Prescott v. Comm'r of Internal Revenue
| Decision Date | 21 April 1976 |
| Docket Number | Docket No. 3141-73. |
| Citation | 66 T.C. 128 |
| Parties | EDWARD J. PRESCOTT AND WANDA D. PRESCOTT, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
In 1954 petitioner elected to have his sole proprietorship taxed as a corporation under sec. 1361. Such election terminated by operation of law on Jan. 1, 1969. Held:
1. Petitioner is deemed to have received the assets of his business enterprise in a complete corporate liquidation on Jan. 1, 1969.
2. No portion of the gain realized on such liquidation is exempt from tax because of the character of the assets deemed distributed.
3. Petitioner has failed to carry his burden to show that he was not negligent in failing to report his income from the liquidation of his sec. 1361 corporation. A. H. Michals, for the petitioners.
David J. Duez and Jay B. Kelly, for the respondent.
Respondent has determined a deficiency in petitioners' Federal income tax for the calendar year 1969 in the amount of $108,051.78, plus an addition to tax under section 6653(a)1 of $5,402.59. Various concessions having been made, the issues remaining for our decision are whether the termination of section 1361 status pursuant to section 1361(n)(2) should be treated as a corporate liquidation under section 331, whether any portion of the gain on such liquidation (if found to exist) is exempt from taxation, and whether the section 6653(a) penalty is applicable.
Most of the facts have been stipulated and, as amended and supplemented, are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.
Petitioners Edward J. Prescott and Wanda D. Prescott, husband and wife, resided in Minnetonka, Minn., at the time of filing the petition in the present case. Wanda D. Prescott is a party to this proceeding solely by virtue of having filed a joint Federal income tax return with her husband for the calendar year 1969 with the District Director of Internal Revenue in Kansas City, Mo. Accordingly, the designation ‘petitioner’ will hereafter only refer to Edward J. Prescott.
Petitioner has been doing business since 1932 as a registered securities dealer in Minnesota. His business involves the buying and selling of State and municipal bonds, the interest on which is exempt from Federal income tax under present law.
For all the years relevant to this litigation, petitioner has conducted his business as a sole proprietorship under the name of E. J. Prescott & Co.
Beginning with the taxable year 1954, petitioner properly elected to have his business taxed as a corporation under section 1361 of the Internal Revenue Code of 1954, as in effect at that time. Federal corporate income tax returns (Form 1120) were filed by E. J. Prescott, d.b.a. E. J. Prescott & Co., for the taxable years 1954 through 1968. No Federal corporate income tax return was filed for the taxable year 1969. By letter dated March 7, 1969, and attached to the corporate income tax return for the year 1968, petitioner informed the Internal Revenue Service that 1968 was the last year his business could report its income as a corporation.
The parties have agreed that the basis of petitioner's investment in his ‘section 1361 corporation’ as of January 1, 1954, was $330,922.36.
In the course of his business, petitioner made numerous loans from banks to enable him to carry tax-exempt securities for the years 1954 through 1968. No deductions for income tax purposes were taken by petitioner for the interest paid on such loans.
Petitioner has never filed or caused to be filed documents with the State of Minnesota to do business as a Minnesota corporation. He has at all times represented himself to the business community as a sole proprietor, doing business under the trade name of E. J. Prescott & Co.
On January 1, 1969, the assets (at fair market value) and liabilities of E. J. Prescott & Co., were as follows:
On January 1, 1969, by operation of law, petitioner's business ceased to be taxed as a section 1361 corporation. The parties have agreed that in the event we decide the termination of the status of petitioner's business as a section 1361 corporation should be treated as a liquidation of a corporation, petitioner received, in addition to the gain taxable on liquidation, ordinary income from the sale of bond inventory in the amount of $12,330.35 for the taxable year 1969. However, should we decide there was no corporate liquidation upon termination of 1361 status, then there will be no such additional ordinary income.
OPINIONThe issues remaining for our decision are whether the termination of the section 1361(a)2 election by the operation of section 1361(n)(2)3 has the effect of a corporate liquidation of petitioner's business; whether part of the gain on such liquidation, if it is found to exist, is tax exempt by virtue of the character of the assets of the proprietorship; and whether the negligence penalty under section 6653(a) is applicable.
Petitioner makes several contentions regarding the termination of his subchapter R status under section 1361(n)(2). First, he claims there was no liquidation of a corporation here because there was never any corporation to liquidate. Further, he points out that the statute itself is silent on the question of whether such termination is a taxable transaction. He claims imposition of a liquidation tax here would defeat the congressional intent to help small unincorporated businesses compete with larger corporate enterprises through equating the tax burden of each. The effect would be to ‘penalize’ a taxpayer who has been lured into this web of tax benefits (only to be stung at the end of the line when the benefits are taken from him by subsequent, unforeseen legislation and regulations). Finally, he argues section 1.1361-16(b), Income Tax Regs., is inconsistent with congressional policy to benefit taxpayers and is, therefore, invalid. He says that what was involved here was a purely formal readjustment of business operations, that no actual change in business operations occurred, and that, therefore, no tax consequences ought to result on the termination of his section 1361(a) election.
Respondent contends that the legislative history behind section 1361(n)(2), which provides for termination of subchapter R status on January 1, 1969, indicates that Congress did indeed intend there to be a constructive liquidation of the pseudocorporation on such termination, and that if taxpayers wished to avoid a tax, they would have to incorporate under the corporate organization and reorganization provisions of the Code (secs. 351 through 374). Respondent argues that section 1.1361-16(b), Income Tax Regs., is consistent with congressional policy and should be followed.
Section 1361(a) provides that the owner of a qualifying proprietorship or all the partners in a qualifying partnership may elect to have their business taxed as a domestic corporation for Federal income tax purposes. Subsection (b) of section 1361 sets forth the qualifications required of the business enterprise to elect to be taxed as a corporation and is not in issue here.
The election does not mean that the proprietorship will just be subject to corporate tax rates and otherwise be treated as a proprietorship for Federal income tax purposes. Rather, the impact of such an election is much broader. Section 1361(c) provides:
Under regulations prescribed by the Secretary or his delegate, an unincorporated business enterprise as to which an election has been made under subsection (a), shall be considered a corporation for purposes of this subtitle, except chapter 2 thereof, with respect to operation, distributions, sale of an interest, and any other purpose; and each owner of an interest in such enterprise shall be considered a shareholder thereof in proportion to his interest.
Clearly, the business enterprise, when the election is in effect, is treated as a corporation for many purposes. This is particularly true for distributions from the business. Section 1361(k) provides that distributions other than in liquidation of the business enterprise shall be treated generally as corporate distributions under sections 301 through 318. Distributions in liquidation of the business enterprise are treated under section 1361(1) as distributions in a corporate liquidation under sections 331 through 346.
Once an election has been made under section 1361(a), the election is generally irrevocable for all subsequent taxable years. See sec. 1361(e). As originally enacted, there was but one exception to this rule and that was provided by section 1361(f) where there was a change of...
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Prescott v. C. I. R.
...9 * The Honorable John K. Regan, United States District Court for the Eastern District of Missouri, sitting by designation.1 Prescott v. Commissioner, 66 T.C. 128, an appeal from the Tax Court of the United States, was submitted after oral argument on February 17, 1977.Simpson v. Commission......
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Barrow v. Commissioner of Internal Revenue, T.C. Memo. 2008-264 (U.S.T.C. 11/25/2008)
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