Wasserstrom v. Commissioner
| Decision Date | 04 September 1986 |
| Docket Number | Docket No. 15943-81. |
| Citation | 1986 TC Memo 417,52 TCM (CCH) 392 |
| Parties | David E. Wasserstrom and Sandra R. Wasserstrom v. Commissioner. |
| Court | U.S. Tax Court |
Joseph E. Lundy, 20th Floor, Three Parkway, Philadelphia, PA. and Gerhart L. Klein, for the petitioners. Kenneth J. Rubin, for the respondent.
Memorandum Findings of Fact and Opinion
By notice of deficiency dated April 6, 1981, respondent determined a deficiency in petitioners' 1977 Federal income tax in the amount of $250,487, and an addition to the tax pursuant to section 6653(a)1 in the amount of $12,524.
Petitioners attack the validity of the notice of deficiency, contending that respondent is barred from assessing additional tax liabilities because petitioner David E. Wasserstrom signed a Form 1902-E (Report of Individual Income Tax Audit Changes) with respect to 1977 on February 2, 1979. Thus, before deciding the substantive issues, we must decide whether Form 1902-E is a final closing agreement within the meaning of section 7121. In the event we determine that Form 1902-E is not a final closing agreement, then both parties have made certain concessions. After concessions, the remaining substantive issues are: (1) whether petitioners are entitled to deduct their distributive share of losses from the coal mining activities of two limited partnerships, Campbell Hollow Associates, II, Ltd. and North Fork Associates; and (2) whether petitioners are liable for an addition to tax pursuant to section 6653(a).2
Some of the facts have been stipulated; the stipulation of facts and attached exhibits are incorporated herein by this reference.
David E. Wasserstrom and Sandra R. Wasserstrom, husband and wife, resided in Melrose Park, Pennsylvania at the time they filed their petition. Sandra Wasserstrom is a party in this case solely because she filed a joint return with her husband for 1977; therefore David Wasserstrom will be referred to as petitioner.
Petitioner is an attorney concentrating in taxation and business related matters. He received a Masters of Law Degree in taxation and was a law clerk for one of the judges on this Court from 1963 to 1964. He has prepared numerous private offering memoranda for partnerships engaged in coal tax shelters,3 including the private offering memoranda for the two limited partnerships involved herein.
Campbell Hollow Associates II, Ltd.
Campbell Hollow Associates II, Ltd. (CHA) is a Florida limited partnership formed on December 28, 1977, for the purpose of mining coal on leased land located in Whitley County, Kentucky. The sole general partner was Richard D. Kaplan.4
During 1977, petitioner and Morris L. Chucas were equal partners in Elliott H. Lewis Associates ("Lewis Associates").5 On December 28, 1977, Lewis Associates contributed $150,000 to CHA6 and became a 25.62 percent limited partner therein; accordingly, petitioner had a 12.81 percent indirect interest in CHA.
On December 30, 1977, CHA obtained from Williamsburg Associates (Williamsburg), a Florida general partnership, the right to mine and remove all mineable and merchantable coal from three tracts of land in Whitley County, Kentucky (the Campbell Hollow site) pursuant to a lease for a basic term of 20 years.7 Under the lease, CHA agreed to pay Williamsburg a royalty of $2.50 per ton for all coal mined and sold and a minimum annual royalty of $153,866 during the term of the lease. The minimum annual royalty for the first 15 years (i.e., $2,308,000)8 was payable in advance as follows: $496,800 in cash and a note for the $1,811,200 balance. The note bore interest at the rate of six percent per annum and was to mature on December 31, 1992. Payment of the note was dependent upon CHA's "available cash", i.e., cash remaining after CHA paid "all normal and ordinary" expenses other than payment on the note and distributions to its partners. The note was described as "fully recourse" as to both CHA and all its partners except that it became nonrecourse (secured only by the assets of CHA) if: (1) CHA's average tonnage of coal mined and sold for any consecutive three year period was less than 55,000 tons; or (2) the principal balance of the note was reduced to $1 million by December 31, 1987.
On December 30, 1977, CHA entered into (1) a mining contract with Medlin Coal Company9 under which Medlin would operate a coal mine on the Campbell Hollow site and receive $16 per ton for all coal mined and sold, and (2) a sales agreement with London Brokerage Company to sell the coal mined at the Campbell Hollow site at a fixed price of $20.75 per ton until 1983, and $20.88 thereafter.
The Campbell Hollow site had never previously been mined; no core samples to indicate the existence (and amount) of coal on the site were taken, and no mining permits were obtained. No coal was mined on the Campbell Hollow site by Medlin or by CHA, and CHA made no payments on its note to Williamburg.
The $577,000 CHA received as capital contributions was used as follows:
Payee Amount Purpose
Williamsburg ..................... $496,800 advanced minimum royalty
David E. Wasserstrom .............. 32,000 legal fees
Richad Kaplan ..................... 40,000 management fee
________
$568,800
8,200 working capital
________
TOTAL .................... $577,000
In its 1977 return, CHA reported a loss of $2,377,955, including the advanced royalty payment of $2,308,000; petitioner through his interest in Lewis Associates, deducted $304,616 as his distributive share of the partnership's 1977 loss, which deduction respondent disallowed.
Petitioner contributed, as a limited partner, $11,250 to the capital of North Fork Associates (North Fork), a New Jersey limited partnership formed on December 27, 1977, for the purpose of mining coal on subleased land located in Perry County, Kentucky.10 North Fork's sole general partner was Barry Wasserstrom.11
On December 29, 1977, North Fork obtained from Partridge Coal Company, a Kentucky corporation (Partridge), the right to mine and remove all mineable and merchantable coal from two tracts of land located in Perry County, Kentucky (the Boggs property), pursuant to a sublease for a basic term of 20 years. Under the sublease, North Fork agreed to pay Partridge a royalty equal to 12.5 percent of the gross selling price of all coal mined and sold and a minimum annual royalty of $125,000 during the term of the sublease. The minimum annual royalty for the first 14 years (i.e., $1,750,00012) was payable in advance as follows: $500,000 in cash and a note for the $1,250,000 balance. The note bore interest at the rate of six percent per annum and was to mature on December 31, 1989. Payment was dependent on North Fork's "available cash", i.e., cash remaining after North Fork paid "all normal and ordinary" expenses other than payment on the note and distribution to its partners. The note was described as "fully recourse" as to both North Fork and all its partners except that it became nonrecourse (secured only by the assets of North Fork) if: (1) North Fork's average tonnage of coal mined and sold for any consecutive three year period was less than 30,000 tons; or (2) the principal balance of the note was reduced to $750,000 by December 31, 1983.
On December 29, 1977, North Fork entered into a contract with Partridge Mining Company, a Kentucky corporation, (Partridge Mining)13 to mine coal on the Boggs property at a price of 75 percent of the gross selling price (excluding commissions) of all coal mined and sold.
No coal was mined by Partridge Mining or North Fork on the Boggs property, and North Fork made no payments on its note to Partridge.
The $526,000 NFA received as capital contributions was used as follows:
Payee Amount Purpose
Partridge $500,000 advanced minimum royalty
David E. Wasserstrom 17,500 legal fees
Barry Wasserstrom 6,000 management fee
_________
$523,500
2,500 working capital
________
TOTAL .......................... $526,000
In its 1977 return, North Fork reported a loss of $1,773,500, including the advanced royalty payment of $1,750,000; petitioner deducted $37,244 as his distributive share of the partnership's 1977 loss, which deduction respondent disallowed.
As a result of an office audit involving substantiation of medical and charitable deductions claimed in 1977, petitioner agreed to certain adjustments resulting in a $42 tax increase. At the time of the audit (February 2, 1979), petitioner signed respondent's Form 1902-E, entitled "Report of Individual Tax Audit Changes." The form contained the following language:
Although this report is subject to review, you may consider it as your written notice that your case is closed if you are not notified of an exception to these findings within 30 days after a signed copy of this report or a signed waiver, Form 870, is received by the District Director. If you agree, please sign one copy and return it in the enclosed return envelope. Keep the other copy with your records.
Petitioner's wife, who was not present at the meeting with respondent's agent, did not sign the form, nor did the auditing agent. Several months thereafter, petitioner received a bill from the Internal Revenue Service for $42, plus interest, which he promptly paid.
Subsequently, respondent questioned the deductions claimed by petitioner with respect to his share of losses from various partnerships, including CHA and North Fork. In November, 1980, respondent sent petitioner a Form...
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