Wilson v. U.S.

• Decision Date: 04 March 1976
• Docket Number: Nos. 74--1937,74--1938,s. 74--1937
• Citation: 530 F.2d 772
• Parties: 76-1 USTC P 9225 Garland WILSON, Jr. and Jane Wilson, Appellees, v. UNITED STATES of America, Appellant. AMERICAN NATIONAL BANK OF ST. JOSEPH, a National Banking Association, Executor of Estate of Elmore Y. Lingle, Deceased, and Florence A. Lingle, Appellees, v. UNITED STATES of America, Appellant.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 772

530 F.2d 772

76-1 USTC P 9225

Garland WILSON, Jr. and Jane Wilson, Appellees, v. UNITED STATES of America, Appellant.

AMERICAN NATIONAL BANK OF ST. JOSEPH, a National Banking

Association, Executor of Estate of Elmore Y.

Lingle, Deceased, and Florence A.

Lingle, Appellees, v. UNITED STATES of America, Appellant.

Nos. 74--1937, 74--1938.

United States Court of Appeals Eighth Circuit.

Submitted May 12, 1975.

Decided Feb. 11, 1976.

Rehearing and Rehearing En Banc

Denied March 4, 1976.

Joseph M. McManus, Tax Div., Dept. of Justice, Washington, D.C., Bert C. Hurn, U.S. Atty., Kansas City, Mo., Scott P. Crampton and Gilbert E. Andrews, Appellate Sec., Tax Div., U.S. Dept. of Justice, and Jonathan S. Cohen, Tax Div., Dept. of Justice, Washington, D.C., for appellant.

Joseph A. Hoskins, Walter J. Kennedy, Kansas City, Mo., for appellees.

Before LAY, ROSS and WEBSTER, Circuit Judges.

WEBSTER, Circuit Judge.

Following a deficiency determination by the Commissioner of Internal Revenue resulting from the exercise of his reallocation of income powers, taxpayers brought a tax refund suit in the District Court. The government appeals from an adverse judgment.

Before giving a more detailed recitation of the facts in evidence which otherwise may seem complex and confusing, it may be helpful to present in capsule form the genesis of the dispute and the government's contentions on appeal.

In 1964, taxpayers formed a corporation to provide consulting services in connection with the establishment of a new meat packing plant in Sterling, Colorado. Compensation was to be based upon a percentage of the profits of the plant. The service corporation paid taxpayers only a small portion of the compensation received. Taxpayers subsequently transferred their stock to members of their families. The Commissioner determined that the income paid to the service corporation had actually been earned by the taxpayers and reallocated such income, which resulted in tax deficiencies in 1968 and 1969.

The government contends that the District Court erred in directing a verdict for taxpayers on the Commissioner's allocation under Section 482 of the Internal Revenue Code of 1954 and in refusing a directed verdict for the government on the issue of assignment of income under Section 61 of the Code.

We now examine the facts in more detail.

Taxpayers Garland Wilson and Elmore Lingle ¹ were, during the period of the events previously summarized, the president and chairman of the board respectively of Seitz Packing Company of St. Joseph, Missouri. In 1962, Seitz purchased cattle from John Leibsek, a cattle feeder in Sterling, Colorado. Later that year, Leibsek and Bill Seckler contacted Wilson and Lingle concerning the possibility of establishing a meat packing house in Sterling. Lingle traveled to Colorado to study the area, but nothing developed from that visit.

In the spring of 1964, Wilson and Lingle were contacted by Seckler and another cattle feeder, Edward Sonnenberg, neither of whom were knowledgeable about the meat packing industry. They sought the taxpayers' advice and assistance in establishing a packing house. Wilson and Lingle traveled to Colorado to meet with a group of cattle feeders. The two men, with the assistance of Mr. McGlumphy, a Seitz vice-president, then conducted an all-encompassing feasibility study. Sometime during that period, an arrangement to pay these three Seitz officials was set up. It provided:

Management Fee. Twenty per cent of the profit of the plant before taxes will be paid to the Wilson, McGlumphy and Lingle interest as a management fee. This is for the work of planning the operation, laying out the plant, training the people in Sterling as employees, setting up the systems and controls and developing the markets. Certain key people will be brought from the Seitz Packing Company to be the resident manager of the new plant and to take charge of various departments.

The feasibility study and negotiations between the parties continued for several months until a decision was made to carry out the project under a corporation to be named Sterling Colorado Beef Company. Sterling was incorporated in October, 1964.

Wilson, Lingle, and McGlumphy decided to incorporate their own consulting functions in order to avoid the risks of liability inherent in operating on an individual or partnership basis, and, on November 5, 1964, Packers Advisory Company was incorporated. Shortly thereafter, Packers elected to be taxed as a Subchapter S corporation. As of December 31, 1964, Wilson and Lingle each owned 120 shares of the Packers stock and McGlumphy owned the remaining 60 shares.

On February 9, 1965, Packers and Sterling entered into a contract providing for contingent compensation payments to Packers based on a percentage of Sterling's net profits in return for advice by Packers to Sterling. ² The contract specifically provided that it was to be construed solely as an agreement between Sterling and Packers and was not to be taken as requiring the individual services of any particular officer or employee of Packers. Sterling retained the right to cancel the agreement if Packers failed to provide 'qualified, experienced, competent and capable personnel'; it was stipulated that present and future officers, directors, and employees recruited from Seitz met these requirements as long as Seitz remained an independent packer.

A period of considerable efforts to establish Sterling as a viable operation followed. Wilson made three or four trips to Colorado in the summer of 1965 and moved there in September, 1965, remaining until May, 1966. Lingle remained in St. Joseph managing Seitz, but continued to help set up Sterling. McGlumphy devoted his time in the Sterling area to procuring high quality cattle for the packing house. Packers also secured the services of several other Seitz employees as they were needed. Sterling was not an immediate success, but by 1968 its problems had been largely worked out. As the company became established, the need for Wilson and Lingle's services diminished.

During the years from 1964 to 1967, taxpayers received no compensation from Packers in payment for their services to Sterling because Sterling earned no profit. In both 1968 and 1969, they each received a $6,000 'consulting fee' from Packers for their efforts. During these same two years, Sterling paid Packers a total of $233,000 ($113,000 in 1968 and $120,000 in 1969).

In January, 1967, Wilson gave 110 of his 120 shares of Packers stock to his children--55 to each child--and Lingle did likewise. Later in 1967, McGlumphy disposed of his 60 shares; Wilson and Lingle each thereafter acquired 10 additional shares, leaving each with a total of 20 shares. In February, 1968, Wilson and Lingle each transferred 18 of their shares to their children and the remaining 2 shares to a third party, thereby terminating their ownership interests in Packers. Wilson and Lingle remained as the directors and officers of Packers and continued to vote the stock through proxies given by their children.

The Commissioner determined that Wilson and Lingle had each received compensation from Packers in the amounts of $41,953.38 in 1968 and $44,937.62 in 1969 in excess of the $6,000 which each had reported on their federal income tax returns.

Following payment of the deficiency, the taxpayers brought this action to obtain a refund pursuant to 26 U.S.C. § 7422. At trial, the government defended the assessments on four grounds: (1) Section 482 of the Internal Revenue Code ³ empowered the Commissioner to make such a reallocation between two commonly owned trades or businesses in order to properly reflect income as it was earned; (2) Section 1375(c) of the Code ⁴ supported the Commissioner's action since it requires apportionment of income among shareholders who are members of the same family in order to properly reflect the value of services rendered to a Subchapter S corporation; (3) Section 61 of the Code ⁵ and the 'assignment of income' doctrine developed under that section justified the determination since Wilson and Lingle had assigned income they earned to Packers; and (4) Packers was a sham corporation having no legitimate business purpose and should be disregarded as an entity for tax purposes.

At the conclusion of the taxpayers' case, the District Court denied the government's motion for a directed verdict on the Section 482, Section 61, and sham corporation issues. At the close of all the evidence, the taxpayers moved for a directed verdict on all four issues. The District Court granted taxpayers' motion on the Section 482 issue, holding that there were not two or more trades or businesses under the taxpayers' common control as is required by the statute. The court also granted a directed verdict on the Section 1375(c) issue since at the time that the first income was paid from Sterling to Pakers the taxpayers were not shareholders in Packers. The court refused to grant a directed verdict on the sham corporation issue and instructed the jury that the sole issue for it to decide was whether Packers was a sham corporation; it thereby precluded consideration of the assignment of income issue on any other grounds. There was no express ruling on, or submission to the jury of, the Section 61 issue. The jury returned a verdict in favor of Wilson and Lingle on the sham corporation issue. ⁶ The District Court thereafter denied the government's motion for judgment notwithstanding the verdict and for new trial.

I

Section 482 Issue

Section 482 of the Internal Revenue Code provides:

In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such...