Jensen v. Commissioner
| Decision Date | 17 September 1979 |
| Docket Number | Docket No. 8040-77. |
| Citation | 1979 TC Memo 379,39 TCM (CCH) 163 |
| Parties | Drew Jensen and Mary Jensen v. Commissioner. |
| Court | U.S. Tax Court |
William H. Adams, 200 Main Street, Salt Lake City, Utah, for the petitioners. Richard W. Kennedy, for the respondent.
Respondent determined deficiencies in petitioners' Federal income taxes as follows:
Year Deficiency
1970 .............. $4,762.68
1971 .............. 5,662.82
1973 .............. 8,947.96
Concessions having been made, the only issue remaining for decision is whether Drew Jensen (hereinafter petitioner) sustained a theft loss within the meaning of section 165 (c) (3)1 during 1973.
All of the facts have been stipulated and are so found.
At the time of filing their petition herein, Drew Jensen and his wife Mary Jensen, resided in Salt Lake City, Utah.
Petitioner earned most of his income from investment activities. In early 1972 petitioner became interested in investing in small, privately owned businesses. Thereafter, petitioner met Steve Baughman (Baughman) while patronizing a motorcycle sales business operated by Baughman. Baughman told petitioner he was having difficulty raising sufficient capital to keep the business in operation and indicated that he was looking for new sources of capital to finance his business.
After petitioner became convinced that Baughman, with proper financial backing, could manage a successful motorcycle sales business, petitioner agreed to go into business with Baughman. To operate the business and to provide him with limited personal liability, petitioner formed a corporation, Performance Cycle, Inc. (Cycle). A corporate charter was issued to Cycle by the State of Utah on March 16, 1972. All of the stock in Cycle was issued to petitioner, who became president of Cycle. Baughman was hired by Cycle as general manager.
As part of its corporate activities, Cycle bought and sold merchandise, advertised under the name "Performance Cycle, Inc." and filed U.S. corporate income tax returns for the taxable years ending March 31, 1973, and March 31, 1974.
In his capacity as general manager Baughman was to provide the management expertise necessary to a successful motorcycle sales business. Thus, Baughman made many of the decisions concerning the day-to-day operation of Cycle. Petitioner, as owner of Cycle, provided the financing necessary for the business to operate. However, petitioner also made decisions relating to the company's operation. In addition, petitioner was the only individual authorized to sign checks drawn on Cycle's checking account.
When Cycle first began to operate, petitioner personally established a flooring account which enabled the corporation to buy inventory on credit. Petitioner subsequently closed this personal flooring account and transferred funds directly to the corporation to be used for the purchase of inventory. He planned to have the corporation reimburse him for the funds advanced from proceeds received on the sale of inventory. While it was anticipated that the corporation would use the funds advanced by petitioner to purchase inventory, as part of the franchising arrangement with major suppliers petitioner also signed standard flooring arrangements as guarantor for Cycle.
During 1972 and 1973, petitioner transferred substantial sums to the corporation in the form of capital and loans. However, the parties have stipulated that it is impossible to determine exactly which amounts were capital and which were loans. Listed below are all the amounts petitioner transferred to the corporation, the date upon which such amounts were transferred, and the amounts which were ultimately repaid to him:
Date Amounts Transferred Payments Balance
2/4/72 $ 2,049.00 $ 2,049.00
3/1/72 $ 7,000.00 (Flooring -4,951.00
Payment)
3/14/72 2,200.00 -2,751.00
3/14/72 6,000.00 3,249.00
3/16/72 1,500.00 4,749.00
3/18/72 4,000.00 8,749.00
3/18/72 6,500.00 15,249.00
3/23/72 7,500.00 22,749.00
4/13/72 3,000.00 25,749.00
4/25/72 3,941.64 29,690.64
5/31/72 1,000.00 30,690.64
6/12/72 7,000.00 37,690.64
7/31/72 4,000.00 41,690.64
8/23/72 10,000.00 51,690.64
8/10/72 6,000.00 57,690.64
9/20/72 5,000.00 62,690.64
10/13/72 8,000.00 70,690.64
10/19/72 9,000.00 79,690.64
11/2/72 3,000.00 82,690.64
1/5/73 24,000.00 106,690.64
2/13/73 9,000.00 115,690.64
3/12/73 115,690.64
4/16/73 115,690.64
5/29/73 3,000.00 (Payment) 112,690.64
6/7/73 112,690.64
6/20/73 112,690.64
6/26/73 112,690.64
7/8/73 3,000.00 (Payment) 109,690.64
8/8/73 3,000.00 (Payment) 106,690.64
8/11/73 106,690.64
8/11/73 106,690.64
8/11/73 3,000.00 (Payment) 103,690.64
11/6/73 24,000.00 127,690.64
12/6/73 21,617.53 149,308.17
12/31/73 2,312.29 (Payment) 146,995.88
___________ ___________ ____________
TOTAL $168,308.17 $21,312.292 $146,995.88
=========== =========== ===========
2 This total excludes $4,062.36 in interest payments that
Cycle also made to petitioner during 1973
Shortly after the corporate business commenced, Baughman used proceeds from the sale of corporate merchandise to pay off his personal debts. Thereafter Baughman continued to appropriate for his personal use the proceeds of a significant portion of the sales. He also extracted funds through the use of forged checks and checks made payable to fictitious payees. These misappropriations continued throughout the period of time that Baughman managed Cycle. Also during this period, Baughman represented to petitioner that additional inventory was being purchased with the funds petitioner advanced to the corporation. However, Baughman was actually financing the purchase of inventory through the flooring arrangements set up by petitioner with Cycle's major suppliers. This use of the flooring arrangements was contrary to petitioner's instructions and without his knowledge.
After September 1972, Baughman was responsible for keeping the corporate books. In preparing the books, he recorded substantial accounts receivable which did not exist and failed to reflect substantial accounts payable, particularly amounts owed to the two major suppliers, which amounts were incurred by Baughman's unauthorized use of the flooring accounts. In addition, Baughman regularly supplied petitioner with financial statements which overstated the accounts receivable and understated the liabilities of Cycle.
In September 1973, petitioner discovered that Baughman had been embezzling from Cycle. Although at the time petitioner was unaware of the true nature and extent of the embezzlement, he took prompt action and bodily evicted Baughman from Cycle's premises on September 17, 1973.
To minimize his losses, petitioner considered two alternatives: declaring Cycle bankrupt or continuing the business under new management. In an effort to avoid the adverse impact the bankruptcy of Cycle might have on his personal business reputation, petitioner decided to continue the business. Consequently, in late 1973 petitioner hired a new manager for Cycle. At this same time, petitioner paid off the amounts owed to two major suppliers on the flooring accounts which he had personally guaranteed. In November 1973 he paid one of these suppliers $24,000 from his personal funds and in December 1973 he transferred to Cycle $21,617.53 to pay the other supplier.
Petitioner discovered in early 1974 that most of the receivables being carried on Cycle's books were nonexistent, that the corporation had substantial debts which were not reflected on its books, and that a great deal of additional capital would be required to keep the business in operation. Because of these factors and the difficulty of finding a competent manager, petitioner decided to liquidate Cycle. The assets of Cycle were sold on June 1, 1974, and at that time the corporation ceased doing business. The proceeds from the sale were used solely to pay creditors of the corporation.
In connection with a civil suit filed against Baughman in 1974, petitioner discovered that the only assets Baughman held in his name had little or no value. Petitioner also learned that Baughman had declared bankruptcy in 1971. One year after filing suit, petitioner concluded that proceeding with the action would not result in recovery of any of the embezzeld funds and, therefore, the suit was not further prosecuted.
No criminal action was ever commenced against Baughman as a result of his embezzlement activity. However, petitioner did turn over all the information he had regarding the...
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