MEMORANDUM FINDINGS OF FACT AND OPINION
CHABOT, Judge: Respondent determined deficiencies in Federal individual income tax against petitioners, and petitioners claimed overpayments, 1 as follows:
| Deficiency | Overpayment |
| Year | Determined | Claimed |
| 1972 | $ 5,667.77 | $ 5,668 |
| 1973 | 4,460.00 | 4,460 |
| 1974 | 6,745.00 | 6,745 |
| 1976 | 3,598.00 | 1,390 |
The parties have reached agreement on several issues; the issues for decision are as follows:
(1) Whether petitioners are entitled to deduct $ 252,951 for 1975 on account of petitioner-husband's guaranty of payment of debts under a factoring agreement;
(2) Whether petitioners are entitled to deduct a total of $ 17,700 for 1976 on account of three State court judgments rendered in 1976 against petitioner-husband;
(3) Whether petitioners are entitled to deduct $ 1,876 for 1976 on account of a 100-percent penalty assessment (pursuant to sec. 66722) against petitioner-husband; and
(4) Whether petitioner-wife is not liable for any deficiencies because of the "innocent spouse" provisions of section 6013(e).
FINDINGS OF FACT
Some of the facts have been stipulated; the stipulation and the stipulated exhibits are incorporated herein by this reference.
When the petition in this case was filed, petitioners Joseph W. Reid (hereinafter sometimes referred to as "Joseph") and Alice B. Reid (hereinafter sometimes referred to as "Alice"), husband and wife, resided in Dalton, Georgia.
A petition was filed with the Superior Court for Whitfield County, Georgia, on behalf of Robert Chambers (hereinafter sometimes referred to as "Chambers") and Joseph to incorporate Huntington Carpet Mills, Inc. (hereinafter sometimes referred to as "Huntington, Inc."). Attached to that petition were Articles of Incorporation executed by Joseph as one of the two incorporators. 3 On February 1, 1974, the Superior Court entered an order incorporating Huntington, Inc., under the laws of Georgia. Huntington, Inc., was organized to "manufacture, buy, sell, distribute and generally deal in carpets and other textile products * * *"; Chambers and Joseph were its sole shareholders.
Also on February 1, 1974, Chambers signed an agreement as Huntington, Inc.'s president, assigning all of its customer sales receivables to Hamilton Factors, Inc. (hereinafter sometimes referred to as "Hamilton Factors"). Chambers and Joseph signed a related agreement on that date as Huntington, Inc.'s shareholders guaranteeing Huntington, Inc.'s obligations to Hamilton Factors.
Huntington, Inc., filed Federal corporate income tax returns for 1974 and 1975.
A petition was filed with the Superior Court for Whitfield County, Georgia, on behalf of Chambers and Joseph to incorporate Chalet Carpets, Inc. (hereinafter sometimes referred to as "Chalet, Inc."). Attached to that petition were Articles of Incorporation executed by Joseph as one of the two incorporators. 4 On September 24, 1974, the Superior Court entered an order incorporating Chalet, Inc., under the laws of Georgia. 5Chalet, Inc., was organized to "manufacture, buy, sell, retail, wholesale, distribute and generally deal in carpets and other textile products * * *."
To their 1974 Federal income tax return, petitioners attached a Form W-2 from "Huntington Carpet Mills, Inc.", to Joseph showing $ 3,158.60 Federal income tax withheld, $ 19,200 FICA wages, and $ 859.95 FICA employee tax withheld. Although the Form W-2 did not show an amount in the "Wages, tips, and other compensation" block, the $ 19,200 FICA wages was consistent with the total "Wages, salaries, tips, and other employee compensation" reported on line 9 of their Form 1040. On Part III "Income or Losses from Partnerships, Estates or Trusts, Small Business Corporations" of Schedule E, petitioners claimed a deduction for a $ 563 partnership loss from "Chalet Carpets".
To their 1975 Federal income tax return, petitioners attached a Form W-2 from "Huntington Carpet Mills, Inc.", to Joseph showing $ 2,403 Federal income tax withheld, $ 15,000 FICA wages, and $ 789.75 FICA employee tax withheld. Although the Form W-2 showed "0" in the "Wages, tips, and other compensation" block, the $ 15,000 FICA wages was consistent with the total "Wages, salaries, tips, and other employee compensation" reported on Line 9 of their Form 1040. On Part III of Schedule E, petitioners claimed a deduction for a loss of $ 252,951 attributable to Joseph's personal guaranty of Huntington, Inc.'s debts to Hamilton Factors.
Operating costs of Huntington and Chalet equalled $ 233,602.25. 6
On January 12, 1976, Hamilton Factors filed suit in the Whitfield County Superior Court against Joseph, Chambers, and Huntington, Inc., for debts incurred under the factoring agreement. In 1976, after filing its suit against Joseph, Chambers, and Huntington, Inc., Hamilton Factors entered chapter XI bankruptcy proceedings in the United States District Court for the Eastern District of Tennessee. By order dated August 31, 1978, that court authorized the trustee in bankruptcy to release all claims of the bankruptcy estate against Joseph, Chambers, and Huntington, Inc., in exchange for an agreed order dismissing with prejudice a claim for $ 500,000 filed by Huntington, Inc., against the bankrupt estate.
On their 1976 Federal income tax return (Part III of Schedule E), petitioners claimed deductions for losses relating to judgments rendered during 1976 by the Whitfield County Superior Court. The designations of the cases and the amounts of the claimed deductions are set forth in table 1.
| | Claimed |
| Designation of Case | | Deduction |
| Harold Albright, St. and | C.A. No. 13,739 | $ 9,500 |
| Ethel Albright v. J. W. Reid, |
| d/b/a Chalet Carpets of |
| Charlotte |
| Coronet Industries, Inc. v. | C.A. No. 13,613 | 4,700 |
| J. W. Reid, Sr., Jack W. Hix, |
| and Robert Chambers |
| Northwestern Factors, Inc. v. | C.A. No. 13,738 | 3,500 |
| Chalet Carpets, Inc., a Georgia |
| Corporation, J. W. Reid and |
| Robert Chambers |
| | $ 17,700 |
In the Albright case (C.A. No. 13,739), a jury verdict for the plaintiffs was filed on December 6, 1976, for $ 8,533.34, plus interest and costs. The judgment of the Whitfdield County Superior Court was affirmed by the Court of Appeals of Georgia in an opinion dated July 13, 1977. 7
In the Coronet case (C.A. No. 13,613), a jury verdict for the plaintiff against Joseph was filed on September 24, 1976, for $ 4,351.78, plus interest and costs. Judgment was entered against Joseph, Chambers, and Jack W. Hix, predicated on findings that the defendants failed to give adequate notice of the dissolution of their partnership to partnership creditors, failed to give adequate notice of the continuation of the partnership's previous business in corporate form, and intermingled individual and partnership assets with those of Chalet, Inc., and Huntington, Inc.
In the Northwestern case (C.A. No. 13,738), a Superior Court judgment was filed on March 26, 1976, against Joseph, Chambers, and Chalet, Inc., for $ 3,397.89, plus interest and costs; the same decree also included a judgment against Joseph and Chambers for $ 369.86 attorneys' fees.
Petitioners have not paid anything toward the liabilities represented by these judgments.
On their 1976 Federal income tax return (Part III of Schedule E) petitioners claimed a deduction of $ 1,876 designated "INTER REV.", which represents a 100-percent penalty assessment made by respondent against Joseph on September 27, 1976, as a responsible officer of one or more of his companies. 8 A claimed overpayment on petitioners' 1976 Federal income tax return in the amount of $ 990.40 was applied by respondent on February 11, 1977, to this assessment; application of this overpayment plus an additional credit in 1978 satisfied the assessment, along with interest.
Both petitioners signed their joint Federal income tax returns for each of the years 1972 through 1976. 9 However, Alice signed these returns without reading or reviewing them or in any way joining in their preparation.
OPINION
I. 1975 Loss
Petitioners contend that their 1975 claimed Huntington, Inc. loss was from a partnership, asserting that Huntington, Inc. "never qualified to do business or attained corporate status." Thus, they argue, they are entitled to deduct Joseph's allocable share of losses for that year. They also argue that the agreed dismissal of Joseph's claim against Hamilton Factors in the bankruptcy proceeding in 1978 constitutes "consideration" for the dismissal of Hamilton Factors' claim against Joseph and Huntington, Inc. Petitioners assert that allowance of this deduction would entitle them to net operating loss carryover deductions for each of the years before the Court.
Respondent contends that Huntington, Inc., is a corporation, the amount claimed relating to Joseph's guaranty agreement was not established as his liability because it was never reduced to judgment, and that amount was never paid by petitioners, who used the cash method of reporting income. 10
We agree with respondent.
Petitioners bear the burden of proving that their claimed 1975 loss resulted from one or more businesses operated in partnership form. Rule 142(a), Tax Court Rules of Practice and Procedure; Blue Flame Gas Co. v. Commissioner, 54 T.C. 584, 598 (1970). Generally, the corporate entity will not be disregarded for purposes of Federal income taxation where it is created for business purposes or it actually conducts business following incorporation. Moline Properties v. Commissioner, 319 U.S. 436, 438-439 (1943); Stoody v. Commissioner, 66 T.C. 710, 717 (1976), supplemental opinion 67 T.C. 643 (1977); Strong v. Commissioner, 66 T.C. 12, 22-23 (1976), affd. without opinion 553 F.2d 94 (CA2 1977). This is particularly the case where the demand that the corporate entity be ignored comes from the taxpayer-shareholder who chose to do business in this form. Sangers Home For Chronic Patients v. Commissioner, 72 T.C. 105, 115-116 (1979); Strong v. Commissioner, 66 T.C. at 22.
In the instant case, the record persuades us that Huntington, Inc., was a corporation for such purposes. The documents necessary to incorporate Huntington, Inc., were executed and filed with the State court. Ga. Code Ann. sec. 22-803 (1970). 11 Furthermore, under Georgia law then applicable, Huntington, Inc.'s corporate existence began on the date of the State court order incorporating it. Ga. Code Ann. sec. 22-803(h) (1970). 12 A factoring agreement was signed on Huntington, Inc.'s behalf as a corporation by its president, Chambers and Joseph guaranteed debts under that agreement as its shareholders, and it filed Federal corporate income tax returns for 1974 and 1975. The Forms W-2 attached to petitioners' Federal individual income tax returns show that Joseph was an employee of, and received compensation income from, Huntington, Inc., for 1974 and 1975.
The foregoing facts outweigh Joseph's testimony that there were no meetings of Huntington, Inc.'s boards of directors or stockholders, assets were intermingled, and he never sent letters to the business' existing creditors about the incorporation or kept corporate minutes. This is so even though State law may, under certain circumstances, disregard the limited liability that would otherwise be an attribute of the corporation's existence. Stoody v. Commissioner, supra; Perry v. Commissioner, 49 T.C. 508, 516-518 (1968); Skarda v. Commissioner, 27 T.C. 137, 144-145 (1956), affd. 250 F.2d 429, 433-434 (CA10 1957); cf. Blue Flame Gas Co. v. Commissioner, 54 T.C. at 599.
We conclude that Huntington, Inc., was a corporation for Federal income tax purposes in 1975. Petitioners have failed to show that any part of their 1975 claimed loss deduction of $ 252,951 was a loss from a partnership, that any part of this amount was paid 13 by them in 1975, or that any part of this amount constituted a debt which became worthless in 1975 in the course of petitioners' business. We conclude that petitioners are not entitled to any part of their 1975 claimed loss deduction of $ 252,951.
Petitioners claim that the Huntington, Inc., business was a partnership in 1975 on the basis that the business: (1) was operated as a partnership before the incorporation; (2) was never properly formed as a corporation; (3) was found to be a partnership under State law by the State courts; and (4) was not a corporation as a matter of law for Federal income tax purposes because corporate characteristics were not established under sec. 301.7701, Proc. and Adm. Regs., and the noncorporate characteristics of lack of limited liability and lack of limited life were established by the holdings of the State courts.
As to the first contention, the record contains little evidence. In any event, the question is whether the business was operated as a corporation in 1975. Petitioners have failed to show that what went on before the February 1, 1974, incorporation affected what went on after that event.
Petitioners' second contention is not supported by the record or State law. We recognize that under Georgia law directors' or stockholders' failure to conduct their business as a corporate entity (for example, by commingling personal and corporate assets) can affect the extent of their liability to third parties. Brooke v. Day, 129 Ga. 694, 59 S.E. 769 (1907); Bone Constr. Co., Inc. v. Lewis, 148 Ga. App. 61, 250 S.E. 2d 851 (1978); Southern Cotton Oil Company v. Duskin, 92 Ga. App. 288, 88 S.E. 2d 421 (1955); Ga. Code Ann. sections 22-805 and 22-715(a)(4) (1970). However, we have not found any Georgia law suggesting that failure to hold board of directors' or stockholders' meetings, failure to notify existing creditors about incorporation, failure to keep corporate minutes, or commingling of assets negates a corporation's existence for all purposes. Indeed, Ga. Code Ann. section 22-5103 (1970) provides that: "[t]he existence of a corporation, claiming a charter under color of law, cannot be collaterally attacked by persons who have dealt with it as a corporation. Such persons are estopped from denying its corporate existence." The State courts have applied the doctrine of "corporation by estoppel" against stockholders. Consolidated Textile Corp. v. Exposition Cotton Mills, 158 Ga. 747, 124 S.E. 707 (1924); Torras v. Raeburn, 108 Ga. 345, 33 S.E. 989 (1899).
The only evidence in the record that arguably supports petitioners' third contention is the findings of the Whitfield County Superior Court in the Coronet case (see table 1, and the second paragraph after this table, supra). Joseph and Chambers were held liable by the Superior Court in part because they failed to observe the lines of the artificial entities they created. As a result, apparently, they were not permitted to avail themselves of the defense of limited liability against the plaintiff in that suit. This is not enough to establish that the Superior Court found that Huntington, Inc., was a partnership.
Petitioners' fourth contention is based on the so-called "Kintner regulations". Under sec. 301.7701-2(a)(3), Proc. and Adm. Regs., an unincorporated organization is not to be classified as a corporation unless it has more corporate characteristics than noncorporate characteristics. Under sec. 301.7701-2(a)(2), Proc. and Adm. Regs., the relevant characteristics are "centralization of management, continuity of life, free transferability of interests, and limited liability." At most, the Coronet case suggests that Huntington, Inc., lacked limited liability in the circumstances presented in that case. Petitioners have failed to show that Huntington, Inc., lacked any of the other above-mentioned corporate characteristics. In particular, petitioners have failed to substantiate their assertion that Huntington, Inc., lacked continuity of life.
Petitioners assert that Joseph was a personal guarantor of Huntington, Inc.'s liabilities to Hamilton Factors. The record amply supports this assertion. Petitioners assert that the 1978 dismissal of Hamilton Factors' claim against Joseph, Chambers, and Huntington, Inc., was in exchange for a dismissal of Huntington, Inc.'s claim against Hamilton Factors. The record amply supports this assertion. However, petitioners have not shown that this 1978 exchange of dismissals affects petitioners' entitlement to the claimed 1975 deduction.
There is no evidence in the record that Joseph's guaranty of Huntington, Inc.'s liability to Hamilton Factors resulted in a payment by Joseph in 1975. Indeed, the fact that Hamilton Factors sued Joseph, Chambers, and Huntington, Inc., in 1976, suggests that no payment was made in 1975. Petitioners do not contend that they were accrual basis taxpayers in 1975 (see n. 13, supra). But, even if they were, the 1976 Hamilton Factors suit and its compromise in 1978 would lead us to conclude that petitioners have failed to show that they met the "all events" test, and so we would conclude that they were not entitled to accrue any liability on account of Joseph's guaranty in 1975. Security Mills Co. v. Commissioner, 321 U.S. 281 (1944); Dixie Pine Co. v. Commissioner, 320 U.S. 516 (1944); LX Cattle Co. v. United States, 629 F.2d 1096 (CA5 1980); Goebel Brewing Co. v. Commissioner, 43 T.C. 8 (1964); General Communication Co. v. Commissioner, 33 T.C. 640 (1960).
On this issue we hold for respondent.
II. 1976 Judgments
Petitioners claim deductions on account of three judgments rendered during 1976 (see table 1, supra). On brief, they appear to argue that the deductions should be allowed because Huntington, Inc., and Chalet, Inc., operated as partnerships. Respondent arguers that no deductions should be allowed, because petitioners did not pay the judgments.
The record in the instant case does not disclose the nature of the suits that resulted in these judgments. Except for the Coronet case, it does not suggest the basis for Joseph's liability.
Petitioners do not suggest that they are accrual basis taxpayers, nor do they assert that they paid any of the judgments. For a cash basis taxpayer, a deduction relating to a judgment is allowed in the year it is paid. Magnon v. Commissioner, 73 T.C. 980, 1001-1002 (1980); Insurance Finance Corp. v. Commissioner, 84 F.2d 382 (CA3 1936), affg. a Memorandum Opinion of this Court.
III. Section 6672 Penalty
Petitioners contend that, for 1976, they are entitled to deduct $ 1,876 (see n. 8, supra) representing a 100-percent penalty assessment made against Joseph in that year as a "loss" and that section 162(f) does not preclude this deduction. Respondent asserts that section 162(f) and section 1.162-21(b)(1)(ii), Income Tax Regs., preclude the deduction of this penalty, imposed under section 6672.
Section 162(a) allows deductions for ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Section 162(f), however, provides:
(f) Fines and Penalties.--No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.
Subsection (f) was added to section 162 by section 902 of the Tax Reform Act of 1969, which also revised section 162(c), relating to illegal bribes and kickbacks. In the Revenue Act of 1971 (Pub. L. 92-178, 85 Stat. 497), the Congress amended section 162(c). In connection with that amendment, the Congress commented as follows with respect to section 162(f):
In connection with the proposed regulations relating to the disallowance of deductions for fines and similar penalties (sec. 162(f)), questions have been raised as to whether the provision applies only to criminal "penalties" or to civil penalties as well. In approving the provisions dealing with fines and similar penalties in 1969, it was the intention of the Finance Committee to disallow deductions for payments of sanctions which are imposed under civil statutes but which in general terms serve the same purpose as a fine exacted under a criminal statute. The provision was intended to apply, for example, to penalties provided for under the Internal Revenue Code in the form of assessable penalties (subchapter B of chapter 68), as well as to additions to tax under the internal revenue laws (subchapter A of chapter 68) in those cases where the government has the fraud burden of proof (i.e., proof by clear and convincing evidence). It was also intended that this rule should apply to similar type payments under the laws of a State or other jurisdiction.
General Explanation of the Revenue Act of 1971, Staff of the Joint Committee on Internal Revenue Taxation, p. 71; S. Rept. 92-437 (to accompany H.R. 10947), pp. 73-74, 1972-1 C.B. 559, 600.
Thus,it is clear that the Congress intended section 162(f) to prevent the deduction of assessable penalties under subchapter B of chapter 68.
Section 1.162-21(b)(1)(ii), consistent with the legislative history in this regard, also provides that no deduction is to be allowed for an amount "[p]aid as a civil penalty imposed by Federal * * * law, including * * * assessable penalties imposed by chapter 68 of the Internal Revenue Code of 1954".
Section 667214 is part of "Subchapter B--Assessable Penalties" of chapter 68. (Cf. Helvering v. Mitchell, 303 U.S. 391, 404-405 (1938).)
It follows that, under section 162(f), petitioners are not permitted to deduct any part of the section 6672 penalty imposed on Joseph. Patton v. Commissioner, 71 T.C. 389 (1978).
In light of the Congress' clear directive, it is not necessary to analyze the effect of the cases and rulings cited by petitioners, since all of these cases and rulings preceded the enactment of section 162(f). In any event, these cases and rulings would not lead us to a different conclusion. Smith v. Commissioner, 34 T.C. 1100 (1960), affd. 294 F.2d 957 (ca/5 1961).
IV. Innocent Spouse
Petitioners contend that Alice should not be liable for the deficiencies determined by respondent because she is an "innocent spouse" entitled to relief from liability under section 6013(e). Respondent contends that Alice is not entitled to relief under section 6013(e) because the deficiencies for the years in issue result from erroneous deductions claimed, not from omissions from gross income.
Section 6013(e)15 expressly provides relief from liability for tax (including interest, penalties and other amounts) attributable to omissions from gross income. Inasmuch as the deficiencies in issue are totally attributable to deductions, and not omissions, we conclude that Alice is not entitled to relief under section 6013(e). Estate of Klein v. Commissioner, 63 T.C. 585, 595 (1975), affd. 537 F.2d 701 (CA2 1976); Resnick v. Commissioner, 63 T.C. 524, 527 (1975). See Allen v. Commissioner, 514 F.2d 908, 915 (CA5 1975), affg. in part and revg. in part on another issue 61 T.C. 125, 132 (1973).
Petitioners ask us to provide relief to Alice under section 6013(e) by analogizing liability attributable to omissions of gross income, to that attributable to erroneous deductions. We cannot do so where the statute expressly limits relief to liability from the former.
Petitioners also direct our attention to the innocent spouse rule of section 6653(b). Firstly, no fraud additions to tax have been determined or asserted in the instant case. Secondly, both the language of the statute, 16 and its legislative history serve only to highlight the statutory restriction on application of section 6013(e). These two innocent spouse provisions were both enacted by Pub. L. 91-679, 84 Stat. 2063-2064, January 12, 1971. Both the House Ways and Means Committee Report (H. Rept. 1734, p. 4) and the Senate Finance Committee Report (S. Rept. 91-1537, p. 4, 1971-1 C.B. 606, 608) state as follows:
This potential relief from the fraud penalty [sic] applies even though the spouse in question may be jointly liable for the underpayment in tax due. This relief would apply, for example, where the underpayment resulted from fraudulent deductions (rather than on omission from gross income)--an example of a situation in which no relief is provided the spouse for the tax liability as such.
See Allen v. Commissioner, 514 F.2d at 915.
In accordance with the foregoing and because of concessions by the parties,
Decision will be entered under Rule 155.