Lychuk v. Comm'r of Internal Revenue, 11794–99

CourtUnited States Tax Court
Citation116 T.C. 374,116 T.C. No. 27
Docket Number11863–99.,No. 11794–99,11855–99,11794–99
PartiesDavid J. LYCHUK and Mary K. Lychuk, et al.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Decision Date31 May 2001

OPINION TEXT STARTS HERE

Taxpayers petitioned for redetermination of adjustments made to income from a subchapter S corporation arising from recharacterizing deductible business expenses as capital expenses. The Tax Court, Laro, J., held that: (1) salaries and benefits related to anticipated acquisitions of assets with expected useful lives exceeding one year were capital expenditures; (2) overhead expenses were current business deductions; (3) capitalized salaries attributable to contracts never acquired were deductible as business losses; (4) offering expenditures had to be capitalized; and (5) expenses of abandoned offering were currently deductible losses.

Decision for IRS in part, and for taxpayer in part.

Swift, J., concurred in written opinion.

Ruwe, J., concurred in part and dissented in part in written opinion, in which Whalen, Halpern, Beghe, Foley, Gale, and Marvel, JJ., joined.

Halpern, J., concurred in part and dissented in part in written opinion, in which Whalen and Beghe, JJ., joined.

Beghe, J., concurred in part and dissented in part in written opinion, in which Gale, J., joined. A acquires and services multiyear installment contracts as its sole business operations. A acquires each contract at 65 percent of its face value and is entitled to all principal and interest payments. A's employees perform various credit review services in order to decide whether to acquire each contract offered to A and, as to the contracts which A chooses to acquire, perform additional services in paying the sellers. R determined that all of A's salaries, benefits, and overhead (printing, telephone, computer, rent, and utilities) relating to its acquisition (and not to its service) operation were capital expenditures. R also determined that A had to capitalize professional fees and commissions (collectively, offering expenditures) relating to its offering of notes in 1993 and a second offering that was planned in 1993 and abandoned in 1994.Held: The salaries and benefits are capital expenditures; A's payment of these items was directly related to its anticipated acquisitions of assets with expected useful lives exceeding 1 year.Held, further, The overhead expenses may be deducted currently under sec. 162(a), I.R.C.; A's payment of these items was not directly related to the anticipated acquisitions, and any future benefit that A received from these expenses was incidental to its payment of them.Held, further, sec. 165(a), I.R.C., allows A to deduct the portion of the capitalized salaries and benefits that was attributable to installment contracts which it never acquired; A may deduct those amounts for the respective years in which it ascertained that it would not acquire the related contracts.Held, further, A must capitalize all of the offering expenditures; A's payment of these expenditures was anticipated to provide A with significant future benefits.Held, further, sec. 165(a), I.R.C., allows A to deduct in 1994 the portion of the capitalized offering expenditures that was attributable to the abandoned offering.Oksana O. Xenos, for petitioners.*

Eric R. Skinner, for respondent.

LARO, J.

Petitioners petitioned the Court to redetermine deficiencies attributable primarily to adjustments which respondent made to their income from a subchapter S corporation, Automotive Credit Corporation (ACC). Respondent determined a $1,202 deficiency in the 1993 Federal income tax of David J. and Mary K. Lychuk. Respondent determined $2,149 and $11,461 deficiencies in the 1993 and 1994 Federal income taxes, respectively, of Edward C. and Virginia M. Blasius. Respondent determined $23,683 and $89,609 deficiencies in the 1993 and 1994 Federal income taxes, respectively, of James E. and Mary Jo Blasius.2 Both Blasius couples alleged in their respective petitions that they had an overpayment for 1994 on account of costs which ACC failed to deduct for that year.

Following concessions, we must decide whether ACC must capitalize certain expenditures made during 1993 and 1994. The expenditures were generally ACC's payment of (1) salaries, benefits, and overhead (printing, telephone, computer, rent, and utilities) relating to its acquisition of retail installment contracts (installment contracts) in the ordinary course of its business (installment contracts expenditures) and (2) professional fees and commissions relating to a private placement offering of notes that ACC accomplished in 1993 and a second offering that ACC planned in 1993 and abandoned in 1994 (collectively, PPM expenditures). We hold that ACC must capitalize both groups of expenditures to the extent described herein. We must also decide whether ACC may deduct the portion of the capitalized installment contracts expenditures relating to installment contracts which it never acquired. We hold it may deduct that portion under section 165(a).3 We must also decide whether ACC may deduct the portion of the PPM expenditures relating to the abandoned offering. We hold it may deduct that portion for 1994 under section 165(a).

FINDINGS OF FACT

The parties have stipulated many of the facts. We incorporate herein the parties' stipulation of facts and the exhibits submitted therewith. We find the stipulated facts accordingly. Each petitioning couple is a husband and wife who resided in Michigan when their petition was filed. Each petitioning couple filed a joint Federal income tax return for the relevant years.

ACC is a cash method taxpayer that was incorporated in 1992 and elected shortly thereafter to be taxed as an S corporation for Federal income tax purposes. It was formed to provide alternate financing for purchasers of used automobiles or light trucks (collectively, automobiles) who have marginal credit. Its sole business operation is (1) the acquisition of installment contracts from automobile dealers (dealers) who have sold automobiles to high credit risk individuals and (2) the servicing of those contracts. Its primary business activities are credit investigation, credit evaluation, documentation, and the monitoring of collections on installment contracts. Its business is conducted out of space that it rents in Bingham Farms, Michigan, pursuant to a 5–year lease that began on October 22, 1992. Under the lease, ACC pays monthly rent of $3,137.50 during the first 24 months and $3,250 afterwards.

ACC's shareholders and their respective ownership interests are as follows:

+-------------------------------------+
                ¦                           ¦1993¦1994¦
                +-------------------------------------¦
                ¦                                     ¦
                +-------------------------------------¦
                ¦James and Mary Jo Blasius  ¦77% ¦86% ¦
                +---------------------------+----+----¦
                ¦Edward and Virginia Blasius¦13  ¦14  ¦
                +---------------------------+----+----¦
                ¦Donald Terns               ¦5   ¦0   ¦
                +---------------------------+----+----¦
                ¦David Lychuk               ¦5   ¦0   ¦
                +-------------------------------------+
                

None of the shareholders, except James Blasius, works in ACC's daily business. The other male shareholders serve as the directors of ACC's board.

ACC's key management personnel includes its president, James Blasius, its vice president and chief financial officer, Steven Balan, its credit manager, Cass Budzynowski, and its credit investigator, Hope McGee. During the relevant years, each of these individuals performed services in connection with ACC's acquisition of installment contracts. James Blasius managed ACC's overall operation and handled personally all contracts with dealers. Steven Balan supervised and oversaw ACC's day-to-day management and its financial and general office management. Cass Budzynowski analyzed credit applications and supervised credit investigations. Hope McGee analyzed credit reports and verified all information provided by credit applicants, e.g., by directly contacting employers, banks, and creditors.

ACC pays each of its key management personnel a base salary. Each of these individuals is also entitled to receive an annual bonus at the sole discretion of ACC's board of directors. The bonuses are paid from a “bonus pool” established by ACC and in which ACC places funds in an amount up to 16.25 percent of its pretax net profits. Except in the case of James Blasius, no restrictions exist as to the amount of compensation that ACC may pay to its officers or key employees. James Blasius' bonus is limited to 55 percent of the pool.

Under the terms of each installment contract, an individual buys an automobile from a dealer at a set price to be paid (with interest) in monthly installments. The average rate of interest charged to the buyers is approximately 22 percent. The length of repayment ranges from 12 to 36 months.

ACC and the dealers have an independent agreement under which the dealers sell some of the installment contracts (and the right to the corresponding payments of principal and interest) to ACC at a price equal to 65 percent of each contract's principal amount (i.e., at a 35–percent discount). As of April 30, 1993, ACC acquired the installment contracts from 13 dealers, 3 of which sold to ACC 69.4 percent of the installment contracts which ACC acquired. ACC is not obligated to acquire all of the installment contracts offered to it by the dealers but generally must decide on whether it will acquire a particular installment contract before the related automobile sale is finalized. ACC rests its decision as to the acquisition of an installment contract on its analysis of the buyer's credit worthiness. That analysis generally includes ACC's review of the buyer's credit application, ACC's obtaining of one or more credit reports on the buyer, ACC's verifying of the buyer's job status, salary, and residence, and ACC's evaluation of various aspects of the buyer's credit history such...

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