Morris v. Commissioner
| Decision Date | 19 June 1990 |
| Docket Number | Docket No. 20318-87. |
| Citation | 1990 TC Memo 306,59 TCM (CCH) 923 |
| Parties | Donald S. Morris and June E. Morris v. Commissioner. |
| Court | U.S. Tax Court |
Alvin L. Freeman, 10333 Richmond Ave., Houston, Tex., for the petitioners. Ana G. Cummings, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined a $288,250.93 deficiency and a $13,259.10 addition to tax under section 6651(a)(1)1 against petitioners for their calendar year ending December 31, 1981.
On brief, petitioners concede that they are liable for the addition to tax under section 6651(a)(1). Furthermore, the parties agree that $165,000 is a partnership distribution within the meaning of section 731(a) and is taxable as a short-term capital gain.
After concessions, the issues for decision are whether petitioners are entitled to deduct any portion of the expenditures made to complete earthen dam contracts as (1) trade or business expenses under section 162; if not (2) whether any portion is deductible as a bad debt under section 166.
Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein.
Petitioners resided in Houston, Texas, at the time they filed their petition in this Court. Petitioners' joint individual Federal income tax return for calendar year 1981 was received by the Internal Revenue Service Center, Austin, Texas, on September 30, 1982, extensions to file having been granted to September 15, 1982.
Unless otherwise indicated, reference to petitioner refers to Donald S. Morris.
The "completion costs" at issue in 1981 actually involve expenditures and advances made by petitioner in prior years. Therefore, we must consider the circumstances of these payments.
Before 1953 petitioner and his brother, Tommy Morris (hereinafter referred to as "Tommy"), operated a family business. In March 1953 petitioner and seven others formed Drillco Incorporated ("Drillco"). Thereafter, petitioner and Tommy merged their business into Drillco. As a result of the this merger, petitioner purchased 375 shares (15 percent) of Drillco's stock. Drillco was engaged in the oil field service business and subsequently expanded its business into manufacturing.
In 1968 Drillco was acquired by Smith International, Inc. ("Smith"), a publicly held corporation, in a stock-for-stock reorganization, and became a Division of Smith. Between 1968 and 1977 petitioner served as president of Drillco and as Group Vice President of Smith. In August 1977 petitioner terminated his employment. At that time petitioner was drawing an annual $120,000-plus salary, was 48 years of age, and owned Smith stock having a substantial value.
In August or September 1977 petitioner was approached by Winslow Whiting2 ("Mr. Whiting") and Glenn G. Chance ("Mr. Chance") each wanting to go into their own separate businesses. Petitioner had known both men for over 15 years as a result of their business relationship in the oil industry. Petitioner agreed to go into business with them.
On September 2, 1977, and September 9, 1977, petitioner entered into two separate pre-incorporation agreements with Mr. Whiting and Mr. Chance forming Whiting Oil Field Rental, Inc. ("Whiting") and Chance Collar Company ("Chance"), respectively, both Texas corporations.
Whiting was to engage in the business of owning and renting various items of oilfield tools and equipment, while Chance was to engage in the business of fabricating, repairing, and selling equipment and tools used in drilling oil wells.
Both Whiting's and Chance's preincorporation agreements provided that petitioner be retained as a consultant for a monthly fee of the lesser of a percentage of the after-tax profits, or $1,000. Additionally, petitioner was allowed to purchase 250 shares of the companies' stock at one dollar ($1.00) per share.
Neither Mr. Whiting nor Mr. Chance was financially able to obtain sufficient financing to start his corporation. Therefore, petitioner agreed to lend or guarantee bank loans of up to $300,000 to each corporation.
Additional facts relating to Whiting
Pursuant to Whiting's preincorporation agreement, petitioner acquired 25 percent of the stock for $250, and Mr. Whiting acquired the remaining 75 percent for $750.
Petitioner made sales calls and management decisions for Whiting. During 1978 and 1979 petitioner spent approximately 25 percent and 10 percent of his time, respectively, working for Whiting. However, he did not report any income from the consulting activity from 1977 through 1979 on his Schedule C.
In August 1979 Whiting was acquired by Philadelphia Suburban Corporation ("PSC"), a Pennsylvania corporation, in a stock-for-stock reorganization. After this acquisition, petitioner served on the board of PSC's sister company, Oil Field Rental. Petitioner received dividend income from PSC from 1979 through 1982.
In 1978 Chance was formally incorporated. The incorporation agreement differed from the terms of the preincorporation agreement in three distinct ways. First, the consulting arrangement was changed to include Tommy as an additional consultant. Second, it provided that both petitioner and Tommy be paid a specific monthly consulting fee pursuant to the amounts indicated in the schedule contained therein. Third, it provided that petitioner and Tommy would jointly guarantee loan obligations of up to $2,000,000. Moreover, they were to secure that guarantee with their individually owned assets, rather than Chance's. However, Chance was required to pledge its assets as security for petitioner and Tommy. Petitioner and Tommy guaranteed the loans in order to help Chance establish its own line of credit, to get the necessary inventory Chance needed to operate, and to enable Chance to pay its consulting fees.
Pursuant to the incorporation agreement Tommy and petitioner each purchased 12.5 percent of the stock in Chance for $125, while Mr. Chance purchased the remaining 75 percent for $750.
During 1978 and 1979 petitioner spent approximately 40 percent and 10 percent of his time, respectively, rendering services to Chance. However, he did not report any income from this activity on his Schedule C for either year.
Sometime between December 1979 and mid-1980 Chance was acquired by W. R. Grace, Co. ("Grace"), a publicly held corporation, in a stock-for-stock reorganization. Petitioner remained affiliated with Grace after the stock swap, and received dividends on his Grace stock from 1980 through 1982.
On February 22, 1978, Barron Muegge ("Mr. Muegge"), Joe S. Rosson ("Mr. Rosson"), and petitioner formed Producers Construction Co., Inc. ("Producers"). Producers was to engage in the business of excavating, dirt contracting, general contracting, and construction. Petitioner had no knowledge of or experience in the earth-moving business.
On May 5, 1978, Producers filed a Statement of Change of Registered Office and Registered Agent, removing Mr. Muegge and substituting Mr. Rosson. Mr. Rosson was also Producers' president and operating officer. Petitioner and Messrs. Rosson and Muegge also agreed to the following: (1) that petitioner would receive 50 shares of stock at $1.00 per share (50 percent), while Mr. Rosson and Mr. Muegge would receive 25 shares each; (2) that petitioner would arrange for Producers to borrow a total sum of $1,000,000 and guarantee its repayment by collateralizing his individually owned assets, including any stock; and (3) that petitioner would be retained as a consultant to Producers and paid a monthly fee, as set forth in the schedule contained therein. Producers' total capitalization was $1,000.
Producers had two divisions. One was engaged in site preparation, general construction, and maintenance of oil field locations and pipeline construction. All of the required equipment was financed by purchase money loans guaranteed by petitioner. The other division was engaged in heavy construction, primarily construction of earthen dams.
On March 10, 1978, Producers, through Mr. Rosson as president, signed a 90-day note for $1,000,000 payable to Houston National Bank, and petitioner executed a guarantee agreement with Houston National Bank for that amount.
In May or June 1978 Producers secured three contracts with the United States Department of Agriculture to build earthen dams. The contracts required payment and performance bonds in favor of the United States. Since Producers lacked sufficient capital to obtain the required payment and performance bonds, petitioner and Messrs. Rosson and Muegge, individually, and Mr. Rosson, as president of Producers, executed a General Indemnity Agreement on June 27, 1978, with American General Insurance Company ("American") guaranteeing both performance and payment of the government contracts.
Thereafter, Producers began performance of the government contracts. Sometime later, petitioner and Messrs. Rosson and Muegge realized that Producers was incapable of completing the jobs since they lacked the technical expertise and the necessary equipment. Therefore, in or around August 1978 Producers informally sub-contracted with KC&S Construction Company, a partnership, to complete performance of the contracts. KC&S, however, was unable to perform on this subcontract without additional financing. Therefore, petitioner, concerned that the government contracts would not be completed, guaranteed both working capital and equipment loans for KC&S. On August 11, 1978, petitioner executed a Specific Guaranty to the Lufkin National Bank related to KC&S's $56,204 debt, and on September 19, 1978, petitioner executed a Guaranty Agreement to Houston National Bank relating to KC&S's outstanding debts of $68,000 and $300,000.
Sometime between June 27, 1978, and September 19, 1978, petitioner learned that the government would not allow Producers to...
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