Nazarian v. Commissioner
| Decision Date | 19 April 1989 |
| Docket Number | 7971-79,9598-80.,4230-77,5389-72,5737-74,Docket No. 4876-71,3224-73,5779-78 |
| Citation | 1989 TC Memo 179,57 TCM(CCH) 188 |
| Parties | Estate of Mildred C. Nazarian, Deceased, Sippi Nazarian, Executor, and Sippi Nazarian v. Commissioner. |
| Court | U.S. Tax Court |
Louis E. Goebel, Los Gatos, Calif., for the petitioners. Erik P. Doerring, for the respondent.
Memorandum Findings of Fact and Opinion
These consolidated cases were assigned to Special Trial Judge Hu S. Vandervort pursuant to the provisions of section 7456(d) of the Internal Revenue Code (), and Rule 180 et seq.1 The Court agrees with and adopts the opinion of the Special Trial Judge which is set forth below.
VANDERVORT, Special Trial Judge: Respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows:
Section 6653(a)
Docket No. Year Deficiency Addition to Tax
4876-76 1967 $ 396,962.33 $19,848.12
5389-72 1968 352,297.23 17,614.86
3224-73 1969 1,484,139.58 74,206.98
5737-74 1970 148,379.00 7,419.00
5737-74 1971 38,316.00 1,916.00
5737-74 1972 53,453.00 2,623.00
4230-77 1973 14,678.00 733.00
5779-78 1974 14,476.00 724.00
7971-79 1975 2,691.00 -
9598-80 1976 8,819.00 -
After concessions, the issues presented are:
A. Whether respondent's notices of deficiency for 1967, 1968, and 1969 were arbitrary so as to preclude respondent from relying on the presumption of correctness and shift the burden of going forward with evidence to respondent.
B. Whether petitioners must recognize taxable gain from the sale of a convalescent hospital in 1969.
C. Whether petitioners must recognize income from the exercise of a stock option in 1969.
D. Whether petitioners received unreported taxable income in 1968, 1969, 1970, 1971, and 1972.
E. Whether petitioners are entitled to deduct interest expense for taxable years 1969 through 1976.
F. Whether petitioners must recognize interest income from certificates of deposit in 1969.
G. Whether petitioners have properly established their basis in certain real estate sold in 1970.
H. Whether petitioners are entitled to short-term and long-term capital loss carryovers in 1970 and 1971.
I. Whether petitioners are entitled to a bad debt deduction in 1970.
J. Whether petitioners are liable for additions to tax under section 6653(a) for 1967 through 1974.
Some of the facts have been stipulated and are so found. This reference incorporates the stipulation of facts and attached exhibits.
Petitioners resided in Palm Springs, California when they filed their petitions. Petitioner Mildred C. Nazarian died in 1982 and her husband, petitioner Sippi Nazarian (Nazarian), was appointed executor of her estate.
Mr. Nazarian and Walter McFadden (McFadden) each contributed $12,500 to a partnership formed in 1957 to own and operate a convalescent hospital in Artesia, California. The partnership purchased a 42 bed hospital facility for $150,000, represented by a $25,000 down payment and a $125,000 purchase money note. Mr. Nazarian managed the hospital. Mr. McFadden did not participate in the day to day operation of the hospital.
In 1962 the partnership obtained a $250,000 Small Business Administration loan from the Golden State Bank. The proceeds were used to construct an additional building and to improve the existing facility. By 1963 the hospital had 102 beds.
On August 2, 1963, Mr. Nazarian and Mr. McFadden formed a California Corporation named Twin Palms Sanitarium, Inc. (Twin Palms). The partners transferred all the partnership's assets to this newly created corporation and each partner received 50 percent of all outstanding Twin Palms' stock.
John McTernan (McTernan), a California attorney, served as counsel to Twin Palms. Mr. McTernan's law partner was Ben Margolis, the brother of Harry Margolis (Margolis), a California attorney who specialized in tax planning. Harry Margolis represented Mr. Nazarian and advised him on tax planning matters.
During 1964, a conflict developed between Mr. Nazarian and Mr. McFadden over the control of Twin Palms. Mr. McFadden objected to the proposed issuance of Twin Palms stock to Flora Logan, a key hospital employee. Mr. McFadden feared that Ms. Logan and Mr. Nazarian would have voting control of Twin Palms.
On the advice of Mr. Margolis, Mr. Nazarian arranged to have a foreign trust established to purchase Mr. McFadden's Twin Palm's stock. Mr. Nazarian gave $1,000 to Virginia Nazarian, his sister-in-law, and instructed her to deposit the sum into a bank account. These funds later served as the corpus of Mr. Nazarian's "family" trust. Under the trust instrument, dated May 14, 1965, Virginia Nazarian was named as settlor and the Aruba Bonaire Curaco Trust Company (Aruba Bonaire), a Bahamas Corporation, was trustee. Aruba Bonaire was an existing corporation which was controlled by the Margolis law office. Neither Virginia Nazarian nor any member of her family, other than Mr. Nazarian, benefitted from this trust.
On March 12, 1965, Mr. McFadden executed a document to purportedly sell all of his Twin Palms stock to Aruba Bonaire for $35,000. A few months earlier, in December 1964, Mr. Nazarian had applied for a $35,000 loan from the Bank of Pico Rivera. He received the loan proceeds on March 30, 1965, and Mr. McFadden was paid for his stock interest on April 9, 1965.
On April 1, 1965, Mr. McFadden executed a document with Twin Palms under which he was to receive $110,000 for his agreement to refrain from future competition against Twin Palms. From April 1965 through June 1967, Mr. McFadden received $1,000 per month under this agreement. On June 7, 1967, Mr. McFadden received a $37,528 payment from Associated Convalescent Enterprises (Associated). The check from Associated was signed by Mr. Nazarian as a member of Associated's board of directors. Associated was controlled by the Margolis law office.
Mr. Nazarian also executed a document in March 1965, to sell his Twin Palms stock to Aruba Bonaire for $35,000. Mr. Nazarian stated at trial that he did not possess an ownership interest in Twin Palms after March 1965. Petitioners, 1965 joint return reflects that the Twin Palms stock was sold for a gross sales price of $35,000 with an adjusted basis of $42,324, and accordingly reported a net loss of $7,324.
Mr. Nazarian's June 30, 1965, financial statement contains a reference to his ownership of 85 percent of the stock in Twin Palms valued at $330,000. David Menkes, Mr. Nazarian's accountant, prepared this financial statement which was based entirely on information supplied by Mr. Nazarian and was not independently verified.
On June 29, 1967, the Golden State Bank issued a $32,062 certificate of deposit to Associated. On June 29, 1967, Elaine Fishel, president of Associated and an attorney associated with the Margolis law office, endorsed the certificate of deposit to Mr. McFadden. The certificate was personally guaranteed by Mr. Nazarian.
During 1966, Mr. Margolis purportedly made arrangements for Mr. Nazarian to obtain a $400,000 loan from World Minerals, N.V. to be used for the construction of additional improvements to the convalescent hospital facility. Mr. Nazarian received $350,000 from North American Financial Corporation (North American) between January and April 1966. These funds were spent on additions to the hospital, so that by early 1967, the facility had 222 beds.
During June 1967, Aruba Bonaire purportedly dissolved Twin Palms and distributed its assets. A certificate of dissolution was filed with the California Secretary of State's office, and a copy of the minutes from a purported "special meeting" of Twin Palms' board of directors recites that a plan of liquidation was adopted. The assets of Twin Palms were transferred to Mr. McTernan as trustee for Aruba Bonaire. Mr. McTernan was also a member of the Twin Palms board of directors at the time the purported decision to dissolve the corporation was made.
On June 15, 1967, two deeds were filed in the Los Angeles County records office which recite that certain real estate located in Artesia, California, and related personal property, were transferred from Twin Palms to Mr. McTernan as trustee for Aruba Bonaire. These deeds do not specifically describe the property which was conveyed.
In July 1967, Aruba Bonaire purported to sell the assets received in the liquidation of Twin Palms to Associated. The purchase agreement provides a total consideration of $2,125,000 which was to be paid in principal part through an unsecured promissory note of $1,872,815. A deed was filed in the County of Los Angeles for the State of California which recites that Aruba Bonaire transferred certain real estate to Associated. The deed, however, does not describe the property conveyed.
On August 1, 1967, Associated purportedly leased the hospital facility to Artesia Convalescent Hospital Enterprises (Artesia), an entity which had been incorporated that same day. Artesia was organized by the Margolis law office. Mr. Nazarian owned 80 percent of Artesia's outstanding stock and signed the purported lease as Artesia's president.2 Mr. Nazarian retained managerial control over the hospital after Twin Palms had been liquidated, and the hospital was sold to Associated and leased to Artesia.
On July 2, 1968, Associated entered into an agreement with Consolidated Convalescent, Inc. (Conso...
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