DocketNumber: Docket No. 13472-88
Judges: PARR
Filed Date: 8/15/1991
Status: Non-Precedential
Modified Date: 11/21/2020
*434
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiencies in and additions to petitioners' Federal income tax:
The issues for decision are:
(1) Whether petitioners are entitled to deductions and investment tax credits claimed in connection with the purchase 2 of a master recording;
(2) whether petitioners are *435 liable for additions to tax for negligence pursuant to
(3) whether petitioners are liable for additions to tax for valuation overstatement pursuant to
(4) whether interest should be computed pursuant to
(5) whether petitioners conceded that the long-term capital loss carryovers on their 1984 and 1985 tax returns were computed incorrectly.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioners resided in Cypress, California, at the time they filed their petition. Everett H. Hinojos (hereinafter*436 petitioner) was employed as an aviation safety inspector by the Federal Aviation Administration. Christine Hinojos was employed by the Social Security Administration in Long Beach, California.
In 1983, petitioners were solicited by their accountant, G. West Munz (hereinafter Munz), concerning a "lucrative" business opportunity in the purchase of a master recording. Prior to signing the agreement, petitioner listened to a portion of the recording and was shown a potential income projection for the Munz tape collection.
On December 9, 1983, petitioner signed a master recording agreement for the purchase of master recording BR-46 for $ 60,000 with K.C. Agency, a marketing company set up and owned by Munz to handle the direct mailing aspect of the business. Petitioner did not negotiate with Munz regarding the price or the terms of the master recording agreement. Munz retained the original master recording as well as the copyright to it. The purchase price was to be paid in three installments: $ 2,250 was due upon the signing of the agreement, $ 2,250 due by April 30, 1984, and the final installment for $ 55,500 was payable over 10 years at an annual interest rate of 10 percent. *437 The deferred payments were secured by a recourse note, which was to be paid from royalties from the distribution or retail sales of recordings made from the master recording.
On January 3, 1985, petitioner entered into a royalty agreement with FAC $, a marketing company set up and owned by Munz to distribute the cassettes through bookstores. The agreement stated in part that petitioners would receive quarterly royalty payments at a rate of 25 percent of all proceeds received from the distribution of the cassettes after the note is paid in full. Petitioners made the first two cash installments totaling $ 4,500, but made no payments with respect to the $ 55,500 recourse note since there have been no meaningful profits resulting from the master recording. 3
Petitioner had no expertise in the recording industry, marketing, or investment analysis, yet he never consulted*438 with an attorney, had the master recording appraised, insured, or evaluated as to its commercial viability prior to signing the agreement. He failed to conduct a title search to ascertain whether the recording was free from any encumbrances. He never inquired as to how Munz determined the purchase price of $ 60,000, for which there was no negotiation. He relied solely on Munz' representations as to the master recording's worth and commercial viability.
Munz, a certified public accountant (CPA), was "responsible" for advertising, marketing, distributing, and updating petitioner's master recording, although he was not legally obligated to do so. At no time during the periods in issue did petitioner receive an accounting from Munz, nor was Munz legally obligated to provide one.
Munz did not have the master recording appraised. He determined the price of $ 60,000 by conjecture; he read some opinions from the attorneys of very large cassette manufacturers, which valued other master recordings from $ 180,000 to $ 300,000 and with a conservative intent, chose $ 60,000. Munz wrote the script and narrated the master recording. The tangible property constituting the recording cost *439 30 cents.
On his 1983 return, petitioner reported a long-term capital loss of $ 11,057 and claimed a $ 3,000 deduction; he also claimed a depreciation deduction of $ 12,838 and an investment tax credit of $ 5,500. 4 On his 1984 return, petitioner reported gross receipts derived from the master recording of $ 295, claimed a long-term capital loss of $ 3,000, a depreciation deduction of $ 11,495, and an interest deduction from business indebtedness of $ 295. On his 1985 return, petitioner reported gross receipts derived from the master recording of $ 367, claimed a long-term capital loss of $ 1,029, a depreciation deduction of $ 10,450, and an interest deduction from business indebtedness of $ 367.
In his notice of deficiency, respondent disallowed the entire amount of these deductions and the investment tax credits claimed in connection*440 with the master recording. Furthermore, respondent reduced petitioner's deductions derived from the capital loss carryovers for tax years 1984 and 1985.
OPINION
The first issue is whether respondent properly disallowed petitioner's deductions and credits with respect to the master recording. Petitioner bears the burden of establishing that he is entitled to the claimed deductions and credits.
It is well settled that a taxpayer's right to both depreciation deductions under
The determination of whether an activity is engaged in for profit is to be made by reference to objective standards, taking into account all of the facts and circumstances of each case. Greater weight must be given to objective facts than to the taxpayer's mere statements of intent.
The regulations under
Petitioner had neither education nor experience in the recording industry at the time he purchased the master recording. Moreover, despite his lack of expertise, petitioner did not seek the advice of counsel or have the recording appraised. In fact, petitioner was unaware, and somewhat unconcerned, as to whether Munz had the recording appraised. Petitioner relied solely upon the advice of a party with an interest in the transaction, Munz, that the recording was worth $ 60,000.
Munz, a CPA, had no previous expertise in the valuation of recordings, investment analysis, or marketing strategies. His only previous experience in the industry was with Magnamedia Company. Magnamedia sold motivational cassettes throughout the nation to AMWAY distributors. Munz made a tape on tax information for Magnamedia, but he was in no way involved in the valuation, distribution, or the advertising of that cassette.
Munz determined *443 the price of $ 60,000 for petitioner's investment by reviewing dissimilar tapes which sold for $ 180,000 to $ 300,000 and valuing his tapes "conservatively" downward, i.e., guessing. Yet, although counsel for petitioner states that reliance on such professional advice is expressly stated as evidence of good faith in the regulations as well as in case law, petitioner failed to make such elementary inquiries as to Munz' qualifications as a valuation, investment, or marketing expert. He failed to obtain independent expert advice as to the soundness of the transaction. Such behavior is inconsistent with ordinary business practice and is evidence that petitioner lacked a profit objective.
The presence of deferred debt that is in substance or in fact not likely to be paid is an indicium of lack or exaggeration of economic substance.
Here, the bulk of consideration was deferred by a recourse note that was nonrecourse in substance. The terms of the note read: First, $ 2,250 due upon the*445 signing of this Contract. Second, $ 2,250 due and payable by the 30th day of April, 1984 (thus completing the down payment). Third, $ 55,500 which is the balance due within a term of no more than 10 years and at an interest rate of 10%. Well, hopefully, I would have had some profits by then, to be able to make payment, if there was anything. With ten-year projections, I figured, you know, in ten years, there's a good chance I can get my money back, plus.
As to Munz, he asserts only that he is hopeful that petitioner will pay the note, not that he intends to enforce it. He admits that he never checked petitioners' *446 creditworthiness, although he alleges that he knows their financial strength via their tax return. In view of the foregoing, we believe that there was never an intent by petitioner to pay off the note, or by Munz to enforce it.
All in all, petitioner managed his investment in an unbusinesslike fashion and expended no effort or time. We conclude that petitioner's investment in the master recording is void of economic substance and was entered into solely for the purpose of receiving tax benefits. Accordingly, the master recording investment should be ignored for Federal income tax purposes.
Having so concluded, we now address the interest paid on recourse debt. In
We sustain respondent's disallowances as to the depreciation deductions, interest deductions, and investment tax credits.
Additions to Tax
Petitioner relied solely upon the purported representations of Munz, a party with an interest, who created the transactions giving rise to the erroneous deductions and credits. Such reliance is unreasonable and contrary to what a reasonably prudent investor would have done. A reasonably prudent investor would have, at the least, sought independent counsel, obtained an appraisal, and determined the commercial viability of the master recording prior to signing the agreement. Petitioner has clearly not met his burden. Accordingly, the additions to tax under
Respondent determined additions to tax for 1980, 1983, 1984, and 1985.
In
The exact date the master recording was put in service was never established. Petitioner signed the contract in December 1983, took depreciation deductions starting 1983, and signed the royalty agreement in January 1985.
We have found petitioner's investment*451 in the master recording devoid of economic substance, and thus, disregarded for Federal tax purposes. Therefore, petitioner's adjusted basis in the asset is zero for purposes of depreciation and investment tax credit.
Accordingly,
This section provides that with respect to interest payable under section 6601, any substantial underpayment (an amount exceeding $ 1,000) attributable to tax motivated transactions shall be subject to an annual*452 rate of interest of 120 percent of the adjusted rate established under
Capital Loss Carryovers
Finally, we address the issue whether petitioner conceded that the long-term capital loss carryovers on petitioners' 1984 and 1985 tax returns were computed*453 incorrectly. The long-term capital loss carryover remained an issue when the case was tried. Because petitioner failed to address the issue in his brief and since the issue was not stipulated, the issue is deemed to be conceded.
Even if petitioners did not concede the issue, the Court agrees with respondent's determination in his notice of deficiency. If capital losses exceed gains,
Hence, petitioners could deduct $ 3,000 from ordinary income in 1983 from their long-term capital loss carryforward of $ 11,057. The amount carried forward to 1984 is determined by reducing the 1983 loss by $ 6,000, i.e., double the $ 3,000 loss recognized in that year. Sec. 1212(b)(2)(B). Petitioner correctly calculated his 1983 long-term capital loss.
In 1984, however, respondent allowed petitioner $ 2,528 as a long-term loss carryforward deduction from ordinary income, *454 not $ 3,000 as claimed by petitioner. The amount of loss carryforward to tax year 1985 is reduced by double the 1984 deduction, i.e., $ 5,057. Thus, petitioners had no remaining long-term capital loss to carry forward to 1985. The calculations determined by respondent in his notice of deficiency are sustained.
To reflect the foregoing,
1. All section references are to the Internal Revenue Code as amended and in effect for the taxable years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure. ↩
*. 50 percent of the interest due on the deficiency.↩
2. The use of such terms as "agreement," "lease," "paid," and "purchase" are used strictly for convenience to describe the transactions involved in this case, and should not be construed as connoting any conclusions as to the legal effect of the documents and transactions.↩
3. Petitioner reported income from the master recording of $ 295 in 1984 and $ 367 in 1985, all of which was attributable to interest on indebtedness.↩
4. Of the $ 5,500 credit in 1983, petitioner used $ 1,115 in 1983, carried forward $ 1,953 to 1984, and filed for a refund of $ 4,385 for 1980 by amending his return for that year.↩
*. By official Tax Court Order dated August 21, 1991, and signed by Judge Carolyn Miller Parr↩, the decision line was amended to read as indicated.
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