In re Wilhelm
| Decision Date | 02 September 1994 |
| Docket Number | Bankruptcy No. 93-20037-MDM. |
| Citation | 173 BR 398 |
| Parties | In re Joyce P. WILHELM, Debtor. |
| Court | U.S. Bankruptcy Court — Eastern District of Wisconsin |
David J. Winkel, Neenah, WI, for debtor.
Christopher Grigorian, Washington, DC, for claimant.
This matter comes before the court on debtor's objection to the proof of claim filed by the United States ("IRS") in the chapter 13 bankruptcy of Joyce Wilhelm ("debtor"). By this objection, the court has been asked to determine the amount of personal income tax owed by the debtor. Only the years 1985, 1986 and 1987 are at issue.
The question is whether the debtor may deduct on her personal income tax return certain farm related expenses paid from her personal checking account. These expenses were related to the debtor's operation of a farming business, which she had organized as an S Corporation. The corporation filed returns and passed through gains and losses that are not in dispute. The expenses in question were not paid from the corporation's checking account and were not taken as deductions on the corporation's return. Disallowance of these deductions from other income on the debtor's personal returns resulted in the IRS' secured claim of over $32,000. The debtor's chapter 13 plan cannot be confirmed until her tax liability is resolved.
The parties briefed the issues and presented evidence at trial. The court will rule on the sole legal issue raised at trial, i.e., whether the debtor was engaged in an activity having a profit motive. 26 U.S.C. (I.R.C.) § 183. If the court determines that the debtor has a profit motive in an activity that produces taxable income and deductible expenses or losses, the debtor may deduct expenses and losses in excess of income from the activity, thus reducing other taxable income unrelated to the activity that gave rise to the deductions. If the debtor had no profit motive, the expenses that exceed income from the activity are not deductible.
The court will not calculate the tax or rule on the propriety of any particular deduction at this time. The final determination of the dollar amount of tax liability will be left to the parties, which they can calculate based on the legal findings in this decision. A further motion can be brought for resolution of these other matters, if necessary.
This court has jurisdiction in this contested matter pursuant to 28 U.S.C. § 1334(b); this is a core proceeding under 28 U.S.C. § 157(b)(2)(B). The following are the court's findings of fact and conclusions of law as required by Fed.R.Bankr.P. 7052.
Joyce Wilhelm's family moved to the farm she now owns when she was a small child in 1948. She grew up working on the farm, helping with the family's dairy operation. She was married in 1963, and in January of 1968 she purchased the farm, then 120 acres, from her mother. Since she has been running it, the farm has been primarily a horse breeding (black Arabians) and training operation, although she raises some cattle and grows all of the feed for the animals. She also trains other people's horses.
The debtor was employed off the farm in 1968 and 1969, but she worked solely on the farm from 1970 until 1983. Her husband worked briefly off the farm after the marriage but was employed almost exclusively in farming until the spouses separated in 1979. Thus, during the 1970's, the farm was the family's sole source of support. The Wilhelms were divorced in 1982, with the debtor's former husband receiving 40 of the 120 acres pursuant to the decree of dissolution. The debtor has run the farm alone since 1979. During the tax years in question, she was the farm's sole regular employee, although she received help from time to time from a son and daughter and their friends, whom she paid or provided with room and board in return for work.
In 1977, some of the debtor's heifers broke loose, and a neighbor attempted to help recover them. The heifers took up with another neighbor's bull, and the neighbor who was attempting to help was gored. He sued the debtor and her husband, and they eventually paid $2,000-2,500 to satisfy the liability. Their attorney and accountant advised them to form a corporation that owned few assets to guard against this kind of liability in the future.
Thus, Ride-Away Ranch, Inc. was born. The debtor made an election under I.R.C. § 1361 to organize Ride-Away Ranch as an S Corporation. Two mares and their tack were transferred to the corporation, which would then own their foals. The corporation leased other horses, equipment, and real estate from the debtor, and the lease agreement called for payments to the debtor equal to the annual taxes, interest and depreciation on the leased property. There was no change in how the farm was run.
The debtor testified that due to financial difficulties brought on by the divorce, she was obliged to seek outside employment in 1983. She began selling insurance, which she was able to do because most of her calls could be done at night. Except for a few business meetings, she could still operate the farm as before. Her daughter testified that her mother would be up at 5:00 a.m., do farm chores until 2:30-3:00 p.m., and then start her insurance calls. She also cooked for whoever was working on the farm. During 1985-87, the debtor earned about $29,000 per year selling insurance. She stopped selling insurance in 1988, and virtually all of her income has been from her farm operation since that time.
When the corporation was established, a separate bank account was opened for farm income and expenses. The debtor used this account to prepare a ledger showing farm income and expenses, and every year she gave this to her accountant to use in preparation of the corporation's tax returns and her personal tax returns. She testified that occasionally a farm expense would be paid from her personal account, usually because that account had money and the corporate account did not. She prepared a list of these payments separately and sent them along with the ledger, and she assumed the accountant would deduct these in the proper place as well as those written on the corporate account. When the returns came back for her signature, usually a day or two before they were due, she signed them with little or no review and mailed them. She stated that she trusted her accountant completely. Her accountant deducted the farm related expenses that she paid personally on the schedule where she reported her income from the farm lease; they were not deducted on the corporate return.
The debtor was not only casual with which account was used to pay farm expenses, she paid little attention to the legalities of the lease of the real estate, equipment and animals. In two of the three years in question, the corporation did not pay rent, even though all the debtor had to do was write a check from the corporate account to her personal account. As far as she was concerned, she thought of herself as the farm as well as an individual; she thought of the S corporation as having no tax consequences, so there was no reason to do so.
The I.R.S. disagreed. Even if the debtor was the only person working for the corporation, the corporation and the individual are separate entities and must be treated as separate taxpayers. Furthermore, it decided that the debtor had two taxable activities. She (1) rented out real estate, equipment and animals for which she had an agreement for payment, and (2) she ran a farm corporation. They do not argue that she did not intend to make a profit on the farm or that the farming operation was a hobby. However, the lease payment was equal to the deductible expenses associated with the leased property. The net income in every year the lease was in effect would be zero. Once the I.R.S. determined the debtor did not have a profit motive for her rental activity, it disallowed the deduction of personally paid farm expenses in excess of her rental income.
The debtor filed a petition under chapter 13 of the bankruptcy code on January 6th, 1993. On January 19th, 1993, the IRS filed a proof of claim for $32,620.07 of secured and $18,300.00 priority debt, and the debtor filed an objection to that claim on July 22, 1993.
The bankruptcy code provides bankruptcy courts with the authority to "determine the amount or legality of any tax" assessed against debtors. 11 U.S.C. § 505(a)(1). Since this dispute has come before the court in the context of the claims objection process, however, the court need not resort to section 505 of the bankruptcy code to determine the debtor's tax liability. See, Sheinfeld, Witt and Hyman, Collier on Bankruptcy Taxation, 1993 at §§ 5.031, 5.042.
This case presents an interesting legal dilemma regarding the burden of proof in bankruptcy proceedings in which tax claims are challenged. It is well-established in bankruptcy law that a properly filed proof of claim constitutes prima facie evidence of the validity and amount of the claim. 11 U.S.C. §§ 501, 502(a); Fed.R.Bankr.P. 3001(f). The objecting debtor or trustee initially has the burden of presenting evidence to rebut the prima facie validity of the claim. Once this is accomplished, a creditor must present evidence as to the claim's validity, and the ultimate burden of proof is on the creditor. Matter of Dahlman Truck Lines, Inc., 59 B.R. 218, 219 (Bankr.W.D.Wis.1986). The burden is, therefore, just as it would be in a non-bankruptcy lawsuit in which the creditor is attempting to recover money from the debtor. In re Premo, 116 B.R. 515, 518, 90-2 USTC ¶ 50,396 (Bankr.E.D.Mich.1990).
In tax law, however, the IRS enjoys a presumption that its notice of deficiency constitutes a valid claim, and the taxpayer must present evidence to prove the Service's assessment is wrong. Helvering v. Taylor, 293 U.S. 507, 55 S.Ct. 287, 79 L.Ed. 623 (1935). Thus, the relevant...
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