McIngvale v. C.I.R., 90-4698

• Decision Date: 30 July 1991
• Docket Number: No. 90-4698,90-4698
• Citation: 936 F.2d 833
• Parties: -5267, 91-2 USTC P 50,376 George C. and Angela B., McINGVALE, Sr., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. Summary Calendar.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 833

936 F.2d 833

68 A.F.T.R.2d 91-5267, 91-2 USTC P 50,376

George C. and Angela B., McINGVALE, Sr., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 90-4698

Summary Calendar.

United States Court of Appeals Fifth Circuit.

July 30, 1991.

D. Kevin McCorkingdale, Tobolowsky, Prager & Schlinger, Dallas, Tex., for petitioners-appellants.

Abraham N.M. Shashy, Jr., Chief Counsel, I.R.S., Gary R. Allen, Chief, Curtis C. Pett, Kenneth L. Greene, Sara S. Holderness, Appellate Section, Shirley D. Peterson, Asst. Atty. Gen., Tax Div., U.S. Dept. of Justice, Washington, D.C., for respondent-appellee.

Appeal from a Decision of the United States Tax Court.

Before JOHNSON, SMITH and WIENER, Circuit Judges.

WIENER, Circuit Judge:

This kaleidoscopic federal income tax case was filed in the United States Tax Court by Petitioners-Appellants George C. and Angela B. McIngvale (collectively, Taxpayers) against the Commissioner of Internal Revenue (the Commissioner) for a redetermination of federal income tax deficiencies previously determined by the Internal Revenue Service (IRS). Following a trial on the merits, the tax court ruled in favor of the Commissioner, holding that (1) Taxpayers had failed to meet their burden of proof to support a claimed reduction of $15,000 for overstatement of income, and (2) Taxpayers' 1978 loss, incurred in connection with their interest in a Nautilus franchise transferred in 1974 to their children's corporation in consideration of that corporation's grant of a private annuity which became worthless in 1978, was governed by the annuity provisions of 26 U.S.C. 72 (hereafter Section 72 of the Internal Revenue Code (I.R.C.) of 1954, as amended), and not by the franchise provisions of I.R.C. Sec. 1253, so that the loss sustained by the Taxpayers was a capital loss rather than an ordinary loss under I.R.C. Sec. 165. On appeal, Taxpayers claim that the tax court clearly erred in its factual determination regarding the $15,000 item, and erred as a matter of law in failing to apply I.R.C. Sec. 1253 to Taxpayers' franchise loss to produce ordinary loss, or alternatively in failing to allow ordinary loss treatment under I.R.C. Sec. 165.

Concluding that the tax court was not clearly erroneous in finding Taxpayers' evidence insufficient to overcome the presumption of correctness of the deficiency determination of the IRS, we affirm the tax court's refusal to reverse the $15,000 determination. Likewise concluding that the tax court correctly analyzed Taxpayers' loss that resulted from the failure of their children's corporation as a loss on the annuity that Taxpayers acquired when the franchise was transferred to the corporation--and thus a capital loss--rather than either an ordinary loss on "licensing" of franchise rights under I.R.C. Sec. 1253 or an ordinary loss under I.R.C. Sec. 165(a), we affirm the tax court's holding on that issue as well.

I. OPERABLE FACTS

Early in 1974, Mr. McIngvale acquired rights to market exercise equipment manufactured by Nautilus (the franchise) in prescribed geographical areas. The franchise cost Mr. McIngvale $209,439. Realizing that his involuntary bankruptcy was imminent and wishing to insulate the franchise from his bankruptcy, Mr. McIngvale arranged for the incorporation of Nautilus of the Southwest, Inc. (Nautilus Southwest) on May 3, 1974, all capital stock of which was acquired equally by Taxpayers' six children as original owners. Just days later, on May 14, 1974, shortly before he was involuntarily placed in bankruptcy, Mr. McIngvale assigned and transferred the franchise to Nautilus Southwest in consideration for which the corporation assumed Mr. McIngvale's present and future obligations under the franchise and contracted to pay Mrs. McIngvale $4,000 a month for the rest of her life, beginning on or before January 1, 1976 (the private annuity). When, shortly thereafter, Mr. McIngvale was involuntarily placed in bankruptcy, he listed neither the franchise or any rights or interests in it, nor his wife's private annuity, on the schedule of assets he filed with the bankruptcy court.

Although Mr. McIngvale was employed and served as general manager of Nautilus Southwest from its incorporation in 1974 through its bankruptcy in 1978, with responsibility for sales, management and employee training, there is no evidence that he personally retained rights to license other parties as Nautilus franchisees or sub-franchisees. Nautilus Southwest obtained all right, title and interest in the franchise from Mr. McIngvale in exchange for the private annuity granted to Mrs. McIngvale for life.

Nautilus Southwest paid Mrs. McIngvale $48,000 in 1976 and a like amount in 1977, which Taxpayers reported on their joint income tax returns as "proceeds from the sale of Nautilus franchises" offsetting an equal amount of their investment (basis) in the franchise. A subsequent audit by the IRS, however, determined that such reporting was improper under I.R.C. Sec. 72. The return position for those payments under I.R.C. Sec. 72, as proposed by the IRS, was accepted by Taxpayers.

In 1978 Nautilus Southwest declared bankruptcy, paying only $16,000 to Mrs. McIngvale that year. Taxpayers claimed an ordinary loss of $193,367 on their 1978 income tax return, being the amount of their remaining investment (basis) in the private annuity. Taxpayers also amended their returns for 1976 and 1977, claiming an ordinary loss carryback.

In 1977, the IRS determined that the Taxpayers' $193,367 loss was capital rather than ordinary, on the basis of which the IRS determined deficiencies of $30,455 and $36,900 for 1976 and 1978, respectively. An additional tax of $9,155.75 was imposed for 1978 pursuant to I.R.C. Sec. 6651 for Taxpayers' failure to file a timely return. Taxpayers concede that if they are liable for a deficiency for 1978 the additional tax is proper.

II. PROCEEDINGS

The foregoing facts are straightforward and undisputed; the same cannot be said for the procedural history of this case, during which the Taxpayers and the Commissioner repeatedly changed their respective positions. In October of 1987, Taxpayers filed their original petition in tax court seeking a redetermination of the IRS's deficiency determination for 1976 and 1978, claiming that the annuity became worthless upon the bankruptcy of Nautilus Southwest in 1978, thereby producing an ordinary loss in the amount of Taxpayers' remaining basis in the franchise. They claimed that the ordinary loss created a net operating loss for 1978 that could be carried back to 1976.

Late in 1988, Taxpayers amended their petition, asserting that the receipt of the annuity by Mrs. McIngvale was a closed transaction requiring Taxpayers to recognize capital gain in 1974 in the amount by which the present value of the annuity exceeded the investment in the annuity. The Taxpayers further claimed that the amounts received under the annuity reduced their investment in it so that when Nautilus Southwest became bankrupt in 1978, Taxpayers became entitled to an ordinary loss in the amount of their unrecovered investment.

In March of 1989, Taxpayers' January 30, 1989, motion was granted, permitting them to amend their petition again. For the first time Taxpayers advanced the argument that the transfer of the franchise should be governed by I.R.C. Sec. 1253 which provided that under specified circumstances the transfer of a franchise would not be treated as a sale or exchange of a capital asset; as a result of which, i.e., absent a sale or exchange, the transfer would give rise to ordinary gain or loss rather than capital gain or loss.

This case was tried to the tax court in November of 1989, when, for the first time, Taxpayers contested the $15,000 item. That was the amount reported as income on Schedule C of their 1978 return as "Additional--To Offset Any Other Income Which Might Be Included by the IRS." At trial Taxpayers insisted that no such item was ever received so the amount should not have been included on the return.

In January of 1990, the due date of Taxpayers' post-trial brief, the Commissioner sought to amend his Answer to conform with Taxpayers' trial testimony which indicated that the franchise had substantial value after the bankruptcy of Nautilus Southwest in 1978; that Taxpayers suffered no loss in 1978; and that their tax deficiency was greater than previously known. The tax court denied the Commissioner's motion to amend as being prejudicial to Taxpayers.

Finally, late in May of 1990, the Commissioner raised yet another theory: that Mr. McIngvale made a gift to Mrs. McIngvale in 1974 when he transferred the franchise in exchange for the private annuity payable to her for life, eschewing loss between related parties under I.R.C. Sec. 267. The tax court refused to consider that tardy theory.

Although Mr. McIngvale testified that the $15,000 entry did not represent income received in 1978, he could not explain the presence of the entry on the return, and the return preparer was not present at trial. The tax court found that the unsupported conclusory testimony of McIngvale was insufficient to support reduction of 1978 income by $15,000, but allowed Taxpayers the opportunity to make their 1978 return preparer available for an interview with the IRS, after which the tax court would accept a stipulation regarding the $15,000. No such stipulation was ever submitted to the court.

The tax court also found that Taxpayers had transferred their entire interest in the franchise to Nautilus Southwest in 1974 in exchange for a private annuity, and that the annuity became worthless in 1978 as a result of that corporation's bankruptcy. On those facts the tax court held that the annuity provisions of I.R.C. Sec. 72, not the franchise provisions of Sec. 1253, governed the treatment of Taxpayers' loss, concluding that the Taxpayers had sustained a capital loss rather than an ordinary loss. Taxpayers...