Jones v. Commissioner, Docket No. 23676-93.

CourtUnited States Tax Court
Writing for the CourtParr
Citation74 T.C.M. 473
Decision Date10 September 1997
Docket NumberDocket No. 23676-93.
PartiesCarl E. Jones and Elaine Y. Jones v. Commissioner.
74 T.C.M. 473
T.C. Memo. 1997-400
Carl E. Jones and Elaine Y. Jones
Docket No. 23676-93.
United States Tax Court.
Filed September 10, 1997.

[74 T.C.M. 475]

William E. Frantz, Atlanta, Ga., and John B. Grattan, for the petitioners. Eric B. Jorgensen, for the respondent.


PARR, Judge:

Respondent determined deficiencies in, and penalties on, the Federal income tax for 1989, 1990, and 1991 of Carl E. Jones (petitioner) and Elaine Y. Jones (Mrs. Jones) as follows:

                Year Deficiency Penalties Sec. 6662
                1989 ............. $210,819 $42,164
                1990 ............. 125,150 25,030
                1991 ............. 90,018 18,004

All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. All dollar amounts are rounded to the nearest dollar, unless otherwise indicated.

After concessions,1 the issues for decision are: (1) Whether petitioner received taxable distributions from Carl E. Jones Development, Inc. (Development), of $307,976, $261,591, and $224,827, in 1989, 1990, and 1991, respectively. We hold petitioner received distributions from Development the character and amounts of which are set out below. (2) Whether petitioner had sufficient basis in Development's indebtedness to him to deduct pass-through losses of $163,487 and $21,022 in 1990 and 1991, respectively. We hold he did not. (3) Whether petitioners had constructive dividend income of $80,051 in 1989 from either INI, Inc. (INI), or Spalding Partners, Ltd. (Spalding). We hold they did not. (4) Whether petitioner received constructive dividends of $314,504, $27,298, and $116,163 in 1989, 1990, and 1991, respectively, from INI. We hold petitioner received distributions from INI the character and amounts of which are set out below. (5) Whether petitioners realized a $28,248 loss from a nonbusiness bad debt in 1991. We hold they did not. (6) Whether petitioners are liable for an accuracy-related penalty pursuant to section 6662 for 1989, 1990, and 1991. We hold they are. (7) Whether Mrs. Jones qualifies as an innocent spouse under section 6013(e) for 1989, 1990, and 1991. We hold she does not.2

Some of the facts have been stipulated and are so found. The stipulated facts and the accompanying exhibits are incorporated into our findings by this reference. At the time the petition in this case was filed, petitioners resided in Atlanta, Georgia.

For convenience, we present a general background section and combine our findings of fact with our opinion under each separate issue heading.

General Background

A. Petitioners

Petitioners are married and filed joint Federal income tax returns (Form 1040) for 1989, 1990, and 1991 with the Internal Revenue Service Center in Atlanta.

During the years at issue, petitioner was a realtor, a real estate developer, and an investor in real estate. He owned and operated several companies that built townhouses and expensive homes, and he engaged in other real estate development activities. Petitioner attended 2 years of law school but did not pass the bar exam.

Mrs. Jones is a mother and a homemaker. At the time of trial, petitioners had two children, a daughter and a son, 21 years and 8 years of age, respectively. During the years at issue, Mrs. Jones received $3,000 each month from petitioner

74 T.C.M. 476

which she used to pay for utilities and food.

Mrs. Jones has long suffered from Raynaud's disease. As a result of this disease, she had surgery on her feet in 1988 and again in 1991. During the 1988 surgery, Mrs. Jones contracted a staph infection that complicated her medical condition and eluded detection until 1991.

Petitioners separated temporarily in September of 1991 and reunited in May of the following year. During the separation, Mrs. Jones received $150,000, which she had in a bank account in her name at the time of trial.

B. The Corporations

During the 3 years at issue, petitioner was the sole shareholder and president of INI, a C corporation, and of Towergate Townhomes, Inc. (Towergate), and Development, which are both S corporations. Also during this time, petitioner and Mrs. Jones were each 50-percent owners of Carlsgate Properties, Inc. (Carlsgate), an S corporation. During 1989 and 1990, petitioner was president and owner of Winterchase Townhomes, Inc.

(Winterchase), a C corporation.


INI operated as a developer of real estate and managed a 60,000-square-foot building that was developed by a related C corporation, Spalding.

INI was incorporated on June 25, 1984, at which time it issued 1,000 shares of stock—500 to petitioner and 500 to Ronald Cares (Cares). When INI was incorporated, petitioner and Cares each owned 50 percent of Spalding. operated as a holder of raw land and a developer of real estate.

On November 1, 1984, petitioner and Cares transferred all of their shares in INI to Spalding, and INI became a wholly owned subsidiary of Spalding. Thus, petitioner and Cares each owned 50 percent of Spalding, and Spalding owned 100 percent of the INI shares outstanding.

From its inception, Spalding filed its returns on the basis of a fiscal year ending on September 30. When Spalding became the 100-percent owner of INI, Spalding and INI elected to file consolidated returns using Spalding's September 30 fiscal year.

In 1988, petitioner and Cares reached an impasse as to the business direction of Spalding and INI. They agreed to dissolve their business relationship according to the terms set forth in the Shareholders' Agreement and Plan of Reorganization (the Agreement) that they signed on September 29, 1988, and the Agreement to Amend the Agreement (the Amendment) signed on March 1, 1989. The Agreement was executed to separate Spalding and INI pursuant to section 355.3

After the Amendment was executed, Spalding disposed of its interest in a general partnership that was engaged in providing parking services at an airport and transferred $80,051 to INI as part of the division of corporate assets. See INI, Inc. v. Commissioner [Dec. 50,526(M)], T.C. Memo. 1995-112, affd. without published opinion 107 F.3d 27 (11th Cir. 1997).

At the time of the separation, Spalding had on its books and records accounts in which it recorded the loans the corporation had made to its shareholders. Spalding had lent petitioner a total of $128,429 at the time of the splitup. As part of the Agreement, Spalding transferred the loan account with the balance owed by petitioner to INI. INI added the balance of the transferred account to the receivables account it maintained on its books for the loans that it had made to petitioner for the fiscal year ending September 30, 1988.

After the separation, petitioner became the president and sole shareholder of INI, and Cares became the sole shareholder of Spalding.


Development was primarily engaged in building single-family homes. Development was incorporated as a C corporation in 1973, elected to be an S corporation in 1986 and ceased doing business in 1991. For the years at issue, Development had a taxable year ending September 30. Development was owned entirely by petitioner, who was also its president.


Carlsgate was the marketing arm for the properties built by Development. Carlsgate was incorporated in 1984, elected S corporation status in 1987, and filed its final return in 1991. Petitioner was the president of Carlsgate from its inception.


Towergate was a project of approximately 70 townhouses built in the mid-1980's that sold for prices ranging from $72,000 to $94,000. Towergate was incorporated in 1981 and elected S corporation status in 1986. During its taxable years ended October 31, 1989 through 1992,

74 T.C.M. 477

petitioner was president and sole stockholder of Towergate.


Winterchase Townhomes was a 40-unit townhouse project in which only 34 units were completed. Winterchase was incorporated in 1983, and was liquidated on or about September 30, 1990. During its taxable years ended September 30, 1989 and 1990, petitioner was president and sole stockholder of Winterchase.

C. The Accountants

Petitioner employed an in-house bookkeeper, Sawat Lavantucksin (Lavantucksin) to maintain his personal books and his corporations' books. Under the direction of petitioner, Lavantucksin prepared the records of the cash transactions and the monthly bank statements and made the journal entries recording the amounts the corporations lent to petitioner, the amounts petitioner repaid to the corporations, petitioner's alleged assumptions of the corporations' indebtedness, the transfers of the indebtedness between the corporations, and the transfers between the corporations and petitioner. Lavantucksin did not testify at the trial.

Petitioner employed a certified public accountant, Donald L. Ricks (Ricks), to prepare his personal and corporate returns. Ricks, or his employee, William Morrisett (Morrisett), checked the entries that were made by Lavantucksin on the corporate books for consistency against the entries that were made by Lavantucksin on petitioner's personal books. The accountants then prepared the returns by using the journal entries. Neither Morrisett nor Ricks verified Lavantucksin's entries by examining the corporate minutes, bank statements, canceled checks, or other external sources.

D. Transfers by Journal Entries

Petitioner transferred debt between himself and his corporations in two general circumstances. In one circumstance, petitioner was indebted to one of his corporations, and the corporation was going out of business. In this circumstance, petitioner used journal entries to transfer his indebtedness from the corporation that was going out of business to another of his corporations. For instance, petitioner made withdrawals from Winterchase that were recorded on its books as loans. On December 31, 1989, when Winterchase was going out...

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