Pack v. Commissioner
| Decision Date | 06 March 1980 |
| Docket Number | 11991-77.,11081-77,10943-77,Docket No. 10941-77,10942-77,10944-77 |
| Citation | 39 TCM (CCH) 1179,1980 TC Memo 65 |
| Parties | Sharon K. Pack, et al. v. Commissioner. |
| Court | U.S. Tax Court |
Patrick J. Regan, Michael C. Doering, KSB&T Bldg., Wichita, Kan., for the petitioners. Juandell D. Glass, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies and transferee liabilities as follows:
Petitioner Year Deficiency
Sharon K. Pack ......... 1974 $ 1,236.58
1975 246.00
J. Ernest and
Mary Ann Talley ...... 1970 1,585.11
1973 12,862.07
1974 401,209.72
1975 20,782.11
Sharon K. Pack
Transferee 2 .... 1974 22,852.97
1975 478,574.00
J. Ernest Talley
Transferee ........... 1974 22,852.97
1975 478,574.00
Robert A. Walton
Transferee ........... 1974 22,852.97
1975 478,574.00
V.B. May
Transferee ........... 1974 22,852.97
1975 478,574.00
Concessions having been made by the parties in Docket No. 10943-77 (J. Ernest and Mary Ann Talley), the issues for decision are:
1. The amount of depreciation required to be recaptured by Mr. T's Rental, Inc., upon the sale of its rental assets.
2. The fair market value of a promissory note distributed to the shareholders of Mr. T's Rental, Inc., in a section 3373 liquidation.
Some of the facts have been stipulated and are found accordingly.
At the time they filed their petitions, Sharon Pack and J. Ernest and Mary Ann Talley resided in Wichita, Kansas, Robert A. Walton resided in Memphis, Tennessee, and V.B. May resided in Holt, Missouri.
Mr. T's Rental, Inc. ("Mr. T's") was incorporated in Kansas on June 26, 1962, and its principal place of business was Wichita, Kansas. Mr. T's financial statements and tax returns reflected a June 30 fiscal year. From 1970 to its dissolution in 1975, J. Ernest Talley ("Talley") served as president and Sharon K. Pack ("Pack") served as secretary of Mr. T's.
Mr. T's rented televisions and stereo units to the general public. Its clientele generally consisted of transient individuals who were either unable or unwilling to obtain the financing necessary to purchase these items elsewhere. These characteristics of its customers exposed Mr. T's to a relatively high level of missing televisions and stereos.
Mr. T's offered rentals on a weekly, renewable basis. The rental agreement required the customer to pay the weekly fee in advance in order to retain possession and use of the equipment. If the customer rented the equipment for 104 consecutive weeks the equipment became the customer's property. Prior to that time the customer possessed no ownership rights in the rental property. Mr. T's also offered its customers the option of a daily rental plan at slightly higher rates. A typical rental of a black and white portable television was approximately $7 per week. The same television, rented on a daily basis, cost $3 for the first day and $1 for each succeeding day.
Mr. T's provided complete maintenance of the televisions and stereos during the rental term. If a rental unit was not working and could not be serviced in the renter's home Mr. T's provided a replacement unit until the original unit was repaired.
Mr. T's purchased their televisions and stereos new from wholesalers. These units were classified as "inventory" for financial and tax reporting purposes. Mr. T's maintained on hand approximately five to ten percent of the total units being rented at any given moment. These surplus units provided flexibility to meet increased demand and to replace units that required repair. Early in its corporate life, Mr. T's engaged an accounting firm to determine the economic life of an average rental unit. After tracing the histories of a sampling of the rental units, the accounting firm assigned to the units an economic life of approximately sixteen to eighteen months. Mr. T's amortized the cost of the rental equipment over this time.
By 1974 Mr. T's had established itself as a very profitable enterprise with rental offices in fourteen major cities predominantly situated in the southern part of the United States.4
On March 6, 1974, Mr. T's board of directors adopted a plan of complete liquidation. Two days later Mr. T's entered into a sales agreement with Remco Enterprises, Inc., and its subsidiary Action Industries, Inc. (sometimes hereinafter collectively referred to as "Remco") whereby Mr. T's agreed to transfer its rental business as a going concern to Remco for $40,000 cash and a $2,210,000 note. The closing date of the sale was April 1, 1974.
In 1974 the following individuals owned stock in Mr. T's:
Name Shares
J. Ernest Talley ......... 613,000
Sharon K. Pack ........... 6,400
V.B. May ................. 1,000
Robert A. Walton ......... 200
Since its inception in 1969 Remco conducted the same type of business as Mr. T's, i.e., the renting of televisions and stereos. Charles Sims ("Sims"), a former officer and stockholder of Mr. T's, founded Remco and was its president and controlling shareholder. By 1974 Remco operated six stores at various locations. Remco hoped to accelerate its expansion program by acquiring Mr. T's assets and business. Remco, however, intended to change its marketing approach in order to attract a higher-income customer. It hoped that as a result of this change in marketing strategy only 12 to 13 percent of its customers would have characteristics similar to those who previously patronized Mr. T's. It expected to achieve this goal within six months of the acquisition.
In 1973, its last full year prior to the acquisition of Mr. T's, Remco reported earnings of $82,094 on revenues of $1,265,589.
The sales agreement between Remco and Mr. T's provided for the sale and transfer of the following properties and rights: (a) all of the "inventory" of television sets or other appliances or merchandise held for rental on the closing date, as shown by the books of Mr. T's, and wherever located; (b) all of the furniture, fixtures, equipment (including rolling stock), and leasehold improvements owned by Mr. T's and located on or about or used in connection with the business conducted by the stores and the Wichita, Kansas, home office of Mr. T's; (c) all of the right, title and interest of Mr. T's in and to the leases of the stores (Remco agreed to assume liability on all leases for the stores of Mr. T's); (d) all of the right, title and interest of Mr. T's in and to the rental agreements; and (e) all of its right, title and interest in and to the tradename "Mr. T's", together with the perpetual right to use all trademarks, labels and other advertising media or devices adopted or used by Mr. T's in connection with its business conducted at or through the stores. Mr. T's remained responsible for all the preclosing liabilities and obligations as well as any legal proceedings arising from pre-closing transactions. Mr. T's retained all the cash on hand as of April 1, 1974.5
According to the sales agreement, the purchasing corporations paid $50,000 for Mr. T's goodwill. The sales agreement also recited that on or prior to April 1, 1974, the balance of the contract price would be allocated to (1) "inventory" and (2) furniture, fixtures, equipment and leases.
For many years Mr. T's and Remco were clients of the same accounting firm. Prior to March 8, 1974, Talley and Sims met in the office of their accountant at least once to discuss the sale of Mr. T's assets. During the course of that conversation the parties briefly discussed the allocation of the contract price to the purchased assets. On March 22, 1974, Sims wrote a letter to the accountant outlining his thoughts as to the proper allocation of the contract price to the acquired assets.
In deriving the portion allocable to Mr. T's inventory, Sims began by dividing the inventory into categories, i.e., black and white televisions, stereos with tape players, color television consoles, portable color televisions, and color television combinations. He then estimated the cost of a new unit in each category and discounted this new cost by a certain amount. The discount applied did not take into account the age or condition of the televisions or stereos at the time of their sale to Remco. Rather, the discount reflected Sims' perceptions of changes in consumer preferences and changes in the various product lines. For example, Sims provided the following explanation of the value he assigned to the stereo equipment acquired from Mr. T's:
On stereo equipment, there are two classifications. Stereos without tape players, which we will assign the cost of $100, and stereos with tape players, which we will assign a cost of $115. New cost today on similar equipment can vary tremendously, based on quality. Stereos without tape players of similar quality cost approximately $140 new. Stereos with tape players of same quality would cost approximately $165 new, but there have been some major innovations in stereos recently. One of these innovations has been quadraphonic sound, which may affect the market for stereos that are not equipped for quadraphonic. In addition to this, component stereos have become very popular recently, and also could have an effect on the value of stereo equipment.
Sims ended the March 22 letter by stating:
If these methods of allocating cost and the logic used appears reasonable to you, then I suggest we use these methods and these figures for assigning the cost of assets in this transaction. I would appreciate any recommendations or thoughts you may have in reference to this matter.
The accountant agreed...
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