DocketNumber： Docket No. 3681-67.
Citation Numbers： 30 T.C.M. 817, 1971 Tax Ct. Memo LEXIS 136, 1971 T.C. Memo. 196
Filed Date： 8/10/1971
Status： Non-Precedential
Modified Date： 11/21/2020
(1) DP sold certain stock in 1963 in order to make a loan to a corporation. She received a noninterest-bearing demand note and an agreement in which the corporation acknowledged her loan and promised to pay any additional amounts necessary for her to repurchase the number of shares she sold in order to make the loan. Held, DP realized a capital gain in 1964 when, in accordance with the agreement, she received payments in excess of the amount loaned by her.
(2) JP was a member of a partnership, which in 1958 transferred substantially all of its assets and its business activity to a corporation. Thereafter, the partnership continued to hold some assets, made loans to the corporation, and filed Federal partnership returns. In 1963, it was issued certain
Memorandum *137 Findings of Fact and Opinion
SIMPSON, Judge: The respondent determined deficiencies in the income tax of the petitioners of $18,645.12 for 1964 and $2,496.00 for 1965. The issues for decision are (1) whether the petitioner, Doris Prizant, realized a gain, which is taxable as ordinary income, as a result of her loaning money to a corporation and being repaid more than she loaned; and (2) whether the petitioners are entitled to treat the loss on certain stock as an ordinary loss under
H. G. Prizant and Co. (the partnership) was a family partnership, organized on July 1, 1952, by Harry G. Prizant and his son, Jerome. Sometime during the fiscal year ending June 30, 1955, Sheldon H. Prizant, Jerome's brother, became a member of the partnership. The partnership's principal business activity consisted of designing, fabricating, and installing air conditioning and ventilation systems for multi-storied structures.
In May 1958, H. G. Prizant and Company (the corporation) was formed. Thereafter, at all relevant times, Jerome was 818 employed by the corporation. At such time, the partnership transferred a substantial amount of its assets and its business activity to the corporation in exchange for 100 shares of $100 par value common capital stock of the corporation. Such stock was continuously held by the partnership until June 30, 1964. The partnership, during the period prior to January 2, 1963, held cash in addition to the common stock of the corporation, and made loans to the corporation during such period in the aggregate amount of $42,000.
On January 2, 1963, at a special joint meeting of *139 the board of directors and the shareholders, the corporation was authorized to increase its capital structure. On the same date, pursuant to a plan conforming with the requirements of
On or about October 10, 1963, the corporation was in need of approximately $45,000 with which to meet its payroll. Apparently, neither Jerome nor the other shareholders had ready access to such sum. Jerome asked his wife to sell her stock in the Livingston Oil Company and loan the corporation $45,000. She then owned 7,350 shares of such stock, and she was reluctant to sell it, for she expected it to increase in *140 value. In discussions with Jerome, she indicated that she would not sell such stock unless the corporation would promise to repay her in such a way that she would be put back in the market with the number of shares of Livingston Oil that she had originally purchased.
On October 10, 1963, Mrs. Prizant sold 7,350 shares of Livingston Oil stock for the net amount of $108,417.32. Of the total proceeds realized on the sale, $57,205.50 was applied to Mrs. Prizant's margin account with her brokerage house, the stock having been purchased on margin. Of the remainder of such proceeds, $45,000.00 was delivered to the corporation.
The corporation, in return for the loan of $45,000, gave Mrs. Prizant a noninterestbearing demand note in the amount of $45,000 dated October 10, 1963, and also issued to her a letter agreement (the agreement) dated October 10, 1963. The agreement provided in part:
In consideration of the loan you have made to H. G. Prizant and Company it is mutually agreed that you shall suffer no monetary loss as it is understood that you have had to sell certain Stocks in order to obtain the funds for this loan.
The H. G. Prizant and Company hereby agrees to reimburse you for all *141 monies that may be required for you to repurchase SEVEN THOUSAND (7000) shares of Livingston Oil at the time the loan is paid back.
In addition, H. G. Prizant and Company will reimburse you for all selling and buying costs of said Stock, such as commission fees, etc.
In the event the market price of said Stock is lower than at the time it was sold, H. G. Prizant and Company will then be obligated to pay the principal amount of the loan and commission expenses only.
During the period October 24, 1963, through March 6, 1964, the corporation paid to Mrs. Prizant the aggregate amount of $77,500. Of such sum, $45,000 was reflected on the corporation's books as "Note payable," and $32,500 was reflected on such books as "Interest expense." No other amounts were paid by the corporation to her. On its United States corporation income tax return for the taxable year ended April 30, 1964, the corporation deducted as interest expense $32,500. Mrs. Prizant did not include such amount on her 1964 return.
During the period October 24, 1963, to March 19, 1964, Mrs. Prizant purchased on margin 6,400 shares of Livingston Oil stock with amounts paid to her by the corporation. The total purchase price, *142 plus brokerage fees in the approximate amount of $1,700.00, was $113,176.78. As a margin requirement, she paid $76,180.00 toward the purchase of such stock.
On June 30, 1964, the partnership transferred all of the stock it held in the corporation to Jerome, Harry Prizant, and Sheldon Prizant in accordance with their respective interests in the partnership. Jerome's share of such stock was 50 shares 819 of the original issue and 105 shares of the stock issued in 1963.
The corporation became insolvent on September 9, 1965, and on their 1965 joint income tax return, the petitioners claimed an ordinary loss deduction in the amount of $10,500 with respect to the worthlessness of the stock issued in 1963. On such return, the petitioners also reported the sale of 7,471 shares of Livingston Oil stock at a gross sales price of $79,438, having a cost basis of $111,669 and a date of acquisition of March 19, 1964.
Opinion
The issues for decision are (1) whether the petitioner Mrs. Prizant realized a gain in 1964, and if so, whether such gain is taxable as ordinary income; and (2) whether in 1965, the petitioner Jerome Prizant was entitled to an ordinary loss deduction under
Mrs. *143 Prizant initially takes the position that the amounts she received from the corporation in excess of the principal amount of her loan constituted a restoration of her capital. As we understand her argument, it is to the effect that the transactions in which she sold her stock, made a loan to the corporation, received payments from the corporation, and purchased stock should be treated for tax purposes as if she had loaned the stock itself. This Court rejected a similar contention in
It seems to us to be fundamentally unsound to determine income tax liability by what might have taken place rather than by what actually occurred. Even though the practical effect may be the same in either case, the resulting tax liability may be quite different. * * *
In effect, Mrs. Prizant is asking us to provide nonrecognition treatment for the series of transactions in which she engaged. Although there may have been ways in which she could have arranged such transactions to avoid tax consequences, we cannot, for that reason, ignore what was done.
Under section 1002, any gain realized on the sale or exchange of property must be recognized, *144 unless the gain comes within one of the statutory exceptions. Mrs. Prizant did not merely transfer her Livingston Oil stock to the corporation; she sold 7,350 shares then owned by her and received the proceeds of the sale, which she was free to use in any manner that she desired. Approximately $57,000 was used to discharge her margin account with her broker, and approximately $6,000 was apparently retained by her. Although she was under no obligation to make a loan to the corporation, she did, in a separate transaction, deliver $45,000 to the corporation as a loan. When the corporation repaid her, it did so with money, not stock, and although the amount of the repayment was determined by the then value of the Livingston Oil stock, she was free to use such money as she wished. She did reinvest it in Livingston Oil stock, but she was not required to do so. Under these circumstances, none of the statutory exceptions is applicable to this series of transactions, and we cannot overlook their tax consequences. Mrs. Prizant sold stock at a gain and made a loan which was repaid to her at a gain. Those gains must be recognized for tax purposes.
The petitioner urges that in theory her case *145 is similar to
Though Mrs. Prizant's gain on the loan must be recognized, it is not taxable as interest. Interest, for tax purposes, is an amount received as compensation for the use of money. Sec. 61(a)(4);
However, in
The arrangement in this case is quite unusual and presents us with an unusual problem; namely, was the agreement by the corporation additional consideration for the sale of the stock by Mrs. Prizant *148 or compensation for the loan by her? It appears that if she had possessed sufficient funds to make the loan, she would have done so without charging the corporation any interest or compensation for the use of her money. She was not seeking to make a profit on the loan; in fact, if the stock had remained at the same value or had declined in value, she would have realized no gain from the arrangement. She sought merely to be reimbursed for her selling and purchasing expenses and to be restored to her place in the market. Although the agreement did provide that she would be repaid at least $45,000 if the stock declined in value, that provision was not significant in the negotiations between the parties, since they did not expect the stock to fall in value; in fact, it did not.
The impediment to Mrs. Prizant making the loan was that she lacked sufficient funds to do so without selling her Livingston Oil stock, and she was most reluctant to sell it at that time. Unless the corporation could overcome that impediment, it could not secure the funds that it needed to borrow. The agreement was not a promise to pay her stated interest for the period of the loan, nor other income that varied with *149 the time, amount, or risk of the loan; instead, the amounts she was to receive pursuant thereto varied with the value of the Livingston Oil stock. Moreover, in asking her to sell her stock, the corporation was asking her to act substantially against her best interests with respect thereto, and it appears that once she had sold it, Mrs. Prizant would have an enforceable right to recover under the agreement assuming that she offered to make the loan.
The terms of the agreement are ambiguous as to the reasons for which it was made. At one point, it states that it is made in consideration of the loan; but later, it states that the agreement is made as it is understood that she had to sell certain stock to make the loan. Thus, two reasons are stated as the bases for making the agreement. In view of this ambiguity in the terms of the agreement and the other circumstances surrounding its making, we are convinced that it should be treated as additional consideration for the sale of the stock.
When the fair market value of property received in a sale cannot be ascertained, the proceeds of a sale which *150 are attributable thereto are taxable in the year in which they are received.
The character of any proceeds attributable to the agreement was not altered because such proceeds were received from an interested third party rather than the vendee (
There is no requirement of which we have been made aware that the sales price of an article can not be paid in whole or in part by one other than the vendee. * * *
The respondent attempts to distinguish DeLong on the basis that it involved a single transaction, whereas the case before us involves two transactions, a sale and a loan. However, since we have found that the agreement by the corporation was consideration for the sale, we think that DeLong is not distinguishable.
The fact that the corporation treated the payment on its books as a payment of interest may be relevant to our question, but it is not decisive.
Accordingly, we conclude that the agreement was received as consideration for the sale of Mrs. Prizant's Livingston Oil stock in 1963. We also conclude that the value of such agreement could not be ascertained with fair certainty at the time of the 1963 sale, and that any proceeds of such sale received pursuant thereto are taxable in 1964 as proceeds from the sale of a capital asset. Secs. 61(a), 451(a);
We must now decide whether Jerome was entitled to ordinary loss treatment of a loss sustained with respect to the stock issued to the partnership in 1963 and transferred to him in 1964.
(b) Taxpayers entitled to ordinary loss. The allowance of an ordinary loss deduction for a loss on
(1) An individual sustaining the loss to whom such stock was issued by a small business corporation, or
(2) An individual who is a partner in a partnership at the time the partnership acquired such stock in an issuance from a small business corporation and whose distributive share of partnership items reflects the loss sustained by the partnership.
In order to claim a deduction under
The regulations appear to be based upon the following statements in the conference committee report *154 dealing with
It is understood that in the case of partnerships any losses from small-business stock will be passed through to the partners * * *. Also, since to qualify for the ordinary loss treatment the qualifying stock must be held by the individual or partnership to whom issued, loss on stock issued to a partnership which was distributed to a partner before the loss was sustained would not qualify.
It is agreed that the stock issued to the partnership in 1963 qualified as
State law is applied to ascertaining the legal relationships between persons. Sec. 301.7701-1(c), Proced. & Admin. Regs.;
(b) Termination - (1) General rule.* * * a partnership shall be considered as terminated only if -
(A) no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership, or
(B) within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.
The tests set forth in
We have held in *156 cases arising under
Furthermore, under Illinois law, a partnership does not cease to exist unless it is terminated.
Effect of dissolution - Continuance to to wind up
On dissolution the partnership is not terminated, but continues until the winding up of partnership affairs is completed.
In Englestein, the court said at 357-358:
The terms "dissolution" and "termination," as employed in the Partnership Act are not synonyms and, as used, have different meanings. Dissolution does not 823 terminate the partnership and does not end completely the authority of the partners. The order of events is: (1) dissolution; (2) winding up; and (3) termination. Termination extinguishes their authority. It is the ultimate result of the winding up and occurs at the conclusion of the wind up. * * *
In Englestein, a partnership which had been *158 dormant for 28 years was held not to have terminated although there had been a decree of dissolution in 1931, some 28 years before an action for general accounting was brought. In the present case, there is no evidence of a dissolution or a winding up prior to the termination of the partnership in 1964, and hence, there has been no showing that the partnership was terminated under Illinois law prior to 1964.
The petitioners argue that the incidents of taxation depend upon who are the real owners of the stock and not where mere naked title lies, and to support such proposition, they rely upon
The petitioners also rely upon
In conclusion, we hold that Mrs. Prizant realized a gain in 1964, and that such gain is taxable to her in that year as gain from the sale of a capital asset. We also hold that Jerome has failed to prove that he was entitled to an ordinary loss deduction with respect to stock distributed to him by the partnership which became worthless in 1965. Accordingly,
Decision will be entered under Rule 50.
1. All statutory references are to the Internal Revenue Code of 1954.↩
Dorzback v. Collison, Collector of Internal Revenue , 195 F.2d 69 ( 1952 )
Rupe Investment Corporation v. Commissioner of Internal ... , 266 F.2d 624 ( 1959 )
Estate of Sam Marsack, Deceased, Betty Marsack, ... , 288 F.2d 533 ( 1961 )
Joseph I. Lubin and Evelyn J. Lubin, and Estate of Joseph ... , 335 F.2d 209 ( 1964 )
david-h-foxman-and-dorothy-a-foxman-v-commissioner-of-internal-revenue , 352 F.2d 466 ( 1965 )
Commissioner v. Tower , 66 S. Ct. 532 ( 1946 )
Harry Rosen and Rose Rosen v. United States , 288 F.2d 658 ( 1961 )
Fisher v. Commissioner of Internal Revenue , 209 F.2d 513 ( 1954 )
Deputy, Administratrix v. Du Pont , 60 S. Ct. 363 ( 1940 )
Lavery v. Commissioner of Internal Revenue , 158 F.2d 859 ( 1946 )
Baker Commodities, Inc., a California Corporation v. ... , 415 F.2d 519 ( 1969 )
Old Colony Railroad v. Commissioner , 52 S. Ct. 211 ( 1932 )
Englestein v. MacKie , 35 Ill. App. 2d 276 ( 1962 )
Burnet v. Logan , 51 S. Ct. 550 ( 1931 )
Seligmann v. Commissioner of Internal Revenue , 207 F.2d 489 ( 1953 )