Waters v. Commissioner
| Decision Date | 23 September 1991 |
| Docket Number | Docket No. 9983-88. |
| Citation | 62 T.C.M. 778 |
| Parties | John J. Waters and Jeanne M. Waters v. Commissioner. |
| Court | U.S. Tax Court |
Stephen D. Gardner and Michael G. Lefkowitz, 1345 Avenue of the Americas, New York, N.Y. 10105, for the petitioners. Jody Tancer and Laurie B. Kazenoff, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows:
Sec. 6661
Year Deficiency Addition to Tax1
1982 ................ $14,361 $3,590
1983 ................ 20,258 5,065
1984 ................ 18,700 4,675
1985 ................ 2,443 --
Increased interest under section 6621(c) also was determined for each year.
The primary issues for decision are: (1) Whether petitioner John J. Waters (petitioner) was at risk within the meaning of section 465 with respect to debt obligations incurred in connection with an investment in peripheral computer equipment; (2) whether petitioner's investment was a sham transaction devoid of economic substance; and (3) whether petitioner's investment constituted an activity entered into for profit within the meaning of section 183.
Some of the facts have been stipulated and are so found. Petitioners are husband and wife and resided in Huntington, New York, at the time their petition was filed.
During the years in issue, petitioner was a certified public accountant. In early 1982, petitioner and Gerald A. Moffatt (Moffatt), one of petitioner's partners at the public accounting firm at which petitioner worked, sought advice from Michael Gorin (Gorin) concerning possible investments in computer equipment leasing transactions. Gorin was a certified public accountant and had performed accounting and financial services for computer equipment leasing companies, and Gorin had given advice to other investors concerning investments in computer equipment leasing transactions. Further, Gorin had experience purchasing computer equipment for a prior employer.
On August 31, 1982, after considering and discussing for a number of months with Gorin and other colleagues various investment opportunities, including computer equipment leasing transactions, and after investigating the credit standing of the prospective end user of the equipment, petitioner and Moffatt entered into the transactions with respect to certain peripheral computer equipment described below.
On March 26, 1981, Equitable Financial Management, Inc. (Equitable), a general equipment leasing company, entered into a master purchase agreement to purchase a large quantity of new peripheral computer equipment from ITT Courier, Inc. (ITT), the manufacturer of the equipment. Equitable's purchase price for the particular computer equipment that is at issue in this case (and that was purchased from ITT under the referred-to master purchase agreement) was $278,775. The equipment included display terminals, keyboards, printers, printer interfaces, and remote terminal controllers. The equipment was to be delivered in stages throughout 1981 and 1982.
ITT peripheral computer equipment was highly regarded in the computer industry. The particular controllers purchased by Equitable had a redundancy feature that made them particularly attractive to financial institutions, utility companies, and other end users whose business necessitated computer equipment with backup capability.2
Charles L. Dixon (Dixon) was the president of Equitable. Fred E. Cooper (Cooper) was the corporate secretary. During the years in issue, Dixon and Cooper each owned 50 percent of the voting and nonvoting stock of Equitable, with the exception of a small minority stock interest held by another individual.
In connection with its purchase of the computer equipment, Equitable borrowed on a nonrecourse basis from The First National Bank of Allentown approximately the full stated purchase price of the equipment. The proceeds from the nonrecourse bank loan were used by Equitable to pay ITT the purchase price of the computer equipment. The loan was subsequently refinanced on a nonrecourse basis by another bank.
As collateral for the bank loan, Equitable gave the bank security interests in the computer equipment and in the lease payments due under all end-user leases of the equipment. Neither the term of, nor the interest rate due, on Equitable's bank loan is established in the record.
The $278,775 purchase price (for the computer equipment that is in issue in this case and that was purchased by Equitable from ITT) reflected a 7- to 10-percent discount from ITT's list price for the equipment because the purchase was part of a purchase by Equitable from ITT under the master purchase agreement of a much larger quantity of computer equipment.
On April 6, 1981, Equitable entered into a master end-user lease agreement with Duquesne Light Co. (Duquesne Light), a public utility company located in Pittsburgh, Pennsylvania, with respect to the peripheral computer equipment purchased from ITT. The initial terms of the various end-user leases with Duquesne Light began on either March 16, 1982, May 27, 1982, or August 16, 1982, and had terms of 5 years and 7 months, running (depending on the installation date at Duquesne Light of the various pieces of equipment) through March 16, 1988.
During the initial 5-year 7-month lease terms, total monthly end-user lease payments in the amount of $6,953 were due from Duquesne Light with respect to the equipment. The monthly end-user lease payments effectively matched the payments due on Equitable's purchase money promissory note to the bank. Under lease renewal provisions, if Duquesne Light chose to renew the leases, Duquesne Light would pay the fair market rental rates at the time of renewal up to a maximum of 40-51 percent of the original lease rental rates.
The end-user leases with Duquesne Light were net leases under which Duquesne Light was liable for all costs and expenses of maintaining the computer equipment. In order to fulfill its obligation in that regard, Duquesne Light entered into an equipment maintenance agreement with ITT with respect to the computer equipment, under which ITT (for a fee to be paid by Duquesne Light) was obligated to provide remedial and preventive maintenance throughout the term of the end-user leases. Under the end-user lease agreements, Duquesne Light also was required to and did maintain casualty insurance on the computer equipment during the term of the end-user leases.
On August 31, 1982, 17 months after the initial master purchase agreement for the purchase of computer equipment was entered into between Equitable and ITT, two additional and simultaneous transactions occurred (involving the particular computer equipment in issue in this case) with the objective of transferring ownership of the equipment and assignment of the end-user leases with respect to the equipment (subject to the security interests therein of the bank) to petitioner and to Moffatt.
The first transaction was a sale of the computer equipment and assignment of the end-user leases by Equitable to Cooper Leasing Corporation, Inc. (Cooper Leasing), followed by the immediate resale of the computer equipment and reassignment of the end-user leases by Cooper Leasing to petitioner and to Moffatt. Both transactions were subject to the prior security interests of the bank in the equipment and in the end-user lease payments.
The total stated price for the purchase of the computer equipment by Cooper Leasing from Equitable was $298,000 (reflecting, among other things, the fact that ITT peripheral computer equipment had appreciated in value from March of 1981 to August of 1982). The total purchase price was to be paid with a cash downpayment of $1,000 and by the execution by Cooper Leasing in favor of Equitable of a purportedly recourse promissory note in the amount of $297,000.
Interest was to accrue on the promissory note at 12 percent per year, and payments designated as prepaid interest, deferred interest, or interest were to be made as follows: $10,000 on August 31, 1982; $26,643 on February 28, 1983; $27,720 on February 28, 1984; $934 monthly from September of 1982 through December of 1984. Payments of principal and interest were to be made as follows: $5,806 monthly from January of 1985 through December of 1990.
Cooper Leasing was in the general business of equipment and real estate leasing. The officers and ownership of Cooper Leasing were the same as the officers and ownership of Equitable, except that Fred E. Cooper was president of Cooper Leasing, and Charles L. Dixon was the corporate secretary. Cooper and Dixon each owned 50 percent of the stock of Cooper Leasing.
On August 31, 1982, simultaneously with the above transaction between Equitable and Cooper Leasing, Cooper Leasing sold the computer equipment to petitioner and to Moffatt as joint tenants for a stated purchase price of $300,000, represented by cash downpayments by petitioner and by Moffatt of $1,500 each and by the execution of separate 8-year and 4-month purchase money promissory notes by petitioner and by Moffatt each in the amount of $148,500, reflecting a total purchase money debt reflected by the promissory notes of $297,000. Petitioner's and Moffatt's debt obligations to Cooper Leasing under the promissory notes were secured by security interests in the equipment executed and filed in favor of Cooper Leasing.
Interest was to accrue on petitioner's and Moffatt's promissory notes in favor of Cooper Leasing at 12 percent a year, and payments of prepaid interest, deferred interest, accrued interest, and principal with respect to each of the promissory notes were to be made in total amounts that matched the payment obligations...
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