Packard v. Comm'r of Internal Revenue
| Citation | 85 T.C. 397,85 T.C. No. 23 |
| Decision Date | 05 September 1985 |
| Docket Number | Docket Nos. 23163-82,24088-82. |
| Parties | SUE B. PACKARD A/K/A VIRGINIA S. WAINWRIGHT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRICHARD A. WAINWRIGHT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
Petitioners, then husband and wife, cash basis taxpayers, invested in a cattle-feeding program in late December 1971 through a subchapter S corporation of which one of petitioners was the sole shareholder. Petitioners funded the investment in part with the proceeds of a bank recourse loan that was secured by a certificate of deposit purchased and pledged by the feed yard. The corporation prepaid and deducted feed expenses in 1971 although none of the feed was consumed in that year. In February 1972 a general partnership formed by petitioners purchased all of the stock of the corporation through a purported installment sale under sec. 453, the corporation was liquidated, and the partnership claimed a step-up in basis of the assets received from the corporation, including fully expensed feed. HELD, the program in which petitioners invested was not a sham, but the form in which the transactions were cast was inconsistent with their true nature, and the step-transaction doctrine applies so as to disregard the corporation. HELD FURTHER, the cattle-feed expenditure was fully deductible in the year in which it was paid. HELD FURTHER, the partnership did not suffer a theft loss in 1973. SHERIN V. REYNOLDS, for the petitioner in docket No. 23163-82.
KENNETH B. WECKSTEIN, for the petitioner in docket No. 24088-82.
CYNTHIA J. MATTSON, for the respondent.COHEN, JUDGE:
In these consolidated cases, respondent determined deficiencies in Federal income tax of petitioners as follows:
+--------------------------------------------------+
¦Petitioner/docket No. ¦Taxable year¦Amount ¦
+-----------------------+------------+-------------¦
¦Sue B. Packard (a.k.a. ¦1971 ¦$207,421.00 ¦
+-----------------------+------------+-------------¦
¦Virginia S. Wainwright)¦FYE 2/1/72 ¦1 157,282.24¦
+-----------------------+------------+-------------¦
¦Docket No. 23163-82 ¦1972 ¦226,724.00 ¦
+-----------------------+------------+-------------¦
¦ ¦1975 ¦3,193.71 ¦
+-----------------------+------------+-------------¦
¦Richard A. Wainwright ¦1971 ¦207,421.00 ¦
+-----------------------+------------+-------------¦
¦Docket No. 24088-82 ¦1972 ¦226,724.00 ¦
+-----------------------+------------+-------------¦
¦ ¦1975 ¦10,766.19 ¦
+--------------------------------------------------+
After concessions, we must decide the correct tax treatment of petitioners' investment in a cattle-feeding operation. Respondent claims that the total program was a sham, disputes the deductibility of a prepayment for feed, and attacks the use of a subchapter S corporation and a partnership formed by petitioners in order to defer the reporting of gains through an installment sale under section 4532 and to secure additional deductions through a subsequent liquidation of the corporation. Finally, petitioner Wainwright claims a net operating loss resulting from an alleged theft of partnership funds by petitioner Packard.
Some of the facts have been stipulated and are so found. The stipulations of facts and attached exhibits are incorporated herein by reference.
Petitioners Richard S. Wainwright (Wainwright) and Sue B. Packard,.also known as Virginia S. Wainwright, (Packard) were husband and wife during taxable years 1971 and 1972 and filed joint Federal income tax returns for those years. Petitioners were divorced in December 1973, and filed separate returns for 1973, 1974, and 1975. Petitioners filed their income tax returns for taxable years 1971 through 1975 using the cash method of accounting. Wainwright resided in Silver Spring, Maryland, and Packard resided in Boca Raton, Florida, when they filed their respective petitions in these cases.
On December 10, 1971, petitioners received a liquidating distribution from an electronics company that they founded in 1962. Wainwright, an electrical engineer, had managed the technical aspects of the company, while Packard had managed the financial affairs of the company and the family. Petitioners reported the liquidating distribution on their 1971 return as long-term capital gain of $735,961, which resulted in additional taxable income to them of $365,480.
In late 1971, petitioners explored investment possibilities in cattle feeding. Petitioners discussed an investment in cattle feeding with their attorneys, Arthur Schneck (Schneck) and Martin Todtman (Todtman). Although petitioners had invested previously in oil, stocks, bonds, and real estate, they had no experience in the cattle business.
An investment opportunity in a cattle-feeding program was made available to petitioners by Cornwall Investment Corp. (Cornwall). Although Cornwall's involvement in cattle feeding was primarily for its own account, it also offered the program to a limited number of clients, friends, and other individuals with whom it was associated. Petitioners had no prior association with Cornwall. The program was made available to petitioners, however, after preliminary discussions in late 1971 among Schneck and Todtman and Martin Blackman (Blackman), one of the principals of Cornwall. Petitioners did not participate in the preliminary discussions and neither met nor spoke with anyone from Cornwall until they met in Blackman's New York City office on December 17, 1971, to discuss further and finalize the transaction. Blackman, a tax attorney, had been involved in the cattle-feeding business since the early l960's.
In general, the Cornwall program offered to petitioners called for the feeding of the cattle in three rounds over approximately 12 months, with one-third of the cattle contracted to be purchased and fed at one time. The use of three rounds of feeding minimized risks attributable to such factors as weather, disease, and market. Under the program, an investor would enter into a feeding contract with a local feed yard, usually Zimmerman Feed Yards, Inc. (Zimmerman) of Springfield, Nebraska. Zimmerman contracted with other feed yards to feed the cattle if it lacked sufficient space in its own feed yards. J. P. Latham (Latham) was president of Zimmerman. Latham and his wife were primarily responsible for the daily feeding of the cattle, and in consultation with personnel of Cornwall, for decisions relating to the purchase and sale of the cattle. Cornwall and Latham charged management and supervision fees, respectively, for their services. Under the Cornwall program, financing and other banking services were provided to investors by Omaha National Bank (ONB) of Omaha, Nebraska, of which Latham and Zimmerman had been long-standing customers.
Petitioners, Blackman, Robert Tanenbaum (Tanenbaum), also a principal of Cornwall, Schneck, and Todtman were present at the December 17, 1971, meeting. At the meeting, Blackman explained to petitioners the nature of the cattle-feeding business, the proposed transaction, its prospects for profit or loss, and the likely tax consequences. No written explanation of the Cornwall cattle-feeding program was made available to petitioners or other participants in the program. Petitioners received no written explanation of the economic results from previous Cornwall transactions.
The participants at the December l7th meeting discussed the purchase by Packard of the stock of a subchapter S corporation, the prepayment of feed by the corporation, and the resulting tax deduction to petitioners in the year of purchase for the amount of the prepaid feed expense. Petitioners were advised at the meeting that expenses such as labor and insurance were deductible in the year such expenses were incurred, and that the cost of cattle was a capital item. The participants also discussed the possibility of an installment sale in the following year of the stock of the subchapter S corporation and the subsequent liquidation of the corporation's assets into a partnership that could be formed by both petitioners to proceed with the cattle-feeding operations. Petitioners were advised of the tax consequences of an installment sale election under section 453.
At the December 17, 1971 meeting, and in accordance with the discussions during that meeting, Packard purchased for $350,000 1,000 shares of common stock of Queen Feeding & Livestock Company (Queen), a Delaware corporation organized on December 14, 1971. Queen's stated purpose was to engage in feeding livestock.
Although Packard was the sole shareholder of Queen, petitioners considered the investment in the cattle-feeding program a joint investment.
Packard paid for the Queen stock in part with two checks totaling $140,000 from an account held jointly with Wainwright at Suburban Trust Company of Wheaton, Maryland. Packard paid the balance of the purchase price with a $210,000 check dated December 17, 1971, drawn from a new account at ONB.
The source of the funds in the ONB account was a loan to Packard from ONB arranged by Cornwall and Zimmerman. The loan was evidenced by a demand note executed by Packard, dated December 17, 1971, in the principal amount of $210,000, with interest at a rate of 7-3/4 percent per annum. The note was presented to Packard by Blackman and signed in his office during the December 17, 1971, meeting. The note contained the following provision regarding collateral:
3. To secure the payment of this note and all other indebtedness or liability, direct or indirect, joint or several, absolute or contingent, now existing or hereafter acquired or contracted, of Borrower to Bank (hereinafter collectively designated ‘Obligations‘), whether such Obligations are created directly or acquired by Bank by...
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