T.C. Memo. 1997-533

UNITED STATES TAX COURT

JANET D. REED, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 26792-95. Filed December 1, 1997.

Thomas M. Herbert, for petitioner.

Susan E. Seabrook, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS, Judge: Respondent determined the following

deficiencies in, and additions to, petitioner's Federal income

taxes:
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 Additions to Tax 

 Sec. Sec. Sec.

Year Deficiency 6651(a)(1) 6653(a)(1) 6654

1988 $36,638 $8,960 $1,832 $2,287

1989 74,747 18,491 --- 4,995

1990 12,515 2,931 --- 730

1991 13,084 3,271 --- 752

1992 26,708 6,532 --- 1,138

1993 15,679 3,720 --- 620

These determinations were reflected in two notices of

deficiency (one for years 1988, 1989, and 1990; the other for years

1991, 1992, and 1993), each dated September 29, 1995. Subsequent

to the issuance of the notices of deficiency, the docketing of this

case, and after the joinder of issues, petitioner filed delinquent

Federal income tax returns for each of the years at issue. (The

notices of deficiency were based on income items reported by third

party sources and utilized the standard deduction.) The

delinquently filed returns incorporated the income adjustments

determined by the notices of deficiency and reported income in

excess of that contained in the notices of deficiency. The returns

also reported deductions not contemplated by the notices of

deficiency. Upon review by respondent, except for losses reported

in Schedules F, the returns were accepted as filed.

Petitioner orally sought leave to amend her petition to raise

the issue of the Schedule F losses via a conference call held on

April 11, 1997. Respondent's counsel consented to the trying of

this issue, and the trial proceeded accordingly. See Rule 41(b).
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1 Petitioner agrees that except for the disallowance of

the Schedule F losses, respondent's income adjustments in the

notices of deficiency are correct.

2 At trial, we found that the cattle-ranching activities

were operated for profit.

After respondent's acceptance of petitioner's tax returns, the

resulting tax deficiencies and additions to tax in dispute are as

follows:

 Additions to Tax 

Year Deficiency Sec. 6651(a)(1) Sec. 6654

 1988 --- --- ---

 1989 --- --- ---

 1990 1$12,485 $3,319 $779

 1991 14,178 1,045 241

 1992 135,031 8,903 1,523

 1993 128,390 5,656 911

1 These amounts do not take into account prepayment credits

in the amounts of $816, $783, $792, $2, $580, and $801 for tax

years 1988, 1989, 1990, 1991, 1992, and 1993, respectively.

Following concessions,1 the sole unagreed matter concerns

petitioner's entitlement to losses sustained from certain cattleranching business activities. In this regard, we must determine

whether petitioner conducted these cattle-ranching business

activities as a sole proprietor or through Spirit Horse Ranch,

Inc., during the years at issue.2

All section references are to the Internal Revenue Code as in

effect for the years in issue. All Rule references are to the Tax

Court Rules of Practice and Procedure.
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FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

At the time the petition was filed, petitioner resided in

Albuquerque, New Mexico. 

Cattle-Ranching Business

Spirit Horse Ranch, Inc. (Spirit Horse Ranch), was

incorporated in New Mexico on July 3, 1986. The incorporation

documents listed Sonny Jim James as president and petitioner as

vice president, secretary, and treasurer. Spirit Horse Ranch

operated under several different names during the years in issue.

Spirit Horse Ranch was engaged in cattle-ranching activities

located near Grants, New Mexico. The activities included the

breeding of cattle, as well as the sale of steers (male calves) for

beef or roping. The cattle grazed on land owned by the El Morro

Valley Land Co. (El Morro). (Petitioner, who was a licensed New

Mexico real estate broker, sold El Morro's subdivisions and later

became the majority stockholder and president of that company.) 

Spirit Horse Ranch acquired parcels from El Morro for its own

use. It maintained some improvements on the land, including

corrals, a boxcar (used for a shop), and a tack room to store

feed, saddles, and bridles. Petitioner also maintained three
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mobile homes on the ranch property, one of which served as her

personal residence. 

Spirit Horse Ranch never issued any stock. Nor did Spirit

Horse Ranch ever file Federal corporate income tax returns or New

Mexico corporate franchise tax reports. 

Spirit Horse Ranch maintained bank accounts with both United

New Mexico Bank and Ranchers State Bank. These bank accounts were

used to pay the expenses of operating the ranch. Both petitioner

and Mr. James were signatories on the bank accounts. Deposits into

the accounts came solely from petitioner. Occasionally, cash

disbursements were made from the bank accounts to petitioner and

Mr. James, although more frequently to Mr. James. 

Petitioner maintained Spirit Horse Ranch's books and records.

In addition, she paid the bills and wrote the checks. 

On July 29, 1988, petitioner conveyed title in her personal

residence in Albuquerque, New Mexico, to Spirit Horse Ranch. Title

to that property was conveyed back to petitioner on December 18,

1996. On February 24, 1997, the Albuquerque residence was again

conveyed to Spirit Horse Ranch. 

Petitioner's Other Business Activities

During the years in issue, petitioner had ownership interests

in several entities other than Spirit Horse Ranch, including: Red

Carpet Realty, Inc., Red Barn Realty, Inc., Western Escrow Corp.,
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New Mexico Chemical Corp., and El Morro Valley Land Co. Some of

these entities were S corporations; others were C corporations. 

Petitioner filed with the State of New Mexico a statement of

intent to dissolve some of these entities. Petitioner did not

timely file Federal corporate income tax returns for some of the

entities even though she was aware of her obligation to do so. 

Request To Grant Spirit Horse Ranch S Corporation Status

Retroactively

On December 21, 1996, petitioner's accountant wrote the

Internal Revenue Service Center (IRS) in Austin, Texas, requesting

the IRS to validate Spirit Horse Ranch's invalid S corporation

election for tax year 1986 forward, or in the alternative to

validate the election for tax year 1990 forward. In pertinent

part, the letter states:

We have been engaged to file certain past due income tax

returns for Janet D. Reed and to file certain past due

income tax returns for corporations owned by her

including Spirit Horse Ranch, Inc. In the course of

reviewing and reconstructing the past financial records

of Spirit Horse Ranch, Inc. and from discussions with Ms.

Reed concerning her intent for the corporation, it has

been determined that Spirit Horse Ranch, Inc. should have

been operated as an S Corporation. Under the new

provisions of IRS Section 1362 referenced above, we are

requesting that the IRS validate the S Corporation

election for Spirit Horse Ranch, Inc. effective for the

corporation's initial tax year of December 31, 1986 and

for all years since that first year. We feel that there

is reasonable cause to allow this validation of election.

 * * * * * * *

Based on a review of the corporate records it is unclear

as to whether this Form 2553 was ever filed with the IRS

or whether any acknowledgment of the S Corporation status
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was ever received from the IRS if it was filed. As

stated above, it was Ms. Reed's intention to have Spirit

Horse Ranch, Inc. be an S Corporation from it's [sic]

inception in 1986 even though there is no evidence of a

Form 2553 being prepared until 1989.

 * * * * * * *

* * * it is requested that the election as an S

Corporation by Spirit Horse Ranch, Inc. effective for the

calendar year ending December 31, 1986 be validated and

the taxpayer be promptly notified of the decision. In

the alternative it is requested that the election be

validated for the calendar year ending December 31, 1990

as shown on the Form 2553.

Petitioner signed the letter acknowledging its content and

accuracy. As of the date of trial, the IRS had not responded to

petitioner's request. 

Federal Tax Returns

Petitioner filed her 1988 through 1993 Federal income tax

returns in February 1997. Petitioner's 1988 tax return reported

adjusted gross income of negative $97,376, which included farm

losses from her cattle-ranching activities on Schedule F (Profit or

Loss From Farming) of $67,904; the 1989 tax return reported

adjusted gross income of negative $62,337, which included farm

losses on Schedule F of $61,960; the 1990 tax return reported

adjusted gross income of $42,247, which included farm losses on

Schedule F of $44,838; the 1991 tax return reported adjusted gross

income of $13,250, which included farm losses on Schedule F of

$35,992; the 1992 tax return reported adjusted gross income of

$109,928, which included farm losses on Schedule F of $33,060; and
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the 1993 tax return reported adjusted gross income of $84,484,

which included farm losses on Schedule F of $20,220. 

OPINION

Our task herein is to determine whether petitioner operated

her cattle-ranching activities as a sole proprietor or through

Spirit Horse Ranch during the years in issue. If we decide that

petitioner ran the business as a sole proprietor, then petitioner

is entitled to deduct the losses from the cattle-ranching

activities on her Federal income tax returns. 

Petitioner contends that she formed Spirit Horse Ranch in

order to own the cattle ranch with Mr. James. She reasons Spirit

Horse Ranch's corporate form should be disregarded because (1) Mr.

James failed to make capital contributions to the entity, (2) no

stock was ever issued, and (3) no Federal corporate income tax

returns or New Mexico franchise tax reports were ever filed.

Additionally, petitioner asserts that the only reason she used the

corporate checking accounts was that she "hated to pay money for

checks and not use them". 

Generally, a corporation organized for the purpose of carrying

on business activity constitutes a separate taxable entity. Moline

Properties, Inc. v. Commissioner, 319 U.S. 436, 439 (1943); New

Colonial Co. v. Helvering, 292 U.S. 435, 442 (1934). Once the

taxpayer has elected to conduct his business affairs in corporate

form, the taxpayer must accept the tax disadvantages of that form.
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Higgins v. Smith, 308 U.S. 473, 477 (1940). A taxpayer is not free

to "turn around and disclaim the business form he created in order

to realize a loss as his individual loss." Sangers Home for

Chronic Patients, Inc. v. Commissioner, 72 T.C. 105, 116 (1979);

see also Barker v. Commissioner, T.C. Memo. 1993-280. An exception

to these rules exists where the corporate form is a sham or unreal.

Higgins v. Smith, supra at 477-478.

Whether a corporation is formed or not is a matter of State

law; however, whether the corporate entity (if found to exist)

should be disregarded for Federal taxation purposes is a matter of

Federal law. Stoody v. Commissioner, 66 T.C. 710, 716-717 (1976).

Under New Mexico law: (1) The filing of the articles of

incorporation is conclusive evidence that all conditions precedent

to the existence of a corporation have been satisfied. N.M. Stat.

Ann. sec. 53-12-4 (Michie 1978); (2) A corporation that has

commenced business activity may dissolve voluntarily by written

consent of the shareholders or by an act of the corporation. Id.

at secs. 53-16-2 and 3; (3) Following the decision to dissolve the

corporation, a statement of intent to dissolve must be filed with

the State. Id. at sec. 53-16-4; and (4) Upon the filing of the

statement of intent to dissolve, the corporation must cease to

carry on its business; however, its corporate existence continues

to exist until a certificate of dissolution has been issued by the

State. Id. at sec. 53-16-5.
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Petitioner formed Spirit Horse Ranch as a New Mexico

corporation in 1986, and it continued to exist throughout all of

the years in issue. That entity owned real property, maintained

bank accounts in its name, and conducted a business activity for

profit. All of these factors indicate that Spirit Horse Ranch was

not a sham and had a business purpose as well as a substantive

business activity. Higgins v. Smith, supra.

It is evident that petitioner did not dissolve Spirit Horse

Ranch pursuant to New Mexico law. She never filed a statement of

intent to dissolve the corporation even though she may have desired

no longer to use its form. To be sure, she admitted that she knew

how to dissolve corporations and that she needed to do so.

Further, petitioner's failure to comply with the filing of

biennial State franchise tax reports following the formation of a

corporation does not cause the corporation's automatic cessation.

"[S]uch non-compliance in the absence of * * * [a State forfeiture]

proceeding does not in anywise affect the legal existence of the

corporation." Skarda v. Commissioner, 250 F.2d 429, 435 (10th Cir.

1957), affg. 27 T.C. 137 (1956).

Finally, it is clear that petitioner did not transfer the

business assets of Spirit Horse Ranch to another entity. Spirit

Horse Ranch retained the real property (underlying land,

improvements, and mobile homes) and the bank accounts during the

years in issue. See Weigman v. Commissioner, 47 T.C. 596 (1967),
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affd. 400 F.2d 584 (9th Cir. 1968); Hinz & Landt, Inc. v.

Commissioner, 8 B.T.A. 375, 379 (1927); see also Perry v.

Commissioner, 49 T.C. 508 (1968); cf. Blue Flame Gas Co. v.

Commissioner, 54 T.C. 584, 599-600 (1970); Estate of Faris v.

Commissioner, T.C. Memo. 1955-268. 

Thus, we conclude that the farming losses resulting from

petitioner's cattle-ranching activities are those of Spirit Horse

Ranch, a New Mexico corporation, and not that of petitioner.

Consequently, petitioner is not entitled to deduct those losses on

her Federal income tax returns for the years in issue.

To reflect the foregoing and the concessions of the parties,

Decision will be entered

under Rule 155.