Wang v. Commissioner
| Decision Date | 31 March 1998 |
| Docket Number | Docket No. 19176-94.,Docket No. 3857-95.,Docket No. 10511-94.,Docket No. 19177-94.,Docket No. 10512-94.,Docket No. 3858-95. |
| Parties | Chen C. and Victoria R. Wang, et al.<SMALL><SUP>1</SUP></SMALL> v. Commissioner. |
| Court | U.S. Tax Court |
Martin A. Schainbaum, San Francisco, Calif., David B. Porter (specially recognized), for the petitioners. Patricia A. Golembiewski and Thomas G. Schleier, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
These consolidated cases involve the following determinations by respondent of deficiencies in, and penalties on petitioners' Federal income taxes:
Docket Nos. 10511-94, 19177-94, 3857-95
Chen C. & Victoria R. Wang
--------------------------
Penalty
Year Deficiency Sec. 6662(a)
1989 ............... $ 76,529 $ 15,306
1990 ............... 398,475 79,695
1991 ............... 7,309 1,461
Docket Nos. 10512-94, 19176-94, 3858-95
EIC Group, Inc. and Subsidiaries
--------------------------------
Penalty
Year Deficiency Sec. 6662(a)
1989 ............... $5,469,221 $1,093,844
1990 ............... 1,919,053 383,811
1991 ............... 977,776 195,555
1992 ............... 1,171,312 234,262
All section references are to the Internal Revenue Code in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.
These cases were consolidated for trial, briefing, and opinion. Prior to trial, the parties settled a number of issues.2 As a result, the deficiencies now asserted by respondent have been reduced from those set forth in the notices of deficiency. After concessions, the issues remaining for decision are:
1. Whether petitioners improperly elected to use the installment method of accounting to report income from sales of real property; and, if the elections were improper, whether petitioners should use the accrual method as determined by respondent or the cost recovery method advocated by petitioners;3
2. whether petitioner Chen C. Wang's closely held corporation, EIC Group, Inc. (EIC), is entitled to deduct as reasonable compensation commissions of $901,428 and a bonus of $500,000 paid to Chen C. Wang in 1989 and 1990, respectively;
3. whether expenditures of $550,663 made in 1990 by EIC for the benefit of the Wangs represent loans to the Wangs or constructive dividends; and
4. whether petitioners are liable for the accuracy-related penalties under section 6662(a).
Some of the facts have been stipulated and are so found. The stipulation of facts, the first supplemental stipulation of facts, the second supplemental stipulation of facts, and the exhibits attached thereto are incorporated herein by this reference. Petitioner Chen C. Wang (petitioner) and his wife, petitioner Victoria R. Wang, resided in Woodside, California, at the time their petitions were filed. At the time its petitions were filed, the principal place of business for EIC was located in Redwood City, California.
Petitioner moved to the United States from Taiwan nearly 40 years ago. He has a degree in electrical engineering from San Jose State University and a Masters in Business Administration from the University of California at Berkeley. After completing his education, petitioner went to work for IBM. While at IBM, petitioner investigated ways to increase his income, and he ultimately decided that the best way to make money was to invest in real estate. Thereafter, petitioner began investing in real estate, eventually leaving IBM to devote more of his time and energy to increasing his real estate business. In 1982, petitioner incorporated EIC and used it as the vehicle to effectuate his real estate investment strategy. Nevertheless, occasionally petitioner personally purchased and sold land for his own account.
Petitioner's real estate strategy focused on purchasing raw, undeveloped land and reselling it to investors. Typically, petitioner advised his investors that they would have to hold the land at least 7 to 10 years in order to realize profitable returns. Petitioner believed that the most profitable land was located on the outskirts of a large metropolitan center. Based on this belief during the years at issue, petitioner had decided that the land with the best investment potential was located in Lancaster, California, and Palmdale, California, areas well outside of Los Angeles. Petitioner felt that this land was well positioned, given the expected population growth for Los Angeles.
The property petitioner purchased in Lancaster and Palmdale was generally flat, semi-arid, undeveloped land. At one time, the land may have been used as farmland, but, by 1989 it had reverted to desert. The land was zoned for agricultural use, with a density that allowed for one house to be built on every 2 acres of land. There were no improvements to or on the land petitioner purchased, such as utilities, streets, curbs, or gutters. The land was not subdivided, but simply consisted of "raw" land in the desert described by metes and bounds.
Typically, either petitioner or EIC would acquire the raw land by paying 10 or 20 percent down, and giving the seller a note for the balance. Then petitioner would sell the land at a substantial markup in what was described at trial as the "retail land market". The markup could range anywhere from 4 to 6 times the amount paid for the land. The buyer would make a sizeable downpayment to EIC and take the property subject to an all-inclusive deed of trust. An all-inclusive deed of trust includes the promissory note made by EIC in favor of the original seller. Under this arrangement, as the buyer made payments on the promissory note to EIC, a part of the payment was used by EIC to make the payments due on EIC's promissory note given to the original seller. EIC also used what is termed an "agreement of sale". An agreement of sale is different than a trust deed because, unlike a trust deed, the agreement of sale is not recorded. Rather, in the agreement EIC simply promised to transfer the deed to the buyer at some future time, presumably after the buyer had made all the payments due on its promissory note to EIC.
The promissory notes held by EIC were secured by the land. As outlined supra, typically EIC or petitioner would purchase large parcels of real estate and then sell undivided interests in the property to various investors. These fractional interests were less attractive as security because an owner would have to receive the consent of the remaining property owners before making use of the property. However, it appears that people who purchased land from EIC only held it as an investment, and few buyers, if any, actually built any structures on, or made any improvements to the property.
During the years at issue, petitioner and his wife owned approximately 98 percent of the stock in EIC. Further, during this period, petitioner was the chief executive officer, chairman, and, except for a brief period, the president of EIC. Since its inception, Mrs. Wang has been the secretary, treasurer, and chief financial officer of EIC. Petitioner typically worked 10 hours a day, 6 days a week. Petitioner is very driven, and he is involved with nearly every sale transaction that occurs at EIC.
The success enjoyed by EIC and petitioner is a reflection of petitioner's industry and dedication. Revenues reported in EIC's financial statements grew from $4,118,262 in 1985 to $29,411,411 in 1989, while assets grew from $23,343,200 to $46,231,210. Recent promotional materials for EIC indicate that the company owns investment property worth in excess of $60,000,000, and that investors have enjoyed an average annual appreciation of 25.9 percent on their investments, based on a sampling of prices over a 15-year period. At the peak of operations, approximately 12 people were employed at EIC's headquarters full time. In addition, there were 11 branch offices located throughout California, and as many as 50 sales agents worked at these branches. Most of the agents were independent contractors, although a few were classified as employees of EIC.
The market for raw land suffered a downturn in 1990. However, EIC was able to continue selling land despite this downturn. Companies that were able to sell land, like EIC, did so by developing superior marketing techniques or by utilizing connections with overseas buyers.
EIC keeps its books and records on the accrual basis for the purpose of preparing its financial statements. For tax purposes, during the years in issue, EIC and petitioner elected to use the installment method for reporting income in their tax returns.
This is the second instance where petitioner has been involved in litigation before the Tax Court. Previously, respondent issued petitioner and Mrs. Wang notices of deficiency for their 1979 and 1980 Federal income tax returns. The most significant portion of the deficiencies for the 2 years related to the income and expenses respondent determined in connection with the Wangs' land sales activities. Petitioner and Mrs. Wang presented these issues to this Court in a trial that was held on November 30, 1989, and December 1, 1989. However, no opinion was issued because all of the issues were resolved by the parties after the trial. The parties executed a closing agreement on final determination covering specific matters for the 1979 tax year (the 1979 closing agreement).4 A decision was entered pursuant to the terms of the 1979 closing agreement.
Petitioner and Mrs. Wang timely filed their 1989 Federal income tax return, which was received by the Internal Revenue Service on October 11, 1990. On their 1989, 1990, and 1991 Federal income tax returns,...
To continue reading
Request your trial