Court Opinion

ID: 4592683
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:08:30.575432+00
Date Added: 2024-06-11T07:50:54.451500
License: Public Domain

Michael F. Beirne and Corinne A. Beirne, Petitioners v. Commissioner of Internal Revenue, RespondentBeirne v. CommissionerDocket No. 1219-66United States Tax Court52 T.C. 210; 1969 U.S. Tax Ct. LEXIS 136; May 8, 1969, Filed *136 Decision will be entered under Rule 50.  Petitioner purported to transfer to his minor children 90 percent of the stock of Kelly Supply Co. which then elected to be taxed as a subchapter S corporation.  Held, that the purported transfers were not bona fide as they lacked economic reality and petitioner remained the real owner of the stock; accordingly, all income of the corporation is taxable to petitioner.  Robert C. Lowe, for the petitioners.Richard H. M. Hickok, for the respondent.  Withey, Judge.  WITHEY*210  Respondent determined deficiencies in petitioners' income tax as follows:YearAmount1960$ 4,737.21196113,278.51196214,827.67After concessions by the parties, the issues remaining for our determination are:(1) Whether petitioner's purported transfers to his minor children of 90 percent of the stock in Kelly Supply Co., which then elected to be taxed as a subchapter S corporation, were bona fide and economically real so that the income therefrom is taxable to the children.(2) If the transfers are bona fide and economically real, whether the income from Kelly Supply Co. should be allocated to petitioner pursuant to section 1375(c) in order to reflect the value of his services thereto.FINDINGS *137 OF FACTSome facts are stipulated and are found accordingly.Petitioners Michael F. Beirne and Corinne A. Beirne were husband and wife with legal residence in Anchorage, Alaska,  at the time the petition herein was filed.  They filed their joint Federal income tax returns for the taxable years 1960, 1961, and 1962 with the district director of internal revenue at Anchorage, Alaska.Michael F. Beirne (hereinafter referred to as petitioner) is a medical doctor specializing in the practice of pathology at Anchorage, Alaska, and was so practicing during the years in issue.*211  Petitioners are the natural parents of each of the following children born on the dates set forth:NameBirth dateBeverly Lorraine Beirne (Beverly)June 5, 1953David Michael Beirne (David)July 3, 1955Mark Joseph Beirne (Mark)Sept. 9, 1959Paul Roe Beirne (Paul)May 25, 1961In 1959, Dr. Beirne and other doctors formed a corporation known as Raypath, Inc. (hereinafter referred to as Raypath), which constructed a medical-dental building in Anchorage known as the Medical Arts Building.  This building was financed by a loan from the Small Business Administration, one of the provisions of which required that any management fees paid *138 by Raypath in connection with the operation of the building would be paid only by the issuance of stock in Raypath.  The loan agreement also provided that no cash dividends could be paid upon the stock of Raypath so long as the loan to the Small Business Administration was outstanding.  Dr. Beirne's pathology laboratory, known as Alaska Medical Laboratories, was located in the Medical Arts Building as was the Medical Arts Pharmacy, also owned by Dr. Beirne.  Prior to January 1966, Dr. Beirne managed the Medical Arts Building for Raypath and received stock in Raypath as compensation for these management services.Kelly Supply Co. (hereinafter referred to as Kelly Supply) is a corporation duly incorporated under the laws of the State of Alaska on April 27, 1960.  Kelly Supply had authorized capital stock of 100,000 shares of $ 1 par value stock, with 1,000 shares originally issued in May 1960 constituting the only issued and outstanding stock during the years involved.Kelly Supply's first board of directors meeting was held on May 4, 1960, and the minutes of that meeting included the following:The President [i.e., petitioner] announced that he wished to invest $ 1,000.00 for the company's *139 capital stock to comply with Paragraph Fifth [sic Fourth] of the Articles of Incorporation.  1The President announced that he intended to give stock to the minor children of himself and the corporation Secretary.  He stated that he intended to give to Beverly Lorraine Beirne, 300 shares; David Michael Beirne, 300 shares, and Mark Joseph Beirne, 300 shares.  He directed that the said gifts would not be effective until the stock is issued by the corporation to Michael F. Beirne, custodian for    .On motion duly made and seconded it wasResolved: That the corporation issue to the President 100 shares and to each of the three minor children of the President, 300 shares.The Secretary was instructed to prepare the proper stock certificates with the legend above indicated, entering the same into and making them a part of the *212  permanent records of the corporation.  The President observed that he would then hold stock certificate No. 1 for 100 shares, Beverly Lorraine Beirne would hold No. 2 for 300 shares, David Michael would hold No. 3 for 300 shares, and Mark Joseph would hold No. 4 for 300 shares.  The President further announced that he is making gifts of securities to his minor children *140 pursuant to Capter [sic] 24, SLA 1957, and asked that his intent to bring himself within that law be spread upon the corporate records and minutes.The Kelly Supply corporation minute book containing the record of stockholders indicates the stock was issued in accordance with the resolution.On the stock certificates of Kelly Supply, numbered 2, 3, and 4, the names of the owners were designated as Beverly Lorraine Beirne, David Michael Beirne, and Mark Joseph Beirne, respectively.Petitioner paid the consideration for the 1,000 shares of Kelly Supply stock by transferring $ 5,000 worth of Raypath stock owned by him to Kelly Supply in exchange for the 1,000 shares and a $ 4,000 balance on an open account due from Kelly Supply to petitioner.On May 24, 1960, the stockholders of Kelly Supply executed a consent to Kelly Supply's election to be taxed under section 1372(a).  2*141  This consent was executed by petitioner having 100 shares and by petitioner as custodian for Beverly, David, and Mark having 300 shares each.On May 25, 1961, Paul was born to the petitioners.  Thereafter, the minutes of Kelly Supply signed by petitioner reflect that Beverly, David, and Mark were each to transfer 75 of their shares to Paul so that thereafter petitioner's four children would each own 225 shares of the stock of Kelly Supply.On December 29, 1961, the stockholders of Kelly Supply executed a new consent to have the corporation taxed under section 1372(a).  This consent was executed by Corinne A. Beirne as the custodian of the stock of Beverly, David, Mark, and Paul 3 and states that each of the children owns 225 shares and that they had acquired their stock on December 27, 1961.*142  On January 20, 1962, petitioner delivered Beverly, David, and Mark's stock certificates numbered 2, 3, and 4, respectively, to his attorney, Clifford Groh, with the following memorandum of petitioner attached:1. Here are the certificates requested.2. I will be in later this week with names and amts. per Bill Scott.  So hold up.*213  This transaction was never completed in accordance with the memorandum and no new certificates of stock indicating Corinne A. Beirne's designation as custodian and Paul's interest in Kelly Supply were ever issued.After the birth of Paul, income tax returns in his name were filed reflecting a proportionate share of the income of Kelly Supply.Prior to the formation of Kelly Supply, petitioner purchased his medical supplies for Alaska Medical Laboratories, the name under which he conducted his pathology practice, directly from wholesalers and retail men.  After the formation of Kelly Supply, Alaska Medical Laboratories bought its supplies from Kelly Supply.  For the years 1960 through 1963, Kelly Supply had the following gross profits on sales made to Alaska Medical Laboratories:1960196119621963Gross sales$ 26,368.54$ 35,250.47$ 40,045.23$ 12,409.45Cost of sales15,639.4714,449.5619,086.666,915.43Gross profits10,729.0720,800.9120,958.575,494.02*143  Kelly Supply had no warehouse facilities other than petitioner's space in the Medical Arts Building.The Medical Arts Pharmacy was owned and operated by petitioner as a sole proprietorship until April 1, 1961, at which time it was transferred to Kelly Supply for its net book value of $ 4,967.15.  The Medical Arts Pharmacy is conducted in the same manner as any other commercial pharmacy.  Its income is basically derived from filling prescriptions for patients of doctors whose offices are located in the Medical Arts Building.From April 1, 1961, until September 1, 1962, Medical Arts Pharmacy was operated by Kelly Supply.  On September 1, 1962, Kelly Supply formed a partnership with a licensed pharmacist, Osborn Allen, and the Medical Arts Pharmacy was transferred to this partnership by Kelly Supply at book value.  Although Allen did not put any capital into the partnership, the profits were divided on a 50-50 basis.  This situation continued until Allen's death in 1965, whereupon the pharmacy was reconveyed to Kelly Supply which thereafter operated it and employed a pharmacist on a salary-plus-bonus basis.The income of Kelly Supply for the years 1960 through 1965 was as follows:YearAmount1960$ 9,665.95196126,239.35196231,817.78196318,192.82196419,358.77196525,091.87*144 *214   Pursuant to the election of Kelly Supply to be taxed as a small business corporation, its stockholders filed tax returns for the year 1960 reporting their ownership of stock in and income from Kelly Supply as follows:NumberStockholderof sharesIncomeMichael F. Beirne100$ 966.55Beverly L. Beirne3002,899.80David M. Beirne3002,899.80Mark J. Beirne3002,899.80Pursuant to the election of Kelly Supply to be taxed as a small business corporation, its stockholders filed tax returns for the years 1961 through 1965 reporting their ownership of stock in and income from Kelly Supply as follows:Number ofIncomeStockholdershares19611962M. F. Beirne100$ 2,623.93$ 3,181.78B. L. Bierne2255,903.867,159.00D. M. Beirne2255,903.867,159.00M. J. Beirne2255,903.857,159.00P. R. Beirne2255,903.857,159.00Total1,00026,239.3531,817.78IncomeStockholder196319641965M. F. Beirne$ 1,819.30$ 1,935.88$ 2,378.42B. L. Beirne4,093.384,355.725,351.44D. M. Beirne4,093.384,355.725,351.44M. J. Beirne4,093.384,355.725,351.44P. R. Beirne4,093.384,355.735,351.44Total18,192.8219,358.771 23,784.18The *145 following distributions were made by Kelly Supply in order to pay the income tax liability reflected upon the income tax returns of the minor children of the petitioner as follows:Name196019611962196319641965B. L. BeirneNone$ 456$ 1,189.58$ 1,559.19$ 1,115.20$ 1,292.40M. J. BeirneNone4561,189.581,559.201,115.201,292.40D. M. BeirneNone4561,189.581,559.201,115.201,292.40P. R. BeirneNoneNone1,189.581,559.201,115.201,292.40M. F. BeirneNoneNone680.70NoneNone1,763.02The distributable income of Kelly Supply, the cash distributions to stockholders, and the income accumulated by Kelly Supply for the years 1960 through 1965 were as follows:YearDistributableDistributionsAccumulatedincomeincome1960$ 9,665.95None$ 9,665.95196126,239.35$ 1,368.0024,871.35196231,817.785,439.0226,378.76196318,192.826,236.7911,956.03196419,358.774,460.8014,897.97196525,091.876,932.6218,159.25Total130,366.5424,437.23105,929.31*215   During the years 1960 through 1965, petitioner received unsecured advances totaling $ 72,790.29 4*146  from Kelly Supply as follows:YearAmount1960$ 5,000.00196112,467.15196229,867.21196313,000.0019643,455.9319659,000.00Total72,790.29The following payments of principal were made by petitioner to Kelly Supply:1960No payments were made during the year 1960.Date1961Amount4/1/61Transfer of Medical Arts Pharmacy to Kelly Supply$ 4,967.154/27/61Transfer of Raypath stock for management fees5,400.0012/31/61Deposit by Michael F. Beirne of check from St. Joseph'sHospital4,849.1615,216.31196212/31/62Transfer of Raypath stock6,900.0012/31/62Kelly Supply dividend680.7012/31/62Cash payment from Alaska Medical Laboratories1,500.009,080.7019636/7/63Cash payment from Alaska Medical Laboratories3,700.001964No payments were made during the year 1964.19653/3/65Transfer of Raypath stock bought from Dr. Grabah5,000.00Oct. 1965Alaska Mutual Savings Bank -- debenture No. 123,000.00Nov. 1965Transfer of note from Commercial Stationers, Inc 16,966.86Dec. 1965Cash payment926.423/31/65Dividend of Kelly Supply1,763.0217,656.30On December 31, 1966, petitioner paid $ 40,000 to Kelly Supply by personal check which *147 payment was credited upon its books against the balance of amounts then due Kelly Supply from petitioner.  Kelly Supply then purchased a 30-day time certificate of deposit from the National Bank of Alaska in the amount of $ 40,000.  At the end of the 30-day period Kelly Supply cashed the certificate of deposit and then loaned $ 40,000 to petitioner.*216  The books and records of Kelly Supply reflect that petitioner was indebted to Kelly Supply prior to the end of each of the years 1960 through 1965 in the following amounts:YearAmount1960$ 5,000.0019612,850.84196221,387.35196326,187.35196431,893.28196524,825.64In 1960, petitioner paid interest of $ 400 to Kelly Supply on his borrowings.  Petitioner made no payments of interest to Kelly Supply on the amounts he owed it in 1961, 1962, and 1963.  In 1964, Kelly Supply's books and records indicate an interest payment of $ 3,000, by petitioner's check dated December 30, 1964.  This check was deposited by Kelly Supply on February 5, 1965, and on February 9, 1965, Kelly Supply advanced petitioner $ 3,000.  In 1965, Kelly Supply's books and records indicated accrued interest of $ 1,588.66 on loans to petitioner, which was accounted for by offsetting *148 the dividend due from Kelly Supply to petitioner for that year.Although petitioner had always maintained bank accounts for his minor children, there were never any substantial deposits made to those accounts and the income of Kelly Supply which was taxed to the minor children was not deposited to those accounts.OPINIONThe issue to be decided in this case relates to the income tax consequences of petitioner's purported gifts to his minor children of 90 percent of the outstanding stock of Kelly Supply, which then elected to be taxed as a subchapter S corporation.  Respondent contends that the purported gifts were so devoid of economic reality that they should be disregarded for tax purposes and that all of the taxable income of Kelly Supply should be taxable to petitioner as the actual owner of the stock. 5*149  In the event we recognize petitioner's children as the owners of the stock, respondent contends that the taxable income of the corporation should be allocated to petitioner pursuant to section 1375(c), 6 in order to reflect the value of his services thereto.In this case, we are again faced with the task of determining the efficacy of a taxpayer's attempt to split income within a family group.  *217  The tax principles that control this determination were aptly stated in Jeannette W. Fitz Gibbon, 19 T.C. 78 (1952), as follows:Transactions within a family group are subject to special scrutiny in order to determine if they are in economic reality what they appear to be on their face.  This is not to say, however, that all arrangements between members of a family which affect their tax liabilities will be disregarded. It is authoritatively *150 established that where a taxpayer attempts to transfer property and the end result of such transfer does not effect a complete shift in the economic incidents of ownership of such property, the transaction will be disregarded for Federal income tax purposes.  This is true because the transferor in such cases retains such control over the property that he is the one who derives the real benefit from the economic gain thereon.  * * *Section 1.1373-1(a)(2), Income Tax Regs., reflects these principles in the area of transfers of stock of subchapter S corporations.  7This regulation provides that:(2) * * * A donee or purchaser of stock in the [subchapter S] corporation is not considered a shareholder unless such stock is acquired in a bona fide transaction and the donee or purchaser is the real owner of such stock. The circumstances, not only as of the time of the purported transfer but also during the periods preceding and following it, will be taken into consideration in determining the bona fides of the transfer.  Transactions between members of a family will be closely scrutinized.Petitioner's *151 position is that a valid gift of the stock was made in accordance with the requirements of the Alaska Gifts of Securities to Minors Act and that this was a bona fide gift for tax purposes so as to make the income taxable to his children pursuant to section 1373(b).  8*152  It is well established that the validity of a transaction under State law is not conclusive of its bona fides for the purpose of Federal taxation. Commissioner v. Tower, 327 U.S. 280">327 U.S. 280 (1946); Gouldman v. Commissioner, 165 F. 2d 686 (C.A. 4, 1948).  Thus, petitioner's assertion that the gift was valid under the Alaska Gifts of Securities to Minors Act, even if true, does not resolve the question before us.  9 Rather, our question is whether petitioner has transferred all command over and enjoyment of the economic benefit of the Kelly Supply *218  stock so as to have made his children the true owners thereof for Federal tax purposes.  Commissioner v. Court Holding Co., 331">324 U.S. 331 (1945); Helvering v. Clifford, 309 U.S. 331">309 U.S. 331 (1940); Corliss v. Bowers, 281 U.S. 376 (1930). We do not think petitioner has done so.Respondent relies principally on the Henry D. Duarte case, 44 T.C. 193">44 T.C. 193 (1965). In that case, the taxpayer, the sole shareholder of a corporation, transferred a 25-percent stock interest to each of his two minor children, pursuant to the New York Uniform Gifts to Minors Act, with the taxpayer's wife serving as custodian of the stock. A gift tax *153 return was filed reporting the transfer, although no gift tax liability resulted.  Thereafter, the corporation elected to be taxed under subchapter S. We found as facts, inter alia, that the petitioner, rather than the custodian of the children, continued after the transfers to exercise complete control over the policies and operation of the corporation; and that despite the reporting of dividends, both actual and constructive, by the corporation on its information returns and the taxpayer and his sons on their individual returns, neither son actually received any dividends. Viewing all the evidence therein, we held that the purported transfers of stock by the taxpayer had no economic reality; and that the taxpayer was the true economic owner of all the stock of the corporation.  Although we think the instant case less clear cut than Duarte, nevertheless, for the reasons to be discussed below, we hold that petitioner's stock transfers lacked economic reality and that petitioner remained the true economic owner of the Kelly Supply stock during the years at issue.In the instant case, there is no evidence that either petitioner's wife, as the custodian of the Kelly Supply stock, or the *154 children themselves exercised any influence in the operation of Kelly Supply.  Rather, it appears that petitioner, at all times continued to completely control the policies and operation of Kelly Supply.  Henry D. Duarte, supra.Further, petitioner continued to exercise control over  the Kelly Supply stock, even after its purported transfer, by his intention to retain the power to adjust the stock ownership among his minor children. After the birth of his fourth child, Paul, in May 1961, petitioner intended to redistribute the stock of Kelly Supply among his children.  In this regard, petitioner had the corporate minutes reflect there was to be a transfer of 75 shares each from Beverly, David, and Mark to Paul; had the stockholders, including Paul, file a new subchapter S election for Kelly Supply; had Paul file individual tax returns reflecting his income from Kelly Supply; and had Paul's interest reflected in Kelly Supply's tax returns.  The fact that petitioner's attorney, for whatever reason, never issued the new stock certificates does not weaken the inference that, in the mind of petitioner, he had *219  such complete dominion and control over the stock as to have it redistributed *155 among his children.  Ralph R. Anderson, 5 T.C. 443">5 T.C. 443, 451 (1945), affd.  164 F. 2d 870 (C.A. 7, 1947).In addition to the dominion and control exercised by petitioner, he also, in substance, retained the enjoyment of the economic benefits of ownership of the Kelly Supply stock after its purported transfer.  During the years 1960 through 1965, Kelly Supply had distributable income of $ 130,366.54.  Of that amount, only $ 21,993.51 was distributed to the children, solely in order to defray their income tax liabilities.  Although petitioner maintained bank accounts for his children during this period, there were never any substantial deposits made to these accounts and the income of Kelly Supply which was reflected on the children's tax returns was not deposited therein.  Rather, the bulk of Kelly Supply's income was retained by the corporation and borrowed by petitioner on open account for his personal use.  In this manner, petitioner availed himself of Kelly Supply to generate over $ 70,000 in funds for his personal use, in the form of unsecured advances from that corporation.These advances were made by Kelly Supply without interest for some years and, when interest was charged by the *156 corporation, petitioner never actually went "out of pocket" to pay it.  10 Furthermore, the manner of repayment of the advances casts doubt on their arm's-length nature.  During the years in issue petitioner transferred $ 12,300 worth of Raypath stock to Kelly Supply in reduction of his indebtedness thereto.  This Raypath stock was earned by petitioner as a management fee from Raypath and his transfer of it to Kelly Supply provided a simple manner of converting to cash this compensation received in the form of close corporation stock. In addition, petitioner transferred a note of Commercial Stationers, Inc., which he valued at $ 6,966.86, as satisfaction of part of his indebtedness to Kelly Supply.  Commercial Stationers, Inc., was a corporation owned 20 percent by petitioner which was in financial difficulty, and up to the time of trial, it had not made a payment of either principal or interest on its note held by Kelly Supply.Even were *157 we to conclude that these advances created a genuine indebtedness of petitioner to Kelly Supply, we think it follows nevertheless, that under the circumstances herein, petitioner must be considered to have retained the enjoyment of the economic benefits of ownership of the Kelly Supply stock after its alleged transfer to his children.*220 For the reasons discussed above, we hold that petitioner's purported transfers of the Kelly Supply stock were not bona fide, as they lacked economic reality, and petitioner remained the real owner thereof during the years in issue.  In light of this determination, we need not consider respondent's alternative contention that the income of Kelly Supply should be allocated to petitioner pursuant to section 1375(c) to reflect the value of his services thereto.  11Decision will be entered under Rule 50.  Footnotes1. "The corporation will not commence business until at least one thousand dollars has been received by it as consideration for the issuance of shares."↩2. All statutory references are to the Internal Revenue Code of 1954.3. The parties stipulate that the minutes of Kelly Supply indicate that Corinne A. Beirne was designated as custodian for the stock of the four children.  Although those minutes are not in evidence herein, we will accept the parties stipulation and assume that Corinne A. Beirne was so designated.↩1. Kelly Supply Co. received a long-term capital gain in the amount of $ 1,307.69 which was taxed to its stockholders as follows:↩StockholderAmountMichael F. Beirne$ 130.77Beverly L. Beirne294.23David M. Beirne294.23Mark J. Beirne294.23Paul R. Beirne294.234. Although it is stipulated that petitioner received $ 72,790.29 in cash advances, respondent on brief states that the advances totaled only $ 68,290.29.1. A corporation owned 20 percent by petitioner.  No payments of either principal or interest have been made on this note as of the time of trial herein.↩5. Respondent does not contend that Kelly Supply is itself a sham, Britt v. United States, 292 F. Supp. 6">292 F. Supp. 6 (M.D. Fla. 1968), but rather that the gifts of the stock thereof were without economic reality.6. SEC. 1375(c). Treatment of Family Groups.  -- Any dividend received by a shareholder from an electing small business corporation (including any amount treated as a dividend under section 1373(b)↩) may be apportioned or allocated by the Secretary or his delegate between or among shareholders of such corporation who are members of such shareholder's family (as defined in section 704(e)(3)), if he determines that such apportionment or allocation is necessary in order to reflect the value of services rendered to the corporation by such shareholders.7. See note, "Assignment of Income: Possibilities Under Subchapter S," 23 Tax L. Rev. 213">23 Tax L. Rev. 213↩ (1968).8. SEC. 1373(b). Amount Included in Gross Income.  -- Each person who is a shareholder of an electing small business corporation on the last day of a taxable year of such corporation shall include in his gross income, for his taxable year in which or with which the taxable year of the corporation ends, the amount he would have received as a dividend, if on such last day there had been distributed pro rata to its shareholders by such corporation an amount equal to the corporation's undistributed taxable income for the corporation's taxable year. * * *9. Respondent argues on brief that the gifts to the children did not qualify under the Alaska Gifts to Minors Act because the stock certificates were made out in the names of petitioner's minor children and not in the name of a custodian. However, even assuming arguendo↩ that the gift did qualify under the Alaska statute, in light of our discussion below we think the transfers were not bona fide gifts for Federal tax purposes.10. In one instance, petitioner concurrently borrowed the same amount from the corporation as he supposedly was paying in interest, and in another, the interest payment was offset against the dividend due petitioner in that year from the corporation.↩11. See Walter J. Roob, 50 T.C. 891↩ (1968).