IN THE OREGON TAX COURT MAGISTRATE DIVISION Income Tax
MICHAEL E. LYDON, an individual, and ) PATRICIA LYDON, an individual, and ) MIKE LYDON ENTERPRISES INC., an ) Oregon Corporation, ) ) Plaintiffs, ) TC-MD 170356R ) v. ) ) DEPARTMENT OF REVENUE, ) State of Oregon, ) ) Defendant. ) FINAL DECISION1
Plaintiffs appealed Defendant’s Notices of Deficiency, dated August 25, 2016, and
October 10, 2016, for the corporate tax years ending June 30, 2013, and June 30, 2014, and for
the individuals’ tax years ending December 31, 2012, December 31, 2013, and December 31,
2014. A trial was held on June 21 and 22, 2018, in the courtroom of the Oregon Tax Court.
Kevin Shuba of Garrett Hemann Robertson P.C. appeared on behalf of Plaintiffs. Michael
Lydon (Lydon), Clark Williams (Williams), and Calvin “Skip” Palmer (Palmer) testified on
behalf of Plaintiffs. Plaintiffs called Penny DeTello (DeTello), an Oregon Department of
Revenue Conference Officer, as a rebuttal witness. Nancy Berwick (Berwick) and Genevieve
Traub appeared on behalf of Defendant. Berwick testified on behalf of Defendant. Plaintiffs’
Exhibits 1 to 55 were admitted into evidence without objection. Defendant offered Exhibits A to
OO, which were admitted except for KK, LL, MM and NN. Prior to the start of trial, the parties
1 Plaintiffs timely filed its Statement for Costs and Disbursements on October 30, 2019. Defendant filed its objection on November 7, 2019, titled “Response to Motion(s).” The court’s Final Decision incorporates its prior Decision without change in Sections I and II. The court’s analysis and determination regarding costs and disbursements is contained in Section III.
FINAL DECISION TC-MD 170356R 1 stipulated to remove the audit adjustments based on the rollover of Plaintiffs’ profit-sharing plan
and for allowance of the net operating loss deduction as reported on the 2012 and 2013 corporate
returns. At the conclusion of trial, the parties were given the opportunity to submit concurrent
post-trial briefs by August 6, 2018. Plaintiffs filed a brief on August 3, 2018, and Defendant
filed a brief on August 6, 2018. The parties each submitted rebuttal briefs after the deadline that
were not reviewed.
I. STATEMENT OF FACTS
A. General Facts
Lydon began building homes in 1975, working with various entities. In 2004, he formed
Mike Lydon Enterprises Inc., an Oregon “C” corporation (“MLE”). (Exs A, B, 35 at 2.) Lydon
is MLE’s sole shareholder and, except for a brief period, the corporation did not have any
employees. Lydon acted as the general contractor and he hired subcontractors to perform the
work. Lydon’s strategy was to purchase raw or developed land and build homes on the lower
end of the cost spectrum. Lydon testified that the economy and housing were doing very well
when he started, but business tapered off after 2008, due to the recession. Lydon testified that he
sold his last properties in 2013 and waited until 2016 to end MLE operations to account for
potential warranty work. He testified that MLE only made a profit for two or three years of its
operation.
Palmer testified that he is a CPA in the state of Oregon, kept the books for MLE and
prepared all the tax returns for the years at issue. For the period July 1, 2012, to June 20, 2013,
MLE sold three houses and proceeds for the sales is contained in the corporation’s 2012 tax
return. Palmer testified that for taxpayers he generally initially put building costs in a Costs of
Goods Sold (COGS) ledger, then moved them to inventory if the property was not sold by the
FINAL DECISION TC-MD 170356R 2 year’s end because the COGS cannot be deducted until the year the property is sold. Palmer
generally treated empty lots differently and put them immediately into inventory; but he
acknowledged that he did not do so in all cases. Palmer testified that on MLE’s 2012 tax return
he did not list corporate inventory on the COGS form line 1, even though there was inventory.
(Ex A at 6.) Palmer testified that the lack of an inventory figure does not impact the taxes for the
year. Similarly, in MLE’s 2013 tax return, a figure was erroneously noted for inventory at line 1.
(Ex B at 6.) Williams agreed that for a corporation that has inventory (houses), costs can only be
subtracted from corporate gross receipts when they are sold.
MLE’s 2012 return for the period July 1, 2012, to June 30, 2013, documents gross
receipts of $625,800, COGS of $603,308, and other deductions of $46,072, resulting in a loss of
$25,571. (Ex A at 1.) Under loans from shareholders, the return shows that MLE owed
$794,582 in shareholder loans at the beginning of the tax year and owed shareholder loans in the
amount of $552,162 at the end of the year. (Id at 5.) MLE’s 2013 return for the period July 1,
2013, to June 30, 2014, documents gross receipts of $240,000, COGS of $245,044, with other
deductions of $17,056, resulting in a loss of $22,818. (Ex B at 1.) The return reports
shareholder loans of $552,162 at the beginning of the year and $489, 001 at the end of the year.
(Ex B at 5, 14.) Plaintiff’s ledger for notes payable to stockholders also shows a balance as of
June 15, 2013, at $552,161.51. (Ex H at 10.)
Defendant is requesting that its adjustments be upheld and that the 2014 COGS allowed
in conference in the amount of $130,993 be disallowed for lack of substantiation.
B. 871 Fifth Street
In 2007, Lydon purchased 26 lots in Jefferson, Oregon, (“Grice Acres”) for
$1,537,438.43. (Ex U at 3, 19; Ex 1.) The infrastructure of the subdivision was already in place
FINAL DECISION TC-MD 170356R 3 and the lots were ready for building. Lydon paid for the purchase using his own funds and title
to the lots was placed in his name as an individual. (Ex U at 19-22.) Lydon testified that MLE
was to build on the lots and the amount paid for Grice Acres was intended to be a loan to MLE.
Lydon testified that after a home was built and ready to be sold, he would transfer title to MLE
and then record the sale. Palmer recorded a journal entry dated December 31, 2007, showing an
increase to notes payable to stockholder in the amount of $1,537,438.43 for Grice Acres; no
contemporaneous loan documents were created, nor funds transferred to MLE. Defendant
presented documents showing that most but not all of the deeds in Grice Acres were transferred
from Lydon to MLE just prior to beings sold to third-party buyers.2
Lydon testified due to the recession and his desire to wind down his business, he entered
into an agreement with Jacobe Construction, Inc. for them to build a home on 871 5th Street, also
known as lot 27 of Grice Acres, and MLE would be paid $55,000 for the lot only when the
property sold. He testified that Jacobe Construction built the house on the lot and he only
incurred minimal cost. The Seller’s Final Settlement Statement for sale of this property, dated
April 14, 2014, shows consideration from the buyer of $194,250 with disbursements to MLE in
the amount of $55,000 and the net proceeds of $130,993.36 to Jacobe Construction, Inc. (Ex P at
3.) Palmer testified that he recorded the transaction in MLE’s books as sale of the lot for
$55,000.
Berwick testified that she asked for a copy of the agreement between MLE and Jacobe
Construction during the audit and never received it. She further testified that her audit notes
reflect a conversation with Lydon’s representative who stated the agreement was oral. At trial
2 Lots 14 and 15 were transferred from Lydon to Jacobe Construction on October 13, 2010, for $110,000. (Ex U at 64.) Lot 24 was transferred from Lydon to MLE and Paulson Homes, Inc., for no consideration, on April 22, 2009. (Ex U at 85.)
FINAL DECISION TC-MD 170356R 4 Plaintiffs submitted a written agreement dated in late 2013 which states “Mike Lydon will
receive payment for the lot of $55,000 upon completion and sale of the new home. If the sale
does not happen by November 1, 2014 (approximately one year from the date of this agreement)
Jacobe Construction will make monthly payments of $150.00 until the lot is sold.” (Ex 27 at 4.)
The typewritten agreement states the lot is “owned by Mike Lydon” but is interlineated by hand
to add after Lydon’s name “Enterprises Inc.” Berwick also testified that she received a copy of
the agreement in June 2017, a date which corresponds to the fax encoded date at the top of the
document. Id. Berwick testified that she was given no evidence that Jacobe Construction built
the house or any substantiation of the building costs. She treated the full purchase price minus
minor expenses as MLE’s gross profit but did not allow the proceeds allocated to Jacobe
Construction to be considered as an offset to gross proceeds. DeTello testified that her
conference decision agreed with Berwick’s audit that the gross proceeds of the sale belong to
MLE but allowed the amounts for Jacobe Construction to be deducted as COGS.
C. 824 Fir Cone Drive
MLE purchased a lot which later became 824 Fir Cone Drive (“Fir Cone”) on October
13, 2006, for $101,542.41. (Ex 21 at 3; Ex 7 at 127; Ex 8 at 11.) Lydon testified that he bought
the lot to build a house for his daughter. The house was completed in 2010 and Lydon’s
daughter moved in. Despite living in the house for several years, she was unable to complete the
purchase due to medical and personal issues. Lydon’s daughter did not pay rent during the
period she occupied the house. The house was marketed and eventually sold to a third party in
2013 for $255,900, and MLE received the net amount of $247,116.15. (Ex 46 at 2.) The parties
stipulated at trial that the cost to build Fir Cone was $242,937.55. (See Ex 8 at 2.)
///
FINAL DECISION TC-MD 170356R 5 Williams testified that Palmer transferred Fir Cone on the books from MLE to Lydon and
deducted the amount from his shareholder loan even though in his opinion no transaction had
actually occurred. He testified that no deed was recorded, and it was simply an accounting error.
Further, although the error was also included in that year’s corporate tax return, there was no tax
consequence related to the error. Finally, assuming the audit was correct, he testified that there
would be a distribution and profits.
Palmer testified that on June 20, 2010, he posted a journal entry removing the amount of
$229,446.08 from the COGS ledger and subtracting it from Lydon’s stockholder loan balance.
(Ex. U at 8.) Palmer testified that he did not remember exactly why he performed the journal
entries as he did, because costs for the property should have been in the inventory account until
the house was sold. He testified that he was under the impression that Lydon was removing the
house from corporate assets and was taking the house for personal use. He testified that in
retrospect, the posting was in error. Palmer posted a general ledger correction of $4,287.62 out
of the property (Ex U at 10), which he also asserts was a mistake and was corrected. On June 4,
2013, when Fir Cone sold, Palmer posted a journal entry for $233,733.70 putting the property
into COGS and debited shareholder loans to correct the 2010 postings. (Ex U at 14.; Ex H at
15.)
Berwick testified that Lydon’s daughter lived at Fir Cone for a period of at least one year,
maybe more. She opined that this represented a sale of the property to her with zero basis;
because Lydon did not personally pay for the property. Berwick testified that relying on the
theory of “substance over form” led her to conclude that Fir Cone was transferred back from
Lydon to MLE. She also asserted that the daughter’s use of the property represented a benefit to
Lydon and should be considered a dividend to him in 2010.
FINAL DECISION TC-MD 170356R 6 D. Loans and/or Capital Contributions to MLE
Lydon testified that MLE never paid him dividends and he took no wages during the tax
years in issue. He testified that funds paid to him from MLE during the tax years in issue were
repayment of loans he had made to the corporation. Williams testified that he is a lawyer in
private practice concentrating on business and tax transactional work. He testified that he has
represented Lydon and his spouse in the past but was engaged for this matter only toward the end
of the audit and through the conference proceedings. Williams observed that there were no
contemporaneously created loan documents or notations between Lydon and MLE in the
corporate minutes or notes. During the audit Williams prepared loan documents and corrected
corporation minutes and notes to reflect the intent of Lydon that he loaned money to MLE.
Williams testified the documents he created and presented to the auditor, to memorialize loans
from Lydon to MLE, were based on the accounting records created by Palmer. Williams
testified that he did not have sufficient time to review the underlying documents prior to the
auditor’s deadline for response. Williams wrote a letter to Defendant stating “the notes
themselves constitute the substantiation for the loans. I don’t have documentation (bank
statements) at this time to show the funds leaving the Lydon’s bank account and entering the
corporation’s bank account, and vice versa.”
Williams also testified that when Lydon transferred funds to MLE it would either be a
capital contribution or a loan. When funds were transferred from MLE to Lydon, there were no
profits, so the transfers would either be characterized as return of capital or repayment of a loan.
Williams testified that in some cases there is difference in effect on taxes, but in this case, there
would be no appreciable tax difference. Further, in either characterization, there is no tax
consequence to Lydon for either return of capital or loan repayment. Williams testified that
FINAL DECISION TC-MD 170356R 7 documentation of loans to MLE do not have to be perfect considering the “overwhelming”
evidence showing Lydon’s intent to make loans to MLE.
Berwick stated that she asked for but did not receive any “bona fide” evidence of loans
between Lydon and MLE; she only received a general ledger report created by Palmer. She
noted that there were no promissory notes provided during the audit, and documentary evidence
presented at trial evidencing loans were created just for the audit. She testified that if there was
no proof of loans to MLE, then funds spent by MLE on Lydon’s behalf or funds transferred to
Lydon would either be constructive dividends or return of capital. She further testified that if
MLE had no earnings or profits, monies transferred from MLE to Lydon would be return of
capital up to the basis he had in MLE. Since she received no evidence of Lydon’s basis in MLE,
she considered funds from MLE to Lydon to be dividends. Berwick noted that MLE’s 2012
corporate tax return documents Lydon’s basis at $40,388. (Ex A at 5, line 22b.) Berwick
testified that she was given no details to support Plaintiff’s “Note Payable – Stockholder” ledger
for the period from June 10, 2012, to June 30, 2015. (Ex U at 13-18.)
1. Loans from Lydon to MLE
Lydon testified that over the years he transferred funds from his personal account to MLE
that were intended to be loans. Lydon acknowledged that he did not create contemporaneous
loan documentation or corporate minutes reflecting the loans and that he was unable to provide
bank documentation underlying the transactions. He testified that he told his accountant
(Palmer) that certain deposits were loans. Lydon presented as examples an MLE bank statement
from July 2006 which shows a deposit of $200,000 deposit from his personal account, as
evidence of contributions which represented loans to MLE. (Ex 34 at 2.) Similarly, he noted
transfers from him to MLE in the amount of $100,000 on August 10, 2006 (Ex 34 at 3);
FINAL DECISION TC-MD 170356R 8 $160,953.54 on March 16, 2007, (Ex 34 at 4); $10,000 on January 28, 2013 (Ex 34 at 13.);
$5,000 on March 11, 2013 (Ex 34 at 14); and $5,000 on April 5, 2013. (Ex 34 at 15.) The
exhibit representing the “notes payable to stockholder” covers the time from August 15, 2004,
through June 4, 2013. (Ex 1.) That document shows loans to MLE totaling $8,124,773.53. The
largest transaction is dated December 31, 2007, when Lydon purchased the 26 lots of Grice
Acres for $1,537,438.43. No funds were moved to MLE or deeds recorded to MLE at that time.
Also, of note was a transaction on June 4, 2013, for the Fir Cone property in the amount of
$233,733.70.
MLE’s 2012 form 1120 shows loans from shareholders at $552,162 (Ex 9 at 5), but
shareholder meeting notes show that the figure for the year ending June 20, 2012, was
$1,028,315.44. (Ex 9 at 10.) On September 15, 2004, MLE’s bank records show a deposit for
$633,500 which is noted on notes payable ledger as a loan (Ex 1), but there is no evidence as to
the source of the funds.
2. Payments from MLE for benefit of Lydon
MLE bank accounts and credit cards were used extensively to make charitable
contributions and pay bills which could represent personal or business expenses. Lydon and
Palmer testified that personal expenses paid from MLE reduced Lydon’s stockholder notes
payable. Many of Lydon’s personal expenses were paid through MLE: $15,823.15 for
automobile expenses for the period July 15, 2012, through June 15, 2014 (Ex 16 at 15 and 16);
$2,011.40 for dues and subscriptions (Id. at 16); and $5,913.69 for insurance. (Id. at 17.) MLE
paid Lydon $300,000 on November 3, 2006, which is reflected in reducing MLE’s note payable
to stockholder by the same amount. (Ex 41 at 40). On August 30, 2013, MLE made a payment
in the amount of $16,935.49 to Citi card. (Ex 40 at 5.)
FINAL DECISION TC-MD 170356R 9 3. Deviations from Lydon’s loan evidence
On October 13, 2010, Lydon sold lots 14 and 15 of Grice Acres to Jacobe Construction
for $110,000. (Ex U at 64.) There is no evidence that the funds were paid to MLE. On April
22, 2009, Lydon transferred lot 24 of Grice Acres to MLE and Paulson Homes to “correct title.”
(Ex U at 85.) There is no evidence that funds were accounted for on MLE’s ledger. (See Ex U
at 5.)
II. ANALYSIS
In analyzing Oregon income tax cases, the court starts with several general guidelines.
First, the court is guided by the intent of the legislature to make Oregon’s personal income tax
law and the taxable income of corporations identical in effect to the federal Internal Revenue
Code (IRC). ORS 316.007; ORS 317.013; ORS 317.018.3 Second, in cases before the court, the
party seeking affirmative relief bears the burden of proof and must establish their case by a
“preponderance” of the evidence. ORS 305.427. Third, allowable deductions from taxable
income are a “matter of legislative grace” and the burden of proof (substantiation) is placed on
the individual claiming the deduction. INDOPCO, Inc. v. Comm’r, 503 US 79, 84, 112 S Ct
1039, 117 L Ed 2d 226 (1992). Fourth, taxpayers are required to keep sufficient records to prove
their tax liability. IRC § 6001.
A. “Cost of Goods Sold” (“COGS”)
Costs that are directly related to constructing a home must be capitalized. IRC § 263A;
Treas Reg 1.263A–2; Frontier Custom Builders, Inc. v. Comm’r, 106 TCM (CCH) 393 (2013).4
3 The court’s references to the Oregon Revised Statutes (ORS) are to 2011. 4 COGS is an adjustment to gross income for merchants and manufacturers and is computed with the proper adjustment for opening and closing inventories of goods for the year. See Treas Reg 1.61–3(a); Treas Reg 1.162–1. This is known as the inventory method of accounting. IRC §§ 471, 472. The income from a business of selling land
FINAL DECISION TC-MD 170356R 10 “[T]he costs of improvements to subdivided real estate held for sale are capital expenditures,
allocable to the basis of the taxpayer in the various unsold lots.” Homes by Ayres v. Comm’r,
795 F 2d 832, 835 (9th Cir 1986); see also Estate of Ronning v. Comm’r, 117 TCM (CCH) 1206
(2019). “Costs so capitalized may then be recovered by the builder upon the sale of the home.”
Cartier v. Comm’r, 97 TCM (CCH) 1042 (2009), 2009 WL 89216 at *2 (US Tax Ct). It is clear
from the evidence presented that the “completed contract method” used by Plaintiffs is a
permissible method. See Shea Homes, Inc. v. Comm’r, 142 TC 60 (2014).
1. 871 Fifth Street
Taxpayers must show their entitlement to amounts claimed as costs and must keep
sufficient records to substantiate those costs. IRC § 6001. Here, Plaintiffs provided proof that
they purchased the lots including Lot 27 for $1,537,438.43. (Ex U at 19, 25-96.) This results in
an initial cost basis of around $59,132 per lot. Defendant allowed additional costs of $8,560 for
escrow and title costs related to the sale increasing the basis to $67,692. At audit, the auditor
included the total sale price of $194,250 in gross receipts but did not allow the corresponding
cost of $130,993 remitted to Jacobe Construction for building the house on the property. The
conference officer allowed the full construction cost of $130,993, but Defendant now asks the
court to disallow that cost for lack of substantiation.
In Cartier, the taxpayer’s construction costs were denied where taxpayer submitted
numerous receipts for construction-type items because taxpayer failed to prove that they were
linked with the specific property that was sold and were unreliable. 2009 WL 89216 at *2-3 (for
and improvements to land cannot be computed under the inventory method of accounting. W.C. & A.N. Miller Dev. Co. v. Comm’r, 81 TC 619 (1983). The costs of constructing real property improvements is deductible in the year the property is sold. Shaw Construction Co. v. Comm’r, 35 TC 1102, 1121 (1961), aff’d on other grounds 323 F2d 316 (9th Cir 1963). In Atlantic Coast Realty v. Comm’r, 11 BTA 416 (1928), the court held that the inventory method as applied to various parcels of bare land that taxpayer held was imprecise and impractical.
FINAL DECISION TC-MD 170356R 11 example, some receipts were dated before taxpayer purchased the property in issue). There is no
dispute that MLE owned the lot. There is likewise no dispute that when the lot was sold in April
2014 that it was improved by a house. The evidence presented to the court certainly links the
expense to the specific property at issue, particularly the HUD statement showing that $130,993
was remitted to Jacobe Construction when the house was sold. This combined with Lydon’s
testimony and the contract with Jacobe construction make it more likely than not that the
payment represented a cost that may be offset the income from the sale. Defendant’s request to
adjust this item is denied. The conference officer’s decision is affirmed.
2. Fir Cone
Defendant denied certain costs associated with building and sale of the Fir Cone house.
Defendant argues that Lydon’s purpose was to build a house, not for business profit, but for his
daughter and when Palmer moved the property from “inventory” to “notes payable shareholder”
it reflected a change to the home becoming a personal asset. When that transaction occurred,
Defendant argues, no consideration was paid by Lydon to MLE and Lydon’s basis was zero.
Additionally, Defendant argues that Lydon’s daughter lived in the house for more than a year
which represented a benefit to Lydon, a shareholder, and thus constituted a constructive dividend
to him. Plaintiffs argue that no real transaction occurred; MLE purchased the property, did not
change title to the property (despite Lydon’s intention to take the property for personal use) and
MLE sold the property to a third-party buyer. Plaintiffs urge the court to look at the substance of
the transaction and allow costs to offset gross profits received from sale of the property.
Looking at transaction as a whole, the court is persuaded that no transfer of the property
to Lydon’s daughter occurred. Even if the court accepted that a transfer occurred, Defendant
provided no authority for its idea that a gifting real property strips the basis to zero. See IRC §
FINAL DECISION TC-MD 170356R 12 1015 (providing basis of gift is same as donor’s or the fair market value at the time of transfer).
It is true that no business expense deduction should be allowed for the period when Lydon’s
daughter occupied the house rent-free but that is not the issue before the court. See Van Malssen
v. Comm’r, 108 TCM (CCH) 549 (2014), 2014 WL 6603868 at *4 (Us Tax Ct) (personal use
includes use by qualifying relatives). Likewise, IRC Section 267 prohibits losses being claimed
upon property transfers between closely related persons. Miller v. Comm’r, 75 TC 182 (1980).
Defendant has failed to show that such a transfer occurred. The transfer at issue is between MLE
and an unrelated third-party. The court agrees that when Lydon’s daughter moved into the
property for a period of at least one year, a benefit was conferred to Lydon. However, an
adjustment for imputed rent was not contained in Defendant’s audit or assessment, and thus
Defendant had the burden of proof at trial to present evidence on that issue. Without evidence on
the value of the lost rent, the court cannot make an adjustment.
B. Evidence of Shareholder Loan or Return of Capital
In general, funds distributed from a corporation to a shareholder are taxable under IRC
Section 301(c). A distribution is taxed to the distribute shareholder as a dividend to the extent of
the corporation’s earnings and profits. Any excess is treated as a nontaxable return of capital to
the extent of the shareholder’s basis in the corporation, and any remaining amount is taxable to
the shareholder as gain from the sale or exchange of property. See IRC §§ 301, 316. Diverting
funds from C corporations to controlling shareholders are taxable as dividends and not subject to
treatment as repayment of shareholder loans where the shareholder loans are not sufficiently
evidenced. Knutzen-Rowell, Inc. v. Comm’r, 101 TCM (CCH) 1293 (2011), 2011 WL 990160
(US Tax Ct). “Such a diversion may also occur where a controlling shareholder causes the
corporation to pay his or her personal expenses and the payment primarily benefits the
FINAL DECISION TC-MD 170356R 13 shareholder and is made without expectation of repayment or without a bona fide intent that it be
in repayment of a shareholder loan.” Id. at *13. Courts consider a number of non-exclusive
factors to determine whether there is a bona fide loan including: (1) whether a note or other
evidence of indebtedness exists; (2) whether interest is charged; (3) whether a fixed repayment
schedule was established; (4) whether there was collateral; (5) repayments made; (6) whether
lender had reasonable expectation of repayment; (7) conduct of parties. Id.
Federal and state tax decisions are filled with references acknowledging that certain
business expenses, deductions, or loans likely occurred but cannot be allowed because the
evidence is so lacking that the decider cannot even estimate what those amounts would be. Such
is the case here. Lydon’s testimony was persuasive that he transferred funds from time to time
from his personal bank account to, or on behalf of, MLE, and those transactions were intended to
be loans. But in analyzing the evidence, the court sees transactions accounted for in very
unorthodox ways. When there are documents they are deficient. And most importantly there is a
complete lack of separation between Lydon’s personal and corporate accounts. Plaintiffs assert
that the loan documents and corporate minutes “themselves constitute the substantiation for the
loans.” (Ex S at 51.) The court disagrees. First, the documents were created retroactively, back-
dated, and solely for the audit. They were drafted years after the purported transactions and
without reliance on primary documentation. The court has previously opined that back-dated
documents created solely for an audit are given little weight except to the extent that they reflect
the economic realities of the time as shown by objective and contemporaneous evidence. See,
Hannon v. Dept. of Rev., TC-MD 160324R, WL 3037507 at *3 (Or Tax M Div July 18, 2017).
Further, the ledgers offered here are not reliable, often contradicting other ledgers, and
evidence supporting loans is lacking. As an example, Plaintiffs’ submitted a ledger purportedly
FINAL DECISION TC-MD 170356R 14 documenting shareholder loans from Lydon to MLE, for the period 2004 through June 4, 2013,
in the amount of $8,124,473.53. (Ex 1.) The general ledger accrual basis for notes payable
ended at $552,161.51 as of June 15, 2013. (Ex 16 at 10.) Promissory notes from MLE to Lydon
appear to be more than $12 million. These figures do not match corporate tax return figures for
MLE’s 2012, 2013, or 2014. Only a handful of the purported loans on this ledger are supported
by documentary evidence— a check, a bank statement or other evidence. Even those
transactions for which substantial trial time was expended have issues. For example, Lydon
purchased 26 lots of Grice acres using personal funds and titled the lots in his own name. Setting
aside Defendant’s assertion that no money changed hands and the deeds were not immediately
recorded in MLE’s name and thus there was no loan, Lydon’s testimony is most compelling on
this point. Lydon argues that his plan was to deed the lots to MLE just before the lots with
finished houses are sold to a third party. As acknowledged by Plaintiffs’ attorney and CPA, that
is probably not the best way to transact business, but the court understands the plan. However,
lots 14 and 15 appear to be sold from Lydon to Jacobe Construction, and the funds did not go to
MLE. (Ex U at 64.) Similarly, lot 24 appears to be transferred to a third party but there is no
evidence money went to MLE. There is also the mistaken entry for $233,733.70 “loan” for Fir
Cone dated June 4, 2013. (Ex 16 at 10.) The end result is that there are no bona fide shareholder
loans to the corporation and even on a capital contribution theory Lydon left MLE badly under-
capitalized resulting in no basis in MLE. The court finds that return of capital theory
unconvincing.
Aside from the loan side, there is the repayment side. Seldomly did MLE pay Lydon
directly by check. Instead, MLE paid Lydon’s credit card bills, other miscellaneous bills, and
charitable contributions. These payments represented hundreds of thousands of dollars without
FINAL DECISION TC-MD 170356R 15 adequate substantiation. In taking all the above in account, the court generally believes that Lydon
loaned MLE some money at some time between 2004 and 2013, but the court is unable to even
estimate the amount. The evidence before the court shows that MLE had no accumulated earnings
and profits and that its sole shareholder had insufficient basis in the company to cover the amounts
disbursed to him. The court finds that any distributions made in excess of Lydon’s basis in MLE
should be taxable as capital gains under IRC § 316(a). See Han v. Comm’r, 83 TCM (CCH) 1824
(2002), WL 1298745 at *31 (US Tax Ct). Thus, the audit adjustment is sustained.
III. COSTS AND DISBURSEMENTS
Plaintiffs’ request an award of costs and disbursements in the amount of $330.32
including the filing fee ($265); “Subpoena – Penny DeTello” ($13); and “Mileage – Salem to
Portland and return to deliver exhibits to ODOR reps” ($52.32). No receipts were attached.
Defendant objects to Plaintiffs’ request on the basis that only Plaintiff MLE is a prevailing party
and the statement for costs and disbursements did not identify the party to which the costs relate.
Defendant also asserts that some information was not provided during the earlier audit.
The court has discretionary authority to award costs and disbursements to prevailing
parties under ORS 305.490(2); Wihtol I v. Dept. of Rev., 21 OTR 260, 267-68 (2013). Costs and
disbursements “are reasonable and necessary expenses incurred in the prosecution or defense of
an action other than for legal services * * *.” TCR–MD 16 A.5 A party is a prevailing party if
they receive a favorable outcome on a claim. ORS 20.077(2); see e.g. Ellison v. Dept. of Rev.,
362 Or 148, 166, 404 P3d 933 (2017) (a party is prevailing if they successfully defend against
the other party’s claim). “[I]t does not necessarily follow that, merely because a party does not
obtain all the relief sought, a party is not a prevailing party.” Kohl’s Dept. Stores v. Washington
5 Tax Court Rule–Magistrate Division
FINAL DECISION TC-MD 170356R 16 County Assessor, TC-MD 130220D, WL 196150 at *13 (Or Tax M Div Jan 14, 2015) (internal
quotations committed). The court must “weigh what was sought by each party against the result
obtained.” Id. Defendant concedes that Plaintiff MLE prevailed in this matter. Plaintiffs
Michael and Patricia Lydon did not prevail on their claims before the court, however they did
receive some relief on the issue of the rollover distribution from the profit-sharing plan by the
parties’ stipulation before trial; at a minimum, Plaintiffs did not put themselves in a worse
position. The court is satisfied that both Plaintiffs are prevailing.
The issue becomes whether the court should exercise its discretion to award costs and
disbursements in this case. The court is guided by Wihtol II v. Multnomah County Assessor, TC-
MD 120762N, WL 274126, (Jan 24, 2014), which noted that failure to comply with timely filing
requirements or to provide information at an earlier administrative proceeding might make a cost
award inappropriate. The court has held that a cost award might be denied where there are
“multiple claims or issues that were variously won or lost by the parties.” Chiles v. Multnomah
County Assessor, TC-MD 130384N, WL 2993791 at *9 (Jul 3, 2014) (internal citation omitted).
Such is the case here. This case involved multiple claims and parties. The court’s task was
simplified by the fact that the parties were able to resolve two of the issues before trial. It
appears that these issues could have been resolved without appeal if Plaintiffs had been more
forthcoming with information during the audit. On the issues that remained, Plaintiffs won on
the deductibility of the costs from the Fir Cone and 871 5th Street properties for the 2013 tax
year but lost on the issue of shareholder loans for both years. The shareholder loan issue was the
more significant issue. The court notes that the case was complicated by Plaintiffs’ poor record
keeping and that the outcome was by no means apparent. The court finds that an award of costs
and disbursements is inappropriate under the circumstances.
FINAL DECISION TC-MD 170356R 17 IV. CONCLUSION
After careful consideration, the court concludes that Plaintiffs are eligible to deduct costs
from the gross proceeds on the sales of the Fir Cone and 871 5th Street properties. Plaintiffs
have failed to meet their burden of proof that funds transferred from MLE to Lydon represented
either repayment of loans or return of capital. Consequently, the transfers represent capital gains
under IRC §§ 316, 301. Now, therefore,
IT IS THE DECISION OF THIS COURT that Plaintiffs’ appeal is granted in part and
denied in part. Plaintiffs shall be allowed to deduct costs from the gross proceeds from the sales
of the Fir Cone and 871 5th Street properties. Plaintiffs’ appeal is also granted, pursuant to the
parties’ stipulation, with respect to the rollover of Plaintiffs’ profit-sharing plan and for
allowance of the net operating loss deductions as reported MLE’s 2012 and 2013 tax return. The
remainder of Plaintiffs’ appeal is denied.
IT IS FURTHER DECIDED that Plaintiffs’ request for costs and disbursements is
denied.
Dated this day of November 2019.
RICHARD DAVIS 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 signed by Magistrate Richard Davis and entered on November 22, 2019.
FINAL DECISION TC-MD 170356R 18