Thompson v. Commissioner

• Decision Date: 20 July 1964
• Docket Number: Docket No. 3598-62.
• Parties: James G. Thompson v. Commissioner.
• Court: U.S. Tax Court

23 T.C.M. (CCH) 1193 (1964)

T.C. Memo. 1964-198.

James G. Thompson v. Commissioner.

Docket No. 3598-62.

United States Tax Court.

Filed July 20, 1964.

Carl A. Stutsman, Jr., 411 W. 5th St., Los Angeles, Calif, and Jack R. White, for the petitioner. Thomas F. Greaves, for the respondent.

Memorandum Findings of Fact and Opinion

FAY, Judge:

The Commissioner determined deficiencies in petitioner's income tax, as follows:

                  Taxable Year    Amount
                  1956................    $28,480.01
                  1957................     21,444.79
                  1958................     41,640.75
                  1959................     25,597.95
                  1960................     23,286.57
                

The parties have agreed to certain adjustments with respect to the deficiencies.

The remaining issues for decision are: (1) Whether the sum of $200,000 payable to petitioner by virtue of a certain agreement executed in March 1956 constitutes ordinary income or long-term capital gain; (2) whether, in the year 1960, petitioner received additional interest income in the amount of $7,767.87; (3) whether petitioner, in the year 1958, suffered a "theft" loss in the amount of $23,000; and (4) whether petitioner is entitled to claim business deductions for entertainment, yachting, and travel in the year 1956.

Findings of Fact

Some of the facts have been stipulated, and the stipulations of facts, together with the exhibits attached thereto, are incorporated herein by this reference.

Petitioner resided in Huntington Park, California, during the years involved herein. He filed his individual income tax returns computed on a cash basis for the taxable years involved with the district director of internal revenue at Los Angeles, California.

Tapered Air Products Corp. (hereinafter referred to as Tapered) was a corporation organized under the laws of the State of California. Tapered was organized for the purpose of engaging in the business of milling aluminum sheets into aircraft wings with machinery and equipment designed by petitioner. The stock of Tapered was owned 70 percent by petitioner, 15 percent by Gust Fotis (hereinafter referred to as Fotis), and 15 percent by Victor Kaytis (hereinafter referred to as Kaytis).

Aero Tool Sales Corporation (hereinafter referred to as Aero) was a corporation organized under the laws of the State of California. It was organized for the purpose of owning and renting to Tapered the machinery and equipment used to manufacture aircraft wings. All of the stock of Aero was owned by petitioner.

Avi-Air, Inc., (hereinafter referred to as Avi-Air) was a corporation organized under the laws of the State of California. The controlling stockholders of Avi-Air for all purposes material hereto were Lloyd L. Hill (hereinafter referred to as Hill) and Oliver M. Bell (hereinafter referred to as Bell). Petitioner is not in any way related to Hill or Bell.

On October 7, 1955, petitioner entered into a written agreement with Avi-Air, Hill, and Bell for the sale by petitioner to Avi-Air of all the stock owned by petitioner in Tapered and all of the stock of Aero. The total purchase price was $1,150,000, payable $70,000 currently with the execution of the contract and the balance, $1,080,000, to be paid over a period of eight years. A promissory note bearing 4½ percent interest and secured by a chattel mortgage on the equipment owned by Tapered and Aero as well as a pledge of the stock of the two corporations was executed by Avi-Air.

The agreement provided, in part, as follows:

In connection herewith, it is recognized by and between the parties that underlying the capital stock purchased hereby are certain machines and equipment of advanced and specialized design and it is agreed by and between the parties that the fair market value of said machinery and equipment of Tapered Air Products Corp. and Aero Tool Sales Corporation is $1,150,000.00 and the net working capital is approximately $150,000.00. The parties further agree that in view of the fact that the companies are wholly engaged in defense industries and the contracts are awarded on a competitive bid basis no goodwill exists or was contemplated in the valuation and sale of the stock hereby.

The sales agreement did not contain a provision prohibiting petitioner from competing with Avi-Air. However, the employment agreement, infra, did contain such a clause. In addition to said agreement for the sale of stock and as part of the same transaction, petitioner and Avi-Air entered into numerous other agreements and contracts dated October 7, 1955. One such contract was an employment contract whereby petitioner was to be employed by Avi-Air. It was Avi-Air's idea to obtain the services of petitioner. The equipment and machinery of Tapered and Aero had been designed by him. He had selected and trained the employees of Tapered. It was felt by Avi-Air that the services of petitioner would be necessary for a transitional period. The pertinent parts of the employment contract are as follows:

I

The EMPLOYER does hereby hire and employ THOMPSON to be a Consulting Engineer and to perform all the duties incident to such position for a period of eight (8) years from and after October 1, 1955, at an annual compensation of not less than Eighteen Thousand Dollars ($18,000.00) per annum, such compensation to be payable in monthly or other convenient installments as agreed upon from time to time between THOMPSON and the EMPLOYER.

II

THOMPSON does hereby agree to perform faithfully all of the duties incident to the position of Consulting Engineer, and to devote reasonably his time, attention and abilities thereto. THOMPSON shall not engage, during the term of this contract in any other business or line of work, whether as proprietor or employee, which shall be competitive with the lines of business carried on by EMPLOYER, without the prior written consent of EMPLOYER being first had and obtained.

III

This contract may be terminated by the EMPLOYER only for cause, which shall mean continued intoxication while in the course of employment, moral turpitude achieving such publicity as to reflect adversely upon the EMPLOYER or its business, or breach of the provisions just hereinabove contained. If this contract shall be terminated by the EMPLOYER other than for cause, THOMPSON shall be entitled to the compensation agreed upon during the remaining term of the agreement and shall not be required to mitigate damages by seeking other employment.

This contract was amended so that the rendering by petitioner of his services six days a month would constitute full performance of his obligations.

The following collateral agreement was also executed on October 7, 1955:

COLLATERAL AGREEMENT

THIS AGREEMENT made this 7 day of October, 1955, by and between JAMES G. THOMPSON, an individual, of Los Angeles, California, hereinafter called "THOMPSON", and AVI-AIR, INC., a corporation organized and existing under the laws of the State of California, hereinafter called "AVI-AIR".

WITNESSETH

WHEREAS, the parties hereto are concurrently entering into an agreement for the sale of all of the capital stock owned by Thompson in Tapered Air Products Corp. and Aero Tool Sales Corporation to Avi-Air, and

WHEREAS, the Federal and State Governments have not made an audit of the income tax returns of Tapered Air Products Corp. and Aero Tool Sales Corporation for the fiscal years ended July 31, 1955, and prior thereto, and

WHEREAS, the Federal Government has not completed its audit in connection with the renegotiable contracts or work performed by Tapered Air Products Corp.

IT IS THEREFORE AGREED:

1. That certain agreement for the sale of Thompson's stock in Tapered Air Products Corp. and Aero Tool Sales Corporation to Avi-Air is incorporated herein and made a part hereof as though set forth at length.

2. Any Federal Corporate income taxes and/or State Corporate franchise taxes due with interest and penalties that may be found to be due for the fiscal years ending July 31, 1955, and prior thereto of Aero Tool Sales Corporation and Tapered Air Products Corp. shall be borne 90% by Thompson and 10% by Avi-Air.

3. Any net refunds (after taking into consideration tax benefits) due to the Federal Government on renegotiable contracts shall be borne 90% by Thompson and 10% by Avi-Air.

4. It is expressly agreed, however, that any deficiency that shall be owed by Thompson by reason of paragraphs 2 and 3 above shall be paid and deducted by Avi-Air out of the interest payments due to Thompson on that ceratin promissory note being executed concurrently herewith in the amount of $1,080,000.00. Thompson's total liability for any tax deficiency interest and penalties and renegotiation refunds shall be limited to the amount of any interest received or receivable by him under said promissory note.

5. To secure the payment by Thompson of his share of any tax deficiency or renegotiation refund, Avi-Air is authorized and directed to make all interest payments due Thompson to the account of Kindel & Anderson, Attorneys at Law, who will, in turn, impound said interest payments in their trust account.

6. In connection with such funds impounded, it is hereby agreed that Thompson shall have the right to invest such funds in U. S. Government Bonds, Federal Savings and Loan Associations and National Savings Banks.

IN WITNESS WHEREOF, the parties hereto have hereunto signed this Agreement.

/s/ JAMES G. THOMPSON AVI-AIR, INC., a California corporation By: /s/ O. M. Bell, Pres. By: /s/ L. L. Hill, Sec.

Also on October 7, 1955, the following collateral agreement was executed:

COLLATERAL AGREEMENT

THIS AGREEMENT made the 7 day of October, 1955, between JAMES G. THOMPSON, an individual of Los Angeles, California, hereinafter called "Thompson", and AVI-AIR, INC., a Corporation organized and existing under the laws of the State of California, hereinafter called "Avi-Air".

WITNESSETH:

WHEREAS, concurrently herewith Thompson in entering into an agreement for the sale of his stock interest in Tapered

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