Volume 67 — Tax Court Memorandum

P's tax-protester petition, the seventh he has filed in this Court, will be dismissed for failure to state a claim upon which relief can be granted. Penalty awarded to the United States under sec. 6673(a), I.R.C., in the maximum amount of $ 25,000.

R determined a deficiency based on Ps claimed deductions and loss. Held: Ps' business deductions and loss redetermined; Held, further, R's determination of the addition to tax for fraud under former sec. 6653(b)(1)(A) and (B), I.R.C., not sustained; R's determination of the addition to tax for substantial understatement of liability under former sec. 6661, I.R.C., sustained.

Ps paid A, an architect, to design a single-family house on oceanfront property in East Hampton, New York. Held: Ps cannot deduct A's architectural fees as an abandonment loss incurred in connection with a transaction entered into for profit under sec. 165(c), I.R.C.; A's fees are a nondeductible personal loss.

P purchased shares of stock, subject to a 5-year transfer prohibition, at a bargain price from his employer. Held: The restrictions remained in effect until the 5-year prohibition lapsed. R's determination is sustained.

R determined income tax deficiencies against P for 1981 and 1982 using the net worth plus expenditures method. P took money from his corporation. Held: The statute of limitations does not bar the assessment and collection of tax for 1981 and 1982. Sec. 6501(c)(1), I.R.C. 1954. 2. Held, further, P is liable for additions to tax for civil fraud for 1981 and 1982. Secs. 6653(b) and 6653(b)(1), I.R.C. 1954. 3.

On their 1988 tax return, Ps, a husband and wife, claimed various Schedule C deductions with respect to a venture carried on by petitioner wife. Held: Ps' Schedule C activity was not engaged in for profit within the meaning of sec. 183, I.R.C. 2. Held, further, on account of personal use of the property, Ps are not entitled to the losses claimed in connection with the rental of their condominium located in Ashland, Massachusetts. See sec. 280A(e), I.R.C. 3.

P engaged in fishing boat and related activities. P incurred only losses with respect to these activities, and did not keep books and records for such activities. Held: P did not engage in the boat activities for profit within the meaning of sec. 183, I.R.C.Held, further, P may not deduct unsubstantiated expenses. Held, further, P is entitled to a portion of the depreciation claimed for a fishing boat.

R determined that H and W (Ps) were not at risk for the full amount deducted with respect to a computer leasing transaction and disallowed certain deductions; Ps contend that they were at risk. Held: Ps were not at risk within the meaning of sec. 465, I.R.C.Held further: W is not entitled to innocent spouse relief under sec. 6013(e), I.R.C.

P and C were each 50-percent owners of a design service corporation (Y). P and C purchased property and formed a partnership (X) to operate it. Held: P does not qualify for a rollover under sec. 1034, I.R.C., on gain from the sale of property

P was the president and sole shareholder in C, a professional association. C advanced funds to or on behalf of P for his personal expenses and investments. In 1987, P filed for bankruptcy. Held: P retained beneficial ownership of C's stock and thus could receive constructive dividends.

Ps lost their property in a flood and in a subsequent inverse condemnation proceeding were awarded payments for loss of property and prejudgment interest. Held: prejudgment interest is taxable as ordinary income. Held, further, attorneys' fees incurred in the condemnation proceedings are not currently deductible to the extent related to P's condemnation claims; attorneys' fees deductible to extent solely related to interest rate determination.

Petitioners' 1987 dividend and capital gain distributions from a mutual fund were reinvested in the fund. At the end of 1987 petitioners' holdings in the fund were worth less than their original investment. Petitioners deducted lodging expenses for petitioner husband (H); expenses for H's tools and professional dues; clothes and grooming expenses for petitioner wife (W); and H's contribution to an individual retirement account. During 1987 W was an active participant in her employer's tax-qualified employees plan. 1. Held: Petitioners' dividend and capital gain distributions were income in the year distributed. Sec. 61, I.R.C. 1986. 2. Held, further, H's employment in 1987 was not temporary. Petitioners may not deduct expenses for H's lodging. Sec. 162(a)(2), I.R.C. 1986. 3. Held, further, petitioners may not deduct expenses for H's tools and professional dues. Sec. 162(a), I.R.C. 1986. 4. Held, further, petitioners may not deduct W's clothes and grooming expenses. Sec. 262, I.R.C. 1986. 5. Held, further, petitioners may not deduct H's contribution to an individual retirement account. Sec. 219(g), I.R.C. 1986. 6. Held, further, petitioners are liable for additions to tax under subpars. (A) and (B) of sec. 6653(a)(1), I.R.C. 1986. Burden of proof allocated and amount determined as to subpar. (B). 7. Held, further, petitioners are liable for an addition to tax under sec. 6661(a), I.R.C. 1986.

P and her husband, H, filed joint returns over a 4-year period. Held: The assessment and collection of deficiencies are not barred by the statute of limitations since R has established, by clear and convincing evidence, that H intentionally sought to avoid the payment of taxes known to be owing. Proof of fraud in a joint return will permit assessment and collection against either spouse at any time.

1. R asserted increased deficiencies for 1984 and 1985 and fraud on the part of D in the filing of the returns for those years. The allegations of fraud were well pleaded. Held: R's increased deficiencies and additions to tax for fraud sustained as to D. 2. M, D's spouse, claimed the innocent spouse protection of sec. 6013(e), I.R.C., and also claimed that no valid joint tax returns were filed because 1984 and 1985 returns were signed by her under duress.

In 1982, the year in issue, P entered into an agreement with S to purchase from S a 75-percent interest in a racehorse; the agreement was contingent on S's exercising options to buy the interest. Held: P's basis in the racehorse equals the cash P expended to purchase such horse. Held, further, P must reduce his basis for depreciation in the racehorse to reflect the sale of a portion of his interest therein. Held, further, the racehorse is properly depreciable over 3 years.

In connection with six commercial loans that C made to P, C commenced a lawsuit against P alleging that P was in default on three of the loans. Held: P failed to prove that any portion of the payment that C made to him was paid on account of a tortlike personal injury; accordingly, the payment is not excludable from P's gross income under sec. 104(a)(2), I.R.C. Held, further, P is not liable for the additions to tax for negligence that respondent determined under sec.…

R disallowed P's claimed Schedule C and Schedule E deductions and determined certain additions to tax. Held: For purposes of sec. 183, I.R.C., P was not engaged in an activity for profit. Held: For purposes of sec. 183, I.R.C., P was not engaged in an activity for profit.

P conducted three businesses during 1984 and 1985, the taxable years in issue. P also had a 50-percent interest in a partnership. Held: The statute of limitation does not bar the assessment and collection of income taxes for P's 1984 and 1985 taxable years. Held, further, P overstated expenses for two businesses for the taxable years 1984 and 1985. Held, further, P understated income received from his interest in the partnership for the taxable years 1984 and 1985.

In 1979, a group of doctors organized a corporation, C, to develop and operate a hospital. C's shareholders formed a limited partnership, D, comprised of 43 partners, all but 2 of which were shareholders of C. C leased certain land to D and D agreed to lease to C certain fixed equipment and a hospital building to be constructed on the land. D did not manufacture or produce the equipment subject to the lease to C. Under the lease from D to C, D's maximum contributions for expenses related to the fixed equipment totaled $ 550,000. Under the lease, the rent C owed D was the amount necessary to maintain and service any indebtedness incurred in connection with the construction of the hospital, and C was also liable for "additional rent" in the amount of $ 550,000. For one of the taxable years in issue, D paid C the amount of the $ 550,000 cap on expenses, without determining its actual liability. For another year in issue, D and C did not actually exchange payments. Held: D does not qualify for the investment credit for 1984. Held, further, certain interest claimed as an ordinary deduction for 1985 and 1986 must be recharacterized as investment interest. Held, further, certain construction-period interest may be currently deducted by D.

Mrs. Spector (W) and Dr. Ehrenworth (H) were married from 1955 to 1980. They divorced in 1980. In connection with the divorce, they executed a settlement agreement. The settlement agreement required H to make weekly payments to W for 12 years and identified the payments as alimony. W remarried shortly after the divorce. H stopped making the weekly payments. W sued in State court to compel H to continue making the payments. The State court ordered H to continue making the payments. H made the payments throughout the years in issue. W did not report the payments in her gross income. H deducted the payments from his gross income. R determined that the payments were taxable to W and not deductible by H. H and W separately petitioned this Court, and the cases were consolidated. W and H each filed motions for partial summary judgment. W contends that these payments were not taxable to her as alimony because of provisions of New Jersey law that restrict court-ordered postremarriage alimony. H contends that the payments were alimony for Federal tax purposes because the agreement identified the payments as alimony and New Jersey courts enforced the agreement. Held, if a former spouse agrees to pay alimony after his or her spouse remarries, and the agreement is enforced under State law, then the fact that courts in that State may not order postremarriage alimony absent such an agreement does not in itself determine whether the payments are treated as alimony for Federal income tax purposes. Taylor v. Campbell, 335 F.2d 841 (5th Cir. 1964); Mass v. Commissioner, 81 T.C. "12 (1983); Dixon v. Commissioner, 44 T.C. 709 (1965); Hogg v. Commissioner, 13 T.C. 361 (1949); Hesse v. Commissioner, 7 T.C. 700 (1946); see Engelhardt v. Commissioner, 58 T.C. 641 (1972). Hoffman v. Commissioner, 54 T.C. 1607 (1970), affd. 455 F.2d 161 (7th Cir. 1972), distinguished. Held further, the character of payments for Federal income tax purposes under sec. 71(a)(1) is determined by consideration of all the facts and circumstances, and not solely by reference to how it is characterized by the separation agreement. Yoakum v. Commissioner, 82 T.C. 128 (1984); Beard v. Commissioner, 77 T.C. 1275 (1981); Gammill v. Commissioner, 73 T.C. 921 (1980), affd. 710 F.2d 607 (10th Cir. 1982); Hesse v. Commissioner, 60 T.C. 685 (1973), affd. without published opinion 511 F.2d 1393 (3d Cir. 1975). Both motions for partial summary judgment will be denied.

During the years at issue, Ps purchased two furnished residences in Sarasota, Florida, for future appreciation in value. Held: Ps are entitled to deduct otherwise allowable expenses attributable to their holding of the properties, but not rental expenses in excess of rental income.

Evidence in the record demonstrates that (1) P valued inventory in accordance with the "lower of cost or market" method, and (2) P's method of accounting involved valuing inventory cost at 125 percent of invoice cost. During the years at issue, P attempted to mark down certain classes of its inventory to reflect reductions in market value. That markdown was disallowed in our earlier opinion, Hitachi Sales Corp. of America v. Commissioner, T.C. Memo. 1992-504, due to lack of substantiation. R moves for partial summary judgment that P must value closing inventory at 125 percent of invoice cost because no consent to use a new accounting method has been requested or granted. Sec. 446(e), I.R.C. P opposes R's motion, arguing that it valued inventory at market value, without regard to cost (and specifically, without regard to 125 percent of invoice cost). Alternatively, P argues that, if it must value inventory at 125 percent of invoice cost, no adjustment under sec. 481, I.R.C., should be made, either because (1) R has not changed P's method of accounting or (2) R has delayed too long in raising sec. 481, I.R.C. 1. Held: P has not set forth specific facts demonstrating that there is a genuine dispute as to its method of accounting. See Rule 121(d), Tax Court Rules of Practice and Procedure. Accordingly, we find: (1) P valued inventory in accordance with the lower of cost or market method, and (2) P's method of accounting involved valuing inventory cost at 125 percent of invoice cost. P valued inventory at the lower of 125 percent of invoice cost or market. 2. Held, further, R has changed P's method of accounting with regard to inventory and has not merely corrected an error within P's method. 3. Held, further, R did not delay too long in raising an adjustment under sec. 481, I.R.C.

T is an attorney. In September 1983 he entered into an agreement with a client as to fees in respect of a medical malpractice suit to be brought on behalf of the client. Held: The entire income earned by T as his contingent fee in the malpractice suit is includable in his gross income, notwithstanding that his ex-wife's share was paid to her. Lucas v. Earl, 281 U.S. 111 (1930).

Individual petitioner G was the beneficial owner of corporate petitioner T and managed T's restaurant. G deposited some of T's receipts into his personal bank accounts, and marked certain deposits that were made into T's corporate accounts as being loans from shareholder. The notices of deficiency were sent to petitioners more than 3 years after petitioners filed their Federal income tax returns for 1981, 1982, and 1983. 1. Held: The statute of limitations does not bar the assessment and collection of tax against G and T for 1981 and 1982, or against T for 1983; it does bar assessment and collection against G for 1983. Secs. 6501(c)(1) and 6501(e)(1), I.R.C. 1954. 2. Held, further, G and T are liable for 50-percent additions to tax for civil fraud for each of the open years. Secs. 6653(b) and 6653(b)(1), I.R.C. 1954. 3. Held, further, G (for 1982) and T (for fiscal 1982 and 1983) are liable for additional additions to tax based on the portions of the underpayments attributable to fraud; amounts determined. Sec. 6653(b)(2), I.R.C. 1954. 4. Held, further, Amounts of deficiencies determined.

D's estate included a QTIP trust that was formed by D's deceased wife, and for which her estate had previously taken a deduction under sec. 2056(b)(7). D's will directed that any estate tax imposed in relation to any trust included in his taxable estate would be paid out of his residuary estate without apportionment against the legatees, beneficiaries, donees, or transferees. Following D's death, his co-executors (Ps) calculated his Federal estate tax utilizing the estate tax apportionment provision prescribed in Ohio Rev. Code Ann. sec. 2113.86(I) (Page 1990); Ps argue here that the apportionment provision applies because D's will did not elect out of that provision. Held, D's direction in his will constituted an election out of the apportionment provision, and Ps may not use it to calculate D's Federal estate tax.

Held: Petitioner is liable for additions to tax for fraud under sec. 6653(b) for its 1978 and 1979 taxable years. Held: Petitioner is liable for additions to tax for fraud under sec. 6653(b) for its 1978 and 1979 taxable years.

The notice of deficiency in this case involving the taxable years 1979, 1980, and 1981 was mailed to Ps on April 3, 1984. Held: This Court has jurisdiction under sec. 6214(b), I.R.C., to consider whether there is an investment tax credit to be carried back to the 1980 year. Hill v. Commissioner, 95 T.C. 437 (1990); Mennuto v. Commissioner, 56 T.C. 910, 922-923 (1971), followed. 2. Ps' motion to amend is untimely and will be denied. 3.

In Nalle v. Commissioner, 99 T.C. 187 (1992), we held sec. 1.48-12(b)(5), Income Tax Regs., to be a valid regulation and sustained R's determination of deficiencies against Ps. On appeal, the U.S. Court of Appeals for the Fifth Circuit reversed holding the regulation in question invalid. Nalle v. Commissioner, 997 F.2d 1134 (5th Cir. 1993). On remand, Ps filed a motion for reasonable litigation costs under sec. 7430, I.R.C.Held, Ps' motion is denied on the ground that R's decision to defend the validity of sec. 1.48-12(b)(5), Income Tax Regs., in the context of these proceedings was substantially justified.

During 1980 and 1982 through 1988, the years in issue, Ps engaged in a horse breeding, training, and jumping activity. Held: Based on the facts and circumstances of the case, the horse activity was not engaged in for profit under sec. 183. Held, further, Ps are not entitled to a sec. 1231 loss in 1988 from the disposition of a horse used in the activity.

In Stoller v. Commissioner, T.C. Memo. 1990-659, affd. in part and revd. in part 994 F.2d 855 (D.C. Cir. 1993), we held that S, a partner in Holly, was not entitled to ordinary loss treatment with… Held: R is not collaterally estopped from arguing that P is not entitled to ordinary loss treatment with respect to the cancellation and replacement of certain forward contracts. Held, further: P's motion for summary judgment is denied.

Ps employed money managers who engaged in numerous securities transactions on Ps' behalf during the years in issue. Ps actively oversaw the money managers. Ps' focus was long-term capital growth. The average holding period of Ps' stocks sold during the years in issue was approximately 1 year. Ps' principal sources of income from their securities transactions were dividends, interest, and long-term capital gains. Ps did not allocate any costs of their securities activity to particular purchases or sales. Held: Ps were mere investors, and their securities activity does not constitute a trade or business. Held, further, Ps may not capitalize their securities-related costs incurred during the years in issue. Held, further, Ps' securities activity was not a passive activity within the meaning of sec. 469, I.R.C., so their capital gains from sales of securities were not passive income.

R determined that the Estate of C (EC) was liable for gift and estate taxes that arose from alleged gifts made by C to C's children, petitioner R (PR) and petitioner M… Held: EC is not liable for gift tax owed for a transfer of property from C to PM during the period in issue. No gift tax liability arose because the promised transfer did not occur during that period. 2. Held, further, EC is not liable for gift tax owed for gifts made by C to PR during the period in issue.

P was employed as chairman and CEO of a thrift savings and loan, C. C was subject to the regulatory authority of the Federal Home Loan Bank Board (Bank Board). As part of 1987 yearend tax planning, C decided to sell certain stock in X in order to offset the capital losses against its capital gains. P arranged for an indirect sale of the X stock to himself. After completing the transaction and learning that it violated a Bank Board regulation, P so informed the Bank Board. C's auditor determined that C's expected capital loss from the sale of the X stock would be disallowed under sec. 267, I.R.C. The auditor informed the Bank Board that C's lost tax benefits amounted to $ 755,172. The Bank Board informed P that because of the violation of the regulation, P must either give back the X stock or pay C $ 755,172. Had P not agreed to one of these choices, the Bank Board would have sought P's removal. In 1988, the year in issue, P paid C $ 755,172. P deducted this payment as the only item on Schedule C, Profit or Loss from Business (Sole Proprietorship). Held: P's payment is not deductible under sec. 162, I.R.C., but must be capitalized in his basis in the X stock.

Petitioner husband (M) pled guilty to a charge of income tax evasion, sec. 7201, I.R.C. 1954, and conspiracy, 18 U.S.C. sec. 2 (1982), for 1983. Held: Imposition of additions to tax under secs. 6653(b) and 6661, I.R.C. 1954, and increased rate of interest under sec. 6621(c), I.R.C. 1954, are not precluded by the Double Jeopardy Clause.

In 1982, P sued his former employer, M, for age discrimination under the Age Discrimination in Employment Act (ADEA). Held: R is not barred by statute or regulation from reopening P's case. Held, further, R is not equitably estopped from reopening P's case. Held, further, R bears the burden of proof with respect to her tax benefit theory. Held, further, the $ 25,000 payment is not includable in P's income.

P1 and P2, a police officer and former firefighter, respectively, received payments under the Connecticut Heart and Hypertension Statute, Conn. Gen. Stat. Held: The Connecticut Heart and Hypertension Statute, Conn. Gen. Stat. Ann. sec. 7-433c (West 1989), is not a statute in the nature of a workmen's compensation act which provides compensation to employees for personal injuries or sickness incurred in the course of employment. Sec. 1.104-1(b), Income Tax Regs.