Luke v. Commissioner, Docket No. 88890-88892
| Decision Date | 23 June 1964 |
| Docket Number | 89322.,Docket No. 88890-88892 |
| Citation | 1964 TC Memo 176,23 TCM (CCH) 1022 |
| Parties | Herbert Luke and Cecille Luke, et al. v. Commissioner. |
| Court | U.S. Tax Court |
Harold R. Burnstein, 105 W. Adams St., Chicago, Ill., for the petitioners. Seymour I. Sherman, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioners' income taxes for the calendar year 1958 in the following amounts:2
Docket Petitioner Amount
No
88890 Herbert Luke and Cecille Luke.................. $ 3,640.24
88891 Howard R. Conant and Doris Conant.............. 120,838.62
88892 Estate of Lawrence Farkas, Deceased, et al. ... 3,816.46
89322 Interstate Steel Co............................ 184,203.95
The issues presented for our consideration are: (1) Whether the corporate petitioner in Docket No. 89322 is entitled to carry over net operating losses in the amount of $487,692.88 from the fiscal period February 1 to December 31, 1955, and from calendar year 1957 against its earnings realized in the taxable year 1958, and (2) whether proceeds realized from the sale of certain notes sold by the individual petitioners herein are taxable as ordinary income or as capital gains.
Some of the facts have been stipulated and, together with exhibits, are incorporated herein by reference.
Petitioners, Herbert Luke (hereinafter referred to as Luke) and Cecille Luke, were at all times material husband and wife residing in Highland Park, Illinois. They filed a joint income tax return for the calendar year 1958, the year in question, with the district director at Chicago, Illinois. Petitioners, Howard R. Conant (hereinafter referred to as Conant) and Doris Conant, were at all times material husband and wife residing in Glenview, Illinois. They filed a joint income tax return for the calendar year 1958 with the district director at Chicago, Illinois. Petitioners, Estate of Lawrence Farkas, Deceased, et al., (hereinafter referred to as Farkas) and Regina Farkas, were during the relevant taxable year husband and wife residing in Highland Park, Illinois. They filed a joint income tax return for the calendar year 1958 with the district director at Chicago, Illinois. Petitioner in Docket No. 89322 is the Arlington Corp. (hereinafter referred to as Arlington) and was organized on January 30, 1951, under the laws of the State of Minnesota and had its principal office and place of business, until 1958, in St. Paul, Minnesota. On January 15, 1958, its name was changed to Interstate Steel Co. (hereinafter referred to as Interstate) and had its principal place of business moved to Evanston, Illinois. Arlington filed its corporate income tax return for the fiscal year ending January 31, 1952, with the collector of internal revenue and for the years 1953, 1954 and 1955, and a short fiscal period February 1, 1955, to December 31, 1955, and the calendar years 1956 and 1957 with the district director at St. Paul, Minnesota. In 1958 Interstate Steel Co. (formerly Arlington) filed its corporate income tax return for the calendar year 1958 on the accrual basis with the district director at Chicago, Illinois.
Arlington's original capitalization consisted of 500 shares of common stock with a par value of $100 per share, of which 400 shares were owned by Cortland J. Silver (herein-after referred to as Silver). About July 10, 1953, the other 100 shares of its stock were purchased and retired by Arlington. Thereafter, and until November 8, 1956, Silver was Arlington's sole stockholder.
Arlington was incorporated to acquire and continue a business established in 1912. The principal operations of said business, and of Arlington from its inception were those of a machine shop rather than those of a manufacturer, that is, the performance of work under specific contracts or subcontracts rather than the manufacturer of a proprietary item, i.e., its own line of goods.
When first organized, Arlington's advertising and publicity material indicated principally a machine shop operation. It also held itself out as manufacturing a line of metal trays. The record does not disclose the extent of this latter activity, the portion of Arlington's manufacturing operations and facilities devoted thereto, or the portion of its income attributable thereto. This latter activity, however, never represented a major phase of petitioner's business or activities, received only a minor share of the publicity devoted to Arlington's operations as contrasted with that devoted to its machine shop operations, and was never responsible for more than a minor part of petitioner's sales and gross income.
Arlington had within its possession a prototype of a trailer hitch which it contemplated producing sometime in the future.
Arlington operating primarily as a machine shop performed work for the United States Government on a contract basis. One of these contracts was with the Department of the Navy and consisted of the production of practice bombs.
From its inception and through its fiscal year ended January 31, 1953, contract work subject to the Renegotiation Act of 1951 accounted for over 50 percent of Arlington's gross sales. Thereafter and until some time in 1956, such contracts accounted for almost 100 percent of Arlington's gross sales. At no time prior to January 15, 1958, did Arlington sell or warehouse steel.
By September 21, 1956, Arlington was exclusively a job shop and did not have a product or line of its own. In 1957, Arlington derived no income from contracts or subcontracts subject to the Renegotiation Act of 1951.
Arlington's returns from its inception through the calendar year 1957 show the following net or taxable income (loss) as follows:
Taxable Year or Period Income (Loss)
F/Y/E 1-31-52 .................. $ 26,356.39
F/Y/E 1-31-53 .................. 26,984.84
F/Y/E 1-31-54 .................. (65,696.80)
F/Y/E 1-31-55 .................. 252,688.11
Period 2-1-55 to 12-31-55 ...... (628,296.70)
Calendar year 1956 ............. 2,085.84a
Calendar year 1957 ............. (96,746.05)
a The net profit during 1956 was due to a
special supplemental award on a contract for
the production of practice bombs which it had
with the Department of the Navy. After Arlington
was sold in this year it sustained losses
until the year-end
Arlington carried on its operations at two separate plants known as Plant No. 1 and Plant No. 2. In 10 months ending October 31, 1956, Arlington had sales in Plant No. 1 () of $389,197.85. Plant No. 2 burned down on February 13, 1956, and Arlington's Government work therein ceased. Manufacturing operations at that plant were never resumed. Thereafter, pursuant to a creditor's committee, which had been organized to consider the fiscal problems of Arlington, the Government contract was assigned to another company.
During Arlington's fiscal year ended January 31, 1955, and its fiscal period February 1 to December 31, 1955, its activities at its two plants and the net profit (loss) from such operations, according to its books, were as follows:
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Period
-----------------------------------------
Plant Fiscal Year Ended Period
1-31-55 2-1-55—12-31-55
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Plant No. 1 — Regular Work................... ($213,864.76) ($ 99,199.38)
Plant No. 2 — Booster Renovation............. 478,368.89
Plant No. 2 — U. S. Navy Practice Bomb....... ......... (420,777.28)
_____________ ______________
Net income (loss) per books ....................... $264,504.22 ($519,976.66)
============= ==============
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Throughout the existence of Arlington, prior to the transaction between Cortland Silver, who was president of Arlington, and the individual petitioners as hereinafter described, the only items of business specifically noted in its corporate minutes referred to Government contract work of an essentially military nature.
Arlington began to experience financial and operational difficulties at least by early 1954. Silver pledged his personal assets in or prior to February 1954 in order to permit the corporation to place itself in a position to meet its responsibilities with respect to military production commitments. In 1955 Silver agreed to advance funds to the corporation and to waive withdrawals of his salary.
By May 14, 1956, Arlington had substantially reduced its operations, substantially changed its management, and laid off sufficient employees to effect a reduction of $1,800 per month in its payroll. By no later than July 1956 Arlington's financial condition was such that it was impossible to borrow money from a bank. Its equipment was antiquated and required replacement in order to operate properly.
Arlington's balance sheet as of December 31, 1955, shows a deficit in stockholder's equity in the amount of $262,031.18, and a deficit in retained earnings in the amount of $399,398.56. In computing stockholders' equity, Arlington's balance sheet shows an addition thereto in the amount of $97,367.38, designated as "Stockholders' Equity arising out of Revaluation of Fixed...
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