Morgan v. Comm'r of Internal Revenue, Docket Nos. 1156-65— 1158-65.

• Decision Date: 30 September 1966
• Docket Number: Docket Nos. 1156-65— 1158-65.
• Citation: 46 T.C. 878
• Parties: WESLEY H. MORGAN AND HARRIETT B. MORGAN, ET AL.,1 PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

46 T.C. 878

WESLEY H. MORGAN AND HARRIETT B. MORGAN, ET AL.,1 PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket Nos. 1156-65— 1158-65.

Tax Court of the United States.

Filed September 30, 1966.

Julie M. Reardon and Gene W. Reardon, for the petitioners

Harold Friedman, for the respondent.

Petitioners' partnership paid $8,400 for equipment acquired by Junction Drilling Co. on February 23, 1961. Junction was formally incorporated on March 2, 1961. The directors of Junction adopted a ‘plan’ for issuance of stock under section 1244, I.R.C. 1954, in the minutes of their meeting on April 3, 1961. The certificate of stock representing 8,400 shares of stock of Junction was issued to the partnership on May 29, 1961. Junction adopted a resolution to liquidate and dissolve on September 15, 1961, at which time it needed about $25,726 to pay all of its creditors, including two corporations controlled by the partnership in which the partnership owned substantial interest. The stockholders of Junction contributed sufficient additional capital to Junction, in proportion to their stockholdings, to pay all of Junction's debts, the partnership contributing $21,103 for which the certificate of stock was issued on September 26, 1961. Held: The 8,400 shares of stock and the 21,103 shares of stock issued by Junction to petitioners' partnership do not qualify as ‘section 1244 stock.’ Upon liquidation of Junction the partnership and petitioners realized a capital loss rather than ordinary loss on the stock of Junction. Held; further, the 21,103 contributed by the partnership to Junction is not deductible by the partnership as an ordinary and necessary business expense. DRENNAN, Judge:

In these consolidated proceedings respondent determined deficiencies in petitioners' income tax for the taxable year 1961 as follows:

+-------------------------------------------------------------+
                ¦Docket No.¦Petitioner                             ¦Deficiency¦
                +----------+---------------------------------------+----------¦
                ¦          ¦                                       ¦          ¦
                +----------+---------------------------------------+----------¦
                ¦1156-65   ¦Wesley H. Morgan and Harriett B. Morgan¦$5,099.10 ¦
                +----------+---------------------------------------+----------¦
                ¦1157-65   ¦James C. Collum and Kathleen O. Collum ¦390.00    ¦
                +----------+---------------------------------------+----------¦
                ¦1158-65   ¦Milton H. Collum and Janie Lou Collum  ¦3,384.12  ¦
                +----------+---------------------------------------+----------¦
                ¦          ¦                                       ¦          ¦
                +-------------------------------------------------------------+
                

By amendment to answer respondent has asserted claims for increased deficiencies in income tax against each of the joint petitioners, over and above those set forth above, for the taxable year 1961 as follows:

+------------------------------------------------------+
                ¦Docket No.¦Petitioner                      ¦Increased ¦
                +----------+--------------------------------+----------¦
                ¦          ¦                                ¦deficiency¦
                +----------+--------------------------------+----------¦
                ¦          ¦                                ¦          ¦
                +----------+--------------------------------+----------¦
                ¦1156-65   ¦Wesley H. and Harriett B. Morgan¦$2,637.88 ¦
                +----------+--------------------------------+----------¦
                ¦1157-65   ¦James C. and Kathleen O. Collum ¦279.00    ¦
                +----------+--------------------------------+----------¦
                ¦1158-65   ¦Milton H. and Janie Lou Collum  ¦2,166.90  ¦
                +----------+--------------------------------+----------¦
                ¦          ¦                                ¦          ¦
                +------------------------------------------------------+
                

The issues presented for our consideration are:

(1) Whether all or any part of the amounts claimed on petitioners' returns as a loss incurred by Petroleum Drilling Co., a partnership (totaling $29,503) should be accorded ordinary loss treatment under section 1244, I.R.C. 1954, ² as contended by petitioners, or as capital loss ($8,400 long term and $21,102 short term) under section 165(g), as determined by respondent in his notices of deficiency; and (2), in the alternative, whether $21,103 of the total $29,503 loss incurred by Petroleum Drilling Co. should be allowable as an ordinary and necessary business expense of the partnership as urged by petitioners, or, as alleged by respondent in his amended answer, should be treated as nondeductible.

All other issues raised by the original petition in docket No. 1158-65 were conceded by petitioners in the opening statement.

In docket No. 1157-65, a medical expense adjustment is purely computational and will follow from a determination of the afore-said issues.

The issues to be decided are entirely dependent on whether Petroleum Drilling Co., a partnership in which the individual petitioners herein were the partners, is entitled to a deduction either as an ordinary loss on section 1244 stock, or as an ordinary and necessary business expense under section 162, or as a capital loss under section 165, for amounts, totaling $29,503, advanced by it to or for the benefit of Junction Drilling Co., a corporation in which the partnership owned about 76 percent of the stock.

FINDINGS OF FACT

Some of the facts are stipulated and are found accordingly.

Petitioners Wesley H. Morgan and Harriett B. Morgan are husband and wife, and reside at 4949 Lake Shore Drive, Littleton, Colo. Petitioners James C. Collum and Kathleen O. Collum are husband and wife, and reside at 1161 South Vivian, Denver, Colo. Petitioners Milton H. Collum and Janie Lou Collum are husband and wife, and reside at 5245 Sky Trail, Littleton, Colo. All petitioners herein filed income tax returns for the calendar year 1961 with the district director of internal revenue at Denver, Colo. Each petitioner-wife is involved herein solely by virtue of having filed a joint return with her husband and hereinafter petitioner or petitioners is used to refer to the husband or husband-petitioners.

Petroleum Drilling Co. was a partnership in existence prior to and during the taxable period involved herein and was comprised of Wesley H. Morgan, hereinafter referred to as Morgan, Milton H. Collum, and James C. Collum, who owned 50-,40-, and 10-percent interests in the partnership, respectively. Petroleum Drilling Co. is sometimes hereinafter referred to as Petroleum or the partnership. Its fiscal year ends September 30.

Junction Drilling Co., hereinafter sometimes referred to as Junction, was a corporation organized under the laws of the State of Colorado on March 2, 1961. Junction's principal business was to drill core holes and deep exploratory holes for minerals. It was dissolved on September 28, 1961.

Petroleum Geophysical International Corp., hereinafter sometimes referred to as International, was a corporation organized under the laws of the State of Colorado in 1958. Apparently 50 percent of the capital stock of International was owned by Petroleum and the remaining 50 percent of the stock was owned by an unrelated party. International's principal business was geophysical and geological exploration for minerals, primarily in the Philippines.

Uranium Drilling & Exploration, Inc., hereinafter sometimes referred to as Uranium or UDX, was a corporation organized under the laws of the State of Colorado in 1954. During the period here involved and at the time of its dissolution in 1962 Petroleum owned about 96 percent of the capital stock of UDX. Some of the remaining shares were owned by Charles E. Lichtenwalter, hereinafter sometimes referred to as Lichtenwalter.

Although the articles of incorporation of Junction provided that its principal office was to be located in Grand Junction, Colo., all of the books and records of Petroleum, Junction, Uranium, and International were kept at 2011 Glenarm, Denver, Colo., under the direction of Lichtenwalter. Lichtenwalter was the accountant for Petroleum and he was also an officer and/or director of Junction, Uranium, and International.

On or before February 20, 1961, Milton H. Collum, Morgan, L. W. Eklund, hereinafter referred to as Eklund, Lichtenwalter, and some other individuals discussed organizing a new corporation to engage in a drilling venture which became available at about that time. The new corporation was to be formed for the purpose of drilling core holes and deep exploratory holes to discover minerals. All of the petitioners had experience in the mineral exploration business and were aware of the economic hazards incident to such a venture.

On February 20, 1061, a meeting was held in Denver, Colo., to organize the new company, which was to be called Junction Drilling Co. The incorporators of Junction were Eklund, J. L. Wood, and Lichtenwalter. The minutes of this meeting reflect that the above individuals, being all the incorporators and all the subscribers to the capital stock and stockholders of Junction, were present. The articles of incorporation were approved and the three incorporators were recognized as the first directors of the corporation. The articles provided that the corporation should have perpetual existence and that its capital stock should consist of 49,000 shares, with a par value of $1 per share, and should be issued as fully paid stock and nonassessable. The articles were signed by the incorporators on February 20, 1961, and filed with the secretary of state of Colorado on March 2, 1961. A certificate of incorporation was issued to Junction under date of March 2, 1961.

The first meeting of the board of directors of Junction, consisting of Eklund, Wood, and Lichtenwalter, was held in Denver on February 20, 1961. At this meeting Eklund was elected president of the corporation, Wood was elected vice president, and Lichtenwalter was elected secretary-treasurer. The bylaws were adopted, a form of stock certificate was approved, the Denver United States National Bank,...