UNITED STATES TAX COURT

T.C. Memo. 1996-62

UNITED STATES TAX COURT

JOSEPH P. AND MARILYN SCHNELLER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 497-94.

Filed February 15, 1996.

Irwin G. Waterman and Michael T. Hymson, for petitioners.

Martha Sullivan, Jack A. Joynt, and William C. Shouse, for

respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS,

Judge:

Respondent

determined

a

deficiency

in

petitioners’ Federal income tax for 1990 in the amount of $138,748

and an accuracy-related penalty pursuant to section 6662(a) in the

-2amount of $26,676 for such year.1

Respondent reflected this

determination in a notice of deficiency dated October 13, 1993.

The

principal

unagreed

item

involves

respondent’s

determination that petitioners realized forgiveness of indebtedness

income pursuant to section 61(a)(12) as a result of a $476,363

writeoff in 1990 of accounts that had been carried on the books of

petitioners’ wholly owned corporation (Land Air Delivery, Inc.)

essentially as shareholder loans.

6662

accuracy-related

settlement

of

a

tax

Also in dispute is the section

penalty.

The

examination

for

writeoff

years

followed

1982-84.

In

the

the

settlement, the parties agreed that petitioners’ withdrawals from

Land Air Delivery, Inc., should have been characterized, in part,

as dividends rather than shareholder loans.

Petitioners maintain

that such withdrawals constitute dividend income in the year of

withdrawal, not 1990, and hence the writeoff in 1990 did not give

rise to a taxable event.

Accordingly, the issues we must decide

are:

(1)

Whether, as a result of the settlement agreement for

years 1982-84, respondent is estopped from asserting that the

corporate advances written off in 1990 were loans.

We hold that

respondent is not.

(2)

1

Whether petitioners realized discharge of indebtedness

Petitioners made income tax payments for 1990 totaling

$138,748 after filing their petition in this Court to stop the

accrual of interest.

-3income in 1990.

(3)

We hold that they did.

Whether petitioners are liable for the accuracy-related

penalty pursuant to section 6662.

We hold that they are.

All section references are to the Internal Revenue Code in

effect for the year under consideration.

All Rule references are

to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

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

The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

Background

Petitioners, husband and wife, resided in Bowling Green,

Kentucky, at the time they filed their petition.

a

joint

Federal

income

tax

return

for

1990,

They timely filed

the

year

under

consideration.

Petitioners own all the stock of Land Air Delivery, Inc.

(Delivery or the corporation), an air freight motor carrier that

engages in the pickup and delivery of packages for overnight

carriers.

Joseph P. Schneller (petitioner) started Delivery in

1963 with a single truck.

At its peak, Delivery operated 250

trucks and delivered freight nationwide.

For all periods relevant

to this case, petitioner was the president and Mrs. Schneller was

the secretary of Delivery.

Delivery

inception.

has

been

a

subchapter

C

corporation

from

its

Corporate income tax returns (Forms 1120) were filed

-4for Delivery through 1989. All such returns for periods bearing on

this case were executed by one or the other of petitioners in their

capacities as corporate officers.

Delivery was a union company.

After a bout of trouble with

the Teamsters, Delivery was phased out in favor of a new nonunion

company named Land Air Express, Inc. (all the stock of which is

owned by petitioners), which today operates the business formerly

conducted by Delivery.

Delivery underwent a reorganization in 1990 and filed its

corporate income tax return for that year under its new name, KTM,

Inc.

Shareholder Loan Accounts

From

time

to

time,

commencing

at

dates

prior

to

1976,

petitioner made withdrawals from Delivery. Some of the withdrawals

were recorded as shareholder loans, advances, or investments. None

was

included

in

petitioners'

income.

In

1979,

Delivery's

stockholders adopted a resolution ratifying all existing loans,

advances,

and

investments

continue such transactions.

and

authorized

the

corporation

to

As part of the resolution, petitioner

agreed to repay the amounts on demand.

In 1982, petitioner sold his interest in a waste management

company for $800,000.

He did not use any of the proceeds to repay

his withdrawals from Delivery.

In September 1984, petitioner was advised by his accountant,

-5James Luscombe,2 that interest-bearing notes should be prepared to

evidence the loans, advances, and investments.

Petitioner did not

follow this advice although petitioners did agree to the accrual of

interest for the year 1984.

Petitioners’ 1982, 1983, and 1984 individual tax returns and

Delivery’s related corporate returns were selected for examination

by respondent’s Wichita, Kansas, district office.3 The examination

included an analysis of Delivery’s shareholder loan accounts.

The

balances in the accounts increased by $14,995 in 1982, $75,404 in

1983, and $42,502 in 1984, for a 3-year total increase of $132,901.

Throughout

the

examination,

petitioners

(through

their

representatives)4 insisted that their withdrawals from Delivery

were loans. The examining agent concluded that a portion ($51,065)

of the increase in the account balances for the 1982-84 years

($132,901) should be taxed as dividend income to petitioners; he

2

From 1963 through 1987, Mr. Luscombe prepared all of

the financial statements and corporate tax returns for Delivery,

as well as petitioners’ individual tax returns. The financial

statements were prepared monthly from records delivered to Mr.

Luscombe by Mrs. Schneller. Following petitioners’ move from

Kansas City to Kentucky, petitioners retained William B. Arthur,

Jr. to perform the accounting and tax work for Delivery and

themselves. The first return Mr. Arthur prepared in 1990 was the

1988 corporate return for Delivery.

3

The examination centered around the examiner’s

determination that the Schnellers underreported their income for

years 1982-84, as well as the examiner’s proposal to assert the

fraud addition to tax.

4

James Baker, an attorney, and Mr. Arthur represented

petitioners with respect to the 1982-84 tax examination.

-6further concluded that the majority ($81,896) of the increase

should be treated as loans, as should all balances existing prior

to 1982.

All issues arising from that examination (for both

petitioners and Delivery) were ultimately settled by execution of

two Forms 870-AD (one for petitioners individually and the second

for Delivery) by petitioners and a representative of respondent’s

Kansas City Appeals Office on June 1, 1990.

Shortly after the settlement, petitioners’ accountant (Mr.

Arthur) wrote off $527,428 against the corporation’s retained

earnings.

The $527,428 represented the balances in the following

12 accounts (which reflected withdrawals either by or for the

benefit of petitioners):

Title

Joe Schneller

Farm

S & S Oil

Jim Schneller

Cattle

Oil wells

Barnard Realty

Transportation management

Payable to Marilyn Schneller

Insulating coating

BG Beer

Investment-BG Beer

TOTAL

Amount

$ 70,125

163,694

16,646

11,500

34,967

3,700

46,031

5,585

(23,856)

54,656

8,200

136,180

$527,428

Respondent does not challenge $51,065 of the $527,428 written off.

Respondent does, however, challenge $476,363 of the writeoff on the

grounds that the 12 accounts had consistently been carried on the

corporate books as loans, and petitioners never included any part

of the $476,363 in their personal income. Petitioners were solvent

-7both before and after the writeoff of the 12 accounts.

Before the

writeoff

gave

neither

petitioners

nor

their

corporation

indication that the accounts would not be repaid.

any

Since the date

of the writeoff, Delivery has made no demands for repayment of the

account balances involved, nor has Delivery in any other way

asserted

that

petitioners

petitioners

in

any

way

still

owe

indicated

the

that

balances.

they

still

Nor

have

consider

themselves indebted to the corporation for those balances.

On Delivery's 1990 tax return (filed under the name KTM,

Inc.), the $527,428 writeoff is characterized as the writeoff of

previous dividends.

Delivery's accountant (Mr. Arthur) knew that

only $51,065 had been taxed as dividend income to petitioners

during the audit of years 1982 through 1984.

Mr. Arthur also knew

that interest had been imputed on the remaining loan balances. And

he was aware that characterizing the amounts as dividend income was

advantageous

to

petitioners.

The

purported

dividend

income

involved years now closed by the statute of limitations.

OPINION

Preliminarily,

we

note

that

petitioners

claim

that

respondent’s notice of deficiency is invalid because it was based

solely on the revenue agent’s arbitrary conclusion that the amounts

written off should not go untaxed.

without merit.

We find this argument to be

The revenue agent credibly testified that he had

sufficient evidence concerning the distributions at issue to make

his determination.

Petitioners offered no evidence to contradict

-8the agent’s

testimony.

Instead, petitioners proved only that the

agent did not conduct a new examination of the nature of each

shareholder distribution.

A deficiency determination generally is afforded a presumption

of correctness unless it is without any foundation.

v. Janis, 428 U.S. 433, 440-441 (1976).

United States

The agent had the results

of the 1982 through 1984 examination, petitioners’ records of the

accounts and the entries charging them off, and the applicable

individual and corporate returns.

The documents showed that

interest

pre-1982

had

been

computed

on

the

shareholder

loan

balances and the portion of the 1982 through 1984 account increases

that was treated as loans.

Hence, there was a sufficient basis for

the agent’s determination in this case.

Issue 1.

The

Estoppel

first

issue

for

decision

is

whether

respondent

is

estopped, as petitioners contend, from asserting that the corporate

advances written off in 1990 were loans.

As the basis for this

argument, petitioners rely on their settlement with the IRS for

years

1982-84,

wherein

the

IRS

and

petitioners

characterized

approximately 38 percent of the additions to the accounts at issue

as dividends with the remainder as loans.

We believe petitioners’

estoppel argument to be without merit.

A settlement agreement is binding only with respect to the

years specified by the agreement. Goldman v. Commissioner, 39 F.3d

402, 405-406 (2d Cir. 1994), affg. T.C. Memo. 1993-480.

The

-9applicable Forms 870-AD petitioners and respondent executed address

only years 1982, 1983, and 1984 and treat only a portion of the

account increases as dividends.

The forms have no application to

other years.

Issue 2.

Discharge of Indebtedness Income

Each of the parties is taking a position contrary to that

taken in connection with the 1982-84 examination.

Respondent

maintains that the character of the items written off was that of

loans

and

as

such,

the

writeoff

gave

rise

to

indebtedness income under section 61(a)(12).

discharge

of

Petitioners now

maintain that the items written off should be characterized as

dividends.

Respondent

further

contends

that

petitioners

are

estopped by the duty of consistency from denying that the character

of

the

corporate

advances

was

that

of

loans.

We

agree

with

respondent.

Section 61(a)(12) defines income to include amounts realized

from the discharge of indebtedness.

The discharge of a debt below

face value accords the debtor an economic benefit functionally

equivalent to income.

Babin v. Commissioner, 23 F.3d 1032, 1034

(6th Cir. 1994), affg. T.C. Memo. 1992-673.

The shareholder accounts at issue were carried on Delivery's

books as shareholder loans, some dating back to 1976, until they

were written off in 1990.

Further, Delivery's stockholders (that

is, petitioners) adopted a resolution ratifying all existing loans,

advances,

and

investments,

and

authorized

the

corporation

to

-10continue such transactions.

amounts on demand.

And petitioner agreed to repay the

Petitioners' accountant (Mr. Luscombe) advised

petitioners that interest-bearing notes should be prepared to

bolster their position that the amounts were loans.

Petitioners

maintained that position throughout the audit of their 1982, 1983,

and 1984 returns.

Further, the increases in the accounts were not

included in petitioners' income except certain amounts stemming

from the 1982 through 1984 audit.

Petitioners made repayments of more than $300,000 between 1984

and

1990.

Repayments

constitute loans.

(1974).

are

evidence

that

corporate

advances

See Pierce v. Commissioner, 61 T.C. 424, 431

Repayments suggest that withdrawals were made with an

intent to repay, which supports a finding that the withdrawals were

loans.

Miele v. Commissioner, 56 T.C. 556, 567-568 (1971), affd.

474 F.2d 1338 (3d Cir. 1973).

A debt is discharged when it becomes obvious that the debt

will not have to be repaid.

445 (1987).

Cozzi v. Commissioner, 88 T.C. 435,

Cash withdrawals from a corporation by a stockholder

in the form of loans generally are taxed in the year that corporate

action was taken canceling or charging off such accounts against

surplus.

Shephard v. Commissioner, 340 F.2d 27, 30 (6th Cir.

1965), affg. per curiam T.C. Memo. 1963-294.

In this case, the

discharge took place in 1990 when Delivery charged off the accounts

against retained earnings.

In sum, we hold that as a result of the

1990 writeoff, petitioners realized income from the discharge of

-11indebtedness in that year.

Even assuming, arguendo, that the character of the amounts

dispersed to petitioners from Delivery was that of a dividend, we

still

believe

respondent

should

prevail

on

the

grounds

that

petitioners are precluded by the duty of consistency from denying

See Bartel v. Commissioner, 54 T.C.

that the amounts were loans.

25 (1970).

Petitioners

consistently

maintained

that

accounts represented loans, not dividends.

the

shareholder

The accounts were

written off only shortly after the audit of years 1982 through 1984

was resolved.

That was the first time petitioners had taken the

position that the amounts received in prior years were dividends.

The statute of limitations had closed on those prior years.

A taxpayer who obtains a benefit by taking a position in one

year cannot disavow that position in a later year to the detriment

of the Government.

See Commissioner v. Liberty Bank & Trust Co.,

59 F.2d 320, 325 (6th Cir. 1932); see also Commissioner v. National

Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974) (citing

Higgins v. Smith, 308 U.S. 473, 477 (1940); Beltzer v. United

States, 495 F.2d 211 (8th Cir. 1974)).

Issue 3.

Accuracy-Related Penalty

The final issue is whether petitioners are liable for the 20percent

accuracy-related

penalty

for

underpayment

of

tax

attributable to negligence or disregard of rules or regulations.

Sec. 6662(a) and (b)(1).

Petitioners contend that they should not

-12be liable for the accuracy-related penalty because they did not

review their 1990 return, but rather relied on their accountant,

Mr. Arthur.

“The voluntary failure to read a return and blind reliance on

another for the accuracy of a return are not sufficient bases to

avoid liability for negligence additions to tax.”

Bollaci v.

Commissioner, T.C. Memo. 1991-108 (citing Bagur v. Commissioner, 66

T.C. 817, 823-824 (1976), remanded on other grounds 603 F.2d 491

(5th Cir. 1979)).

Taxpayers have a duty to read a return and make

sure all income items are included.

Magill v. Commissioner, 70

T.C. 465, 479-480 (1978), affd. 651 F.2d 1233 (6th Cir. 1981)

(citing Bailey v. Commissioner, 21 T.C. 678, 687 (1954)).

The

accuracy-related penalty under section 6662(a) does not apply to

any portion of an underpayment if it is shown that there was

reasonable cause for such portion and if the taxpayer acted in good

faith.

Tippin v. Commissioner, 104 T.C. 518, 533-534 (1995).

Petitioners claim that they were completely ignorant of what

appeared

on

their

tax

returns,

which

accountant.

We do not believe them.

testifying

and

found

him

to

be

were

prepared

by

an

We observed petitioner while

financially

astute.

Despite

petitioner’s limited formal education, he built a highly successful

nationwide

company.5

writeoff.

In our opinion, both petitioner and his wife possessed

5

Obviously,

petitioners

knew

about

the

Petitioner attempted to portray himself as a “country

bumpkin”, but we believe he was “sly as a fox”.

-13sufficient knowledge to understand, and in fact knew, the benefits

flowing to them by Mr. Arthur’s acts.

They could have objected to

the writeoff but either affirmatively acquiesced in it or purposely

chose to be silent.

Accordingly, we conclude that petitioners had

no reasonable cause for omitting income realized from the discharge

of indebtedness.

We therefore hold that the underpayment of tax

was due to petitioners’ negligence and disregard of rules or

regulations.

To reflect the foregoing,

Decision will be entered

for respondent.