Leger v. Commissioner
| Decision Date | 18 March 1987 |
| Docket Number | Docket No. 18640-84. |
| Citation | 1987 TC Memo 146,53 TCM (CCH) 384 |
| Parties | Thomas J. Leger and Margaret H. Leger, v. Commissioner. |
| Court | U.S. Tax Court |
Jules Ritholz, Elliot Silverman, Herman Schwartzman, and Howard L. Mann, for the petitioners. Andrew M. Winkler and Jillena A. Warner, for the respondent.
Memorandum Findings of Fact and Opinion
This case was assigned to and heard by Special Trial Judge Joan Seitz Pate pursuant to section 7456(d) redesignated as sec. 7443A(b) by the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2755 and Rules 180, 181 and 183.2 The Court agrees with and adopts the Special Trial Judge's opinion which is set forth below.
PATE, Special Trial Judge:
Respondent determined deficiencies in petitioners' Federal income tax of $24,140.75 for 1979 and $46,260.023 for 1980. In determining these deficiencies, respondent alleged that petitioners improperly claimed losses and an investment credit arising from their participation in Literary Arts Associates (hereinafter "Arts"), a limited partnership involved in the book publishing industry. Respondent subsequently determined that petitioners had improperly claimed on their 1980 Federal income tax return other losses and investment credits passed through from entities not involved in this opinion, and also alleged that petitioners were liable under section 6621 for increased interest on the deficiency for both 1979 and 1980 resulting from their participation in Arts as well as the other entities.4 All issues relating to petitioners' in Arts during 1979 were tried,5 and are the subject of this opinion.
The issues for our decision are:
(1) Whether Arts' publishing activities constituted activities not engaged in for profit within the meaning of section 183;6 and
(2) Whether petitioner's participation in Arts constituted a tax motivated transaction subjecting the deficiency resulting therefrom to an increased rate of interest under section 6621(d).7
Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Introduction. Thomas J. Leger (hereinafter "petitioner") and Margaret H. Leger,8 husband and wife, filed a joint Federal income tax return for 1979. Petitioner was a professional accountant and business consultant producing a substantial (six figure) annual earned income therefrom. In 1979, petitioner purchased, for $15,000, one-third of a limited partnership unit in Arts.
Arts was organized on July 23, 1979 by Jonathan T. Bromwell & Associates, Inc. (hereinafter "Bromwell"),9 its general partner, to acquire and exploit mass market paperback books.10 Bromwell sold twenty-five limited partnership units in Arts at $45,000 cash per unit for a total of $1,125,000.
Subsequently, Arts acquired, for a total purchase price of $12,319,000 ($824,000 in cash and $11,495,000 in nonrecourse notes), certain rights and properties associated with the following 23 books (hereinafter "titles")11 from Madison Library, Inc. (hereinafter "Madison"):12
All 23 titles were produced from original manuscripts, none were reprints.13 They included 4 historical fiction, 2 historical romance, 3 contemporary romance, 2 science fiction, 1 fantasy, 2 thrillers, 1 romantic mystery and 8 mystery puzzlers. All were written by professional authors. The four historical fiction (titles 1-4) were the first titles in the "Making of America" series. This series attempted to capitalize on the popularity of three novels, written by John Jakes and James Michener, which had sold millions of copies. However, neither Jakes nor Michener wrote any of the novels in the Making of America series. The 8 mystery puzzlers (titles 16-23) were numbers 21 through 28 of a series. As an innovative feature, each mystery puzzler contained a sealed final chapter giving the solution to the mystery. This provided the reader with an opportunity to solve the mystery before finding out "who done it."
The Transactions Involved. Between November 1978 and January 1979 the authors of titles 1-5 sold exclusive rights to print, publish, license and sell their works14 to James A. Bryans Books (hereinafter "Bryans Books"). The latest delivery dates for these works ranged between December 31, 1978 and April 1, 1979. As consideration, the authors received advances totaling $42,000; no single advance exceeded $10,000.15 In addition, each author was entitled to royalties at the rate of 6 percent of net retail sales on the first 150,000 copies sold and 8 percent on all additional copies sold thereafter. On March 29, 1979, Bryans Books assigned all of its rights in titles 1-5 to Richard Gallen & Co., Inc. (hereinafter "Gallen") for an interest in profits.
On November 17, 1977, the author of title 6 sold his rights to GM Publishing, Inc. This work was deliverable by March 31, 1978. As consideration, the author received a $5,000 advance plus the right to royalties of 6 percent of net retail sales on the first 150,000 copies and 8 percent thereafter. This agreement also was subsequently assigned to Gallen.16 Hereinafter titles 1-6 will be referred to collectively as the "Gallen titles."
By agreements dated between July 26, 1978 and April 2, 1979 the authors of titles 7-23 sold exclusive rights to license, manufacture, print, publish and distribute their works to Kensington Publishing Corp. (hereinafter "Kensington"), with deadlines ranging between January 1, 1979 and April 15, 1979. As consideration, the authors received advances ranging between $1,500 and $7,50017 and totaling $43,500. The agreement for title 11 provided for the payment of a royalty at the rate of 8 percent on the net retail sales on the first 150,000 copies sold and 10 percent on all additional copies sold thereafter. Each of the other authors were entitled to royalties based on the net retail sales of his work, at the rate of 6 percent on the first 150,000 copies sold and 8 percent on all additional copies sold thereafter. The agreements also obligated Kensington to publish 10,000 copies of each title on or before dates ranging between March 31, 1980 and December 30, 1981. Hereinafter titles 7-23 will be referred to collectively as the "Kensington titles."18
Early in 1979, Cohen, as president of Madison, negotiated with Gallen and Kensington to purchase the 23 titles subsequently acquired by Arts. From the titles Gallen and Kensington intended to publish, Cohen "cherry-picked" the ones he wanted based on the expected initial printing, a synopsis of the story, a biography of the author, and evaluations by people familiar with the industry. He read only one of the works. By agreement dated March 28, 1979, Madison purchased from Gallen and Kensington the "physical properties" for each title19 together with the right to print, publish, distribute and sell each title in paperback form.20 Gallen and Kensington retained their obligations to the authors under their respective contracts.
As consideration for the transfer of the Gallen titles, Madison agreed to pay Gallen $73,000 in cash (a down payment of $6,500 plus $66,500 by December 31, 1979) and to execute a separate nonnegotiable, nonrecourse promissory note for each title, all due by October 1, 1988 and totaling $5,525,000.21 As consideration for the transfer of the Kensington titles, Madison agreed to pay Kensington $91,000 in cash by December 31, 1979 and to execute and deliver a separate nonnegotiable, nonrecourse promissory note for each title, all due on October 1, 1988 and totaling $5,970,000.22 If Madison failed to make the cash payments required under the agreements by December 31, 1979 all the transferred properties and rights would revert back to Gallen and Kensington without further liability on Madison's part.
The notes, dated March 28, 1979, and carrying a 6 percent interest, were payable semi-annually from 60 percent of the gross proceeds23 derived from sales.24 However, no interest or principal payments were required from an initial amount of proceeds (hereinafter "guaranteed proceeds") which ranged from $20,000 to $40,000 for the Gallen titles and from $6,000 to $17,000 for the Kensington titles. In a separate security agreement for each note, Madison conveyed to Gallen or Kensington, as appropriate, its rights in the related title. In the event of default, forfeiture of the rights to the transferred properties was the sole remedy available to the sellers.
On March 28, 1979, Madison also entered into services agreements with Confucian Press, Inc., a subsidiary of Gallen, (hereinafter "Confucian"), and Hercules Service Corporation, an affiliate of Kensington, (hereinafter "Hercules"), in which Confucian and Hercules agreed to produce, print, bind, distribute, sell and promote paperback editions of the 23 titles for 9 years.25 The contracts guaranteed that a specified minimum number of copies (between 35,000 and 200,000)26 of each title would be printed before the end of 1979 (hereinafter the "guaranteed initial printing"). Madison had the right to terminate the services agreements if Confucian and Hercules did not sell at least 20 percent of the guaranteed initial printing by December 31, 1981...
To continue reading
Request your trial