JPB Holdings Inc v. Dept. of Rev.

IN THE OREGON TAX COURT
MAGISTRATE DIVISION
Income Tax
JPB HOLDING, INC., JAMES )
BRINSFIELD, DEC’D, and JANET )
BRINSFIELD, )
)
Plaintiffs, ) TC-MD 150319N
)
v. )
)
DEPARTMENT OF REVENUE, )
State of Oregon, )
)
Defendant. ) FINAL DECISION
This Final Decision incorporates without change the court’s Decision, entered March 7,
2016. The court did not receive a statement of costs and disbursements within 14 days after its
Decision was entered. See TCR-MD 16 C(1).
Plaintiffs appeal Defendant’s Notice of Deficiency Assessment dated April 29, 2014, for
the 2011 tax year. The parties agreed at the case management conference held June 4, 2015, to
submit the matter to the court on cross motions for summary judgment. The parties agreed to
and adhered to a schedule for filing stipulated facts, stipulated exhibits, motions for summary
judgment, and responses. A hearing by telephone was held on December 3, 2015. Douglas A.
Capps, CPA, appeared on behalf of Plaintiffs. Gwendolyn S. Hessong (Hessong), CPA, testified
on behalf of Plaintiffs. Celita C. Holt (Holt) appeared and testified on behalf of Defendant. The
parties stipulated to Exhibits 1 through 9 and Exhibits A through F. Plaintiffs filed their
Statement for Costs and Disbursements on December 9, 2015, and Defendant filed its Objection
to Award of Costs and Disbursements on December 16, 2015.
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FINAL DECISION TC-MD 150319N 1
I. STATEMENT OF FACTS
JPB Holding, Inc. (JPB) is a holding company with no operations itself. (Stip Facts at
¶16.) JPB was formerly Brinsfield’s Boat Basin, Inc. (Company); on November 16, 2005,
Company filed amended Articles of Incorporation to change its name to JPB. (Id. at ¶7.)
Company was incorporated in Oregon on September 6, 2002. (Stip Facts at ¶1.) Also on
September 6, 2002, James Brinsfield (Brinsfield) transferred the assets of the unincorporated
entities, Brinsfield Boat Basin (Boat Basin) and Fabulous 50’s Motor Car Company (Motor) to
Company, in exchange for stock and securities of Company.1 (Id. at ¶2.) Company assumed the
liabilities of the two unincorporated entities. (Id.) Brinsfield was the sole shareholder of
Company. (Id.) The parties stipulated that an unsecured promissory note (Note Payable) was
issued to Brinsfield by Company. (Id. at ¶3.) However, the Note Payable referenced in the
Stipulation of Facts was executed between JPB and Brinsfield, with an effective date of
September 6, 2002. (See Ex 2.)
On January 1, 2005, Brinsfield transferred the assets of Valley View Stables (Stables) in
exchange for stock and securities of Company, and Company assumed the liabilities of Stables.2
(Stip Facts at ¶4.) The debt assumed by Company in the exchange of Stables “is collateralized
by the business equipment and real estate located at 10037 SE 172nd Ave in Happy Valley,
Oregon.” (Id. at ¶5.) “James and Janet Brinsfield personally borrowed the debt collateralized by
the buildings and land used in the operations of [Stables]. This debt [is comprised of] mortgage
line of credit loans with Wells Fargo Bank and 1st Independent Bank.” (Id. at ¶6, citing Ex 4.)
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1
Motor “is a classic automobile repairing, renovating and selling business.” (Stip Facts at ¶10.)
2
Stables “is a horse raising, breeding and training business.” (Stip Facts at ¶9.)
FINAL DECISION TC-MD 150319N 2
JPB “sold all of the business assets of [Boat Basin] on November 25, 2005.” (Stip Facts
at ¶8.) Thus, as of the 2011 tax year, JPB held only the assets of Motor and Stables.
Motor and Stables maintained accounting records using the cash basis method of
accounting under the Generally Accepted Accounting Principles (GAAP). (Stip Facts at ¶13.)
The records contained the balances of the assets, liabilities, equity, income and expenses of
Motor and Stables. (Id.) The accounting records of Motor and Stables were consolidated and
recorded into the accounts of JPB through the use of a general consolidating journal entry at the
year end. (Id. at ¶14–15) This accounting journal entry debited assets and expenses, and
credited liabilities and income. (Id.) The difference between those debit and credit entries,
which equaled shareholder equity, was posted to a “Note Payable Shareholder” account. (Id.)
JPB has annually reported the consolidated accounting information to tax authorities by
filing consolidated corporate income tax returns with the Internal Revenue Service and the
Oregon Department of Revenue. (Stip Facts at ¶17.) The parties agreed that JPB’s 2011 Form
1120S, U.S. Income Tax Return for an S Corporation, (Form 1120S) reports a beginning balance
for Note Payable Shareholder of $297,937 and an ending balance of $223,524.3 (Id. at ¶19; Ex A
at 1.) Form 1120S reports beginning and ending balances of “Building and other depreciable
assets” of $620,446 and $615,446, respectively. (Stip Facts at ¶20; Ex A-1.)
Defendant audited the 2010 and 2011 tax returns of JPB and, for the 2010 tax year,
decreased the ending balance of Note Payable Shareholder by $117,734, to $180,800. (Stip
Facts at ¶21; Ex C at 3.) In its 2010 Auditor’s Report, Defendant explained that “[t]here was a
decrease to the loans from shareholder of $117,734, as shown on the tax return and the basis
calculation worksheet.” (Ex C at 3.) Defendant noted that the decrease “was not labeled as a
3
The return attached as an exhibit reports “Other liabilities” as $297,937 (beginning) and $331,262
(ending). (Ex A at 1.)
FINAL DECISION TC-MD 150319N 3
distribution or loan repayment,” but concluded it was a loan repayment “because the notes
payable account on the tax return decreased by $117,734.” (Id.) Defendant determined that,
because “the adjusted basis of the loan was less than the face value, this resulted in a gain.” (Id.
at 1.) Defendant calculated the gain on the repayment to be $17,043. (Id. at 1, 3.)
For the 2011 tax year, Defendant “disallowed” an accounting journal entry made to Note
Payable Shareholder in the amount of $606,482.43. (Stip Facts at ¶22.) In its 2011 Auditor’s
Report, Defendant explained that it was “unknown how this number was derived; therefore it has
been disallowed.” (Ex C at 4.) Defendant wrote that it asked Plaintiffs “to provide information
regarding the shareholder loan, inclusive of cancelled checks and bank statements showing that
loans were received.” (Ex C at 3.) In response, Plaintiffs provided bank statements but not
cancelled checks. (See id.) Defendant found that Plaintiff failed to provide adequate
substantiation of the journal entry amount. (Def’s Mot Summ J at 1–2.) “Defendant did not
make a credit adjustment for $117,734 or $606,482.43 to an account in the accounting records of
[JPB].” (Stip Facts at ¶23.) The combination of Defendant’s adjustments to Note Payable
Shareholder created a negative balance of $392,357.43. (Id. at ¶24.) Defendant determined that
the negative balance in Note Payable Shareholder constituted a distribution in excess of basis to
Brinsfield, resulting in a taxable gain. (Id. at ¶25.)
Hessong testified that the $606,482.43 consolidating journal entry was made by JPB’s
bookkeeper and that the entry was the type required by JPB’s accounting software (QuickBooks)
“simply to make it balance.”
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FINAL DECISION TC-MD 150319N 4
II. ANALYSIS
Plaintiffs challenge the adjustments made by Defendant to JPB’s 2010 and 2011
corporate income tax returns that resulted in Defendant’s determination that Brinsfield realized a
taxable gain in 2011. (Ptfs’ Mot Summ J at 4.)
The Oregon Legislature intended to “[m]ake the Oregon personal income tax law
identical in effect to the provisions of the Internal Revenue Code relating to the measurement of
taxable income of individuals, estates and trusts, modified as necessary by the state’s jurisdiction
to tax and the revenue needs of the state[.]” ORS 316.007(1).4 “Any term used in this chapter
has the same meaning as when used in a comparable context in the laws of the United States
relating to federal income taxes, unless a different meaning is clearly required or the term is
specifically defined in this chapter.” ORS 316.012.
Generally, items of income or loss of an S corporation pass through to its shareholders.
IRC § 1366(a). “An S corporation must report, and a shareholder is required to take into account
in the shareholder’s return, the shareholder’s pro rata share, whether or not distributed, of the S
corporation’s items of income, loss, deduction or credit * * *.” Treas Reg 1.1366-1(a). “The
aggregate amount of losses and deductions taken into account by a shareholder * * * for any
taxable year shall not exceed the sum of” the shareholder’s adjusted stock basis and the
shareholder’s adjusted debt basis. IRC § 1366(d)(1). Disallowed losses and deductions may be
carried over to the succeeding tax year. IRC § 1366(d)(3). The shareholder’s stock and debt
bases must be adjusted as provided in IRC section 1367. If an S corporation with no
accumulated earnings and profits makes a distribution in excess of the adjusted stock basis,
“such excess shall be treated as gain from the sale or exchange of property.” IRC § 1368(b)(2).
4
The court’s references to the Oregon Revised Statutes (ORS) are to 2009.
FINAL DECISION TC-MD 150319N 5
In its audit of JPB’s 2010 and 2011 tax returns, Defendant decreased the 2010 ending
balance of Note Payable Shareholder by $117,734 based on Plaintiffs’ basis calculation
worksheet showing a $117,734 decrease to “loans to corporation”; and Defendant disallowed the
$606,482 credit journal entry to Note Payable Shareholder because Plaintiffs failed to
substantiate that credit journal entry. Defendant determined that the combined effect of those
adjustments was a negative balance in Note Payable Shareholder of $392,357, which Defendant
determined to be a distribution in excess of basis to JPB’s shareholder, Brinsfield.
Plaintiffs make several arguments in opposition to Defendant’s determination that
Brinsfield realized a taxable gain in 2011. Plaintiff’s arguments can be summarized as follows:5
A. Defendant’s audit determination contradicted the agreed upon Stipulation of
Undisputed Facts and Exhibits.
B. Plaintiffs provided substantiation for the $606,482.43 consolidating credit journal
entry so that Defendant’s disallowance of the journal entry on the basis of lack of
substantiation was erroneous.
C. Defendant incorrectly classified the distribution as taxable income from a
distribution in excess of basis.
(See Ptfs’ Mot Summ J at 4–5; see also Ptfs’ Resp at 6, 9.)
“In all proceedings before the judge or a magistrate of the tax court and upon appeal
therefrom, a preponderance of the evidence shall suffice to sustain the burden of proof. The
burden of proof shall fall upon the party seeking affirmative relief * * *.” ORS 305.427.
Plaintiffs must establish their claim “by a preponderance of the evidence,” or the more
convincing or greater weight of the evidence. Feves v. Dept. of Rev., 4 OTR 302, 312 (1971).
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5
Plaintiffs advanced an additional argument, that “Defendant is required to use the same methods of
accounting when applying the Defendant’s adjustments to the Plaintiffs’ accounting records that the Plaintiff and the
Plaintiffs’ businesses use.” (Ptfs’ Mot Summ J at 11–13.) In the court’s view, Plaintiffs’ disagreement with the
accounting methods used by Defendant is, at its core, a disagreement over the effect of Defendant’s adjustments to
Note Payable Shareholder. The court will address that issue through its discussion of Plaintiffs’ other arguments.
FINAL DECISION TC-MD 150319N 6
A. Contradiction of Stipulated Facts and Exhibits
The first issue raised by Plaintiffs is whether Defendant’s audit determination contradicts
the stipulated facts and exhibits. (Ptfs’ Mot Summ J at 6.) The Stipulation of Facts signed by
both parties details the beginning and evolution of JPB’s corporate structure, as well as the
accounting methods of JPB and its unincorporated subsidiaries, Motor and Stables. Plaintiffs
contend that, because Defendant stipulated to the existence of a set of facts at a particular point
in time as reported on Plaintiffs’ financial statements, Defendant has corroborated the underlying
transactions reflected in those financial statements, including the $606,482 consolidating journal
entry necessary to balance the balance sheet. (Ptfs’ Mot Summ J at 9.)
Defendant responds that it did not stipulate to the validity of the accounting transactions
recorded by Plaintiffs, nor did it agree that the note payable entry at issue was substantiated.
(Def’s Resp at 2.) Defendant did not accept the transactional methodology that produced
Plaintiffs’ final balances after the consolidating journal entry was made. (Id. at 2–3.) Defendant
wrote that “journal entries are not proof that contributions were actually made.” (Id. at 3.)
Plaintiffs’ logic is unpersuasive. An account balance reflected on a financial statement
could be calculated in any number of ways and the method of that calculation is critical to the
validity of the account’s ending balance. Whether amounts reported are adequately substantiated
is a separate issue. There is no dispute that the financial statements provided as exhibits were
prepared by Plaintiffs. However, Defendant did not agree that all amounts stated on Plaintiffs’
financial statements were substantiated—indeed, Defendant explicitly disagrees that Plaintiffs
substantiated the credit to Notes Payable Shareholder. Plaintiffs have failed to prove that
Defendant’s determination contradicts the Stipulation of Facts and Exhibits.
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FINAL DECISION TC-MD 150319N 7
B. Substantiation of Consolidating Entry
Plaintiffs argue that they offered sufficient substantiation for the consolidating journal
entry in the amount of $606,482, which Defendant disallowed.
Defendant explained that “[c]redit entries on a notes payable from shareholder increase
that notes payable; an increase to notes payable shareholder indicates that the shareholder made
contributions of some sort for the corporation; an increase to notes payable by the shareholder
would typically increase the shareholders debt basis in a corporation.” (Def’s Resp at 3.)
Defendant wrote that it requested documentation from Plaintiffs “to support the credit to Notes
Payable,” and, in response, Plaintiffs “provided the journal entries and mortgage loan
documents.” (Id.) In Defendant’s view, the “journal entries are not proof that contributions were
actually made. Furthermore, the mortgage loan documents did not show how they tied in with
the credit to Notes Payable.” (Id.)
ORS 314.425(1) states, in pertinent part, that taxpayers must be ready to produce “any
books, papers, records or memoranda bearing upon [any] matter required to be included in the
return[.]” OAR 150-314.425(2)(a) further states that “[a] taxpayer shall maintain all records that
are necessary to a determination of the correct tax liability under Chapters 316, 317 or 318. 6 All
required records shall be made available on request by the Department of Revenue or its
authorized representatives as provided for in ORS 314.425.”
When questioned about the amount of the credit entry during the hearing, Hessong
testified that the entry was made by JPB’s bookkeeper because QuickBooks required the entry to
balance the books. Plaintiffs provided no further evidence that any contributions were made to
substantiate the $606,482 credit entry (increase) to Note Payable Shareholder. In response to
6
References to OAR are to the Oregon Administrative Rules (OAR).
FINAL DECISION TC-MD 150319N 8
Defendant’s request for documentation during the audit, Plaintiffs provided Defendant with
mortgage loan documents and bank statements. (Ex E at 3–6.). Only one document provided
pertains to the 2011 tax year: A Wells Fargo bank statement from December 2011. (See id. at 3.)
Another document provided was a 2012 mortgage interest statement for Plaintiffs’ personal
residence. (See Ex E at 4; Stip Facts at ¶12.) The court agrees with Defendant that the
documentation provided by Plaintiffs do not substantiate the $606,482 credit journal entry to
Note Payable Shareholder.
If Plaintiffs had complied with the formalities of a third-party business loan and proven
the existence of a bona fide debt, or even provided mortgage documents and bank statements to
justify the consolidating journal entry amount, the note payable journal entry may have been
accepted by Defendant. Despite ample opportunity throughout the audit and this court
proceeding, Plaintiffs never provided adequate substantiation for the $606,482 credit journal
entry to Note Payable Shareholder.
C. Distribution as Taxable Income
As a result of its disallowance of the $606,482 credit to Note Payable Shareholder,
Defendant calculated a negative balance of $392,357. Plaintiffs argue that Defendant incorrectly
classified the negative balance of $392,357 as a taxable distribution in excess of basis.
Plaintiffs contend that for the negative balance of $392,357 to be treated as a distribution,
Plaintiffs must have actually received that distribution or be in constructive receipt of that
distribution, which Plaintiffs maintain did not occur in this case. (See Ptfs’ Mot Summ J at 14)
Generally, “[g]ains, profits, and income are to be included in gross income for the taxable year in
which they are actually or constructively received by the taxpayer unless includible for a
different year in accordance with the taxpayer’s method of accounting.” Treas Reg 1.451-1(a).
FINAL DECISION TC-MD 150319N 9
The “constructive receipt” doctrine holds that it is not necessary that a taxpayer always receive
money or property for income to be recognized because constructive receipt occurs when income
is credited and made available to the taxpayer. See Treas Reg 1.451-2(a). “However, income is
not constructively received if the taxpayer’s control of its receipt is subject to substantial
limitations or restrictions.” Id. Plaintiffs argue that they “did not receive a distribution of
$392,357 either in cash or by constructive receipt.” (Ptfs’ Mot Summ J at 15.)
In its Response, Defendant agreed with Plaintiffs that “[o]nly the amounts that were
distributed to or constructively received by the shareholders should have been a distribution.”
(Def’s Resp at 6.) Defendant revised its prior calculation of Plaintiffs’ taxable gain:
“Valley View Stables balance sheet showed that distributions were $312,745.29.
* * * As the distribution is in excess of their stock basis as shown on their basis
calculation provided * * *, according to IRC 1368, the excess is a taxable gain to
the shareholder. The reduced gain should be $287,597.29 ($312,745 updated
distribution - $20,498 income per basis calculation - $4,650 per capital
contributions determined during the audit).”
(Id.)
Despite Defendant’s revision, the parties fundamentally disagree as to the effect of
Defendant’s disallowance of the $606,482 credit to Notes Payable Shareholder. Defendant
classified the resulting negative balance as a distribution. Plaintiffs contend that
“[t]he disallowance by the Defendant of the year end consolidating general
journal credit to Note Payable Shareholder of $606,482 increased JPB Holding
Inc shareholder’s equity by $606,482. This increase to the JPB holding Inc
shareholder’s equity is a contribution to the capitol of the JPB Holding Inc by the
Plaintiffs. This contribution by the Plaintiffs increased the Plaintiffs’ shareholder
stock basis in the S corporation JPB Holding Inc by $606,482.”
(Ptf’s Mot Summ J at 13.)
The United States Tax Court “has looked to [IRC] section 1012 when defining ‘basis’ for
purposes of a shareholder’s stock in an S corporation.” Foust v. Comm’r, 70 TCM (CCH) 928,
FINAL DECISION TC-MD 150319N 10
1995 WL 581090 at *2 (US Tax Ct). Section 1012(a) states that “[t]he basis of property shall be
the cost of property * * *.” “The cost is the amount paid for such property in cash or other
property.” Treas Reg §1.1012-1(a). In Foust, the court held that a shareholder could not claim
basis credit where they failed “to demonstrate the necessary economic outlay.” Foust, 1995 WL
581090 at *2. Thus, a shareholder must demonstrate the requisite economic outlay necessary to
claim basis. See id.As discussed above, Plaintiffs failed to satisfy the burden of proof on this issue because
they did not provide evidence to substantiate a basis increase, such as documentation of money
or property exchanged for a note. The mere inference that shareholder basis has increased
because a journal entry indicates that it should fails to meet the requisite burden to prove that
Plaintiffs made an economic outlay that would increase shareholder basis. See ORS 305.427.
Accordingly, the court accepts Defendant’s revised calculation that Plaintiffs’ 2011 taxable
distribution in excess of basis was $287,597. See ORS 305.575 (“the tax court has jurisdiction to
determine the correct amount of deficiency,” even if that amount differs from the assessment
determined by the Department of Revenue.)
III. COSTS AND DISBURSEMENTS
Tax Court Rule-Magistrate Division (TCR-MD) 16 B allows for the award of costs and
disbursements to “the prevailing party.” To request costs and disbursements, a party must file a
statement of costs and disbursements “not later than 14 days after the entry of a decision * * *.”
TCR-MD 16 C(1). Plaintiffs’ Statement for Costs and Disbursements was filed on December 9,
2015, before the court issued this Decision; it was therefore filed prematurely. Moreover,
because Plaintiffs failed to carry the burden of proof, they are not the prevailing party.
Consequently, Plaintiffs’ request for costs and disbursements must be denied
FINAL DECISION TC-MD 150319N 11
IV. CONCLUSION
After careful consideration of the parties’ written arguments, testimony, and evidence, the
court concludes that Plaintiffs failed to carry the burden of proof. Defendant provided sufficient
evidence to support its disallowance of the $606,842 credit journal entry to note payable
shareholder, resulting in a taxable distribution of $287,597 to Plaintiffs in 2011. Now, therefore,
IT IS THE DECISION OF THIS COURT that Plaintiffs’ appeal is denied. Defendant’s
revised determination that Plaintiffs received a taxable distribution of $287,597 in 2011 is
upheld.
IT IS FURTHER DECIDED that Plaintiffs’ request for costs and disbursements is
denied.
Dated this day of March 2016.
ALLISON R. BOOMER
MAGISTRATE
If you want to appeal this Final Decision, file a complaint in the Regular
Division of the Oregon Tax Court, by mailing to: 1163 State Street, Salem, OR
97301-2563; or by hand delivery to: Fourth Floor, 1241 State Street, Salem, OR.
Your complaint must be submitted within 60 days after the date of the Final
Decision or this Final Decision cannot be changed. TCR-MD 19 B.
This document was filed and entered on March 25, 2016.
FINAL DECISION TC-MD 150319N 12