Spencer v. Comm'r of Internal Revenue

• Decision Date: 09 February 1998
• Docket Number: No. 16338–95,22465–95.,16338–95
• Parties: Bill L. and Patricia M. SPENCER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Joseph T. and Sheryl S. SCHROEDER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

110 T.C. 62

110 T.C. No. 7

Bill L. and Patricia M. SPENCER, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.Joseph T. and Sheryl S. SCHROEDER, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 16338–95

22465–95.

United States Tax Court.

Feb. 9, 1998.

Oliver C. Murray, Jr., and Stephen S. Ritchey, for petitioners.

Bonnie L. Cameron, for respondent.

WELLS, Judge:

The instant cases were consolidated for purposes of trial, briefing, and opinion, and will hereinafter be referred to as the instant case. Respondent determined deficiencies in petitioners' Federal income tax, additions to tax, and accuracy-related penalties as follows:

+---------------------------------------------------------+
                ¦Bill L. and Patricia M. Spencer, docket No. 16338–95  :¦
                +---------------------------------------------------------+
                

                                                                Additions to    Penalties
                                                                Tax
                                Year            Deficiency      Sec. 6651(a)(1) Sec. 6662
                                1990            $ 696           —               $ 139
                                1991            41,396          $10,335         8,279
                                1992            32,479          —               6,496
                

Joseph T. and Sheryl S. Schroeder, docket No. 22465–95  
                

                                                                Additions to    Penalties
                                                                Tax
                                Year            Deficiency      Sec. 6651(a)(1) Sec. 6662
                                1991            $12,298         —               $2,460
                                1992            8,023           $ 1,731         1,605
                

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. After concessions ¹ by the parties, the issues to be decided are as follows:

(1) Whether, within the meaning of section 1366(d)(1)(B), certain transactions in which certain petitioners acquired assets from Spencer Services, Inc. (SSI), and subsequently conveyed such assets to Spencer Pest Control of South Carolina, Inc. (SPC–SC), and Spencer Pest Control of Florida, Inc. (SPC–FL), gave basis to the shareholders of the transferee corporations;

(2) whether, within the meaning of section 1366(d)(1), petitioner Bill L. Spencer (Mr. Spencer) had basis in SPC–SC as a result of a bank loan made directly to SPC–SC and guaranteed by him; and (3) whether amortization allowable to SPC–SC and SPC–FL for taxable years after 1990 should be computed based on (1) the corrected amortizable basis of the property, without regard to previously allowed amortization deductions, as petitioners contend, or (2) the corrected amortizable basis, as reduced by previously allowed amortization deductions, as respondent contends.

FINDINGS OF FACT

Some of the facts have been stipulated for trial pursuant to Rule 91. The parties' stipulations of fact are incorporated herein by reference and are found as facts in the instant case.

Petitioners Bill L. and Patricia M. Spencer (collectively, the Spencers), husband and wife, resided in Roswell, Georgia, at the time they filed their petition in the instant case. Petitioners Joseph T. and Sheryl S. Schroeder (collectively, the Schroeders), husband and wife, resided in Melbourne Beach, Florida, at the time they filed their petition in the instant case. Sheryl Schroeder is the daughter of the Spencers.

Background

Mr. Spencer graduated from Ohio University during 1966 with a major in accounting and minors in finance and taxation. While living in Columbus, Ohio, he worked as a cost accountant for several companies. During 1966, he moved to Miami, Florida, where he worked as an accountant for an accounting firm, doing primarily audit work and tax return preparation. By 1968, Mr. Spencer began working as the comptroller for a real estate firm known as the Alan Morris Co. (Alan Morris), where he later became the treasurer and chief financial officer. During 1971, while at Alan Morris, Mr. Spencer became involved in the acquisition and sale of pest control companies.

Mr. Spencer remained with Alan Morris until 1979 when he organized SSI. Since SSI's inception, Mr. Spencer has been employed with SSI which was a C corporation. Mr. Spencer was SSI's majority shareholder, owning 87 percent, ² at all times relevant to the transactions in the instant case.

SPC–SC Transaction

During 1987, SSI nominally sold its South Carolina operations to Mr. Spencer and one of SSI's top managers, Toney Boozer (Mr. Boozer), in exchange for $1,170,000. Shortly thereafter, Mr. Spencer and Mr. Boozer nominally conveyed those same assets to a newly organized S corporation, SPC–SC, in exchange for $1,170,000. Mr. Spencer caused SSI to sell its South Carolina assets and operations in an effort to consolidate operations and improve managerial efficiency. The foregoing transactions (collectively, the SPC–SC transaction) are described in detail below.

Carolina Transaction

On May 21, 1987, prior to the organization of SPC–SC, Mr. Spencer and Mr. Boozer entered into an agreement (the Carolina Purchase Agreement) to purchase, as of June 1, 1987, certain assets of SSI, Efird's Pest Control Co. of Charleston, Inc., Efird's Exterminating Co., Inc., of South Carolina, and Efird's Pest Control Co. of Greenville, Inc. (collectively referred to as SSI), in exchange for $1,170,000 (sometimes referred to herein as the Carolina transaction).³ The SSI entities engaged in the pest control business in and around Summerville, Spartanburg, and Greenville, South Carolina. With the exception of the South Carolina National Bank (SCNB) loan documents, discussed infra, Mr. Spencer drafted all of the documents relating to the Carolina transaction.

Pursuant to the Carolina Purchase Agreement, Mr. Spencer and Mr. Boozer assumed liabilities in the amount of $54,625.78, and acquired (1) tangible assets in the amount of $70,768.81, and (2) intangible assets in the amount of $1,153,856.97.⁴ The intangible assets acquired included (1) all of SSI's right, title, and interest in its pest control, lawn care, termite treatment, renewal bond accounts, and contract rights, as well as (2) the sole and exclusive right to use the names “Efird's” and/or “Spencer Pest Control”, trademarks, service marks, and patents. The Carolina Purchase agreement also included the following clause:

Seller agrees and acknowledges that Purchaser intends to transfer the assets purchased and liabilities assumed hereby into a new South Carolina corporation to be formed by Purchaser entitled “Spencer Pest Control Co. of S.C., Inc.” and Purchaser agrees to pledge, and Seller agrees to accept, their capital stock in the new company as partial security for their Promissory Note given to seller, as described above.

Additionally, SSI and SPC–SC had a verbal agreement pursuant to which SSI was to continue to do the accounting for SPC–SC in exchange for a fee of $600 per office, per month. They also agreed, verbally, that SPC–SC would pay SSI a consulting fee equal to the amount paid to the highest paid officer of SPC–SC.

a. Bank Loan

Payment for the acquired assets consisted of $270,000 cash and a $900,000 promissory note issued by Mr. Spencer and Mr. Boozer. On June 3, 1987, SPC–SC borrowed $250,000 of the $270,000 paid in cash from SCNB. The loan (hereinafter referred to as the bank loan) was to be repaid in 36 monthly installments of $6,994.44, including principal and interest.⁵ The first payment on the bank loan was due on July 1, 1987, and the final payment was due on June 1, 1990.

SPC–SC's assets (i.e., the assets acquired in the Carolina transaction) served as security for the bank loan. Additional security included a pledge by Mr. Spencer and Mr. Boozer of their SPC–SC stock and certain real estate ⁶ as well as the assignment of certain life insurance policies ⁷ on their lives.

Mr. Spencer and Mr. Boozer jointly and severally guaranteed the bank loan. SCNB initially agreed to make the bank loan directly to Mr. Spencer and Mr. Boozer in their individual capacities. However, upon learning that they intended to resell the acquired assets to SPC–SC, SCNB decided (1) to make the loan directly to SPC–SC, and (2) to require personal guaranties by Mr. Spencer and Mr. Boozer. Additionally, SCNB required that SPC–SC pay the bank loan proceeds directly to SSI.

b. S/B Note

At closing, Mr. Spencer and Mr. Boozer paid $270,000 in cash and issued a $900,000 promissory note (the S/B note), dated June 3, 1987, to SSI as payment for the assets acquired in the Carolina transaction. Mr. Spencer and Mr. Boozer agreed to pay SSI $900,000 with interest, from June 1, 1987, at a rate of 10 percent per year in 120 equal monthly payments. As was the case with the bank loan, Mr. Spencer and Mr. Boozer were jointly and severally liable on the S/B note.

The S/B note was fully subordinated to the $250,000 bank loan, and payments were to commence on the first day of the month following satisfaction of the bank loan.⁸ The S/B note was secured by (1) a first security interest in the acquired assets, subject only to the bank loan, and (2) by an assignment of all of the issued and outstanding common stock of SPC–SC, also subordinate to the bank loan. Finally, the S/B note contained the following acceleration clause:

AND maker hereby agrees that if at any time any portion of said principal or interest shall be past due and unpaid, the whole amount evidenced by this note shall, at the option of the holder thereof, become immediately due, and said holder shall have the right to institute any proceedings upon this note and any collaterals given to secure the same, for the purpose of collecting said principal and interest, with costs and expenses, or of protecting any security connected herewith.

Organization of SPC–SC

SPC–SC was incorporated on June 1, 1987. The total capital investment in SPC–SC was $1,000,...