Sparks Nugget, Inc. v. Commissioner

Decision Date31 March 1970
Docket NumberDocket No. 4237-67,4277-67 — 4280-67.
Citation1970 TC Memo 74,29 TCM (CCH) 318
PartiesSparks Nugget, Inc., et al. v. Commissioner.
CourtU.S. Tax Court

Valentine Brookes, 1600 International Bldg., 601 California St., San Francisco, Calif., for the petitioners. Gordon B. Cutler, for the respondent.

Memorandum Findings of Fact and Opinion

SIMPSON, Judge:

The respondent determined liabilities of the petitioners as follows:

                                                                  Basis of           Taxable Year
                  Docket No.        Petitioner                    Liability             Ended        Deficiency
                -------------------------------------------------------------------------------------------------
                   4237-67    Sparks Nugget, Inc. .............   Transferee           9/30/59     $ 69,622.34
                                                                  of The Challenger
                                                                  Inc.                 9/30/60       86,211.78
                   4277-67    Sparks Development Co. ..........   Income tax
                                                                  deficiency          11/30/61        9,940.29
                   4278-67    Flora J. Graves .................   Income tax
                                                                  deficiency          12/31/59       29,083.17
                   4279-67    R. L. Graves and Flora J. Graves    Income tax
                                                                  deficiency          12/31/60      137,209.56
                   4280-67    R. L. Graves ....................   Income tax
                                                                  deficiency          12/31/59       29,083.17
                

Some of the issues in this case have been settled; those remaining for decision are:

(1) Whether The Challenger, Inc. (Challenger), can deduct, under section 162 of the Internal Revenue Code of 1954,2 the full amount of payments it made with respect to certain lots leased by it from Sparks Development Co. (Sparks Development).

(2) Whether, for purpose of determining the tax liability of R. L. and Flora J. Graves (the Graves), Challenger should be limited to $2.59 per month in rental deductions, under section 162, for payments with respect to each slot machine leased by it from The Pub, Inc., Saratoga Club, Inc., and United Waldorf, Inc.

(3) Whether the portions of the payments with respect to the lots and the slot machines which are not deductible under section 162 constitute dividends taxable to the Graves.

(4) Whether certain payments made by Sparks Development during its taxable year 1961 to Mr. Graves are deductible under section 162 as "a reasonable allowance for salaries or other compensation."

Findings of Fact

Some of the facts have been stipulated, and those facts are so found.

Sparks Nugget, Inc., is a Nevada corporation which had its principal place of business in Sparks, Nevada, at the time its petition was filed in this case. Sparks Development, also a Nevada corporation, had its principal office in Sparks, Nevada, at the time its petition was filed in this case. For its taxable year ending November 30, 1961, Sparks Development filed its Federal income tax return, using the accrual method of accounting, with the district director of internal revenue, Reno, Nevada. The Graves are husband and wife, who maintained their legal residence in Carson City, Nevada, at the time their petitions were filed in this case. They filed their 1959 individual and 1960 joint Federal income tax returns, using the cash receipts and disbursements method of accounting, with the district director of internal revenue, Reno, Nevada.

Sparks Nugget, Inc., was incorporated on September 29, 1960. Until June 26, 1961, all of the outstanding stock of the corporation was owned by John J. Ascuaga and his wife, Rose. After such date, the Ascuagas owned 98.8 percent of the outstanding stock, and the Graves owned the remaining 1.2 percent. Mr. Ascuaga has been the principal executive officer of Sparks Nugget, Inc., since its incorporation. On September 30, 1960, Sparks Nugget, Inc., purchased all of the outstanding stock of Challenger from the Graves. Thereafter, on June 30, 1961, pursuant to a plan of complete liquidation, Challenger dissolved and all of its assets were distributed in complete liquidation to Sparks Nugget, Inc. Prior to September 30, 1960, at all times relevant hereto, the Graves owned all of the outstanding stock of Challenger. During such years, Mr. Graves was the principal executive officer of Challenger. From September 30, 1960, to June 30, 1961, Mr. Ascuaga was the principal executive officer of Challenger.

Mr. Graves proposed the sale of the Challenger stock to Mr. Ascuaga. Mr. Ascuaga accepted the terms of the proposal without substantial change. The purchase price of the Challenger stock was set at $3,700,000; annual payments in respect of such price were set at the greater of $300,000 or 4.57 percent of Challenger's gross receipts. Sparks Nugget, Inc., agreed that, until the purchase price was paid in full, it would not incur yearly capital expenditures of more than $10,000, without the permission of the Graves. The purchase agreement provided that Mr. Graves would act as a consultant to Sparks Nugget, Inc., for a period of 2 years for an annual compensation of $25,000. Sparks Nugget, Inc., made the final payment in respect of the stock purchase in September 1967.

Sparks Development was incorporated on July 31, 1957. Its outstanding stock has always been wholly owned by the Graves; Mr. Graves has always been its principal executive officer.

The Pub, Inc. (Pub), Caldwell Sports Shop, Inc. (Caldwell), United Waldorf, Inc. (Waldorf), and Saratoga Club, Inc. (Saratoga), are dissolved Idaho corporations. They were organized in 1947 and at all times relevant hereto, prior to May 31, 1963, were wholly owned by the Graves. During such period, Mr. Graves was the principal executive officer of each corporation. On May 31, 1963, the Graves sold all their stock in the corporations to First National Bank of Nevada, as trustee of certain trusts established by the Graves for their children. On December 31, 1963, all of the corporations were completely dissolved and liquidated by the trustee.

I. Rental of Parking Lots

On June 17, 1959, Sparks Development leased 6½ lots located in Sparks, Nevada, to Challenger. Challenger used the lots as parking lots in connection with a gambling casino operated by it known as the Sparks Nugget Casino. Such lots are hereinafter referred to as the Parking Lots.

Practically all of the customers of the Sparks Nugget Casino travel there by car, and the availability of ample free parking has been a substantial factor contributing toward the casino's success. There is some free on-street parking available in the area of the casino, but such space is insufficient to accommodate all of the casino's patrons.

The Parking Lots had originally been acquired by Mr. Graves as follows:

                                     Purchase     Purchase        Square
                        Lot            Date         Price          Feet
                ----------------------------------------------------------
                  Blk. 2
                    S. 65' Lot 1 ..   10/20/58    $ 20,072.35      3,250
                  Blk. 2 Lot 2 ....   11/24/58      32,170.22      7,000
                  Blk. 2 Lot 3 ....    4/27/59      41,950.77      7,000
                  Blk. 4 Lot 5 ....    2/28/59      35,570.41      7,000
                  Blk. 4 Lot 6 ....    4/23/59      40,350.71      7,000
                  Blk. 4 Lot 7 ....    1/ 6/59      40,485.25      7,000
                  Blk. 4 Lot 8 ....    7/23/58      43,009.33      7,000
                                                  ___________     ______
                                                  $253,609.04     45,250
                                                  ===========     ======
                

The location of the Parking Lots is shown below on a plan of a portion of Sparks, Nevada.

On June 3, 1959, Mr. Graves transferred title to the Parking Lots to Sparks Development for cash, an assumption of liabilities, and a note, aggregating in value $253,253.05, and for additional Sparks Development common stock with a par value of $20,000.00. On June 3, 1959, immediately after acquiring title to the Parking Lots, Sparks Development borrowed $150,000 from the Nevada Bank of Commerce on two notes, each bearing 6-percent interest, one being in the amount of $115,000 secured by a first deed of trust on Lots 2 and 3 of Block 2 and Lots 5, 6, and 7 of Block 4, and the other an unsecured note for $35,000.

Mr. Graves negotiated the lease of the Parking Lots (sometimes hereinafter referred to as the Parking Lot Lease) on behalf of both Challenger and Sparks Development. Mr. Ascuaga took no part in such negotiation. Mr. Graves fixed the lease rental on the basis of the amount of income that Sparks Development would need to pay his compensation, its income taxes, and its purchase obligations on the Parking Lots. He prepared a pro forma income and expenditures statement which, together with the proposed lease, he took to the Nevada Bank of Commerce. On the basis thereof, the bank agreed to make the purchase money loans necessary for Sparks Development to acquire the Parking Lots.

The Parking Lot Lease, executed on June 17, 1959, leased the Parking Lots to Challenger for a term of 5 years commencing June 17, 1959, for the following rental: $9,400 per month for the first year of the lease term and $8,000 per month for the following 4 years of the lease term. The larger rental in the first year of the lease term was provided because of the higher loan payments required of Sparks Development during such period. Under the terms of the lease, Challenger was required to keep the premises in good repair, to pay for all utilities used on the premises, to keep the property free of any mechanics' or other liens, to hold Sparks Development harmless from any suits or claims arising out of the operation of the property, to maintain public liability insurance of not less than $100,000 for injury to one person and not less than $300,000 for injury to more than one person, and to pay all real estate...

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