Smith v. Commissioner
| Decision Date | 27 December 1977 |
| Docket Number | Docket No. 8456-75. |
| Citation | 36 TCM (CCH) 1770,1977 TC Memo 433 |
| Parties | Estate of Clint M. Smith, Deceased, Donna J. Smith, Independent Executrix and Donna J. Smith v. Commissioner. |
| Court | U.S. Tax Court |
Hugh O. Mussina, 3131 Turtle Creek Blvd., Dallas, Tex., for the petitioners. Charles R. Billings, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent issued a statutory notice of deficiency on June 17, 1975 in which he determined deficiencies in, and additions to, petitioners' Federal income tax for the calendar years 1968 and 1970 as follows:
Addition to
Year Deficiency under Sec. 6651(a)
1968 .... $1,210,297.43 $ 60,514.87
1970 .... 799,127.67 119,869.15
The issues before us are as follows: (1) whether petitioners realized gain from the sale of an installment obligation; (2) whether petitioners realized gain upon the liquidation of the Eight Twenty Land Company; (3) whether petitioners realized income due to the assumption of liability by the Tract #140 Trust; (4) whether petitioners realized income due to the assumption of liability by the Tract #1257 Trust; (5) whether the assumption of the debts and retention of the life estates resulted in a part-sale part-gift transaction; (6) whether the applicable statute of limitation for the years in question is 3 or 6 years; and (7) whether a penalty can be assessed for late filing for petitioners' taxable years 1968 and 1970.
Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Clint M. Smith (hereinafter decedent) and Donna J. Smith (hereinafter petitioner) were husband and wife at the time of filing the returns in issue herein. Clint M. Smith died on February 20, 1975 and Donna J. Smith has been appointed Independent Executrix of his estate. Petitioner resided in Fort Worth, Texas at the time the petition herein was filed. Petitioner used the cash basis method of accounting.
Petitioner's return for her taxable year 1968 was mailed on June 18, 1969. Petitioner had been granted a valid extension until June 15, 1969 which fell on a Saturday. Petitioner's return for her taxable year 1970 was mailed on July 15, 1971. Petitioner had been granted a valid extension until July 15, 1971 which fell on a Thursday. Respondent received the return on Monday, July 19, 1971. On their respective briefs petitioner concedes that the return for the taxable year 1968 was filed two days late while respondent concedes that petitioner's return for the taxable year 1970 was timely filed.
Eight Twenty Land Company (hereinafter Land) was a corporation formed under the laws of Texas on May 13, 1968. Two days later a resolution of the board of directors of Land authorized the purchase of 140 acres from decedent for $1,100,000 payable as an installment loan.
On May 15, 1968 decedent purchased 140 acres from George and Corinne Jackson. The purchase price of $580,000 was paid by Southwest Land Title Company (hereinafter Title). Decedent then signed a deed transferring the 140 acres to Land in exchange for an installment note with a face amount of $1,100,000. At the same time he endorsed this note (remaining personally liable thereon) over to Republic National Life Insurance Company (hereinafter Insurance) in return for $650,000; $600,000 of which Insurance distributed to Title. This was the fund out of which Title paid Jackson $579,450.91 and paid closing costs of $3,869.59 for the transfer to land. All the above exchanges occurred at one meeting.
Insurance retained the $50,000 balance to ensure payment of taxes and other expenses relating to the property. During 1968 Insurance issued checks payable to decedent in the amount of $32,000 and $16,805.04. The latter check was issued December 31, 1968 and was received by decedent in January of 1969. In 1970 Insurance issued a check payable to decedent in the amount of $15,564.21. On September 30, 1968 the fair market value of the 140 acres, if unencumbered, was $2,100,000.
Decedent transferred all of his Land stock into Tract #140 Trust on November 25, 1968 pursuant to a trust agreement executed on the same day. From the time of Land's incorporation until this transfer decedent had owned 100 percent of the outstanding shares of its stock. Land's only activity during its life was the purchase and retention of the 140 acres and the application for rezoning this property.1 Land was officially liquidated March 31, 1971 though the articles of dissolution were adopted June 27, 1969 and executed November 25, 1970. On May 5, 1970 Land executed a warranty deed transferring its sole asset, the 140 acres, to the Tract #140 Trust pursuant to its plan of liquidation.
A separate tract of land consisting of 1257 acres was also purchased from the Jacksons. Decedent purchased 514 acres on April 22, 1966 for $350,000. He purchased an adjoining 743 acres on April 27, 1967 for $525,000. Both purchases were financed by loans from Insurance to decedent. Two supplemental notes executed by decedent on April 24, 1967 totaling $345,899.95 were secured by the 1257 acres. These notes represented an "interest element."
This tract was transferred on November 25, 1968 to a second trust, referred to as the Tract #1257 Trust, created by the same instrument as the Tract #140 Trust. The tract had a fair market value, unencumbered, of $2,500,000 as of September 30, 1968. Under both trusts decedent retained a 2/3 income interest for his life which was reduced at his death to a ½ income interest for petitioner's life, further reduced at her death to a 1/8 income interest for the life of each of their two daughters. The remainder interest and the income interest not retained above vested in Brigham Young University. The trusts assumed the outstanding liabilities to which the 140 acre tract and the 1257 acre tract were subject. In addition, the trusts paid the accrued interest on these debts. The trustees of these trusts were decedent and David B. Haight who was Assistant to the President of Brigham Young University. To date no income has been paid to decedent or petitioner out of either trust.
Brigham Young University subsequently employed decedent at a salary of $25,500 per year for which he showed the trust property to prospective buyers and did consultant work.
OpinionIssue 1. The Installment Loan. Respondent contends that the transfer of property from decedent to Land in exchange for an installment loan constituted a sale of property. Petitioner claims that the totality of the transaction should be examined. She asserts that the capacity in which decedent acted is not relevant because the end result of the transaction was a loan by Insurance on Land's note secured by Land's mortgage. The loan proceeds financed the purchase of the property subject to the mortgage.
Petitioner bases her argument on Gatlin v. Commissioner Dec. 9250, 34 B.T.A. 50 (1936) and Arthur R. Jones Syndicate v. Commissioner 1 USTC ¶ 266, 23 F. 2d 833 (7th Cir. 1927), wherein the intent of the parties prevailed over the form of the transaction in determining whether the transaction should be characterized as a loan or a sale. Both cases dealt with transactions whose forms were necessitated by the local usury laws.
Respondent counters by asserting that the trend is to recognize the corporate entity where it is created for a business purpose, e.g. the avoidance of local usury laws, citing Collins v. United States 75-2 USTC ¶ 9553, 514 F. 2d 1282 (5th Cir. 1975); Strong v. Commissioner Dec. 33,748, 66 T.C. 12 (1976) affd. 77-1 USTC ¶ 9240 553 F. 2d 94 (2nd Cir. 1977); and Moline Properties v. Commissioner 43-1 USTC ¶ 9464, 319 U.S. 436 (1943). These cases held that a taxpayer could not pick and choose among the positive and negative results of using the corporate form.
Respondent's argument obfuscates the issue. Petitioner is not asking us to ignore the reality of the corporate existence, but to recognize the true capacity in which decedent acted in transacting business between Insurance and Land.
At trial respondent outlined the dealings between Insurance and decedent involving the 1257 and 140 acres. He agreed that the form of these transactions was dictated by the necessity of avoiding the Texas usury laws. The legal limit on interest rates in Texas is 10 percent.2 By arranging the transaction as a sale between decedent and Land in which decedent exchanged the property for a $1,100,000 installment loan which he then "sold" to Insurance for $650,000, Land received the funding necessary for the purpose of the 140 acres in a mode which assured Insurance of a 69 percent return3 on its extension of credit. As respondent noted in his opening statement the entire transaction occurred on May 15, 1968 with the exception of the three checks issued in 1968 and 1970 for the monies that had been retained by Insurance to ensure payment of taxes on the property Land had mortgaged to secure the loan.
Respondent argues that the issuance of these checks in decedent's name supports his sale treatment. Actually, this fact supports neither party's argument because both sides agree that in form the transaction consisted of a note written by Land payable to decedent then discounted by him to Insurance. To maintain the charade necessitated that Insurance release all funds either to decedent or in his name.
We find for petitioner on this issue. Decedent conducted business in his individual capacity only because he could not obtain equivalent results for Land when acting as its agent. The use of decedent as a middleman makes no sense unless the substance of the transaction is considered. Respondent agrees that in substance the transaction was a loan from insurance to Land secured by the property purchased with the proceeds thereof. We see no reason to treat it...
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