Jones v. C.I.R., 041493 FEDTAX, 26909-89
| Opinion Judge | PARKER, Judge |
| Party Name | William B. JONES, Jr., and Christina B. Jones, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent. DEXEL SYSTEMS CORPORATION OF WASHINGTON, D.C., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Attorney | Jonathan J. Broome, Jr. and Robert E. Scully, Jr., Vienna, VA, for petitioners. Karen E. Chandler, Washington, DC, for respondent. |
| Case Date | April 14, 1993 |
| Court | U.S. Tax Court |
MEMORANDUM FINDINGS OF FACT AND OPINION
In these consolidated cases,[1] respondent determined deficiencies in and additions to the Federal income taxes of the individual petitioners and the corporate petitioner as follows:
William B. Jones, Jr. and Christina B. Jones-Docket No. 26909-89
Additions to Tax
Year Deficiency Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6661
1985 $195,544 $ 9,777 [*] $ 48,886
Additions to Tax
Year Deficiency Sec. 6653(a)(1)(A) Sec. 6653(a)(1)(B) Sec. 6661
1986 $ 86,723 $ 4,336 [*] $ 21,681
Dexel Systems Corporation of Washington, D.C.-Docket No. 28048-89
Additions to Tax
Year Deficiency Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6661
1985 $458,470 $22,924 [**] $113,894
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. After concessions,[2] the issues remaining for decision are: (1) Whether petitioner William B. Jones, Jr.'s purported 1985 stock sale was, in substance, a sale of an agreement not to compete by Dexel Systems Corporation of Washington, D.C., and the receipt of a constructive dividend by petitioner William B. Jones, Jr.; (2) Whether the individual petitioners and the corporate petitioner are liable for additions to tax for negligence or intentional disregard of rules or regulations under section 6653(a)(1) and (2) for the taxable year 1985; (3) Whether the individual petitioners are liable for additions to tax under section 6653(a)(1)(A) and (B) for the taxable year 1986; and (4) Whether the individual petitioners and the corporate petitioner are liable for additions to tax for substantial understatement of income tax under section 6661 for the years before the Court. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations of facts and the exhibits attached thereto are incorporated herein by this reference. At the time the petition was filed, the individual petitioners maintained separate legal residences. Petitioner William Braun Jones, Jr. (petitioner or Braun Jones) resided in Alexandria, Virginia, and petitioner Christina B. Jones (Mrs. Jones) resided in Clearbrook, Virginia. Petitioner and Mrs. Jones timely filed, within the time period as extended, their joint United States individual income tax returns (Forms 1040) for the years 1985 and 1986 with the Office of the Internal Revenue Service in Memphis, Tennessee. The corporate petitioner, Dexel Systems Corporation of Washington, D.C. (Dexel), is a Virginia corporation having its principal office in Vienna, Virginia. Dexel timely filed its United States corporate income tax returns (Forms 1120) for the years 1985 and 1986 with the Office of the Internal Revenue Service in Memphis, Tennessee. A. History of Dexel Between 1968 and 1978, petitioner was employed by International Business Machines (IBM) in various positions. In 1978, petitioner left his position as an IBM marketing manager in Baltimore, Maryland, to start his own computer business. Dexel, originally named Information Systems Corporation (ISC), was incorporated in Virginia on January 24, 1978. Petitioner was one of the founders, shareholders, and original directors.[3] The business of Dexel initially was to develop customized software programs for various industries, such as accounting firms and collection agencies. Dexel employees, who were technical specialists in data processing, sold contract programming services to companies that already had data processing installations, i.e., computer hardware systems. In providing such services, Dexel employees frequently created entirely new customized computer programs for customers. Such software programs were thereafter " packaged" by Dexel with sales material and documentation and sold to similar businesses. As Dexel developed, it expanded from selling only software and services to " bundling" hardware into its packages. Dexel began providing consultation, planning, and operational advice and services to businesses regarding the acquisition, installation, maintenance, and uses of complete computer systems. Dexel offered " turnkey systems" that included the software, the hardware necessary to run the software, and the services and training necessary to install and operate the complete system. Dexel obtained the hardware offered in its turnkey systems from IBM, Hewlett Packard Corporation,[4] and, at one time, TRW Corporation. By 1984, petitioner and W. Kellogg Achenbach (Achenbach) owned all of the issued and outstanding shares of Dexel. In June of 1984, petitioner and Achenbach entered into an agreement with Dexel providing that, if a shareholder were to die, Dexel would purchase the shareholder's shares with life insurance proceeds.[5] Dexel had a right of first refusal to buy any shares sold by a stockholder. See supra note 3. Dexel purchased an $800,000 policy on the life of Achenbach and a $1.2 million policy on the life of petitioner. In determining those amounts, petitioner did not refer to any specific business records or consult with any outside advisers or Dexel's comptroller. Petitioner and Achenbach informally evaluated Dexel's past performance, as reflected in the company's financial statements, estimated Dexel's future earnings to the extent that they were able, and reached a valuation with which they were mutually satisfied. B. IBM's VAR Program In the early 1980s, petitioner began to explore the possibility of contracting with IBM to sell IBM equipment as a value added remarketer. In the early 1980s, IBM began marketing computer systems through value added remarketers (VARs). VARs add software programs, which constitute the " value added" component, to midrange IBM computer systems. VARs then resell these packages through agents or directly to specific customers, known as unaffiliated end users. VARs are responsible for both the sale and the installation of the IBM equipment and the software that they develop. A VAR's relationship with IBM need not be exclusive; a VAR can sell hardware manufactured by other computer companies as well. A VAR's customers are required to productively use the VAR's software, and such customers cannot resell or remarket the IBM computers purchased from a VAR. By the terms of its standard VAR contract, IBM can terminate a VAR's contract for failing to add the software value and merely reselling IBM hardware. From the beginning of its use of VARs, IBM has permitted VARs to use agents to generate sales leads and perform similar functions in making sales of IBM equipment. Some VAR agents are strictly software-oriented companies while others serve as conduits between manufacturers of hardware and of software and end users. By 1985, large leasing companies/brokers, such as Datacomp Group (now known as XL Data Company), Ceres, and Sun Data Corporation, were also VAR agents. C. Dexel's Relationship with IBM In 1980, IBM began granting Dexel marketing rights and discount schedules on various products. Dexel had established to IBM's satisfaction that it had the software and service-support capability to bundle with IBM hardware. As IBM developed new products, Dexel would attempt to qualify to distribute them. Dexel would apply for a particular product, and IBM would investigate to ensure that Dexel had the ability to successfully sell and support that product. In April of 1984, Dexel entered into an 18-month " Agreement for Volume Procurement of IBM Products (Value Added Remarketer)" (the VAR Agreement) to sell System 32 and System 34 computers.[6] That agreement was scheduled to expire in October of 1985. Dexel had had a VAR contract or contracts prior to April of 1984. Normally VAR contracts were for short terms of 1 year or 18 months. D. Jacore's History and Relationship with IBM James L. Jacobson (Jacobson) first met petitioner in the early 1970s when both men were salesmen for IBM. Before Jacobson left his employment at IBM, he discussed with petitioner the possibility of his (Jacobson's) forming a company like Dexel in Atlanta, Georgia. In September of 1979, Jacobson left IBM and cofounded Dexel Systems Corporation of Atlanta (Dexel Atlanta). By that time, Dexel had established a reputation for customized software. Jacobson wanted to use a similar name for its reputational value, but there was no common ownership or other control between Dexel and Dexel Atlanta. Dexel and Dexel Atlanta entered into a licensing arrangement whereby Dexel Atlanta could utilize Dexel's accounting software package in creating systems for its clients. Dexel Atlanta's primary business was as a software consulting and programming company for IBM general systems division's product lines. Dexel Atlanta began working with IBM sales representatives in selling and installing IBM hardware. In 1982, Dexel Atlanta also became an IBM VAR. Dexel Atlanta subsequently became known as Jacore Systems, Inc. (Jacore) and was incorporated in 1984. From the end of 1984 through 1987, Jacobson was chairman of Jacore's board of directors. During that period, C. Noel Wadsworth (Wadsworth) was the president and chief operating officer of Jacore and a member of Jacore's board of directors. During 1985 and 1986, Jacobson owned 85 percent of Jacore's stock and Wadsworth owned the remaining 15 percent.[7] During the first half of 1985, Jacore sold only IBM manufactured hardware. By 1985, Jacore...
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