Wilhelm v. United States
| Decision Date | 18 August 1966 |
| Docket Number | 4939.,Civ. No. 4938 |
| Citation | 257 F. Supp. 16 |
| Parties | Leo WILHELM and Nedalyn Wilhelm, Plaintiffs, v. UNITED STATES of America, Defendant. Rubie K. DOVER, Executrix, Estate of W. E. Dover, Deceased, and Rubie K. Dover, Plaintiffs, v. UNITED STATES of America, Defendant. |
| Court | U.S. District Court — District of Wyoming |
Arthur Kline, of Kline & Tilker, Cheyenne, Wyo., and Lorin Guild, Wheatland, Wyo., for plaintiffs.
Robert N. Chaffin, U. S. Atty. for Dist. of Wyoming, Cheyenne, Wyo., and Lawrence E. Doxsee, Dept. of Justice, Tax Div., Washington, D. C., for defendant.
Judge's Memorandum.
The above-captioned cases involving the same facts and issues under Sub-chapter S, Sections 61, 119, 162 and 167 of the Internal Revenue Code of 1954, were consolidated for trial to facilitate the disposition of the questions before the Court. In civil action No. 4938 the plaintiffs-taxpayers seek a refund of income taxes and interest for 1961 in the amount of $600.13. In civil action No. 4939, the plaintiffs-taxpayers seek a refund of income taxes and interest in the amount of $633.46. Jurisdiction is conferred upon this Court by 28 U.S.C. Sections 1340 and 1346(a) (1). W. E. Dover died on July 27, 1964, and Letters Testamentary were issued to Rubie K. Dover, who is the duly qualified and acting Executrix of the Estate of W. E. Dover, deceased.
The stipulation of facts to which the parties agreed and the evidence at the trial show that there are no material differences concerning the ranching business of the plaintiffs. Prior to August 1960, W. E. Dover and Rubie K. Dover owned ranch lands in Platte and Albany Counties in Wyoming. Approximately 16,500 acres were deeded land and approximately 8,500 acres were in State and Taylor Grazing Act leases. The lands in Albany County were used principally by all the plaintiffs for summer pasture. The lands in Platte County consisted of two separate units, the Home Place, where the Dovers had lived since 1921, and the Brush Creek Ranch.
Prior to 1960 plaintiffs were attempting to operate from the Home Ranch and to winter cattle on the Brush Creek Ranch. Such operation was found not to be feasible due to the loss incurred. They decided that if they were to use the grass on the Brush Creek Ranch they would need responsible people who were willing and sufficiently experienced to run a grass ranch and who would move on it and live there. Early in 1960 the Dovers gave 1,839.32 acres of the Brush Creek Ranch lands to their daughter and son-in-law, the Wilhelms. Deciding to change their operation to utilize the Brush Creek Ranch profitably, the Wilhelms thereupon sold their 240 acre farm in Platte County and with $27,000.00 of the selling price, they built a residence and other buildings on the Brush Creek Ranch. In the tax year ended 1961, Mr. and Mrs. Wilhelm lived there and both actively operated the Brush Creek Ranch.
On August 5, 1960, the plaintiffs incorporated the "Thirty-One Bar Ranch Company" and on August 8, 1960, they transferred all of their buildings and their lands, deeded and leased, to the corporation in exchange for its common stock. On that same day the corporation filed its election under Section 1372(a) of the Internal Revenue Code of 1954 as amended, to have its income taxed directly to its shareholders, all of its shareholders duly consenting to said election. The livestock and equipment owned by the Dovers and Wilhelms were transferred to the corporation on January 2, 1961, in exchange for more common stock. All shares of the corporation were owned by the Dovers and Wilhelms.
Thereafter the ranching business was run by the Thirty-One Bar Ranch Company, Incorporated. It hired W. E. Dover as general manager, and Leo Wilhelm as assistant manager at a monthly salary of $400.00 each. In 1961, the Dovers were paid $5,074.69 cash as salary, and the Wilhelms $4,944.00 cash. The corporation claimed a net operating loss in 1961 of $3,238.97. The Dovers and Wilhelms each duly filed their 1961 Federal Income Tax returns, reporting their respective cash salaries from the corporation, and claiming their respective shares of the net operating loss of the corporation for 1961. The corporation also filed its 1961 Federal Income Tax return, which was audited in 1963 by the Internal Revenue Service and certain items were disallowed.
There was one full time employee other than the Dovers and Wilhelms and extra employees were hired for roundups, haying and other peak work periods. The Government allocated certain expenses and depreciation to the employees who were not shareholders of the corporation and allowed said expenses as deductions from the corporation's income. The following table shows the deductions claimed by the corporation and the amounts allowed and disallowed by the Government:
Deduction Deduction Amount
Items Claimed Allowed Disallowed
Utilities and 'phone $1,326.45 $ 663.23 $ 663.22
Board of labor 3,174.43 500.00 2,674.43
Gas and oil for all
vehicles owned by
the corporation 1,506.21 1,129.66 376.55
Depreciation, Tenant)
house, Home Place, )
$1,050.00 )
) 2,400.00 287.50 2,112.50
Depreciation, Tenant)
house, Brush Creek )
$1,350.00 )
Depreciation, car 326.40 0.00 326.40
The total amount of deductions disallowed to the corporation by the Government, namely, $6,153.10, was apportioned according to the shares of stock owned by the shareholders. That is, 52.789%, or $3,248.16, of the corporation's deductions disallowed was added to the Dover's 1961 personal income, and 47.211%, or $2,904.94, of the corporation's deductions disallowed was added to the Wilhelm's personal income. On July 2, 1963, additional income tax of $616.13 and interest of $45.66 was assessed against the Dovers, and additional income tax of $558.73 and interest of $41.40 was assessed against the Wilhelms. Said additional tax assessments and interest were timely paid and taxpayers' claims for refunds were duly filed. The disallowance of their claims was mailed to the taxpayers on May 1, 1964.
Taxpayers' complaint against the Government arises from the fact that the amounts disallowed the corporation for utilities, telephone, depreciation of the houses, and board of labor, are the values ascribed by the Government to the lodging and board furnished the Wilhelms and the Dovers. They complain also that the Government allocated $376.55 for oil and gas expenses to the car and improperly disallowed that expense.
It is the position of the Government that the Dovers and Wilhelms were the corporation and could not be its employees, and that the value of the food and lodging furnished to the taxpayers by the corporation was a constructive dividend. The Government contends that the food and lodging provided by the corporation was not provided primarily for the convenience of the corporation but rather for the joint convenience of the taxpayers and "their" corporation.
The first question to be decided is the effect of the Section 1372 election by the Thirty-One Bar Ranch Company not to be subject to the payment of income tax, and of the consent of the shareholders thereto.
It is the Government's position that the effect of an election to be taxed under Subchapter S of the Internal Revenue Code is to convert a corporation into a partnership and to make the shareholders, in effect, partners. Counsel for the Government have cited no authority for this position and independent research by this Court has not found any to support it. An analysis of Subchapter S and its companion, Subchapter R, and of their legislative history leads to the contrary conclusion. 1954 U. S. Code Congressional and Administrative News, Pages 4752-4753, 5096-5101, 5333-5334; 1958 U. S. Code Congressional and Administrative News, Pages 4791, 4795, 4798, 4876-4878, and 5005-5014.
In the 1954 revisions of the Internal Revenue Code the Senate Finance Committee proposed new provisions, not included in the House bill, which would eliminate the influence of the Federal income tax laws in the selection of the form of organization adopted by certain small businesses. This was to be accomplished by giving certain corporations the option to be taxed as a partnership, and by allowing certain partnerships the option to be taxed as a corporation. Subsection (c) of the Senate's amendment provided that a corporation making the election would be considered a partnership for purposes of income taxes, and, with an exception not herein material, each shareholder would be considered a partner. Prior to the enactment of the Internal Revenue Code of 1954, the House struck the Senate's amendment which purported to give certain corporations an option to elect to be taxed as partnerships. The 1954 Code therefore, contained only the provision that certain partnerships could elect to be taxed as a corporation and they would be considered to be corporations and its partners would be considered shareholders for purposes therein specified. (Section 1361(c) I.R.C. of 1954.)
In 1958 Congress passed the "Technical Amendments Act of 1958" to correct unintended benefits and hardships and to make technical amendments. The House version of the bill would have repealed Section 1361 permitting partnerships to elect to be taxed as corporations. The Senate Committee on Finance, however, reinstated that section, and also added the new Subchapter S (Sections 1371-1377) permitting certain small-business corporations to elect that no corporate income tax be imposed on them, and to transfer the tax to the shareholders of the corporation. It is important to note that Section 1371 as proposed by the Senate Committee in 1958 and as finally passed by Congress does not...
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