Rotolo v. Comm'r of Internal Revenue
| Decision Date | 22 June 1987 |
| Docket Number | 8329-85,8328-85,8337-85.,Docket Nos. 8048-85,8117-85,8116-85,8330-85 |
| Citation | 88 T.C. No. 85,88 T.C. 1500 |
| Parties | LOUIS S. ROTOLO and DOROTHY R. ROTOLO, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
D, a closely held corporation engaged in the manufacturing business, was liquidated in 1975. It used the completed contract method to report its income, and in computing its gross profits for its final taxable year, D included in gross receipts the advance payments which it had received under certain incomplete long-term contracts and offset the costs of inventory which it had on hand at the end of such year. Shortly before the liquidation, the principal stockholder of D transferred stock to three employees of D in recognition of their services for D.
HELD: (1) The Commissioner's disallowance of the inventory offset does not result in a clear reflection of income and is unreasonable; D's gross profits determined using the costs-incurred alternative of the percentage of completion method of accounting for long-term contracts. See sec. 1.451-3, Income Tax Regs.
(2) The compensation paid to the three employees, including the value of stock transferred to them, is reasonable and deductible by D. Neil S. Kurlander, James S. Eustice, 2 and John L. Wood, for the petitioners.
Cynthia J. Mattson, for the respondent.
The Commissioner determined the following deficiencies in the petitioners' Federal income taxes and the following liabilities against the petitioners as transferees of corporate assets:
+----------------------------------------------------------+
¦Petitioner ¦Taxable year ¦Deficiency¦Liability¦
+-------------------+-----------------+----------+---------¦
¦Louis S. Rotolo and¦ ¦ ¦ ¦
+-------------------+-----------------+----------+---------¦
¦Dorothy R. Rotolo ¦1976 ¦$5,571 ¦--- ¦
+-------------------+-----------------+----------+---------¦
¦James B. Wilson ¦4/1/75 to 2/13/76¦--- ¦$85,265 ¦
+-------------------+-----------------+----------+---------¦
¦Thomas J. Golab and¦ ¦ ¦ ¦
+-------------------+-----------------+----------+---------¦
¦Ivalee N. Golab ¦1976 ¦4,242 ¦--- ¦
+-------------------+-----------------+----------+---------¦
¦Louis S. Rotolo ¦4/1/75 to 2/13/76¦--- ¦85,265 ¦
+-------------------+-----------------+----------+---------¦
¦James B. Wilson ¦1976 ¦5,817 ¦--- ¦
+-------------------+-----------------+----------+---------¦
¦Robert S. Ledley ¦4/1/75 to 2/13/76¦--- ¦518,465 ¦
+-------------------+-----------------+----------+---------¦
¦Thomas J. Golab ¦4/1/75 to 2/13/76¦--- ¦78,708 ¦
+----------------------------------------------------------+
After concessions by the parties, the issues for decision are: (1) Whether a corporation is entitled to offset the cost of inventory attributable to certain incomplete contracts against advance payments on such contracts, when such contracts and such inventory are distributed to its stockholders in a complete liquidation; and (2) whether, in the circumstances of this case, stock treated as transferred by a corporation to certain of its employees was reasonable compensation for services performed.
Some of the facts have been stipulated, and those facts are so found.
At the times their petitions were filed in this case, the petitioners, Louis S. and Dorothy R. Rotolo, husband and wife, maintained their legal residence in Silver Spring, Maryland; the petitioner, James B. Wilson, maintained his legal residence in Arlington, Virginia; the petitioners, Thomas J. and Ivalee N. Golab, husband and wife, maintained their legal residence in Beltsville, Maryland; and the petitioner, Robert S. Ledley, maintained his legal residence in Silver Spring, Maryland. For the year 1976, all of the petitioners, except Mr. Wilson, filed their Federal income tax returns with the Internal Revenue Service Center in Philadelphia, Pennsylvania; Mr. Wilson filed his return with the Service Center in Memphis, Tennessee. For convenience, Thomas Golab, Robert Ledley, Louis Rotolo, and James Wilson will sometimes be referred to as the petitioners.
Dr. Robert Ledley has a master of arts degree from Columbia University and doctor of dental science from New York University. In the early 1950s, he was a physicist at the National Bureau of Standards where he was involved with the world's first successful digital computer. In the late 1950s, he became a professor at George Washington University, where he prepared and taught the first digital computer engineering courses in the country. In 1960, he authored the first textbook on digital computer engineering. From 1960 through the years in issue, he was president of the National Biomedical Research Foundation (NBRF). In 1970, he joined the faculty of Georgetown University. In addition, from the 1950s to the years in issue, he held numerous positions in the fields of medicine and computer technology. Dr. Ledley has authored over 200 books and periodicals, primarily dealing with the application of computer technology to medicine. At the time of trial, in addition to his other activities, he was the editor-in-chief of four journals: Computerized Tomography, Computers in Biology and Medicine, Journal of Computer Languages, and Journal of the Pattern Recognition Society.
Louis Rotolo has a bachelor of science degree in electrical engineering from the University of Michigan and a masters degree in engineering from George Washington University. In the early 1950s, he was a project engineer in the United States Navy and was responsible for the design and procurement of electrical shipboard systems. In the late 1950s, he was a senior research scientist and lecturer at George Washington University, where his research dealt with digital computers. From 1961 through the years in issue, he was a senior research scientist and the treasurer at NBRF. From 1970 through the years in issue, he was on the faculty of Georgetown University. In addition, Mr. Rotolo has held faculty positions in the fields of computer science and engineering. Mr. Rotolo has authored approximately 41 articles dealing with computers, computer logic design, and the application of computers to medical problems.
Thomas Golab has a bachelor's degree in electrical engineering and a master of science degree in engineering from George Washington University. From 1961 to 1963, he was an electronics engineer for the United States Navy working on passive sonar systems. During the 1960s, he was an engineer for several private corporations developing radar and ‘anti-jam‘ communications systems. From 1968 through the years in issue, he was a senior research scientist at NBRF. He has authored six articles on the use of computers in medicine.
James Wilson has a bachelor's degree in electrical engineering from George Washington University and has taken graduate courses in math and computer science. In the late 1950s, he worked with Dr. Ledley as a research associate at George Washington University. Since 1960, he has been a senior research scientist and the secretary at NBRF.
In 1960, Dr. Ledley and Mr. Wilson formed NBRF, an organization described in section 501(c)(3) of the Internal Revenue Code of 1954, 3 and exempt from Federal income tax. NBRP was devoted to research in the area of computer applications in medicine and was primarily funded by Federal grants, including grants from the National Institutes of Health. In 1970, NBRF became affiliated with Georgetown University.
In early 1973, representatives of Georgetown University asked Dr. Ledley if NBRF could build a computerized timograph (CT) scanner, for less than the price charged by the then current manufacturer, EMI. A CT scanner is a diagnostic machine which produces images of an internal part of the body without requiring an injection of dye or surgery. The EMI scanner could only make images of a patient's head and required a water interface between the patient and the machine. Dr. Ledley determined that NBRF could build a better machine, called the Automatic Computerized Transverse Axial Scanner, or the ACTA scanner, for less than the cost of the EMI scanner. The ACTA scanner did not require a water interface and could scan every part of a patient's body; the images created by it had four times the resolution of those provided by the EMI scanner. Most of the modern CT scanners are based on the ACTA scanner.
The first ACTA scanner was primarily designed by Dr. Ledley and was built by NBRF, with Mr. Golab in charge of electronics, Mr. Rotolo as industrial coordinator, and Mr. Wilson in charge of computer software. Georgetown University purchased the prototype from NBRF for approximately $300,000. This prototype was installed at Georgetown University Hospital, where it was placed in clinical operation in February 1974. The prototype attracted a tremendous amount of attention; its effect on medical diagnostic techniques was almost equivalent to that caused by the development of the X-ray tube. Most of the chiefs of hospital radiology departments in this country, and many from around the world, came to Georgetown to see the ACTA scanner.
In early 1974, while the prototype was in full clinical operation and radiologists from around the world were observing its operation, Georgetown University, NBRF, and the petitioners decided to manufacture commercially the ACTA scanner. Digital Information Service Corporation (Digital) was the organization chosen to manufacture the ACTA scanners. Digital was formed in 1971 by Dr. Ledley to produce commercially the AZOR, a machine that was used for evaluating the efficacy of antibiotic drugs. Messrs. Golab, Rotolo, and Wilson, and Gerald Pence were employed by Digital to manufacture the AZOR, and were employed by Digital at the...
To continue reading
Request your trial
-
Bank One Corp. v. Comm'r of Internal Revenue
...See Harden v. Commissioner, 223 F.2d 418 (10th Cir.1955), revg. and remanding 21 T.C. 781, 1954 WL 460 (1954); Rotolo v. Commissioner, 88 T.C. 1500, 1514, 1987 WL 31362 (1987); Brountas v. Commissioner, 74 T.C. 1062, 1069, 1980 WL 4441 (1980), supplementing 73 T.C. 491, 1979 WL 3779 (1979),......
-
Bank One Corporation v. Commissioner of Internal Revenue
...reflect income. See Harden v. Commissioner, 223 F.2d 418 (10th Cir. 1955), revg. and remanding 21 T.C. 781 (1954); Rotolo v. Commissioner, 88 T.C. 1500, 1514 (1987); Brountas v. Commissioner, 74 T.C. 1062, 1069 (1980), supplementing 73 T.C. 491 (1979), vacated and remanded on other grounds ......
-
Berger v. Commissioner
...deduction of the cost of construction until the cash is spent, certainly not a clear reflection of income. See Rotolo v. Commissioner [Dec. 43,985], 88 T.C. 1500, 1514 (1987) ("`the cost of goods sold must be deducted from gross receipts in order to arrive at gross income'" (quoting Sulleng......
-
Hamilton Indus., Inc. v. Comm'r of Internal Revenue
...bears a heavy burden of overcoming a determination that a method of accounting does not clearly reflect income. Rotolo v. Commissioner, 88 T.C. 1500, 1513-1514 (1987); Peninsula Steel Products & Equipment Co. v. Commissioner, 78 T.C. 1029, 1044-1045 (1982). If a taxpayer establishes that a ......
-
The Internal Revenue Service's increasing power with the clear reflection of income standard.
...power under the clear reflection of income standard. (1) Boynton v. Pedrick, 136 F. Supp. 888 (S.D.N.Y 1954). (2) Rotolo v. Commissioner, 88 T.C. 1500, 1513-14 (1987). (3) Thor Power Tool Co. v. Commissioner, 439 U.S. 532 (1979). (4) 721 F. Supp 300 (D. Ga. 1989), aff'd, 916 F.2d 720 (11th ......
-
Should cost of goods sold be subject to economic performance?
...meaning of section 461 and that they are not subject to the rules governing deductions under such section." (Emphasis added.) In Rotolo, 88 TC 1500 (1987), a corporation that manufactured computerized timograph (CT) scanners was liquidated pursuant to an agreement to transfer its scanner ma......