Perrett v. Commissioner

U.S. Tax Court

Perrett v. Commissioner

74 T.C. 111, 1980 U.S. Tax Ct. LEXIS 144

United States Tax Court·Decided April 24, 1980·No. Docket Nos. 4446-74, 5900-76·Published·Cited by 26 cases

Opinion

Featherston, Judge:

This case was tried before Special Trial Judge Lehman C. Aarons pursuant to Rule 180, Tax Court Rules of Practice and Procedure. His report was served on the parties. Petitioners filed exceptions, and respondent filed a brief in response to petitioners’ exceptions. After careful consideration, the Special Trial Judge’s report, which is set forth below, is adopted with minor modifications.

REPORT OF THE SPECIAL TRIAL JUDGE

Footnotes

*

Aarons, Special Trial Judge:

Respondent determined deficiencies in the amounts of $9,172 and $45,065, respectively, in petitioners’ Federal income tax for 1970 and 1972, together with negligence penalties under section 6653(a)¹ of $459 and $2,253, respectively. Two of the issues to be decided depend on determinations of the proper amounts of income, in 2 different years, of a partnership in which petitioner-husband was a partner. (An adjustment to partnership income will change the size of the portion of that income includable on petitioners’ return.) After concessions by respondent, these issues are whether the partnership correctly deducted, in 1970, a loss on the sale of section 1244 stock, and whether the partnership is entitled to an interest deduction for certain payments in 1972. The third issue, although originally raised separately, has now been conceded by respondent to be an alternative to the stock loss issue. If we find that the partnership properly deducted an amount for loss on the sale of stock, we must consider whether petitioners realized income in 1972 from cancellation of indebtedness. Finally, we must determine whether petitioners are liable for additions to tax under section 6653(a).

A constitutional objection raised by petitioners is no longer an issue before this Court. This matter was disposed of when the Court granted respondent’s motion to strike amendments to the petitions herein, for reasons set forth in a memorandum sur order dated October 27, 1978. This memorandum sur order is a part of the record in this case and fully sets forth the positions of the parties with respect to the constitutional issue as well as the Court’s disposition of the matter.²

FINDINGS OF FACT

Although Rule 91 of this Court’s Rules of Practice and Procedure requires that the parties stipulate all matters to the fullest extent possible (and although an oral stipulation of documents was made), no written stipulation of facts was filed in this case. This failure has compounded the Court’s difficulties in synthesizing and making an orderly and understandable presentation of the extremely complex facts in this case. We believe all of the facts set forth below — obfuscating as they appear to be — are necessary for an understanding of the issues herein.

Petitioners resided in Ventura, Calif., at the time the petitions herein were filed. Their Federal income tax returns for 1970 and 1972 were filed with the Internal Revenue Service Centers in Ogden, Utah, and Fresno, Calif., respectively.

Michael F. Perrett (hereinafter petitioner) was an attorney during the years involved herein in the firm Hathaway, Cla-baugh & Perrett (HCP). In 1970, the law firm was operating as a partnership (the partnership). At that time, two of the partners were active in the business of the firm. Hathaway had retired almost completely from the practice of law and owned a nominal share of the partnership, if any. In mid-1971, the law practice was incorporated, although the partnership continued in existence as a vehicle for managing other interests of the partners. During this period, Clabaugh concentrated, for the most part, on administrative law problems and trials. Petitioner, generally responsible for overseeing the business affairs of the firm, was certified as a specialist in the law of taxation by the State Bar of California.

In 1970, prompted by concern for financing his children’s education, petitioner decided to establish some kind of trust or other fund for their use. Petitioner discussed this matter with Harry Margolis (Margolis), an attorney whom he had met a few years earlier through a former business associate. Together they agreed on a plan, detailed below, which provided for trusts for petitioner’s children, a series of loans, and the purchase by the partnership of stock in Jowycar Music Corp. (Jowycar).³

By execution of three trust agreements dated October 23, 1970, petitioners created a trust for each of their three minor children. The agreements named as trustees John Webster and Robert Soares (two former business associates of petitioner), and Patrick Perrett (petitioner’s brother). At some later point, Webster and Patrick Perrett resigned and David Schmutte, petitioner’s accountant, was substituted. The initial corpus of each trust was $10.

Signing a note dated December 2, 1970, petitioner borrowed $100,000 from Anglo Dutch Capital Co. (Anglo Dutch). Anglo Dutch, during this period, was a California corporation engaged in the business of lending money. Petitioner’s loan was negotiated on behalf of Anglo Dutch by Margolis, who was president of the company and owned one-half of the stock. (An accountant associated with Margolis’ law firm owned the other half.) The note, bearing a maturity date of December 1, 1971, required the payment of quarterly interest installments at the rate of 10 percent annually. The loan was unsecured.

The next step in the plan was the loan by petitioner of the $100,000 to his children’s trusts. Soares, as trustee, signed an agreement to borrow money, dated December 6, 1970, and a promissory note, dated December 7, 1970, on behalf of each of the three trusts. Two of the notes were in the amount of $33,333.33. The third was for $33,333.34. Each note promised payment of principal on demand and provided for annual interest payments at 3 percent, with the first payment due January 31, 1972.

On December 10, 1970, loan agreements and promissory notes were executed for the loan of $100,000 by the Perrett children’s trusts to the HCP partnership. The terms of these documents provided that the partnership would pay principal to the trusts on demand and 6-percent interest annually on or before December 31 of each year, beginning in 1971. At approximately the same time, the partnership borrowed $100,000 from two trusts created for Clabaugh’s children. This money had been borrowed by the trusts from Clabaugh, who had also originally borrowed it from Anglo Dutch. After the three sets of loans had been completed, the partnership had $200,000 with which to purchase stock in Jowycar.

In early October 1970, Jowycar was essentially an inactive corporation. Associated Arts, N.V., was its sole shareholder; the corporation’s officers were Ben Margolis, brother of Harry Margolis; John McTernan; and Elaine Fischel, an attorney and associate of Margolis.

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