UNITED STATES TAX COURT
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T.C. Memo. 1996-288
UNITED STATES TAX COURT
JOSEPH NACHMAN, Petitioner v. COMMISSIONER OF
INTERNAL REVENUE, Respondent
Docket No. 623-94.
Filed June 20, 1996.
Joseph Nachman, pro se.
Brian Condon, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COLVIN, Judge:
Respondent determined that, for 1988,
petitioner is liable for a deficiency in Federal income tax of
$63,600 and additions to tax of $10,779 for failure to timely
file under section 6651(a) and $3,281 for negligence under
section 6653(a)(1).
- 2 After concessions,1 the issues for decision are:
1.
Whether petitioner's transfer of $350,000 to Swirl, Inc.
(Swirl), in October 1986 was a loan or a contribution to capital.
We hold that it was a loan.
2.
Whether, based on our holding that petitioner lent
$350,000 to Swirl, petitioner may deduct as a bad debt $290,325,
as respondent contends; $308,000, as petitioner contends; or some
other amount.
We hold that petitioner may deduct the amount that
Swirl owed petitioner less the amount that petitioner owed Swirl
on December 31, 1988.
3.
Whether petitioner is liable for the addition to tax for
failure to file under section 6651(a).
We hold that he is.
Section references are to the Internal Revenue Code in
effect for the year in issue.
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.
A.
Petitioner
Petitioner lived in New York City when he filed the
petition.
Petitioner received a bachelor of science degree in
economics from the Wharton School at the University of
Pennsylvania in 1968.
Larry Nachman is petitioner's brother.
1
Respondent concedes that petitioner is not liable for the
addition to tax for negligence for 1988.
- 3 B.
Swirl, Inc.
Swirl was incorporated in South Carolina on March 4, 1954.
Swirl's sales and executive offices were in New York City.
Swirl
owned 100 percent of the voting stock of Swirl Sales, Inc.
(Swirl Sales), and Easley Realty Co. (Easley).
incorporated in New York.
Carolina.
Swirl Sales was
Easley was incorporated in South
Swirl and Swirl Sales designed, manufactured, and
distributed women's robes, loungewear, and intimate apparel which
were sold to specialty stores in the United States, Canada,
Japan, Great Britain, Germany, France, and the Middle East.
C.
Petitioner's Employment By and 50 Percent Ownership
Of Swirl
Petitioner began to work in the sales and executive offices
of Swirl in 1970.
Petitioner became assistant to the president
in 1972, vice president in 1975, and executive vice president and
co-chief executive officer in 1979.
Petitioner and his brother
began to manage Swirl in 1975.
Petitioner and his brother each acquired 50 percent of
Swirl's stock in 1979.
Petitioner became Swirl's president and
co-chief executive officer in 1983.
Almost all of petitioner's
income from 1970 to 1988 was from Swirl.
Petitioner and his brother obtained a 50-percent-undivided
interest in the Easley Plant and a 40-percent-undivided interest
in Ware Place at a date not specified in the record.
The Easley
- 4 Plant and Ware Place are parcels of land and facilities in South
Carolina.
In 1982, petitioner and his brother bought Swirl's main
manufacturing and distribution facility for $625,000 (facility
purchase).
Petitioner and his brother each executed a purchase
money mortgage for $312,500.
The purchase money mortgages
required petitioner and his brother to pay interest for the first
5 years and to repay the principal over 10 years.
his brother rented the facility to Swirl.
Petitioner and
Petitioner's share of
Swirl's rental payments was about $140,000 per year starting in
1985.
Swirl's net sales and net profits (losses) were as follows:
Fiscal Year
Net Sales
Net Profits (Loss)
1983
$19,450,740
($23,342)
1984
21,692,838
(260,531)
1985
21,453,412
101,728
1986
18,108,296
(658,144)
1987
16,127,276
(272,197)
96,832,562
(1,112,486)
In May 1985, petitioner lent $270,000 to Swirl.
The May
1985 loan was subordinated to the claims of all Swirl creditors.
Swirl paid about $30,000 of interest each year to petitioner on
this loan.
In 1986, Swirl ended its licensing agreement with Bill Tice,
one of its designers.
As a result, Swirl had losses.
Shortly
- 5 after Swirl ended the Bill Tice agreement, Swirl introduced the
Oscar de la Renta product line under a business plan it designed
to eliminate the losses.
D.
Swirl's Line of Credit With Chemical Bank
In the mid-1980's, Swirl had a $3.8 million line of credit
with Chemical Bank which was secured by Swirl's trade accounts
receivable, machinery and equipment.
Swirl had borrowed $3.3
million against its line of credit by January 1986.
In January 1986, Chemical Bank became unhappy with Swirl as
a customer.
Chemical Bank believed that Swirl was not meeting
the standards Chemical Bank set for its borrowers.
froze Swirl's line of credit in January 1986.
Chemical Bank
At that time,
Swirl had serious financial difficulties and needed the line of
credit for working capital.
Lack of working capital precluded
Swirl from buying enough raw materials and filling orders.
Swirl began to lose money.
Chemical Bank told Swirl in March 1986 that it no longer
wanted to have Swirl as a customer and wanted another lender to
assume the $3.3 million line of credit.
Chemical Bank had a workout division which handled loans it
made to companies that were financially troubled.
The workout
division tried to maximize Chemical Bank's recovery on loans by
liquidating the loans or by taking other steps.
The workout
division generally did not help borrowers find new financing; it
concentrated on trying to get borrowers to repay the loans.
- 6 Chemical Bank transferred Swirl's account to its workout division
in March 1986.
Swirl needed about $3.8 million to operate, but only had
enough collateral to secure a $3.3 million loan.
Swirl sought
debt financing from five lenders but was not successful.
No
lender would lend Swirl $3.8 million without additional
collateral from Swirl or a capital infusion from Chemical Bank.
In May 1986, Swirl hired Financo, Inc. (Financo), a subsidiary of
Shearson Lehman Brothers, Inc., to find a buyer or investor for
Swirl.
E.
Financo found neither.
Chemical Bank and Swirl's New Financing Arrangement
1.
The New Agreement
In September 1986, Chemical Bank told Swirl that it was
willing to continue to lend funds to Swirl if its financing
arrangement could be restructured.
Swirl and Chemical Bank
executed a new financing agreement (new agreement) on October 15,
1986, which gave Swirl a revolving line of credit secured by 80
percent of the net amount of its receivables.
About $1.5 million
of the old line of credit was replaced by two promissory notes
payable to Chemical Bank.
The promissory notes required Swirl to
pay eight quarterly installments of $187,500 starting on
January 15, 1987, and interest at a rate of 2 percent higher than
Chemical Bank's prime rate.
The promissory notes were secured by
Swirl's accounts receivables, machinery and equipment, and the
cash surrender value of its officers' life insurance.
- 7 As part of restructuring Swirl's debt, Chemical Bank
required petitioner to grant a $1 million lien on his personal
residence.
Chemical Bank reduced the amount of the lien to
$450,000 in April 1987.
Chemical Bank also required petitioner
and his brother to make $500,000 available to Swirl as working
capital.
2.
Petitioner's Transfer of $350,000 to Swirl in
October 1986
Petitioner and his brother borrowed $500,000 from Nathan
Addelstone (Addelstone) (not identified in the record) in October
1986.
They executed a second mortgage on the Easley Plant and
Ware Place as collateral.
Petitioner borrowed $150,000 from Jack
Lehman (Lehman) in October 1986.
On October 27, 1986, petitioner transferred2 $350,000 to
Swirl in exchange for two promissory notes.
This amount included
$250,000 from petitioner's one-half share of the Addelstone loan
and $100,000 from the Lehman loan.
Swirl agreed to pay interest
of prime plus 2 ½ percent monthly starting on November 1, 1986,
and to make a balloon payment of the principal on April 1, 1988.
The notes were subordinated to the claims of Swirl's other
creditors.
Also on October 27, 1986, petitioner's brother
transferred $250,000, the other half of the Addlestone loan, to
Swirl.
2
By using the terms "transfer" or “advance”, we do not
intend to characterize the transaction as debt or equity.
- 8 Swirl used the $600,000 for working capital.
Swirl reported
the transaction as a loan from stockholders in its financial
statements dated December 31, 1986, June 30, 1987, and
December 31, 1987.
Swirl paid interest to petitioner quarterly.
Swirl paid
about $56,841 in interest on the notes, from November 1, 1986, to
July 2, 1988.
In April 1987, petitioner and Swirl changed the
maturity date on the notes from April 1 to September 15, 1988.
Later, they changed the maturity date from September 15 to
October 15, 1988.
F.
Petitioner and His Brother's Resignation From and Sale of
Swirl
1.
Sale of Swirl
On May 13, 1988, Swirl, Swirl Sales, Easley, Chemical Bank,
petitioner, and petitioner's brother agreed to restructure some
of Swirl's debt to Chemical Bank.
Shortly thereafter, Chemical
Bank told petitioner that it wanted to end its lending
relationship with Swirl.
Swirl hired Anthony Gasson (Gasson) in July 1988, to arrange
new debt financing for Swirl.
Gasson specialized in finding
buyers and lenders for troubled companies.
Swirl hired Joseph
Santalarsci (Santalarsci), an investment banker, in September
1988 to find a buyer for Swirl.
- 9 Petitioner and his brother resigned from Swirl in October
1988.
In October 1988, Santalarsci and Gasson sought offers to
buy Swirl.
2.
In January 1989, four parties offered to buy Swirl.
The Three Rejected Offers
I. Appel Corp. offered to buy some of Swirl's assets.
L.G.
Strelecki, on behalf of a company to be incorporated as L.G.
Strelecki & Associates, offered to assume some of Swirl's
liabilities in exchange for specific assets.
The Shearson Group
offered to assume some of Swirl's liabilities in exchange for
specific Swirl assets.
3.
Swirl rejected these offers.
The Accepted Offer
On January 24, 1989, the Sandhurst Co. (Sandhurst) offered
to acquire substantially all of Swirl's assets and liabilities.
Swirl accepted Sandhurst's offer.
New Swirl, Inc. (New Swirl), was incorporated and bought
Swirl's assets in November 1989.
New Swirl's shareholders were
Sandhurst Venture Fund-I, L.P., Whitby Santalarsci & Company,
and T.G. Capital, Inc.
New Swirl did not buy any Swirl stock
or assume Swirl's liabilities to petitioner or his brother.
Petitioner did not sue to recover any unpaid interest or
principal on the notes from Swirl.
G.
Petitioner's 1988 Tax Return
Jeffrey Elias (Elias), a certified public accountant at
Weinick Sanders & Company, was petitioner's accountant.
prepared petitioner's 1988 tax return.
He
Elias discussed the 1988
- 10 return with petitioner before completing it.
petitioner's losses from Swirl.
Elias estimated
Elias filed a request to extend
the time to file petitioner's 1988 tax return to August 15, 1989
(Form 4868).
Petitioner estimated on the Form 4868 that he had
no additional tax liability for 1988.
On August 19, 1989,
petitioner requested an extension of time to file his 1988 return
to October 15, 1989, which respondent granted.
Elias expected petitioner to receive a refund for 1988.
In
calculating petitioner's potential tax liability, Elias concluded
that petitioner owed Swirl $42,500 ($312,500 that petitioner owed
to Swirl from the facility purchase minus $270,000 that Swirl
owed to petitioner from the May 1985 loan).
He also concluded
that petitioner was entitled to deduct a bad debt loss of
$307,500 ($350,000 transferred to Swirl minus $42,500).
H.
Petitioner's Financial Records
Petitioner was involved in a divorce proceeding from July
1988 to May 1989.
He gave his financial records to the law firm
which represented him.
After the divorce proceeding ended,
petitioner stored his financial records and other personal
belongings.
Petitioner found the financial records in July 1990.
Petitioner filed his 1988 return on October 17, 1990.
deducted $308,000 for his bad debt to Swirl.
a $20,486 refund.
He
Petitioner claimed
Respondent refunded that amount to petitioner
on November 19, 1990.
- 11 OPINION
A.
Whether the $350,000 Petitioner Transferred to Swirl
Was Debt or Equity
1.
Background and Contentions of the Parties
Petitioner transferred $350,000 to Swirl on October 27,
1986.
He deducted $308,000 of that amount as a bad debt on his
1988 return.
Sec. 166(a)(1).
Respondent determined and contends
that the $350,000 payment was a capital contribution.3
Whether a payment to a corporation is a contribution to
capital or a loan is a question of fact.
Gilbert v.
Commissioner, 262 F.2d 512, 513 (2d Cir. 1959), affg. T.C. Memo.
1958-8.
controls.
The substance and not the form of the transaction
Gregory v. Helvering, 293 U.S. 465 (1935); 1432
Broadway Corp. v. Commissioner, 160 F.2d 885 (2d Cir. 1945),
affg. 4 T.C. 1158 (1945).
We apply special scrutiny because
petitioner transferred the funds in issue to his closely held
corporation.
Fin Hay Realty Co. v. United States, 398 F.2d 694,
697 (3d Cir. 1968).
The factors we consider in deciding whether payments to a
corporation are debt or equity include:
(a) The name given to
the certificate evidencing the indebtedness; (b) whether there is
a fixed maturity date; (c) whether the party providing the funds
3
Respondent concedes that, if the $350,000 is debt,
petitioner may claim a business bad debt deduction under sec.
166(a).
- 12 can enforce payment; (d) the source of the payments; (e) whether
the party providing the funds is given an increased participation
in management; (f) the intent of the parties; (g) whether the
corporation is adequately capitalized; (h) whether interest is
paid; (i) whether the corporation can obtain loans from outside
lenders; (j) the extent to which the corporation uses the advance
to acquire capital assets; (k) whether shareholders provide funds
in proportion to their stock interests; (l) whether the business
repaid the amount advanced when due; and (m) whether
the business’ obligation to repay the advance is subordinated to
other creditors.
Selfe v. United States, 778 F.2d 769, 773-774
n.9 (11th Cir. 1985); American Offshore, Inc. v. Commissioner, 97
T.C. 579, 602-606 (1991); Dixie Dairies Corp. v. Commissioner, 74
T.C. 476, 493 (1980); Georgia-Pacific Corp. v. Commissioner, 63
T.C. 790, 796-800 (1975).
No single factor controls.
John
Kelley Co. v. Commissioner, 326 U.S. 521, 530 (1946); Plantation
Patterns, Inc. v. Commissioner, 462 F.2d 712, 719 (5th Cir.
1972), affg. T.C. Memo. 1970-182; Georgia-Pacific Corp. v.
Commissioner, supra; Blum v. Commissioner, 59 T.C. 436, 440
(1972); see also American-LaFrance-Foamite Corp. v. Commissioner,
T.C. Memo. 1959-101, affd. 284 F.2d 723 (2d Cir. 1960).
2.
Factors Favoring Petitioner
a.
Name Given to the Certificate Evidencing the
Indebtedness
- 13 Respondent concedes that petitioner's transfer of $350,000
to Swirl has all the formal indicia of a loan; e.g., Swirl gave
two promissory notes that provided for the payment of interest in
exchange for the transfer; Swirl treated the transfer as a loan
on its financial statements and tax return; and petitioner
reported Swirl's payments as interest income on his tax returns.
This factor suggests that the transfer was a loan.
b.
Whether the Party Providing the Funds Can
Enforce Payment
A definite obligation to repay an advance suggests that it
is a loan.
603.
American Offshore, Inc. v. Commissioner, supra at
Petitioner had the right to enforce payments on the notes.
If any payment was past due, petitioner could accelerate the
payments due on the notes and collect those amounts and any
remaining principal.
This factor suggests that the transfer was
a loan.
c.
Whether There Is a Fixed Maturity Date
The absence of a fixed maturity date suggests that a
transfer is equity.
supra at 602.
date.
American Offshore, Inc. v. Commissioner,
Swirl’s promissory notes included a fixed maturity
However, respondent points out petitioner agreed to delay
the maturity date of the notes from April 1 to September 15,
1988, and then to October 15, 1988.
Respondent cites Ambassador
Apartments, Inc. v. Commissioner, 50 T.C. 236 (1968), affd. 406
F.2d 288 (2d Cir. 1969) for the proposition that the delay in the
- 14 maturity date shows petitioner had no desire to protect his
interest as a creditor, suggesting that the transfer was equity.
In Ambassador Apartments. Inc., the taxpayers transferred assets
to a corporation in exchange for stock and a promissory note.
Id. at 239.
The note required monthly payments of principal and
interest for 10 years and payment of the balance due after 10
years.
Id.
The taxpayer and corporation later agreed to relieve
the corporation of its obligation to pay principal and interest
for 5 years.
Id.
We held that this modification showed that the
transfer was equity.
Id. at 246.
The facts here are different from those in Ambassador
Apartments.
Petitioner and Swirl changed the maturity date:
There was no obligation to amortize principal.
We believe that
petitioner was interested in protecting his rights as a creditor.
This factor suggests that the transfer was a loan.
d.
Source of the Payments
If repayment of principal or interest is required only if
the corporation has earnings, the advance is more likely to be
equity.
Estate of Mixon v. United States, 464 F.2d 394, 405 (5th
Cir. 1972); American Offshore, Inc. v. Commissioner, supra at
602.
The notes required Swirl to pay petitioner interest each
month and to pay the principal on April 1, 1988.
The note did
not make repayment of principal or interest dependent upon Swirl
- 15 having earnings.
This factor suggests that the transfer was a
loan.
e.
Whether the Party Providing the Funds is Given
an Increased Participation in Management
A taxpayer's payment is more like equity if, in exchange for
it, the taxpayer is given an increased right to participate in
management.
603.
American Offshore, Inc. v. Commissioner, supra at
Petitioner's transfer of $350,000 did not increase his
right to participate in Swirl's management.
This factor suggests
that the transfer was a loan.
f.
Intent of the Parties
The intent of the parties may show whether a transfer of
funds was debt or equity.
Commissioner, supra at 246.
Ambassador Apartments, Inc. v.
If a corporation does not make
required payments or a shareholder does not enforce his or her
right to receive payments, an advance appears more like equity
than debt.
Id.
Petitioner testified that he and Swirl intended the transfer
to be a loan.
Swirl treated the notes as debt on its financial
statements and Federal income tax returns.
Petitioner reported
Swirl's payments as interest income on his tax returns.
Respondent points out that petitioner did not sue Swirl or
New Swirl to recover amounts due under the notes.
Respondent
contends that this fact and the fact that Swirl did not repay the
- 16 principal amount of the note show that petitioner's transfer was
equity.
We disagree.
Petitioner testified that he did not want to spend money and
effort in a futile attempt to collect.
Another reason for not
suing was to avoid problems with Chemical Bank.
Chemical Bank
set the terms by which Sandhurst acquired Swirl.
Gasson
testified that, if petitioner had insisted that Swirl or New
Swirl repay amounts due on the notes, Chemical Bank would have
not agreed to the sale to Sandhurst.
After examining all the
facts, i.e., how petitioner and Swirl treated the advance on
financial statements and tax returns and that petitioner did not
sue on the notes, we conclude that Swirl and petitioner intended
the advance to be loan.
This factor suggests that the transfer
was a loan.
g.
Whether the Borrower Is Adequately Capitalized
An advance to a corporation is more likely to be equity if
the corporation is thinly capitalized.
Gilbert v. Commissioner,
248 F.2d 399, 407 (2d Cir. 1957), remanding T.C. Memo. 1956-137;
American Offshore, Inc. v. Commissioner, 97 T.C. at 604.
To
calculate a debt to equity ratio, we compare a corporation’s
total liabilities to its stockholders' equity.
Bauer v.
Commissioner, 748 F.2d 1365, 1369 (9th Cir. 1984), revg. T.C.
Memo. 1983-120.
The difference between assets and liabilities
is stockholders' equity.
Bauer v. Commissioner, supra at 1369.
- 17 No specific ratio of debt to equity determines whether a
corporation is adequately capitalized.
2554-58 Creston Corp. v.
Commissioner, 40 T.C. 932, 937 n.3 (1963).
We have held that
debt to equity ratios of 800 to 1, American Offshore, Inc. v.
Commissioner, supra at 604; 205 to 1, 2554-58 Creston Corp. v.
Commissioner, supra at 937; and 123 to 1, Ambassador Apartments
v. Commissioner, supra at 245, showed that an advance was equity.
In Bauer v. Commissioner, supra at 1370, the U.S. Court of
Appeals for the Ninth Circuit held that debt to equity ratios
ranging from 2 to 1 to almost 8 to 1 did not show that advances
were equity.
In Kraft Foods Co. v. Commissioner, 232 F.2d 118,
127 (2d Cir. 1956), the U.S. Court of Appeals for the Second
Circuit held that a debt to equity ratio of .77 to 1 did not show
that advances were equity.
Swirl's debt to equity ratios were as follows:
Year
1983
1984
1985
1986
1987
Liabilities
$5,171,502
6,382,277
5,876,278
6,807,846
6,667,408
Equity
$2,234,108
1,973,577
2,075,305
1,417,161
1,144,964
Debt-Equity Ratio
2.31 to 1
3.23 to 1
2.83 to 1
4.89 to 1
5.82 to 1
This chart is based on audited fiscal yearend Swirl
financial statistics.
Based on an unaudited mid-fiscal-year
Swirl balance sheet, respondent contends that Swirl’s debt to
equity ratio was 6.4 to 1 on December 31, 1987.
Even if
respondent's computation is proper, these ratios do not establish
- 18 that petitioner’s transfer to Swirl was equity.
This ratio is
consistent with holdings that the transfer was a loan.
h.
Whether Interest is Paid
A shareholder's failure to insist on receiving interest may
show that his or her relationship to the corporation is more like
that of a shareholder than a creditor.
v. Commissioner, supra at 605.
American Offshore, Inc.
See also Stinnett's Pontiac Serv.
v. Commissioner, 730 F.2d 634, 640 (11th Cir. 1984), affg. T.C.
Memo. 1982-314.
The promissory notes Swirl exchanged for petitioner's
$350,000 advance required Swirl to make monthly interest payments
based on an interest rate of prime plus 2 ½ percent starting on
November 1, 1986.
Swirl paid interest to petitioner quarterly.
Swirl paid a substantial amount of interest on the notes.
Respondent contends that the advance was equity because,
from November 1, 1986, to July 2, 1988, Swirl paid interest to
petitioner quarterly instead of monthly, and because Swirl paid
petitioner less than the full amount of the interest it owed on
the notes.
Respondent concedes that Swirl paid petitioner about
two-thirds or three-fourths of the interest it owed petitioner.
Even though Swirl paid only quarterly and did not pay all
required interest, we believe that petitioner was concerned about
and did receive a substantial amount of interest.
suggests that the transfer was a loan.
This factor
- 19 i.
The Extent to Which the Advance Is Used To
Acquire Capital Assets
An advance is more like equity if it is used to acquire
capital assets.
410.
Estate of Mixon v. United States, 464 F.2d at
Swirl used the $600,000 transferred by petitioner and his
brother as working capital.
This factor suggests that the
transfer was a loan.
3.
Factors Which Are Neutral
a.
Whether an Outside Lender Would Have Lent Funds
to the Corporation When The Advance Was Made
If an outside source would not lend funds to a corporation
when funds are advanced by a shareholder, the advance is more
likely to be equity.
Estate of Mixon v. United States, 464 F.2d
at 410; American Offshore, Inc. v. Commissioner, supra at 605.
If the shareholder's advance was made under terms that are far
more speculative than an outside lender would accept, the advance
is likely to be a loan in name only.
Fin Hay Realty Co. v.
United States, 398 F.2d at 697; Segel v. Commissioner, 89 T.C.
816, 828 (1987).
Respondent contends that no reasonable lender would lend
money to Swirl when petitioner made the $350,000 advance because
Swirl had losses in 3 of the 4 fiscal years before petitioner
made the advance in 1986, Chemical Bank wanted to end its
lending relationship with Swirl, and Swirl had a working capital
shortfall which created losses of about $1 million from
September 30, 1985, to September 30, 1986.
Respondent also
- 20 points out that five potential lenders refused to replace
Chemical Bank as Swirl's creditor.
Respondent contends that this
shows that Swirl could not borrow funds from an outside source
when petitioner transferred the $350,000 in October 1986.
disagree.
We
First, Swirl had a profit in 1985, the year preceding
the year petitioner made the advance at issue.
Second, in
September 1986, Chemical Bank told Swirl that it would not
require Swirl to find new financing.
In October 1986, Chemical
Bank executed the new agreement with Swirl.
The execution of the
new agreement shows that Swirl could continue to borrow funds
from an outside lender.
However, the new agreement with Chemical Bank required
petitioner and his brother to provide $500,000 of working capital
to Swirl.
Petitioner has not shown that an outside lender would
have provided funds to Swirl under the same terms as were
accepted by Petitioner and his brother.
Because Swirl could
borrow funds when petitioner made the advance, but not under the
same terms, we conclude that this factor is neutral.
b.
Whether Shareholders Provide Funds In Proportion
to Their Stock Interest
An advance is more likely to be equity if it is
proportionate to the shareholder's stock ownership.
Commissioner, supra at 830.
Segel v.
A sharply disproportionate ratio
between a stockholder's percentage stock holdings and debt,
however, may indicate that the advance is debt.
American
- 21 Offshore, Inc. v. Commissioner, 97 T.C. at 604-605; Leach Corp.
v. Commissioner, 30 T.C. 563, 579 (1958).
Petitioner and his brother each held 50 percent of Swirl's
stock.
Petitioner advanced $350,000, and his brother advanced
$250,000.
The $350,000 is about 58 percent of $600,000 ($350,000
plus $250,000).
Petitioner's advance was neither proportionate
nor sharply disproportionate to his share of Swirl stock.
This
factor is neutral.
4.
Factors Which Favor Respondent
a.
Whether The Loan is Subordinated to Other
Obligations
If repayment of an advance is subordinated to claims of
other creditors, it is more likely to be equity.
American
Offshore, Inc. v. Commissioner, supra at 603; Ambassador
Apartments, Inc. v. Commissioner, 50 T.C. at 246; 2554-58 Creston
Corp. v. Commissioner, 40 T.C. at 937 n.3.
The notes petitioner
received from Swirl were subordinated to the interests of
Chemical Bank.
This factor suggests that the transfer was
equity.
b.
Whether Swirl Repaid the Amount Advanced When Due
Subsequent payment history may show whether the recipient
of an advance intended to repay it when it was made.
American
Offshore, Inc. v. Commissioner, supra at 606; see Diamond Bros.
Co. v. Commissioner, 322 F.2d 725, 732 (3d Cir. 1963), affg. T.C.
Memo. 1962-132; Wilbur Sec. Co. v. Commissioner, 279 F.2d 657,
- 22 662 (9th Cir. 1960), affg. 31 T.C. 938 (1959).
This could be the
case if it appears that the recipient of the transfer treats an
obligation to repay the transfer as less bona fide than its other
obligations, such as, for example, if the recipient of the funds
paid other expenses or made other payments to the person
providing the funds while not repaying the advance at issue.
Swirl did not pay petitioner the principal on the notes, and New
Swirl did not assume petitioner's $350,000 advance as a
liability, even though it bought Swirl’s assets and assumed most
of its liabilities.
This factor suggests that the transfer was
equity.
5.
Conclusion
While no single factor controls, according to the
preponderance of the evidence, we hold that petitioner's $350,000
advance was debt.
B.
The Amount of Petitioner’s Bad Debt Deduction for 19884
1.
Petitioner's Calculation
Elias calculated petitioner's 1988 bad debt deduction by
netting the face amounts of the facility purchase mortgage, the
May 1985 loan, and the $350,000 October 1986 loan.
Elias first
subtracted $270,000, the amount of the May 1985 loan which Swirl
was required to pay petitioner, from $312,500, the face amount of
the facility purchase mortgage which petitioner owed to Swirl,
4
The parties agree that if the advance is debt it became
worthless in 1988.
- 23 yielding $42,500 that petitioner owed to Swirl.
He then
subtracted the remaining $42,500 from the $350,000 yielding
$307,500.
Petitioner deducted $308,0005 for his bad debt from
Swirl.
2.
Respondent's Calculation
Respondent and petitioner used the same three transactions
to calculate petitioner’s 1988 bad debt deduction.
However,
respondent used loan balances from a March 31, 1989, balance
sheet.
Respondent used the $154,175 balance on the facilities
mortgage that petitioner owed to Swirl.
Respondent subtracted
the $94,500 balance on the May 1985 loan that Swirl owed to
petitioner, yielding $59,675 that petitioner owed to Swirl.
Respondent subtracted $59,675 from petitioner’s October 1986
$350,000 loan to Swirl, yielding $290,325.
Thus, respondent
contends that if petitioner had a bad debt, then petitioner may
deduct only $290,325.
3.
Analysis
The following compares petitioner’s and respondent’s
computations:
5
Petitioner apparently made a $500 error, which he has not
explained.
- 24 Transaction
Petitioner’s
Calculation
Respondent’s
Calculation
Facilities mortgage
May 1985 loan
October 1986 loan
($312,500)
270,000
350,000
($154,175)
94,500
350,000
Net amount owed to
petitioner
307,500
290,325
We disagree with both parties’ calculations in part because
they used improper amounts for the facilities mortgage and the
May 1985 loan.
We disagree with petitioner’s calculation because
petitioner used the original face amounts of the loans.
We
disagree with respondent’s calculation because respondent used
balances on March 31, 1989.
The parties should have used the
balances on December 31, 1988.
We would conclude that petitioner might deduct as a bad debt
for 1988, the net amount of the balances on December 31, 1988, of
the facilities mortgage, May 1985 loan, and October 1986 loan if
the record included those amounts.
However, it does not.
Petitioner has the burden of proof on this issue.
Welch v. Helvering, 290 U.S. 111, 115 (1933).
Rule 142(a);
Thus, we limit
petitioner's deduction to $290,325.
C.
Whether Petitioner Is Liable for the Addition to Tax
for Failure To File
Respondent determined that petitioner is liable for the
addition to tax under section 6651(a)(1) for not timely filing
his tax return.
A taxpayer is not liable for this addition to
tax if he or she shows that the failure to file was due to
- 25 reasonable cause and not willful neglect.
Sec. 6651(a)(1).
Reasonable cause means that the taxpayer exercised ordinary
business care and prudence, but could not timely file the return.
Sec. 301.6651-1(c)(1), Proced. & Admin. Regs.
Petitioner contends that he had reasonable cause for not
filing by October 15, 1989, because he did not have his financial
records until July 1990.
We have held that an illness which kept
taxpayers from their records was reasonable cause for late
filing.
Hayes v. Commissioner, T.C. Memo. 1967-80.
However,
here, petitioner did not claim illness or similar reason for not
having his records.
Rather, he testified that his records were
in storage in a room about 6 feet high, 7 feet wide and 9 feet
long, packed with furniture and boxes.
He looked for the box,
but did not find it until he moved everything out of the storage
area in July 1990.
He had his records in storage since May 1989.
Petitioner did not explain why there was a 3-month delay between
when he found his records (July 1990) and when he filed his
return (October 1990).
Petitioner contends that he had reasonable cause for not
filing earlier because he believed that he would get a refund.
We have held that a taxpayer's failure to timely file a return
because he or she believed no taxes were due is not reasonable
cause under section 6651(a)(1).
Colbert v. Commissioner, T.C.
Memo. 1992-30; Worm v. Commissioner, T.C. Memo. 1980-481;
Armaganian v. Commissioner, T.C. Memo. 1978-305; Fox v.
- 26 Commissioner, T.C. Memo. 1975-64; Lowe v. Commissioner, T.C.
Memo. 1955-150.
We hold that petitioner is liable for the addition to tax
for failure to timely file his 1988 tax return.
To reflect the foregoing and concessions,
Decision will be entered
under Rule 155.
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