# UNITED STATES TAX COURT

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

T.C. Memo. 1999-193

UNITED STATES TAX COURT

RICHARD C. AND HATTIE M. MARTIN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
WILLIAM L. AND SYLVIA L. MARTIN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 18241-97, 18247-97.

Filed June 15, 1999.

William M. Weintraub and Brian J. Wright, for petitioners.
Michael H. Salama and Ian Russell, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS, Judge:

These cases were consolidated for purposes of

trial, briefing, and opinion.

- 2 Pursuant
determined

to

the

separate
following

notices

of

deficiency,

deficiencies

and

respondent

accuracy-related

penalties:
Richard C. and Hattie M. Martin, Docket No. 18241-97:
Year

Deficiency

Sec. 6662(a)

1992
1993
1994

$103,871
55,302
35,991

$20,774
11,060
7,198

William L. and Sylvia L. Martin, Docket No. 18247-97:
Year

Deficiency

Sec. 6662(a)

1992
1993
1994

$62,427
21,793
31,405

$12,485
4,359
6,281

Following concessions by the parties, the primary remaining
issue to be resolved is whether Cola Performance Products, Inc. is
to be recognized as a distinct taxable entity during 1992, 1993,
and

1994,

the

consequence

being

the

disallowance

of

certain

business losses individually claimed by petitioners for each of
those years.1

Also at issue is whether petitioners are liable for

section 6662(a) accuracy-related penalties.

1

William L. Martin acknowledged that he was not involved
in the automotive crankshaft manufacturing business at issue, and
therefore he and his wife concede that they are not entitled to
the business losses they individually claimed. They request that
all business losses for the years in issue be attributed to
Richard C. and Hattie M. Martin.

- 3 All section references are to the Internal Revenue Code and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulation of
facts is incorporated in our findings by this reference.
Petitioners Richard C. (Richard) and Hattie M. Martin, husband
and wife, and petitioners William L. (William) and Sylvia L.
Martin,

husband

and

wife,

resided

in

Rolling

Hills

Estates,

California, at the time they filed their respective petitions in
this Court contesting respondent's determinations.

Richard and

William are brothers.
Richard is a principal shareholder of a corporation that is
one of the largest commercial drywall, framing, and plastering
contractors in the Los Angeles area.

For many years, he had an

interest in car racing.
Formation of Cola, Inc.
In 1988, Richard and Raul Negrete (Raul) (formerly, the
general

manager

of

L.A.

Billet,

a

manufacturer

of

race

car

crankshafts) decided to form a corporation that would engage in the
business of manufacturing automotive crankshafts for race cars (the
business).

Both agreed to contribute $100,000 to the corporation.

On June 22, 1988, Richard's attorney, Mark A. Treadwell, of
Mantalica & Treadwell, filed the necessary corporate documentation

- 4 with

the

State

of

California.

Originally,

corporation was Motor Motion, Inc.

the

name

of

the

On July 11, 1988, the name of

the corporation was changed to Cola Performance Products, Inc.
(Cola, Inc.).

Cola is an acronym for Crankshafts of Los Angeles.

The first organizational meeting for Cola, Inc. was held on
July 22, 1988.

The minutes for that meeting (prepared by Mr.

Treadwell) reveal: (1) Corporate bylaws were adopted; (2) Raul and
Richard were elected directors of the company; (3) Raul was elected
president, and Richard was elected secretary/treasurer and chief
financial officer; (4) 200 shares of stock were authorized to be
issued and sold (100 shares to Raul and 100 shares to Richard)

at

a price of $25 per share; and (5) the company was authorized to
establish a bank account with Union Bank.
Shortly after the company was incorporated, Richard learned
that Raul would be financially unable to contribute to the business
because of a dispute with his prior business partner.

In the

latter part of 1988, Richard discussed this situation with his
accountant, Sam White (a partner in the accounting firm of Deloitte
&

Touche),

Hemphill.

and

the

controller

They

recommended

of

that

his
as

drywall
long

as

company,
Raul

Sandy

could

not

financially contribute to the business, the business should be
operated by Richard as a sole proprietorship.
No corporate stock was ever issued.

- 5 At all times during the years in issue (1992, 1993, and 1994),
Cola, Inc. was a California corporation in good standing.

As of

the date of trial, it had never been dissolved.
Equipment
In mid-1988, Richard purchased the equipment to operate the
business.

The equipment (crankshafts and grinding machines) was

purchased from L.A. Billet and others.

Richard paid for this and

other equipment, as well as furniture and fixtures, using funds
from his own bank accounts and credit lines.

These assets were

never contributed to Cola, Inc.
Lease Agreement
On July 21, 1988, Cola, Inc. entered into an agreement to
lease a building located at 19122 S. Santa Fe Avenue, Rancho
Dominguez, California (S. Santa Fe Avenue), which became the situs
for its business operation.

The lease was for a period of 60

months, commencing August 1, 1988, and was in existence at all
relevant times.
Bank Account and Financial Affairs
The bank account with Union Bank was utilized as the business'
operating account during the years in issue.

The checks used for

this account contained the imprint "Cola Performance Products,
Inc.". Checks drawn on Cola, Inc.'s bank account were used to pay:
(1) Vendors and suppliers of the business; (2) various business

- 6 expenses (such as utilities and telephone); and (3) rental payments
for the S. Santa Fe Avenue building.
Cola,

Inc.

issued

invoices

to

its

clients

(vendors

and

suppliers) with the imprint Cola, Inc. at the top of the invoices.
Moreover, Cola, Inc.'s vendors and suppliers issued invoices to
Cola, Inc. for goods and services the business purchased.
Cola, Inc. maintained a company credit card, which was used to
purchase goods and services for the business during 1992.

Cola,

Inc. also maintained a general ledger, cash receipts journals, and
sales journals.
Employer Identification Number
On

February

6,

1991,

Richard

applied

for

an

employer

identification number as an individual using the business trade
name "Cola Performance Products".

The Internal Revenue Service

assigned an identification number to him.

This number was used by

the business in filing returns and reports with State and Federal
tax authorities.
Lawsuits Filed Against Cola, Inc.
In August 1993, Beta Maskin AB (Beta Maskin), a Swedish
corporation, filed a civil action in the U.S. District Court for
the Central District of California against Cola, Inc., as well as
Richard and Raul individually, for failure to pay the contract
price of crankshafts Beta Maskin sold to Cola, Inc.
to this action, the defendants stated:

In the answer

- 7 Defendant Cola Performance Products, Inc. is at
this time, and was at all times relevant hereto, a fully
capitalized California corporation in good standing. Any
and all dealings between plaintiff and any of the
defendants were dealings between plaintiff and Cola
Performance Products, Inc. Defendants Dick Martin and
Raul Negrete were acting in their official capacities as
officers and directors of Cola Performance Products, Inc.
at all times relevant hereto, as was known to plaintiff
and its representatives. Therefore, defendants Martin
and Negrete, and each of them, have no liability to
plaintiff in this action.
During Richard's May 17, 1994, deposition, relating to the
Beta Maskin lawsuit, he stated:

(1) He owned 100 shares of Cola,

Inc.

held

stock;

(2)

Cola,

Inc.

regular

shareholders'

and

directors' meetings; (3) Cola, Inc. owned property such as grinding
equipment, mills, lathes, and other equipment for manufacturing
race car crankshafts; (4) he lent money to Cola, Inc. on several
occasions (as recent as 2 weeks prior to his deposition); and (5)
the debt owed to Beta Maskin was only that of Cola, Inc.
Further, during his deposition, Richard answered the question:
"What information do you have that leads you to believe that Mr.
Lindstrom [the owner of Beta Maskin] and Beta Maskin dealt with
Cola Performance Products as a corporation as opposed to you and
Mr. Negrete as individuals?" by stating: "Mr. Lindstrom dealt with
Cola Performance Products, period.

He didn't deal with us as

individuals under any conditions, never has. We don't operate that
way.

We operate as a corporation."

- 8 Raul also was deposed on May 17, 1994, and he corroborated the
statements Richard made in his deposition.
On

July

1,

1994,

contentions

of

facts

substantial

capital

the

and

defendants

law,

assets,

filed

asserting

a

that

stockholders,

memorandum
Cola,

a

Inc.

lease

for

of
had
a

manufacturing plant, and had engaged in a continuous course of
business activity since 1988.
In November 1994, the Beta Maskin lawsuit was settled. The
parties agreed that only Cola, Inc. was liable for the asserted
obligation to Beta Maskin.

Richard and Raul signed the settlement

agreement as officers of Cola, Inc.

A note payable was created on

Cola, Inc.'s general ledger reflecting Cola, Inc.'s obligation
under the settlement agreement.
Cola, Inc. was sued by other businesses with which it had
contracted; i.e., Axis Engineering in 1992, and Sterling Air Cargo,
Inc. in 1994.
Engineering

In satisfaction of the default judgment in the Axis

lawsuit,

Cola,

Inc.

issued

a

check

drawn

on

the

corporate bank account with the imprint "Cola Performance Products,
Inc."
Income Tax Returns
Petitioners timely filed Federal income tax returns for 1992,
1993, and 1994. They individually claimed losses on Schedules C of
their respective tax returns for those years with respect to the
automotive crankshaft business, as follows:

Richard and his wife,

- 9 Hattie, claimed Schedule C losses of $540,567, $173,480, and
$248,653 for 1992, 1993, and 1994, respectively; and William and
his wife, Sylvia, claimed Schedule C losses of $195,541, $66,991,
and $90,170 for 1992, 1993, and 1994, respectively.
Cola, Inc. filed corporate income tax returns (Forms 1120) for
1992, 1993, and 1994, reporting no taxable income or expenses
(other than a franchise tax fee paid to the State of California).
Respondent

disallowed

the

Schedule

C

losses

petitioners

claimed on their respective returns on the grounds: (1) The losses
belonged to Cola, Inc., and not petitioners as individuals; and (2)
petitioners failed to demonstrate that the losses were actually
incurred.
OPINION
Issue 1.
The

Characterization of Cola, Inc.
fundamental

issue

involved

is

whether

Cola,

Inc.

constituted a separate corporate taxable entity during 1992, 1993,
and 1994.

Respondent contends that it did, and accordingly, Cola,

Inc.'s losses were improperly deducted on petitioners' individual
returns.

On the other hand, petitioners maintain that shortly

after Cola, Inc.'s formation, Richard learned that Raul would be
unable to contribute capital to the corporation as anticipated and
consequently, Richard was forced to abandon the business' corporate
form and operated it as a sole proprietorship.

- 10 Generally, a corporation organized for the purpose of carrying
on a business activity constitutes a separate taxable entity.

See

Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943).

A

corporation will not be disregarded for Federal tax purposes if it
(1)

served

business.

an

intended

business

See id. at 438-439.

function,

or

(2)

engaged

in

However, if the corporate form is

a sham or unreal, it will be disregarded.

See

Higgins v. Smith,

308 U.S. 473, 477-478 (1940).
Once the taxpayer has elected to conduct his business affairs
in corporate form, the taxpayer must accept any tax disadvantages
of that form.

See id. at 477.

A taxpayer is not free to "turn

around and disclaim the business form he created in order to
realize a loss as his individual loss."

Sangers Home for Chronic

Patients, Inc. v. Commissioner, 72 T.C. 105, 116 (1979); see also
Barker v. Commissioner, T.C. Memo. 1993-280.
Whether a corporation exists or not is a matter of State law;
however, whether the corporate entity (if found to exist) should be
disregarded for Federal taxation purposes is a matter of Federal
law.

See Stoody v. Commissioner, 66 T.C. 710, 716-717 (1976).

Here, it is clear that Cola, Inc. was formed on June 22, 1988, as
a distinct corporate entity under California law and it continued
to be a valid, legally existing corporate body during the years at
issue.

And, for the reasons set forth below, we believe Cola,

- 11 Inc.'s corporate status for Federal tax purposes should not be
disregarded.
Cola, Inc. was not a sham.
purpose.
form,

It served an intended business

Indeed, in this regard, through Cola, Inc.'s corporate

Richard

liability.

and

Raul

insulated

themselves

from

individual

See, e.g., Strong v. Commissioner, 66 T.C. 12, 25

(1976), affd. without published opinion 553 F.2d 94 (2d Cir. 1977);
Bolger v. Commissioner, 59 T.C. 760 (1973). Most notably, this was
done when Beta Maskin filed a lawsuit against Cola, Inc., and
Richard and Raul.

Tellingly, in defending themselves, Richard and

Raul asserted that Cola, Inc. was "a fully capitalized California
corporation

in

good

standing",

and

that

they

acted

in

their

official capacities as officers and directors of Cola, Inc. in all
dealings with Beta Maskin.
In addition to serving an intended business function, Cola,
Inc. engaged in business activities.

It maintained a bank account

from which receipts and expenditures flowed.

It leased property

which was the situs of the automotive crankshaft manufacturing
business.

It maintained books and records.

clients.

It maintained a credit card.

It issued invoices to

And it held itself out to

the public as a distinct corporate entity.
We

are

convinced

that

Cola,

Inc.

engaged

in

sufficient

business activities so as to render it a separate taxable entity.
In this regard, whether or not a corporation is deemed to engage in

- 12 a business activity does not depend upon the quantum of business
activity but simply whether the entity engaged in some business
activity. See Dooley v. Commissioner, T.C. Memo. 1984-548 (citing
Britt v. United States, 431 F.2d 227 (5th Cir. 1970)); see also
Hospital Corp. of Am. v. Commissioner, 81 T.C. 520, 579-580 (1983);
Reed v. Commissioner, T.C. Memo. 1997-533.
Petitioners point to Blue Flame Gas Co. v. Commissioner, 54
T.C. 584 (1970), as factually similar to the case herein.

We

disagree.

articles

of

incorporation in Blue Flame, they operated as a partnership.

No

At

the

time

the

taxpayers

filed

property was contributed to the corporation, no business was
conducted, and the corporation was subsequently abandoned.

We

therein concluded that the losses were produced by the partnership.
See id. at 599.

The facts herein are clearly distinguishable from

those in Blue Flame.

Moreover, the taxpayer in Blue Flame "did not

seek the protective shield of corporate existence against business
creditors", id. at 600, in sharp contrast to what happened here.
In

sum,

the

losses

resulting

from

the

manufacture

of

crankshafts for race cars during the years in issue are those of
Cola,

Inc.,

and

not

those

of

petitioners.

Consequently,

petitioners are not entitled to deduct those losses on their
respective individual Federal income tax returns.

- 13 Issue 2.

Section 6662(a) Accuracy-Related Penalties

The other issue for decision is whether petitioners are liable
for the section 6662(a) accuracy-related penalties for the years in
issue.
Pursuant to section 6664(c)(1), a section 6662 penalty does
not apply to any portion of an underpayment if reasonable cause
existed and the taxpayers acted in good faith. Pursuant to section
1.6664-4(b)(1), Income Tax Regs., all facts and circumstances must
be examined in order to determine whether a taxpayer acted with
reasonable cause and in good faith.
Petitioners assert that they had reasonable cause to deduct
Cola, Inc.'s losses on their individual Federal income tax returns
for the years in issue.

They contend that they relied in good

faith upon Sam White who prepared their returns for the years in
issue.

Mr.

White

did

not

testify

due

to

the

fact

he

was

incarcerated at the time of trial.
In order to establish good faith reliance on the advice of an
adviser, the taxpayer must prove:

(1) He gave the return preparer

complete and accurate information, (2) an incorrect return was a
result of the preparer's mistakes, and (3) the taxpayer believed in
good faith that he was relying on a competent return preparer's
advice.
(1987).

See Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662

- 14 As to Richard and his wife, we are satisfied that they
reasonably relied upon the advice of Mr. White in claiming the
business losses on their individual tax returns for the years at
issue. After Richard learned that Raul would be financially unable
to contribute to the business, he met with Mr. White and Ms.
Hemphill.

Ms. Hemphill corroborated that such a meeting occurred.

She testified that, at this meeting, it was decided that "Cola
Performance would operate as a sole proprietorship and was not
going to operate as a corporation."
credible witness.

We found Ms. Hemphill to be a

Accordingly, we do not sustain respondent's

accuracy-related penalties determination as to Richard C. and
Hattie M. Martin for any of the years in issue.
However, as to William and his wife, we are not satisfied that
they reasonably relied upon the advice of Mr. White in claiming the
business losses on their individual tax returns for the years at
issue.

William testified that "Sam White came to me and said that

he * * * [believed] * * * that [I could] participate in some
losses.

And I said, if that's what you think I can do, be my

guest."

William and his wife, Sylvia, claimed Cola, Inc.'s losses

even though they were aware that they had neither an ownership
interest in, nor an involvement with, the business.

By doing so,

they did not act in good faith; we believe a reasonably prudent
person under the same circumstances would not have claimed the
losses.

Accordingly, we sustain respondent's accuracy-related

- 15 penalties determination as to William L. and Sylvia L. Martin for
1992, 1993, and 1994.
To reflect the foregoing and concessions of the parties,

Decisions will be
entered under Rule 155.

---

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