a $4,200,000 subordinated participation in Union Commerce's loans to AVC under the terms of the Guarantee Agreement of December 6, 1974 has been appraised by Lehman Brothers, New York City, as having negligible value.

On October 10, 1978 respondent sent petitioner a Report of Estate Tax Audit Changes. The Report proposed an increase in the value of petitioner's possible right to subordinated participation in the Bank's loans to AVC from $0 to $2,100,000.00. On June 25, 1979 the parties entered into a Closing Agreement pursuant to section 7121. ¹ The Agreement established a value for estate tax purposes and an unadjusted basis for income tax purposes of $600,000.00 for petitioner's right to subordinated participation in the Bank's loans to AVC.

AVC became financially solvent after substantial capital investment by a subsequent owner. In 1980 and 1981 AVC paid the balance of its debt to the Bank and to petitioner. Petitioner received $3,699,526.00 from AVC in 1980 and $421,329.00 in 1981. On its fiduciary income tax return for 1980, petitioner reported a basis of $520,755.00 for its interest in the AVC notes. This amount represented the $600,000.00 unadjusted basis set in the Closing Agreement less $79,245.00 received from AVC in 1979. Petitioner claimed a $0 basis in the notes on its fiduciary income tax return for 1981. Petitioner reported capital gains in the amount of $3,178,771.00 for 1980 and $421,329.00 for 1981.

Petitioner subsequently concluded that it was entitled to increase its basis in the AVC notes by the $4,200,000.00 that Occidental paid on the insurance policies. Petitioner filed amended returns claiming refunds of capital gains taxes paid in 1980 and 1981 on the repayment of the AVC notes. In his notice of deficiency dated March 21, 1985 respondent rejected petitioner's refund claims.

There are five residuary beneficiaries of decedent's estate: Willard T.C. Johnson (Willard), Elizabeth R. Johnson, Robert W. Johnson, IV, Christopher Johnson and Sheila Johnson Brutsch. Willard survived decedent but died soon after him, and Willard's estate was entitled to his distributive share of decedent's estate. The estates of decedent and Willard have the same executors and accountants.

The sole beneficiaries of Willard's estate are charitable organizations. In his will, Willard bequeathed $100,000.00 to the Lawrenceville School in Lawrenceville, N.J. The residue of his estate was to be transferred to a charitable foundation, the Willard T.C. Johnson Foundation, Inc. (the ‘Foundation‘), to be established by the executors of the estate. The estate transferred $100,000.00 to the Lawrenceville School on December 2, 1976 and organized the Foundation prior to 1980. The executors of Willard's estate were also the directors of the Foundation.

The accounting firm of Main Hurdman or its predecessor has at all times served as accountant for both estates. Richard Stone, C.P.A., has been the partner charged with reviewing the estates' tax compliance. In this capacity he worked with Miles Rosenberg, C.P.A., a senior partner in Main Hurdman, and Samuel Klein, an executor of the two estates. Rosenberg is now deceased.

In the early part of 1976, Klein met with Rosenberg to discuss tax matters relating to petitioner, and particularly how to make annual distributions of income from petitioner to Willard's estate. On Rosenberg's advice, Klein instructed the accountants to transfer funds by making book entries on the records of each estate each year crediting a 20 percent share of petitioner's income to Willard's estate. The entries were characterized as deemed distributions from petitioner to Willard's estate. In the course of preparing fiduciary income tax returns for petitioner and for Willard's estate for each year, accountants at Main Hurdman prepared work...