Wallach v. Commissioner

• Decision Date: 31 August 1982
• Docket Number: Docket No. 871-79,19525-80.,15338-80,3795-79
• Citation: 1982 TC Memo 502,44 TCM (CCH) 1002
• Parties: Jacques B. Wallach and Doris F. Wallach, et al. v. Commissioner.
• Court: U.S. Tax Court

44 TCM (CCH) 1002

1982 TC Memo 502

T.C. Memo. 1982-502.

Jacques B. Wallach and Doris F. Wallach, et al.¹ v. Commissioner.

Docket Nos. 871-79, 3795-79, 15338-80, 19525-80.

United States Tax Court.

Filed August 31, 1982.

Waldron Kraemer and Douglas E. Burns, 1180 Raymond Blvd., Newark, N.J., for the petitioners in docket Nos. 871-79 and 15338-80. Leonard M. Goldberg and Ronald A. Sinaikin, for the petitioner in docket Nos. 3795-79 and 19525-80. William F. Halley, for the respondent.

Memorandum Findings of Fact and Opinion

GOFFE, Judge:

The Commissioner determined deficiencies in the Federal income tax of petitioners Dr. and Mrs. Jacques B. Wallach as follows:

                  Year                    Deficiency
                  1973 .................. $27,144.76
                  1974 ..................  13,329.36
                  1975 ..................  21,796.02
                  1976 ..................  15,990.78
                

The Commissioner determined deficiencies in the Federal income tax of petitioner Alden Bioclinical Laboratories, Inc., as well as additions to tax under section 6651 (a),² as follows:

                  Year            Deficiency   Addition to Tax
                  1973 .......... $27,269.62      $6,817.41
                  1974 ..........  30,666.14       7,666.54
                  1975 ..........  19,852.96       4,963.24
                  1976 ..........  11,401.24       2,850.31
                

After concessions by the parties, the only issues remaining for decision are: (1) the proper allocation between stock and a covenant not to compete of the price paid to acquire an incorporated clinical pathology business; (2) the proper allocation of the purchaser's basis in the stock to assets received on liquidation of the corporation; and (3) whether the petitioner Alden Bioclinical Laboratories, Inc., is liable for additions to tax for its failure to file its corporate income tax returns on time.

Findings of Fact

Some of the facts in these cases have been stipulated. The stipulations of fact and stipulated exhibits are incorporated herein by this reference.

The petitioners Dr. and Mrs. Jacques B. Wallach filed timely joint Federal income tax returns for their taxable years in question. At the time their petitions in these cases were filed they resided in New Jersey.

The petitioner Alden Bioclinical Laboratories, Inc., is a corporation organized and existing under the laws of New Jersey. As discussed below, it filed delinquent Federal income tax returns for its taxable years in question. At the time its petitions in these cases were filed, its principal office was located in New Brunswick, New Jersey.

We will present issues (1) and (2) together, because they arose out of the same general facts.

Issue 1. Sale of Wallach Lab and Issue 2. Liquidation of Wallach Lab

The petitioners in these consolidated cases are the seller and purchaser of a clinical laboratory business.

The petitioner Jacques B. Wallach is a doctor of medicine. He received his M.D. degree in 1947 at the State University of New York and thereafter received further training in medicine and cytology at various hospitals in New York City. He then taught at various medical schools in New York City until 1959, when he left to take a position at a hospital in Elizabeth, New Jersey. Dr. Wallach left this position in 1960 to enter the private practice of laboratory medicine. His first laboratory was in Cranford, New Jersey, but from 1961 until the sale of the business described below, his laboratory was located in Westfield, New Jersey. His practice was incorporated on February 14, 1969, under the laws of New Jersey. The corporate name was The Laboratory of Dr. Wallach, Inc. (hereinafter referred to as Wallach Lab). One hundred shares were issued to Dr. Wallach, representing all of Wallach Lab's issued and outstanding shares.

Dr. Wallach described his practice as:

essentially divided into two areas: one area of anatomic pathology consisted of examining specimens under the microscope. These were principally pap smears in screening for cancer of the uterus and biopsies from various sites, usually to distinguish cancer from non-malignant lesions, occasionally performing autopsies. The other part of the practice was what's called clinical pathology and refers to doing laboratory tests on various body fluids, such as blood chemistries, blood counts, urinalyses and so forth.

In order to practice anatomic pathology, a person is required to be a licensed physician. Clinical pathology, on the other hand, may be practiced by a layman.

Wallach Lab's clinical pathology business came from two sources, "pickup" business and "walk-in" business. The "pickup" business consisted of picking up specimens taken by physicians in their own offices and taking them to Wallach Lab's facilities, where the tests were performed. In this case, the decision to use the services of Wallach Lab was made by the referring physician. The "walk-in" business consisted of the performance of tests which had been prescribed by the patient's physician, but for which the physician had not specified a particular laboratory. In the case of the "walk-in" business, Wallach Lab's services were chosen by the patient himself. About half of Wallach Lab's clinical pathology business came from each source. The "walk-in" business was more profitable than the "pickup" business; charges were typically about three times as high for the former as for the latter.

Wallach Lab served Westfield and the surrounding communities. One other clinical laboratory was located in the Westfield area but it was very small and not very active, and thus was not a competitive factor. Apart from that, the only other laboratories which the residents of Westfield could have used were in hospitals in "somewhat more distant communities."

Dr. Wallach did not advertise the services of Wallach Lab extensively. He placed an announcement in a local newspaper when the laboratory was opened and made some telephone calls to local doctors advising them of the availability of its clinical testing services, but no greater efforts to secure business were necessary because "there was basically no other laboratory for them to go to in that town."

During the years from the mid-1960's to the early 1970's, the clinical laboratory business became increasingly automated, with a resulting increase in efficiency. As Dr. Wallach stated,

The trends were that the increasing automation, particularly in blood chemistry, meant that more chemistries could be done at a much lower price, and that the whole price structure was markedly being changed as a result of this. And so tests that would formerly have resulted in a cost of five dollars or an income of five dollars were now being batched at a cost of perhaps 12 tests for $15.

This trend toward automation posed a problem for small laboratories such as Dr. Wallach's. They were forced to compete with automated laboratories which could offer the same services at a lower price, and the cost of purchasing the new equipment was often prohibitively high.

This trend led Dr. Wallach in 1972 to contact Dr. Stanley Levy, the president and majority shareholder³ of the petitioner Alden Bioclinical Laboratories, Inc., (hereinafter referred to as Alden Lab). Alden Lab had been incorporated on or about January 3, 1968, under the laws of New Jersey, and was also engaged in the clinical laboratory business. Alden Lab was more automated than Wallach Lab,⁴ and Dr. Wallach was interested in pooling the resources of the two laboratories as a means of competing with other automated laboratories. Dr. Levy agreed to this arrangement, but the relationship soon became one-sided. As Dr. Wallach explained,

As it turned out, the gist of it was that he ended up doing all of these particular chemistry tests for me. But since he already had the other equipment that I had, there was really no work I could do for him in exchange. Therefore I ended up paying him money for doing those tests.

After the two laboratories had been engaged in this relationship for some months, Dr. Wallach approached Dr. Levy with the suggestion that Alden Lab buy Wallach Lab. In addition to the difficulty of competing with more automated laboratories, there were a number of other reasons that Dr. Wallach was interested in selling his laboratory at that time. The principal one was his desire to spend more time with his family. He also wanted to revise a textbook on cytology he had written and do more teaching at medical schools. He also wanted to travel. Finally, he wanted to ensure the financial security of his family against the possibility of his death, and he believed that the liquidity which would result from the sale of the business would help him achieve that goal. Because of all these factors, Dr. Wallach had no intention of practicing clinical pathology following the sale of Wallach Lab.

The negotiations for the sale of Wallach Lab lasted several months, and different persons were involved at different stages. Initially, the bargaining was conducted solely between Dr. Wallach and Dr. Levy. They agreed that the sale would involve only the clinical pathology portion of Wallach Lab's business. Dr. Wallach wanted to retain his anatomic pathology practice, and Dr. Levy was not interested in purchasing that portion of the business.

In their preliminary negotiations, Dr. Wallach and Dr. Levy reached a working agreement that the price of the clinical pathology business would be $330,000. This figure was first suggested by Dr. Wallach and was arrived at by multiplying the gross receipts of Wallach Lab's clinical pathology business for the previous year by two and one-half.⁵ The $330,000 figure, which remained the sales price in the final agreement, was mentioned before any discussion of including a covenant not to compete as part of the agreement. It was, however, understood by the parties that, after the sale was completed, Dr. Wallach would not continue to practice clinical pathology. Dr. Levy was aware that, for the reasons mentioned above, Dr. Wallach did not wish to remain in that business.

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