Thompson v. Commissioner, Docket No. 8307-75

CourtUnited States Tax Court
Writing for the CourtPARKER
Citation1983 TC Memo 81,45 TCM (CCH) 693
PartiesDeWitt C. Thompson, III and Diana R. Thompson v. Commissioner. Thompson & Green Machinery Co., Inc. v. Commissioner.
Docket Number5125-80.,4325-76,4326-76,8314-75,Docket No. 8307-75
Decision Date08 February 1983

45 TCM (CCH) 693
1983 TC Memo 81

T.C. Memo. 1983-81.

DeWitt C. Thompson, III and Diana R. Thompson

Thompson & Green Machinery Co., Inc.

Docket Nos. 8307-75, 8314-75, 4325-76, 4326-76, 5125-80.

United States Tax Court.

Filed February 8, 1983.

45 TCM (CCH) 694

Ervin M. Entrekin and Mark H. Westlake, 26th Fl., First American Center, Nashville, Tenn., for the petitioners. Charles W. Kite, for the respondent.

Memorandum Findings of Fact and Opinion

PARKER, Judge:

Respondent determined deficiencies in petitioners' Federal income taxes as follows:

 DeWitt C. Thompson, III and
                 Diana R. Thompson
                 Docket No. Year Deficiency
                 8307-75 ...... 1971 $29,810.29
                 4326-76 ...... 1972 12,268.18
                 4326-76 ...... 1973 18,826.36
                 Thompson & Green Machinery Co., Inc.
                 Docket No. Year Deficiency
                 8314-75 ..... 1971 $272,255.93
                 4325-76 ..... 1973 61,938.63
                 5125-80 ..... 1976 392,830.88

After concessions by both parties,1 the following issues remain for our decision:

1. Whether a debt, charged off to petitioner Thompson & Green Machinery Co., Inc.'s bad debt reserve in 1971 and used in determining the addition to its bad debt reserve for that year under the "Black Motor" formula, was wholly or partially worthless in 1971, and whether respondent abused his discretion in redetermining the allowable addition to petitioner's bad debt reserve for that year;

2. Whether petitioner Thompson & Green Machinery Co., Inc.'s addition to its bad debt reserve in 1976 was reasonable and whether respondent abused his discretion in redetermining the allowable addition to the bad debt reserve for that year;

45 TCM (CCH) 695

3. Whether interest income received by petitioner Thompson & Green Machinery Co., Inc., from political subdivisions of the State of Tennessee was excludable as exempt interest income under section 103;2 and

4. Whether petitioner Thompson & Green Machinery Co., Inc., is entitled to deductions for the payment of certain travel and entertainment expenses under sections 162 and 274, and, if the deductions are not allowable, whether certain of those payments constitute constructive dividends to the principal shareholder, petitioner DeWitt C. Thompson, III.

Findings of Fact

Some of the facts have been stipulated and are so found. The stipulation of facts, supplemental stipulation of facts, and exhibits attached thereto are incorporated herein by this reference.

Petitioner Thompson & Green Machinery Co., Inc. ("Thompson & Green") is a Tennessee corporation having its principal place of business in Lavergne, Tennessee. The company is a dealer in heavy construction equipment. For the calendar year 1971, Thompson & Green filed its Federal corporate income tax return with the Director, Southeast Service Center, Chamblee, Georgia. For the calendar years 1973 and 1976, Thompson & Green filed its Federal corporate income tax returns with the Internal Revenue Service Center at Memphis, Tennessee.

Petitioners DeWitt C. Thompson, III and Diana R. Thompson resided in Nashville, Tennessee, during the taxable years involved and when they filed their petitions in this case. For the calendar years 1971, 1972, and 1973, they filed joint Federal income tax returns with the Internal Revenue Service Center at Memphis, Tennessee. Diana R. Thompson is a party to these proceedings solely because she filed joint Federal income tax returns with her husband. Accordingly, references to an individual petitioner or to "Thompson" will refer solely to DeWitt C. Thompson, III. Thompson is the principal shareholder of Thompson & Green.

I. Bad Debt Deductions

A. 1971

As of 1970, Thompson & Green had entered into various equipment leases with James T. Gregory, Inc. ("Gregory"). Gregory was in the business of highway construction and was bonded on its highway projects by United States Fidelity and Guaranty Company ("USF&G"). Late in 1970 Gregory suffered severe cash shortages and was unable to meet its obligations under the highway construction contracts. As a result, USF&G took possession and control of Gregory's business in early 1971. USF&G, under its bond, completed Gregory's highway contracts by hiring other contractors to complete the work. USF&G terminated all of Gregory's employees except Gregory's office manager, James Gardner, and his secretary, whom USF&G hired temporarily to help administer the claims against Gregory. Both were terminated by USF&G in May of 1971. USF&G paid all claims made against it as surety on account of Gregory's highway construction contracts, except those of Thompson & Green.

After USF&G took over Gregory, Gregory no longer had employees or assets except those in the possession of USF&G, and Gregory has not since acquired assets or resumed business operations. Gregory's corporate charter was revoked November 19, 1971, for nonpayment of franchise taxes.

By 1971, Thompson & Green believed that recovering its debt from Gregory was unlikely and that the best hope of collecting was through the surety. At that point the surety had paid all claimants except Thompson & Green, and the principal owner of the Gregory company, apparently motivated by personal animosity, was refusing to cooperate and was trying to keep USF&G from paying Thompson & Green. Thompson & Green finally filed suit in early 1971 against the surety, USF&G, and against Gregory for unpaid equipment rentals and parts, services, and repairs. Gregory asserted a counterclaim against Thompson & Green, alleging that the agreements were not leases but conditional sales contracts and that it had an equity interest in the equipment that Thompson & Green had repossessed from it. In the retainer agreement for the USF&G litigation, Thompson & Green agreed to pay its attorneys a minimum of $10,000, and 30 percent of the total recovery (minus the $10,000 minimum). Under Tennessee law, claimants cannot recover attorneys' fees from the surety and Thompson & Green understood this when they filed suit in 1971.

45 TCM (CCH) 696

On December 31, 1971, Thompson & Green's accounts receivable shown on its Federal income tax return included $416,276.15 due from Gregory. One receivable was a "machine account" for $405,704.12. The other was a "parts and service account" for $10,572.03. At the end of 1971, Thompson & Green charged its receivables from Gregory to its bad debt reserve account as worthless, and its computation of its addition to the bad debt reserve and hence the bad debt deduction claimed on its 1971 return were based largely upon this charge-off of the Gregory debt.3

In 1971, Thompson & Green used the "Black Motor" formula for computing its deduction for an addition to its bad debt reserve.4 Thompson & Green's year-end accounts receivable, bad debts charged to the reserve, and bad debt recoveries for 1971 and for the five prior years were as follows:

                 With Gregory Debt
                 Balance of A/R Bad debts Bad debts
                 Year at end of year charged off recovered
                 1966 ............. $ 1,590,985.27 $ 9,073.29 $ 44,216.00
                 1967 ............. 1,370,049.53 13,495.69 46,664.76
                 1968 ............. 2,979,449.88 16,151.14 30,816.70
                 1969 ............. 3,174,649.57 28,318.92 21,249.14
                 1970 ............. 3,386,179.26 8,069.04 5,626.78
                 1971 ............. 3,616,895.92 460,905.99 2,235.09
                 ______________ ___________ ___________
                 6-yr. Total ...... $16,118,209.43 $536,014.07 $150,808.47
                 6-yr. Average .... $ 2,686,368.24 $ 89,335.68 $ 25,134.75

Of the $460,905.99 that petitioner charged off in 1971, the amount of $405,704.12 represented the disputed Gregory debt. Without the Gregory debt, the bad debts charged off in 1971 would amount to only $55,201.87, which would mean that the total of all debts charged off over the six-year period would be less than the total of bad debts recovered over the same period.5 In his notice of deficiency, respondent determined that the disputed Gregory debt was not worthless in 1971 and accordingly redetermined Thompson & Green's addition to its bad debt reserve and hence its bad debt deduction to reflect that determination.6

45 TCM (CCH) 697

On September 14, 1973, Chancellor Drowota of the Chancery Court at Nashville, Tennessee, determined that USF&G was liable on its bond to Thompson & Green for Gregory's unpaid machine rentals and that Gregory was liable for both unpaid machine rentals and for services, parts, and repairs rendered during the terms of the leases. He also determined that Gregory had no equity in the machines and thus dismissed Gregory's counterclaim against Thompson & Green. The Chancellor then referred the case to a Master to determine damages, i.e. the amount of Thompson & Green's provable claims for the various items. The Chancellor noted that it was still incumbent on Thompson & Green to prove, as in any ordinary action for debt, the existence and amount of the debt sued on. After the Special Master issued his report on May 28, 1974, Thompson & Green, Gregory, and USF&G, each through its attorneys, took various exceptions to that report. The Chancellor subsequently modified the Master's report in certain respects. Pursuant to the Special Master's report, as modified, the Chancellor on April 4, 1975, entered judgment for Thompson & Green against USF&G in the sum of $273,753.84 for unpaid machine rentals and against James T. Gregory, Inc., in the sum of $403,482.23, plus interest at the legal rate from November 20, 1973, until paid, for the unpaid machine rentals and in the sum of $9,884.29, plus interest from April 8, 1971, for unpaid parts and repair services. USF&G's petition for rehearing and motion for a new trial were apparently denied. USF&G then appealed. Only the surety, USF&G, appealed the Chancellor's decree. On August 6, 1976, the Court of Appeals for the Western Section of Tennessee (sitting at Nashville) reduced the judgment against USF&G...

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