TAX COURT OPINION

Case: Fredric & Elena S. Pelsinger
Docket Number: 14350-11
Judge: Goeke
Opinion Type: bench
Filed: 12/03/2012
Pages: 17

UNITED STATES TAX COURT WASHINGTON, DC 20217 FREDRIC AND ELENA S. PELSINGER, ) Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) Docket No. 14350-11. ) ) ) ) ORDE R Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioners and to respondent a copy of the pages of the transcript of the trial in the above case before Judge Joseph Robert Goeke at Houston, Texas, containing his oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, a decision will be entered under Rule 155, Tax Court Rules of Practice and Procedure. (Signed) Joseph Robert Goeke Judge Dated: Washington, D.C. December 3, 2012 SERVED DEC - 6 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 P R O C E E D I N G S 2 (12:30 p.m.) THE CLERK: Recalling from the calendar 1 2 3 4 Docket Number 14350-11, Fredric and Elena S. 5 Pelsinger. 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 (Whereupon, a bench opinion was rendered.) (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 3 1 Bench Opinion by Judge Joseph Robert Goeke 2 November 1, 2012 3 Fredric & Elena S. Pelsinger v. Commissioner 4 Docket No. 14350-11 5 6 THE COURT: The Court has decided to render 7 oral findings of Fact and Opinion in this case, and 8 the following represents the Court's oral findings of 9 Fact and Opinion. The oral Findings of Fact and 10 Opinion shall not be relied upon as precedent in any 11 other case. 12 13 This Opinion is rendered pursuant to Rule 152 of the Tax Court Rules of Practice and Procedure. 14 Pursuant to Rule 152 (b), the transcript of this 15 proceeding shall be forwarded by the Clerk to the 16 parties in the case. 17 18 Hereinafter, section references are to the Internal Revenue Code in effect in the year 2008 and 19 rule references are to the Tax Court Rules of 20 Practice and Procedure. 21 22 The Court has jurisdiction over the present case pursuant to Section 6213(a). This is a 23 deficiency case involving income tax and the addition 24 25 to tax for Section 6662 (a) for the year 2008. A computation under Rule 155 will be (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 4 1 2 3 necessary regardless of the outcome of the Opinion because of substantial concessions by Respondent. Petitioners resided in Texas when the 4 petition in this case was filed and any appeal of 5 6 7 8 9 this case would normally fall to the Court of Appeals for the Fifth Circuit. Petitioners filed a joint federal income tax return for the year 2008. Mr. Pelsinger operated several businesses but, for tax purposes, all these 10 businesses were reported on the joint federal income 11 tax return. There were four separate Schedule Cs 12 which reported Mr. Pelsinger's business in 2008. 13 14 15 Respondent, in the notice of deficiency issued to the Petitioners, disallowed tens of thousands of dollars of deductions relative to these 16 businesses. Prior to trial, Respondent conceded all 17 the expenses that had been disallowed with the 18 exception of certain business bad debts which remain 19 at issue in the case. The amount of the business bad 20 debts remaining at issue are $256,520. 21 22 The case was tried and a stipulation of facts was entered into evidence. Vari.ous exhibits 23 were also admitted into the record. 24 All the evidence at trial related to the 25 question of the proper treatment of certain payments (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 5 1 Mr. Pelsinger had made through the businesses which 2 were reported as Schedule C operating companies in 3 4 2008. These payments were made to an individual named Dennis Vitcovich, and specifically to his 5 business called Orca Moving Systems. At trial, 6 Petitioners specifically conceded that, to the extent 7 there is a deficiency determination in this case, the 8 addition to tax under Section 6662 (a) should apply. 9 10 11 The evidence at trial included two documents related to the payments at issue. The first document is entitled, Independent Contractor 12 Service Agreement. This agreement was entered into 13 in 2000 between Dennis Vitcovich, individually, and 14 operating as Orca Moving Systems, and an entity 15 referred to as FPC International, Inc., which the 16 parties have agreed was a company operated by Mr. 17 Pelsinger and was part of the enterprises which were 18 referred to as Schedule C reporting companies 19 previously. Hereinafter, Mr. Vitcovich's enterprise 20 will be referred to simply as Orca. 21 This agreement in 2000 provided that the 22 entity operated by Mr. Pelsinger would provide a line 23 of credit of up to $250,000 to Orca to assist Orca in 24 conducting its business. The agreement further 25 provided that Orca would operate independent of Mr. (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 6 1 Pelsinger's business and would be operated solely by 2 Mr. Vitcovich. The agreement did not provide a 3 duration but did have a termination clause which 4 5 required notice of 30 days prior to termination. A subsequent related document in the record 6 was a memorandum addressed to Mr. Vitcovich at Orca 7 from Mr. Pelsinger dated January 5, 2003. This 8 memorandum provided as follows: 9 "Dear Dennis, "Confirming our phone 10 conversation, since you started to receive monies 11 directly and not to the lockbox, I have stopped 12 13 14 15 sending monies from the credit line. You opted to have me make loans to you. To date, I have not received any balance sheets to know how much monies you owe re our agreement of 75 percent of profits. 16 Will you please do so. 17 18 "If you have any questions, please feel free to contact me and I would be happy to discuss 19 this with you once again. 20 21 22 "Best regards, Fred" At trial, Mr. Pelsinger testified that the initial agreement was terminated because he 23 discontinued a lockbox through which funds were made 24 available to Orca. We specifically find that this 25 testimony regarding subsequent payments evidenced in (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 1 2 the record to Orca after January 5, 2003, is not credible because it is not clear that Mr. Pelsinger 3 did not continue to make payments to Orca pursuant to 4 the other terms of the Independent Contractor Service 5 Agreement entered into in 2000. 6 7 8 The payments by Mr. Pelsinger to Orca, as evidenced in the record, include checks made directly to Orca and two other checks paid to third parties, 9 which Mr. Pelsinger testified he paid on behalf of 10 Orca. The checks made directly to Orca are paid from 11 12 2002 through 2006 and they total $186,000. We find that, in fact, Mr. Pelsinger did pay Orca the amount 13 of $186,000. 14 . The two checks paid allegedly on behalf of 15 Orca to third parties are in the amounts of 16 $12,345.07 and $15,506. We believe Mr. Pelsinger's 17 testimony that he did pay these amounts on behalf of 18 Orca, and we believe these two checks should be 19 included and treated the same as our determination 20 relative to the $186,000 in checks paid directly to 21 Orca. 22 23 24 25 The factual issue framed by the documents in the testimony is what was the nature of these payments to Orca and when, if ever, has a taxable event occurred relative to these payments. There is (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 8 1 2 no question that Mr. Pelsinger had a business relationship with Orca and that some of his various 3 businesses had distinct business relationships with 4 Orca. However, we believe the determination in the 5 present case should be based upon an analysis of the 6 Independent Contractor Service Agreement and a 7 determination whether the payments based upon that 8 9 10 11 12 agreement should be treated as debt or equity. The only provision for payment in the Independent Contractor Service Agreement reads, in paragraph two of the agreement, as follows: "Dennis Vitcovich, d/b/a Orca Moving 13 Systems, agrees that FPC International will receive 14 75 percent of the net profits generated by all 15 business of Dennis Vitcovich, individually, and under 16 d/b/a Orca Moving Systems. Dennis Vitcovich, 17 18 individually, and/or d/b/a Orca Moving Systems will receive 25 percent of the net profits. FPC 19 International, Inc., will set up and solely control 20 bank account, lockbox account, in the name of Orca 21 Moving Systems, which said account will be designated 22 to receive all account receivable funds due Orca 23 Moving Systems for their business services, which out 24 of this account will honor Orca Moving Systems' 25 requests for funding. FPC International will be (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 1 given first priority on these funds to pay back or 2 pay down the FPC International, Inc., line of credit 9 3 existing with Comerica Bank-Texas . " 4 5 Although Mr. Pelsinger said this arrangement was terminated in '03 when he 6 discontinued the lockbox, he nevertheless continued 7 to make payments directly to Orca, and on behalf of 8 Orca, for several years thereafter without any other 9 evidence of indebtedness or any other ability to 10 obtain repayment. 11 His letter to Orca in January of 2003, 12 which was previously quoted, does not terminate his 13 14 15 agreement to continue to forward funds to Orca but simply indicates that the lockbox arrangement had been stopped. In fact, the letter asks for an 16 accounting as to the 75 percent profits. 17 No other record is present at to any 18 , accounting for these profits or any other efforts by 19 Mr. Pelsinger to obtain any kind of repayment from 20 Orca or Mr. Vitcovich. 21 22 The burden of proof in the present case resides upon the Petitioner, pursuant to Rule 142 (a). 23 The facts of the present case do not support a 24 shifting of the burden pursuant to 142(a) (2) of the 25 Tax Court Rules of Procedure nor pursuant to Section (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 1 2 3 7491. Petitioner did not introduce any credible evidence relative to his assertions concerning a loan arrangement with Orca nor did Petitioner meet the 4 other requirements of Section 7491 with respect to 10 5 cooperation in the course of the audit of the 6 underlying case; therefore, the burden of proof 7 8 remains upon the Petitioner. To substantiate a business bad debt 9 deduction under Section 166, a taxpayer must show the 10 existence of a bona fide debt, and that the debt 11 12 became worthless, and that it became worthless in the year claimed, which in the present case is 2008. 13 Treas. Reg. Section 166-1(c) in American Offshore, 14 15 Inc., v. Commissioner, 97 T.C. 579 (1991). Relative to the question of whether 16 Petitioners' entitled to bad debt treatment 17 concerning the payments made on behalf of a third 18 party, the Petitioners must establish that they were 19 subrogated to the position of Mr. Vitcovich and that 20 Mr. Vitcovich became obligated to the Petitioners by 21 their payment to the third parties. Putnam v. 22 Commissioner, 352 U.S. 82, 85 (1956). 23 We specifically find that the payments in 24 question, based upon Mr. Pelsinger's testimony, to 25 the third parties in the respective amounts of (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 11 1 2 $12,345.07 and $15,506 were consistent with the other payments made to Orca and will be treated in accord 3 with those payments. There was no testimony or other 4 5 6 7 evidence that would distinguish those payments from the payments made directly to Orca. The Court of Appeals for the Fifth Circuit has recognized 13 factors in resolving a question of 8 whether payments are debt or equity. Estate of Mixon 9 v. United States, 464 F 2d 394, 402 (5th Cir. 1972). 10 11 12 This Court has also articulated 13 factors germane to a debt equity analysis. These factors are the names or labels given the instruments by the 13 parties, the presence or absence of a fixed maturity 14 date, the source of the payments, the right to 15 enforce repayment, participation in management by the 16 payor, the status of the payments relative to other 17 creditors of the entity receiving the payments, the 18 intent of the parties relative to the character of 19 the payments, whether interest is paid on the 20 21 payments, the thinness of the capital structure of the party receiving the payments, the ability of the 22 party receiving the payments to obtain credit, the 23 use to which the payments were put, the failure to 24 25 repay, or the history of repayment, and the risk of repayment. These factors were outlined in Dixie (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 1 Dairies Corp. v. Commissioner, 74 T.C. 476, 493 2 (1980). These factors are only aids to our 3 determination in the present case. Fin Hay Realty 4 Company v. United States, 398 F 2d 694, 697 (3d Cir. 12 5 6 7 1968). If, in fact, we determine that the payments in question were debt, we still must also determine 8 whether other requirements of a bad debt are 9 applicable. If we determine that the payments in 10 question were in the nature of payments to obtain 11 equity, then we must determine whether a capital loss 12 is available to Mr. Pelsinger in 2008 because the 13 entity in which equity was sought terminated its 14 operations. 15 16 17 18 We specifically find that Orca did terminate its operation in 2008, based upon the testimony of Mr. Pelsinger, which was unchallenged at trial. We now will review the specific factors in 19 order to determine whether we should treat the 20 21 payments in question as debt or equity. The agreement in which we find the payments 22 were originally made, and which we also find was the 23 basis for the subsequent payments after 2003, 24 specifically characterizes the payments as being made 25 from a line of credit. The checks issued directly to (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 1 Orca generally have a notation that they are loan 13 2 3 4 payments so we find that the first factor would support a debt characterization. The second factor, relating to the duration 5 of the obligation, provides no maturity date and we 6 believe this factor supports an equity 7 8 characterization of the payments. The source of repayment and the character 9 of the repayments in the Independent Contractor 10 Service Agreement support a determination that the 11 payments were to be made out of profits and that 12 there was no other defined basis for the payments. 13 This clearly supports a determination that the 14 15 payments were made to obtain equity in Orca. The next factor, involving the right to 16 enforce the payments, also supports an equity 17 determination because there was no right to enforce 18 repayment from Orca to Mr. Pelsinger. He made no 19 efforts to obtain repayment and there's absolutely no 20 evidence in the record that there was an obligation 21 22 on the part of Orca to repay Mr. Pelsinger. The next factor, involving Mr. Pelsinger's 23 participation in the management of Orca, supports a 24 characterization of debt because the Independent 25 Contractor Service Agreement clearly provides that (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 14 1 Mr. Pelsinger had no right to manage Orca. 2 3 The next factor, involving the status of these payments relative to other creditors of Orca, 4 would support an equity characterization of the 5 payments because there was no priority given to Mr. 6 Pelsinger's payments over those of any other 7 creditors of Orca because there was no obligation on 8 behalf of Orca to repay Mr. Pelsinger, other than the 9 obligation that he receive 75 percent of the profits 10 of Orca. 11 12 The next factor, involving the intent of the parties, is unclear because while it appears that 13 Mr. Pelsinger had the intent to make loans, because 14 of the character he testified the payments 15 represented at trial and because of the fact that he 16 wrote "loan" on the checks that he sent, it is not 17 18 19 clear that Orca treated the payments it received as a loan obligation to Mr. Pelsinger, and the agreement itself would not support such an obligation because 20 it only provides that Mr. Pelsinger was to receive 75 21 percent of the profits. Given the disparity between 22 Mr. Pelsinger's statement of intent and the 23 agreement, we will treat this factor as neutral. 24 The next factor involves whether interest 25 was paid. Since no interest was paid, this factor (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 15 1 2 3 4 5 6 7 8 9 10 11 12 supports an equity determination. The next factor, involving whether Orca was thinly capitalized, is unknown and not established in the record, and we will treat this factor as neutral. The next factor, involving Orca's ability to obtain credit, appears to support equity simply because it does not appear that Orca had any ability to obtain credit, given Mr. Pelsinger's testimony and the fact that Orca relied so heavily upon his financial support. The next factor, involving Orca's use of the funds in its day-to-day operations, would 13 generally appear to support a debt determination. 14 15 The following final two factors, failure to repay and risk of repayment, both support an equity 16 determination because there was no ability to force 17 repayment, there was no repayment, and there was 18 obviously substantial risk of repayment. 19 20 In summary, three of the factors support debt determination; eight, an equity determination; 21 and two factors we have deemed to be neutral. 22 Obviously, our determination is not based upon a mere 23 accounting of these factors but the substantial 24 weight of the evidence in this case indicates that 25 Mr. Pelsinger made payments to Orca to obtain an (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 16 1 equity interest in Orca in that he was originally 2 motivated to receive 75 percent of Orca's profits and 3 it does not appear that his subsequent payments were 4 motivated by any other reason. 5 Based upon this determination, we find that 6 Mr. Pelsinger had a basis in his equity holdings in 7 Orca in the amount of 186,000 plus the two additional 8 amounts of $12,345.07 and $15,506. We also find that 9 Mr. Pelsinger and the Petitioners are not entitled to 10 11 a bad debt deduction in 2008. We are left with the issue of whether 12 Petitioners are entitled to any tax effect from Mr. 13 Pelsinger's payments to Orca over the years prior to 14 15 2008. Since we have held previously that his testimony that Orca went out of business in 2008 was 16 credible and since that testimony is not refuted in 17 the record, we will hold that Mr. Pelsinger and the 18 Petitioners, accordingly, are entitled to a capital 19 20 21 22 loss in the amount of the total payments to Orca in the years prior to 2008 in 2008. As stated previously, a Rule 155 computation will be necessary to determine the tax 23 effect of our holdings and to take into account the 24 25 concessions made by Respondent prior to trial. This concludes the Court's oral Findings of (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Pelsinger Bench Opinion 11-1-2012 1 Fact and Opinion in this case. 17 (Whereupon, at 1:05 p.m., the bench opinion In the above-entitled matter was concluded.) 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 (866) 448 - DEPO www.CapitalReportingCompany.com 2012