Magee v. Commissioner

• Decision Date: 14 July 1993
• Docket Number: Docket No. 13314-90.
• Citation: 66 T.C.M. 105
• Parties: Dale E. Magee and Ellen F. Magee v. Commissioner.
• Court: U.S. Tax Court

66 T.C.M. 105

T.C. Memo. 1993-305

Dale E. Magee and Ellen F. Magee v. Commissioner.

Docket No. 13314-90.

United States Tax Court.

Filed July 14, 1993.

Dale E. Magee, pro se. Richard A. Stone, for the respondent.

Memorandum Opinion

PARKER, Judge:

Respondent has determined a deficiency in petitioners' Federal income tax and additions to tax as follows:

                Additions to Tax
                                                  Sec.         Sec
                Taxable Year       Deficiency   6653(a)(1)   6653(a)(2)
                1985 ...........     $20,360      $1,018         *
                * 50% of the interest due on the deficiency
                

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

After concessions,¹ the issues remaining for decision are:

(1) Whether petitioners are entitled to a deduction, pursuant to section 1244, for a loss based upon the stock of United Agri-Services, Inc.;

(2) Whether advances of money made by petitioners to United Agri-Services, Inc., represent bona fide loans or contributions to capital;

(3) Whether petitioners were in the business of making loans, and if so, whether, in connection with such a business, petitioners incurred deductible business bad debts;

(4) Whether respondent properly determined the amount of petitioners' rental income; and

(5) Whether petitioners are liable for additions to tax under section 6653(a)(1) and (2) for negligence or intentional disregard of rules or regulations.

Petitioners claim various deductions in their petition and on brief that they had not claimed on their 1985 tax return. We will discuss these deductions under the appropriate headings below. Most of the issues in this case are essentially factual, mainly involving the nature of certain activities of petitioners and whether petitioners have substantiated the amounts of any deductible items.

For convenience, our findings of fact and opinion on each issue will be combined, but each issue will be discussed under a separate heading.

General Background

Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.

Petitioner Dale E. Magee (petitioner) and petitioner Ellen F. Magee (Mrs. Magee) are husband and wife (collectively referred to as petitioners) and resided in Fairbury, Illinois, at the time of the filing of the petition in this case.

During the taxable year at issue, petitioner was the president and sole shareholder of United Agri-Services, Inc. (UAS). UAS was in the business of constructing hog confinement buildings and other farm related structures. The UAS Preorganization Subscription Agreement further described the corporate purposes:

said corporation shall be organized for the purpose of Designing, engineering, manufacturing, constructing, selling, servicing and marketing of environmentally controlled buildings and their component parts and interior equipment principally for the production of Agriculture livestock in the States of Illinois, Indiana, Iowa and Wisconsin and for such other purposes as the incorporators may determine[.]

Ordinary Loss Deduction for Section 1244 Stock

In 1974, UAS was incorporated under the laws of the State of Illinois. The corporation was authorized to issue 500 shares of common stock with a par value per share of $100. In 1974, petitioner purchased from UAS 100 shares of this common stock for $10,000.² The 100 shares represented a 20-percent ownership in UAS. Between 1974 and May of 1980, petitioner purchased the remaining 80 percent of the shares of UAS from the four other original shareholders. As of May of 1980, petitioner became the sole shareholder of UAS. He continued to be the sole shareholder during and beyond the taxable year at issue, 1985.

On March 22, 1985, UAS filed a petition in bankruptcy. Petitioners contend that, as a result, they incurred a $50,000 loss in 1985 on the 500 shares of UAS stock they owned. They claim that the stock became worthless in 1985 because the bankruptcy estate had no residual funds to pay petitioner after the claims of the other creditors had been paid. Petitioners conclude that this loss is eligible as a loss under section 1244 and that they should be allowed to deduct its value, $50,000, against their ordinary income.

Section 1244(a) provides that, "In the case of an individual, a loss on section 1244 stock issued to such individual * * * which would (but for this section) be treated as a loss from the sale or exchange of a capital asset shall, to the extent provided in this section, be treated as an ordinary loss." There is a limit on the amount that can be treated as ordinary loss, but any loss in this case is within such limit. Sec. 1244(b)(2).

Section 1244(c) defines "section 1244 stock" as stock issued by a domestic, small business corporation for money or other property (other than stock and securities). Sec. 1244(c)(1). Section 1244(e) provides that "The Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this section." This Court has recognized that section 1244 was designed to provide a tax benefit to a rather limited group of taxpayers, and as a result, "qualification for those benefits requires strict compliance with the requirements of the law and the regulations promulgated pursuant to the specific instructions therefor included in section 1244(e)". Morgan v. Commissioner [Dec. 28, 131], 46 T.C. 878, 889 (1966).

The regulations for section 1244 provide that the individual must be the person "to whom such stock was issued by a small business corporation" and "must have continuously held the stock from the date of issuance" in order to claim a loss deduction under section 1244. Sec. 1.1244(a)-1(b), Income Tax Regs.; Adams v. Commissioner [Dec. 36,872], 74 T.C. 4, 8 (1980). An individual who acquires stock from a shareholder by purchase, gift, devise, or in any other manner is not entitled to an ordinary loss under section 1244 with respect to such stock. Id. Therefore, petitioner, as original issue owner of only 100 shares of UAS stock, fails to satisfy the statutory and regulatory requirements with respect to the other 400 shares of UAS stock that he purchased from the other shareholders over the years. At most, petitioner may claim an ordinary loss only with respect to the 100 shares he purchased directly from the corporation.

With respect to the 100 shares of stock that petitioner has owned since original issuance, the regulations contain strict reporting requirements for taxpayers who claim application of section 1244. Sec. 1.1244(e)-1, Income Tax Regs. The regulations provide that any taxpayer who is claiming a deduction for an ordinary loss for stock under section 1244 "shall file with his income tax return for the year in which a deduction for the loss is claimed a statement" that sets forth the address of the corporation that issued the stock, the manner in which the stock was acquired, and the nature and amount of the consideration paid. Sec. 1.1244(e)-1(b), Income Tax Regs. In addition, the taxpayer must maintain records sufficient to distinguish such section 1244 stock from any other stock he may own in the corporation. Id. In this case, petitioners did not file the statement required by section 1.1244(e)-1(b), Income Tax Regs., with their 1985 tax return. As a result, the 100 shares of original issue UAS stock owned by petitioner fail to qualify as section 1244 stock. Cournan v. Commissioner [Dec. 46,044(M)], T.C. Memo. 1989-520; Cosgrove v. Commissioner [Dec. 44,116(M), T.C. Memo. 1987-401; cf. Morgan v. Commissioner [Dec. 28,131], 46 T.C. at 889. It follows then that petitioners are not entitled to an ordinary loss deduction pursuant to section 1244 for a loss upon the UAS stock.

Schedule C Deductions

The loss reported on Schedule C of petitioners' 1985 Federal income tax return was computed by petitioners as follows:

                Funds from a mortgage at First Federal
                 Bank on petitioners' residence .............   $ 75,000
                Collateral provided by petitioners for a
                 loan from the Bank of Forrest ..............     40,000
                Petitioners' certificate of deposit pledged
                 for a loan from First Federal Bank .........      9,000
                Alleged miscellaneous unreimbursed
                 corporate expenses .........................      6,000
                Less
                Petitioners' receipt of proceeds from the
                 sale of bonds held in the name of UAS ......    (17,126)
                Petitioners' receipt of interest on notes of
                 UAS ........................................    ( 8,741)
                   Net Loss* ................................   $104,133
                * The parties have stipulated that the difference between
                the above net loss of $104,133 and the figure reported on the
                return of $104,434 is unknown
                

On the Schedule C, petitioners characterized the claimed loss as "CORPORATION EXPENSES PAID BY TAXPAYER AT DIRECTION OF COURTS. EXPENSES NOT DEDUCTED BY CORPORATION".

Petitioners now contend that they had a personal business proprietorship of "making loans", separate and distinct from any other business or employment, that they operated from 1980 through 1985. Petitioners claim that, by making these alleged loans, they intended to earn income from the interest generated. In the years prior to 1985, petitioners claim that they had no income or expenses from that alleged business and, therefore, did not file Schedules C for that business during those years.

Petitioners now contend that, in 1985, they had business losses totaling $202,987.70 from their business of making loans. Petitioners claim that they gave all of their business information to their accountant who prepared their 1985 tax return. Petitioners contend that the accountant incorrectly underreported business losses on Schedule C and also mischaracterized those losses as due to the payment of UAS expenses rather than properly characterizing them as business bad debt losses. P...