Williams v. Commissioner
| Decision Date | 16 July 1997 |
| Docket Number | Docket No. 557-95. |
| Citation | 74 T.C.M. 138 |
| Parties | Timothy L. and Jane Williams v. Commissioner. |
| Court | U.S. Tax Court |
Timothy L. Williams, pro se. Julie M.T. Foster, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined deficiencies in petitioners' Federal income tax and accuracy-related penalties for substantial understatements of income tax as follows:1
Penalty Sec
Year Deficiency 6662(a) and (b)
1991 .............. $ 4,024 -0-
1992 .............. 14,645 $2,929
1993 .............. 8,013 1,603
All references to petitioner are to Timothy L. Williams. All numbers are rounded to the nearest dollar. After concessions,2 the issue for decision is whether petitioners are entitled to deduct losses attributable to certain S corporations in excess of the amounts allowed by respondent. Disposition of this issue turns on the amount of petitioner's basis in his stock in and loans to the S corporations and the extent, if any, to which petitioner recognized income upon the acquisition by one of these corporations of assets from the other.
Some of the facts have been stipulated, and are so found. The stipulations of fact and attached exhibits are incorporated by this reference. At the time the petition was filed, petitioners resided in Columbia, South Carolina.
In 1987 petitioner founded Williams Investigative & Security Services, Inc. (WIS). Petitioner was the operator and sole shareholder of WIS throughout its existence. WIS was primarily engaged in the business of insurance investigations; it also provided security services.
Throughout 1990 WIS was in a dispute with a client over a major security services contract. The client unilaterally cut back the amount of services required, then terminated the contract prematurely and disavowed representations it had made to WIS concerning future work engagements. At the end of the year, WIS filed suit for fraud, breach of contract and promissory estoppel, seeking recovery of compensatory and punitive damages arising from the loss of the contract and the valuable engagements. See Kemira, Inc. v. Williams Investigative & Sec. Serv., Inc., 450 S.E.2d 427 (Ga. Ct. App. 1994).
As WIS's financial situation deteriorated, it was compelled to borrow. Third-party loans were not sufficient, however, to keep WIS afloat. During 1990 petitioner provided additional capital, both through contributions and loans. In January 1990 petitioner made two deposits totaling $29,000 into the WIS payroll account maintained at the Citizens & Southern National Bank. On February 28, petitioner executed a promissory note and security agreement in favor of Navy Federal Credit Union in exchange for a personal loan of $14,000. He then deposited the loan proceeds into the WIS account at Palmetto Federal. The deposit slip identifies the amount deposited as "Loan". On March 1 petitioner entered into a sale-leaseback agreement with Palmetto Rental & Leasing, Inc. (PR&L), with respect to five motor vehicles. PR&L purchased the vehicles and agreed to lease them to WIS for a stated term. All proceeds of the sale were deposited into WIS's account at Palmetto Federal on March 5. The proceeds attributable to each vehicle were as follow:
Ford Aerostar ........................ $3,330
Toyota Pickup ........................ 2,050
Toyota Pickup ........................ 4,800
Toyota Cressida ...................... 4,000
Ford Bronco .......................... 8,000
______
22,180
For each vehicle except the Ford Aerostar, an Affidavit & Notification of Sale of Motor Vehicle identifies the seller as either petitioner alone or petitioners jointly. In the case of the Ford Aerostar, the seller is listed as "WMS Invest Sec & T. Williams". In each case the seller(s) correspond to the owner(s) identified on the vehicle's Certificate of Title.
On January 5, February 5, and May 30, 1990, petitioner used his personal credit cards to obtain cash advances on WIS's behalf totaling $19,500. On August 24, petitioner deposited a personal check in the amount of $15,000 into WIS's account at Palmetto Federal. The deposit slip identifies the amount as "Loan".
At some point in 1991, WIS filed a petition for reorganization under chapter 11 of the Bankruptcy Code. Petitioner continued to operate the corporation in bankruptcy while it endeavored to pay its debts. By the end of the year petitioner had formulated a plan of reorganization (the business reincorporation transaction). The insurance investigation business would be continued through a newly formed entity called Southeast Professional Services, Inc. (SPS), and the security services business discontinued. WIS would transfer assets to SPS to provide the new company's initial capital and would also lease to SPS its equipment and furniture. As an inducement to help him manage the business, petitioner would share ownership of SPS with two associates named Lewis and Tate. Each would hold an equal one-third share of SPS's newly issued stock, but only petitioner among the three holders would be responsible for an initial contribution of property, which would be supplied by WIS.3
SPS was organized on December 31, 1991. Its opening balance sheet as of that date shows current assets of $23,509, consisting of $5,000 in cash and $18,509 in accounts receivable. Deposit slips show three separate deposits in the total amount of $5,000 were made into SPS's account at NCNB National Bank during December 1991. Two of these deposits are traceable to a check for $3,000 drawn on WIS's account. Transfer of the accounts receivable reflected on SPS's opening balance sheet is substantially confirmed by payments made to SPS on these accounts in the total amount of $17,911 in January and February 1992. The parties have stipulated that WIS transferred additional accounts receivable to SPS in 1992. These receivables represent work for which WIS issued invoices during January 1992. Although the stipulated amount of the receivables transferred in 1992 is $8,141, comparison of the invoices evidencing these additional receivables with the checks evidencing the initial $18,509 of receivables reveals an overlap of $1,003. Accordingly, a total of $7,138 of accounts receivable was transferred by WIS to SPS at the beginning of 1992.
There is no evidence that any liabilities of WIS to petitioner or third-party creditors were assumed by SPS or otherwise satisfied or discharged as part of the business reincorporation transaction. There is no evidence that Lewis and Tate received their stock in SPS in exchange for any contribution of property or preincorporation services on SPS's behalf. Nor is any indebtedness of the corporation to a shareholder or of a shareholder to the corporation reflected on SPS's opening balance sheet.
The record contains no direct evidence establishing when petitioner actually received his stock in SPS. If SPS issued its stock in December 1991 before receiving full payment of the consideration, then the unpaid balance would presumably have appeared as an asset on the corporate balance sheet as of December 31, 1991. The absence of any such entry suggests that the stock was more likely issued when fully paid, following the transfer of the $7,138 of additional receivables at the beginning of 1992.
Following the aforesaid transfers of property, WIS ceased active business but remained in existence to collect rental income from the lease of its fixed assets and any damages that it might be awarded in the lawsuit filed in 1990 (presumably for the benefit of its creditors). The WIS chapter 11 proceedings concluded in 1992. Petitioner's attempt to revive the insurance investigation business through SPS was short lived. Lewis and Tate left the venture in 1992 and 1993, respectively, and SPS ceased business in 1994.
For all relevant years, WIS and SPS qualified as S corporations within the meaning of section 1361(a)(1). It appears that WIS had no accumulated earnings and profits from prior years in which it may have been a C corporation. Each corporation maintained its books and records and filed its returns using the cash method of accounting. In the absence of any evidence to the contrary, we assume that each corporation computed its income on the basis of a calendar year. See sec. 1378.
On their joint Federal income tax return for 1991, petitioners reported income attributable to WIS in the amount of $1,541. They also claimed a deduction for "other losses" in the amount of $136,748, which petitioners claim is attributable to WIS. The computation of the loss was disclosed in an attachment to the return. The attachment purports to be a balance sheet for WIS as of December 31, 1991, prepared for purposes of the chapter 11 reorganization. The balance sheet lists corporate assets, "pre-petition liabilities" and "post-petition liabilities", and reflects a deficit in shareholder's equity of $136,748.
On their joint Federal income tax return for 1992, petitioners reported income attributable to WIS in the amount of $6,777 and a loss attributable to SPS in the amount of $40,560. They also claimed a $129,972 deduction for "other losses". The copy of petitioners' return for 1992 that was submitted in evidence does not disclose how the "other losses" were computed. It appears, however, that this figure simply represents the $136,748 deficit in shareholder's equity of WIS reported for 1991 reduced by $6,777 of income earned by WIS in 1992.
On their joint Federal income tax return for 1993, petitioners reported a $36,464 loss attributable to SPS. The notice of deficiency explained respondent's determination regarding the losses claimed from WIS for 1991 and 1992 as follows:
1.e. The deductions of $136,748.00 and $129,972.00 shown on your returns for the respective taxable...
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