WSB Liquidating Corp. v. Commissioner

T.C. Memo. 2001-9

UNITED STATES TAX COURT

WSB LIQUIDATING CORPORATION, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12891-99. Filed January 19, 2001.

James P. Dalle Pazze, for petitioner.

Gerald A. Thorpe and Jack T. Anagnostis, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GALE, Judge: Respondent determined deficiencies in

petitioner’s Federal income tax, and accuracy-related penalties,

as follows:

Accuracy-Related Penalty

Year Deficiency Sec. 6662(a)

1993 $11,805 $1,915

1994 13,511 1,554

1995 14,307 1,597

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Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the years in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

Petitioner is a dissolved Delaware corporation engaged in

wrapping up its business affairs. Petitioner was originally

named Walter S. Bandurski, Inc. In 1997 Walter S. Bandurski,

Inc., sold substantially all of its assets and changed its name

to WSB Liquidating Corp. WSB Liquidating Corp. was liquidated

and dissolved in 1998. Delaware law requires a dissolved

corporation to be continued as a corporate body for at least 3

years from the date of dissolution, for the purpose of

prosecuting and defending suits and engaging in other activities

to wrap up its affairs. See Del. Code Ann. tit. 8, sec. 278

(1991). The notice of deficiency in the instant case was issued,

and the petition was filed, in 1999, within 3 years of

dissolution, giving us jurisdiction. See Bared & Cobo Co., Inc.

v. Commissioner, 77 T.C. 1194 (1981). Hereinafter, references to

petitioner are to WSB Liquidating Corp. or Walter S. Bandurski,

Inc.

Following concessions by respondent, we must decide the

following: (1) Whether petitioner may deduct certain payments

made to Barbara Bandurski (Barbara) in 1993, 1994, and 1995 after

she had stopped working for petitioner. We hold that it may not.

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(2) Whether petitioner is liable for accuracy-related penalties

as determined by respondent. We hold that petitioner is liable.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. We

incorporate by this reference the stipulation of facts and the

attached exhibits. At the time of filing the petition,

petitioner had been dissolved. Petitioner’s principal place of

business had been Wilmington, Delaware.

Barbara and Walter Bandurski (Walter) founded and

incorporated petitioner in 1967. Petitioner was engaged in the

trash removal business. Petitioner was a close corporation under

Delaware law and was managed directly by its stockholders.1

Walter and Barbara were married in 1956. They both worked

for petitioner. From 1967 until 1983 or 1984, Barbara

essentially ran the office; she worked full time for petitioner

as office manager, bookkeeper, and corporate secretary. Barbara

had a good rapport with customers; in general customers preferred

dealing with her rather than Walter.

Walter and Barbara were divorced in August of 1984.

Beginning in 1983 or 1984, Barbara’s work for petitioner was less

than full time; generally she appeared for work fewer than 5 days

per week. Also in 1984, an unrelated employee replaced Barbara

1

However, petitioner was not an S corporation as defined in

sec. 1361(a).

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as office manager and corporate secretary and eventually took

over most of Barbara’s duties. By the late 1980's, Barbara would

typically work 2 to 3 days per week. She continued to receive a

weekly paycheck from petitioner during the period from 1983 to

1989, in amounts ranging from $225 per week in 1983 to $375 per

week in 1989.

There was tension between Barbara and Walter after their

divorce that was apparent to other employees of petitioner. The

tension grew during the late 1980's, causing some disruption in

petitioner’s office.

Effective May 1, 1989, Barbara agreed to retire from

petitioner and rendered no further services after that date.

Also on that date, Barbara executed two agreements: (1) An

agreement between herself and petitioner entitled “Pension

Agreement” (Pension Agreement); and (2) a “Stipulation, Agreement

and Order” between herself and Walter (Settlement Agreement).

The Settlement Agreement concerned the settlement of the

respective rights and obligations of Barbara and Walter following

their divorce; it was captioned to reflect their divorce

proceedings and also signed by a judge of the Family Court of the

State of Delaware. The Settlement Agreement made specific

reference to, and attached a copy of, the Pension Agreement.

The Pension Agreement, executed by Walter on behalf of

petitioner, provided in relevant part as follows:

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THIS AGREEMENT is made this 1st day of May,

1989 between WALTER S. BANDURSKI, INC. (the “Company”),

a Delaware corporation, and BARBARA BANDURSKI (the

“Employee”).

BACKGROUND

The Employee is presently rendering services

to the Company under a contractual arrangement. For

many years past, however, the Employee served the

Company loyally as an officer and director. During

many of those years, the Employee, in order to assist

the Company in its growth, accepted compensation at a

rate substantially less than her services would have

commanded on the open market.

In the judgment of the directors, it is

advisable and in the interest of the Company that the

Employee’s past service be appropriately compensated in

the form of a retirement pension.

INTENDING TO BE LEGALLY BOUND, THE PARTIES AGREE

AS FOLLOWS:

1. Upon the Employee’s retirement from

fulltime service with the Company on the 1st day of

May, 1989, the Company shall pay to the Employee the

sum of Three Hundred Seventy-Five Dollars ($375.00) per

week for life.

As part of the Pension Agreement, petitioner also agreed not to

sell a substantial portion of its assets to, nor to merge into,

reorganize with, or permit its business activities to be assumed

by, any other company or organization unless the latter assumed

petitioner’s duties and obligations under the Pension Agreement.

The Pension Agreement further provided for an annual adjustment

of the payments thereunder to account for inflation.

The Settlement Agreement, executed by Walter (individually),

Barbara, and a family court judge, recited their marriage,

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divorce, and the intent of the parties thereto “to settle their

respective rights and obligations against and to one another”.

After providing for the division of the parties’ real and

personal property, the Settlement Agreement addressed

“businesses” in which “The parties acknowledge that Husband

and/or Wife have an interest”, including petitioner. The

Settlement Agreement provided that Walter would transfer to

Barbara one-half of his holdings of 80 percent of the outstanding

stock of petitioner, subject to Barbara’s agreement to vote the

stock as requested by Walter.2 The Settlement Agreement further

provided that Walter was prohibited from transferring any assets

of petitioner except in the ordinary course of business to a bona

fide purchaser for value. In addition, the Settlement Agreement

made specific reference to the Pension Agreement, as follows:

(e) Walter S. Bandurski, Inc. has previously

entered into a Non-Qualified Pension Agreement with

Wife for past services, a copy of which is attached

hereto as Exhibit “C”. The Pension Agreement provides

Wife with a payment of $375.00 per week. Husband

further agrees that the company shall provide Wife with

the use of two automobiles of her choosing, together

with reasonable and periodic replacements thereof no

less than every three (3) years and also provide

insurance on such automobiles, maintenance and gasoline

and shall indemnify wife and pay for any increase in

Federal or State income taxes resulting to her as a

result of the provisions regarding such automobiles.

Husband further agrees that the company shall provide

2

In this regard, the Settlement Agreement further provided

that Walter’s voting requests had to be for a valid business

purpose, with any disagreements on this point to be submitted to

arbitration.

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Wife with health insurance, as presently established

and in conformity with the same health insurance

provided to Husband. Such benefits shall continue

until the sale of Walter S. Bandurski, Inc. to a third

party bona fide purchaser. So long as Wife receives

her pension payment and benefits as herein set forth,

Wife waives her right to alimony pursuant to 13 Del. C.

§1512(d). Upon the sale of Walter S. Bandurski, Inc.

and the termination of Wife’s pension payment and the

other benefits provided herein, the parties shall

attempt to agree on Wife’s entitlement to alimony, if

any, and upon their failure to agree, the matter shall

be submitted to the Family Court for a determination.

Husband further agrees to personally

guarantee Wife’s pension payment during Wife’s

entitlement to such pension payment and agrees that any

increase in Husband’s salary from its present amount of

$1,000.00 per week or upon Husband receiving any other

benefits such as stock, bonus or pension amounts that

Wife shall receive a proportionate increase in her

pension payment so that the parties continue to draw

benefits at the same ratio as presently established

between Husband’s salary of $1,000.00 per week and

Wife’s salary of $375.00 per week.

The Settlement Agreement also provided that the reconciliation or

remarriage of Barbara and Walter would not affect its terms and

that “The property division embodied herein has been made in

recognition and as an alternative to the jurisdiction of the

Family Court of the State of Delaware to equitably divide marital

property pursuant to Delaware matrimonial and property statutes.”

Petitioner issued Forms W-2, Wage and Tax Statement, to

Barbara reporting the payments at issue as employee compensation

and claimed deductions for those payments in each year at issue.

Barbara did not report any income as alimony during the years at

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issue, nor did Walter claim deductions for alimony payments for

taxable years 1984 through 1990 and 1994 through 1998.3

Petitioner had retained earnings of $1,526,835 at the end of

1993, $1,752,421 at the end of 1994, and $2,037,873 at the end of

1995. Petitioner did not pay any dividends during its existence.

In July 1997, petitioner sold substantially all of its

assets to an unrelated third party. In connection with the sale,

Barbara and Walter (on his own behalf and acting for petitioner)

executed an agreement releasing petitioner from its obligations

under the Pension Agreement. At the time of trial, Barbara and

Walter were deceased.

In the notice of deficiency, respondent determined that

petitioner was not entitled to deductions for wages it claimed in

the amounts of $24,553 for 1993, $22,854 for 1994, and $23,499

for 1995.4 Respondent further determined that petitioner was

liable for accuracy-related penalties for underpayments due to

the claimed deductions for wages.

3

The record does not reveal what return positions Walter

may have taken in 1991 through 1993.

4

Respondent determined other adjustments not at issue in

the instant case.

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OPINION

Deductibility of Payments

This case raises the question of whether petitioner is

entitled to deduct payments it made to Barbara after she ceased

providing services to petitioner. Petitioner argues that the

payments are deductible under section 162 as ordinary and

necessary business expenses on two bases: (1) The payments were

severance payments made in consideration for past services for

which Barbara had been undercompensated; and (2) the payments

served a business purpose by inducing Barbara’s retirement

because her presence in the workplace, which created tension,

disrupted petitioner’s operations. Respondent argues, inter

alia, that the payments lacked a business purpose because in

actuality they satisfied a personal obligation of a shareholder;

namely, Walter’s alimony obligations to Barbara. Respondent

argues alternatively that the payments were not deductible

because they were constructive dividends to Barbara, constituting

a distribution of her share of petitioner’s retained earnings

attributable to her past equitable ownership interest in

petitioner or the interest she acquired pursuant to the

Settlement Agreement. For the reasons discussed below, we agree

with respondent.

Petitioner relies heavily on the Pension Agreement to

support its position that the payments to Barbara were in the

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nature of severance or retirement benefits to compensate her for

past services for which she was undercompensated. In order for a

payment to be deductible as compensation, it must have been made

with the intent to compensate. See Paula Constr. Co. v.

Commissioner, 58 T.C. 1055, 1058 (1972), affd. without published

opinion 474 F.2d 1345 (5th Cir. 1973). This is a question of

fact decided on the basis of all the facts and circumstances of

the case. See id. at 1059. Further, we are mindful that

transactions involving closely held corporations and their

controlling shareholders demand close scrutiny. See id. at 1058.

While the Pension Agreement does recite that Barbara “during many

* * * years * * * accepted compensation at a rate substantially

less than her services would have commanded on the open market”

and that petitioner intends to “appropriately compensate”

Barbara’s past service with a retirement pension, there is no

other evidence in the record that Barbara’s compensation for past

services was less than market rate or that the value of the

payments provided in the Pension Agreement approximated the past

undercompensation. Cf. Estate of Wallace v. Commissioner, 95

T.C. 525, 553-554 (1990) (taxpayer must show past

undercompensation and that current payments remedy that

undercompensation), affd. 965 F.2d 1038 (11th Cir. 1992); Avis

Indus. Corp. v. Commissioner, T.C. Memo. 1995-434 (same).

Indeed, the available evidence points to the contrary conclusion

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that Barbara was overcompensated for her services, at least from

1984 until May 1, 1989, during which period her weekly salary

increased significantly notwithstanding the substantial

curtailment of her responsibilities and time spent at the office.

In the absence of corroborating evidence, we accord little weight

to the self-serving recitals in the Pension Agreement. See,

e.g., Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).

We are similarly unimpressed with petitioner’s argument that

its business interests were served by providing a monetary

inducement for Barbara to retire because her office presence had

become disruptive. If an employee interferes with the efficient

operation of an employer’s business, we do not find it plausible

that the employer would “induce” the employee to retire with an

offer of full salary for life, adjusted for inflation. The

provisions connected with the termination of Barbara’s services

for petitioner make considerably more sense when placed in the

context of Barbara’s status as (1) the estranged former spouse of

petitioner’s controlling shareholder and (2) the probable holder

of a significant equitable interest in petitioner, by virtue of

her property rights arising from the marital relationship and/or

her contributions as a cofounder to petitioner’s success.

This is not to suggest that the characterization of the

payments by petitioner to Barbara is based on mere speculation.

We believe the Settlement Agreement, which is clearly

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interdependent with the Pension Agreement, makes the character of

the payments clear and fully supports respondent’s contention

that the payments functioned as alimony or as a constructive

dividend to Barbara. Although petitioner argues that the Pension

Agreement and the Settlement Agreement are independent and

separate agreements, the record contradicts this claim. Both

agreements were executed on the same day; the Settlement

Agreement makes specific reference to, and attaches as an

exhibit, the Pension Agreement. More significantly, the

Settlement Agreement modifies and supplements the terms of the

Pension Agreement, in one instance providing for a modification

of the amount of the payments (in the event that Walter’s salary

or other benefits from petitioner increased) and in another

supplementing the Pension Agreement’s terms (by providing for

Walter’s personal guaranty of petitioner’s obligation in the

Pension Agreement to make the payments). It also bears

mentioning that the Settlement Agreement effectively imposed

obligations on petitioner, notwithstanding the fact that

petitioner was not a party to the agreement. The Settlement

Agreement does so by having petitioner’s controlling shareholders

“agree” that the payments under the Pension Agreement will be

increased in certain circumstances. Obviously, the Settlement

Agreement contemplated that petitioner’s shareholders would use

their controlling positions to effect petitioner’s implementation

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of any modifications in the payments mandated outside of the

Pension Agreement’s terms. We therefore reject petitioner’s

claim that the Pension and Settlement Agreements were separate

and independent. In light of their contemporaneous execution and

interrelated terms, we find that both the Pension Agreement and

the Settlement Agreement governed the payments at issue in this

case and both are therefore relevant in ascertaining the nature

of the payments.

The Settlement Agreement by its terms constituted a

settlement of Barbara’s and Walter’s “respective rights and

obligations against and to one another” in connection with their

marriage and “a partition of all marital property”. The

Settlement Agreement acknowledges that “Husband and/or Wife have

an interest” in petitioner and contains a detailed disposition

thereof. The transfer to Barbara of one-half of Walter’s 80-

percent stock interest in petitioner is required. The Settlement

Agreement then acknowledges petitioner’s obligation to make

payments to Barbara under the Pension Agreement and in the same

section obligates Walter to cause petitioner to provide Barbara

certain additional “benefits” including the use of two

automobiles of her choosing, together with fuel, maintenance, and

payment of Barbara’s income tax liability arising from receipt of

the foregoing, as well as health insurance comparable to that

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provided to Walter.5 The Settlement Agreement then provides with

respect to the pension payment and benefits as follows:

So long as Wife receives her pension payment and

benefits as herein set forth, Wife waives her right to

alimony pursuant to 13 Del. C. §1512(d). Upon the sale

of Walter S. Bandurski, Inc. and the termination of

Wife’s pension payment and the other benefits provided

herein, the parties shall attempt to agree on Wife’s

entitlement to alimony, if any, and upon their failure

to agree, the matter shall be submitted to the Family

Court for a determination.

On the basis of these provisions, and the fact that the

Settlement Agreement by its terms was intended to settle Walter

and Barbara’s “respective rights and obligations against and to

one another”, we conclude that the payments at issue satisfied

Barbara’s rights to alimony and relieved Walter of an obligation

to make alimony payments. Barbara waived her right to alimony

for so long as the payments under the Pension Agreement

continued. Petitioner argues that Barbara’s waiver of her

alimony rights was made in exchange for various benefits she

received under the Settlement Agreement other than the payments

under the Pension Agreement–-e.g., exclusive occupancy of the

5

It is not clear from the record whether the amounts

petitioner reported as compensation to Barbara on Forms W-2 and

claimed as wages deductions for the years in issue consisted of

(i) the weekly $375 payments provided for in the Pension

Agreement (as adjusted for inflation) or (ii) the foregoing plus

the “benefits” (automobile use, health insurance) provided for in

the Settlement Agreement. As respondent’s determination covered

a specified figure in each year, and the parties have not

addressed this possible distinction, we do not consider it

further.

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marital home and divisions of various marital property. However,

the language of the Settlement Agreement belies petitioner’s

position; Barbara waives her rights to alimony in exchange for

the “pension payment and benefits as herein set forth” and in

context these “benefits” refer to the health insurance and

automobile fringe benefits that are outlined immediately before.

To the extent the payments relieved Walter of his obligation

to pay alimony, they are nondeductible by petitioner. A

corporation’s payment of its shareholder’s personal expense or

obligation is not deductible by the corporation. See Greenspon

v. Commissioner, 229 F.2d 947 (8th Cir. 1956), affg. in part and

revg. in part 23 T.C. 138 (1954); Enoch v. Commissioner, 57 T.C.

781 (1972); American Properties, Inc. v. Commissioner, 28 T.C.

1100 (1957), affd. per curiam 262 F.2d 150 (9th Cir. 1958). This

Court has found in circumstances similar to the present ones that

payments made by a closely held corporation to the former spouse

of a controlling shareholder and claimed as deductible

compensation or other business expense were disguised alimony or

part of a property settlement and therefore nondeductible

personal expenditures of the shareholder. See J.B.S. Enters.,

Inc. v. Commissioner, T.C. Memo. 1991-254; Greenwood v.

Commissioner, T.C. Memo. 1989-368; Frankland Racing Equip., Inc.

v. Commissioner, T.C. Memo. 1987-210. These cases concerned

situations where the shareholder’s spouse had at no time rendered

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services to the corporation. Here, the spouse provided past

services to the corporation. Given the particular facts and

circumstances of this case, however, we do not think Barbara’s

prior services afford a basis for distinguishing the results in

the prior cases. We reach this conclusion because of the absence

of any persuasive evidence that Barbara was undercompensated for

her services and the provisions of the Settlement Agreement in

which Barbara waives her right to alimony so long as petitioner

makes the payments to her that are at issue. The contention that

these payments served primarily as disguised alimony is amply

supported in the record.

Respondent argues in the alternative that the payments were

constructive dividends to Barbara, representing a distribution of

earnings to which she was entitled by virtue of her past

equitable interest in petitioner or her stock interest acquired

as a result of the Settlement Agreement. We are satisfied that

Barbara possessed a significant ownership interest in petitioner

when the payments in issue were made. The Settlement Agreement

expressly recited that Barbara “[had] an interest in” petitioner

and that the agreement was intended to be a “property division *

* * as an alternative to the jurisdiction of the Family Court * *

* to equitably divide property pursuant to” State law. As part

of the disposition of Barbara’s “interest” in petitioner, the

Settlement Agreement provided for Walter’s transfer to Barbara of

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one-half of his stock interest in petitioner and acknowledged the

“pension” payments from petitioner to Barbara. Clearly, the

transfer of the stock to Barbara was in consideration of her

ownership interest in petitioner. However, in light of the facts

that petitioner had substantial retained earnings and never paid

dividends, that Barbara provided no services to petitioner in the

years petitioner made the payments, and that petitioner has not

proved that Barbara was undercompensated in prior years, it is

probable that some portion of the payments constituted a

distribution of earnings to Barbara. Nevertheless, it is not

necessary for us to decide what portion of the payments

constituted disguised alimony and what portion constituted a

distribution of earnings; in either event, they would not be

deductible by petitioner.6

Accuracy-Related Penalties

The remaining issue is whether petitioner is liable for

accuracy-related penalties under section 6662(a) as determined by

respondent. Respondent determined that the portion of

6

Respondent also argues that the deductions are limited by

sec. 404(a). In general, sec. 404(a) disallows deductions for

certain contributions to pension, annuity, and other plans, or

for compensation paid under a plan deferring the receipt of such

compensation. However, sec. 404(a) permits a deduction if the

contributions or compensation “would otherwise be deductible”, in

which case it affects the year in which deductions may be taken.

Because we find that the payments at issue in the instant case

are not “otherwise * * * deductible”, we need not address the

effect of sec. 404(a).

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petitioner’s underpayment attributable to the deduction of

compensation was due to negligence or disregard of rules or

regulations. See sec. 6662(b)(1). However, the penalty under

section 6662(a) shall not be imposed with respect to any portion

of an underpayment if there was reasonable cause for such portion

and the taxpayer acted in good faith. See sec. 6664(c)(1).

We find that petitioner’s attempt to deduct personal

expenses of Walter, or dividends paid to Barbara, constitutes

negligence or disregard of rules or regulations. The effort,

evidenced in the drafting of the Pension Agreement, to cast the

payments as compensation for services reflects an awareness of

the applicable tax principles. However, the fact that the

payments to Barbara satisfied Walter’s alimony obligations is

abundantly clear under the Settlement Agreement. Further,

petitioner has not argued reasonable cause or offered any other

argument against the application of the accuracy-related

penalties. Accordingly, we sustain respondent’s determinations.

To reflect the foregoing,

Decision will be entered

under Rule 155 with respect to

the deficiencies, and for

respondent with respect to the

accuracy-related penalties.