Bone v. CommissionerBone v. Commissioner
Larry D. Anderson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: In separate notices of deficiency,1 respondent determined deficiencies in petitioners’ income taxes as follows:
| Docket No. | Year | Deficiency |
|---|---|---|
| 20220-98 | 1993 | $524,103 |
| 20221-98 | 1993 | 545,324 |
After concessions,2 the issues for our consideration are: (1) Whether A.J. Concrete Services, Inc. (AJCS), is entitled to deduct $2,261,555 in expenses; (2) whether AJCS overreported its income by $2,680,500; (3) whether AJCS is entitled to a $269,815 deduction for accrued workmen‘s compensation expense. Unless otherwise indicated, all section references are to the
FINDINGS OF FACT3
Petitioners Jeffrey and Genedine Guerrero resided at 4215 Osprey Pointe, Woodstock, Georgia, on the date their petition was filed. Petitioners Alan and Kathleen Bone resided at 617 North Lake Drive, Canton, Georgia, at the time their petition was filed.
Alan Bone (Mr. Bone) and Jeffrey Guerrero (Mr. Guerrero) owned 49 percent and 51 percent, respectively, of AJCS, an S corporation incorporated in 1987 and engaged in the business of supplying construction forming equipment and materials to various contractors.4 AJCS, a calendar year taxpayer, maintained its books on the percentage of completion method for financial accounting purposes and the completed contract method for tax purposes.
As of December 31, 1992, AJCS owned ongoing construction contracts with a total value of $19,975,949 and estimated projected gross profits of $8,763,221. AJCS’ schedule of contracts reflects that, as of December 31, 1992, it had $2,680,500 of recognized gross profit on its partially completed contracts.
On January 1, 1993, AJCS transferred its incomplete contracts to four C corporations: A.J. Concrete Forming of Georgia, Inc. (Georgia); A.J. Concrete Forming Central, Inc.
The stock ownership of these four affiliates6 was as follows: (1) Georgia was owned 47.5 percent by Mr. Guerrero, 47.5 percent by Jeff Klewein, and 5 percent by Jeff Hoylman; (2) Central was owned 47.5 percent by Jeff Klewein, 47.5 percent by Rick Klewein, and 5 percent by Dave Entinghe; (3) East was owned 47.5 percent by Rick Klewein, 47.5 percent by Mr. Bone, and 5 percent by Robb Webb; and (4) West was owned 47.5 percent by Jeff Klewein, 47.5 percent by Mr. Bone, and 5 percent by Ken Ritter.
On its 1993 tax return, AJCS reported the $2,680,500 it had recognized on its partially completed contracts. On its 1993 tax return, AJCS claimed deductions on line 20 totaling $2,808,034.
After transferring all of its outstanding contracts to the affiliates, AJCS was no longer in the construction forming business. AJCS‘s primary business, after the transfer of the contracts, was to provide management services to the four affiliates that were performing on the contracts. Under agreements, AJCS was entitled to charge each affiliate for a
AJCS was entitled to receive the management fees at the time the affiliates completed the contracts. All four affiliates used the completed contract method to report income for Federal tax purposes. For the affiliates’ tax years ending in 1993, they reported gross income as follows:
| Affiliate | TYE | Gross Income |
|---|---|---|
| West | Sept. 30, 1993 | $2,394,029 |
| Georgia | Sept. 30, 1993 | 5,962,994 |
| Central | June 30, 1993 | -0- |
| East | Mar. 31, 1993 | 76,116 |
Georgia deducted $490,000 as management fees paid to AJCS on its September 30, 1993, tax return. Central deducted $724,880 as management fees paid to AJCS on its June 30, 1994, tax return. AJCS did not report any management fee income on its 1993 tax return.
The four affiliates extended loans to AJCS during the 1993 calendar year. As of the end of the 1993 tax year, the affiliates had outstanding loans to AJCS as follows:
| Affiliate | Loan Amount |
|---|---|
| West | -0- |
| Georgia | $1,674,722 |
| Central | 568,065 |
| East | 80,201 |
AJCS reported taxable income of $117,018, $358,860, and $309,967 for the 1990, 1991, and 1992 tax years, respectively. AJCS‘s and the four affiliates’ “schedule of contracts” for the
AJCS, for Federal tax purposes, reported a $236,300 loss for its 1993 tax year. The four affiliates reported Federal tax losses for the tax year ending 1993 as follows:
| Affiliate | Reported Loss |
|---|---|
| West | ($72,041) |
| Georgia | (5,507) |
| Central | (8,873) |
| East | -0- |
The combined Federal tax loss reported for the 1993 calendar year by AJCS and the four affiliates is $322,721.7 AJCS and the four affiliates reported tax losses in their subsequent reporting periods as follows:
| Company | TYE | Reported Loss |
|---|---|---|
| AJCS | Dec. 31, 1994 | ($577) |
| West | Sept. 30, 1994 | (300,451) |
| Georgia | Sept. 30, 1994 | (222,782) |
| Central | June 30, 1994 | (14,627) |
| East | Mar. 31, 1994 | (354,826) |
The Schedules L, Balance Sheet, attached to AJCS‘s 1993 and 1994 tax returns do not reflect the same 1993 ending figures as the amounts reflected for the 1994 beginning figures with respect
Respondent determined that $2,261,555 of the $2,808,034 deducted on AJCS‘s 1993 tax return was expended for completing the contracts that had been transferred to the four affiliate corporations.
Workmen‘s Compensation Expenses
In 1993, AJCS had transferred its contracts to the four affiliates and, as a result, had no employees performing concrete forming work. AJCS, however, deducted $135,194 as insurance on line 19 of its 1993 return. AJCS accrued $269,815 as a workmen‘s compensation insurance liability on its 1993 return. In computing its 1993 taxable income, AJCS reversed the workmen‘s compensation accrual.
AJCS made payments of approximately $275,000 to various insurance companies. West and Georgia for their years ended September 30, 1993 and 1994, and Central for its years ended June 30, 1993 and 1994, did not claim a workmen‘s compensation or insurance expense on line 26 of the corporate Federal tax returns. West reported a relatively large amount of cost of goods sold, but no breakdown was provided to reflect whether
East was the only affiliate that was shown to have deducted an insurance expense for workmen‘s compensation. East‘s short year return for the period ended March 31, 1993, reflects a $5,332 deduction on line 26 for “W/C insurance“, and East‘s Schedule M-1 reflects a “W/C accrual” of $83,536. No workmen‘s compensation insurance deduction is listed on East‘s March 31, 1994, return.
OPINION
Petitioners were the shareholders of AJCS, an S corporation. Accordingly, any adjustment to AJCS flows through to petitioners. Respondent determined that several adjustments were necessary to items reported on AJCS‘s 1993 return, resulting in flowthrough adjustments and income tax deficiencies for petitioners’ 1993 taxable year.
I. AJCS‘s Expenditures in Connection With the Contracts Transferred to the Affiliates
The first issue for our consideration is whether AJCS‘s expenditure of $2,261,555 is deductible as AJCS‘s ordinary and necessary business expenses or whether those expense obligations pertained to the four affiliates.8
Respondent contends that AJCS‘s claimed $2,261,555 deduction on its 1993 tax return represents expenses that AJCS paid to complete the construction projects that had been transferred to the four affiliates and, therefore, are not deductible expenses of AJCS. Petitioners agree that the expenses paid by AJCS were in aid of the completion of the transferred contracts of the four affiliates. Nevertheless, petitioners advance several arguments in support of the position that the expenses are deductible by AJCS.
First, petitioners argue that the facts of this case fit within the narrow exception carved out by this Court in Lohrke v. Commissioner, 48 T.C. 679 (1967). In Lohrke, we held that a taxpayer may deduct the expenses of another taxpayer in
AJCS must show that its motive for paying the affiliates’ expenses was in furtherance or promotion of AJCS‘s trade or business. See id. at 688. Secondly, AJCS must show that the expenses are ordinary and necessary expenditures in furtherance of its trade or business and not just in furtherance of the affiliates’ trade or business. See id.
To determine AJCS‘s motive for payment of the affiliates’ expenses, we can consider whether there is “a clear proximate danger to the taxpayer and * * * a payment made to protect an existing business from harm.” Young & Rubicam, Inc. v. United States, 187 Ct. Cl. 635, 410 F.2d 1233, 1243 (1969). The deduction is not available if the paying taxpayer fails to demonstrate a direct nexus between the purpose of the payment and the taxpayer‘s business or income-producing activities. See Lettie Pate Whitehead Found., Inc. v. United States, 606 F.2d 534, 538 (5th Cir. 1979).
In an attempt to come within this narrow exception, petitioners argue that AJCS was bound by contract to pay the costs of completing the contracts and, further, that the affiliates could not afford the expenses. We find petitioners’ arguments unpersuasive. Petitioners also point out that AJCS was
Petitioners also argue that the four affiliates could not afford to pay their own expenses. That argument is directly contradicted by the record. During the period in question, three
Petitioners also argue that AJCS was entitled to deduct the expenses because AJCS could not allocate its general and administrative expenses among the various contracts transferred to the affiliates. At trial, John Snider, AJCS‘s chief financial officer, testified that the affiliates paid AJCS a “fee based on the proportional overhead that applies to the revenue and expenses“, and “the overhead for * * * [general and administrative] expenses was charged to the * * * [affiliates] based on their revenues.” Accordingly, petitioners’ contention that AJCS could not allocate its general and administrative expenses to each transferred contract is, in effect, incorrect.
Petitioners also cited several cases without attempting to analyze the facts and law of those cases and how they apply to the facts and circumstances in our record. Petitioners cite Mel Dar Corp. v. Commissioner, 309 F.2d 525 (9th Cir. 1962), and Frank Lyon Co. v. United States, 435 U.S. 561 (1978). Those cases deal with the claim of right doctrine and a sale and leaseback, respectively. We fail to see the relevance of the above-referenced cases to the dispute currently before us. In the absence of any analysis or explanation by petitioners, we find these case citations unhelpful.
Petitioners also attempted to show that respondent‘s determination is in error by attempting to show that respondent‘s revenue agent‘s examination may have been inadequate.
On the basis of the foregoing, we hold that petitioners have failed to show that they are entitled to deduct the expenses paid by AJCS on behalf of the affiliates. Accordingly, we sustain respondent‘s determination that AJCS is not entitled to deduct expenses of $2,261,555 that were expenses of the four newly formed affiliates.
II. Did AJCS Erroneously Overstate Its Income?
Next, we consider petitioners’ contention that AJCS overstated its income by $2,680,500. On brief and for the first time in the course of the trial, petitioners raised an issue as to whether AJCS‘s 1993 income was overstated because the four affiliates may have mistakenly reported the same income.10 Although petitioners included an allegation on this point in their petitions, it was not addressed in the opening statement at trial and, accordingly, was not tried by consent and was untimely
Even if petitioners had timely raised this issue, it is well established that the person who earns or otherwise creates the right to receive income is taxed. See Lucas v. Earl, 281 U.S. 111 (1930). The assignment of income doctrine requires compensation to be taxed to the person who earns it regardless of the anticipatory arrangements and contracts, however skillfully devised. See Leavell v. Commissioner, 104 T.C. 140 (1995). AJCS earned the income at issue even though it might have been erroneously reported by others. Accordingly, AJCS may not reduce its income by $2,680,500.
III. Workmen‘s Compensation Insurance Expenses
Finally, we consider petitioners’ contention that AJCS is entitled to deduct $269,815 in workmen‘s compensation insurance expenses for its 1993 tax year.
Petitioners allege in their petitions that they are entitled to deduct accrued workmen‘s compensation expenses of $269,815. Respondent contends that, under
Petitioners, in their posttrial brief, state as follows: AJCS “is also entitled to an additional insurance expense of $269,815 per
Petitioners submitted copies of checks written from AJCS to various insurance companies. These checks totaled approximately $275,000. Petitioners also offered copies of checks remitted by W&J, Inc., to various insurance companies. These checks totaled over $800,000. On this record, we remain unaware of the relevance of checks remitted by W&J, Inc. Finally, petitioners
Another complicating factor is that AJCS claimed insurance expenses under several different categories on its tax returns. It is impossible to tell from the evidence whether the checks petitioners submitted are already claimed on AJCS‘s 1993 tax return as insurance under other deductions or whether they are included in other general categories. Finally, the record in this case does not reveal whether the amounts in dispute are AJCS‘s expenses or more properly those of the affiliates.11
Petitioners have failed to show that AJCS is entitled to deduct workmen‘s compensation expenses of $269,815, and, accordingly, we hold for respondent on this issue.12
To reflect the foregoing,
Decisions will be entered under Rule 155.