Opinion
Docket Nos. 35639 35640.
1953-05-28
SAM E. WILSON, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.ADA ROGERS WILSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
J. A. Martin, Esq., for the petitioners. Joseph P. Crowe, Esq., and M. Clifton Maxwell, Esq., for the respondent.
In connection with a sale of assets to Wil-Tex Oil Corporation on January 1, 1947, Wilson agreed to reimburse the corporation for $42,104.87, the difference between the value of a note which the corporation assumed from Wilson and the basis of the property. The account payable was recognized as valid on the books of Wilson and the corporation, and was a valid indebtedness. The indebtedness was reduced and the balance of $33,950 was canceled by Wil-Tex Oil Corporation as of January 31, 1948. Held, that upon the cancellation of the indebtedness in 1948, petitioners thereby realized income of $33,950. Petitioners sold all their stock in Wil-Tex Oil Corporation on April 8, 1948. Held, further, that the income thus realized by the cancellation of the indebtedness was not capital gain arising from the sale of stock, and respondent's determination that it is ordinary income arising from dividends is sustained. J. A. Martin, Esq., for the petitioners. Joseph P. Crowe, Esq., and M. Clifton Maxwell, Esq., for the respondent.
The respondent has determined an income tax deficiency for the calendar year 1948 of $8,653.32 for each petitioner. The two cases involving a husband and wife are consolidated.
It is unnecessary to discuss respondent's adjustments since they are not contested by petitioners. In amended petitions, each petitioner assigns certain other errors seeking a refund of $6,962.16. Each petitioner assigned the following errors:
A. The Commissioner erred in failing to eliminate from gross community income the amount of $33,950.00 which Petitioner erroneously included in gross ordinary community income as a dividend from Wil-Tex Oil Corporation.
B. The Commissioner erred in failing to allow as community cost of Wil-Tex Oil Corporation stock the amount of $8,154.87 which Petitioner erroneously failed to claim as such community cost in determining and reporting gain on sale of said Wil-Tex Oil Corporation stock.
C. In the alternative, if the Commissioner did not err as stated in paragraphs A and B above, then the Commissioner erred in failing to treat the $33,950.00 amount in question as additional long-term capital gain from the sale of Petitioner's Wil-Tex stock instead of treating said amount as ordinary income.
In his answer respondent denies the three alleged errors.
FINDINGS OF FACT.
Many of the facts have been stipulated and are so found as a part of these findings.
Petitioners Sam E. Wilson, Jr., sometimes hereafter called Wilson, and Ada Rogers Wilson are husband and wife, residing in Corpus Christi, Texas. Their Federal income tax returns for the calendar year 1948 were filed separately on a community property basis with the collector for the first district of Texas. Petitioners kept their books on an accrual basis during the years 1946 to 1948, inclusive.
On December 27, 1946, petitioners purchased as community property all of the outstanding stock of W. R. R. Oil Company (being 1,000 shares) for the sum of $1,410,930.76, plus expenses of acquisition in the amount of $91,210.49. Petitioner's total investment in such stocks was $1,502,141.25.
In order to secure funds for the purchase of W. R. R. Oil Company stock Wilson borrowed $1,500,000 from the Massachusetts Mutual Life Insurance Company executing a note dated December 27, 1946, in favor of the insurance company in the amount of $1,500,000. Wilson pledged the 1,000 shares of W. R. R. Oil Company stock as security for payment of the note. The mortgage was recorded on the books of Wilson by a voucher dated December 27, 1946, showing a debit to the Mercantile National Bank account of $1,500,000 and a credit to the Mortgage Notes Payable account of $1,500,000.
On December 27, 1946, Wilson caused W. R R. Oil Company to be dissolved and to distribute to him as a first and final liquidating dividend all the assets of W. R. R. Oil Company subject to all liabilities. On the same day, following the dissolution of W. R. R. Oil Company, Wilson executed a deed of trust in favor of the City National Bank of Houston as security for the note to Massachusetts Mutual Life Insurance Company, in lieu of the stock which had previously been pledged.
The cost to petitioners of the net assets acquired by them on the liquidation of the W. R. R. Oil Company was $1,502,141.25, which amount was recorded on petitioners' books. Wilson operated the properties received in liquidation of W. R. R. Oil Company for the last 5 days of 1946.
During the year 1947, petitioners owned 2,458 shares of the 2,500 shares of stock outstanding of Wil-Tex Oil Corporation. By assignment dated January 10, 1947, made retroactive to January 1, 1947. Wilson assigned to Wil-Tex Oil Corporation three oil, gas, and other mineral leases, together with the equipment needed to operate them, the principal assets which he had acquired in the liquidation of the W. R. R. Oil Company. These assets had an adjusted basis to petitioners of $1,457,895.13. In connection with the above assignment, Wil-Tex Oil Corporation assumed payment of the promissory note executed by Wilson on December 27, 1946, in the amount of $1,500,000 payable to Massachusetts Mutual Life Insurance Company.
The transfer of the leases by Wilson to Wil-Tex Oil Corporation and the assumption of the note payable to Massachusetts Mutual Life Insurance Company by Wil-Tex Oil Corporation were entered on the books of Wilson under date of January 1, 1947, by a debit to the account ‘Wil-Tex Oil Corporation‘ in the amount of $1,457,895.13, and a credit to various asset accounts (principally Producing Leases, and Lease and Well Equipment) in the amount of $1,457,895.13. The account Mortgage Notes Payable was debited in the amount of $1,500,000 and the account of Wil-Tex Oil Corporation was credited in the amount of $1,500,000. The net effect of the entries to Wil-Tex Oil Corporation account was a credit balance of $42,104.87, representing an account payable owed by Wilson.
Wil-Tex Oil Corporation retired the note payable to Massachusetts Mutual Life Insurance Company in the amount of $1,500,000 which it had assumed on January 1, 1947, by executing a new note dated January 10, 1947, in the amount of $2,200,000. Only the difference between the two notes of $700,000 was forwarded to Wil-Tex Oil Corporation. On January 10, 1947, Wilson, as president of Wil-Tex Oil Corporation, executed a deed of trust in favor of the City National Bank of Houston pertaining to the leases referred to above, which was to secure payment of the new note in the amount of $2,200,000. By voucher dated January 16, 1947, Wil-Tex Oil Corporation entered this transaction on its books in the following manner:
+------------------------------------------------------+ ¦Dr.: City National Bank ¦$700,000.00 ¦ ¦ +----------------------------+------------+------------¦ ¦Sam E. Wilson, Jr., ¦ ¦ ¦ +----------------------------+------------+------------¦ ¦Producing Properties account¦1,502,166.67¦ ¦ +----------------------------+------------+------------¦ ¦Cr.: City National Bank ¦ ¦$2,166.67 ¦ +----------------------------+------------+------------¦ ¦Notes Payable ¦ ¦2,200,000.00¦ +------------------------------------------------------+
The entries made to the account of Sam E. Wilson Jr., on the books of Wil-Tex Oil Corporation referred to in paragraphs above resulted in a debit balance in the account, an account receivable of $44,271.54. On January 31, 1947, the receivable item of $44,271.54 on the books of Wil-Tex Oil Corporation due from Wilson was reduced by the amount of $2,166.67, leaving a balance of $42,104.87
On August 31, 1947, Wilson transferred a warehouse and building to Wil-Tex Oil Corporation which had cost $8,637.18, and of which amount $5,314.28 remained unpaid. On his books Wilson credited the warehouse and building account with $8,637.18 and charged Caffie Lumber and Building Company with $5,314.28 and Wil-Tex Oil Corporation with $3,332.90, thereby transferring the liability for the unpaid balance to Wil-Tex Oil Corporation and reducing his account payable to Wil-Tex Oil Corporation by $3,322.90. On its books Wil-Tex Oil Corporation showed a corresponding debit to warehouse and building account of $8,637.18, a credit to Chaffie Lumber and Building Company of $5,314.28, and a credit to the account receivable from Sam E. Wilson, Jr., of $3,322.90. This left a balance receivable in the account of Sam E. Wilson, Jr., of $38,781.97.
On November 29, 1947, Wilson forwarded a check in the amount of $17,117.68 to Wil-Tex Oil Corporation. Of this amount, $4,831.97 was applied to the account payable of $38,781.97 which petitioner owed Wil-Tex Oil Corporation, thereby reducing the aforementioned balances on the books of Wilson and Wil-Tex Oil Corporation to $33,950.
L. A. Rankin was general manager for Wilson, and secretary-treasurer of Wil-Tex Oil Corporation. Under date of January 31, 1948, Rankin prepared a voucher for Wilson showing the following journal entries:
+----------------------------------------------------------+ ¦Dr.: Accounts payable, Wil-Tex Oil Corporation,¦ ¦ +-----------------------------------------------+----------¦ ¦“Producing Properties Transfer Account” ¦$33,950.00¦ +-----------------------------------------------+----------¦ ¦Cr.: Dividends Earned “Wil-Tex Oil Corporation”¦$33,950.00¦ +----------------------------------------------------------+
EXPLANATION To clear account of Wil-Tex Oil Corporation “Producing Properties Transfer” as this account cleared in form of Dividend to Sam E. Wilson, Jr.
On April 8, 1948, petitioners sold all stock in Wil-Tex Oil Corporation to Panhandle Producing and Refining Company for $2,288,170.06. Wil-Tex Oil Corporation had earnings and profits for its taxable year ended February 29, 1948, of not less than $172,099.56.
On April 12, 1948, Wil-Tex Oil Corporation filed its Federal income tax return for the fiscal year ending February 29, 1948. The return was signed by Sam E. Wilson, Jr., as president, and L. A. Rankin, as treasurer, and bore the signature of W. S. Touchstone, a certified public accountant of the firm of Smith and Touchstone, as having prepared the return. Exhibit C attached to the return showed a dividend by Wil-Tex Oil Corporation for the fiscal year ending February 29, 1948, of $33,950. Schedule M of the return showed a cash dividend by Wil-Tex Oil Corporation of $33,950 for this same fiscal year.
On April 15, 1949, Sam E. Wilson, Jr., filed his Federal income tax return for the calendar year 1948. The return was signed by Wilson and bore the signature of W. S. Touchstone as the individual preparing the return. On Exhibit A of the return Wilson reported a dividend of $33,950, which was included in the amount of $33,962.50 reported as dividends and interest earned.
Wilson's operations were extensive and his business transactions involved millions of dollars. In handling the transactions in question, Wilson had the assistance of Rankin, his general manager and secretary-treasurer of Wil-Tex Oil Corporation. Rankin had considerable business experience and bookkeeping knowledge and understands the meaning of a dividend. Wilson further had the advice of a certified public accountant, who prepared the tax returns, and a law firm which handled the property transfers in question.
As ultimate facts we find the following: On January 1, 1947, Sam E. Wilson, Jr., transferred certain of his assets to Wil-Tex Oil Corporation. Wil-Tex Oil Corporation paid Wilson the sum of $1,457,895.13 for these assets by assuming a note payable by Wilson to the Massachusetts Mutual Life Insurance Company in the amount of $1,500,000, Wilson agreeing to reimburse Wil-Tex Oil Corporation for the difference of $42,104.87. The transaction outlined above was properly entered on the books of Sam E. Wilson, Jr., and the books of Wil-Tex Oil Corporation. Wilson reduced his indebtedness to Wil-Tex Oil Corporation during the year 1947 from $42,104.87 to $33,950 by transferring certain property and cash to Wil-Tex Oil Corporation. We sustain respondent's determination that petitioners realized ordinary income in the amount of $33,950 in 1948, when Wil-Tex Oil Corporation canceled its account receivable from Sam E. Wilson, Jr., by means of a dividend.
All facts stipulated by the parties are incorporated herein by this reference.
OPINION
BLACK, Judge:
There are three questions presented as follows: Did the petitioners erroneously include $33,950 in gross community income in 1948? Did petitioners erroneously fail to claim $8,154.87 as a part of their community adjusted basis in the stock of Wil-Tex Oil Corporation upon computing their gain from the sale of said stock of Wil-Tex Oil Corporation upon computing their gain from the sale of said stock in 1948? If the $33,950 is properly includible in petitioners' community income for 1948, should the $33,950 be treated as additional long-term capital gain received on the sale of petitioners' stock in Wil-Tex Oil Corporation rather than as ordinary income?
Whether petitioners realized taxable dividend income of $33,950 arising from the cancellation of a debt in 1948 turns on whether the entries made on the books of Wilson and Wil-Tex Oil Corporation in 1947, setting up the account of $42,104.87 owed by Wilson to Wil-Tex, were erroneous and did not represent the actual transaction. This account was subsequently reduced to $33,950 when Wilson transferred to Wil-Tex Oil Corporation a building and warehouse in which he had an equity, and some cash. Petitioners contend that there was no valid account payable in 1947 and in fact they realized capital gains income in 1947. Respondent contends that the bookkeeping entry properly reflected an account payable in 1947 to Wil-Tex Oil Corporation and that petitioners realized taxable income in 1948 upon the cancellation of the indebtedness by Wil-Tex Oil Corporation.
Book entries are presumed to be correct unless sufficient evidence is adduced to overcome the presumption. National Contracting Co., 25 B.T.A. 407, 413, affd. on appeal of other issues, 69 F.2d 252. In the instant case, petitioners seek to have the book entries in question ignored with the explanation that Wilson did not intend to pay the amount of $42,104.87 to Wil-Tex Oil Corporation, and the indebtedness was set up because Rankin did not know what else to do with this figure which represented a difference between the amount of the assets transferred by Wilson and the indebtedness assumed by Wil-Tex Oil Corporation. Contrariwise, the record shows that Wilson consulted a law firm which prepared all of the legal documents connected with the acquisition, the subsequent dissolution of W. R. R. Oil Company, and the transfer of assets by Wilson to Wil-Tex Oil Corporation. It shows that Rankin ho was general manager for Wilson and secretary-treasurer of Wil-Tex Oil Corporation, supervised both sets of books, personally preparing the entries in question and that he had had many years of experience in keeping both corporate and individual books. During the years that Rankin was employed by Wilson, the latter's operations involved millions of dollars. Rankin worked with a firm of certified public accountants in connection with the transactions in question. A member of this firm, who was also a certified public accountant, prepared the Federal income tax returns of Wilson for the year 1948, which reported dividend income in the amount of $33,950, and of Wil-Tex Oil Corporation for the fiscal year ending February 29, 1948, which reported a dividend paid by Wil-Tex Oil Corporation in the amount of $33,950.
By setting up the account payable in 1947, petitioners thereby avoided capital gains tax in 1947 and from a tax standpoint this was advantageous. Wilson was dealing with a corporation he controlled. Now, when it turns out that due to subsequent events the total tax consequences would have been less had a capital gains tax been paid in 1947 because of 1948 ordinary income taxes, Wilson cannot rearrange the transactions by declaring that he did not intend the 1947 indebtedness he created to be valid. We conclude that when Wilson's account payable to Wil-Tex Oil Corporation was set up in 1947, the transaction was intended to represent a valid indebtedness.
We hold that the amount of $42,104.87 was a valid obligation running from Wilson to Wil-Tex Oil Corporation, later reduced to the amount of $33,950. The $33,950 became income to Wilson in the year 1948 upon outright cancellation by the corporation. Wilson was entirely solvent and good for the debt. See Commissioner v. Jacobson, 336 U.S. 28. Petitioners do not contend that if the indebtedness was valid and canceled that income did not arise from the cancellation. In view of our holding above, petitioners concede that they have no ground for claiming $8,154.87 as part of the adjusted basis of the stock before computing the gain in 1948.
The last question to decide is whether the income realized in 1948, as a result of the cancellation of the indebtedness, was a capital gain or ordinary income. Respondent determined it was a dividend and ordinary income. Petitioners contend that in substance and effect the transaction increased the consideration they received for selling their stock in Wil-Tex Oil Corporation to Panhandle Producing and Refining Company. All the Wil-Tex Oil Corporation stock was sold for $2,299,170.06 on April 8, 1948. Of the total 2,500 shares petitioners owned 2,458 shares. The journal entries canceling the $33,950 indebtedness were made under date of January 31, 1948. There is no showing that this amount was ever again placed on the books of Wil-Tex Oil Corporation or that Wilson ever paid his indebtedness to Wil-Tex Oil Corporation. The obligation was effectively canceled prior to the sale and formed no part of the sale price of the stock. In order for this amount to be taxable as long-term capital gain, it would have had to have been included in the computation of the sale price of petitioner's stock in Wil-Tex Oil Corporation to Panhandle Producing and Refining Company. There is no showing that this amount ever entered into the computations. On petitioners' 1948 tax returns the sale price was reported as $2,288,170.06, minus $38,441.26 representing the 42 shares of stock held by others, and no mention was made of the $33,950 debt. We conclude that the cancellation of the $33,950 debt was not part of the consideration received for the sale of stock and respondent's determination that it is a dividend taxed as ordinary income is sustained.
Decisions will be entered for the respondent.