Wise v. Commissioner
| Decision Date | 26 October 1995 |
| Docket Number | Docket No. 18958-92. |
| Citation | 70 T.C.M. 1095 |
| Parties | James K. Wise and and Claudia R. Wise v. Commissioner. |
| Court | U.S. Tax Court |
Mario A. Mata, for the petitioners. Carl D. Inskeep, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined a deficiency in and additions to petitioners' Federal income tax as follows:
Additions to Tax
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Sec. Sec. Sec. Sec
Year Deficiency 6651(a)(1) 6653(a)(1) 6653(a)(2) 6661(a)
1985 ................................ $35,693 $8,881.50 $2,276.30 1 $8,923
1 50 percent of the interest due on the portion of the underpayment attributable to negligence
The issues for decision are: (1) Whether petitioners are entitled to deductions for business bad debts. We hold that they are to the extent stated herein. (2) Whether petitioners are entitled to interest expense deductions in excess of the amounts allowed by respondent. We hold that they are to the extent stated herein. (3) Whether petitioners are liable for the addition to tax under section 6651(a)1 for failure to timely file their Federal income tax return. We hold that they are liable. (4) Whether petitioners are liable for the addition to tax under section 6661(a) for substantial understatement of income tax. We hold that they are to the extent stated herein. (5) Whether petitioners are liable for the addition to tax under section 6653(a) for negligence. We hold that they are liable.
The stipulation of facts and attached exhibits are incorporated herein by this reference. At the time the petition herein was filed, petitioners resided in San Marcos, Texas. Petitioners filed a Form 1040, U.S. Individual Income Tax Return, using the status "married filing joint", for the year at issue. References to petitioner are to James K. Wise.
Prior to 1980, petitioner was in the banking business. He served as president and executive vice president of the First National Bank of San Marcos, Texas, from July 1973 until August 1980. After terminating his employment with the bank, petitioner became involved in the oil and gas business. He formed a number of partnerships and joint ventures with various individuals.
National Resources Oil Co. (NROC)
NROC was formed pursuant to the Texas Uniform Partnership Act by petitioner, Wilbur Wood (Wood), and Carlos Klutts (Klutts). Initially, NROC was involved in drilling and operating oil and gas wells for various partnerships and joint ventures formed by petitioner and his business associates. Petitioner had financial responsibilities as well as operational responsibilities for NROC. Petitioner withdrew $10,000 per month as a draw from the partnership.
NROC drilled approximately 80 to 90 wells in the Luling, Texas, area. Of these, approximately 36 wells were drilled and operated for seven partnerships formed by petitioner, Klutts, Wood, and other individuals.
During 1980, NROC was experiencing difficulties in obtaining pipe, tubing rods, pump jacks, and other oil and gas inventory due to the high demand for such products. To finance its purchases of inventory, NROC and its partners entered into a series of loan transactions with First State Bank of Weimar (Weimar Bank), resulting in an aggregated indebtedness on October 6, 1980, to Weimar Bank of $297,800. On October 6, 1980, the partners of NROC executed guaranty agreements with respect to the indebtedness to Weimar Bank. On October 12, 1982, the indebtedness was increased by $2,200 to $300,000.
Wise Oil Co.
Petitioner was also a partner in Wise Oil Co. (Wise Co.), with Klutts, Wood,2 and John Heger (Heger).3 Heger was president and chairman of the board of Weimar Bank during 1980 and 1983. During 1980 and 1981, Wise Co. borrowed money to finance its oil and gas operations from Victoria Bank & Trust (Victoria Bank), resulting in an aggregated indebtedness in the amount of $645,902. Petitioner signed promissory notes to Victoria Bank in different capacities, including individually and as a partner of Wise Co. The partners of Wise Co. guaranteed repayment of the borrowed funds to Victoria Bank.
AMROC Energy Corp.
On August 11, 1981, petitioner and his partners and coventurers organized AMROC Energy Corp. (AMROC), a Texas corporation. In connection with the formation of AMROC, the corporation participated in a private placement of its stock designed to raise working capital for the newly organized corporation. Petitioner was president, chief executive officer, and chairman of the board of AMROC. Petitioner was paid a salary of $3,000 per month from AMROC.
Sometime in 1981, all of the assets (except one piece of real estate) and liabilities of NROC along with the assets and liabilities of Wise Co. and the other partnerships and joint ventures were transferred into AMROC. The liabilities transferred to AMROC included the NROC note to Weimar Bank and the Wise Co. notes to Victoria Bank. In December 1981, petitioner and Klutts borrowed $300,000 from First National Bank of San Marcos and lent this amount to AMROC.
During the early part of 1982, AMROC could not make payments on its outstanding debts. In June 1982, petitioner severed his employment with AMROC when the corporation could no longer pay his salary. The corporation was insolvent by December 1982. Some of the assets of the partnerships and joint ventures that had been transferred to AMROC in 1981 were transferred, in 1982, back to some of the former partners and joint venturers. AMROC ceased doing business.
H&W Energy Corp.
The assets that AMROC had received from Wise Co. were transferred to H & W Energy Corp. (H & W), a partnership formed by Heger and Wood. Heger and Wood assumed the liabilities to Victoria Bank that had originated from Wise Co.
In April 1983, the $300,000 debt, plus accrued interest of $22,553.42, to Weimar Bank matured. At the time of maturity, the obligors on the loan were Wood, Klutts, and petitioner. Unable to pay off the loan, the obligors and Weimar Bank entered into another loan agreement (referred to as a renewal agreement), effective April 26, 1983. As a condition for renewal, the bank required payment of the accrued interest and a pledge of collateral. Because the obligors could not make a payment, Heger arranged for Klutts and petitioner to borrow $52,553.42 from Weimar Bank (loan #2). Of that amount, $22,553.42 was applied as payment of the accrued interest on the original indebtedness. The balance, $30,000, was transferred to the National Bank of Commerce to pay a secured debt owed by Wood. The collateral on the secured debt, certain oil and gas wells in which Wood had an interest, was then released. Thereafter, the oil and gas wells were pledged as collateral on the original Weimar Bank indebtedness.
By April 1983, petitioner and his partners were substantially in debt. Eventually, Wood and petitioner had approximately $3 million in personal liability on debts incurred in connection with the various partnerships and joint ventures. Wood's indebtedness at Weimar Bank reached such a high level that the bank would not give him any additional financing.
In January 1985, a restructuring of the Weimar Bank loan took place. On January 25, 1985, a new promissory note to Weimar Bank in the amount of $400,000 was executed by petitioner and Klutts. The new note represented a consolidation of: $200,000 of the original indebtedness (two-thirds of $300,000, i.e., the amount allocated to Klutts and petitioner); $6,877.73 representing petitioner's and Klutts' share of accrued interest on the original indebtedness; $53,919.44 representing the principal, plus accrued interest on loan #2; $41,046.73 representing a separate personal obligation of Klutts to Weimar Bank; and $100,000 which was applied to the debt owed by Wise Co. to Victoria Bank. The total interest financed or refinanced through the $400,000 loan was $30,797.17.4 In April 1985, a payment of $53,189 was made on the $400,000 obligation.
Petitioners executed a promissory note, dated August 15, 1975, to Mrs. F.K. Wise, the mother of petitioner. The note was in the original amount of $37,624 and provided that installment payments of $3,000 would be made annually in August. On August 21, 1985, petitioner signed a check for $6,000 payable to Mrs. F.K. Wise. The amount included the annual installment payment of $3,000, due in August 1985, and an additional amount of $3,000. The interest due at the time of the 1985 installment payment was $2,773.
On their Federal income tax return for 1985, petitioners claimed deductions for business bad debts as follows: Miscellaneous — $1,545; Texaroda — $30,000;5 Wood — $53,919; and Heger and Wood — $50,000.6
Petitioners delivered their 1985 Federal income tax return to an individual who came to San Marcos to pick up tax returns for filing with the Internal Revenue Service (IRS).
OPINIONIssue 1. Bad Debt Deductions
Respondent disallowed all of petitioners' bad debt deductions claimed on their 1985 Federal income tax return. Petitioners argue that petitioner was liable as guarantor for business-related debts of the various oil and gas entities, and consequently they are entitled to deductions for payments made on the entities' obligations. Furthermore, petitioners claim that a business-related debt owed to petitioner became worthless in 1985.
Petitioners assert that petitioner made a $1,000 payment on a $20,000 debt owed to Texas Commerce Bank. Petitioners assert that the debt was part of the liabilities transferred from Wise Co. and assumed by AMROC. Respondent argues that the loan is not deductible on a number of grounds, including that the payment was not...
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