Skinner v. Commissioner, Docket No. 2237-65.
| Citation | 1968 TC Memo 138,27 TCM (CCH) 680 |
| Decision Date | 27 June 1968 |
| Docket Number | Docket No. 2237-65. |
| Parties | Claude E. Skinner v. Commissioner. |
| Court | United States Tax Court |
James J. Waters, 922 Walnut St., Kansas City, Mo., for the petitioner. Donald W. Geerhart, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined a deficiency in petitioner's income tax liability for the year 1960 in the amount of $9,645.37 resulting solely from his conclusion that petitioner received ordinary gain of $37,500 for a covenant not to compete instead of capital gain on the sale of stock as reported.
Petitioner herein and his wife sold their stock of a cement company for the total consideration of $75,000. The final written contract of sale contained a covenant in which the sellers promised not to compete with the corporation for a specified period of time within a given distance of its home office. The written contract assigned one-half of the total consideration to the sale of stock and one-half to the covenant.
The legal issue with which we initially must deal concerns whether this Court should look behind the contract in a situation such as this in order to examine the substance of the transaction, or whether the tax should be assessed upon the face of the contract. If we may look past the face of the document, we then must determine whether the amount purportedly received by petitioner and his wife for the covenant not to compete in fact reflected payment for that promise, or was in reality a part of the payment for the stock.
If the payment was for the promise, the amount received therefor was ordinary income to petitioner. If, however, the payment in reality was not for the promise, but instead the entire consideration was for the stock, then petitioner is entitled to capital gain treatment on the entire amount.
Those facts which were stipulated by the parties are found accordingly and adopted as our findings. Other facts relevant to the issue presented are set forth below.
Claude E. Skinner (hereinafter called Claude or petitioner) and Nellie M. Skinner were husband and wife and filed their joint income tax return for 1960 with the district director of internal revenue at Kansas City, Missouri. Petitioner's legal residence was Camdenton, Missouri, at the time the petition was filed.1
Claude E. Skinner was born on April 8, 1907, at Mack's Creek, Missouri, in an area commonly known as the "Ozarks." He lived most of his life in Camden County, Missouri, not far from Mack's Creek. He had only a sixth-grade education. Camdenton is approximately 148 miles from Kansas City. Claude was released from military duty in World War II because of a very serious back injury. He also was plagued with frequent stomach problems, and was the victim of a generally poor physical condition.
Following his return to civilian life, Claude and his brother-in-law, Charles Lewis, went into the trucking and excavating business together in Kansas City. In 1954, Claude purchased a 225-acre farm in Camden County and went there nearly every weekend and other times just as frequently as possible. Claude hoped to live on the farm after his years in business were completed. Charles left Kansas City for Camden County in 1957 where he entered the real estate business. Soon thereafter, Claude asked Charles to look out for ground in Camden County so that they could go into business there together.
In 1957, Claude went into a business with Miller J. Fields, known as Lee's Summit Ready-Mixed Concrete and Materials Company, hereinafter sometimes referred to as Ready-Mix. The business operated in the Kansas City area with Claude and Miller as the only stockholders. Miller was vice president and Claude was president. In 1958, Claude and Miller each owned 50 percent of the outstanding Lee's Summit stock, but during that year they each sold half of his respective stock interest to Union Construction Company. Thereafter Union owned 50 percent, and Claude and Miller each owned 25 percent of the stock. George Bair, secretary-treasurer of Union Construction Company, became secretary-treasurer of Ready-Mix, while Miller and Claude retained their former offices. George was the "top man, the manager on the spot of the operation" and Claude was engaged mostly in selling. Claude and George were not able to get along well together in the running of Ready-Mix.
Claude and Miller had a standing oral agreement that if either of them wanted to leave Ready-Mix the other would have the first chance to buy the withdrawing stockholder's stock. On or about April 1, 1960, Claude approached Miller and told him that he wanted to get out of the company, that "I have to get out," and that he had had about all that he could take. Miller asked how much money Claude wanted for his stock, and Claude set a price of $75,000. No reference was made to any covenant not to compete. Miller and Claude then orally agreed to a sale and transfer of the stock at that price. The reasons for Claude's desire to leave Ready-Mix were his continuing poor health, his inability to get along with George Bair, and his continued intention and desire to return to the Ozark country. He could not have created any competition with Ready-Mix from that distance and Miller knew it. Apparently it did not occur to either of them that such a covenant was even a possibility. No mention was made of a covenant not to compete by Claude or by Miller at any time before they agreed to sell and buy the 25 percent stock interest for $75,000.
The oral agreement between Miller and Claude for sale of Claude's stock at a price of $75,000 was to be reduced to writing. Although Claude was a good salesman, he had only a sixth-grade education; he did not have a lawyer, but consulted and discussed the matter with his accountant, who advised him about the installment method of reporting gain on the sale of his stock and also that if any allocation of consideration was made to a covenant not to compete he would realize ordinary income therefrom. Petitioner advised the accountant that his agreement with Miller was for a cash sale and that he wanted it that way so that he could get his money and go back to the Ozarks. He further told the accountant that no amount was to be put in the contract for a noncompetition agreement
Miller arranged to obtain the $75,000 from Ready-Mix to purchase Claude's interest and agreed to asign the stock to Ready-Mix when it was acquired. Ready-Mix and Union Construction were both represented by a Kansas City lawyer, who happened to have offices at that time in the same building with petitioner's accountant.
On April 8, 1960, George Bair, who, as we have indicated, was secretary-treasurer of both Union Construction and Ready-Mix, and Miller Fields met to discuss the terms of the sale. Bair or Miller communicated with the Ready-Mix lawyer to outline the transaction and have a contract prepared. The record does not disclose what transpired during that conversation.
Claude, Nellie, and Miller attended a meeting on April 9, the following day, in the lawyer's office, by prearrangement. At that time a proposed contract was presented which contained a covenant binding petitioner and Nellie not to compete with Ready-Mix for five years within an area of 50 miles of Lee's Summit, Missouri. This covenant and an allocation of the total consideration, one-half to the stock and one-half to the covenant had been placed in the contract by the lawyer as a tax-saving device for his client, Ready-Mix. The record does not disclose whether this was in accordance with Bair's instructions or on the lawyer's own motion on behalf of his client, Ready-Mix, but it was not known to Miller or to petitioner. The geographical area covered by the covenant was discussed when petitioner became aware of the covenant itself. Petitioner did not object to the covenant, but he objected to the 50-mile area, and requested that it be reduced. He and Miller then agreed on a smaller area. There was no discussion at any time concerning either the consideration involved, the allocation of part thereof to the covenant or the tax consequences. In fact, allocation of part of the total consideration for the covenant was never even mentioned to Claude at all by Miller or by the lawyer or by anyone else in Miller's presence at any time. The allocation was also not mentioned or discussed by the lawyer with Miller at any time although he had arrived at the office before the Skinners and was alone with the lawyer on April 9 prior to their arrival for the closing. Claude had no previous knowledge of the existence of the proposed covenant itself until that morning in the lawyer's office, and at no time prior to execution of the agreement was he made aware of the allocation provision. Neither was Miller.
Claude had invited his accountant, who had offices in the building, as previously mentioned, to drop by to see "him and mama get their check for $75,000." The accountant was late, however, and as he walked in, some 10 or 15 minutes after the meeting began, the lawyer was retyping the last page of the agreement to change the area of the covenant not to compete as previously discussed and agreed to by petitioner and Miller. The first page of the agreement, which contained all provisions thereof except the covenant not to compete, remained unchanged. No discussion of the covenant at all took place in the accountant's presence and he was unaware of the prior discussion; he gave no counsel or advice to petitioner and was merely there as a spectator and because of his long friendship and association with petitioner. The completed agreement, with a retyped page two, was subsequently passed around for everyone to glance over. No one read it at that time and at no time thereafter during the conference was there any mention of or reference made to any consideration for the covenant or that the contract made any allocation between...
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