1994 Tax Ct. Memo LEXIS 63 | Tax Ct. | 1994
1994 Tax Ct. Memo LEXIS 63">*63 An appropriate order will be issued denying petitioners' motion for reconsideration without further trial.
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. In 1988, C advanced $ 95,101 in payments to or on behalf of P, including payments to the bankruptcy trustee to repurchase C's stock from the bankruptcy estate. In all instances, P made decisions as C's sole shareholder, despite the fact that the bankruptcy trustee held legal title to the stock. In
This opinion supplements our memorandum findings of fact and opinion in
SUPPLEMENTAL MEMORANDUM1994 Tax Ct. Memo LEXIS 63">*64 FINDINGS OF FACT AND OPINION
PARR,
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulation1994 Tax Ct. Memo LEXIS 63">*65 of facts, together with the attached exhibits, is incorporated herein by this reference. At the time they filed their petition, petitioners resided as husband and wife in El Paso, Texas. ECPA's principal place of business was in the State of Texas. References to petitioner in the singular are to Eduardo Cepeda.
We have previously addressed the constructive dividend issue as it relates to petitioners and to ECPA in
After attending medical school in Mexico, Eduardo Cepeda completed his residency in Pittsburgh, Pennsylvania, and his fellowship in pulmonary medicine in Cleveland, Ohio. Petitioner subsequently created and organized ECPA as a professional association in the State of Texas on August 26, 1980. Petitioner was the sole shareholder and president of ECPA.
Prior to January 1, 1988, ECPA advanced $ 161,479 to or on behalf of petitioner for the payment of his personal expenses and investments. Petitioner made 1994 Tax Ct. Memo LEXIS 63">*66 the decision to have the corporation advance the funds as ECPA's sole representative. ECPA maintained a "due from stockholders account" reflecting advances by the corporation for petitioner's personal expenses and investments. ECPA passed no corporate resolution authorizing the advances made to petitioners. Similarly, petitioners did not execute a loan or note or provide security or collateral in exchange for such advances. In addition, no documents were presented that contained a schedule of repayment or the rate of interest to be charged on the above advances.
On November 23, 1987, petitioners voluntarily filed bankruptcy under chapter 7 of the United States Bankruptcy Code. Petitioners filed a Statement of Financial Affairs for Debtor Engaged in Business on January 25, 1988, listing ECPA as an unsecured creditor. On February 29, 1988, the United States Bankruptcy Court for the Western District of Texas discharged petitioners from all dischargeable debts.
On January 1, 1988, ECPA wrote off the stockholder account balance in the amount of $ 161,479 as a bad debt deduction. ECPA made no efforts to collect on the debt owed by petitioners.
Despite the bankruptcy, during 1988, 1994 Tax Ct. Memo LEXIS 63">*67 ECPA advanced $ 95,101 in issued, $ 43,461 was made in payments to the bankruptcy trustee on petitioner's behalf to repurchase ECPA's stock from the bankruptcy estate. The bankruptcy court authorized the sale of the stock to petitioner on October 21, 1988. The first payment from ECPA to the bankruptcy trustee was on May 2, 1988, in the amount of $ 25,000. ECPA made six additional payments of $ 3,000 each to the trustee from May 27, 1988, to November 5, 1988, not including an unidentified payment of $ 461.43. The remaining $ 51,640 was made in payments to various insurance companies, the Internal Revenue Service, and a car dealership, on behalf of petitioner.
As before, no notes were signed and no collateral was provided by petitioner as security in exchange for ECPA's advances. Furthermore, ECPA did not pass any corporate resolutions authorizing the advance of funds. As with the pre-1988 advances, ECPA's decision to make the advances was petitioner's sole decision. 2
1994 Tax Ct. Memo LEXIS 63">*68 Petitioners did not present any checks from their personal account which reflected repayment to ECPA during 1988. However, during 1988, 1989, and 1990, petitioner deposited distribution checks from his investment in El Paso Health Care Systems into the corporate account of ECPA in the amounts or $ 3,678, $ 9,731, and $ 10,199, respectively.
During 1988, petitioner received compensation from ECPA in the amount of $ 125,444. ECPA did not declare or pay any dividends. ECPA's unappropriated retained earnings for FYE December 31, 1988, were $ 103,254.
On October 8, 1991, respondent issued a notice of deficiency to petitioners for tax year 1988, 3 determining that they had received corporate distributions in the form of dividends from ECPA in the amount of $ 91,423 4 during 1988.
1994 Tax Ct. Memo LEXIS 63">*69 In
OPINION
Petitioners contend that we fundamentally erred in our determination because the bankruptcy estate, not petitioners, owned the stock from January 1, 1988, to 1994 Tax Ct. Memo LEXIS 63">*70 October 21, 1988, the period during which ECPA made some of the advances. Because they were not stockholders, petitioners contend that the advances cannot be classified as constructive dividends. See sec. 301;
Respondent acknowledges that the stock was owned by the bankruptcy estate from the filing of the bankruptcy petition on November 23, 1987, until the sale date of October 21, 1988, pursuant to
To resolve this dispute, we will address the issue in two separate but related contexts -- beneficial ownership and substance over form.
The concept of beneficial ownership has been frequently used by this Court to ascertain when a sale of stock has occurred and thus determine which party is to be charged with receipt of dividend income. For purposes of Federal income taxation, a sale of stock depends1994 Tax Ct. Memo LEXIS 63">*72 upon transferring sufficient incidents of beneficial ownership rather than upon technical requirements for the passage of title under State law. See
As to inclusion of dividends in income, courts have consistently held that record ownership of stock, standing alone, is not determinative in answering the question as to who is required to include any dividends attributable to such stock in gross income. Rather, beneficial ownership is the controlling factor.
Transfer of legal title upon the sale of stock is analogous to transfer of legal title during bankruptcy, for dividend purposes, and the same factors are relevant in an analysis of beneficial ownership. In both instances, while the legal ownership or title may have passed, the actual benefits or control associated with stock ownership can still remain with the original owner or transferor.
Beneficial ownership is marked by command over property or enjoyment of its economic benefits.
An economic benefit need not increase the recipient's net worth; relief from a personal obligation constitutes a substantial benefit.
In the case at hand, beneficial ownership of ECPA stock by petitioner can be found from both control over the property and irrefutable economic benefit. In regard to control, despite the fact that petitioner's ownership interest in the corporation was legally and technically transferred to the bankruptcy estate, petitioner was still able to cause the corporation to advance corporate funds both to himself and to the bankruptcy trustee on his behalf (to repurchase the ECPA stock). As to benefit, petitioner clearly incurred substantial economic benefit by compelling ECPA to pay for the stock repurchase, insurance premiums, and various other expenses.
Furthermore, objective evidence of petitioner's overt acts leads to the conclusion of continuing ownership and control. The advances to petitioner by ECPA were still recorded in the corporate books under the account, "due from stockholders". When arguing that1994 Tax Ct. Memo LEXIS 63">*76 the advances constituted loans, petitioner never asserted he received such advances as an employee of the corporation; he consistently argued he received them in his capacity as the sole shareholder. Although legal title to ECPA's stock had passed to the bankruptcy trustee, petitioner was still able to cause the corporation to advance the funds on his behalf. The lack of any corporate formalities -- board resolution, signed note, etc. -- only affirms petitioner's total control and the ease with which he was able to transfer funds between himself and his business entity. Finally, petitioner stated that the decision to advance funds was made in the "best interests of the corporation", despite the fact the corporation knew it was advancing money on behalf of a bankrupt individual.
Consequently, we conclude that in order to be charged with receipt of constructive dividends, beneficial ownership, as established through control over the property or continuing enjoyment of its economic benefits, will suffice. Accordingly, we find that petitioners have failed to meet their burden of proving that they did not receive the advances "with respect to" their stock, which is a necessary element1994 Tax Ct. Memo LEXIS 63">*77 of constructive dividends. Therefore, we find that petitioners had beneficial ownership of ECPA's stock while in bankruptcy and thus received constructive dividends in their capacity as stockholders.
Respondent contends that the actions of petitioners make it appropriate to determine, as a matter of substance, that petitioners were the true owners of the ECPA stock and that the corporate distributions were taxable dividends.
It is well established that the economic substance of a transaction, rather than its form, controls for Federal tax purposes.
In several cases, the Supreme Court has refused to permit the transfer of formal legal title to shift the incidence of taxation attributable to ownership of property where the transferor continues to retain significant control over the property transferred. See, e.g.,
A similar analysis of control and command over property as that which determines economic benefit is present in a substance over form determination. We have found that petitioner*79 retained and exerted total control over the corporation, even during bankruptcy, resulting in petitioners' repurchase of the ECPA stock and the payments of significant amounts of personal expenses by the corporation. Therefore, although in form the legal ownership of the ECPA stock had passed to the bankruptcy estate, the substantive reality was that petitioner continued to benefit and exert total control over the ECPA stock.
Accordingly, under either theory of beneficial ownership or substance over form, petitioners retained the benefits of ownership and thus the advances they received from ECPA are taxable as constructive dividends. 8
To reflect the foregoing,
Footnotes
1. All section references are to the Internal Revenue Code in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩
2. Despite the fact that the bankruptcy trustee began receiving payments as to the ECPA stock sale as early as May 2, 1988, no evidence in the record discloses the trustee's involvement, as the sole legal owner of the stock, in ECPA's decision to make the advances.↩
3. Respondent also issued a notice of deficiency to ECPA for FYE Aug. 31, 1987, and Dec. 31, 1988. The issues as to ECPA were addressed in
Cepeda v. Commissioner , T.C. Memo. 1993-477↩4. In the statutory notice of deficiency, respondent determined that petitioners had received constructive dividends from ECPA during tax year 1988 computed as follows:
↩ Expenses paid by ECPA $ 95,101 Less: Partnership withdrawals deposits to corporate account ( 3,678) Total constructive dividend 91,423 5. Although ECPA joined petitioners in their objection to our prior holding, ECPA did not submit any separate argument to refute our disallowance of its bad debt deduction.↩
6. Sec. 301 provides that in order to be in receipt of taxable dividend income, there must be a distribution of property from a corporation to a shareholder with respect to its stock. Sec. 301 is not applicable to an amount paid by a corporation to a shareholder unless the amount is paid to the shareholder in his capacity as such.
Sec. 1.301-1(c), Income Tax Regs.↩ 7. Under the Bankruptcy Code,
11 U.S.C. sec. 541 (1988)↩ , the commencement of a case under ch. 7 creates an estate comprised of all legal or equitable interests of the debtor (petitioner) in property as of the filing of the petition. The bankruptcy estate possesses legal ownership of the property until it is sold or otherwise disposed of.8. Even if we concluded that petitioner was not a shareholder under either espoused theory, the advances were, nevertheless, an accession to petitioner's wealth and, thus, would be income under the general principles of sec. 61.↩