Opinion
Docket Nos. 19467 19468.
1950-05-9
ESTATE OF L. B. WHITFIELD, DECEASED, FRED S. BALL, JR., JOHN A. MILLER AND L. B. WHITFIELD, JR., EXECUTORS, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.ESTATE OF L. B. WHITFIELD, DECEASED, FRED S. BALL, JR., JOHN A. MILLER AND L. B. WHITFIELD, JR., EXECUTORS, ALLEGED TRANSFERREE OF WHITFIELD REALTY COMPANY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
H. C. Kilpatrick, Esq., for the petitioners. S. Earl Heilman, Esq., for the respondent.
Primarily in order to avoid expense and delay in administration, the decedent conveyed real estate to a corporation formed, of which he was president and owner of all stock except qualifying shares. The properties which were the only corporate assets were rental properties subject to yearly leases producing monthly rentals. Income tax returns were filed for several years by the corporation showing the corporate business to be real estate operating and leasing real estate, and showing various activities and deducting expenses of corporate operation. Leases were renewed. Books were kept for the corporation by an employee of another company in which the decedent was interested and to which he was indebted. The net rentals from the properties were, upon the books of that company, credited on decedent's indebtedness and shown in the corporate return as compensation to officers, and included in decedent's income tax returns. Some of the real estate was sold. Held that the corporate entity is to be recognized for Federal income tax purposes. H. C. Kilpatrick, Esq., for the petitioners. S. Earl Heilman, Esq., for the respondent.
These proceedings were consolidated for hearing. Docket No. 19467 involves a deficiency in income tax in the amount of $7,284.30 for the period January 1 to December 1, 1942, and Docket No. 19468 involves liability as a transferee of the Whitfield Realty Co. for deficiencies of $7,132.40 in income tax and $3,347.07 in declared value excess profits tax for the year 1942. The issue in Docket No. 19467 is whether gain realized from a sale of real property is taxable to the decedent or to the Whitfield Realty Co. It was stipulated that the estate of the decedent is liable as a transferee for any deficiency determined against the Whitfield Realty Co. The estate of L. B. Whitfield, deceased, filed its income tax return for the taxable period with the collector for the district of Alabama.
FINDINGS OF FACT.
At all times material, L. B. Whitfield, who died November 30, 1942, and who is referred to hereinafter as the ‘decedent,‘ was a resident of Montgomery, Alabama, and was president and a majority stockholder of the Alabama-Georgia Syrup Co., hereinafter called the ‘Syrup Co.,‘ a corporation engaged in the manufacture of cane syrup in Montgomery.
Decedent, prior to 1934, had borrowed substantial sums from the Syrup Co. The Syrup Co. was in turn indebted to banks for money borrowed. Decedent's borrowings were carried in a number of open accounts on the books of the Syrup Co. In 1934 the banks required that these accounts be consolidated into one account, that decedent give the Syrup Co. his promissory note for the total amount due it, that this note be secured by the assignment of his life insurance policies and by mortgages on his real estate in Florida, and that all rents received from the Florida properties be turned over to the Syrup Co. in reduction of his indebtedness to it. This was done, and from that time on all rents received by decedent were turned over at once by decedent to the Syrup Co. in reduction of his debt. These rental receipts were in the form of checks, which decedent would endorse and deliver to the treasurer of the Syrup Co., who would deposit them in the Syrup Co.'s bank account and credit decedent with the amount thereof as payments on his indebtedness.
Prior to the death of decedent's wife in the early nineteen-thirties, decedent's attorney in Florida advised him to convey all of his real estate in Florida to himself and his wife as tenants by the entireties in order to avoid the trouble and expense of an administration thereof in Florida in the event of the death of either of them. After her death the attorney recommended to decedent that, to avoid ancillary administration proceedings on his estate in Florida, he organize a ‘dummy‘ corporation to hold title to the property and that decedent thereafter operate the real estate in the name of the corporation. The decedent consulted his attorney in Montgomery, Alabama, concerning the matter, and, thereafter, in 1938, the Whitfield Realty Co., hereinafter referred to as the Realty Co., was organized under the laws of Alabama, with an authorized capital stock of $2,000, consisting of 200 shares, each of a par value of $10.
The organizers of the Realty Co. were the decedent, his son, L. B. Whitfield, Jr., and John M. Chisholm, Secretary-treasurer of the Syrup Co. Decedent subscribed for and received 98 shares, and the others one share each, of the corporation's authorized stock. The charter of the Realty Co. recited that the purpose of forming the corporation was ‘ * * * carrying on the business hereinafter stated * * * .‘ The stated business was the following:
The object for which the corporation is formed is to acquire, own, sell and otherwise dispose of real estate and to have all of the powers conferred upon such corporation by the general laws of the State of Alabama.
The decedent's son and Chisholm paid no consideration for the stock issued to them. Promptly upon its issuance they endorsed the certificates and delivered them to the decedent. The organizers of the corporation were listed in the charter as the directors and officers for the first year, decedent as president, his son as vice president, and Chisholm as secretary-treasurer. The decedent continued to be president of the Realty Co. until his death.
Prior to the organization of the Realty Co., the decedent and his attorney in Montgomery informed Chisholm, and decedent informed his son, that the purpose of forming the corporation was to take title to the property of the decedent in Florida and save administration expenses. Chisholm was informed that the net income of the corporation would be paid to decedent at the end of each year as salary.
On September 17, 1938, the decedent conveyed to the Realty Co. two lots situated in Miami, Florida, and a parcel of real estate in Pensacola, Florida, subject to a mortgage outstanding on the property in Pensacola, which was then held by an insurance company. The three parcels of real estate were rental properties. There were seven leases outstanding on the Miami properties and three on the Pensacola real estate, all on a yearly basis, with rental payable monthly. The properties were entered in the books of the Realty Co. at a value of $88,936.87.
The Realty Co. had no office or permanent employees; it was not listed in telephone or city directories; it was never a party to a suit in court; it never borrowed money or incurred any indebtedness; it had no bank account; and it owned no assets other than the real property conveyed to it by the decedent at the time of its organization.
At the first meeting of the stockholders of the Realty Co., held on September 16, 1938, bylaws were adopted which provided, among other things, for annual and special meetings of the stockholders, the selection and tenure of officers and directors, and that the officers should consist of a president, vice president, and secretary and treasurer. The duties of the officers were set forth therein to be as follows:
7. The President shall preside at all meetings of the stockholders and Directors, shall execute on behalf of the corporation all contracts authorized by the Board of Directors, shall have general supervision of the business of the corporation and the performance of their duties by the other officers and shall have authority concurrent with the Treasurer to sign checks and notes in the name of the corporation, to borrow money for the corporation, to exercise all power and authority not withheld from him by action of the Board of Directors and perform any other duties imposed upon him by the Board of Directors.
8. The Vice-President shall have the power and authority of the President in case of the disability or absence of the President from the State of Alabama when requested to do so by the President.
9. The Secretary shall keep correct minutes of all meetings of the stockholders and Directors, preserve all correspondence, take care of and affix the seal of the corporation when authorized to do so by the Board of Directors, see that correct and accurate accounts are kept of all receipts and disbursements and execute all instruments authorized by the Board of Directors and perform all other duties imposed upon him by the Board of Directors in the conduct of the details of the business of the corporation.
10. The Treasurer shall be the custodian of all funds and securities of the corporation, shall see that the funds are deposited daily in a bank designated by the Board of Directors and that full information is given to the Secretary so that accurate accounts may be kept thereof.
At the same meeting the president was authorized ‘to draw as his salary an amount equal to all of the net earnings of the corporation after paying all other salaries and expenses,‘ and to sell property of the corporation ‘upon such terms as he may see fit.‘
After the organization of the Realty Co. there was a continuation of the procedure of transmitting rentals from the properties to the Syrup Co. for application on the indebtedness of the decedent to it. The amounts so received by the Syrup Co. were deposited in its bank account and expenses of operating the properties and other disbursements on account thereof were paid by that corporation. Appropriate entries were made in the books of the Syrup Co. for the receipts and disbursements. The net rentals were credited on decedent's indebtedness to the Syrup Co. From vouchers prepared by the Syrup Co., for the receipts and disbursements, its bookkeeper made corresponding entries under the supervision of Chisholm in books bearing labels reading ‘Whitfield Realty Co.,‘ one of which books contained entries for the original stock subscriptions and payments thereon and cost of the properties, with a balancing credit to surplus for the Pensacola property. The books were kept with the decedent's records in the office of the Syrup Co. Similar records were kept for the decedent prior to the organization of the Realty Co.
The opening balance sheets of the Realty Co. in 1938 and 1942, as disclosed by its income tax returns, listed assets and liabilities as follows:
+--+ ¦¦¦¦ +--+
1938 1942 Assets: Cash $1,000.00 Capital assets 105,236.87 $100,568.32 Notes and accounts receivable 4,834.91 Liabilities: Accounts payable 7,431.20 Bonds, notes and mortgages payable 25,936.73 23,177.68 Accrued taxes 2,680.30 Common stock 1,000.00 1,000.00 Paid-in or capital surplus 79,300.14 71,114.05 The balance sheet at the close of 1942 shows no liability for bonds, notes, and mortgages payable.
In 1939, in compliance with a request made by the banks, the decedent caused the Syrup Co. to assign to the banks, as security for indebtedness of the Syrup Co. to the banks, the note and collateral therefor which the Syrup Co. held for indebtedness of the decedent to it.
Income tax returns were filed in the name of the Realty Co. for the years 1938 to 1943, inclusive. In its return for 1938 ‘Real Estate Operating‘ was specified as its kind of business; in 1939, ‘Leases of Real Property Buildings— Business‘; and in 1940, 1941, 1942, and 1943, ‘Lessors of Real Property.‘ The income and deductions reported in the returns were as follows:
+------+ ¦¦¦¦¦¦¦¦ +------+
1938 1939 1940 1941 1942 1943 Income: Interest $140.07 $106.05 Rents $2,841.25 9,057.15 11,052.50 $10,952.50 $7,193.76 $2,460.30 Insurance rebate 114.66 Short term capital gain 1,339.19 Other income 21.49 Total income 2,841.25 9,197.22 11,273.21 12,291.69 7,193.76 2,481.79 Deductions: Compensation of officers 426.86 2,642.89 2,142.49 2,369.43 1,974.07 Repairs 3.25 162.37 1,845.13 1,508.73 20.17 Interest 430.68 1,266.02 1,353.60 1,182.80 574.73 Taxes 938.83 3,399.60 4,344.98 3,859.41 1,670.70 991.83 Bad debts 60.00 50.00 Depreciation 541.34 1,856.07 1,856.07 1,856.07 727.18 484.79 Salaries and wages 330.00 90.00 Other deductions 500.29 32.64 1,413.70 1,118.85 327.71 772.31 Total deductions 2,841.25 9,197.22 11,273.21 12,291.69 7,113.12 2,409.10 Net income None None None None 80.64 72.69
‘Other deductions‘ included, among other items, stationery and office supplies (1939, $7.64), traveling (1940, $35; 1942, $92.50), advertising (1941, $2.52), telephone (1940, 1941, 1942), ‘lease renewal fees‘ (1943) or ‘renewal fees‘ (1940, 1941), and large amounts in 1938, 1940, 1941, and 1943 for commissions, including rental commissions. Auditing or accounting items appear in three years. Form for ‘cost of operations‘ is blank as to all years except 1942, where items for commissions, ‘lease renewal fees,‘ insurance, and inspection fees appear. Legal fees are shown as expense in 1940, 1942, and 1943. Balance sheets attached to returns show reserves set up for bad debts as to all years except 1943. The return for 1941, under short term capital gains, shows $2,000 ‘earnest money recovered,‘ less expense of $660.81, net $1,339.19. The net rentals from the properties, shown in the corporate returns as compensation of officers, were included as income in returns filed by the decedent.
The Realty Co. filed corporate franchise tax returns with, and Aid franchise taxes to, the State of Alabama. It also filed Federal capital stock tax returns.
On June 5, 1942, the directors of the Realty Co. authorized a sale of the Pensacola property upon the terms agreed upon by its president. The sale was made about July 1, 1942. The deed executed by the Realty Co. for the property included an assignment of the leases on the property, subject to an assignment on August 10, 1938, of one of the leases to an insurance company. The negotiations for the sale were conducted by the decedent through a real estate agent in Pensacola. In some of the correspondence with the agent the decedent referred to the real estate as his property. Of the cash in the amount of $35,000 paid at the time of sale, the banks authorized the decedent to retain $10,000 and required him to apply $25,000 against a loan on the life insurance policies the banks were holding as collateral.
In its return for 1942 the Realty Co. reported the sale of the Pensacola property, but included none of the gain on the transaction for the reasons set forth therein and reported that the gain would be reported in the return to be filed for the decedent's estate. Gain of $19,439.78 was included in the return filed by the executors of the decedent's estate for the taxable year. The gain realized on the sale was $28,444.78.
The Realty Co. was dissolved on August 31, 1943, by consent of its then stockholders, namely, the First National Bank of Montgomery, which, as an executor at that time, held 98 shares of the corporation's stock, a trust officer of the bank, who held the shares originally issued to L. B. Whitfield, Jr., and John M. Chisholm.
In his determination of the deficiency and transferee liability the respondent held that the gain realized from the sale of the Pensacola property constituted income of the Realty Co. in 1942.
OPINION.
DISNEY, Judge:
The sole question left for our consideration is whether the gain realized on the sale of the Pensacola property is taxable to the Realty Co., as determined by the respondent, or to the decedent, as contended by the petitioners. The point of difference between the opposing parties is whether the Realty Co. should be recognized here as a taxable entity. Petitioners assert that the Realty Co. was organized for the sole purpose of holding title to the decedent's Florida real estate to avoid the trouble and expense that would be involved in administration proceedings in the event of his death while seized of the property and that it engaged in no activity other than as a passive holder of record title to the real estate and matters incident thereto and flowing from its corporate existence. The respondent contends, in effect, that the activities of the Realty Co. were broad enough to require that the corporate form be recognized for tax purposes.
The general rule is that a corporation is a taxpayer separate and distinct from its stockholders, even though, as here, all of the stock is owned by one individual, and the corporate entity may be disregarded only in exceptional circumstances, such as where it is a sham or unreal. Burnet v. Commonwealth Improvement Co., 287 U.S. 415; New Colonial Ice Co. v. Helvering, 292 U.S. 435; Moline Properties v. Commissioner, 319 U.S. 436; National Carbide Corporation v. Commissioner, 336 U.S. 422. In the Moline Properties case the Court said:
The doctrine of corporate entity fills a useful purpose in business life. Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator's personal or undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity. * * *
One of the purposes for the organization of the Realty Co. was avoidance of costly and prolonged ancillary administration proceedings at the situs of the properties in the event the decedent was the owner thereof at the time of his death. If the Realty Co. had no purpose other than to hold bare title, and did not engage in business, as petitioners assert, the case would fall within a recognized exception to the general rule. North Jersey Title Insurance Co. v. Commissioner, 84 Fed.(2d) 898; United States v. Brager Building & Land Corporation, 124 Fed.(2d) 349; Paymer v. Commissioner, 150 Fed.(2d) 334. Here, there were other purposes, and the formation of the corporation was followed by activities sufficient to constitute a business separate from the individual.
The decedent's Florida attorney testified not only that he recommended that the corporation be organized to hold title, but that the decedent ‘thereafter conduct and operate that real estate in the name of the corporation. The objective of the plan so recommended was a corporate form of operation of the business then being conducted by the individual to avoid consequences that would flow from continued individual operation, and to give him all of the resulting advantages.
The charter of the Realty Co. provided for a business to acquire, own, sell, and otherwise dispose of real estate and for all the powers conferred by the general laws of Alabama. Thus, the Realty Co. had power to transact a business of acquiring and disposing of real estate, with the statutory powers conferred by the general laws of Alabama upon such a corporation.
Promptly upon its organization, the corporation acquired the decedent's Florida real property by deed. The instrument of conveyance did not exclude the leases outstanding on the properties, only specifying that the grant was subject to a certain mortgage. That the corporation acquired leases on the Pensacola property is definitely shown by an assignment thereof in the deed executed in 1942 in connection with the sale in question. No proof was made and petitioners make no contention that the Realty Co. was not the lessor under all of the leases outstanding on the properties during the taxable year. The income tax returns filed by the corporation show in different years expenses deducted for rental commissions, or commissions, renewal fees, or lease renewal fees. The leases were on a yearly basis, so that obviously leases were renewed. No one but the corporation, holding title, could validly renew them. The rents were on a monthly basis, therefore requiring attention, which might in fact explain such expense items as legal expense. Travel and auditing expenses were deducted, and the balance sheets showed reserve for bad debts. For 1942 some of such expenses appear under ‘cost of operations,‘ though shown as ‘other deductions‘ in other years. For 1941 short term capital gain is shown from ‘earnest money recovered,‘ with $660.81 expense deducted therefrom, from which it appears that in that year there was some capital transaction involving recovery, at expense, of moneys put up as earnest. This appears a matter of doing business. Such activities are beyond a mere holding of bare legal title, or the status of ‘passive holder of title,‘ as the petitioner phrases it. It discloses the operation of a business of owning property for rental and sale purposes in accordance with the pattern made by the sole stockholder. As above seen, in one year ‘operation‘ was affirmatively recognized in the deduction of ‘cost of operations‘ and essentially the same items were claimed in other years as deductions of expense. The corporation by its income tax returns recognized that rental receipts constituted income taxable to it, and not to the individual who owned its stock. Notwithstanding this procedure and recognition by the Realty Co. of receipts of rental income, petitioners assert that the decedent received the rents in his individual capacity after the conveyance of the real estate to the corporation. The evidence is no more than that rental payments were remitted directly to the decedent by the agents appointed to collect rents from the lessees. Nothing in the evidence establishes that he did not receive the money in his capacity as an officer of the Realty Co. Even if he did not, the corporation, as the lessor, was the entity entitled to the rentals. Neither is the fact that the rentals collected, less expenses, were applied to personal debts of the decedent decisive of the question. That was merely an agreement between the Realty Co. and the Syrup Co. not altering the status of the former for tax purposes. The decedent did not treat the amounts as income to him. He reported the net rentals as compensation received as an officer of the corporation.
The absence of a corporate office, bank account, and permanent employees is not controlling. Paymer v. Commissioner, supra. Books which were regarded by the corporation as sufficient for its purposes were maintained by the bookkeeper of the Syrup Co. Under the plan adopted for recording financial transactions involved in the operation of the properties, entries appeared in books of both the corporation and the Syrup Co. No bank account was required under the arrangement decedent had with the Syrup Co. to turn over to it all rental receipts for application, less expenses, on his indebtedness to it. Expenses were incurred in owning and leasing the properties, and deductions therefor were claimed by the corporation in its income tax returns. Though the petitioners suggest in effect that matters such as the corporation's filing state franchise returns, filing income tax returns, and claiming deductions for expenses are mere matters of form, we can not so agree. They are ordinary business practice of a corporation doing business, and convincing indicia not only of the reality of such corporation, but of the fact that its officers at that time considered it as carrying on business.
The petitioners contend that the Realty Co. did not assume liability for the decedent's mortgage debt. The Pensacola property was conveyed to the Realty Co. subject to a mortgage held by the Prudential Insurance Co. and without any provision in the deed for assumption of the debt by the grantee. Notwithstanding the terms of the conveyance, the opening balance sheet of the Realty Co. discloses one liability in the amount of $25,936.73, consisting of bonds, notes, and mortgages having a maturity of one year or more, and the balance sheet on January 1, 1942, discloses a like liability in the amount of $23,177.68. It thus appears that the corporate officers recognized liability. The liability does not appear, however, in the balance sheet for the end of 1942. In this connection and in connection with the fact that the Realty Co. never was sued, it is worthy of note that it executed a warranty deed to the Pensacola property. Such deed subjected the corporation to the possibility of suit on warranty, and the warranty of title by the corporation is in a real sense an affirmation of the reality, and responsibility, of the corporation-warrantor. It is hardly consistent with the position of naked holder of title. In so warranting, the Realty Co. assumed liability, even if it did not do so on the mortgage.
While there is testimony in the record that the Realty Co. had no employees, opposed to such testimony is the fact that $330 was deducted in the 1942 return for salaries and wages in addition to the amount paid to the decedent, which was deducted as compensation paid to officers. Likewise, though there is testimony that no advertising was done, or office stationery, these items appear among expenses claimed though in small amounts, advertising in 1941 and stationery in 1939. With these facts before us, we can not say that there was no advertising and no stationery.
Petitioners contend that the issue here is governed by cases such as Thomas K. Glenn, 3 T.C. 328, and United States v. Brager Building & Land Corporation, supra. In the Glenn case the purpose for which the corporation was organized contemplated the holding of title to certain real property and such other property as the sole stockholder might transfer to it; nothing in the evidence indicated that the stockholder ever intended the corporation to engage in business; the stockholder agreed at the time the corporation was formed to pay, and did pay, taxes and assessments on the property transferred to it and organization expenses; the corporation had no income or expenses and functioned only as a record holder of real estate and stock and beneficiary of insurance on the life of the stockholder. Here, while a purpose for forming the corporation was personal in the sense that it had to do with administration of the property in Florida, to accomplish that objective a corporation was formed to and did operate the business formerly conducted by the decedent as an individual.
United States v. Brager Building & Land Corporation, supra, is also distinguishable. In that case the corporation had no function other than to serve as an agency for passive holding of legal title to property and had no business activities, contrary to the facts here.
After analysis of all of the facts before us, we conclude and hold that the Realty Co. was engaged in business activities during the taxable year and realized gain, taxable to it, on the sale of the Pensacola property. On account of adjustments necessary under the stipulation of the parties
Decisions will be entered under Rule 50.