Laff v. Commissioner
| Decision Date | 31 December 1979 |
| Docket Number | Docket No. 2698-74. |
| Citation | 1979 TC Memo 523,39 TCM (CCH) 813 |
| Parties | Estate of Herman Laff, deceased, June T. Laff, Executrix, and June T. Laff v. Commissioner. |
| Court | U.S. Tax Court |
Walter G. Schwartz, 235 Montgomery St., San Francisco, Calif., for the petitioners. Eugene H. Ciranni, for the respondent.
Respondent determined the following deficiencies in petitioners' Federal income taxes for the years 1964 through 1966:
Year Deficiency
1964 ........................ $1,340.94
1965 ........................ 1,341.48
1966 ........................ 1,504.69
The sole issue for our determination is whether the gain from the sale of petitioners' business in 1963, received by petitioners in the taxable years at issue, constitutes long-term capital gain or ordinary income.
This case was fully stipulated pursuant to Rule 122, Tax Court Rules of Practice and Procedure. The stipulation of facts and attached exhibits are incorporated herein by reference.
At the time of filing their petition, Herman Laff (now deceased) and June T. Laff resided at San Mateo, California. June T. Laff was appointed executrix of her husband's last will and testament by the Superior Court of the State of California for the County of San Mateo, California. Petitioners timely filed joint Federal income tax returns for the years 1964 through 1966 with the District Director of Internal Revenue at San Francisco, California.
For 1958 until 1963, Herman operated Jay Hampton Tailors (hereinafter Tailors), a sole proprietorship engaged in the suit-selling business. Tailors operated as a "suit club" in which suits and topcoats, manufactured by a Los Angeles company, were sold in weekly installments through the use of coupon books.
Outside salesmen would solicit a customer to come into one of Tailors' three sales offices (in Oakland, San Jose, or San Francisco) where he would be measured, sign a contract, and receive a coupon or payment book. After the customer paid at least $20 in weekly payments of $2, he would be fitted for a suit which would then be ordered from Los Angeles. When the customer received his suit, he would often still owe money under the contract (generally $15 to $30).
Tailors' accounting records were maintained on an accrual basis. As a payment was received on a suit contract, the cash account would be debited and "customers' deposits," a deferred-income account, would be credited. After the customer picked up his suit, the deferred-income account would be debited and the sales account, credited. Any unpaid balance remaining on the contract would then be charged to an accounts receivable account.
Tailors' salesmen received their commissions when Herman verified and accepted the contracts. The sales commission expense, however, would be charged as a deferred expense ("deferred commissions") and would not be claimed as a business expense until the customer actually picked up his suit.
On July 26, 1963, petitioners sold Tailors. According to the balance sheet on the date of the sale, the following assets were sold and liability assumed:
Assets Basis
Accounts receivable ................. $ 5,273.88
Inventories ......................... 12,489.11
Furniture and Fixtures $1,657.20
Accumulated Depreciation .. (330.00) 1,327.20
_________
Deferred commissions ................ 65,000.00
Goodwill (purchased) ................ 13,842.03
__________
97,932.22
Liabilities
Customers' deposits ................. 164,184.16
__________
The contract for sale made no allocation of the purchase price to the items sold. According to the contract, specifically excluded from the sale were cash and investments which petitioners retained. Specifically included were accounts receivable, inventory, work in progress, furniture and fixtures, goodwill, business name and customers' lists.
The total gain realized by petitioners was $137,572.52 calculated, and stipulated by both parties, as follows:
Total sales price
Note: ............................... $ 71,600.00
Assumption of liabilities ........... 164,184.16
__________
$235,784.16
Less
Basis in assets transferred ......... 97,932.22
Selling expense ..................... 279.49 (98,211.64)
__________ ___________
Total gain realized ................................ $137,572.52
The buyer gave petitioners a promissory note in the face amount of $71,600 as partial payment for the sale. Additionally, he assumed the obligations on petitioners' deferred-income account as of the date of sale. Under the promissory note, petitioners were to receive $4,000 immediately plus weekly payments of $200 for 338 consecutive weeks or until Herman died, whichever occurred first.
After the buyer acquired Tailors, 60 percent of the customers whose contracts he had purchased actually completed payments under their contracts. Of those who did complete payments, 7 percent returned as repeat customers.
In 1963, petitioners received $8,400 with respect to the note. That amount together with $164,184.16, the assumption of the deferred-income liability account, was treated by respondent as being received in 1963.1 Because of the contingent nature of the note payments, the parties agree that the gain from the sale of the business should be reported under the "recovery of basis" method.
In each of the years 1964 through 1966, petitioners received 52 weekly payments or a total of $10,400. Since petitioners fully recovered their basis in 1963, all of the $200-per-week payments they received in the years at issue constitute gain to them.
Petitioners contend that the payments on the promissory note received by them in the taxable years 1964 through 1966 are taxable as long-term capital gain since the income represented by the "customers deposits" account could have been taxed in earlier years and since the payments were not the result of the assumption by the buyer of liabilities under the deferred income account (which, they assert, occurred in 1963) nor of advanced payments which were also taxed as ordinary income in 1963.
Respondent argues that the gain from the sale of petitioners' business is attributable to the sale of only one item, the "customers' deposits" deferred-income account, which item, he maintains, is an ordinary income item. Alternatively, respondent contends that since petitioners disposed of an ordinary income item which they received but, because of their accounting method, had not reported as income, they must recognize ordinary income on the sale of that item. Pridemark, Inc. v. Commissioner Dec. 26,840, 42 T.C. 510 (1964), affd. as to this point 65-1 USTC ¶ 9388 345 F. 2d 35 (4th Cir. 1965); Jud Plumbing & Heating, Inc. v. Commissioner 46-1 USTC ¶ 9177, 153 F. 2d 681 (5th Cir. 1946). Respondent asserts, finally, that none of the gain petitioners realized on the sale of their business is attributable to the sale of goodwill.
We agree with respondent.
Respondent's determination of a deficiency is presumptively correct. Petitioners have the burden of proving such determination is wrong. Welch v. Helvering 3 USTC ¶ 1164, 290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure.
The sale of a going business by a sole proprietor is the sale of all the assets of that business, rather than the sale of a single entity. The selling price must, therefore, be allocated among the individual assets with the character of the gain with respect to an asset...
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