Schultz v. Comm'r of Internal Revenue, Docket No. 4947-66.
| Decision Date | 31 July 1968 |
| Docket Number | Docket No. 4947-66. |
| Citation | 50 T.C. 688 |
| Parties | GEORGE L. SCHULTZ AND MARGARET F. SCHULTZ, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Myles A. Cane and Lewis J. Hecker, for the petitioners.
Alan M. Stark, for the respondent.
Petitioner purchased raw whisky, distilled as bourbon, as an investment and, at the time of purchase, made payment in advance to the seller of 4 years of carrying charges, consisting of insurance, storage, and an amount equal to estimated State ad valorem taxes. The normal aging period of bourbon whisky is 4 years. Petitioner also expended certain sums in payment for certain legal services. Held, that petitioner's objective was to acquire 4-year bourbon whisky. Held, further, that the expenditures for carrying charges are not deductible expense under sec. 212(2), even on a prorated basis, and are required to be added to the cost of the whisky. Held, further, that, there being no evidence that the ad valorem taxes were paid to the State taxing authority, the amounts equal to such estimated taxes are not deductible under sec. 104. Held, further, that petitioner has failed to prove that the legal fees were paid in connection with matters within the scope of sec. 212(2) or (3) and therefore allowable deductions thereunder.
Respondent determined deficiencies in the joint Federal income taxes of petitioners in the amounts of $32,905.63 and $30,933.35 for the taxable years 1962 and 1963, respectively. After certain concessions by respondent, the following questions remain for our consideration: (1) Whether petitioners may take deductions in 1962 and 1963 for storage charges, insurance, and taxes in connection with the purchase and holding of bulk bourbon whisky; and (2) whether petitioners may deduct certain legal fees paid in 1962.
Some of the facts have been stipulated and are found accordingly. Those facts and the exhibits attached thereto are incorporated herein by this reference.
Petitioners are husband and wife and had their legal residence in Essex Fells, N.J., at the time the petition herein was filed. They filed timely joint Federal income tax returns on a cash basis for the taxable years 1962 and 1963 with the district director of internal revenue, Newark, N.J. Margaret F. Schultz is a petitioner herein and a party to this proceeding only by reason of having filed a joint return with her husband, George L. Schultz (hereinafter referred to as petitioner).
Petitioner is chairman of the board and chief executive officer of Shulton, Inc., a publicly held corporation engaged in the business of manufacturing toiletry and cosmetic items. He has been with Shulton for over 20 years and devotes full working time to his duties there.
Issue 1. Costs Incident to Purchase of Bulk Whisky
On November 19, 1962, petitioner purchased from T. W. Samuels Distillery, Inc. (hereinafter referred to as Samuels), warehouse receipts evidencing the ownership of 1,000 barrels of ‘Fall 1961’ bulk whisky and 1,000 barrels of ‘Spring 1962’ bulk whisky. To cover the aggregate purchase price of $134,525.07, petitioner paid Samuels $25,000 in cash, executing and delivering a 6-percent negotiable promissory note for the balance of $109,525.07. On the same day, he delivered to Samuels the warehouse receipts evidencing his ownership of the 2,000 barrels as collateral for the note and, in addition, paid Samuels $26,286, which sum represented interest on the promissory note for the period November 19, 1962, to November 19, 1966. Petitioner claimed a deduction for such interest in determining his taxable income for the taxable year 1962, which has not been disallowed by respondent.
Also on November 19, 1962, petitioner made the following payments to Samuels incident to the whisky purchased: (1) $8,000 for estimated Kentucky ad valorem taxes representing State, county, and school taxes on the bulk whisky from November 19, 1962, to December 31, 1966, based on current assessments and tax rates; (2) $24,000, representing the cost of storing the bulk whisky in a bonded warehouse owned by Samuels for the period November 19, 1962, to November 19, 1966; and (3) $2,800, representing the cost of insuring the bulk whisky against loss for the period November 19, 1962, to November 19, 1966. The storage costs were 25 cents per barrel per month, the customary storage rate charged by Samuels. Casualty insurance premiums amounted to 35 cents per barrel per year, which cost was very close to the premiums regularly charged Samuels by its insurance carrier.
On November 6, 1963, petitioner purchased from Samuels warehouse receipts evidencing the ownership of 1,250 barrels of ‘Spring 1962’ bulk whisky and 750 barrels of ‘Fall 1963’ bulk whisky. Petitioner paid $25,000 in cash towards the aggregate purchase price of $136,927.27, executing and delivering a 6-percent negotiable promissory note due November 6, 1967, for the balance of $111,927.27. On the same day, the warehouse receipts were delivered to Samuels as collateral for the note, and interest of $26,862.54, covering the period November 6, 1963, to November 6, 1967, was paid. Petitioner claimed a deduction for such interest expense in determining his taxable income for the taxable year 1963, which has not been disallowed by respondent.
Also on November 6, 1963, petitioner made the following payments to Samuels, identical to those made incident to the purchase on November 19, 1962:
+--------------------------------+
¦Kentucky ad valorem taxes¦$8,000¦
+-------------------------+------¦
¦Storage ¦24,000¦
+-------------------------+------¦
¦Insurance ¦2,800 ¦
+--------------------------------+
The estimated tax payments covered the period November 6, 1963, to December 31, 1967, and the storage and insurance costs covered the period November 6, 1963, to November 6, 1967.
Petitioner at no time discussed any of the terms and conditions or arrangements respecting the foregoing transactions with any representative of Samuels. All discussions were carried on by petitioner's accountant, who, together with petitioner's attorney, advised petitioner regarding the transactions, including the tax consequences thereof.
At the time of the foregoing transactions, petitioner anticipated that he would probably hold each lot of whisky purchased for 4 years because he understood that to be the normal aging period.
In 1962 and 1963, petitioner claimed deductions for those amounts paid Samuels to cover State taxes, storage, and insurance costs. No part of such deductions was allowed by respondent.
Subject to a right of first refusal requiring petitioner to first offer his bulk whisky to Samuels at the ‘prevailing market price,‘ petitioner was free at any time to sell his whisky in the open market for the highest price he could obtain. The purchase agreement also provided that, in the event Samuels chose not to exercise its right to repurchase and the whisky was ultimately sold to an outsider—
the warehouse receipts representing such whiskey shall, upon delivery to such outsider, be so restricted that no one other than the seller (i.e., Samuels) may use the name T. W. Samuels Distillery, Inc. in any way on the bottled goods which may be produced from such bulk whiskey, nor to have such whiskey identified by any of the brand names owned by T. W. Samuels Distillery or Old Jordan Distillery.
Petitioner and Samuels had no agreement or understanding at any time prior to the middle of 1965 that Samuels would repurchase any of the whisky from petitioner. Petitioner had no facilities for bottling whisky himself.
On August 20, 1965, Samuels purchased petitioner's 4,000 barrels of bulk whisky in order to fill its inventory shortages in the particular ages of whisky held by petitioner and which it required at that time for bottling purposes. The aggregate sales price paid by Samuels was $381,460.93, which sum included unexpired prepaid costs as follows:
+-------------------------------+
¦ ¦1962 ¦1963 ¦
+---------+---------+-----------¦
¦Interest ¦$8,208.90¦$14,863.94 ¦
+---------+---------+-----------¦
¦Storage ¦7,495.00 ¦13,280.00 ¦
+---------+---------+-----------¦
¦Insurance¦874.42 ¦1,549.33 ¦
+---------+---------+-----------¦
¦Taxes ¦2,649.93 ¦4,553.99 ¦
+-------------------------------+
Taking into account all expenditures (including interests), petitioner sustained an economic loss of $12,739.95 on purchase, holding, and ultimate sale of the whisky.
Ownership of whisky stored in bonded warehouses is evidenced by warehouse receipts issued by a warehouseman. Such receipts are used in the industry as collateral for private loans and are purchased and sold by distillers, bottlers, distributors, whisky dealers, and investors.
The parties have stipulated that the market price for bulk whisky warehouse receipts is influenced by such factors as supply and demand, age, type, and quality of the whisky, the identity of the distiller, market conditions pertaining to sales of bottled whisky, existing supplies of bulk whisky, geographical location of the distillery, type of water supply, kind of grain, and type of barrels used. During 1962 and 1963, the whisky market was in a relatively depressed state.
Aging typically improves the quality, flavor, and color of bulk bourbon whisky, but this is not always the case. Moreover, despite such improvement, the market value of such whisky may very well decline during the aging process. Thus, for example, although 4-year-old bulk whisky is ordinarily more valuable than 2-year-old bulk whisky at any given point of time, market conditions relating to supply and demand on occasion result in the reverse being the case.
The season and year identifying bulk whisky refers to the date of its distillation. In the bourbon whisky distilling process, a mixture of ground grains containing at least 51-percent corn is cooked with water....
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