LaStaiti v. Commissioner, Docket No. 6067-77.
| Decision Date | 08 December 1980 |
| Docket Number | Docket No. 6067-77. |
| Citation | 1980 TC Memo 547,41 TCM (CCH) 511 |
| Parties | Gustave and Elsa LaStaiti v. Commissioner. |
| Court | U.S. Tax Court |
Edward F. Hines, Jr., Samuel B. Bruskin, and Mitchell H. Kaplan, 60 State St., Boston, Mass., for the petitioners. W. Terrence Mooney, for the respondent.
Memorandum Findings of Fact and Opinion
The Commissioner determined a deficiency of $2,685.84 in petitioners' 1973 income tax. This deficiency was the result of the Commissioner's determination that a $16,735 business bad debt deduction claimed by petitioners in respect of purported loans and loan guarantees for the benefit of LaStaiti Associates, Inc., and other corporations organized by the petitioner-husband, was allowable only as a non-business bad debt, and was accordingly subject to the limitations applicable to short term capital losses. In their petition, the petitioners increased the stakes in this case by claiming that they were entitled to total business bad debt deductions of $107,698, rather than the lesser amount claimed on their return. By an amended answer filed after the trial, the Government claimed a $1,541.84 additional deficiency on the grounds that petitioners' purported loans and loan guarantees were nondeductible capital contributions, rather than loans, or were debts which did not in fact become worthless in 1973. Thus, with respect to each of the purported loans and loan guarantees in issue, the following questions are presented for decision: (1) Did the purported loan or loan guarantee give rise to a bona fide debt, or was it a nondeductible capital contribution; (2) Did the debt become worthless in 1973; and (3) Was the debt a fully deductible business bad debt, or was it a nonbusiness bad debt subject to the limitations on deductions of short term capital losses.
Some of the facts have been stipulated. The stipulation of facts and related exhibits are incorporated herein by this reference.
Petitioners, husband and wife, are cash basis taxpayers. They resided in New Bedford, Mass. at the time their petition was filed. Since the bad debt deductions in issue arose from claimed advances or loan guarantees for a business controlled by the petitioner-husband, he will sometimes be referred to as "petitioner".
Petitioner Gustave LaStaiti was born in 1910 and immigrated to the United States at the age of 10. After leaving school, he began work as a hairdresser. He subsequently was employed by an operator of beauty shop concessions in department stores and traveled throughout the country opening beauty salons. While he was thus employed, around 1932-1933, his employer offered to sell him a beauty shop concession and to permit him to pay for it over time. Petitioner accepted this offer, and began operating the beauty shop concession in the Cherry & Webb Department Store in New Bedford, Mass. as a sole proprietor. From there, petitioner extended his operations to the other Cherry & Webb stores. In time, other department store chains asked petitioner to open beauty salons in their stores, and petitioner gradually opened more salons at the rate of approximately one to two stores per year. He also established a number of hairdressing schools, to provide his shops with trained employees, and two beauty supply houses, to assure his shops of a supply of beauty products.
Petitioner organized a number of corporations to operate various segments of the beauty enterprise. Some of these corporations also had separate operating divisions and subsidiaries. These corporations and their operating divisions and subsidiaries were all components of the beauty business controlled by petitioner, and references to the beauty business or enterprise include such corporations and their component parts.
In 1955, petitioner organized a Massachusetts corporation to own and operate his beauty salons. He contributed the assets of the business to the corporation solely in exchange for all of its stock. After 1966, the corporation was known as LaStaiti Associates, Inc. (hereinafter sometimes referred to as "Associates").
In 1959, petitioner organized La Baron Hairdressing Academy, Inc. (La Baron), a Massachusetts corporation, to own and operate a number of hairdressing schools. Petitioner owned 66 2/3 per cent of La Baron as of December 31, 1968. In the early 1970's, all of La Baron's stock was transferred to Associates, and La Baron thereafter operated as a wholly-owned subsidiary of Associates. Ron San Realty Corp. (Ron San), was incorporated in 1963 to own certain real estate which it leased to Associates; petitioner owned all of its stock until June of 1972. V.V.N., Inc. (V.V.N.), a Massachusetts corporation, was organized in 1965 by petitioner and his brother, who each initially owned 50 percent of its stock. V.V.N. owned and operated three beauty salons. In early 1972, petitioner purchased his brother's stock, and thereafter remained the sole stockholder of V.V.N. until June of 1972. The beauty supply houses were not separately incorporated; they did business as Dartmouth Discount Beauty Supply Co. (Dartmouth Discount), and were operated as a division of LaStaiti Associates.
By the end of 1968, petitioner's beauty salon operations had expanded from a single shop to some 45 locations, and were associated with six department store chains. Most of the salons were operated on leased premises in department stores. The salons, hairdressing schools, and beauty supply houses were located in upstate New York and throughout Massachusetts and northern New England, except Vermont. In 1968, which appears to have been the beauty enterprise's most successful year, it had approximately 650-700 employees and annual gross sales in excess of $2.5 million.
Around 1969, the beauty enterprise began encountering financial difficulties, and it incurred substantial operating losses in that year, although it earned a modest profit in 1970. The concern's financial problems were primarily the result of working capital shortages caused by the rapid expansion of the business and a lack of adequate management.
The beauty concern's working capital shortages were primarily the result of expansion of the beauty salons at a rate beyond the financial capacity of the beauty enterprise. Although the beauty enterprise as a whole had been growing from the time petitioner opened his first salon, competitive pressures required Associates to expand its beauty salon operations at a greatly increased rate in the late sixties and early seventies, straining the financial resources of the enterprise as a whole and requiring additional financing. At that time, the beauty salons were associated with five to six department store chains, and as these chains opened new stores in newly constructed suburban shopping malls, LaStaiti Associates was forced to open new salons in these stores or face increased competition and the possible loss of its relationships with the department store chains. In order to satisfy the demands of the department store chains, Associates found it necessary to open as many as four to six new beauty salons each year, as opposed to the one or two salons it might have preferred to open. This expansion, which occurred at a pace greatly in excess of any expansion the beauty enterprise had previously experienced, strained Associates' finances. Petitioner had always found it necessary to borrow funds to cover the costs of expansions of the beauty enterprise, although the enterprise had always been able to repay these loans. The newly opened salons also generally incurred initial operating losses, which also had to be financed. Thus, beginning in 1969, the beauty enterprise faced serious working capital difficulties. These difficulties were exacerbated in 1970 by the effects of a recession, although Associates earned a modest profit in that year.
The beauty enterprise also began having management difficulties in 1969. Until 1969, petitioner traveled approximately 60,000 miles per year personally supervising the operations of the beauty business. Since the operation of beauty salons required personal services, petitioner considered supervision of the beauty salons to be very important, and he personally assisted in the selection of employees and methods of operation for each salon, visiting each salon approximately once every two weeks. However, because of his participation in a new business venture, hereinafter described, petitioner could no longer devote his full time to the management of the beauty enterprise.
In 1968, a group of business and professional people in New Bedford, led by petitioner, began an effort to secure a charter for a new commercial bank. The charter was issued in 1969, and the new bank, Southeastern Bank & Trust Co. (Southeastern), opened for business in New Bedford in June, 1969. Petitioner served as president and chief operating officer of Southeastern, and was also among its largest shareholders with holdings of six to ten percent of the corporation's outstanding shares. His principal function with Southeastern was the development of business for the bank. Petitioner began working full time for Southeastern after its charter was acquired early in 1969, sometimes working 60 hours per week, and started receiving a salary from Southeastern at some time early in 1970.
Petitioner attempted to continue to manage the beauty business after he began work at Southeastern. However, he was able to devote only nights and weekends to the beauty business, and he was unable to continue to travel to supervise its operations outside of New Bedford. The beauty business was not well managed in his absence. He hoped to continue running the business part time until his son Ronald graduated from Harvard Business School in the summer of 1970. However, although Ronald became president of LaStaiti Associates after his graduation, he resigned near the end of that year, partly because...
To continue reading
Request your trial