JJJ CORP. v. United States, 2-74.

• Decision Date: 17 May 1978
• Docket Number: No. 2-74.,2-74.
• Citation: 576 F.2d 327
• Parties: JJJ CORPORATION v. The UNITED STATES.
• Court: U.S. Claims Court

576 F.2d 327

JJJ CORPORATION v. The UNITED STATES.

No. 2-74.

United States Court of Claims.

May 17, 1978.

COPYRIGHT MATERIAL OMITTED

Jerome S. Hertz, Boston, Mass., for plaintiff; Dianne C. Roberts and Mintz, Levin, Cohn, Glovsky & Popeo, Boston, Mass., of counsel.

James S. Maxwell, Washington, D.C., with whom was Asst. Atty. Gen. M. Carr Ferguson, for defendant; Theodore D. Peyser, Jr., Donald H. Olson and C. Patrick Derdenger, Washington, D.C., of counsel.

Before COWEN, Senior Judge, KUNZIG and BENNETT, Judges.

OPINION

PER CURIAM:

This action was brought for the refund of an accumulated earnings tax penalty assessed pursuant to sections 531 et seq. of the Internal Revenue Code of 1954. The case comes before the court on plaintiff's exceptions to the recommended decision of Trial Judge Francis C. Browne. After considering the briefs and exceptions of the parties, and after hearing oral argument, we have concluded that we agree with the trial judge's opinion, which is set forth infra, as supplemented and modified by the following.^*

The taxpayer's fiscal year ended August 31, 1970. In holding that the plaintiff corporation was "formed or availed of" for the purpose of avoiding the income tax with respect to its shareholders for the fiscal year, the trial judge determined that the taxpayer had not met the burden of proof of showing that it had not accumulated earnings and profits beyond the reasonable needs of its business, as required by section 533(a) of the Internal Revenue Code, and consequently, there is a statutory presumption that such earnings and profits were accumulated for the purpose of avoiding the income tax.

One of the principal attacks made by the taxpayer against the trial judge's decision is that in making such determinations, the trial judge erred as a matter of law by considering the intentions and actions of the corporate directors and officers during the period September 1, 1970 to February 3, 1971, a period after the close of the taxpayer's fiscal year. In making this contention, the taxpayer relies primarily on the following legislative history:

The criticism has also been made that, in determining the reasonable needs of the business, consideration has been frequently given to events occurring after the close of the taxable year. Your committee agrees with the House that only the facts as of the close of the taxable year should be taken into account in determining whether an accumulation is reasonable. If the retention of earnings is justified as of the close of the taxable year, subsequent events should not be used for purposes of showing that the retention was unreasonable in such year. However, subsequent events may be considered to determine whether the corporation actually intended to consummate the plans for which the earnings were accumulated. (Emphases added.) S.Rep. 1622, 83rd Cong., 2d Sess. 3 U.S.Code Cong. & Admin. News, pp. 4621, 4701 (1954).

Taxpayer's reliance on the quoted portion of the Senate Report is misplaced because it assumes, contrary to the facts, that it has established in this case that its accumulation of earnings was "justified as of the close of the taxable year" 1970. Although the Code permits a taxpayer to retain accumulated earnings and profits to the extent required to meet the reasonable needs of the business, Treas.Reg. § 1.537-1(b)(1) provides that in order to justify the accumulation, the plans for the future use of the business must be "specific, definite, and feasible" rather than "uncertain or vague." See Cataphote Corp. v. United States, 535 F.2d 1225, 210 Ct.Cl. 125 (1976). Here the evidence wholly fails to establish that either during its fiscal year 1970 or in the period from September 1, 1970 to February 3, 1971, taxpayer had formed any plans to use its accumulated earnings for its future business requirements. Rather, as the trial judge found, the taxpayer's president, as early as May 18, 1970, had expressed a wish that the corporation be changed to a personal holding or investment company and the president informed his nephew of this wish in July of 1970. Between August 14, 1970 and August 31, 1970, taxpayer collected its receivables and discharged its payables for the purpose of clearing its books by the end of the fiscal year in order that it could qualify as an investment company for the year 1971. After taxpayer's president died, the previously formed plans to convert the corporation to a securities corporation were adopted by the Board of Directors on October 15, 1970. As early as late October 1970 and certainly not later than February 3, 1971, the taxpayer's Board of Directors had knowledge of the unreasonable accumulation of earnings and profits and of the beneficial tax consequences which would accrue by the failure to pay dividends to the shareholders. As the trial judge found, the taxpayer "developed no specific plans for future development and corresponding reasonable business needs" between September 1, 1970 and February 3, 1971.

Under all the circumstances, the trial judge properly considered events subsequent to the close of the taxpayer's fiscal year in determining whether the corporation was justified in accumulating earnings and profits for the reasonably anticipated future needs of the business. See C. E. Hooper, Inc. v. United States, 539 F.2d 1276, 210 Ct.Cl. 615 (1976).

For the reasons stated by the trial judge, plus those set forth above, we hold that plaintiff is not entitled to recover and its petition is hereby dismissed.

OPINION OF TRIAL JUDGE

BROWNE, Trial Judge:^*

Plaintiff, JJJ Corporation,¹ seeks recovery of $45,776.10 (together with interest as provided by law) which was assessed against the taxpayer as an accumulated earnings tax penalty under Sections 531 et seq. of the Internal Revenue Code² for the taxpayer's fiscal year ending August 31, 1970.

The court has jurisdiction of the case under 28 U.S.C. § 1491.

On April 15, 1975, plaintiff filed a motion for partial summary judgment on one count, seeking a determination that it was entitled to an accumulated earnings tax credit of at least $131,800 under section 535(c). Plaintiff asserted entitlement to the credit, the sum being the amount expended by plaintiff pursuant to a section 303 redemption of the capital stock of the deceased president and principal stockholder of the corporation. According to plaintiff's calculations a ruling in its favor would limit the penalty tax, if applicable, to a maximum figure of $2,510.48. The court in an order entered August 1, 1975, denied plaintiff's motion, without prejudice, and remanded the case to the trial division for further proceedings. The case was tried in March of 1976, following which the parties filed their respective post-trial submissions, proposed findings of fact and suggested conclusions of law.

The ultimate issue is whether the plaintiff corporation was "formed or availed of" for the purpose of avoiding income tax with respect to its shareholders during the taxpayer's fiscal year ending August 31, 1970, within the meaning of section 532 of the Code. We conclude that the corporation was availed of for the prohibited purpose and, accordingly, hold for the Government and dismiss the petition. Resolution of the ultimate issue involves the resolution of several subissues, both legal and factual. A summary of the basic facts upon which the foregoing conclusion has been reached and a discussion of the legal and factual issues are presented as follows.

I. SUMMARY OF THE FACTS.

A. Role of William I. Gorfinkle.

The salient facts in this case revolve around the life and death of William I. Gorfinkle, the late president of the taxpayer corporation.

Prior to 1951 Gorfinkle was brought in as a consultant to a company engaged in the manufacture of gelatin and gelatin products. The company, known as the J. O. Whitten Company, was owned by the Perkins family. In 1951 Gorfinkle brought together a group of investors to buy out and continue operation of the going business under a new and separate Massachusetts corporation of the same name. Gorfinkle was the chief operating officer of the new corporation at the outset. Later he became its president, and eventually he and his wife became the majority stockholders. The company, under Gorfinkle's leadership, actively and continuously engaged in the gelatin manufacturing business until it sold all of its assets to Swift & Co. in May of 1970, the tax year in question. On August 14, 1970, approximately 3 months after sale of the assets and about 2 weeks before the end of plaintiff's fiscal year, Gorfinkle died of heart failure.

Over a period of time the board of directors was reduced from seven members to three members. The three directors at the time of Gorfinkle's death were Gorfinkle, W. O. Whiting³ and George Naylor, Jr.⁴ Whiting and Naylor were only minority stockholders of the corporation. Neither was active in the day-to-day conduct of the business. In fact, Whiting and Naylor functioned primarily in advisory capacities and were not normally known to initiate management policy. The corporation was, in effect, a "one man show," Gorfinkle being the sole "performer."

While Gorfinkle did not acquire controlling interest in the corporation when it was first organized, he and his wife became the controlling stockholders within about 5 to 6 years after it was formed.⁵ Gorfinkle, accordingly, ran the business pretty much to suit himself. He used directors primarily as consultants and displayed a hesitancy to take others into his confidence except to the minimum amount necessary in reaching his own decisions. Gorfinkle employed his nephew, David Gorfinkle, as an administrative assistant. However, he gave David no management responsibilities and did not take him into his confidence with respect to business decisions. He did not discuss business matters with his wife or seek her views on either corporate or personal financial matters even though she was a...