Court Opinion

ID: 4334636
Source: CourtListenerOpinion
Date Created: 2018-11-14 01:46:33.51238+00
Date Added: 2024-06-11T14:48:01.856545
License: Public Domain

121 T.C. No. 14

                UNITED STATES TAX COURT

     JIMMY D. WEAVER AND MARLENE M. MORLOC WEAVER,
        Petitioners v. COMMISSIONER OF INTERNAL
                 REVENUE, Respondent

Docket No. 8262-01.                Filed October 8, 2003.

     P owned 80-percent interests in an S corporation
(CL) and a C corporation (J). CL is an accrual method,
calendar year taxpayer. J is a cash method, fiscal
year taxpayer with a July 31 yearend. On each of its
1996 and 1997 Federal income tax returns, CL deducted
an amount owed to J for services which J rendered to CL
during the corresponding year. J included in its gross
income for its taxable years ended in 1997 and 1998 the
amounts deducted by CL for 1996 and 1997, respectively.
CL had not as of Mar. 15, 1997 and 1998, paid to J any
of those amounts which J included in its gross income.
     Held: CL fails the economic performance
requirement of sec. 461(h), I.R.C., as to its
deductions. That requirement, in conjunction with sec.
404(d), I.R.C., and the temporary regulations
thereunder, mandates that CL deduct each amount for its
taxable year the last day of which is within 2-1/2
months of the day on which the amount is includable in
                                 - 2 -

     J’s gross income. The amount deducted    by   CL for 1996
     was not includable in J’s gross income   as   of Mar. 15,
     1997 (i.e., 2-1/2 months after the end   of   CL’s 1996
     taxable year), and the amount deducted   by   CL for 1997
     was not includable in J’s gross income   as   of Mar. 15,
     1998 (i.e., 2-1/2 months after the end   of   CL’s 1997
     taxable year).

     William H. Gaggos, for petitioners.

     John W. Stevens, for respondent.

                              OPINION

     LARO, Judge:   This case is before the Court for decision on

the basis of stipulated facts.    See Rule 122.    Petitioners

petitioned the Court to redetermine deficiencies of $11,284 and

$12,913 in their 1996 and 1997 Federal income tax, respectively.

     Following concessions, we are left to decide whether

sections 404(d) and 461(h) require that Clarkston Window & Door,

Inc. (Clarkston), an accrual method S corporation, defer its

deductions of fees owed to J.D. Weaver & Associates, Inc. (J.D.),

a cash method C corporation, for services provided by J.D. to

Clarkston.   Clarkston reports its operations on the basis of the

calendar year, and J.D. reports its operations on the basis of a

fiscal year ending July 31.   Clarkston deducted each fee in its

taxable year that closed 7 months before the end of the taxable

year in which J.D. included the fee in its income.      Clarkston had
                                - 3 -

not paid the respective fees to J.D. as of March 15 of the year

following the year in which it claimed the corresponding

deduction.

     We hold that sections 404(d) and 461(h) preclude Clarkston

from deducting the fees for the years claimed.    Unless otherwise

indicated, section references are to the applicable versions of

the Internal Revenue Code.    Rule references are to the Tax Court

Rules of Practice and Procedure.    We refer to petitioner Jimmy D.

Weaver as Weaver.

                             Background

     All facts were stipulated and are so found.    The stipulated

facts and the exhibits submitted therewith are incorporated

herein by this reference.    Petitioners resided in Davisburg,

Michigan, when they filed their petition with the Court.    They

filed with the Commissioner 1996 and 1997 Federal income tax

returns using the filing status of “Married filing joint return”.

     During 1996 and 1997, Weaver owned 80-percent interests in

Clarkston and J.D.   Clarkston is an S corporation whose business

is selling construction materials at wholesale.    Clarkston uses

an accrual method and the calendar year to report its operations

for Federal income tax purposes.    J.D. is a C corporation whose

business is installing windows.    J.D. reports its operations for

Federal income tax purposes using the cash method and on the

basis of a fiscal year ending July 31.    (We refer to J.D.’s
                               - 4 -

taxable years ended July 31, 1997 and 1998, as J.D.’s 1997 and

1998 taxable years, respectively.)

     On its 1996 tax return, Clarkston deducted a professional

(management) fee of $30,000 for services rendered to it during

that year by J.D.   J.D. included the $30,000 in its taxable

income for its 1997 taxable year.    On its 1997 tax return,

Clarkston deducted a professional (management) fee of $63,350 for

services rendered to it during that year by J.D.    J.D. included

the $63,350 in its taxable income for its 1998 taxable year.

     Petitioners reported on their 1996 and 1997 Federal income

tax returns deductions for the fees and other expenses passed

through to them from Clarkston.   As relevant herein, respondent

determined that Clarkston could not deduct the $30,000 as an

expense for 1996 or $60,000 of the $63,350 as an expense for

1997.   Respondent determined that Clarkston could deduct the

$30,000 for 1997.

     As of July 31, 1998, Clarkston had not paid to J.D. any of

the $90,000 in fees ($60,000 + $30,000).    Clarkston issued to

J.D. an intercompany note reflecting this amount.    Subsequently,

J.D. merged into Clarkston pursuant to section 368, and filed a

final tax return as a C corporation for the period ended

April 30, 2000.   The $90,000 intercompany note was during the

final return year of J.D. eliminated by book entry as a result of

the merger.
                                - 5 -

                             Discussion

     Respondent’s determinations in the notice of deficiency are

presumed correct, and petitioners must prove those determinations

wrong in order to prevail.    Rule 142(a)(1); Welch v. Helvering,

290 U.S. 111, 115 (1933).    The submission of this case to the

Court under Rule 122 does not change or otherwise lessen

petitioners’ burden of proof.    Rule 122(b); Kitch v.

Commissioner, 104 T.C. 1, 5 (1995), affd. 103 F.3d 104 (10th Cir.

1996).   Whereas in certain cases section 7491(a) shifts the

burden of proof to the Commissioner, we conclude that this is not

one of those cases.    Petitioners have neither alleged that

section 7491 is applicable to this case nor established that they

have complied with the requirements of section 7491(a)(2)(A) and

(B) to substantiate items, to maintain required records, and to

cooperate fully with reasonable requests of the Commissioner.

See sec. 7491(a)(2).    Petitioners’ burden of proof in this case

is affected by the fact that we carefully scrutinize transactions

between related parties, Maxwell v. Commissioner, 95 T.C. 107,

116 (1990); C.M. Gooch Lumber Sales Co. v. Commissioner, 49 T.C.

649, 656 (1968), remanded pursuant to stipulation of the parties

406 F.2d 290 (6th Cir. 1969), and that the service agreement

between Clarkston and J.D. was such a transaction.
                                 - 6 -

     The parties agree that Clarkston may deduct the fees upon

its satisfaction of the all events test under section 461(h).1

The parties disagree as to whether Clarkston satisfied this test.

According to respondent, Clarkston fails this test in that it

does not meet the timing rule of section 404(d).   Respondent

asserts that this rule must be met because the fees were for

services rendered, and the arrangement of Clarkston and J.D. as

to the payment for those services deferred the receipt of

compensation.   Petitioners argue that the all events test has

been met.   Petitioners in their brief rely solely on the first

two prongs of the all events test, discussed infra, and make no

reference to either section 404 or the economic performance

requirement of section 461(h).

     Deductions under an accrual method of accounting are

generally allowable for the taxable year in which the all events

test has been met.   This test is met when all events have

occurred that establish the fact of the liability, the amount of

the liability can be determined with reasonable accuracy, and

economic performance has occurred with respect to the liability.

Sec. 461(h); sec. 1.461-1(a)(2)(i), Income Tax Regs.   Where a

     1
       Petitioners alleged in their petition that respondent had
disallowed the disputed amounts “on grounds including IRC
Sections 267, 404 and 461", and respondent in answer admitted
this allegation. Respondent in brief has abandoned his reliance
upon sec. 267 to support his determination and relies solely upon
secs. 404(d) and 461.
                                - 7 -

liability arises out of a taxpayer’s receipt of services

performed by another person, economic performance generally

occurs as the services are performed.       Sec. 461(h)(2)(A)(i).

     Respondent argues that section 1.461-1(a)(2)(iii)(D), Income

Tax Regs., mandates that Clarkston also meet the timing rule of

section 404(d) in order to satisfy the requirement of economic

performance.   We agree.   As stated in subdivision (iii)(D):2

     (iii) Alternative timing rules

                *    *     *    *       *    *    *

          (D) Except as otherwise provided in any Internal
     Revenue regulation, revenue procedure, or revenue
     ruling, the economic performance requirement of section
     461(h) and the regulations thereunder is satisfied to
     the extent that any amount is otherwise deductible
     under section 404 (employer contributions to a plan of
     deferred compensation) * * *.

As stated in the relevant parts of section 404:

     SEC. 404. DEDUCTION FOR CONTRIBUTIONS OF AN EMPLOYER TO
               AN EMPLOYEES’ TRUST OR ANNUITY PLAN AND
               COMPENSATION UNDER A DEFERRED-PAYMENT PLAN.

          (a) General Rule.—If contributions are paid by an
     employer to or under a stock bonus, pension,

     2
       We also believe that sec. 1.461-1(a)(2)(iii)(A), Income
Tax Regs., is relevant to our discussion. As stated therein:

     (A) If any provision of the Code requires a liability
     to be taken into account in a taxable year later than
     the taxable year provided in paragraph (a)(2)(i) of
     this section, the liability is taken into account as
     prescribed in that Code provision. See, for example,
     section 267 (transactions between related parties) and
     section 464 (farming syndicates).
                         - 8 -

profit-sharing, or annuity plan, or if compensation is
paid or accrued on account of any employee under a plan
deferring the receipt of such compensation, such
contributions or compensation shall not be deductible
under this chapter; but, if they would otherwise be
deductible, they shall be deductible under this section
* * *

          *    *    *    *       *   *     *

     (b) Method of Contributions, Etc., Having the
Effect of a Plan; Certain Deferred Benefits.—

          (1) Method of contributions, etc.,
     having the effect of a plan.—If—

               (A) there is no plan, but

               (B) there is a method or
          arrangement of employer
          contributions or compensation which
          has the effect of a stock bonus,
          pension, profit-sharing, or annuity
          plan, or other plan deferring the
          receipt of compensation * * *,

     subsection (a) shall apply as if there were
     such a plan.

          *    *    *    *       *   *     *

     (d) Deductibility of Payments of Deferred
Compensation, Etc., to Independent Contractors.—If a
plan would be described in so much of subsection (a) as
precedes paragraph (1) thereof (as modified by
subsection (b)) but for the fact that there is no
employer-employee relationship, the contributions or
compensation—

          (1) shall not be deductible by the payor
     thereof under this chapter, but

          (2) shall (if they would be deductible
     under this chapter but for paragraph (1)) be
     deductible under this subsection for the
     taxable year in which an amount attributable
     to the contribution or compensation is
                                - 9 -

            includible in the gross income of the persons
            participating in the plan.

     The facts at hand establish as to Clarkston’s service

agreement with J.D. a method or arrangement that “has the effect

of a * * * plan deferring the receipt of compensation” by a

nonemployee so as to subject Clarkston’s deduction of the fees

for J.D.’s services to the timing rule of section 404(d).    Sec.

404(a), (b)(1)(B), (d).    Section 404(d) sweeps broadly to apply

to all compensation plans, methods, or arrangements

(collectively, arrangements), however denominated, which in

substance defer the receipt of compensation by a service

provider.    Sec. 1.404(b)-1T, Q&A-1, Temporary Income Tax Regs.,

51 Fed. Reg. 4321 (Feb. 4, 1986); sec. 1.404(d)-1T, Temporary

Income Tax Regs., 51 Fed. Reg. 4322 (Feb. 4, 1986); see also Avon

Prods., Inc. v. United States, 97 F.3d 1435 (Fed. Cir. 1996);

Truck & Equip. Corp. v. Commissioner, 98 T.C. 141, 145-154

(1992).3    An arrangement defers the receipt of compensation if

     3
       We also note that the legislative history of sec. 404(a),
(b), and (d) supports our construction of that section. That
history is generally discussed in detail in Avon Prods., Inc. v.
United States, 97 F.3d 1435, 1439-1442 (Fed. Cir. 1996), and
Truck & Equip. Corp. v. Commissioner, 98 T.C. 141, 145-154
(1992). We stress that the House Committee on Ways and Means, in
describing a 1984 amendment to sec. 404(b), stated that:

     Generally, all compensation arrangements which defer
     receipt of compensation by the employee or independent
     contractor will be subject to these special
     deduction-timing rules. For example, under the bill, a
                                                   (continued...)
                              - 10 -

the service provider does not receive compensation for its

services within a “brief period of time” after the end of the

payor’s taxable year in which the services are performed.     Sec.

1.404(b)-1T, Q&A-2(a), Temporary Income Tax Regs., supra.     An

arrangement is presumed to defer the receipt of compensation for

more than a brief period of time when compensation is received by

the service provider more than 2-1/2 months after the end of the

payor’s taxable year in which the services are performed.     Id.

Q&A-2(b)(1).   This presumption may be rebutted only upon a

showing by a preponderance of the evidence that:   (1) It was

“impracticable, either administratively or economically,” to

avoid the deferral of the service provider’s receipt of the

compensation beyond the 2-1/2-month period, and (2) as of the end

of the payor’s taxable year, this impracticability was

unforeseeable.   Id. Q&A-2(b)(2).

     3
       (...continued)
     limited partnership that uses the accrual method of
     accounting may not accrue deductions for compensation
     owed to cash-method taxpayers, who perform services for
     the partnership, until the partnership taxable year in
     which such compensation is paid. * * * [H. Rept.
     98-432 (Part II), at 1283 (1984).]

The conference committee also reiterated the view that sec. 404
applies broadly to deferred compensation payments, stating that a
deferred compensation arrangement under sec. 404(b) “includes all
compensation, fee, and similar payments, however denominated,
except those which are specifically exempted.” H. Conf. Rept.
98-861, at 1160 (1984), 1984-3 C.B. (Vol. 2) 1, 414.
                                - 11 -

     Pursuant to a method or arrangement between Clarkston, the

service recipient/payor, and J.D., the service provider, the

former did not pay the latter for its services within 2-1/2

months after the close of the respective calendar years in which

the services were performed.4    Nor have petitioners made the

requisite showing to rebut the presumption that Clarkston’s

arrangement with J.D. as to its services did not defer the

receipt of compensation within the meaning of section 404(a).

We sustain respondent’s determination that the fees are not

deductible in the years claimed by petitioners.    See generally

Rev. Rul. 88-68, 1988-2 C.B. 117.    In so doing, we emphasize that

this holding rests on our finding that Clarkson and J.D., whose

transactions with each other are subject to particular scrutiny

because the two entities are related, had a method or arrangement

between them which in substance deferred the receipt of

compensation by a service provider.

     To reflect concessions,

                                           Decision will be entered

                                      under Rule 155.

     4
       Petitioners appropriately make no claim that the fees were
paid under sec. 404 through the issuance of the intercompany
note. See Don E. Williams Co. v. Commissioner, 429 U.S. 569,
581-582 (1977) (provision of a note does not constitute payment
for purposes of sec. 404(a)).