T.C. M em o . 2 0 1 9 -4 0
UNITED STATES TAX COURT
RICK B. FERGUSON AND DEANNA FERGUSON, Pet i ti o n ers v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 1 0 7 33 -1 6
. Fi l edAp ri l 2 3 , 2 0 1 9
.

As h l ea Bro wn , W al t er M . Eb el III, an d J oel F. Ho o v er, fo r p et i ti o n ers . An n L. Darn ol dan dH. El i zab et h H. Do wn s , fo r res p o n d en t
.

M EM ORANDUM FINDINGS OF FACT AND OPINION VASQUEZ, Ju d ge: Res p o n d en td et erm i n edd efi ci en ci es i n p et it io n ers ’ Fed eral i nco m e t ax o f $ 5 7 1 , 0 0 3 an d$ 7 2 ,5 86 fo r 2 0 1 1 an d 2 0 1 2 , res p ect i v el y .- 2
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[* 2 ] Aft er co n ces si o ns , 1 t h e i s s u es fo r d eci si o n are (i ) wh et h er p et i t i o n ers m ay d educta s et t l em en tp aym en tas a b u s i n es s ex p en s e o n a Sch edu l e C, Pro fi to r Lo s s Fro m Bu s i n es s ; (i i ) i f n o t , wh et h er p et i ti o n ers m ay d edu ctth e s et tl em en t as a p as s t h ro u g h l o s s o n a Sch edul e E; an d(i ii ) wh ether p et it io n ers are en ti t l edt o d eductan o rd in ary

l o s s fro m

th e d eem eds al e o f real p ro p ert y th atwas tran s ferred p u rs u an t t o th e s et t l em en t
. Al l s ect i o n referen ces are t o the In t ern al Rev en ue Co de (Co d e) i n effect fo r t h e y ears i n i s s u e, an dal l Ru le referen ces are t o th e Tax Co u rtRu l es o f Pract i ce
an d Pro cedu re, u n l es s o t h erwi s e i n d i cat ed
. FINDINGS OF FACT So m e o f t h e fact s h av e b een s ti p u lat ed an dare s o fo u n d. W e i n co rp orat e t h e s t i p u l at i o n o f fact s an dth e at t ach ed ex h i b i ts b y thi s referen ce. Pet i t i o n ers are h u s b an dan dwi fe. Wh en they t i m el y fi l edth ei r p et i t io n , th ey

res i d edi n Ark an s as . Back g ro u n d Pet i t i o ner Ri ckFerg u s on h as b een i n th e cu s t o m h o m e b u i l d i n g an d
co n st ru ct i o n b us i nes s fo r o v er 3 0 y ears . M r. Ferg us o n’ s b u s i n es s i s g en eral l y

1 Res p o n d en tco n ced es t h atth ere was an erro r i n h i s cal cu l at i o n o f t he ad ju s t m en tfro m

Sch edu l e E, Su

p p l em en tal In co m e an dLo s s , l i s t edi n th e n o t i ce o f d efi ci en cy fo r 2 0 1 1 , n eces si t at i n g a Ru l e 1 5 5 co m pu t at io n . As we ex p l ai n i n fra n o t e 6 , p et i t io n ers ab an d o n edth ei r cl ai m o f a p as st hro u g h d edu ct i o n fo r l eg al fees cl ai m edb y

M r. Ferg u s on ’ s S co rp o rat i o n .- 3
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[* 3 ] kn o wni n h i s co m

m u n it y as “ Ri ckFerg us o n Cu st o m Ho m es ” an d/ o r “ Ri ck Ferg u s on Ho m es ” (co l l ect i vel y , Ri ckFerg us o n Ho m es ). Ho wev er, M r. Ferg u s o n
o p erat es h i s b u s i n es s th ro u g h s ev eral d i fferen t en t i t i es th aten g ag e i n v ari o u s
s t ag es o f h om e d es ig n an dco n s t ru ct i o n . M r. Ferg us o n s erv es as a p art n er,
s h areh o ld er, an dm em

b er i n th es e en ti t i es th atare o rg an i zedas p art n ers h i p s , l i m i ted l i ab i li t y co m

p an ies , an d co rp o rat i o n s . He h as d ev el o pedap p ro x im at el y
s ev en s ub d i v i s i o n s an db u i l tb etween 1 5 0 an d2 0 0 h o m es i n cen t ral Ark an s as t h ro u g h t h es e en t i t ies
. Th i s cas e i nv o l v es two o f M r. Ferg u s o n ’ s en t i t i es . Ri ckFerg u s o n , In c. (RFI), i s a C co rp o rat i on o f wh i ch M r. Ferg u s o n was th e m ajo ri t y s h areh o l d er at al l rel ev an tt i m es . RFI i s th e co rp o rat i o n th ro u g h wh i ch M r. Ferg u s o n o p erat es as a g en eral co n t ract o r o n cu s t o m h o m e co n s tru ct i o n jo bs . Duri n g t h e y ears i n i s s u e M r. Ferg u s o n recei veda s al ary o f $ 4 4 ,4 0 0 fro m

RFI. Th e s eco n den ti ty , Pi nn acl e Precas tCo . (Pi n n acl e), was an S co rp o rat i o n o f wh i ch M r. Ferg us o n was al s o th e m ajo ri ty s h areh ol d er. 2 Pi n nacl e m an u fact u red , s up p li ed , an di ns t al l edcas t s to n e.

2 M r. Ferg us o n h el da 9 6 .2 4 6 5 8 % o wn ers h i p i n t eres ti n Pi n n acl e du ri n g 2 0 1 1 an da 1 0 0 % o wn ers h i p i n t eres t i n 2 0 1 2.- 4
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[* 4 ] Laws u i t an d Set t l em en t In 2 0 0 5 RFI co n t ract edwi t h a t h i rdp art y (h o m eo wn ers ) fo r t he s al e o f t h ree l o t s i n Li t t l e Ro ck , Ark an s as , an dth e co n s t ru ct i o n o f a h o m e o n th o s e l o t s . M r. Ferg u s on s i g n edth e co n s t ru ct io n co n t ract o n b eh al f o f RFI, wh i ch ag reed t o
co n st ru cta l arg e, s i n g le-fam i l y dwel l i n g fo r th e h om eo wn ers an d t o p erfo rm “ al l
wo rkn eces s ary

t o co m p l et e th e d wel l i n g ”. RFI t h en s ub co n t ract edwi t h 4 0
s ub co n t ract o rs t o p erfo rm an d s up erv i s e t h e wo rkan d t o o b t ai n ap p ro p ri at e b u i l d i n g p erm i t s . On e o f t h es e s ub co n t ract o rs was Pi n n acl e, wh ich was h i redt o p ro duce, s up pl y , an d i n s t al l cas ts t o n e fo r u s e i n th e co n st ru ct io n o f t h e dwel l i n g . Aft er co n st ru ct i o n was co m p l et ed , rel at i o n s b etween M r. Ferg u s o n an dth e h o m eo wn ers b ecam e acri m o n i ou s . Th e co n s tru ct i on o f t h e d wel li n g i n v o l v edth e i n s t al l at i on o f cas ts t o n e p an el s, b al u s t rad es , an dco l u m n s. Acco rd i ng t o t he h o m eo wn ers , th e p an el s , b al us t rad es , an dco l u m n s th reat en edt o fal l o r co l l ap s e b ecau s e o f d efect s i n the m an u fact u re an di ns t al l at i o n o f t h e cas ts t on e. Th e h o m eo wn ers fi l eda l aws ui tag ai n st RFI, Pi n nacl e, Val l ey Fal l s Es t at es , In c. (VFE), 3 an dM r. Ferg u s o n s eek i n g a m u l t i m i l l i o n-d o l l ar ju d g m en to n v ari o u s

3 VFE was an S co rp o rat io n o wn ed b y M r. Ferg us o n t h ats o ldth e h o m eo wn ers th e l ot s o n wh ich th e d wel l i n g was co n s tru ct ed . Acco rd i n g ly , th e h o m eo wn ers n am edVFE as a d efen d an ti n th ei r cl ai m s fo r res t i tu t i o n an d res ci ss i o n o f t h e co n st ru ct i on co n t ract . Th e h o m eo wn ers d i dn o tal leg e t h atVFE (co n ti n u ed ...)- 5
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[* 5 ] l eg al g ro un ds . Ov er t h e co u rs e o f t h e l it i g at i on , th e h om eo wn ers fi l ed
am en d edan ds eco n dam en d ed co m p l ai n t s . Wh i l e th e h o m eo wn ers al l eg edv ari o u s p ro b lem s wi t h t h e co n st ru ct i o n o f t h e d wel l i n g , p et it i o n ers an d res p on d en tag ree t h atth e p ri m ary

g ri ev an ce p ert ai n edt o th e cas ts t o n e. Th e h o m eo wn ers al l eg edi n th ei r o ri g i n al co m p lai n t t h atPi n n acl e

“ i m p ro p erl y m an u fact u red ” t h e cas t s to n e an d , al o n g wi t h RFI, “ i m pro p erl y i n s t al l edth e d efect iv e cas ts t on e.” In th ei r am en d edan d s eco ndam en ded
co m p l ai n t s the h o m eo wn ers al l eg edth at : (i ) Pi n n acl e m an u factu redth e cas ts t o n e

“ i n s uch a m an n er as t o ren d er t h e p ro du ctd efect i v e”, (i i ) t h e i m p ro p er
m an u fact u ri n g o f t h e cas t s to n e, co up l ed wi t h t he i m pro p er i n s tal l at i o n , cau s edth e b al u s t rad es an dco l u m

n s o f t he h om e’ s ex t eri o r t o d i s co l or an dcrack , an d(i i i ) t h e d efect i ve i n s t al l at i o n o f t h e cas ts t o n e i n cl u d edPi n n acl e’ s fai l u re t o i n st al l

“ ex p an s i o n jo i n t s ” an d“ weep h o les ”. W i t h res p ect t o RFI t he h o m eo wn ers al l eg edi n t he co m p l ai n t, am en d ed
co m p l ai n t , an ds eco n d am en dedco m p l ai n tthat : (i ) RFI s el ect ed Pi nn acl e t o
s up p ly th e cas ts t o ne fo r t h e co n s t ru ct i o n p ro ject , (i i ) RFI i m

p ro p erl y affi x edth e

3 (...co n t in u ed ) p l ay edan y o t h er ro l e i n th e co ns t ru ct i o n o f t h e d wel l i n g. Nei t h er p art y i n th i s cas e co n ten d s t h atVFE was i n an y way res p o n s i b le fo r t h e co s ts o f t h e h o m eo wn ers ’ l aws u i t
.- 6
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[* 6 ] cas ts t o n e p an el s t o th e s ub s t rat e wal ls , an d (i ii ) RFI i m p ro perl y i n s t al l edth e
cas ts t on e b al u s trad es o n th e h om e’ s p at i o. Th e h o m eo wn ers i d en t i fi edM r. Ferg u s o n i n th ei r p l ead i ng s as th e “ m ajo ri t y
s t ock h o ld er an d p ri n ci pal ” o f RFI an dPi n n acl e. Th e h o m eo wn ers al leg edth atM r. Ferg u s on h adm i s rep res en t edRFI’ s an dPi n n acl e’ s ex pert i s e i n m anu fact u ri n g an d i n s t al l i n g cas t s to ne. Th e h o m eo wn ers al s o al l eg edth atM r. Ferg u s o n , i n co n cert wi t h Pi n nacl e an dRFI, el ect edt o u s e co ns t ru ct i o n m etho d s an d m at eri al s th at
reas on ab l e p ers o n s wo u l d n o th av e em pl o y ed . Onth e b as i s o f t hes e al l eg at i o n s t h e h o m eo wn ers s o u gh tt o h o l dM r. Ferg u so n jo i n tl y an ds ev eral ly

l i ab l e wi t h RFI
an d Pi nn acl e fo r co u nt s o f n eg li g en ce, d ecei t , co n s t ru ct i v e frau d, an dd ecep t i v e t rad e p ract i ces . 4 In 2 0 1 1 th e l aws u i twas s et t l ed . Th e h o m eo wn ers , M r. Ferg u s o n , RFI, Pi n n acl e, an dVFE were p art i es t o t h e s et t l em en tag reem en t , wh i ch M r. Ferg u s o n
s i gn edi n h i s i n d i vi du al cap aci ty . As a p arto f t h e s et t l em en t , M r. Ferg u so n

4 Oth er t han s t at in g t hatM r. Ferg us o n h ada rel at i on s hi p o f tru s twi t h th e h o m eo wn ers fro m

p ri o r b u s i n es s d eal i n g s , th e h om eo wn ers ’ p lead i n g s d o n o t al l eg e th atM r. Ferg u s o n act edi n an y cap aci t y o t h er t h an as th e p ri n ci p al an d m ajo ri ty s h areh o l d er o f RFI an dPi n n acl e. Onth e b as i s o f t h i s an do t h er ev i d en ce i n the reco rd , we s p eci fi cal l y fi n dth atal l o f M r. Ferg u s o n ’ s act i o ns wi t h res p ectt o t h e co n s t ru ct i o n p ro

jectati s s u e were o n b eh al f o f RFI an d Pi nn acl e.- 7
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[* 7 ] tran s ferred n i n e p arcel s o f real es t at e t o t h e h o m eo wn ers . 5 M r. Ferg u s o n al s o g av e th e h o m eo wn ers a ch eck , wh i ch was drawn o n h i s p ers o n al b an kacco u n t . In tu rn th e h o m eo wn ers ag reed t o rel eas e M r. Ferg u s o n , RFI, Pi n nacl e, an dVFE fro m th ei r cl ai m s . Pi n n acl e reco rd edth e ag g reg at e v al u e o f t h e ch eckp aym en tan dth e fai r
m ark etv al u e o f t h e real es tat e tran s fer (co l l ect iv el y , s et tl em en t p aym en t ) o n i t s b o o k s fo r 2 0 1 1 as a l oan fro m M r. Ferg us o n. No wri tt en l oan d ocu m en t s were p rep ared , an dn o i n t eres twas accru edo n t h e l o an . M r. Ferg u s on b el i ev edh e
co u ldtreat th es e am o u n t s as a l o an t o Pi n n acl e b ecau s e h e b el i ev edth at t h e
s et t l em en twas at tri b ut ab l e t o th e d efect i v e cas ts t o ne. Pi nn acl e h adn o s al es o r g ro s s recei p ts i n 2 0 1 2, an dM r. Ferg u s o n s h u ti t d o wnl at er t h aty ear; h e as s u m ed Pi n n acl e’ s l i ab i l i t i es reg ard i n g th e reco rd edl o an , es sen t i al l y rel i ev i n g Pi n n acl e o f t h e o b li g at i o n t o rep ay

h i m . Tax Ret u rn s Oni t s 2 0 1 1 t ax retu rn Pi n n acl e rep o rt edg ro s s recei p ts o f $ 9 4 , 9 8 7 an d cl ai m edd edu ct i on s fo r o rd i n ary b u s i n es s ex p en s es , wh i ch i n cl u d ed : (i ) $ 10 1 ,3 9 3

5 Th es e p ro p ert i es were act u al ly tran s ferred t o t h e h o m eo wn ers b y th ree p as s t h ro u g h en t i t ies own edb y M r. Ferg u s o n th atwere n o tp art i es t o t h e l aws u i to r t h e s et tl em en tag reem en t . Th e n o t i ce o f d efi ci en cy treat edM r. Ferg u so n as th e o wn er an dtran s fero r o f t h e p ro p ert i es rat h er t han t h e p as s t h ro u g h en t i t i es . W e wi l l d eem th i s a co n ces s io n b y

res p o n d en tan d d o th e s am e.- 8
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[* 8 ] i n l eg al fees , (i i ) t h e s et t l em en t p aym en t , an d(i i i ) ano rd i n ary l o ss fro m

th e d eem eds al es o f t h ree (o f n i n e) p arcel s th at were t ran s ferred t o th e h om eo wn ers . Pi n n acl e rep ort ed l o n g -t erm cap i t al g ai n s fro m

the d eem eds al es o f th e o th er s i x p arcel s . Onth ei r 2 0 1 1 i nco m e t ax retu rn p et i t i o n ers rep o rt eda p as s t h ro u g h l o s s fro m Pi n n acl e an dcarri edi t fo rwardt o t h ei r 2 01 2 retu rn . Pet i t i o n ers ’ 2 01 1 i n co m e t ax retu rn i ncl u d es two Sch edu les C fo r a co m m erci al co n s tru ct i o n b u s i n es s an da h o m e rem od el i n g b u s i n es s; t he l at ter rep o rt edn etp ro fi to f $ 8 4 6 ,1 1 9 . M r. Ferg u s o n al s o rep o rt edwag e i n co m e fro m RFI o n p et i t i o n ers ’ 2 0 1 1
an d 2 0 1 2 retu rn s . No t ice o f Defi ci en cy Res p o n d en tt i m el y i s su eda n o t i ce o f d efi ci en cy t o p et it i on ers fo r t ax y ears 2 0 1 1 an d2 0 1 2 rep o rt i n g d efi ci en ci es o f $ 5 7 1 ,0 0 3 an d$ 7 2 ,5 8 6 , res pect i v el y . In t h e n o ti ce res p o n d en td i sal lo w edp et i t i o ners ’ p as s t h ro u g h l o s s d edu ct i o n fro m Pi n n acl e i n i t s en ti ret y . In s t ead , res p o n den ttreat ed t he s et t l em en tp aym en tas an
u n rei m b u rs edem

p l o y ee b us i nes s ex p en s e p ert ai n i n g t o M r. Ferg u s on ’ s
em pl o y m en twi t h RFI an dd i sal l o wedi n fu ll Pi n n acl e’ s d edu ct i o n o f t h e l eg al fees
an d o rd i n ary

l o s s . Res p o n d en t al l o wed p et i t io n ers t o cl ai m an i t em i zedd edu ct i on- 9
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[* 9 ] fo r t h e s et t l em en t p aym en tb u td i dn o tm ak e s i m i l ar al l o wan ces fo r th e l eg al fees 6 o r t he o rd i n ary

l o s s fro m

th e d eem eds al es o f t he p arcel s . Res po n den t ’ s ad ju s t m en t s res u l t edi n th e d is al l o wan ce o f p et i t i o n ers ’ carry fo rward n eto p erat i n g l o s s fo r 2 0 1 2
. 7 Sub s t an t i al p o rt i o n s o f t h e d efi ci en ci es are at t ri b u tab l e t o the ap p li cat io n o f t h e al t ern at i v e m i n i m u m t ax (AM T). 8 Pet it i o n ers t i m el y p et i t i o n ed t h i s Co u rt , an da t ri al was h el di n Li tt l e Ro ck , Ark an s as .

6 Pet i t i on ers as s i g n ederro r i n th ei r p et i t i o n t o res p o nd en t ’ s d i s al l o wan ce o f Pi n n acl e’ s d edu ct i on fo r l eg al fees . Ho wev er, t h ey d i d n otad dres s t h e d i s al l o wed l eg al fees attri al o r o n b ri ef. Acco rd i n gl y , we d eem t h e i ss ue ab an do n ed . See Th i es s en v . Co m

m i s s i o n er, 1 4 6 T.C. 1 00 , 1 0 6 (2 0 1 6 ) (“ [I] s su es an darg u m en t s n o t ad v an cedo n b ri ef are co n s id eredt o b e ab an d o n ed .”).

7 Pet i t i on ers rep o rt edcert ai n i t em s o n t h ei r 2 0 12 retu rn p ert ai ni n g t o th ei r i n t eres ti n Gen eri c Ho l d i ng s, LLC (Gen eri c), wh i ch i s a p art n ers h i p s ub jectt o th e u n i fi edau d i tan d l i t i gat i o n p ro cedu res s etfo rt h i n s ecs . 6 2 21 th ro u g h 6 2 3 4 (TEFRA p art n ers h i p p ro cedu res ). Fo r p u rp o ses o f p rep ari n g t h e n o t i ce o f d efi ci en cy

o n wh ich th i s cas e i s b as ed , res p on d en ttreat edp et i ti o n ers ’ Gen eri crel at ed p art n ers h i p i t em s as i f t h ey were co rrect l y

rep o rt edo n p et i t i o n ers ’ 2 0 1 2 t ax retu rn . Ho wev er, t h e t ax treat m en t o f p et i t i o n ers ’ Gen eri c-rel at edp art ners h i p i t em s i s th e s ub

j ect o f an o n g o in g TEFRA ex am i n at i o n b y th e Co m m i s s i o n er. Th e p art i es h av e s ti p ul at ed t h at t h e ad ju s t m en ts n eces s ary t o ap p l y th e res ul t s o f t h e TEFRA p art n ers h i p p ro ceed i n g t o p et i t i o n ers wi l l b e t reat edas co m p u t at i o n al ad ju s t m en t s u n d er s ec. 6 2 3 1(a)(6 ). Th e p art ies h av e al s o s t i p ul at edth at , t o th e ex t en tan y

p art n ers h ip ad

j u s t m en t s res u l t i n a ch an g e t o p et i t i o n ers ’ t ax l i ab i l i t y at t ri b u t ab l e t o n onp art n ers h i p i t em s (wh i ch are at i s s u e i n th i s cas e), s u ch ch an g e m ay b e t reat edas a co m

p u t at i o n al ad

ju s t m en t u n d er s ec. 6 2 31 (a)(6 ) an d as s es s ed , cred i t ed , o r refu nd edacco rd i n g l y .

8 Th i s an do t h er n um eri cal ad ju st m en t s wi l l b e ad dres s edb y the p art i es i n t h ei r Ru l e 1 5 5 co m

p u t at i o n .- 1 0 -

[* 1 0 ] OPINION I. Bu rd en o f Pro o f Gen eral ly , th e Co m

m i s s i o n er’ s d et erm i n at i o n o f a d efi ci en cy i s p res u m ed
co rrect , an dth e t ax p ay er h as the b urd en o f p ro v i ng i ti n co rrect . Ru l e 1 4 2 (a); W el ch v . Hel v eri n g , 2 9 0 U.S. 1 1 1 , 1 1 5 (1 9 3 3). Th e b u rd en o f p ro of s h i ft s t o th e Co m m i s s i o n er, h o wev er, t o th e ex t en tth e t ax pay er p ro du ces cred i b le ev id en ce wi t h res p ect t o a fact ual i ss ue rel ev an tt o th e d efi ci en cy , th e t ax p ay er co m p l i ed wi t h th e s ub s t an ti at i o n req u i rem en t s , an d t h e t ax p ay er co o p erat edwi t h th e Co m m i s s i o n er wi th reg ardt o al l reas o n ab l e req ues t s fo r i nfo rm at i o n . Sec. 7 4 9 1 (a); s ee al s o Hi g b ee v . Co m m i s s i o ner, 1 1 6 T.C. 4 38 , 4 4 0 -4 4 1 (2 0 0 1 ). Th e p art i es s t i p u l at edth atp et i t i o n ers h av e m ai n t ai n edal l reco rd s req u i red
u n d er t h e Co d e an dh av e co o p erat edwi t h res p o n d en t ’ s reas o n ab l e req ues t s fo r i n fo rm at i o n . Ho wev er, t h e p art i es d i s ag ree ab o u t wh et h er p et i t i on ers h av e p ro duced th e requi si t e cred i b l e ev i d en ce s o th atthe b u rd en o f p ro o f s h o u l d b e
s h i ft edt o res po n d en tu n d er s ect i o n 7 4 9 1 (a). W i t h res p ect t o th e d edu ct i b i l i t y o f t he s et t l em en tp aym en t , we n eedn o t
res o l ve t h i s d i s p u t e b ecau s e o u r co n cl u s i o n s are b as ed o n a p rep o nd eran ce o f t h e
ev i d en ce, an dth u s t h e al l o cat i on o f t h e b u rd en o f p ro o f i s i m m at eri al . See Bl o dg et t v . Co m

m i s s i o n er, 3 94 F.3 d1 0 3 0 , 1 03 9 (8 t h Ci r. 2 0 0 5 ), aff’ g T.C. M em o .- 1 1 -

[* 1 1 ] 2 0 0 3 -2 1 2 ; Knu d s en v . Co m m i s si o n er, 1 3 1 T.C. 1 85 , 1 89 (2 0 08 ),
s up p lem en t i n g T.C. M em o . 2 0 0 7 -3 4 0 ; M art i n Ice Cream Co . v . Co m m i ss i o n er, 1 1 0 T.C. 1 8 9 , 2 1 0 n .1 6 (1 9 9 8). As fo r t h e o rd i n ary

l os s cl ai m edb y Pi n n acl e fo r t h e d eem eds al es o f t h ree t ran s ferred p arcel s , we fi n dthatp et i t i o n ers fai l edt o p ro du ce cred i b le ev id en ce t o
s up p ortth ei r ret u rn p o s it i on th atPi n n acl e i s en t i t l edt o an o rd i naryl o s s d edu ct i o n . See i n fra p artIII. Acco rd i n g l y , s ect i o n 7 4 9 1 (a) d o es n o t ap p l y , an d t h e b u rd en o f p ro o f o n th i s i ss u e rem ai n s wi t h p et i t i o n ers . II. Th e Set t l em en tPaym en t A. Co n t en ti o ns o f t h e Part i es Pet i t i o ners arg ue t h atPi n n acl e p ro p erl y d edu ct edth e s et t l em en tp aym en t
an d t h atth ey

are en t i t l edt o thei r p ro rat a s hare o f t h e d edu ct io n. Acco rd i n g t o p et i t i o n ers , th e h o m eo wn ers ’ l aws u i ti s at tri b u t ab l e t o Pi n n acl e, an dth e p aym en t
o f t h e s et t l em en tb y

M r. Ferg u s o n s h o u l d b e treat edas a l o an o r cap i t al
co n tri b u t i o n t o th e S co rp orat i on . 9 In th e al t ern at i v e p et i t i o n ers co n t en dth atth e

9 If a b u s i n es s m eet s th e req u i rem en t s o f s ec. 1 3 6 1, i t m ay el ectt o b e t reat ed as an S co rp o rat io n an d g en eral l y av o i dco rp o rat e t ax . Secs . 1 3 6 2 (a), 1 3 6 3(a). An S co rp o rat i o n, l i k e a p art ners h i p , i s a fl o wth ro u g h en ti t y ; i t s i n co m e an dl o s s es fl owt h ro u g h t o i ts s h areh o l d ers , wh o th en p ay i n co m e t ax . See s ec. 1 36 3 (b ). Sec. 1 3 6 6 (a)(1 ) p ro v i d es th atan S co rp o rat i o n s h areh o l der d et erm i n es h i s o r h er t ax l i ab i l i t y by

t ak i n g i n t o acco u nth i s o r h er p ro rat a s h are o f t h e S co rp o rat i o n ’ s (co n ti n u ed ...)- 1 2 -

[* 1 2 ] s et t l em en tp aym en t s ho u l db e d edu ct edo n a Sch edul e C 1 0 as an o rd in ary an d
n eces s ary ex p en se o f a b u s in es s act i v i t y o t h er t han em p lo y m en t
. Res p o n d en tco u n ters thatPi n n acl e can no td edu ctan y o f t h e co s t s p ert ai n i ng t o the l aws ui t b ecau s e i td i dn o tp ay o r i n cu r t h em . Res p o n d en tfu rt her co nt en d s t h atth e co st s o f t h e l aws u i twere t h e res p on s ib i l i ty o f RFI. Acco rd i n g l y , p et i t i o n ers m ay

d edu ctth e s et t l em en tp aym en to n l y as an u n rei m

b urs edem

p l o y ee b u s i n es s ex p en s e. B. Sch edu l e C Dedu ct i o n W e fi rs tad dres s p et i t i on ers ’ arg um en tth atth ey are en t it l edt o d edu ctth e
s et t l em en tp aym en tas an o rd in ary an dn eces s ary

b u s in es s ex p en s e o n a Sch edu l e C. Dedu ct i o n s are a m at t er o f l eg i s l at i v e g race, an dthe t ax p ay er g en eral l y b ears th e b urd en o f p ro vi ng en ti t l em en tt o an y d edu ct io n cl ai m ed . Ru le 1 4 2 (a); INDOPCO, In c. v . Co m

m i s s i o ner, 5 0 3 U.S. 7 9 , 8 4 (1 99 2 ); New Co l o n i al Ice Co
.

9 (...co n t in u ed ) i n co m e, l o s s es , d edu ct i o n s , an dcred i t s fo r t h e S co rp o rat io n ’ s t ax ab l e y ear en d i n g wi t h o r i n th e s h areh o l der’ s t ax ab l e y ear. W e h av e ju ri s di ct io n i n thi s d efi ci en cy cas e t o red et erm i n e t h e i n co m e an dex p en se i t em s o f Pi n n acl e. See W i n t er v . Co m m i s s i o n er, 1 3 5 T.C. 2 3 8 (2 0 1 0); Berryv . Co m m i s s i o n er, T.C. M em o . 2 0 1 8
- 1 4 3 , at * 6 ; Al l i v . Co m

m i s si o ner, T.C. M em o . 2 01 4 -1 5 , at* 1 7 n .1 1.
1 0 Iti s co m

m o n l y kn o wnth ata Sch edu l e C i s t h e fo rm a s o le p ro p ri et o r u s es t o rep o rti n co m e an d d edu ct i o ns at t ri b u t ab l e t o th e s o l e p ro p ri et o rs h i p.- 1 3 -

[* 1 3 ] v . Hel v eri ng , 2 9 2 U.S. 4 3 5 , 4 4 0 (1 9 3 4 ). Sect i o n 1 62 (a) p erm i ts a t ax p ay er t o d educto rd i n ary

an dn eces s ary

ex p en s es p ai do r i n cu rredi n carry i n g o n a t rad e
o r b u si n es s . See Co m

m i s s io ner v . Li n co ln Sav . & Lo an As s ’ n , 4 0 3 U.S. 3 4 5 , 3 5 2 (1 9 7 1). Sect io n 6 2 (a)(1 ) al l ows d edu ct i on s fo r t h os e ex p en s es t o b e m ad e fro m g ro s s i n co m e i n co m

p u ti n g ad j u s t edg ro ss i n co m e (AGI) ex cep tfo r t h o s e ex p en s es i n cu rredb y

a t ax p ay er as an em

p l o y ee. Th e p art i es ag ree t h atp et i t i o n ers are en ti t ledt o d eductth e s et tl em en t p aym en t as a t rad e o r b u s i n es s ex p en s e u n d er s ect i o n 1 6 2 . Ho wev er, th ey d i s ag ree
as t o wh et h er t h e s et tl em en tp aym en ts h o u l db e d edu ct ed fro m g ro s s i n co m e i n
co m p u t i n g p et i t i o ners ’ AGI. 1 1 Res p o n d en tas sert s th atth e s et t l em en tp aym en twas RFI’ s ex p en s e b ecau se RFI was res po n s i b l e fo r t h e wo rk t h atg av e ri s e t o th e h o m eo wn ers ’ l aws u i t
. Res po n d en targ u es th atas a s t atu t o ry em p l o y ee o f RFI u nd er s ect i o n 3 1 2 1 (d )(1 ), 1 2

1 1 If t h e s et t lem en tp aym en ti s treat edas an u n rei m b urs edem

p lo y ee b u s i n es s ex p en s e as res p o nd en td et erm i n ed , cert ai n co n s eq u en ces fo l l ow: (1 ) t he d edu ct i o n wo u l db e l im i t edb y sec. 6 7 (a) an d(2 ) p et i t i o n ers m i g h tb e s ubjectt o AM T l i ab i l i t y becau se m i s cel l an eo u s i t em i zedd educt i o n s are n o tt ak en i n t o acco u n ti n t h e d et erm i n at i o n o f t ax p ay ers ’ AM T i n co m e. See s ec. 5 6 (b )(1 )(A); J o hn s o n v . Co m m i s s i o n er, T.C. M em o . 1 9 9 3 -5 3 0
. 1 2 Sec. 3 1 21 (d )(1 ), (3 ), an d(4 ) d es cri b es i n d i v i du al s wh o are co n s i d ered em pl o y ees reg ard les s o f t hei r s t atu s u n d er th e co m m on l aw. In di v i du al s d es cri b ed i n tho s e p arag rap h s are co m m o n l y referred t o as “ s t atut o ry ” em p l o y ees . J o s ep h (co n ti n u ed ...)- 1 4 -

[* 1 4 ] M r. Ferg u s o n m ay

d edu ctth e s et t l em en t p aym en to n l y as an u n rei m

b u rs ed
em pl o y ee b u s i n es s ex p en s e. Pet i t i o n ers co u n ter t h atRFI was n o tM r. Ferg u s o n ’ s
o n l y trad e o r b u si n es s . Acco rd i n g t o p et it i o n ers , th ey m ay d edu ctth e s et t l em en t p aym en t o n a Sch edu l e C b ecau s e M r. Ferg u s o n p ai di tt o p ro t ecth i s b u s i n es s rep u t at i o n an d , b y

ex t en s i o n , h i s o t h er b u s i n es s es . Th e d edu ct i b i l it y

o f l eg al fees d ep en d s o n th e o ri g i n an d ch aract er o f t h e cl ai m fo r wh i ch th e ex p en s es were i n cu rredan dwh eth er t h e cl ai m b ears a
s u ffi ci en tn ex u s t o th e t ax p ay er’ s b u s i n es s o r i nco m e-p ro duci n g act i v i t ies . See Un i ted St at es v . Gi l m ore, 3 7 2 U.S. 3 9 (1 9 6 3 ); Hel g ers o n v . Un i t edSt at es , 4 2 6 F.2 d1 2 9 3 , 1 2 9 7 (8 t h Ci r. 1 9 7 0 ). 1 3 Leg al ex p en s es p ai das o rd i n ary an d n eces s ary

1 2 (...co n t i nu ed ) M . Grey Pub . Acco u n t an t , P.C. v . Co m m i s s i o ner, 1 1 9 T.C. 1 21 , 1 2 6 (2 0 02 ), aff’ d , 9 3 F. Ap p’ x 4 73 (3 dCi r. 2 00 4 ). Sec. 3 1 21 (d )(1 ) d efi n es a s t atu t o ry em p l o y ee as “ an y o ffi cer o f a co rp o rat io n ”. Pet i t i o n ers d o n otco n t en dth ats t atu t ory em p l o y ees u n d er s ec. 3 1 2 1 (d )(1 ) m ay d edu ctb u s i n es s ex p en s es o n Sch edul es C. See Co l e v . Co m m i s s i o n er, T.C. M em o . 2 0 0 6 -4 4 ; Rev . Ru l. 9 0-9 3 , 1 9 9 0 -2 C.B. 3 3 ; cf. Ro s at o v . Co m m i s s i o n er, T.C. M em o . 2 0 1 0 -3 9 (h o l d i n g t h ata s t atu t o ry em p l o y ee u n d er s ec. 3 1 21 (d )(3 ) i s n o tan em p l o y ee fo r p u rp o s es o f s ec. 6 2 an dm ay d edu ct b u s i n es s ex p en s es o n Sch edu l e C).

1 3 Th e s am e cri t eri o n h as b een ap p l i edt o d et erm i n e wh et h er a p aym en tm ad e i n s et t l em en t o f l i t i g at i o n co n s t i tu t es s u ch a b u s i n es s ex p en s e. Red wo odEm p i re Sav
. & Lo anAs s ’ n v . Co m m is s i o n er, 6 2 8 F.2 d5 16 , 5 2 0 (9 t h Ci r. 1 9 8 0 ), aff’ g 6 8 T.C. 9 6 0 , 9 7 7 (1 9 7 7 ); An ch o r Co up l i n g Co . v . Un i t edSt at es , 4 2 7 F.2 d4 2 9 (7 t h Ci r. 1 9 70 ); En t wi ck l un g s & Fi n an zi eru n g s A.G. v . Co m m i s s i o ner, 6 8 T.C. 7 4 9 , 7 5 9 (1 97 7 ).- 1 5 -

[* 1 5 ] ex pen ses m ay

b e d edu ct ib l e o n Sch edu l e C wh en t he m at t er g en erat i n g th e
ex p en s e ari s es fro m , o r i s p ro x im at el y rel at edt o , a b u s i n es s act iv i t y o t h er t h an
em pl o y m en t . Co l v i n v . Co m

m i s s i o n er, T.C. M em o . 2 0 0 7 -1 5 7 , s li p o p . at3 6 -3 7 , aff’ d , 2 8 5 F. Ap p ’ x 1 5 7 (5 t h Ci r. 2 0 08 ); Tes tv . Co m m i s si o n er, T.C. M em o . 2 0 0 0
- 3 6 2 , s l i p o p . at1 2 -1 3 , aff’ d , 4 9 F. Ap p’ x 9 6 (9 t h Ci r. 2 0 0 2); s ee Bag l ey v . Co m m i s s i o n er, 8 T.C. 1 3 0, 1 34 (1 9 4 7 ). A t ax pay er g en eral l y m us trep o rto n Sch edu l e A, It em i zedDedu ct i o n s , l eg al ex pen s es at t ri b u tab l e t o th e t ax p ay er’ s
s erv i ce as an em

p l o y ee. See s ec. 6 2 (a)(1 ); M cKay v . Co m m i s s i o n er, 1 02 T.C. 4 6 5 , 4 9 3 (1 9 9 4), v acat edo n o th er g ro u n d s 8 4 F.3 d4 3 3 (5 t h Ci r. 1 9 9 6 ); O’ M al l ey
v . Co m m i s s i o n er, 9 1 T.C. 3 5 2, 3 6 3 -3 6 4 (1 9 88 ); Tes tv . Co m m i s s i o n er, T.C. M em o. 2 0 0 0 -3 6 2
. Pet i t i o ners d o n otd i sp u t e t h atM r. Ferg u s o n was a s h areh o l d er an d
em pl o y ee o f RFI. Th e qu es t i o n th erefo re b eco m es wh eth er an d t o wh atex t en tth e h o m eo wn ers ’ l aws u i taro se fro m , o r i s p ro x i m at el y rel at edt o , a b us i n es s act i v i t y
o f M r. Ferg u s o n o t h er t h an h i s em pl o ym en twi t h RFI. Th e reco rdes t ab l i s hes t h atth e o ri g i n o f th e h om eo wn ers ’ l aws u i ts t em s fro m wo rk p erfo rm edb y

RFI an dPi n n acl e rat h er t h an a s ep arat e t rad e o r b u s i n es s
o f M r. Ferg u s o n . Wh i l e t he h o m eo wn ers ’ co m p l ai n t , am en d ed co m

p l ai n t , an d
s eco n dam en dedco m

p l ai nt al leg edv ari o u s p ro b lem s wi t h th e co n s tru ct i on o f t h e- 1 6 -

[* 1 6 ] dwel l i ng , th e p art i es ag ree t h at t h e cl ai m s reg ard in g th e cas ts t o n e were t h e h o m eo wn ers ’ p ri m ary

g ri ev an ce. Th e cas ts t o ne wo rkwas p erfo rm edan d/ o r
s up erv i s edb y

RFI an dPi n n acl e. RFI was th e g en eral co n t ract o r fo r t he
co n st ru ct i o n p ro

jectan dag reed t o p erfo rm “ al l wo rkn eces s ary

t o co m pl et e t h e dwel l i n g ”. Pi n n acl e was s ub co n t ract edt o p ro du ce, s upp l y , an d i n s t al l cas ts t o n e fo r u s e i n th e co n s t ru ct i o n . Wh i l e t h e h o m eo wn ers al s o s u edM r. Ferg u so n i n h i s i n di v i du al cap aci t y , h e was n o t a p art y

t o th e co n s t ru ct i o n co n t ract wi t h th e h o m eo wn ers . Fu rt h erm o re, t he h o m eo wn ers d i dn o tal l eg e t h atM r. Ferg u s o n t o o k an y act i o n i n t h e co n s t ru ct i o n o f t h e d wel l in g o t her t han as th e face an d co n t ro ll i ng s h areh o l d er
o f RFI an dPi n n acl e. 1 4 W e reco g ni ze t h atM r. Ferg u s o n h ada s ep arat e h om e rem o d el i n g b u s i n es s t h atg en erat eds ub s t an ti al Sch edu l e C i n co m e fo r 2 0 1 1 , an dwe d o n o t d o ub tth at h e was i n d eedco n cern ed ab o u tth e co n s eq u en ces o f anu n fav o rab l e ju d g m en to n t h i s an do t h er b u s i n es s v en tu res . Ho wev er, we are b o u n db y th e ru l e es t ab l i s h ed

1 4 Pet i t i o ners s u g g es t t h atM r. Ferg u s on was o perat i n g Ri ck Ferg u s o n Ho m es as a s o l e p ro pri et o rs h i p an dth atth i s en t i t y was s ep arat e fro m

RFI. Ho wev er, p et i t i o n ers ’ retu rn s fo r t h e y ears i n i s s u e d o n o ti n cl u d e Sch edu l es C fo r Ri ck Ferg u s on Ho m es . M o reo v er, M r. Ferg u so n t es ti fi ed t h atRFI h as d o ne b u s i n es s as Ri ck Ferg u s on Ho m es . Gi ven th es e fact s , we d ecl i n e t o fi ndth at Ri ck Ferg u s o n Ho m es an dRFI were s ep arat e en t i t i es du ri n g th e co ns t ru ct i o n o f t he h o m eo wn ers ’ dwel l i n g .- 1 7 -

[* 1 7 ] b y Gi l m o re, 3 7 2 U.S. at4 8 , t o l o o k atth e o ri g i n o f t h e u n d erl y i n g cl ai m an d
n o tth e co n s eq u en ces . Inth i s cas e t h e o ri g i n o f t he cl ai m s i s t h e wo rkp erfo rm ed b y RFI an dPi n n acl e, b o t h o f wh i ch fi l edco rp o rat e ret urn s fo r 2 0 1 1 . Acco rd i n g l y , p et i t i o n ers can no td edu ct t h e s et t l em en tp aym en to n a Sch edul e C. C. Lo an t o Pi n n acl e W e n ex tad dres s p et i t i o n ers ’ p ri m ary arg u m en tth atPi n n acl e s h o u l db e t reat ed as h av i n g p ai dth e s et t l em en t . Th ey co n ten dth atM r. Ferg u s o n i nt en d ed t h e s et tl em en tp aym en tt o b e a l o an t o Pi n nacl e b ecau s e i twas res p o n si bl e fo r t h e
wo rkth atg av e ri s e t o t h e h o m eo wn ers ’ cl ai m s . Wh et h er a p art i cu lar t ran s act i o n co n s ti tu t es a l o an i s a qu es ti o n o f factt o b e d et erm i n edb y

co n s i d eri ng al l o f t h e p ert i n en tfact s i n t he cas e, Fi s h er v . Co m m i s s i o n er, 5 4 T.C. 9 05 , 9 0 9 (1 9 7 0 ), an d we l o okfo r b o t h o b ject iv e an d
s ub ject i ve ev i d en ce o f t h e p art i es ’ i nt en t , s ee Un i t edSt at es v . Un eco , In c. (In re Un eco , In c.), 5 3 2 F.2 d 1 2 0 4, 1 20 9 (8 t h Ci r. 1 9 76 ). Th e Co u rto f Ap peal s fo r t h e Ei g h th Ci rcu i t , t o wh i ch an ap p eal wo u ldl i e ab s en ta s t i p u l at i on t o t h e co nt rary , l i st s a n u m

b er o f fact ors t o d et erm i n e wh et h er a b o n a fi d e l o an ex i s t s , s u ch as wh et h er: (1 ) t h e co rp o rat i o n was s o g ro ss l y u n d ercap i tal i zed t h atth e l o an s were i n fact n eed edfo r cap it al p u rp o ses an dwere act ual l y i n t en d edt o b e ri s ked cap i t al rat h er t h ana l o an , (2 ) t h e p u rp o rt edl o an s were m ad e i n p ro p ort i o n t o equ i t y- 1 8 -

[* 1 8 ] h o l d i n g s , (3 ) t h e rep aym en t o f t h e l oan was p red i cat ed o n t h e s u cces s o f t he
v en tu re, (4 ) th ere was a fi x edd at e fo r p aym en t o f t h e n o t e an d a reas o n ab le
ex p ect at i o n o f p aym en tb y th atd at e, (5 ) t h e n o te was s ub o rd i n at edt o o t her
co rp o rat e d eb t s, (6 ) t h i rdp art i es wo u l dh av e m ad e t he l o an u n d er th e s am e
co n di t i o n s , (7 ) t h e cl ai m ed l o an was s ecu redb y a m o rt g ag e o r o th erwi se, (8 ) a p ro v is i o n was m ad e fo r a s i n k i n g fu n dt o ret i re t h e l o an , (9 ) t h e p ers on m ak i n g th e p u rp ort edl o an p art i ci p at edi n th e m an ag em en to f t h e co rp o rat i o n , an d(1 0 ) th e
co rp o rat i o n h ada l arg e p ro p ort i o n o f d eb tt o equ it y . J .S. Bi ri t z Co n s t r. Co . v . Co m m i s s i o n er, 3 8 7 F.2 d4 5 1 , 4 5 7 (8 t h Ci r. 1 9 6 7 ), rev ’ g T.C. M em o . 1 9 66 -2 2 7 ;
s ee al so Un eco , In c., 5 32 F.2 d at1 2 0 8 . Th e fact o rs are n o tequ al l y s i g n i fi can t , an d
n o o n e fact o r i s d et erm i nat i v e. Di xi e Dai ri es Co rp . v . Co m m i s s i on er, 7 4 T.C. 4 7 6 , 4 9 3 (1 98 0 ). No r are al l th e fact o rs rel ev an tt o ev ery cas e. J .S. Bi ri t z Co n st r. Co
. v . Co m m i s s i o n er, 3 8 7 F.2 dat4 5 6 -4 57
. Pet i t i o ners ’ arg u m en tth atM r. Ferg u s o n ’ s p aym en t o f t h e s et t l em en t was act u al l y a l o an t o Pi n n acl e i s n o ts up p o rt edb y the reco rd
. Pet i t i o ners ci t e Pi n n acl e’ s treat in g t he s et t l em en tp aym en tas a l o an o n i ts b o o k s as ev i d en ce o f a b o n a fi d e l oan . Ho w ev er, n o l o an d o cu m en ts were p rep ared , an dth e reco rdi s d ev oi do f an y

ev i d en ce o f a fi x edrep aym en t d at e o r rep aym en ts ch edu l e. No i n t eres to r p ri n ci p al was p ai d o r accru edo n th e p u rp o rt edl o an , wh i ch M r.- 1 9 -

[* 1 9 ] Ferg u s o n effect i vel y can cel edwh en h e en dedPi nn acl e’ s o p erat i o n s i n 2 0 1 2
. Fu rt h erm o re, M r. Ferg u s o n t es t i fi edth atPi n n acl e h adl i t t l e ch an ce o f o b tai n i n g t h i rd -p art y fi nan ci n g o n i t s o wnwh enh e p ai dth e s et t l em en t . Th i s v i ew was
s h ared b y M r. Ferg u s o n ’ s acco u n t an t , wh o ack n o w l ed g edattri al th atPi nn acl e’ s p o o r cas h p o si t i on m ad e rep aym en tu nl i k el y . Onth e b as is o f th es e fact s , we fi n dth atM r. Ferg u s o n kn ew th at Pi n n acl e
wo u l db e u n ab l e t o rep ay h i m wh en h e fu n d edth e s et t l em en t . Acco rd i n g ly , M r. Ferg u s on d i d n o t i n t en dt o es t ab l i sh a cred i to r-d eb t o r rel at io n s h i p wi t h Pi nn acl e,
an d h i s p aym en t o f t h e s et t l em en twas n ota l o an t o th e S co rp o rat io n . D. Deem edCap i t al Co n t ri b u ti o n t o Pi n n acl e Pet i t i o ners arg ue t h at , ev en i f M r. Ferg u s o n ’ s p aym en to f t h e s et t l em en twas
n o ta l o an , th e p aym en twas n ev ert h el es s at t ri b u tab l e t o Pi n nacl e’ s t rad e o r b u s i n es s an dd edu ct i b le b y Pi n n acl e as an o rd i n ary an dn eces saryb u s i n es s
ex p en s e. Acco rd i n g t o p et i t i o ners , M r. Ferg u so n ’ s p aym en to f t h e s et t l em en ti s a
co n tri b u t i o n t o th e cap i t al o f Pi n n acl e i f i t i s n ota l oan . See Ri nkv . Co m m i s s i o n er, 5 1 T.C. 7 46 , 7 5 1 (1 9 6 9 ) (s t at i ng th at p aym en to f co rp o rat e
ex p en s es b y

s h areh o l d er g en eral l y

co n s t itu t es “ ei t h er a l o an o r a co nt ri b u t i o n t o t h e cap i t al o f t he co rp o rat io n an d* * * [i s ] d edu ct i b l e, i f atal l , b y th e
co rp o rat i o n”); Ko ree v . Co m m i s s io n er, 4 0 T.C. 9 6 1 , 9 6 6 (1 9 6 3 ) (h o l d i n g th at- 2 0 -

[* 2 0 ] p aym en ts i n fu rt heran ce o f a v en tu re cal cu l at edt o en ri ch co rp o rat io n are cap i t al i n n ature); s ee al s o Gan t n er v . Co m m i ss i o ner, 9 05 F.2 d 2 4 1 (8 t h Ci r. 1 9 9 0 ), aff’ g 9 1 T.C. 7 1 3 (1 98 8 ) an d9 2 T.C. 1 9 2 (1 9 8 8 ). Res p o n d en tack n owl ed g es th ata s h areh o l der’ s p aym en t o f co rp o rat e
ex p en s es m ay b e d eem ed a cap i t al co n t ri b u ti o n i n ap p ro p ri at e ci rcu m s t an ces . 1 5 Ho wev er, res p on d en t as s ert s that“ [a] n y co ncl u s io n th ata cap i t al co n t ri b u t i o n [t o Pi n n acl e] was d eem ed t o h av e b een m ad e p ri o r t o th e p aym en to f t h e s et t l em en t
co s t s wo u l d s t i l l req u i re a fi n d in g th atth e s et t l em en tco s ts were, i n fact , th e
ex p en s es o f Pi n n acl e * * * d es p i t e t h ei r p aym en t b y Ri ckFerg u s o n .” Acco rd i n g t o res p o n d en t , th e Co u rtcan m ak e n o s u ch fi n d i n g b ecau s e t h e s et t l em en tco s t s
were s o l el y

at t ri b ut ab l e t o RFI. In s up p o rto f h i s arg u m en tres p o nd en t co n t en d s th at(i ) RFI was th e g en eral
co n tract or o n an db o re t h e u l t i m at e res p o n s i b i l i t y fo r t h e co n st ru ct i o n p ro jectthat g av e ri s e t o th e h o m eo wn ers ’ l aws u i t , (i i ) Pi nn acl e was n o t a p art y t o RFI an dth e h o m eo wn ers ’ co n t ract , an d(i i i ) t h e al l eg at i on s i n th e h o m eo wn ers ’ l aws u i t ad dres s RFI’ s d eci s i on s t o u s e d efect i v e m at eri al s an d RFI’ s i n ad equ at e i n s t al l at i on o f t h e m at eri al s . Ci t i n g t h es e fact o rs , res po n d en targ ues th atth e co s ts

1 5 Res p o nd en td o es n ot co n t en dth atth i s p ri n ci pl e i s i nap p li cab l e t o S co rp o rat i o ns .- 2 1 -

[* 2 1 ] an d o b li g at i o ns ari s i ng fro m th e i l l-fat edco n s t ru ct i o n p ro ject were t h e
res p o n s i b i l i t y

o f RFI. W e b el i ev e res p o nd en ti g n o res th e real it i es o f Pi n n acl e’ s ro l e i n t he
co n st ru ct i o n p ro

ject . As m en t i o n ed p rev i o u sl y , th e h o m eo wn ers ’ p ri m ary g ri ev an ce p ert ai n edt o the cas ts t o n e. In the co m p lai n tth e h o m eo wn ers al l eg ed t h atPi nn acl e “ im

p ro perl y m anu fact u red ” t h e cas ts t o n e. In th e am en d edan d
s eco n dam en dedco m

p l ai nt s t h e h o m eo wn ers al l eg ed t h atPi n n acl e m an u fact u red t h e cas ts t o n e “ i n s u ch a m an n er as t o ren d er t h e p ro ductd efect i v e.” Th e am en d ed
an d s eco n dam en dedco m p l ai n t s fu rt h er al l eg edth atth e i m p ro p er m an ufact u ri n g
o f t h e cas ts t o n e, co up l edwi t h th e i m pro p er i n s tal l at i o n, cau s edth e b al us t rad es
an d co l u m

n s o f t h e d wel l i n g’ s ex t eri or t o d i s co l o r an dcrack
. Wh i l e res p o n d en tav ers t h atPi nn acl e p l ay edn o ro le i n th e i ns t al l at i on o f th e
cas ts t on e, t h e reco rdi n d i cat es o t h erwi s e. Th e p art i es s ti p u l at edth atPi n nacl e
s ub co n t ract edwi t h RFI t o “ p ro du ce, s up pl y , an di n st al l cas ts t o ne” fo r u s e i n th e
co n st ru ct i o n o f th e h om eo wn ers ’ h o m e. Th e h o m eo wn ers ’ o ri gi n al co m p l ai n t al l eg es th atPi n n acl e, al o n g wi th RFI, “ i m pro p erl y i n s t al l edth e d efect i v e cas t
s t on e.” In th e am en dedan ds eco n d am en d ed co m p l ai n t s th e h o m eo wners al l eg e t h atth e d efect i v e i n s t al l at i o n o f t h e cas t s t o n e i n cl u d ed Pi nn acl e’ s fai l u re t o i n st al l

“ ex p an s i o n jo i n t s ” an d“ weep h o les ”.- 2 2 -

[* 2 2 ] Fu rt herm o re, Pi n n acl e’ s i n t eres t s were acco un t edfo r i n t h e s et t l em en t ag reem en t . Pi n n acl e was a p art y th eret o an dwas therefo re rel eas edb y the h o m eo wn ers fro m

al l cl ai m s p ert ai n i n g t o th e co n s t ru ct i o n p ro jectati ss u e. In th e l i gh t o f t h es e fact s , we d i s ag ree wi t h res p o nd en tthatth e h o m eo wn ers ’ l aws u i twas
s o l el y at t ri b u t ab l e t o RFI. Th ati s n o tt o s ay , h o wev er, t h at we ag ree wi t h p et it io n ers ’ co n ten t i o n th at t h e l aws u i twas s o l el y

at t ri bu t ab l e t o Pi n n acl e. RFI was al s o a p art y t o th e
s et t l em en tag reem en t . As res p on d en tn o t es , the co m p l ai n t, am en d edco m

p l ai n t , an d s eco n dam en dedco m p l ai n tal l eg e t h atRFI s el ect edPi n n acl e t o s up p l y th e cas t
s t on e fo r t h e co n s tru ct i o n p ro ject . Al l th ree p l ead i n g s al s o co n tai n al l eg at i o n s th at RFI i m p ro perl y i n s t al ledth e cas ts t o n e. Fu rt herm o re, p u rs u an tt o i t s co n t ractwi t h t h e h o m eo wn ers , RFI was res p o n s i b l e fo r “ p erfo rm i n g al l wo rk n eces s ary

t o
co m p l et e t h e d w el l i n g fo r t he Co n t ract p ri ce”. Attri al M r. Ferg u s on co nfi rm ed t h atth e g en eral co nt ract or--RFI, i n th i s cas e--was “ u l t i m at el y res p o n s i b l e” fo r t h e
co n st ru ct i o n o f th e d w el li n g . Th i s Co u rth as ex am i n edl aws u i tal l eg at i o ns t o d et erm i n e wh o , am o n g
as s o ci at ed b u s i n es s es an di n d iv i du al s, m ay d edu ctl eg al fees i n cu rredas jo i n t d efen d an t s i n a l aws u it . See Hau g e v . Co m m i s s i o n er, T.C. M em o. 2 0 0 5 -2 7 6 , s l i p
o p . at1 3 , 1 6 -1 8 ; Grap h i c Bu s . Sy s ., In c. v . Co m m i s s i on er, T.C. M em o . 1 98 2 -1 6 7 ,- 2 3 -

[* 2 3 ] 1 9 8 2 Tax Ct . M em o LEXIS 5 8 3 , at* 1 4-* 1 7 . W e h av e al s o al l o cat ed d educt i b l e an d n o n dedu ct i b l e l i t i g at i o n ex p en ses wh ere ap p ro p ri at e. See, e.g ., Bl ed so e v . Co m

m is s i o n er, T.C. M em o . 1 9 9 5 -5 2 1, s l i p o p . at1 2 (al l o cat in g b u s i n es s an dp ers o n al ex p en s es ). W e b el i ev e an al l o cat i on o f t h e d edu ct i o n fo r t h e s et t l em en tp aym en ti s ap p ro p ri at e i n t h i s cas e. Iti s cl ear fro m t h e reco rdth atth e l aws ui tthatg av e ri s e t o t h e s et tl em en twas p art i al ly at t ri b u t ab l e t o RFI an dp art i al l y at tri b ut ab l e t o Pi n n acl e. Fu rt h erm o re, t h e s et t l em en twas p ai db y M r. Ferg u s o n , th e co n t ro l l i n g
s h areh o ld er o f b o t h co rp o rat i o ns . Acco rd i n g ly , aft er a t h o ro ug h rev i ew o f t h e
reco rd , i n cl u d i n g th e l aws u i t p l ead i n g s an dthe s et t lem en tag reem en t, we al l o cat e 5 0 % o f t h e s et t l em en tp aym en tt o RFI an d 5 0 % t o Pi n nacl e. 1 6 Becau s e M r. Ferg u s o n p ers o nal l y fu n d edth e s et tl em en t p aym en t , 5 0 % o f wh i ch was an ex p en s e o f Pi n n acl e, we wi l l d eem 5 0 % o f t h e p aym en t a cap i t al
co n tri b u t i o n t o Pi n nacl e. See Ri n kv . Co m m i s s i o n er, 5 1 T.C. at7 5 1 -7 5 2; Ko ree v . Co m m i s s i o n er, 4 0 T.C. at 9 6 6
. Acco rd i n gl y , Pi n n acl e m ay d edu ct5 0 % o f th e

1 6 Becau s e al l o f M r. Ferg u s o n ’ s act i o n s wi t h res p ectt o th e co n s t ru ct i o n p ro ject ati ss u e were o n b eh al f o f RFI an dPi n n acl e, s ee s up ra n o t e 4 , we al l o cat e 0 % o f t he s et t l em en tp aym en tt o M r. Ferg u s on i n d i v i du al l y . W e al s o al l o cat e 0 % t o VFE b ecau s e n ei th er p art y h as arg u edth atVFE b o re an y res p o n s i b i li t y

fo r t h e co s t s o f t h e l aws u i t
.- 2 4 -

[* 2 4 ] s et t l em en tp aym en t fo r 2 0 1 1, an dp et i t i o n ers are en t i t l edt o th ei r p ro rat a
s h are o f an y

l o s s t h i s d educt i o n p ro du ces . Becau s e t he rem ai n i n g 5 0 % was an ex p en s e o f RFI, we wo u l dn o rm al l y h o l dth atth i s p o rt i o n o f t h e p aym en ti s n o ta d edu ct i b l e ex p en s e t o p et i t i o n ers b u t rat h er a cap i t al co n t ri b u t i o n t o th e C co rp o rat i o n. See Ri n k v . Co m m i s s io n er, 5 1 T.C. at7 5 1 -7 5 2 ; Ko ree v . Co m m i s s i o n er, 4 0 T.C. at9 6 6 . Ho wev er, res p o nd en t h as co nced edth atp et i t i o n ers can d eductam ou n t s p ai d o n b eh al f o f RFI as
u n rei m b u rs edem

p l o y ee b us i nes s ex p en s es . Onth e b as i s o f t h i s co n ces s i o n , p et i t i o n ers m ay

d edu ctth e rem ai n i n g 5 0 % o f t h e s et t l em en t p aym en t as an
u n rei m b u rs edem

p l o y ee b us i nes s ex p en s e. III. Lo s s Fro m

Deem edSal e o f Real Pro p ert y Res p o n d en td i s al l o wedan o rd i naryl o s s d edu ct i o n cl ai m ed b y Pi nn acl e o n i t s 2 0 1 1 retu rn fo r the d eem eds al e o f th ree p arcel s th at were t ran s ferred t o th e h o m eo wn ers as p arto f t he s et t l em en t . Pet i t i o ners arg ue t h atei t h er M r. Ferg u s o n
o r Pi n n acl e i s en t i t l edt o d edu ctth e l o s s . Inh i s an s weri n g b ri ef res p on d en t
co n ced es th atp et i t i o n ers s h o u l db e al l o weda cap i tal l o s s d edu ct io n t o refl ectth at i n the d eem ed s al es , th e p arcel s were rel i n qu i s hedfo r l es s than th ei r b as es . Iti s
u n cl ear fro m p et i ti o n ers ’ b ri efs wh et h er t h ey s t i l l m ai n t ai n th atth e d eem eds al es
s h o u ldp ro du ce an o rd i n ary l os s rat her t han a cap i t al o n e.- 2 5 -

[* 2 5 ] Sect io n 1 2 2 1 (a) p ro v i d es th ata cap i t al as s eti s “p ro p ert y h el d b y th e t ax p ay er (wh et h er o r n o tco n n ect edwi t h h i s trad e o r b u s i n es s )”. Co n g res s h as p ro v id edi n s ect i o n 1 2 2 1 ei g h t s p eci fi c t y p es o f p ro p ert y

ex cep t ed fro m

th e d efi n i t i o n o f a cap i t al as s et . See s ec. 1 2 2 1(a). Pet i t i o ners h av e n o td i rect ed t h e Co u rtt o an y o f t h e ex cep t io n s l i s tedi n
s ect i on 1 2 2 1 . Th ere i s s can tev i d en ce i n th e reco rdp ert ai ni n g t o th e t h ree p arcel s ati ss u e, an d i t i s u n cl ear wh y th es e p ro p ert i es d i ffered fro m th e o t h er s i x p arcel s , fo r wh i ch cap i tal g ai ns were rep o rt edo n t h ei r d eem eds al es . Acco rd i n g l y , p et i t i o n ers h av e n o t m etthei r b u rd en t o p ro v e t h atth ey are en t i t l ed t o an o rd i n ary l o s s d edu ct i o n fo r t h e d eem ed s al es o f t h e t h ree p arcel s . W e t herefo re accep t
res p o n d en t’ s co n ces s i o n an d h o l dth atp et i t io n ers are en ti t ledt o a cap i t al l os s d educt i o n wi t h res p ect t o th es e p ro pert i es . W e h av e co n s id ered al l o f t h e arg um en t s m ad e b y t h e p art i es an d , t o th e
ex t en tth ey

are n o tad dres s edh erei n , we fi n dth em t o b e m o o t , i rrel ev an t, o r wi t h o u tm eri t
. To refl ectthe fo reg o i n g , Deci s i o n wi ll b e en t eredu n d er Ru l e 1 5 5
.