Mts International, Inc. v. Commissioner
| Decision Date | 12 March 1996 |
| Docket Number | Docket No. 2161-93.,Docket No. 2247-93. |
| Citation | 71 T.C.M. 2393 |
| Parties | MTS International, Inc. v. Commissioner. Robert C. Hughes III v. Commissioner. |
| Court | U.S. Tax Court |
Gary L. Goble, for the petitioners. Frederick W. Krieg and D. Lyndell Pickett, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined deficiencies in petitioners' Federal income tax and additions to tax as follows:
MTS International, Inc
Additions to Tax
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Year Deficiency Sec. 6651(a) Sec. 6653(a)(1)(A)1 Sec. 6661
1987 ..................... $217,716 $54,429 $10,885 $54,429
1 Respondent determined an addition to tax under sec. 6653(a)(1)(B) of 50 percent of the interest due on $217,716
for 1987
Robert C. Hughes III
Additions to Tax
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Year Deficiency Sec. 6651(a)(1) Sec. 6653(a)(1)(A)1 Sec. 6661
1986 ..................... $ 31,740 $13,179 $ 3,236 $ 7,935
1987 ..................... 202,446 49,951 11,190 50,612
1 Respondent determined additions to tax under sec. 6653(a)(1)(B) of 50 percent of the interest due on $31,740 for
1986, and 50 percent of the interest due on $202,446 for 1987
After concessions, the issues for decision are:
1. Whether the loss petitioner Robert C. Hughes III sustained when he sold ZZZZ Best Co. stock in 1987 is deductible as a theft loss. We hold that it is not.
2. Whether petitioner Robert C. Hughes III's withdrawals from petitioner MTS International, Inc. (MTS), and what petitioners contend was its forgiveness of his debts were constructive dividend income to him in the amount of $194,224 in 1987. We hold that they were, except as discussed below.
3. Whether petitioner MTS International, Inc., may deduct $196,672 for travel and entertainment expenses for 1987. We hold that it may not.
References to petitioner are to Robert C. Hughes III. References to petitioner corporation are to MTS International, Inc. Section references are to the Internal Revenue Code in effect for the years in issue. Rule references are to the Tax Court Rules of Practice and Procedure.
Some of the facts have been stipulated and are so found.
Petitioner resided in Prospect, Kentucky, when he filed the petition in this case.
Petitioner corporation had its principal place of business in Louisville, Kentucky, during the years in issue. Petitioner has been the sole shareholder, director, and president of petitioner corporation at all times since it was incorporated. Petitioner controlled petitioner corporation, including its financing, dividends, and loans.
Petitioner corporation was in the business of collecting debts for creditors. It was also in the factoring business; i.e., it bought accounts receivable from businesses for a percentage of face value and then tried to collect the receivables.
In early 1986, petitioner advertised in the Los Angeles Times for businesses that wanted to factor receivables. Barry Minkow (Minkow), the president of ZZZZ Best Co., Inc. (ZZZZ Best), in Los Angeles, saw the ad and contacted petitioner. Petitioner and Mark Morze (Morze), Minkow's accountant, met in Los Angeles in April or May 1986 to discuss petitioner's purchase of ZZZZ Best receivables. Morze gave him balance sheets, operating statements, press clippings on Minkow and ZZZZ Best, and other documents purporting to show the financial strength of Minkow and ZZZZ Best. Petitioner and Minkow spoke several times during the summer of 1986 about petitioner corporation's possible purchase of ZZZZ Best receivables. ZZZZ Best claimed to perform insurance restoration work on buildings damaged by water and fire.
Minkow knew the receivables were fraudulent and that ZZZZ Best's financial statements contained false information about its profitability. Minkow needed capital in 1986 because he frequently borrowed from one investor to repay another investor. On July 10, 1986, Minkow sent documents to petitioner from Interstate Appraisal Services (Interstate) purporting to show that ZZZZ Best's accounts receivable were legitimate. Petitioner examined ZZZZ Best's financials and the Interstate documents in July and August 1986, but could not verify the amount of receivables. Petitioner analyzed the financials and bank statements Morze gave him and concluded that they did not make financial sense.
In December 1986, ZZZZ Best went public. Its stock began to be publicly traded on the National Association of Securities Dealers Automated Quotations (NASDAQ).
By April 1987, petitioner thought that Minkow and ZZZZ, Best stock were legitimate because of the December 1986 public offering of ZZZZ Best stock, Minkow's appearances on talk shows and in business magazines, and other institutions' purchases of ZZZZ Best stock. Petitioner bought 60,000 shares of ZZZZ Best common stock for $912,560.69 in early April 1987. He sold the 60,000 shares on or before April 15, 1987, for $1,014,621.75, resulting in a profit of $102,061.06.
Minkow spoke with petitioner frequently from late April to mid-June 1987 to encourage petitioner corporation to buy $1,269,328.80 of ZZZZ Best receivables. Minkow thought petitioner might buy some of ZZZZ Best's receivables. Minkow told petitioner that ZZZZ Best's stock was one of the best NASDAQ stocks, but he did not try to sell ZZZZ Best stock to petitioner.
Minkow held a press conference on May 28, 1987, to respond to a newspaper article alleging wrongdoings by him. He announced that investigators who had reviewed allegations about a junk bond offering by ZZZZ Best through Drexel, Burnham & Lambert (Drexel, Burnham) found nothing wrong and that the offering would proceed. Drexel, Burnham ended its relationship with ZZZZ Best because Minkow's press conference violated rules regarding public offerings.
In early June 1987, ZZZZ Best stock was one of the most actively traded NASDAQ stocks. Petitioner believed that Minkow was one of the most prominent and successful entrepreneurs in the country at that time. From June 1 to June 4, 1987, petitioner bought 50,000 shares of ZZZZ Best stock for $532,161.40.
On June 4, 1987, shareholders of ZZZZ Best filed a class action suit against ZZZZ Best, Minkow, and others. In re ZZZZ Best Co. SEC Litigation, docket No. CV 87-3574 RSWL (Bx) (C.D. Cal.). Petitioner became a plaintiff in the shareholder class action suit at a time not specified in the record.
In mid-June 1987, Minkow was desperate to raise capital because banks had called his loans and ZZZZ Best stock had lost value due to negative press. On June 12, 1987, Minkow telefaxed a letter to petitioner purporting to confirm ZZZZ Best's sale to petitioner corporation of $1,189,874 in receivables for $600,000. ZZZZ Best did not sell its receivables to petitioner or petitioner corporation then or at any time.
On June 16, 1987, petitioner bought 20,000 shares of ZZZZ Best stock for $146,650.2 He paid a total of $678,811.40 for the 70,000 shares he bought in June. He bought all of his ZZZZ Best stock through stockbrokers; i.e., Merrill Lynch and Drexel, Burnham. He did not buy any ZZZZ Best stock from ZZZZ Best, Minkow, or any other officer or director of ZZZZ Best. Minkow did not try to sell ZZZZ Best stock to petitioner and did not encourage him to buy it.
Minkow telefaxed various documents to petitioner corporation on June 16, 1987.3 These included a Form 10-Q, undated ZZZZ Best financial statements, the May 28, 1987, press release concerning ZZZZ Best's future operations, a security agreement, Minkow's personal guarantee of the receivables, Minkow's personal financial statement (as of January 31, 1987), an irrevocable stock/bond power in which Minkow assigned to MTS 200,000 shares of restricted stock in ZZZZ Best, and documents from Interstate purporting to show that the accounts receivable were legitimate. Minkow also telefaxed a June 16, 1987, agreement to buy accounts receivable that included a blank signature line for petitioner corporation (By: Robert Hughes, President). Minkow's and ZZZZ Best's financial statements were false.
Petitioner examined ZZZZ Best's financial statements in mid to late June 1987 and concluded that its balance sheets were unusually skewed toward accounts receivable. He believed that nearly 80 percent of ZZZZ Best's assets were receivables. He concluded that ZZZZ Best's "nominal balance" did not match the total amount of receivables. Petitioner corporation did not buy ZZZZ Best receivables because petitioner could not verify the source of the receivables.
On June 23, July 13, and July 24, 1987, petitioner sold the 70,000 shares of ZZZZ Best stock he bought in June. His sale price was $45,270.72, and his loss was $633,540.68.
In June 1988, Minkow and other officers of ZZZZ Best were charged with the crimes of conspiracy, unauthorized use of access devices, money laundering, interstate transportation of stolen securities and money, and securities, mail, bank and tax fraud. Minkow was convicted early in 1989.
At various times not specified in the record, petitioner contacted the attorneys who represent the plaintiffs in the shareholder class action suit. A recovery agreement on the class action suit was reached in 1991. It was signed by the parties in July 1994.
Petitioner corporation transferred an amount of funds not specified in the...
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