Siple v. Comm'r of Internal Revenue, Docket No. 5323-67.

• Court: U.S. Tax Court
• Writing for the Court: TANNENWALD
• Citation: Siple v. Comm'r of Internal Revenue, 54 T.C. 1 (T.C. 1970)
• Decision Date: 14 January 1970
• Docket Number: Docket No. 5323-67.
• Parties: J. MEREDITH SIPLE AND DELIA W. SIPLE, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

54 T.C. 1

J. MEREDITH SIPLE AND DELIA W. SIPLE, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 5323-67.

United States Tax Court

Filed January 14, 1970.

Bruce R. Bailey, for the petitioners.

Richard G. Daly, for the respondent.

In implementation of an agreement with a corporation and its majority stockholder to purchase stock in the corporation and otherwise to help it financially, petitioners furnished collateral so that the corporation could borrow from the bank with no personal liability on the part of petitioners. The corporation suffered financial reverses and, as part of an agreement severing all business relations with the corporation and its majority stockholder, petitioners waived or released any rights they had, or might subsequently acquire, against either of them. Petitioners subsequently paid the bank the amounts of the indebtedness in order to redeem their pledged collateral. Held, petitioners' payments to the bank are part of the cost of acquisition of their stock in the corporation and deduction of amounts thereof is subject to the limitations of sec. 165(f).

OPINION

TANNENWALD, Judge:

The respondent determined deficiencies in the petitioners' income tax for the calendar years 1960, 1963, and 1964 in the respective amounts of $35,435.63, $343.25, and $16,262.54. All of the facts have been stipulated by the parties and accordingly the proceeding was submitted under Rule 30 of the Court's Rules of Practice.

At the time of filing their petition, J. Meredith Siple and Delia W. Siple, husband and wife, were residents of Glendale, Calif. Their joint Federal income tax returns for the calendar years 1960, 1963, and 1964 were prepared and filed on the cash receipts and disbursements method of accounting with the district director of internal revenue at Los Angeles, Calif.

For a number of years prior to 1957, Willis O. Mizner and Ruth E. Mizner owned and operated a general grocery market at King's Beach, Calif. On April 23, 1957, the Mizners caused to be organized a Nevada corporation known as the King's Beach Stop & Shop Market, Inc. (hereinafter referred to as King's Beach), with an authorized capitalization of 200,000 shares of $1 par value common stock. The Mizners transferred all of their accounts receivable, accounts payable, and inventory to the corporation in exchange for 4,000 of these shares.

The Mizners, noting that the economy of the Reno-Tahoe area was prospering, decided to diversify and expand the business of King's Beach. From projections furnished by the Brunswick Corp., they determined that a bowling alley and restaurant would be profitable. They therefore decided to construct a 12-lane facility adjacent to their market. This location was desirable because the Mizners held a long-term ground lease on several lots adjoining the market. The Mizners decided to use King's Beach as the corporate entity through which to carry out this project. A projected pro forma financial statement reflecting the proposed venture as of April 30, 1959, was used by King's Beach.

Since King's Beach had limited funds and borrowing power, it was necessary for the corporation to secure additional financing. The Mizners approached petitioners concerning a possible advance to the corporation.

After an extended period of discussion it was orally agreed that petitioners would purchase a number of shares from King's Beach for $100,000 and would advance an additional $50,000 to the corporation. It was also agreed that petitioners would attempt to induce the Reno branch of the First National Bank of Nevada (hereinafter referred to as the bank) to advance to King's Beach a sum not to exceed $200,000. It was contemplated that petitioners would pledge certain securities as collateral for the loan.

The oral agreement was reduced to writing by the Mizners' attorney, upon whom petitioners relied since they had no attorney of their own. The written agreement was signed by Willis O. Mizner for King's Beach and by both Mizners and petitioners in their individual capacities on October 22, 1959, and is hereinafter referred to as the agreement of October 22, 1959.

The agreement provided in pertinent part:

1. The Third Parties (petitioners) agree they will make arrangements with the First National Bank of Nevada, First & Virginia Branch, Reno, Nevada, by depositing with said bank securities owned by the Third Parties whereby said First National Bank * * * will lend to the Third Parties for the use and benefit of First Party (King's Beach) from time to time, not to exceed the sum of $200,000.00; said advancements to be made by said bank only upon the written request of Willis O. Mizner, as president of the First Party, and upon receiving the duly executed promissory notes of First Party evidencing each of said advancements, which said notes shall be made payable to the Third Parties.

The agreement further provided that the money was to be used by King's Beach for various purposes in connection with the proposed expansion. The Mizners were to deliver their 4,000 shares of King's Beach stock, duly endorsed, to the petitioners ‘for the purpose of securing the notes to be given by * * * (King's Beach) to (petitioners) * * * covering advances made by the First National Bank of Nevada.’ As long as such advances were outstanding, the petitioners had the sole right to vote the Mizners' stock.

In addition, the agreement went on to state that, within 30 days after King's Beach notified petitioners that the building was completed, the petitioners would purchase 2,562 shares of the authorized but unissued stock of King's Beach from the corporation for $100,000. The money was to ‘be used to pay off all or a portion of indebtedness of First Party (King's Beach) to First National Bank of Nevada and to the Third Parties (petitioners) resulting from money advanced to the First Party by said First National Bank.’

The agreement also contained an option, exercisable by petitioners for 1 year after the date of purchase of the 2,562 shares, to purchase an additional 1,281 shares for $50,000. This money was to be used in the same fashion as the $100,000.

Following the portion of the agreement detailing the stock purchase and the option arrangements, it is stated:

6. First Party (King's Beach) agrees that while the arrangements by the * * * (petitioners) with the First National Bank of Nevada make the * * * (petitioners) primarily liable to said bank for all advancements made by it to the First Party, that such advancements are solely for the use and benefit of First Party and that the First Party will fully repay the same to said bank and/or to the Third Parties, together with all interest or other charges thereon.

On the same day that the above agreement was signed, October 22, 1959, petitioners and King's Beach executed a bank form entitled ‘Pledge Agreement for Lent Collateral’ which contained two distinct agreements. The first agreement was signed by the Mizners for King's Beach. Beneath the Mizners' signatures followed a second agreement which commenced:

FOR AND IN CONSIDERATION of any financial accomodation given or to be given or continued to KING'S BEACH STOP & SHOP MARKET, INC., hereinafter called the ‘Debtor’, by THE FIRST NATIONAL BANK OF NEVADA, * * * the undersigned does hereby assign, transfer to and deposit with the Bank all property this day delivered by the undersigned or the Debtor to the Bank * * *

The final sentence of the agreement states that it is not to be construed to make ‘the undersigned a guarantor or surety of the indebtedness of said debtor’ and is followed by the signature of the petitioners. In accordance with the agreement, petitioners pledged Minnesota Mining & Manufacturing stock which had at all material times a fair market value in excess of the outstanding debt.

Also on October 22, 1959, the bank agreed to advance the sum of $200,000 to King's Beach. This obligation of King's Beach was evidenced by a note payable to the bank for $200,000 with 5 1/4-percent-per-annum interest. The note was signed by the Mizners in their capacities as officers of Kings Beach.

At no time did King's Beach or the Mizners give the petitioners any notes, nor did the Mizners transfer any of their King's Beach stock to petitioners as security for petitioners' agreement to pledge securities to the bank. The petitioners acquiesced in this variation from their agreement with King's Beach and the Mizners.

By June of 1960 the building had been erected at a cost exceeding $300,000 instead of the $200,000 initially estimated. These additional costs were due to design changes, one of which expanded the number of bowling lanes from 12 to 16.

On June 17, 1960,¹ petitioners, the Mizners, and King's Beach entered into a ‘Supplementary Agreement,‘ which due to the additional costs of construction amended the original agreement between petitioners, the Mizners, and King's Beach to provide that the $100,000 paid by petitioners to purchase 2,562 shares of King's Beach stock would be applied toward payment in full of all cafe and bar conditional sales contracts in a sum not exceeding $40,000; $25,000 would be used for the balance of the construction contract, and the remainder and not less than $35,000 would be used ‘in partial payment of the present indebtedness of * * * (King's Beach)‘ to the bank.

Due to the increased costs and to lack of revenue, King's Beach renewed its note with the bank (the original due date had been April 22, 1960) and obtained further advances culminating in two final notes in the total principal sum of $295,000. All of the notes were made payable to the bank and were signed by the Mizners for King's Beach. The two final notes were in amounts of $275,000 due May 20, 1963, and $20,000 due September 30, 1963. All of these notes were secured by the collateral pledged by petitioners to the bank, with the knowledge of the petitioners.

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