Opinion
Docket No. 2650.
1945-11-30
TATEM WOFFORD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Douglas D. Felix, Esq., for the petitioner. Bernard D. Hathcock, Esq., for the respondent.
1. Where a state court made an adjudication of ownership of property on the basis of an admission of such ownership by all parties to the suit, the Tax Court is not bound to accept such adjudication as conclusive.
2. A hotel building and private residence and other property operated as a business enterprise held to be the property of a corporation and not property owned by its stockholders in their individual capacity; and, upon the basis of such conclusion, it is further held, (a) that the distribution of the property, which constituted all of its assets, among the stockholders, under the direction of a court of equity, was a distribution in liquidation of the corporation; (b) that cash funds and other assets distributed in the liquidation can not be considered as capital or income received by the stockholders in years prior to the year of distribution; (c) that an assignment by a stockholder of a portion of his interest in the assets, executed and delivered after he had recovered the entire basis of his stock, was an assignment of income to be received in the liquidation, and did not affect his liability for tax on the income assigned; and (d) that a stockholder who paid a pro rata share of the corporation's accounts payable and of the taxes on its real estate, was not entitled to any deduction for business expenses or taxes paid.
3. Understatement of gains from distribution, made in reliance upon assignment of an interest in the distribution to taxpayer's wife, held not to warrant the imposition of a penalty for negligence. Douglas D. Felix, Esq., for the petitioner. Bernard D. Hathcock, Esq., for the respondent.
The respondent determined a deficiency in income tax for the fiscal year ended June 30, 1938, in the amount of $6,056.68, and added a penalty for negligence in the amount of $302.83.
The issues presented for decision are: (1) Whether the distribution of property held in the name of the Wofford Hotel Corporation, including hotel and residence buildings and the furnishings therein, made by a master pursuant to a decree of a state court in a suit between the stockholders of that corporation, was a distribution in liquidation of the corporation, and, if so, the amount of gain realized by the petitioner form such distribution; (2) whether the petitioner is entitled to a deduction of $1,037.82 as an expense paid in connection with the operation of the hotel and renting of the residence; (3) whether the petitioner is entitled to deduct $3,084.81 expended in payment of real estate taxes imposed on the hotel and residence buildings, and $256.80 expended for documentary stamps on deeds of the master conveying the hotel and residence properties to purchasers thereof; (4) whether the petitioner is entitled to deduct $8,163.67 for attorney fees and other legal expenses paid in defending the above mentioned suit in the state court; and (5) whether the petitioner is subject to a penalty of 5 percent for negligence.
The petition contains an allegation of error by the respondent in including the sum of $1,232.21 in the petitioner's income as interest received on certain promissory notes, but the petitioner now concedes that the respondent's action was proper.
The petitioner claims an overpayment of tax in the amount of $769.69.
FINDINGS OF FACT.
Tatem Wofford, the petitioner herein, and his wife, Patricia Wofford, were residents of Miami Beach, Florida during the fiscal year ended June 30, 1938, and prior thereto. The petitioner made a separate income tax return for that year on the cash basis, which he filed with the collector for the District of Florida.
On November 16, 1932, upon the death of Ora Wofford, their mother, the petitioner and his brother John B. Wofford, as devisees and legatees under her will, acquired, in equal shares, all of the outstanding stock of the Wofford Hotel Corporation, consisting of 2,000 common shares, and a large private residence and the furnishings therein, situated in Miami Beach, Florida. The principal asset of the Wofford Hotel Corporation at that date consisted of real estate situated in Miami Beach, which was improved by a large hotel building thereon known as ‘The Wofford,‘ together with the furniture, fixtures, and equipment used therein in operating the hotel business. The hotel property, as of November 16, 1932, had a fair market value of $175,000 and was subject to a mortgage indebtedness of $150,000; and the residence property, as of that date, had a fair market value of $16,500 and was subject to a mortgage indebtedness of $6,000. The 2,000 shares of stock and the interest of Ora Wofford in the residence and its contents were valued at $25,000 and $10,500, respectively, as of November 16, 1932, by the appraisers of the County Judge's Court of Dade County, Florida, in which her will was probated, and were returned in an inventory filed in that court at those values. The 2,000 shares of stock had a fair market value of $25,000 on November 16, 1932.
On November 4, 1936, as a result of the action of the petitioner in taking possession of the hotel and residence in 1934 and excluding John B. Wofford from further participation in the management of the hotel business, John B. Wofford and his wife, Olive Wofford, filed a suit in the Circuit Court of the Eleventh Judicial Circuit of Dade County, Florida, against the petitioner, his wife Patricia Wofford, and the Wofford Hotel Corporation, in which they sought a decree declaring the corporation to be a trustee of the hotel property and the Wofford residence, then held in its name, and the furnishings of both, and directing a sale of all the property and division of the proceeds among John B. Wofford and the petitioner and their respective wives, as the beneficial owners thereof. They also sought an accounting by the petitioner for profits derived by him from operation of the hotel and renting of the residence. A special master, after a hearing, filed a report on May 22, 1937, in which he stated, among other matters, those set forth in the paragraphs numbered (1) to (7), following:
(1) In June 1923, after constructing the hotel, Ora Wofford organized the Wofford Hotel Corporation, and by deed and bill of sale conveyed the hotel and all the furnishings and equipment to it in exchange for 2,000 shares of its common stock. At the same time the corporation executed a trust deed on the property to secure a bond issue of $250,000. The bonds were issued and sold by the trustee and the proceeds were used to discharge then existing encumbrances on the property. The bonds were reissued in the amount of $240,000 under a new deed of trust in 1928. On January 15, 1934, the corporation, by Tatem, as president, and John, as secretary, executed a supplemental trust deed to extend the time of payment and reduce the interest rate on the then outstanding bonds, aggregating $136,000, and therein pledged, as additional security for payment of the bonds, the Wofford residence, which was conveyed to the corporation by the petitioner and John. All outstanding bonds were paid prior to June 6, 1936, and on that date the trust deed was satisfied of record.
(2) Upon the death of Ora Wofford, Tatem and John, as legatees under her will, each acquired and held 1,000 of the outstanding 2,000 shares of the stock of the Wofford Hotel Corporation and jointly acquired and held the residence property, their title and interest in both the stock of the corporation being equal. After the death of Ora Wofford, Tatem assigned 1 share of the stock to his wife, Patricia Wofford, and John assigned 20 shares to his wife, Olive Wofford; and, at the date of the filing of the suit, the stock was held as follows: Tatem Wofford, 999 shares; Patricia Wofford, 1 share; John B. Wofford, 980 shares; Olive Wofford, 20 shares.
(3) By an agreement dated July 3, 1934, between Tatem and John, ‘as officers and stockholders‘ of the corporation, and ‘as executors of the Estate of Ora Wofford,‘ it was agreed that their salaries should be $7,500 each for the season 1934-1935, and such salaries have been drawn by them from the corporate funds since the date of the agreement.
(4) The plaintiff (John), in his complaint, charges that Ora Wofford died seized and possessed of the residence and that John and Tatem acquired the property equally under her will; that they conveyed the property to the corporation for the sole purpose of additionally securing the bond issue; ‘that it was agreed that the property would be released on the payment of $10,000 of the amount due, which was done, and that therefore the residence property should no longer be subject to the lien of the mortgage, but should be reconveyed to the individual owners; that the bond issue has been fully paid, that Tatem arbitrarily refuses in order to financially embarrass the plaintiff; that Tatem has assumed management of the residence property and rented same and refuses to sell unless the funds go into the corporation.‘ The defendant (Tatem), in his answer, admits that the residence was conveyed to the corporation, but states that it was at the special request of John; that it was not to better secure the bond issue, but to consolidate their inheritance from Ora Wofford through equal ownership of the corporation; and that since the transfer the corporation has paid taxes and encumbrances on the property to the amount of $7,000 or $8,000.
(5) The plaintiff (John), in his complaint, charges that the corporation is in equity a trustee of and for the hotel property and holds it in trust for the plaintiffs and the defendants; that the trust should be terminated and the hotel property sold and the proceeds divided among the parties; that the corporation has reached a condition of stalemate and deadlock and can not continue to function as such; that it is not in truth and fact a corporation as contemplated under the law; that Tatem conceals information from John, has moved the hotel office to his residence, caused the combination of the safe to be changed, and has instructed hotel employees to disregard the orders of John. The defendant (Tatem), in his answer, denies the allegations except the joint ownership and then recites facts of similar nature charging John with obstructing the operation of the hotel. He alleges that under the management of Tatem the hotel has been highly profitable; that Tatem and John have drawn equal salaries; that Tatem has accounted for all funds coming into his hands and has committed not fraud upon the plaintiffs or the corporation and has not mismanaged the property. He admits receiving the funds of the corporation but states that he holds them for the corporation and that his conduct has inured to the benefit of plaintiffs equally with himself.
(6) Except for acts in connection with the issuing of bonds, the making of returns, and the paying of corporate taxes, the corporation, since its organization, has not functioned as a corporation, and, at the time of the suite, its only service and purpose was the legal entity necessarily preserved as holder of the title to the hotel and residence properties. All of the acts of Tatem in assuming management and control of the property standing in the name of the corporation were exercised and performed by him under assumed powers vested by the charter in the president of the corporation, but were really and actually exercised and performed in his personal capacity and as the representative of himself and John. The corporation, at the time of the suit, was without legally constituted board of directors or corporate officers to manage or control its affairs, and was inactive and dormant in that there was no person or agency through which it could legally act. The property held by it was of considerable value and under proper management would yield large profits, but, by reason of dissension and failure of cooperation among the stockholders, the corporate entity could not function, and the property could be preserved and disposed of and the proceeds equitably distributed only through the intervention of the court.
(7) As of February 22, 1937, Tatem had in his hands $52,047.78 representing net profits from the operation of the hotel property and the residence, from which he and John, by agreement, each withdrew $25,000 prior to April 30, 1937. As of April 30, 1937, Tatem had in his hands $20,926.31, representing net profits from the operation of the property, and there was on deposit in the bank account of the corporation, subject to withdrawal on the joint signatures of Tatem and John, the sum of $3,240.17.
On June 28, 1937, the Circuit Court confirmed the master's report, treated the proceeding as a partition suit among petitioner, John B. Wofford, and their wives as beneficial owners of the property involved, and, finding it impracticable to divide the hotel and residence properties among the plaintiffs and the individual defendants, entered a decree appointing a master to sell the properties at public sale to the highest bidder, to collect the sum of $18,750.59 which had accrued on the property and was, at the date of the decree, in the possession of the petitioner, to collect the sum of $4,040.71 which was then on deposit in the bank in the name of the Wofford Hotel Corporation, and to distribute the said moneys among the parties in accordance with their respective interests therein. The decree declared that the corporation held legal title to the properties in trust for the individual parties to the suit and that those parties were the owners of the hotel and residence properties and of the funds of $18,750.59 and $4,040.71 in the following proportions: Tatem Wofford, 999/2000; Patricia Wofford, 1/2000; John B. Wofford, 980/2000; Olive Wofford, 20/2000. The Supreme Court of Florida affirmed this decree on October 13, 1937.
Thereafter, on November 22, 1937, the master collected the sum of $18,750.59 from the petitioner and the deposit of the corporation of $4,040.71, and he paid one-half of the money, or $11,395.65, to the petitioner and Patricia Wofford and a similar amount to John B. Wofford and Olive Wofford. The amount of $11,395.65 awarded to the petitioner and Patricia Wofford was paid to Frank Smathers, who filed in the Circuit Court under date of November 22, 1937, a statement acknowledging receipt of that sum from the master, declaring that he accepted it as attorney of record for Tatem Wofford and Patricia Wofford in full discharge of their rights under the decree, and stating that ‘the interest of Tatem Wofford in said sum (was) 999/2000ths of said sum and that of Patricia Wofford (was) 1/2000ths of said sum.‘
The master held a public sale on December 6, 1937, at which John B. Wofford and Olive Wofford submitted bids of $230,000 for the hotel property and furnishings, 30 percent of the purchase price to be paid in cash and the balance in notes of the purchasers secured by a mortgage on the property. The Circuit Court confirmed the sale on December 21, 1937, and the master on that date conveyed the properties to John B. Wofford, and Olive Wofford. The decree of June 28, 1937, provided that if any party to the suit should purchase the property he would be entitled to credit on his bid of an amount equal to the amount of his interest in the property; and, in accordance with the decree, John B. Wofford and Olive Wofford, on December 21, 1937, as owners of an undivided one-half of the cash and one-half of the deferred payments required under their bids, and they paid and delivered to the master cash and their notes secured by mortgage on the properties in the following amounts:
+------------------------------------+ ¦ ¦Cash ¦Notes and¦ +------------------+-------+---------¦ ¦ ¦ ¦mortgages¦ +------------------+-------+---------¦ ¦Hotel property ¦$34,500¦$80,500 ¦ +------------------+-------+---------¦ ¦Residence property¦3,975 ¦9,275 ¦ +------------------+-------+---------¦ ¦Total ¦38,475 ¦89,775 ¦ +------------------------------------+
Real estate taxes imposed on the hotel and residence by the city of Miami Beach, Dade County, and the State of Florida for the calendar year 1937 were assessed against the Wofford Hotel Corporation in the total amount of $6,169.61. They were paid on February 28, 1938.
On December 20, 1937, John B. Wofford filed in the Circuit Court a motion for confirmation of the sale of the hotel and residence. He attached to the motion an affidavit of an accountant setting forth in detail ‘all known items of expense in dispute‘ between himself and the petitioner as of that date. The items were as follows:
+--------------------------------------------------------------------+ ¦Credits to Tatem Wofford: ¦ ¦ +----------------------------------------------------------+---------¦ ¦Debt of corporation to Tatem Wofford, due to cash advanced¦$2,796.28¦ +----------------------------------------------------------+---------¦ ¦One-half of meter deposits of the corporation ¦78.75 ¦ +----------------------------------------------------------+---------¦ ¦One-half of bank deposit of corporation ¦74.00 ¦ +--------------------------------------------------------------------+
One-half of unexpired insurance of the corporation as of Dec. 20, 1937 846.12 One-half of expense of advertising corporation property for sale 72.62 One-half of estimated master's fees 1,000.00 Total 4,867.77 Credits to John B. Wofford:
Proration of city, state and county taxes for period from Jan. 1 to Dec. 20, 1937 $3,082.82
One-half of Federal taxes, payable as shown by balance sheet of corporation on Dec. 4, 1937 1,396.42
One-half of open accounts payable after excluding the following bills which are to be assumed in full by John Wofford * * * the total amount of open account being $2,075.65; one-half of above 1,037.83
Bill of Ring & Mahoney against the corporation for services rendered Tatem Wofford 500.00
Bill of Ring & Mahoney, for services to corporation July 1, 1937, to date (not including tax service to Tatem Wofford); one-half total 25.00 Total 6,042.07
In its order of December 21, 1937, confirming the sale, the court directed the master to pay out of the cash proceeds then in his possession the sum of $1,174.30, shown by the above mentioned accountant's statement to be due from petitioner to John B. Wofford; the sum of $2,000 as a fee of the master for his services; and the cost of revenue stamps on the master's deeds conveying the property; and that he pay the balance of the cash proceeds to the petitioner and his wife. The court further directed that all accounts payable, as shown by the affidavit of the accountant, be assumed and paid by John B. Wofford and his wife.
On January 4, 1938, the master filed a report showing that he had disbursed the following from the cash proceeds of the sale:
+----------------------------------------------------------------+ ¦John B. and Olive Wofford, under terms of final decree¦$1,174.30¦ +------------------------------------------------------+---------¦ ¦Federal revenue stamps on hotel deed ¦115.00 ¦ +------------------------------------------------------+---------¦ ¦State revenue stamps on hotel deed ¦115.00 ¦ +------------------------------------------------------+---------¦ ¦Federal revenue stamps on residence deed ¦13.50 ¦ +------------------------------------------------------+---------¦ ¦State revenue stamps on residence deed ¦13.30 ¦ +------------------------------------------------------+---------¦ ¦W. H. Burwell, as special master ¦2,000.00 ¦ +----------------------------------------------------------------+
On January 20, 1938, the master delivered to the clerk of the Court, for the account of the petitioner and Patricia Wofford, the sum of $35,043.90 in cash, together with notes and mortgages of John B. Wofford and Olive Wofford in the aggregate amount of $89,775, duly assigned by the master to the petitioner and Patricia Wofford.
All the foregoing acts of the master were approved by the Circuit Court and the master was discharged on January 20, 1938.
In connection with the suit in the Circuit Court the petitioner paid attorney fees, court costs, and other expenses in the aggregate amount of $9,337.78, of which $8,163.67, consisting of the items listed below, was paid during the fiscal year ended June 30, 1938:
+-----------------------------------------------------------------------------+ ¦Frank Smathers, attorney fee, court costs, and other legal expenses¦$4,433.44¦ +-------------------------------------------------------------------+---------¦ ¦Evans, Mershen & Sawyer, attorney fee ¦1,000.00 ¦ +-------------------------------------------------------------------+---------¦ ¦Special master, fee ¦1,000.00 ¦ +-------------------------------------------------------------------+---------¦ ¦Ring & Mahoney, fee ¦525.00 ¦ +-------------------------------------------------------------------+---------¦ ¦Costs assessed on decree of June 28,1937 ¦1,205.23 ¦ +-------------------------------------------------------------------+---------¦ ¦Total ¦8,163.67 ¦ +-----------------------------------------------------------------------------+
On December 2, 1937, the petitioner executed, acknowledged, and delivered a written instrument to his wife, Patricia Wofford, wherein, after reciting a consideration of love and affection, he conveyed to her an undivided 499/2000 interest in the hotel and residence properties, including the furnishings therein; 499 shares of the stock of the Wofford Hotel Corporation; and a 499/2000 interest in the decree of June 28, 1937, and in all benefits, rights, and interests which he had therein, including the right to receive his proportionate interest of any moneys and things in action due or to become due or enforceable thereunder. The instrument recites its purpose to be to assign and transfer and set over to Patricia Wofford such a proportionate part of the interest of the petitioner in the assets of the Wofford Hotel Corporation, and/or its capital stock, and/or the property described in the final decree as will make the interests of the parties equal. When the master distributed the cash proceeds of the sale of the hotel and residence, Patricia Wofford received one-half thereof and invested it in another hotel property, known as the Tatem Hotel.
In his income tax return the petitioner reported a gain from a distribution in complete liquidation by the Wofford Hotel Corporation in the amount of $66,948.95. He computed this gain on the basis of the receipt of net assets by the stockholders of the market value of $267,795.81 and the receipt by petitioner of one-fourth of such assets as owner of 500 shares of the stock with respect to which he had recovered his basis in prior years. He included in his taxable income 40 percent of the gain, or $26,779.58, as a gain from the sale of capital assets. In addition, the petitioner reported a loss of $3,990.91, which he computed on the basis of the receipt by him, in the liquidation, of real estate having a market value of $64,125 and the sale thereof by the master for the same amount, and the outlay of $3,990.91 as expense of the sale.
In determining the deficiency the respondent likewise treated the transaction as a distribution in complete liquidation. However, he determined petitioner's gain to be $133,300.56, and included 40 percent thereof, or $53,320.22, in the petitioner's taxable income, thereby increasing the income reported in the return by the amount of $26,540.64. The respondent disallowed the claimed loss of $3,990.91 on the ground that it constituted a personal expense.
In computing the gain of $133,300.56, the respondent found the net value of assets received by the stockholders to be the same as that reported by the petitioner in his return, namely, $267,795.81. The respondent's determination of the value of the assets distributed and his computation of the gain are as follows:
+--------------------------------------------------------------------+ ¦Item ¦Fair market value ¦ +--------------------------------------------+-----------------------¦ ¦Wofford Hotel ¦$230,000.00¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Wofford residence ¦26,500.00 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Cash ¦148.00 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Inventories ¦661.85 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Meter deposits ¦157.50 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Moneys held by Tatem Wofford ¦18,750.59 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Money in corporation bank account ¦4,040.71 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Prepaid taxes on hotel and residence ¦483.48 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Prepaid insurance on hotel and residence ¦1,692.23 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Total assets ¦ ¦$282,434.36¦ +--------------------------------------------+-----------+-----------¦ ¦Accounts payable ¦ ¦14,638.55 ¦ +--------------------------------------------+-----------+-----------¦ ¦Net assets received by stockholders ¦ ¦267,795.81 ¦ +--------------------------------------------+-----------+-----------¦ ¦Less: ¦ ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Cost basis of 2,000 shares ¦$25,000.00 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦Capital distribution in 1937 ¦24,072.17 ¦ ¦ +--------------------------------------------+-----------+-----------¦ ¦ ¦ ¦927.83 ¦ +--------------------------------------------+-----------+-----------¦ ¦Total profit realized by stockholders ¦ ¦266,867.98 ¦ +--------------------------------------------+-----------+-----------¦ ¦Profit realized by petitioner (999/2000) ¦ ¦$133,300.56¦ +--------------------------------------------+-----------+-----------¦ ¦Amount taxable at 40 percent ¦ ¦53,320.22 ¦ +--------------------------------------------+-----------+-----------¦ ¦Less taxable gain reported in return ¦ ¦26,779.58 ¦ +--------------------------------------------+-----------+-----------¦ ¦Added to taxable income by deficiency notice¦ ¦26,540.64 ¦ +--------------------------------------------------------------------+
The parties stipulated that, in addition to the proceeds of the sales of the hotel and residence and the funds of $18,750.59 and $4,040.71, the following items were distributed by the master in the final settlement:
+-------------------------------------------------+ ¦Cash ¦$148.00 ¦ +----------------------------------------+--------¦ ¦Inventories ¦661.85 ¦ +----------------------------------------+--------¦ ¦Meter deposit ¦157.50 ¦ +----------------------------------------+--------¦ ¦Prepaid taxes on hotel and residence ¦483.48 ¦ +----------------------------------------+--------¦ ¦Prepaid insurance on hotel and residence¦1,692.23¦ +----------------------------------------+--------¦ ¦ ¦3,143.06¦ +-------------------------------------------------+
The petitioner filed his return showing a tax due of $772.62, which he paid to the collector on September 1, 1938. The petition herein was filed on August 12, 1943.
OPINION.
TYSON, Judge:
The master made a distribution in the taxable year of the property involved in the suit in the Circuit Court of Dade County. The property so distributed consisted of (a) the proceeds of the sale of the hotel and residence and the furnishings therein (hereinafter referred to as the real estate) amounting to $256,500; (b) cash of $18,750.59 in the hands of Tatem Wofford and a balance of $4,040.71 in the bank account of the Wofford Hotel Corporation (hereinafter referred to as the cash funds); and (c) small items of cash, inventories, meter deposits, and prepaid taxes and insurance on the hotel and residence (hereinafter referred to as ‘miscellaneous assets‘), amounting to $3,143.06. The Commissioner held the distribution to be a distribution in liquidation of the Wofford Hotel Corporation from which the stockholders realized a gain of $266,867.98 and determined the petitioner's share of such gain to be $133,300.56, on the basis of his ownership of 999 of the 2,000 shares of outstanding stock.
The petitioner, relying upon a decision by the Florida courts that the property belonged to the Woffords as coowners, opposes the treatment of the transaction for tax purposes as a distribution in liquidation of the corporation. He admits that as a coowner he realized a gain in the taxable year from the sale by the master of the real estate, but contends that, as such coowner, he assigned a 499/2000 undivided interest in the real estate to his wife, Patricia Wofford, on December 2, 1937, and that the gain which was realized from the subsequent sale by the master of their undivided one-half interest to the John B. Woffords is taxable one-half to petitioner and one-half to his wife. Petitioner also contends that no part of the cash funds and miscellaneous assets may be included in his income of the taxable year, for the reason that those items constituted either capital or income of the Woffords individually which was received by them prior to the taxable year and was merely divided among them during that year.
The petitioner, as we have stated above, rests his contention of ownership by the Woffords in their individual capacity upon the decision of the Circuit Court in the suit brought by John B. Wofford and his wife against the petitioner and his wife and the Wofford Hotel Corporation, and the affirmance of that decision by the Supreme Court of Florida. He urges that, in that suit, the title to the property was adjudicated as between the Wofford Hotel Corporation and the Woffords individually; that the Woffords were adjudged to be the coowners at the date when the suit was filed (November 4, 1936; and that the decisions of the Florida courts settling the ownership are conclusive and must be followed by this Court, as required by Freuler v. Helvering, 291 U.S. 35; Blair v. Commissioner, 300 U.S. 5; Helvering v. Rhodes' Estate, 117 Fed.(2d) 509, affirming 41 B.T.A. 62; Estate of Frederick R. Shepherd, 39 B.T.A. 38. Those cases hold that a Federal court must give conclusive effect to the decision of a state court settling property rights; but the rule applies only to a decision entered in a proceeding presenting a real controversy for determination. The decision must settle issues regularly submitted and not be in any sense a consent decree. Francis Doll, 2 T.C. 276; affd., 149 Fed.(2d) 239; certiorari denied, Oct. 8, 1945; Freuler v. Helvering, supra. See also Charles S. McVeigh, 3 T.C. 1246, and First-Mechanics National Bank v. Commissioner, 117 Fed.(2d) 127, affirming 40 B.T.A. 876.
In the suit in the Circuit Court it was shown that the legal title to the property here in question was held by the Wofford Hotel Corporation, and the plaintiffs therein sought to hold the corporation as trustee of such property for all of the Woffords as beneficial owners, and to have the court terminate the trust and direct sale of the property and a distribution among the individual parties to the suit. The Circuit Court decreed that the corporation held the legal title only as a trustee and that the Woffords were the beneficial owners of the property, and it determined their proportionate interests therein and ordered a sale and distribution. The Supreme Court of Florida affirmed this decree. Wofford v. Wofford, 176 So. 499. An examination of the proceedings in the state courts reveals that there was no dispute over the ownership of the property as between the corporation and the individual parties. The master's report states that Tatem Wofford, in his answer, denied the allegations of the complaint respecting the hotel property ‘except the joint ownership,‘ and that he asserted ownership of the residence to be in the corporation. The petitioner has not placed the answer in evidence so that we may determine for ourselves precisely what matters were admitted by the pleadings, but the opinion of the Supreme Court of Florida (Wofford v. Wofford, supra) states in unmistakable language that there was no real controversy respecting the ownership of the property as between the corporation and the Woffords. In stating the facts the Supreme Court said that ‘the parties admit the joint ownership of the property involved in the suit,‘ and throughout its opinion it refers to the admission by all parties that the Woffords were the joint and beneficial owners of all of the property. Furthermore, it appears that both the Circuit Court and the Supreme Court regarded the suit not as a suite to resolve the ownership as between the corporation and the Woffords, but as one for the partition of property admittedly belonging to the latter as beneficial owners. Since it affirmatively appears that ownership in the Woffords was adjudicated in the state courts on the basis of the admission of the parties, there was no real controversy on that question, and the rule of the Freuler case and the other cases cited above does not apply.
Upon the facts shown by the record it is clear that the property in question was the property of the Wofford Hotel Corporation and that the interest of the Woffords therein was none other than that which shareholders ordinarily have in the property of their corporation. The hotel property was acquired by that corporation from Ora Wofford in exchange for all of its stock, and her purpose in organizing the corporation and transferring the property to it was to enable it to mortgage the property to secure an original issue of $250,000 of bonds. The proceeds of those bonds were used to discharge encumbrances which had been placed on the property by Ora Wofford to finance the construction and equipping of the hotel. Between 1923 and the death of Ora Wofford in 1932, the bonded indebtedness was reduced to $150,000 from the profits of the hotel business. In 1934, when the bonded indebtedness had been further reduced to $136,000, the bonds were ‘reissued,‘ and the residence, which was then owned outright by Tatem and John, was conveyed to the corporation and by it mortgaged as further security for the reissued bonds. The profits of the business were thereafter used to reduce the bonded indebtedness until is was finally discharged in June 1936. In other words, the corporation acquired all the property with full power to mortgage it; and, during the thirteen years preceding the institution of the suit, it held the property subject to the rights of the bondholders and used the income therefrom to discharge its obligation to them. There is nothing in this record to indicate that, at any time prior to the distribution under the decree, the corporation relinquished to the Woffords any of its rights of ownership in any of the property.
We think the facts recited in the immediately preceding paragraph alone sufficiently demonstrate complete ownership of the property in the corporation; but there are other facts and circumstances which support such conclusion. Throughout its corporate existence the Wofford Hotel Corporation made returns in its own name and paid corporate taxes. It maintained its own bank accounts, in which it deposited funds derived from operation of the business. Although Tatem and John became involved in a dispute in 1934 over the right to manage the business, they withdrew from corporate funds annual salaries of $7,500 each, by agreement. The corporation apparently incurred all obligations in its own name, as is indicated by the items of accounts payable, insurance, taxes, and meter deposits described in the findings of fact. When Ora Wofford died her executors recognized no property interest of the estate other than the ownership of the stock of the Wofford Hotel Corporation. The stock was inventoried at $25,000, and upon distribution stock certificates were reissued in equal amounts to Tatem and John. The record is devoid of proof that the Wofford brothers and their wives ever treated the hotel and residence properties as their own or that they ever accounted for the profits therefrom in their individual income tax returns. On the contrary, it appears from the master's statement of the final settlement, in which John was credited for one-half of the Federal income taxes payable by the corporation according to its balance sheet of December 4, 1937, that the income of the business for the year 1937 was returned by the corporation.
Since we are of the opinion that all of the property distributed by the master belonged to the Wofford Hotel Corporation, and since all of such property was distributed among the stockholders by the master, there was a liquidation in fact, W. E. Guild, 19 B.T.A. 1186; Frelmort Realty Corporation, 29 B.T.A. 181; Ward M. Canady, Inc., 29 B.T.A. 355; affd., 76 Fed.(2d) 278; certiorari denied, 296 U.S. 612; W. F. Kennemer, 35 B.T.A. 415; affd., 96 Fed.(2d) 177; T. T. Word Supply Co., 41 B.T.A. 965, and the Commissioner properly treated the transaction as a distribution in liquidation of the corporation.
Our conclusion just above disposes of the contention of petitioner that the cash funds and miscellaneous assets were capital or income of the Woffords received prior to the taxable year (cf. Wells Fargo Bank & Union Trust Co. v. Blair, 26 Fed.(2d) 532; Taylor Oil & Gas Co. v. Commissioner, 47 Fed.(2d) 108; certiorari denied, 283 U.S. 818; Mrs. Grant Smith, 26 B.T.A. 1178), and of his further contention that he conveyed by assignment a 499/2000 interest in the real estate to his wife prior to the sale by the master so as to relieve him from tax on the gain from the sale of the portion so assigned. Prior to the assignment of December 2, 1937, the corporation had made a capital distribution to its stockholders of $24,072.17, thereby leaving an unrecovered basis of $927.83 for the 2,000 shares of outstanding stock, and prior to that date, and on November 22, 1937, the master made a distribution of the cash funds of $18,750.59 and $4,040.71, of which the petitioner's share was 999/2000. It is therefore apparent that at the time when the assignment was made the petitioner had recovered more than the basis of his shares of stock, and that the assignment, assuming it was bona fide, operated to transfer 499/2000 of the remaining assets, all of which represented gain derived by the petitioner from the liquidation. The assignment therefore was an assignment of income to be received by the petitioner in the future, and did not relive him from liability for tax when such income was realized. Helvering v. Horst, 311 U.S. 112.
The issue next to be considered is whether the petitioner is entitled to a deduction for trade or business expenses under section 23(a) of the Revenue Act of 1936. In the accounting between the petitioner and John B. Wofford of December 20, 1937, it was found that there was outstanding $2,075.65 of accounts payable. The court directed that these accounts be assumed by John, and, with its approval, one-half of the amount thereof, or $1,037.83, was charged to the petitioner and was paid by him to John in the final settlement. The petitioner contends that he is entitled to deduct 1998/2000 of the amount of $1,037.83 under section 23(a) as an ‘expense incurred prior to the conveyance of that proportionate part of his interest to his wife on December 2, 1937,‘ and, he asserts that the accounts represented accounts then payable for expenses incurred in the operation of the Wofford Hotel and residence. In view of our conclusion that the hotel and residence belonged to the Wofford Hotel Corporation, the expenses of operating those properties were its expenses, and, if deductible, they were deductible by it alone. Hal E. Roach, 20 B.T.A. 919; James F. Curtis, 3 T.C. 648, 651. Furthermore, there is nothing in the record to show the purpose for which the obligations were incurred. They may well have been incurred for items of a capital nature. Interstate Transit Lines, 44 B.T.A. 957, at page 961, affd., 130 Fed.(2) 136; affd., 319 U.S. 590. The petitioner's claim for the deduction is denied.
The next issue is whether the petitioner is entitled to deductions on account of the payment of $256.80 for Federal and state documentary stamps affixed to the deeds of the master conveying the hotel and residence to John B. Wofford and his wife, and the payment of $3,084.81 for one-half of the city, county, and state taxes on those properties for the calendar year 1937. The petitioner rests his claim for the deduction of both items upon the premise that he and his brother John and their respective wives, rather than the Wofford Hotel Corporation, owned the hotel and residence property, and he concedes that, if the Florida courts were wrong in holding that those properties were not owned by the corporation, the respondent is correct in his contention that the stamp taxes and real estate taxes were corporate obligations and not deductible by its shareholders. See Samuel Riker, Jr., 15 B.T.A. 1160; Lone Pine Lawn Corporation, 41 B.T.A. 638; affd., 121 Fed.(2d) 935; Fleming G. Railey, 36 B.T.A. 543. Since the question of ownership of the hotel and residence has been decided adversely to the petitioner under the first issue, we deny his claim for the deduction without further discussion.
The next issue is whether the petitioner is entitled to a deduction for attorney fees and other costs incurred in defending the suit in the Circuit Court and the Supreme Court of Florida. The evidence shows that the petitioner expended $9,337.78 for that purpose and that he paid $8,163.67 of that amount during the taxable year. The petitioner claims a deduction of the latter amount under section 23(a) of the Revenue Act of 1936, and the respondent concedes that the deduction should be allowed to the extent of $7,981.82, which is the amount which the petitioner claimed as a deduction in the petition herein. There is no explanation of the discrepancy between the amount shown by the proof and the amount claimed in the petition. We allow deduction only of the amount of $7,981.82. Ben Greenbaum, 20 B.T.A. 469.
The final issue is whether the penalty of 5 percent for negligence should be imposed. The petitioner in his return filed August 1938 set forth all the details showing the value of each item included in the distribution of the property of the Wofford Hotel Corporation. The respondent found no omission of assets and accepted the petitioner's valuation of each item involved. He differed with the petitioner only as to the proportion of the net profit taxable to the petitioner, holding the petitioner to be the owner of, and taxable with, the profit on 999 shares of stock instead of 500 shares as reported by the petitioner in his return. The final decree of the Circuit Court of June 28, 1937, provided for the distribution as between Tatem Wofford and his wife and John B. Wofford and his wife of all the assets of the Wofford Hotel Corporation in accordance with their respective interests therein. The assignment of December 2, 1937, to his wife by Tatem Wofford purported to embrace one-half of all the benefits, rights, and interest which he had in the final decree, and the assignment recited that its purpose was to transfer and set over to his wife such proportionate interest in the final decree as would make their interests in the assets of the Wofford Corporation equal. We think these facts, together with the other facts of record, were sufficient to justify a belief on the part of petitioner that by his assignment he had effectively disposed of a 499/2000 interest in all of the corporate assets; and this is true notwithstanding that we have held in deciding the effect of the assignment that it operated to transfer only the assets of the Hotel Corporation remaining after the distribution of cash funds in the respective amounts of $18,750.59 and $4,040.71.
If the petitioner was mistaken, as he evidently was, as to the controversial question of what the legal effect of the assignment for income tax purposes was, that is not a sufficient reason for holding that he was negligent within the meaning of section 293(a) of the Revenue Act of 1936. Bennett v. Commissioner, 139 Fed.(2d) 961; and Hans Pederson, 14 B.T.A. 1089. Neither in the notice of deficiency nor in the respondent's brief do we find any suggestion of the act which required the imposition of the penalty, and, as we are unable to discover in the record any ‘understatement of tax attributable to negligence‘ we disapprove the imposition of the penalty. Wilson Bros. & Co. v. Commissioner, 124 Fed.(2d) 606.
Reviewed by the Court.
Decision will be entered under Rule 50.