UNITED TITLE INSURANCE CO. v. Commissioner
| Decision Date | 04 February 1988 |
| Docket Number | Docket No. 10408-83. |
| Citation | 55 TCM (CCH) 34,1988 TC Memo 38 |
| Parties | United Title Insurance Co. v. Commissioner. |
| Court | U.S. Tax Court |
W. Gerald Thornton and David D. Dahl, 801 Wachovia Bank Bldg., Raleigh, N.C., for the petitioner. Frank E. McDaniel and Alan I. Weinberg, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioner's Federal corporate income taxes and section 6653(a)1 negligence additions thereto as follows:
Section 6653(a)
Year Deficiency Addition
1977 $13,738 $ 687
1978 42,275 2,114
1979 32,529 1,626
After concessions,2 the issues for decision are:
(1) Whether petitioner's expenses for three out-of-state trips for board of directors meetings and a fourth trip for a planning conference are ordinary and necessary business expenses within the meaning of section 162;
(2) If so, whether petitioner has satisfied the requirements of section 274 for the trips;
(3) Whether petitioner has satisfied the requirements of section 274 for activities related to an in-state board meeting;
(4) Whether petitioner can deduct certain amounts paid to its majority shareholder as legal and investment counseling fees; and
(5) Whether petitioner is liable for the section 6653(a) negligence additions.
Some of the facts have been stipulated and are so found. The stipulation of facts, the first supplemental stipulation of facts, and the exhibits attached thereto are incorporated herein by this reference.
Petitioner is a North Carolina corporation with its principal place of business in Raleigh, North Carolina. Petitioner filed its Federal corporate income tax returns (Forms 1120) for the years in issue with the Internal Revenue Service Center in Memphis, Tennessee.
Petitioner was incorporated on January 30, 1975. Since its incorporation, petitioner has maintained only one corporate office, which at all times pertinent hereto has been in Raleigh, North Carolina. Petitioner is a real estate title insurance company doing business solely within the State of North Carolina, and principally in the eastern part of North Carolina.
In most North Carolina real estate transactions (residential and commercial) where the purchaser finances the acquisition, the lender requires the purchaser to obtain real estate title insurance. A title insurance company cannot insure a title until an attorney licensed to practice law in North Carolina has examined the public records and rendered an opinion3 on the title. See N.C. Gen. Stat. sec. 58-132(a) (1982). The opinion may not be rendered by an employee of the title insurance company. See N.C. Gen. Stat. sec. 58-132(a) (1982). Thus, in the ordinary course of a real estate transaction, an attorney is designated to examine the public records and render an opinion on the title.
In a residential transaction, the lender, after approving the loan, sends closing instructions to a real estate attorney. In such instructions the lender usually designates the title insurance company to which the attorney is to deliver the title opinion so that insurance may be obtained. The lender often designates a title insurance company with which it is affiliated. The lender's choice may also be influenced by the realtor or by the developer. If the attorney prefers to use a different title insurance company, he can request the lender's permission to do so, but such a request is seldom made. In other instances, the attorney is free to send his title opinion to the title insurance company of his choice. The purchaser of a residential property generally plays no role in deciding which title insurance company will issue the policy.
In a commercial transaction, the attorney usually picks the title insurance company. An attorney chooses a particular title insurance company because of the company's expertise, the quality of service provided, and the attorney's relationship with the company — in other words the company with which the attorney likes doing business.
When a title insurance company receives an application for insurance and the accompanying title opinion, it reviews the opinion to assess insurability against adverse claims. Claims can arise from information in the title opinion or from patent or latent defects in the title. A title insurance policy insures the ownership of the property subject to the specific exceptions enumerated in the policy and also subject to the standard exclusions that are the boilerplate language of the policy.4 In determining whether to insure a title and whether any exceptions should be inserted in the policy, the title insurance company relies upon the title opinion. The opinion reflects the attorney's search of the public records regarding the ownership of and encumbrances on the property. A title insurance company has no control over how the attorney conducts his search of the public records or whether the attorney has someone else, such as a paralegal, actually perform the search. A title insurance company cannot afford to double-check the attorney's opinion by searching the records itself. Thus, in making their underwriting decisions, title insurance companies are almost wholly dependent upon the attorneys from whom they accept title opinions.
Because of their dependence on attorneys, most North Carolina title insurance companies maintain an "approved attorneys list," a list of attorneys from whom the company will accept insurance applications and accompanying title opinions. Before placing an attorney on their approved attorneys list, some companies require the attorney to fill out an application form giving information about the attorney's background and experience. The companies usually try to verify the information by contacting other companies for which the attorney claims to be approved and attorneys listed as references. Some title insurance companies rely primarily on information from other attorneys. When title insurance companies solicit business from an attorney, they also solicit the names of other attorneys who do real estate work. When such a company receives an insurance application from an attorney not on its approved attorneys list, the company checks with other attorneys about the applying attorney's reputation. Some companies are liberal with their approved attorneys list; other companies are more restrictive. Petitioner is quite restrictive and selective in placing an attorney on its approved attorneys list.
The North Carolina real estate title insurance business is highly competitive. Each title insurance company vies for the referral of business primarily from real estate attorneys, but also from lenders, realtors, and developers. The market is particularly competitive because all title insurance companies are selling essentially the same product — standard American Land Title Association title insurance policies. In addition, their rate structures are essentially identical. The only way a title insurance company can effectively differentiate its product is by demonstrating the company's financial soundness and by providing the best service possible.
During the years in issue, North Carolina title insurance companies used a number of marketing techniques to solicit business from real estate attorneys. Many companies had their employees take attorneys to lunch, dinner, and sporting events such as local college football and basketball games. Some title insurance companies had their employees call on attorneys at their offices, but this was not particularly effective because it disturbed busy attorneys during their working hours. A number of companies sponsored cocktail parties at regular bar association meetings and educational seminars that were open to all members of the bar. Many title insurance companies advertised in state and local bar association publications. Companies also provided attorneys with pens, rulers, notepads, and calendars bearing the company's name. Some title insurance companies gave small Christmas presents to attorneys who sent them substantial business. The gifts, usually jars of jelly or preserves, pickles, or oranges, were of nominal value. Finally, some companies sponsored luncheons, informational brochures or newsletters, and courier services for attorneys and others in the real estate industry. In general, these practices may stimulate business and goodwill, provide a form of advertising, and facilitate the company's need to provide services to attorneys and other real estate professionals.
Petitioner was organized on January 30, 1975, by five individuals, including Charles L. Hinton III (Hinton), Walter R. Davis (Davis),5 and Herbert L. Toms, Jr. (Toms). Of the 60,000 authorized and issued shares of petitioner's stock, Davis and Hinton originally acquired 21,000 shares each, and Toms acquired 12,000 shares. Hugh Cannon (Cannon) and Richard G. Singer (Singer) were also original shareholders of petitioner, but the record does not indicate how many shares each of them owned. By mid-1977, Hinton had purchased the stock of Cannon and Singer and had acquired other shares so that he owned 75 percent of petitioner's stock. By December 8, 1978, Hinton had acquired Davis' stock and had become petitioner's sole shareholder. On December 26, 1978, Hinton transferred 10,000 shares to his mother, Mrs. Rebecca M. Davis, thereby reducing his holdings to about 83 percent.
During the years in issue, petitioner had between 11 and 14 members on its board of directors. Of these directors, only Davis, Hinton, Toms, and Singer were inside directors, having at sometime during the years in issue an interest in petitioner as a shareholder, officer, or employee. The remaining directors were independent outside directors who were practicing real estate attorneys in...
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