Stahl v. Commissioner, Docket No. 74890
| Decision Date | 29 July 1963 |
| Docket Number | Docket No. 74890,79580-79585. |
| Citation | 1963 TC Memo 201,22 TCM (CCH) 996 |
| Parties | Oscar C. Stahl and Sylvia Stahl, et al. v. Commissioner. |
| Court | U.S. Tax Court |
George T. Altman, 233 South Beverly Drive, Beverly Hills, Calif., for the petitioners. Douglas W. Argue and Paul G. Wilson, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in the individual income tax of petitioners Oscar and Sylvia Stahl (hereinafter referred to as Oscar and Sylvia) in Docket Nos. 74890 and 79580, as follows:
Docket
No. Year Amount
74890 1954 .......... $ 42,783.84
79580 1955 .......... 11,722.65
1956 .......... 228,535.15
These deficiencies were based primarily on the only issue remaining in these dockets, being whether the amounts reported by Oscar and Sylvia on their joint tax returns for 1954 and 1956 as installment receipts from the sale of their stock in American Extruded Products Co., are taxable as ordinary income or, to the extent of gain, as long-term capital gain.
Respondent also determined a deficiency in the income and excess profits taxes of American Extruded Products Co., a corporation engaged in the manufacture and sale of plastic garden hose, as follows:
Income
Taxable year ending tax Excess profits tax
Feb. 28, 1953 ....... $74,100.44 $30,456.94
Feb. 28, 1954 ....... 30,041.39 871.40
July 31, 1954 ....... 69,345.78
July 31, 1955 ....... 13,158.53
July 31, 1956 ....... 15,886.81
The only issue remaining in connection with this determination is whether the amounts accrued by the corporation on its tax returns for the above taxable years as rents and royalties payable to the University Hill Foundation were proper deductions.
Respondent also determined that petitioners are liable as transferees of American Extruded Products Co. for the above deficiencies of the corporation to the extent set forth below:
Extent of
Docket Petitioner transferee
No. liability
79581 Oscar C. Stahl and Sylvia
Stahl .................. $233,861.29
79582 Irving Weisbart .......... 13,050.00
79583 Richard L. Walker ........ 600.00
79584 E. R. Schochet ........... 11,550.00
79585 Mildred J. Spencer ....... 1,200.00
All other issues have been agreed upon or conceded by the parties.
Oscar and Sylvia were, during the years 1954, 1955, and 1956, husband and wife, residing in Los Angeles, California. They filed joint income tax returns for those years with the district director of internal revenue at Los Angeles, California.
American Extruded Products Co. (hereafter referred to as American) was incorporated under the laws of California on February 21, 1946, and was dissolved on March 9, 1950. It began business by transfer to it, as of February 28, 1946, of an unincorporated business having book net assets of $37,122.03. The said net assets plus $77.97 in cash were transferred to it by Oscar and Sylvia for 372 shares of the corporation's stock having a par value of $37,200. The corporation thereafter, in May 1947, issued a stock dividend of 744 shares, making a total of 1,116 issued shares, all of which were owned by Oscar and Sylvia at the time of the sale herein mentioned. American's principal product, about 80 percent of its total production, was plastic garden hose. The corporation produced about 15 grades of this product. In 1949 American made a change in its manufacturing process. Under a new and secret process it used a plastisol resin for covering the core of its hose.
During the years 1946, 1947, and 1948, American's products were sold primarily on the Pacific coast; the majority of its buyers being hardware firms, hardware jobbers, and department stores. In August 1949, however, it received an order in the amount of $479,520 for its garden hose from Sears, Roebuck and Co. (hereafter referred to as Sears) for distribution on a national basis. Shipments on the order began in January 1950 and by the end of February 1950 approximately 40 percent of the order had been shipped and billed.
In or about October 1949 American received from Montgomery Ward and Company a letter of intent to buy garden hose, also for distribution on a national basis. This letter was not a binding order but merely a letter indicating approximately how much it might buy.
Prior to the end of American's fiscal year ending February 28, 1950, Oscar, who was American's president and general operating officer, anticipated approximately a 40-percent increase in American's sales for the next fiscal year. Prior to the end of February 1950 Oscar estimated American's earnings before taxes for the fiscal year ending February 28, 1951, would be approximately $200,000 to $225,000.
In January or February 1950 a suggestion for a sale of American was received from R. A. Rowan and Company, real estate agents. For this purpose the Rowan firm brought Oscar together with Father Lorenzo M. Malone and Paul Coté (hereafter referred to as Malone and Coté, respectively) of the Loyola University Foundation, later known as University Hill Foundation (hereafter referred to as Foundation). Coté was president of Foundation and one of its directors. Malone was a director of Foundation.
Oscar first discussed the possibility of selling American with Coté and Malone at their office and then they visited American's plant and generally examined the company. In the course of their examination they looked at American's sales orders and learned of the Sears order and Montgomery Ward letter of intent. Oscar provided them with several of American's audits. American's prospective earnings were discussed and Oscar indicated his estimate to be $200,000 a year before taxes. Malone expressed the view that this was an underestimation.
Oscar first asked a price of $1 million for the business, but a figure of $800,000 was ultimately agreed upon with an additional $20,000 added to cover the commission that Oscar agreed to pay the R. A. Rowan Company.
The day after Oscar committed himself to a sale of American to Foundation a representative of Brandeis University, a tax-exempt organization, offered to purchase American from him on the same terms offered by Foundation.
An agreement (hereafter referred to as the purchase agreement) for the purchase of American by Foundation was authorized by Foundation's directors and executed by the parties on February 28, 1950. Coté drafted the agreement. In the course of their negotiations Malone estimated an 8-year period for payment of the purchase price to Oscar and Sylvia under the terms of this agreement.
The purchase agreement provided that as of February 28, 1950, Oscar and Sylvia had sold all the outstanding stock of American to Foundation for $820,000 (hereinafter referred to as the purchase price), $1,000 of the purchase price having been paid concurrently with the execution of the purchase agreement. The remainder purchase price was to be paid in the following manner:
(a) Foundation would immediately liquidate and dissolve American and distribute all the assets to itself. Foundation would assume and pay, or agree to pay, out of the assets received all of the existing obligations of American.
(b) Foundation would execute a lease, sublease, and licensing agreement to Sokol, Inc., a corporation, to operate the business formerly conducted by American and to use its fixed and operating assets and goodwill.
(c) Those current assets not used by Foundation to pay American's obligations were to be sold to Sokol, Inc. Payment was to be in the form of a promissory note requiring Sokol, Inc., to pay the full amount of its net income after taxes to liquidate it. Any payments on the note, after all obligations and liabilities of American assumed by Foundation had been discharged, were to be paid over to Oscar and Sylvia and applied against the purchase price.
(d) The lease and sublease to Sokol, Inc., or any other subsequent lessee or sublessee, was to provide for payment to Foundation of 80 percent of the net profits derived from the operation of the lessee-company before depreciation, and before income, franchise, or other similar taxes, until $900,000 had been paid to Foundation.
(e) Foundation was to pay to Oscar and Sylvia 90 percent of all rental and royalty received until the total purchase price of the stock was paid. The agreement provided that Foundation was obligated to make payment of the purchase price only out of rentals and royalties received from Sokol, Inc., or any other lessee or sublessee, or out of the proceeds of the sale of American's assets.
The purchase agreement provided that Foundation would deliver, and it did in fact deliver, the following collateral to Oscar and Sylvia as security for the purchase price:
(1) A chattel mortgage covering any and all personal property acquired by Foundation upon liquidation of American.
(2) Assignment of any note executed by Sokol, Inc., as evidence of the purchase price of current assets transferred from Foundation to Sokol, Inc.
(3) Assignment of the lease and sublease from Foundation to Sokol, Inc., and any subsequent lessee or sublessee.
(4) Chattel mortgage covering any and all personal property thereafter acquired by Foundation as a result of the sale transaction or the provisions of the lease or sublease to Sokol, Inc., or any other lessee or sublessee.
The purchase agreement provided that in the event Foundation did not pay at least $25,000 of the purchase price in any annual accounting period Oscar and Sylvia could, at their option, declare the remaining balance of the purchase price due and...
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