Appendix — Ocean Sands Holding Corp. v. Commissioner

Office - Supreme Court, Us]

82-2081] FILED

JUN 20 1943

ALEXANDER L. STEVAS,

CLERK

No.

IN THE SUPREME COURT

OF THE UNITED STATES

October Term, 1982

OCEAN SANDS HOLDING CORPORATION,

a Virginia Corporation, et al.,

Petitioners,

Vv.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

APPENDIX TO

PETITION FOR A WRIT OF CERTIORARI

FROM THE UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

Carter R. Anderson, Jr.

Counsel for Petitioners

2240 N. Great Neck Road

Virginia Beach, Virginia

23451

Carter R. Anderson, Jr.

Counsel of Record

2240 N. Great Neck Road

Virginia Beach, Virginia

23451

(804) 481-4646

June 17, 1983

Fate he Ria <

T.

C. Memo. 1980-423

UNITED STATES TAX COURT

OCEAN SANDS HOLDING CORPORATION,

A VIRGINIA CORPORATION, et al.,

Petitioners

v. COMMISSIONER OF INTERNAL REVENUE,

Docket Nos.

Respondent

4261-72,

5139-76,

5143-76,

7352-76,

4929-77,

4509-77,

8027-78,

4262-72,

4140-76,

5976-76,

4927-77,

4930-77,

4510-77,

8028-78,

4728-75

5142-76

6602-76

4928-77

7489-77

7560-77

8029-78

Filed September 23, 1980

Russell W. Chaplain, Sr., pro se in

docket Nos. 4262-72, 5976-76, 7510-77

and 8027-78.

Allen J. Gordon for all other

petitioners.

John C. McDougal and Michael R.

Moore, for the respondent.

1 Cases of the following petitioners

are consolidated herewith; Russell W.

Chaplain and Elsie C. Chaplain, docket

No. 4262-72; Russell W. Chaplain, Jr.,

and Mary H. Chaplain, docket Nos. 4728-

75, 7352-76, 7509-77; Sea Fin Holding

Corporation, docket Nos. 5139-76, 4930-

A-1

77; Ocean Sands Holding Corporation,

docket No. 5140-76, 4928-76; Chattel

Corporation, docket No. 5141-76; Sea

Star Corporation, docket Nos. 5142-76,

4929-77; Colony Holding Corporation,

docket Nos. 4153-76, 4927-77; Russell W.

Chaplain, Sr. and Elsie C. Chaplain,

docket Nos. 5976-76, 7510-77; William J.

Newton, III and Linda G. Thornton,

formerly Linda G. Newton, docket Nos.

6602-76, William G. Chaplain and Sandra

B. Chaplain, docket Nos. 7489-77, 8028-

78; Russell W. Chaplain, Sr. and Elsie

C. Chaplain, docket No. 8027-78; William

J. Newton, III and Linda G. Thornton,

nee Linda G. Chaplain, formerly Linda G.

Newton, docket No. 8029-78.

a

MEMORANDUM FINDINGS OF FACT AND OPINION

FEATHERSTON, Judge: These con-

solidated cases were tried before

Special Trial Judge Lehnmann C. Aaron

pursuant to Rule 180, Tax Court Rules of

Practice and Procedure, His report was

served on the parties, and both parties

filed exceptions. After careful con-

sideration, the Special Trial Judge's

report, which is set forth below, is

adopted with minor modifications.

REPORT OF SPECIAL TRIAL JUDGE*

AARON, Special Trial Judge:

Respondent determined deficiencies in

petitioners’ federal income tax and

additions to tax in these twenty-two

consolidated cases as follows:

ad This report is prepared pursuant to

Rule 182(b), Rules of Practice and

Procedure of the United States Tax

Court. a-3

4261-72

4261-72

4261-72

5140-76

5140-76

4928-77

5143-76

4927-77

5139-76

5139-76

4930-77

Ocean Sands Holding Corporation

Additions to the Tax

Deficiency Sec. 6653(a)

$ 8,914.42 $ 445.71

52,926.15 2,646.31

53,175.15 2,658.76

43,758.90

25,854.31

35,407.27

Colony Holding Corporation

$57,550.48

56,467.60

Sea Fin Holding Corporation

$55,352.02

48,797.82

55,143.93

A-4

Sec. 6653(b)

21,879.45

12,927.16

17,703.64

33,775.24

28, 233.80

27,676.01

24,398.91

27,571.97

5141-76

5141-76

5142-76

5141-76

4929-77

4728-75

7352-76

1971

1972

1971

1972

1973

1971

1972

Chattel Corporation

$ 660.00

660.00

Sea Star Corporation

$ 550.00

550.00

550.00

Russell W. Chaplain, Jr.

and Mary H. Chaplain

$ 525.00

112,600.50

$ 56,300.25

60,104.82

4962-72

4962-72

4962-72

4962-72

4962-72

5976-76

5976-76

7510-77

8027-78

6602-76

7560-77

8029-78

1965

1966

1967

1968

1969

1971

1972

1973

1974

1972

1973

1974

Russell W. Chaplain, Sr.

and Elsie C. Chaplain

$ 26,202.01

27,868.53

22,038.30

17,497.42

20,219.93

145,933.69

116,152.50

124,391.63

348, 352.20

$1,310.10

1,393.43

1,101.92

874.87

1,011.00

William J. Newton, III

and Linda G. Thornton

$ 51,955.83

62,017.73

355,211.08

A-6

72,966.85

58,076.25

62,195.82

174,176.10

$ 25,977.92

31,008.69

177,605.54

7489-77

8028-78

1973

1974

William G. Chaplain

and Sandra B. Chaplain

$121,295.83

345,428.72

$ 60,647.92

172,714.36

The issues for decision are:

(1) With respect to Ocean Sands

Holding Corporation for the years 1967

through 1969;

a) whether its gross receipts

were understated;

b) whether its telephone income

were understated;

c) whether its deductions for

depreciation and for miscellane-

ous expenses were overstated;

a) whether respondent properly

adjusted the claimed net opera-

ting loss deductions (1967 and

(1968 only)

e) whether the statute of

limitations bars the assessment

and collection of the asserted

deficiencies (1967 only)

£f) whether, if taxable income

was understated, any part of the

A-8

UNITED STATES TAX COURT

WASHINGTON, D.C. 20217

Docket Nos.

4162-72,

4262-72,

4728-76,

5139-76,

5140-76,

5141-76,

5172-76,

5143-76,

5976-76,

6602-76,

7352-76,

4927-77,

4928-77,

4929-77,

4929-77,

4930-77,

7489-77,

7590-77,

7510-77,

7560-77,

8027-78,

8028-78,

8029-78.

OCEAN SANDS HOLDING

CORPORATION, A

VIRGINIA CORPORATION,

et al.,

Petitioner,

Vv.

COMMISSIONER OF

INTERNAL REVENUE,

Respondent.

ORDER

For cause, it is

ORDERED that these cases are hereby

reassigned to Judge C. Moxley Featherston

for final disposition.

A-10

/s/ C. Moxley Featherston

Chief Judge

Dated: Washington, D. C.

R September 23, 1980

With respect to Ocean Sands for the

years 1971 through 1973:

g) whether its gross

receipts were understated;

h) whether its deductions

for depreciation and miscellan-

eous expenses were overstated;

i) whether respondent pro-

perly adjusted a claimed net

operating loss deduction (1971

only); and

4) whether if taxable

income was understated, any part

of the underpayment was due to

fraud.

(2) With respect to Colony Holding

Corporation for the years 1972 and 1973:

a) whether its gross re-

ceipts were understated;

b) whether its deductions for

A-12

depreciation and miscellaneous

expenses were overstated; and

c) whether any part of the

alleged underpayments was due

to fraud.

(3) With respect to Sea Fin Holding

Corporation for the years 1971 through

1973:

a) whether its gross receipts

from its motel were understated;

b) whether its gross receipts

from its trailer park business

were understated;

c) whether its deductions for

depreciation and miscellaneous

expenses were overstated; and

a) whether any part of the

alleged underpayments was due

to fraud.

A-13

(4) With respect to Sea Star

Corporation for the years 1971 through

1973:

a) whether its claimed net

operating loss carryover de-

ductions were properly dis-

allowed by respondent, and

whether it is entitled to its

claimed deduction for taxes

in each of the years and for

interest expenses in 1971.

(5) With respect to Chattel

Corporation for the years of 1971 and

1972.

a) whether its claimed net

operating loss carryover de-

ductions were properly dis-

allowed by respondent, and

whether it is entitled to its

claimed deduction for taxes

A-14

in each of the years and for

interest in 1971.

(6) With respect to Russell W.

Chaplain, Sr. and Elsie Chaplain for the

years 1965 and 1969:

a) whether their gross

business receipts were

understated;

b) whether their telephone

income for 1967 through 1969

was understated;

c) whether their deductions

for depreciation and miscellan-

eous business expenses were

overstated.

a) whether the statute of

limitations bars the assess-

ment and collection of the

asserted deficiencies;

e) whether, if taxable

income was wngecetateds any

part of the underpayment was

due to negligence.

With respect to Russell W. Chaplain,

Sr. and Elsie Chaplain for the years 1971

through 1974:

f) whether in 1971 they

realized but failed to report

report a capital gain on the

alleged sale of 913 Virginia

Beach Boulevard.

g) whether they received un-

reported dividend income in

cash and in kind from two or

more the corporate petitioners

in each of said years;

h) whether deductions for

depreciation on a service

station and for rental ex-

penses were overstated for

for 1971;

i) whether they are entitled

to a personal exemption in 1971

for their daughter Linda; and

j) whether any part of the

alleged underpayments was due

to fraud.

(7) With respect to Russell W.

Chaplain, Jr. and Mary H. Chaplain for the

years 1971 through 1973:

a) whether they received

unreported dividend income

in cash and in kind from one

or more of the corporate

petitioners in each of said

years; and

b) whether any part of the

alleged underpayments was due

to fraud.

(8) With respect to William Newton,

IIt_and Linda G. Thornton for 1972 through

1974:

A-17

a) whether they received

unreported dividend income

in cash and in kind from

two or more of the corporate

petitioners in each of said

years.

b) whether they received

unreported wages or salary

in 1972 and 1973;

c) whether they understated

rental income in 1973;

da) whether, for 1974, their

deductions for depreciation

and miscellaneous expenses

with respect to rental prop-

erty were overstated;

e) whether, for 1973, they

overstated their cost in report-

ing gain on the sale of real

property; and

f) whether any part of the

alleged underpayments was due to

A-18

fraud.

(9) With respect to William G.

Chaplain and Sandra B. Chaplain for 1973

and 1974:

a) whether they received

unreported dividend income from

three of the corporate petitioners

in each of said years; and

b) whether any part of the

alleged underpayment was due to

fraud.

In an effort to achieve clarity and

coherence in our treatment of these

numerous and overlapping issues, our

opinion will be organized by topic rather

than by taxpayer. After setting forth our

general findings of fact, we will deal

with the issues, each with its separate

findings of fact and opinion, in the

following order:

A-19

IV.

VIII.

Business gross receipts

Business depreciation

Miscellaneous business

expense deductions

Net operating loss de-

ductions

Fraud penalties,

corporate petitioners

Gain on transfer of

real property to Sea

Fin by Russell W.

Chaplain, Sr. and

Elsie Chaplain

Dividend income and

fraud, individual

petitioners

Miscellaneous issues

and fraud, individual

A-20

petitioners

IX. Negligence penalties.

X. Statute of limitations.

In his reply brief petitioners'

counsel requests “leave to argue the

matter orally, of the Court desires".

See Rule 151 of this Court's Rule of

Practice and Procedure. Particularly in

view of the voluminousness of the briefs

on file herein and the factual nature of

the issues, the Court deems oral

argument to be neither necessary nor

appropriate.

GENERAL FINDINGS OF FACT

Some on the facts have been

stipulated and are so found. The

stipulation of facts and attached

exhibits are incorporated herein by this

reference. Only those facts necessary

A-21

for an understanding of this Opinion

will be summarized below.

All of the corporate petitioners

are Virginia corporations with their

principal place of business in Virginia

Beach, Virginia. With the exception

noted below, all of the individual

petitioners resided in Virginia Beach,

Virginia, at the time the petitions were

filed herein. William G. Chaplain and

Sandra B. Chaplain were divorced prior

to the time their petitions in docket

No. 8028-78 were filed. At that time

Sandra resident in Clearwater, Florida.

All of the returns for the years at

issue were timely filed, and all the

individual returns were joint returns.

All petitioners used the cash receipts

and disbursements method of accounting.

The corporate “returns” of Ocean

Sands Holding Corporation (Ocean Sands),

A-22

Sea Fin Holding Corporation (Sea Fin),

and Colony Holding Corporation (Colony

Corp.) for the year 1974 were filed

(under an extension) with the Internal

Revenue Service on September 15, 1975.

The return forms set forth no income or

deduction figures, but each of them

contained the statement "A completed

return is not being filed due to the IRS

exam of prior years in which an obvious

dispute affecting 1974 income will

result. An amended return will follow.”

At the time of trial an audit of these

three corporations for 1974 was in

progress but lwd not yet been completed.

During the course of this audit, in mid-

1976, additional unsigned 1974 corporate

return forms 1120 for the three

corporations were presented to and

received by the examining agent. The

unsigned 1120's contained the income and

deduction figures gers were lacking on

a

the signed, but blank, forms which had

been filed on September 15, 1975.

Russell W. Chaplain, Sr. and Elsie

C. Chaplain (Wilson and Elsie) are the

parents of eight children, including

petitioner Russell W. Chaplain, Jr.

(Chappy), William G. Chaplain (Jerry),

and Linda G. Thornton (Linda), and

another daughter, Suzanne Goldsticker

(suzanne), who is not a petitioner

herein.

Some understanding of the family

history of the Chaplains and their

financial transactions is essential to a

fair and proper evaluation of the merits

of these cases.

Wilson, who is approaching 60 years

of age, is a man of complex personality

characteristics. As witnessed by the

Court during both the trial and the

A-24

preliminary stages of these cases, he is

highly emotional and subject to

intermittent and well-nigh

uncontrollable outbursts of anger and

vituperation. His hostilities are

directed against federal, state and

local tax collecting and regulatory

authorities, against banking

institutions, and against family members

of the former spouses of his divorced

children. He is ruggedly and fiercely

individualistic and patently supportive

of the “work ethic;" his hostility is

evoked by institutional or individual

attempts to trespass (either physically

or figuratively) on his private domain.2

Since about 1950 Wilson has

suffered severly from “sugar” diabetes.

It is his belief that at the times when

his “nervous pancreas" permits his

glucose to reach a high level, he has

A-25

the greatest of difficulty in

controlling his emotional outbursts, and

that when his pancreas is doing its job,

he is capable of normal social behavior.

Whether or not such correlation is

medically supportable is beyond the ken

of this Court.

Wilson's behavioral problems have

had significant effects upon the history

and development of these cases.

Illustrating one such effect is the

experience of Winfred H. Cartwright, who

was employed in December 1975 in the

arson investigation branch of the

Virginia Beach Fire Department. A fire

had occurred in that month in the

Cadillac car which was used by Jerry and

allegedly destroyed the records of the

three operating corporations herein

involved. Respondent intimates that the

cause was arson on the part of one of

A-26

the petitioners. Petitioners claim that

the fire was set by one of a number of

persons who had grudges against Jerry

and other Chaplain family members.

Cartwright interviewed Jerry on the day

after the fire and reached the point of

asking him if he had any recent

misunderstandings or arguments. Jerry

gave an affirmative answer and

identified at least one such adversary

by name. However, before the interview

could proceed further, Wilson appeared

on the scene and belligerently (and

apparently contrary to his own best

interests) ordered his son to end the

conversation. The record is replete

with other instances in which regulatory

and other government officers were

summarily ordered by Wilson to leave his

premises.

A-27

Another of Wilson's behavioral

irregularities which pervades these

cases is his abiding dislike and

distrust of banks. This was a

characteristic which he claims he

acquired from his own father. Without

detailing the various incidents in the

lives of both the father and Wilson

which reinforced this dislike, it is

clear that both of them cherished the

physical possession of large amounts of

currency which they kept in secluded

safes on the premises in which they

lived or worked. This practice was

motivated at least in part by a

congenital distrust of big institutions

(both financial and governmental).

As strong, and often irrational, as

was Wilson's hostility towards those who

(in his view) has trespassed on his

private domain, he showed notable

A-28

generosity and kindness to those whom he

regarded as his friends or friends of

any member of his family and to trusted

employees. He was no more

"businesslike" in his dealings with such

people than he was in the handling of

cash assets. Again the record is

replete with such instances in which

free rooms and meals and telephone

privileges were furnished to friends and

acquaintances of his children, to

visiting friends of his from other

areas, to workmen who were employed on

the premises, and to impecunious guests.

Wilson was the patriarch and “the

brain" of the Chaplain family; his

thought patterns and precepts (although

engendering many and bitter intra-family

feuds) were guidelines for the history

and the conduct and operational

practices of the family businesses.

A-29

Wilson was brought up on his

father's strawberry and vegetable farm

located just west of Virginia Beach,

Virginia. From an early age he worked

on the farm with his father, and it was

a prosperous operation. In the early

1940's the farm was sold under threat of

condemnation to make room for the Oceana

Naval Air Station, and that was the end

of Wilson's farming career. He had, by

that time, saved close to $200,000 from

his share of the farming enterprise.

Earlier (in 1941) Wilson had married

Elsie, and in 1942 their eldest child,

Suzanne, was born.

Wilsons father had taken a strong

liking toward Elsie and at various times

made gifts to her “for her and the

children." One of those gifts (made in

the late 1950's) was a transfer into

Elsie's name of real property located at

A-30

False Cape (Virginia Beach), Virginia.

That land likewise was subsequently

condemned for a public park, and in 1972

Elsie received the proceeds of $68,000,

which was in turn invested in the Kona

Kai East, an oceanfront motel. On two

other occasions (around 1960) Wilson's

father gave Elsie $20,000 in cash (a

total of $40,000) "for the children.”

This money likewise was invested in the

land on which one of the Chaplain's two

oceanfront motels is located.

Wilson's mother, Gussie, appears as

one of the record owners of some of the

real estate involved herein. Her role,

if any, in these cases must remain a

mystery. Although still living, she was

not called as a witness and her

participation, if any, was totally

unexplained.

A-31

After the Oceana sale Wilson and

Elsie moved to Virginia Beach. There

they engaged in a series of purchases

and sales of real property and profited

on such transactions... Wilson also

became an auto dealer for Kaiser-Frazer

in Virginia Beach during that period and

did well financially in that endeavor.

One of the properties which the

Chaplains began to acquire in the early

1940's was the property which eventually

became the Colony Motel and Trailer

Court, at 913 Virginia Beach Boulevard,

Virginia Beach. This was not oceanfront

property. It was located in a swamplike

area and had to be reclaimed from that

condition in order to accommodate a

trailer park. A portion of that

property was acquired by adverse

possession, evidenced by several deeds

in 1965 from “special commissions." the

A-32 :

Chaplains constructed a home for

themselves and their children at 913

Virginia Beach Boulevard in the mid-

1950's. The home was later expanded for

use as a small motel. The back-land was

cleared, drained and improved for

trailer court purposes on a gradual

basis over the years through the

personal direction of the senior

Chaplains and the physical labor of the

children--in particular Chappy and

Jerry--and of other workmen hired "off

the street" by the Chaplain as needed.

The trailer court business was the main

source of revenue from that property.

‘te 1971 the Colony Motel and Trailer

Park property, as well as an adjacent

Phillips 66 service station (also

acquired by them in the mid-1950's),

were conveyed to a then newly organized

corporation, Sea Fin Holding Corp.

A-33

Another of the properties herein

involved was purchased from a church by

Ocean Sands Holding Corporation in 1964.

This land was located in Virginia Beach

at 18th Street between Atlantic Avenue

and the oceanfront. In January 1966 a

permit was issued to Ocean Sands to

build the Kona Kai Motel. The motel was

built under the planning and direction

of Wilson, and again much of the

construction was accomplished by the

physical labor of Chappy and Jerry and

others of the Chaplain children. The

Kona Kai originally had 26 rooms plus a

4 room apartment. In January 1975 a

permit was issued to Ocean Sands to add

4 more stories to the Kona Kai, and that

addition was constructed much in the

same fashion as the original structure.

A third property, located on 16th

street between Atlantic Avenue and the

A-34

oceanfront, as purchased by Colony Corp.

in 1961. At the time of the purchase

there was an old hotel, the Courtney

Terrace, on the property. That hotel

was demolished--partly as a result of an

explosion or fire in 1969--and a new

motel, the Kona Kai East, was

constructed by the Chaplain family and

completed in 1972.

Two unimproved lots between 18th

and 19th streets on the oceanfront were

owned during the years at issue by

Chattel and Sea Star Corporations,

respectively, and were used by Ocean

Sands under a rental arrangement. The

lots were also used under a rental

arrangement by the Colony Motel and

Trail Park so that their customers had

parking facilities for ocean swimming.

Although none of the stock books of

Ocean Sands, Colony Corp., Sea Fin,

A-35

Chattel or Sea Star is in evidence, it

appears that whatever stock may have

been issued by such corporations was

issued in Elsie's name. The record is

replete with evidence that Elsie, as

well as Wilson and the children,

regarded the entire operation or sets of

operations as one big family

partnership, with no definition of

beneficial ownerships except that those

who contributed to the operations were

to be rewarded in proportion to their

contributions. Inevitably, this loose

communal arrangement has led to bitter

intra-family feuds, elements of which

were manifested to a convincing extent

in the courtroom during various stages

of these proceedings. A genuine dispute

exists within the family as to the

beneficial ownership of the stock of the

various corporations. The Court does

A-36

not make any specific finding on that

score.

The looseness of the handling and

operation of the Chaplain enterprises is

witnessed throughout the record. For |

example, Elsie received a salary from

Sea Fin and no compensation from Ocean

Sands or Colony Corp., although she

performed some services for all three

corporations.. Laundry services were

performed by Sea Fin for Ocean Sands and

Colony, Inc. without any apparent effort

to settle the costs and expenses between

them. One or more automobiles owned by

one of the corporations were used for

business purposes of another of the

corporations and to some degree for

personal purposes, without any apparent

effort to account to the owning

corporation. In their own

minds, the Chaplains created the

A-37

corporations (on advice from their

attorneys and accountants) for family

planning purposes and to prevent

instrusion by outsiders, but they did

not let the corporate entities interfere

with their concept of the total

operation as one big family enterprise.

In spite of this blurring of corporate

entitles, respondent has not sought to

reallocate the corporate income and de-

ductions under section 482 of the Code 3

The looseness in the operation of

the Chaplain businesses also evident in

their bookkeeping. The records which

the petitioners kept in the regular

course of business for the motels and

the trailer park were less than

complete. In spite of the recommendation

of their accountant, petitioners never

instituted a standard system of double-

entry bookkeeping. Instead, as an

A-38

example, the records of Ocean Sands and

Colony Corp. consisted of room

registration cards (to reflect income

and cancelled checks (to refelct

expenses). The records also included

telephone receipts books and a number of

invoices. For the trailer there were no

registration cards, but cash receipt

books were maintained. Bookkeeping

practices at the motels and trailer park

were irregular. For example, it was the

routine practice of Linda, who helped

keep what records of Sea Fin there were

for 1971 though 1973, to discard a bill

if she has a cancelled check to indicate

its payment. She may or may not have

kept a record of those expenses paid in

cash.

Petitioners also failed to preserve

diligently those business records that

were made. This failure stems from

A-39

circumstances revealed in the following

two statements from the testimony of

Wilson:

"I hate records worst than anything

in the world."

"Well, see, we've had quite a few

fires."

There were indeed three fires and

one alleged theft--all involving alleged

destruction or loss of records--which

tempt the trier of fact to place these

statements in context with each other,

with the obvious conclusion to be drawn

from doing so.

The Pine Tree Inn fire in 1965 or

1966, destroying a car belonging to

Suzanne's husband, occurred outside that

gastegenat while Suzanne and other

family members were attending a "good

government" meeting. All the records of

A-40

the Colony Motel and Trailer Park up to

that date were in the car because of a

pending court proceeding involving sales

tax. The records were allegedly

destroyed. the fire was the result of a

multiple car collision causing one of

the involved cards to go out of control

and to smash into the car containing the

records.

The Castaways fire (and explosion)

occurred in 1969 and allegedly destroyed

all the records of the Kona Kai (Ocean

Sands) and the post-1965 or 1966 records

of the Colony Motel and Trailer Park.

The Castaways (formerly the Courtney

Terrace) was located at 16th and Ocean

Front and was in the process of

demolishment to make way for a new

motel, the Kona Kai East. Some time

before the fire one the of the Chaplains

had requested (but was denied)

A-41

permission to complete the demolition by

burning. The burning had been

substantially demolished, but at least

the first floor and basement remained,

and it was in those areas that the

records were kept. At that time Suzanne

and at least some other family members

were still living in the Castaways and

maintained an office there.

The post-1969 records of each of

the corporate petitioners were allegedly

destroyed on December 9, 1975, in the

rear portion of a Cadillac used by

Jerry. The car was parked at the time

behind the Colony Motel. The records

were those which were then being audited

by Revenue Agent Graubics. He had

microfilmed all the records except

possibly those of Sea Fin, for which he

had delivered formal document requests

to petitioners’ accountant the day

A-42

before the fire. The Chaplain family

knew of such microfilming and one or

more family members may have assumed

that the Sea Fin records had been

microfilmed. The fire (very severe in

nature) was of incendiary origin and was

alleged by petitioners to have been

caused by an enemy who had a grudge

against Jerry.

Aside from the question whether the

Cadillac fire could have destroyed so

large a volume of records leaving barely

a trace, there is evidence in the record

which conflicts with such alleged total

destruction. On December 17, 1976,

Elsie filed a report with the local

police alleging theft from the Kona Kai

premises of corporate and business

papers belonging to Ocean Sands, Sea

Fin, Colony Corp., Chattel and other

corporations. The re ee alleges that

A-

Elsie and her family “have been

threatened by a person claiming to be a

member of a Federal Agency." The

records demonstrates, however, that the

corporate papers in question (mostly Sea

Fin records) were taken by Suzanne and

chappy to the office of an attorney, Mr.

Fine, of the North firm of Fine, Fine,

Legum & Fine. It was that firm which

represented Suzanne and Chappy in a

lawsuit against Elsie, other family

members and various family corporations,

is referred to on page 100 herein. When

Agent Graubics on January 12, 1976

renewed his request for the records of

Sea Fin (which had been reported as

having been destroyed in the fire),

Elsie answered on January 14 that they

were not available because they had been

removed or stolen from the corporation's

offices. Although none of these records

A-44

of the corporate petitioners were

produced at the trail, the Court finds

(based upon the above, upon other

conflicts in the record, and upon the

incredibility of the petitioners’

testimony concerning the December 1975

fire) that at least a substantial

portion of the corporate records was not

destroyed in that fire.

I. BUSINESS GROSS RECEIPTS--

FINDINGS OF FACT AND OPINION

Kona Kai (Ocean Sands) and Kona Kai

East (Colony Corp.)

The Kona Kai, an attractive motel

located on 18th Street at the

oceanfront, opened for business at the

end of July 1966. During the years in

issue the motel, owned by Ocean Sands,

was a three story building containing 40

rooms, 24 of which faced the ocean.

A-45

However, during at least a portion of

1967, construction on all the rooms was

still not completed, the elevator was

not functional, and the motel was not

ready for full occupancy. In addition,

from time to time during the years 1967

through 1973, as many as four rooms were

used by Suzanne as a manager's

apartment, particularly in the winter.

During the peak season, however, she

would on occasion curtail her use to

only one or two rooms, or move out

altogether, as she die for most of 1971

and 1973. Although the motel did

contain a restaurant, the restaurant did

not remain open throughout all of the

years in issue.

The Kona Kai East, on the

oceanfront at 16th Street, was a five

story, 50 unit motel with a manager's

apartment on a sixth floor. This

A-46

apartment, called the “penthouse,” was

occupied by Wilson and Elsie during at

least a portion of the years at issue.

All 50 rental units faced the ocean. The

Kona Kai East first opened in late April

1972 and closed in early December.

During 1973 the motel was open from mid-

March to mid-October. Because the

elevator was not installed and operative

until the summer of 1973, the

petitioners had some trouble in renting

the rooms on the top floors. There was

a restaurant in the Kona Kai East during

1973.

The investigation of the returns of

Ocean Sands was assigned by respondent

| to Special Agent Peter Hutts in January

1969. When he and another agent, Harold

Starke, were unable to obtain any

information from the corporation or the

Chaplains about the returns, they

A-47

contacted the Virginia Department of

Taxation. From the sale tax division

they received work papers from the state

investigation of the Kona Kai. These

papers included a reconstruction of

gross receipts from room rents for the

years 1967 and 1968 based upon the

motel's reported laundry expenses. The

state investigators divided each month's

total laundry expense by an estimate of

the daily laundry expense per room. The

quotient was multiplied by the estimated

average daily charge per room for that

| month to arrive at a figure for gross

receipts.

In general, in respondent's

investigation of the corporate returns,

the agents had a hard time getting

information from the Chaplains,

especially Wilson, who on more than one

occasion ordered agents from his

A-48

property. He and other corporate

officers did not return agents’ calls or

letters. When meetings were arranged,

the principals often did not appear, or

they did not bring their records with

them. However, the agents were able to

meet with Suzanne and Elsie on March 5,

1970, and obtained at that time the

following records: the corporate minute

book of Ocean Sands for the period May

1964 until March 1970, the Colony Corp.

minute book for 1961 through 1970,

checkbook stubs of the Kona Kai account

from May 1967 to June 1969, registration

cards for 1966 through 1968, and work

papers prepared by Suzanne in connection

with the Ocean Sands tax returns. The

agents were unable to determine to which

of the three years many of registration

cards pertained, but the cards reflected

total gross receipts for the three years

very roughly equivalent to the total

A-49

gross receipts reported on the tax

returns for those years.

Agent Starke contacted the Virginia

Electric Power Company (VEPCO), the

Chesapeake and Potomac Telephone Company

(C & P Phone Co.), and Princess Ann

County for information about the Kona

Kai. From information provided by the

phone company he computed the number of

telephone calls made from the Kona Kai.

Assuming that the motel charged guests

$0.25 per call, Agent Starke

reconstructed the amount of income

received from telephone charges to

guests for the years 1967 through 1969.

Agent Starke also reconstructed

gross receipts from room rentals for the

years 1967 through 19697 using the linen

expense method employed by the state tax

investigators. Since records of actual

charges for various items of linen were

A-50

not available from the linen supplier,

Agent Starke used the same average daily

room charge as the state investigators

and the lower of the two estimates of

the cost of linen per room each day. to

check this method of reconstruction,

Agent Starke estimated gross receipts

using information concerning average

motel room charges and charges and

occupancy rates which he obtained from

the Virginia Beach Chamber of Commerce.

He also made a net worth analysis using

the scant data that was available. Both

methods indicated higher gross receipts

than his reconstruction based on linen

expenses.

In June 1974 Revenue Agent Graubic

was assigned to examine the returns of

Ocean Sands for the years 1971, 1972 and

1973. Agent Graubics also had

difficulty obtaining information from

A-51

the Chaplains, but from May 5, 1975, to

mid-June he was permitted to examine

certain corporate records at the office

of Milton Mcpherson, an accountant. The

records of Ocean Sands which he examined

were contained in cardboard boxes

labelled as to year and included

registration cards, checking account

records, records of guests' phone calls

indicating the room number and the phone

number called, and receipts and

invoices. Another box was marked "Bills

Paid 1971." Records of Colony Corp.,

including registration cards, cancelled

checks, and receipts and invoices for

1972 and 1973, were also made available

to Agent Graubics at the accountant's

office. Before he had completed his

examination, Agent Graubics was informed

that (because of alleged personal

midconduct during his examination) he

would not be permitted to continue his

A-52

work in Mr. McPherson's office. He did

gain access to the records again in

September 1975 and subsequently

microfilmed them. At that time some of

the telephone slips were missing.

In order to reconstruct the income

of Ocean Sands for 1971, 1972 and 1973,

and of Colony Corp. for 1972 and 1973,

Agent Graubics used an entirely new

approach based on the assumption that

gross receipts per room per month must

have been equal to the average receipts

per room per month of a group of

comparable motels in Virginia Beach.

The comparable group (which he selected

without first examining their gross

4 which

receipts) included 14 motels

ranged in size from 20 to 53 rooms. All

but three were located on the oceanfront

between 10th and 4lst Streets. (The

boardwalk in Virginia Beach extends from

A-53

7th Street to 39th Street.) although

seven of the motel were built between

1964 and 1970, the rest were older,

having been built in the last 1950's or

before. Only two the comparables had

restaurants serving three meals daily;

six others had coffee shops offering

only breakfast and lunch. All 14 had

swimming pools, and all but five had

parking facilities sufficient, when they

were filled to capacity, to accommodate

80% to 100% of their guests.

Approximately half of the units in the

comparable motels faced the ocean. All

of the comparable motels were members of

groups or associations, for at least a

part of the period 1967 through 1973,

which provided referral services or

through which they advertised.

Agent Graubics computed the average

gross receipts per room per month for

A-54

each motel and an average figure fro the

group of 14 for each month. Using these

average monthly gross receipts he

calculated the annual gross receipts of

the Kona Kai as 2 40 unit motel and the

Kona Kai East as a 50 unit motel. To

accompany his brief in this case,

respondent prepared spread sheets

showing the gross receipts per room for

each month and comparable motel as

recomputed to take into consideration

the correct number and to eliminate

receipts for one of the motels from

cottage rentals. These recomputed

figures result in slightly lower gross

receipts for the Kona Kai and the Kona

Kai East than in Agent Graubics'

original computations..

It is a settled rule of law that

where a taxpayer's records are

inadequate or nonexistent, respondent

A-55

may reconstruct income using any method

which will, the respondent's opinion,

clearly reflect income. Section 446(b);

Holland v. United States , 348 U.S. 121

(1954); Welch v. Commissioner , 394 F.2d

366 (5th Cir. 1968), affg. a Memorandum

Opinion of this Court. The only

restriction on this rule is that the

method adopted must be reasonable. Stone

v. Commissioner , 22 T.C. 893, 905

(1954). Approved methods of income

reconstruction have included the “sheet

count" method based upon the number of

rented bedsheets used by a motel. In

Agnellino v. Commissioner , 302 F.2d 797

(3d Cir. 1962), vacating and remanding

on other grounds a Memorandum Opinion of

this Court, the number of guests

(computed from the number of sheets

used) was multiplied by the stipulated

average room rate. Courts have also

approved the use, in reconstruction of

A-56

income, of information from comparable

taxpayers. See, e.g., Meneguzzo v.

Commissioner , 43 T.C. 824 (1969)

(information from comparable restaurant

waiters used to determine average

tipping rate). 5

There is not question that the

records of Ocean Sands and Colony Corp.

are incomplete. Although cash receipts

books and telephone slips were kept for

Ocean Sands, and although these books

were ordered from a supplier by Colony

Corp., no such records for Colony Corp.

were introduced at trial. Furthermore,

there is substantial evidence that the

registration cards in evidence do not

record all the guests who stayed at the

Kona Kai and Kona Kai East. Agent

Graubics' analysis of Ocean Sands

registration cards were frequently made

from rooms for which there were no

A-57

registration cards--in over 350

instances in 1971 and more than 650

times in 1973. There are simply too

many such calls to be reasonably

attributed to non-paying friends of the

family. Furthermore, not more than a

handful of the telephone slips indicate

calls were made from the manager's

apartment during those periods it was

used as such.

In addition, the low occupancy

rates reflected in the registration

cards also indicate that the cards are

not complete. The height of the season

for oceanfront motels in Virginia Beach

is from mid-June through Labor Day,

during which period, in good weather,

motel operators can expect to be full or

nearly full everyday. However, the

registration cards of die Kona Kai for

the months of July and August in 1971,

A-58

1972 and 1973, indicate that the monthly

occupancy rates in the peak season never

exceeded 60% of the available rooms.

Similarly, according to the cards, the

Kona Kai East was never more than 60%

full for any month. In fact, the

registration cards indicate that neither

motel was ever completely full on any

day during the three year period or more

than 75% full except for a few days each

year. (This include the 4th of July

weekend, when all the other oceanfront

motels were filled to capacity.)

Finally, several persons appeared

at trial who were guests at the Kona Kai

during 1973 and 1974, but whose visits

were not recorded on the registration

cards submitted in evidence.

Although the registration cards do

not accurately indicate the number of

guests at the motels, Colony Corp. did

A-59

not even report all the gross receipts

from room rents indicated on the cards.

The $58,744 reported on the 1972 return

is more than $5000 less than the amount

computed from the registration cards.

For 1973, the cards indicate gross

receipts more than $6000 in excess of

the $97,476 reported.

One additional factor indicates

that Ocean Sands and Colony Corp.

underreported their gross receipts. If

these corporations actually had the

gross receipts and expenses which they

reported, they would not have had

sufficient cash from that source to make

payments of loan principal which they

made--$25,000 each year for Ocean Sands

in 1969 through 1973, and $30,000 for

Colony Holding in 1973. As the

following table indicates, according to

the returns both corporations fell far

A-60

short of netting enough, even before

capital outlays, to cover these

payments.

A-61

Amount available

Gross Receipts Cash Expenses for debt reduction

OCEAN SANDS

1969 $ 62,500.00 50,816.53 11,683.44

1971 106,463.98 86,851.80 19,612.18

1972 78,114.00 76,987.00 1,127.00

1973 105,727.00 96,178.00 9,549.00

COLONY CORP.

1973 97,476.00 83,935.00 13,541.00

A-62

We believe that respondent was

entitled to reconstruct the income of

Ocean Sands and Colony Corp. and that

the comparable motel method is reason-

able and more convincing than the linen

expense method of reconstruction.

However, the Kona Kai and Kona Kai East

differed in several important respects

from the average comparable motel. They

were not managed in the most

businesslike manner. Guests and friends

of the Chaplains were sometimes

permitted to stay in rooms and to use

the facilities free of charge. In its

early years of operation the Kona Kai

did little advertising and was not

affiliated with any trade group or

association. Although the motels did

have prime oceanfront locations, there

were a number of bars in the area which

made it more difficult to attract the

desirable family trade. The motels'

A-63

reputations were also harmed by a series

of altercations at the Kona Kai

involving guest, members of the Chaplain

family and police. These altercations

occurred during the early years of the

Kona Kai's operation. Finally, neither

the Kona Kai nor the Kona Kai East had

sufficient on-site parking spaces for

all their guests. The Kona Kai had only

eight spaces until 1969, when it began

renting additional spots on a nearby lot

owned by Sea Star. The Kona Kai East

had parking for 50% of its guests.

Besides respondent's reconstruc-

tions the only other evidence in this

record as to the receipts of two motels

in the bare estimates of various

witnesses. Taking all these factors

into consideration, we find and conclude

that Ocean Sands and Colony Corp. had

the amounts of gross receipts (including

A-64

gross income from the restaurants and

from telephone charges) indicated in the

table below. to arrive at these figures

we have applied a straight 15% discount

to the comparable average (except for

Ocean Sands in 1967 and Colony Corp. in

1972, in which cases we have allowed an

additional 10% since these were the

motels' first years of operation). We

note that our findings of gross receipts

are very roughly equivalent to what

would be indicated if we had taken an

average of the six least productive

comparable motels. Some of the various

figures proposed by the parties are also

included in the table, for purposes of

comparison.

We have not included in the

preceding table petitioners'

reconstruction of gross receipts which

were prepared during trial. These

A-65

reconstructions, a group effect by the

Chaplain family, are based on estimates

of room rents and occupancy rates.

Suzanne admitted to trial that the

estimated figures used were chosen so

that the reconstructed amounts would be

as close as possible to those reported

© She testified that she

on the returns.

knew the figures on the returns were

correct and so saw no problem with such

a reconstruction.

Although the record contains

financial statements made by petitioners

to various banks concerning the income

of their business, we have included none

of these figures in the above table.

Many of the income statements furnished

to creditors show gross receipts

substantially in excess of those

reported. For example, operating

statements of Ocean Sands for 1972 and

A-66

1973, signed by Suzanne as president,

list gross receipts of $180,351 and

$201,277. However, except for rent paid

to Sea Star and legal fees, the expenses

shown on the operating statements are

generally the same as those shown on the

returns. In his explanation of the

discrepancies in gross receipts,

petitioners' counsel argued that a

business always “puts its best foot

forward" in its financial statements to

its creditors. Although the extent of

these discrepancies must be taken into

account as a factor in the fraud issues

in these cases, the Court does not

believe that the operating statements

have probative value, under the

circumstances of these cases, as to the

amounts of the understatements.

Colony Motel and Trailer Park (Wilson

and Elsie, and Sea Fin)

A-67

The Colony Motel, at 913 Virginia

Beach Boulevard, was located several

blocks from the beach. The motel

structure was originally built as the

Chaplain home, and over the years rooms

were added to be rented as motel rooms.

Since 1965, the motel has had 24 rooms,

of which as many as ten at a time were

used as the family residence. During a

portion of the years in issue additional

rooms were used as an office. Because

the Colony Motel was located so far from

the beach, rooms rents were necessarily

lower and occupancy rates were not as

high as with the oceanfront motels. The

trailer park tenants were generally not

tourists. Rather, many were military

personnel, and the occupancy rate of the

park would fluctuate according to how

many personnel were assigned to the

military installations in the area.

A-68

The address of the Colony Trailer

Park was also 913 Virginia Beach

Boulevard during the years in issue,

although in earlier years the location

has been referred to as 920 17th Street.

The Chaplains' trailer park was adjacent

to two other trailer parks, and there

has always been some confusion as to

exactly how many trailer lots were

included in the Colony Park. For

example, three lots, numbered A, B and

C, at the entrance of the Colony Trail

Park were owned by Mr. W. E. Sawyer.

The address for these three lots was 919

Virginia Beach Boulevard, although some

of the tenants may have used the address

913. Sometime before March 1964, in

connection with litigation between the

City of Virginia Beach and the Chaplains

concerning the amount of license tax

owed by the Colony Trailer Park, a

physical count of the trailer spaces was

A-69

taken, and it was determined that the

part had 144 spaces.

For the years 1965 through 1979,

income from the motel and trailer park

was reported on the returns of Wilson

and Elsie. In 1971 the businesses were

transferred to Sea Fin, which filed the

returns for 1971, 1972 and 1973.

Agent Hutts began in the fall of

1968 to look into the business of the

Colony Motel and Trailer Park as a part

of his investigation of the individual

returns of Wilson and Elsie. When he

was unable to meet with either

petitioner or gain any information from

them, he and Agent Starke contacted

VEPCO, C&P Phone Co., and Virginia

National Bank for records pertaining to

the motel and trailer park. From VEPCO

respondent's agents obtained records of

electric service for each trailer lot at

A-70

913 Virginia Beach Boulevard. The

records indicated when connection was

made, the number of months service was

supplied to each lot, and the customer's

name. From these records the agents

computed for each year the number of

"lot-months," i.e. the sum of the lots

each month over the twelve-month period,

for which service was provided.

At the March 5, 1979, meeting

between respondent's agents and Suzanne

and Elsie, at which the agents obtained

some records of other entities, no

records of the Colony Motel and Trailer

Park were available. Elsie and Suzanne

explained that all other records had

been destroyed in the Castaways fire a

few months before. Respondent's agents

were able to obtain, however, Mr.

McPherson's work papers for at least the

year 1965.

A-71

From the number of lot months from

which trailer lots were occupied, as

computed from VEPCO records, Agent

Starke calculated the gross receipts of

the trailer park fro the years 1965

through 1969. In his calculation he

used $40 as the average rent per lot.

Agent Starke also reconstructed gross

receipts from the Colony Motel by the

linen expense mthod. In this

calculation he used the same estimate of

daily linen expense as with the other

motels ($l per room) and an estimated

room rate of $10 per day.

Respondent's agents also computed a

small amount of additional income to the

motel from telephone charges to guests.

Based upon telephone records which

indicated that extra message units were

used in July and August 1967, 1968 and

1969, the agents calculated additional

A-72

income using an estimated charge to

guests of $ .20 per call.

When Agent Graubics became stymied

in his investigation of the Sea Fin

returns for 1971, 1972 and 1973, he also

consulted VEPCO records and computed

lot-months of electric service for those

years. He estimated trailer lot rents

for those years based on interviews with

tenants and upon Sea Fin records for

1974 which were made available to him.

These records included registration

cards, checkbook studs, cash receipt

books, invoices and cancelled checks.

Sea Fin records for earlier years were

probably never microfilmed by Agent

Graubics, who was told that they had

been destroyed in December 9, 1975,

automobile fire. Agent Graubics used

the linen method to reconstruct motel

gross receipts for 1971 andl972,

A-73

employing an estimated of $1.25 per day

per room linen cost and $10 room rent.

For the year 1973, for which there was

no linen expense deduction on the Sea

Fin return, gross receipts were computed

from amounts shown on the motel's state

sales tax returns.

As is the case with Ocean Sands and

Colony Corp., the records of the Colony

Motel and Trailer Park are inadequate.

In fact there are in evidence no records

of this business which pertain to the

years in issue. Respondent is clearly

entitled to reconstruct by reasonable

means the income of the motel and

trailer park.

Petitioners contend that

respondent's use of the linen method of

reconstruction does not accurately

reflect the gross receipts of the Colony

Motel. They allege that the amount

A-74

deducted for linen expense includes the

cost of lien for the Chaplain family and

for workers

who stayed free of charge at

the Colony Motel while they were working

on the expansion of the trailer park.

Petitioners

estimate of

the average

We are

reported on

did not contest respondent's

the cost of linen per day or

room rent.

convinced that the amounts

the returns of Wilson and

Elsie and Sea Fin do not completely

reflect the

gross receipts of the Colony

Motel. Petitioners have furnished no

evidence on

this issue aside from their

bare affirmations that the amounts

reported are correct. Their

reconstructions, based like those for

Ocean Sands and Colony Corp., on

estimates of occupancy rates and room

rents, are entitled to little weight.

Although, with regard to the two other

A-75

motels, we found respondent's comparable

method of reconstruction more convincing

than the linen method, we have no

evidence on which to base a similar

reconstruction for the Colony Motel.

Under the circumstances we do believe

the linen method is a reasonable means

of reconstruction. Doing the best we

can with the record we have and taking

into account petitioner's contentions

7 we find that the

concerning linen use,

Colony Motel had gross receipt from room

rents in the following amounts:

1966 1967 1968

$12,127 10,647 13,449

1969 1971 1972

$12,347 10,000 8,492

In comparison, the following amounts

were asserted by respondent:

A-76

1966 1967 1968

$18,190 15,970 20,170

1969 1971 1972

$18,520 10,000. 12,740

Since there was no linen expense

deduction for 1973, respondent based his

reconstruction on the gross receipts

reported for state sales tax purposes.

Petitioners' reconstruction indicates

more gross receipts for both 1965 and

1973 than respondent asserts. Treating

the issue for those years as conceded,

we find that the motel room receipts

were as follows:

1965 1973

$6,300 $7,200

Petitioners contest seapenéent's

reconstruction of telephone income for

the Colony Motel. They allege that the

motel phones were used by family,

A-77

friends and trailer park tenants.

However, they fail to explain why heavy

phone use occurred only in the months of

July and August, the peak occupancy

period for the motel. Although Elsie

testified that by the time of trial all

telephones had been removed from the

rooms of the Colony Motel, she did not

given any indication when this removal

had taken place. Nor did she flatly

state that no charges were made in the

years in issue to motel guests for

telephone use. We conclude that

respondent's reconstruction is

reasonable and find that Wilson and

Elsie had the following amounts of

income from telephone charges at the

Colony Motel and Trailer Park:

1967 1968 1969

$170.20 $213.20 $182.60

A-78

With respect to the number of trail

spaces which were included in the Colony

Trailer Park in the years at issue,

petitioners assert that ownership of the

spaces was so confused as to be almost

unascertainable. They contend that

respondent's computations based on VEPCO

records for 913 Virginia Beach Boulevard

improperly included lots owned by

neighboring trailer park.

They also allege that respondent's

figures are without basis, since the

agents never made an actual account of

the trailer park spaces.

However, except for the three lots

owned by Mr. Sawyer (which are not

contained in the VEPCO records for 913

Virginia Beach Boulevard and which were

not counted by respondent in his final

tally), petitioners failed to identify

specifically which of the spaced

A-79

attributed to them in the VEPCO records

(in which the tenant's name and lot

number were clearly identified) were not

in fact owned by the. Petitioners have

established, through the testimony of

the city revenue officer who made

account of trailer lots for license tax

purposes, that the trailer park has 144

spaces in late February or early March

1964.8 The only other proof offered by

petitioner as to the number of spaces

was the testimony of various witnesses

who estimated the size of the trailer

park at different times.

The Court has analyzed the VEPCO

records independently of respondent's

summaries of them. we find that the

records show that as of March 1964 the

power company provided service to 149

trailer lots at 913 Virginia Beach

Boulevard. Although the VEPCO records

A-80

in evidence included some information

for other addresses on Virginia Beach

Boulevard, we have attributed them to

trailer parks other than the Colony.

Our total of 149 does not include any

spaces in those other parks or the three

lots owned by Mr. Sawyer. The accuracy

of these records and our interpretation

of them is roughly corroborated by

petitioners' evidence (the testimony of

the city revenue officer) that the

Colony Trailer Park contained 144 spaces

at that time. According to our

analysis, the VEPCO records also clearly

indicate that new service was provided

to at least the following number of

spaces in the Colony Trailer Park

through the years:”

1964291965 1966 1973

61 35 1 15

A-81

This schedule of expansion of the

trailer park was confirmed by the

testimony of the electrician who has

done all the work on the park since 1968

or 1969. He stated that except for the

15 "B" series of lots (which the records

show were first serviced in 1973), there

was no significant expansion of the park

during the years he worked there. We

find unpersuasive the general estimates

of other witnesses as to the number of

spaces added through the years.

VEPCO records indicate that in

1974, service was provided to 273

spaces. Again, this figure is generally

corroborated by the Colony Trailer Park

cash receipt book for 1974 which, |

accordingly to respondent's summary,

shows that rents were co’.lected for 264

of these spaces, plus one space for

which VEPCO records indicated no

A-82

electricity was provided. The cash

receipt book also confirms in a general

way the names of occupants and dates of

occupancy which appear in the VEPCO

records. The correspondence between the

trailer lot numbers listed in

petitioners’ own cash receipt book and

those contained in the VEPCO records of

913 Virginia Beach Boulevard throughout

many of the years in issue supports our

conclusion that the VEPCO records we

have used contain few, if any, trailers

which were not part of the Colony

Trailer Park. We conclude that VEPCO

records are reliable and are the best

evidence of the number of spaces in the

Colony Trailer Park, specially in the

light of the incompleteness of

petitioners' other books and records.

Because we believe that the VEPCO

records for 913 Virginia Beach Boulevard

A-83

do not include more than five lots which

were not part of the Colony Trailer

Park, we also belief that the records

accurately indicate the number of lot-

months for which electric service was

provided. However, as petitioners point

out, rents were not necessarily

collected for all the lot-months that

electricity was supplied. Occasionally

trailer park tenants, who were often

military personnel subject to transfer,

would abandon their trailers or

otherwise default on their purchase

payments, leaving their rent unpaid as

well. Electric service might remain

connected for a period of months. In

such situations the finance company

could foreclose on the t trailer, but

the trailer park could often do nothing

to recover the unpaid rent.

A-84

Petitioners also contest the

accuracy of the average monthly rents

employed by respondent in his

reconstructions. Rental rates for

spaces did vary according to the length

of tie the tenant had been there and the

types of services provided to him.

Petitioners presented two witnesses who

testified as to the rents they paid in

different years. Respondent based his

estimates on a figure used in work

papers for 1966 allegedly prepared by

Mr. McPherson, on the cash receipt book

for 1974, and on the testimony of a

former resident. Respondent also relied

on statements by Wilson and Elsie in

1965 to a bank loan officer that the

trailer park rents averaged $40 per

month.

We believe that the VEPCO records,

which show the number of lot-months for

A-85

which service was provided, provide a

reasonable basis upon which to

reconstruct income. We do not believe

this method is made unreasonable because

of respondent's failure to make an

actual count of the spaces at the

trailer park. The record supports

respondent's allegation that his agents

were prevented by the Chaplains from

personally inspecting the premises. In

any event, a physical count of spaces

during the investigation would not

indicate the size of the park during

earlier years.

II. BUSINESS DEPRECIATION--

FINDINGS OF FACT AND OPINION

Kona Kai (Ocean Sands) and Kona Kai East

(Colony Corp.)

Petitioners have acknowledged that

the bases for depreciation of the motel

A-86

structures claimed on their returns were

erroneously determined from appraisals

rather than from cost figures. It is

not necessary to dwell upon the

explanation for these errors since the

depreciation deductions in question are

not a part of respondent's fraud

allegations.

On their respective returns,

petitioners Ocean Sands and Colony Corp.

claimed a $425,000 basis for the Kona

Kai and a $708,622 basis for the Kona

Kai East. The returns used a 3%

straight line rate of depreciation. In

the notices of deficiency respondent

adjusted the Kona Kai basis to $204,600

and disallowed the Kona Kai East

depreciation in full. At the trail, the

purported actual cost of the two motels

was laboriously reconstructed by

petitioners largely on the basis of

A-87

a;

Chappy's memory and research performed

shortly before and during the trail.

Petitioner's reconstruction cost

figures totalled $301,000 for the Kona

Kai and $473,622 for the Kona Kai East.

Chappy and others also testified at

considerable length as to the relatively

short useful life of various components

of these oceanfront motels. This was

done to convince the Court that these

motels should be depreciated at 4%

annual rate rather than 3% as shown on

the returns. If the Court were to

accept the reconstructed figures and

apply the 4% rate, the annual

depreciation for Kona Kai would be

$12,040 and for Kona Kai East,

$18,944.88. The annual amounts claimed

on the returns were $12,750 and $21,259,

respectively (for full yea}rs in

service). The $21,259 figure claimed

A-88

for Kona Kai East included furnishings.

The Court is persuaded (as was

respondent, as reflected in his brief)

that the actual cost of the Kona Kai

exceeded the amount of $204,600

determined in the notice of deficiency.

In the absence of records, we have

weighted the testimony of Chappy against

the local property tax assessed

valuation, the amount of financing, and

other elements contained in the record

herein. Under the circumstances we feel

warranted in applying the rule of Cohan

v. Commissioner , 39 F.2d 540 (2d Cir.

1930) to this item. Cohan cautions us to

bear heavily il

against the taxpayer

"whose inexactitude is of his own

making." Accordingly, we find that the

cost basis of the Kona Kai was $270,000.

With respect to the Kona Kai East,

respondent on en oe the belief

(based upon petitioner's representations

made to Virginia National Bank and upon

property tax assessed valuation) that

the actual cost was $416,000, as opposed

to Chappy's reconstructed $473,622 cost.

Weighting the opposing contentions, and

in accordance with our overall

evaluation of the record herein, we find

that the cost basis for depreciation of

the Kona Kai East was $450,000.

We are unwilling to accede to

petitioners' contention that the rate of

depreciation of these motels should be

increased from 3% (claimed on their

returns) to 4%. We believe that this

contention is prompted largely by the

recognition of and the desire to

compensate for petitioners' acknowledged

errors in basing depreciation on

appraised values rather than cost.

Although it has long been held that the

A-90

opinion of a knowledgeable corporate

officer may be given some weight in

established valuation of corporate

assets (The Winter Garden, Inc. v.

Commissioner , 10 B.T.A. 71 (1928)),

such weight may be tempered by the

circumstances, including (as true

herein) a change in position at trial

from that taken on the tax return. See

Leonard Refineries, Inc. v. Commissioner

, 11 T.C. 1000, 1008 (1948). Moreover,

petitioners used composite depreciation

accounting on their returns, and we ©

would not be justified in reducing the

useful life of the total structure

because of the claimed injurious effects

of the oceanfront elements upon certain

of the components. Petitioners offered

no expert testimony, and we are not

convinced that the depreciation rate

reflected on petitioners' returns was an

incorrect one. We find and hold that

A-91

the 3% rate used by petitioners on their

returns was the proper rate of

depreciation..

The parties are likewise in

conflict as to the cost of furnishing

the Kona Kai and Kona Kai East.

(However, there is no dispute as to the

10 year useful life petitioners have

claimed with respect to furnishings.)

Petitioners claimed such cost in the

amount of $60,000 for the Kona Kai. As

to the Kona Kai East, the furnishings

were not claimed separately and were

blanketed in the $708,622 appraised

value figure referred to above.

Respondent's notice of deficiency to

Ocean Sands reduced the $60,000 Kona Kai

furnishings figure to $40,000 and the

notices to Colony Corp. disallowed all

Claimed depreciation for the Kona Kai

East.

A-92

At trial, petitioners sought to

establish a $57,850 cost figure for the

Kona Kai East furnishings as well as to

sustain the claimed $60,000 figure for

the Kona Kai. On brief respondent

agrees that the record would support a

finding of $45,700 cost of Kona Kai

furnishings and $46,184 cost of Kona Kai

East furnishings.

With respect to Kona Kai, an

undisclosed portion of the alleged

$24,000 carpeting cost represented

carpets saved for use in the addition to

the motel which was not completed in the

years at issue. Taking this fact into

account and also taking into account

that the claimed furnishings' costs

(approximately $60,000) were

reconstructed figures, the Court finds

that the cost of the depreciable

furnishings of the Kona Kai was $48,000.

A-93

As to the Kona Kai East respondent

agrees on brief that the testimony on

petitioners' behalf was more accurate,

but respondent asks the Court to reduce

the claimed $57,850 furnishings figure

by $11,666, which represents the cost of

carpet and drapes in the penthouse. We

have determined below that Wilson and

Elsie were not required to live in the

penthouse and that the value of its use

as lodging is taxable to them as a

dividend. We likewise conclude that

petitioners have failed to prove that

the use of the penthouse by Wilson and

Elsie or anyone else was non-personal in

nature and hold that the depreciable

cost of the Kona Kai East furnishings

was $46,184.

Service Station (Wilson and Elsie, and

Sea Fin)

A-94

On their individual returns,

commencing in 1965, Wilson and Elsie

claimed a $90,000 cost for the Colony

Motel (acquired in 1957), $5075 fora

1965 building addition, $35,000 for the

service station building (acquired in

the mid-1950's) and $10,000 for the

12 The

service station equipment.

individual returns, commencing in 1968,

also claimed depreciation on $32,000 in

trailer park improvements acquired, as

reported, in 1961. Additionally, the

returns claimed depreciation on |

furniture, air conditioners and

television sets, with an aggregate cost

of $22,000 (per returns), a reported

1957 acquisition date, and 10-year

useful life. These latter items were

depreciated on the individual returns

through 1967.

A-95

j ee

Respondent adjusted the

depreciation for fact of substantiation

of cost but did not assert fraud on any

of the depreciation issues. As to the

individual returns from 1965 through

1969, respondent reduced the motel cost

from $90,000 to 64,040; the 1965

addition was reduced from $5075 to

$1000; the service station was reduced

from $35,000 to $17,380, and its

equipment was reduced from $10,000 to

$8000. No depreciation was allowed by

respondent on the claimed $32,000 cost

of trailer park improvements. The

aggregate cost of the furniture, air

conditioners and television sets was

reduced from $22,000 to $16,133, but

respondent treated these items as having

been fully depreciated by 1965.

Additionally, respondent corrected a

mathematical overstatement of 1969

depreciation on a dump truck.

A-96

As to 1971, respondent likewise

reduced the claimed $35,000 cost basis

of the service station to $17,380,

notwithstanding respondent's claim that

the January 11, 1971, transfer of that

property to Sea Fin was a taxable sale.

The Sea Fin returns, for 1971

through 1973, claimed the same cost

bases as did the prior individual

returns. However, commencing in 1971,

Sea Fin added the item “sewer line to

park," which it claimed was acquired in

1967 23

at a cost of $30,000. In 1973

Sea Fin added the item “automotive

equipment," claimed to have been ~

acquired in 1973 at a cost of $37,909.

Other miscellaneous depreciable items

were added in 1973 return, including

washers and dryers, a fence, carpets,

trailer park improvements, furnishings

and fixtures.

A-97

Respondent, as with Wilson and

Elsie's return, adjusted Sea Fin's

Claimed depreciation for lack of

substantiation as to cost figures.

Respondent's computations show an

acquisition date of January 1971

(consistent with respondent's position

that a taxable transfer of assets took

place at that time). Commencing with

1971, respondent reduced the

depreciation bases of the motel building

to $25,115; the building addition to

$662.00; the pick-up truck to $750; and

the dump-truck to $1035. Respondent

allowed no depreciation on the claimed

$32,000 trailer park improvements, the

claimed $30,000 sewer line to park, or

(as to 1973) the claimed $37,909

automotive equipment. Respondent's cost

figure adjustments on the motel building

are unexplained in the record. They do

not correspond to prior years'

A-98

adjustments, nor do they tie in with the

alleged consideration received on the

property transfers to Sea Fin. There

was no explanation of respondent's

failure to allow any depreciation on the

trailer park improvements, the sewer

line, and the automotive equipment,

other than lack of substantiation,

coupled with the statement by Revenue

Agent Graubics at trial that “the Cohan

rule went out a long time ago."

The only major improvement to the

trailer park which was done under

contract with an outside party was a

road paving job in early 1972 performed

by Ames & Webb for which Sea Fin paid

$29,010.58. This item appears as an

ordinary expense deduction on Sea Fin's

returns for 1971. However, all payments

on that contract were made in 1972,

except for $5000 paid in 1971.

A-99-

On brief, respondent conceded that

Wilson and Elsie have substantiated

their cost in the service station and

equipment and “are entitled to the

rental depreciation claimed on their

income tax returns in the amount of

$2400 for each of the years 1968, 1969,

and 1971." Actually the returns claimed

only $1400 depreciation in those years

on the service station building itself,

since the equipment had been fully

depreciated in 1967. On the other hand,

respondent's concession that costs have

now been established should apply with

equal force to 1965 and 1966, when the

petitioners claimed the full $2400

depreciation on the service station

building and the equipment.

On brief, respondent also conceded

the claimed $30,000 cost and $1500

annual depreciation of the sewer line

, A-100

(even though such cost was

undocumented.) Respondent further

conceded the $29,010.58 paving

expenditure in 1971 but asserts that it

should have been capitalized over at

least eight years.

As was also true with respect to

most of the deductions involved in these

cases, the testimony on petitioners’

behalf as to the original costs of the

Colony Motion and addition was nothing

more than a bare affirmance of the

correctness of the figures on the

returns. Petitioner had the burden of

proof on depreciation, as well as the

other miscellaneous expenses. Welch v.

Helvering , 290 U.S. 111 (1933); Rule

142(a), Tax Court Rules of Practice and

Procedure. Petitioners’ bare assertion

that the returns were correction does

not satisfy that burden. Halle v.

A-101

Commissioner , 7 T.C. 245 (1946), affd.

175 F.2d 500 (2d Cir. 1949), cert.

denied 338 U. S. 949 (1950). We

accordingly sustain respondent's

determination for the years 1965 through

19697 with respect to the costs of the

Colony Motel and building addition.

However, consistent with our

determination below (see page 105) that

the 1971 transfer of these properties to

Sea Fin was tax-free under section 35l,

we hold t hat the unadjusted

depreciation bases of these properties

were the same for 1971 and subsequent

years as determined for the preceding

years. See section 362, I.R.C. 1954.

As to the service station, we hold

(consistently with respondent's

concessions at trial and in his brief)

that petitioners are sustained in the

amounts of depreciation claimed (but not

A-102

, ay

in any greater amounts) for all years at

issue.

With respect to the $32,000 claimed

as trailer park improvements, assertedly

acquired in 1961 (and first reported by

petitioners in 1968), petitioners'

evidence persuades us only that some

costs were incurred in the basic

improvements to the trailer park and

that (because the materials were

obtained cheaply and the labor was

furnished mainly by family members) such

costs were very low. Applying the rule

of Cohan v. Commissioner , supra, we

hold that the original cost of such

improvements was $14,000 (rather than

the $32,000 claimed on the returns) and

that such cost was depreciated over a 20

year life as claimed on the returns.

As to the $29,010.58 paving expense

(which respondent now concedes as a 1971

A-103

expenditure), the Court agrees that this

item must be capitalized rather than

deducted in the year it was allegedly

paid. On the basis of the evidence, and

again taking into account the

imprecision of the evidence, we hold

that the useful life of the paving was

five years and that its costs should be

depreciated over that period rather than

deducted as an expense in 1971. From

the fact that most of the expense was

paid in 1972 and from information on the

final invoice for the paving job, we

conclude that the newly paved road was

put in service in 1972. The first year

for which a depreciation deduction is

allowed is therefore 1972. See section

1.167(a)-10(b), Income Tax Regs.

With respect to all other

depreciation adjustments pertaining to

the Colony Motel and Trailer Park, both

A-104

on the individual returns of Wilson and

Elsie and on the corporate returns of

Sea Fin, there is lack of credible

evidence in the record to rebut the

presumption of correctness of

respondent's determinations. The Court

accordingly sustains all such

determinations except as hereinabove

modifiea. 14

III. MISCELLANEOUS BUSINESS

EXPENSE DEDUCTIONS~~-

FINDINGS OF FACT AND OPINION

General Statement

Because of the alleged absence of

records, the petitioners' “proof" of |

expenses consisted mainly of testimony

from Suzanne, Chappy, and Elsie. This

testimony constituted to a very large

extent either are affirmances of the

correctness of the figures shown on the

A-105

returns, or affirmances of such figures

based upon claimed recollections or

reconstructions generated at family

conferences during the course of the

trial or shortly before trial, which,

quite clearly, were calculated to

coincide with the return figure. In

most instances the recollections or

reconstructed figures were identical or

nearly identical with the amounts on the

returns. It has long been established

that mere reaffirmance of the

correctness of tax returns is not

sufficient evidence to rebut the

presumption of correctness of

respondent's determinations. Halle v.

Commissioner, supra; Roberts v.

Commissioner , 62 T.C. 834, 839 (1974);

Geiger v. Commisioner , 440 F.2d 688

(9th Cir. 1971), affg, per curiam a

Memorandum Opinion of this Court, cert.

denied 404 U.S. 851 (1971). But it does

A-106

not follow, because a reconstructed

figure coincides with the return figure,

that it is ipso facto wrong. It is our

view that in instances where the Court

has been persuaded by the testimony that

Claimed expenses have been sufficiently

matched with specific persons, places or

purposes, the Court is justified in

applying the rule of Cohan v.

Commissioner , 39 F.2d 540 (2d Cir.

1930). In such cases, .n the absence of

records, we are cautioned to bear

heavily against the taxpayer. We will

specify below those instances in which

we think the Cohan rule may properly be

applied, as well as any other expense

items which, we fell, respondent

erroneously disallowed. Although we

believe that each of the expense

deduction issues is deal with below, the

Court holds that any disputed expense

disallowance which may not specifically

A-107

be mentioned below is sustained on the

basis of the above-cited Hall, Roberts

15 In addition, we

and Geiger cases.

sustain any additional expense

deductions allowed by respondent in

excess of the amounts shown on

petitioners’ returns.

Kona Kai (Ocean Sands)

The expenses of Ocean Sands

disallowed in the notices of deficiency

were as follows:

A-108

Expense Deduction Disallowed--Ocean Sands

Expenses 1968

Legal $ 2,919.40

Maintenance 14,452.86

Rents

Taxes

Interest

Insurance

Cleaning

Repair

Linen

Automotive

Food

Advertising

$

1968

485.88

12,300.00

2,500.00

A-108a

1971

2,500.00

4, 139.80

4,500.00

1,050.00

856.15

18,108.30

7,490.81

1972

2,500.00

1,405.34

3,000.00

770.00

1,799.35

4,765.82

795.41

1973

$ 603.00

2,500.00

1,630.00

151.00

1,821.00

Legal fees. Respondent stipulated

at trial both that $400 of the claimed

$2,919.40 legal fees in 1968 qualified

as a deductible expense. All but $50 of

the balance of the 1968 fee, the entire

1969 fee and all of the 1973 fee were

paid to Stanley Sachs, an attorney, for

representation in court proceedings

growing out of altercations which took

place on the Kona Kai premises, in which

various family members were among the

participants. As we rend the parties’

stipulation on this score, Ocean Sands

was (along with the involved family

members) one of the parties so

represented in such litigation. We

believe that Pantages Theatre Co. v.

Welch , 71 F2d 68 (9th Cir. 1934), and

the other cases cited to us by

respondent are in opposite because they

were decited prior to Commissioner v.

Tellier , 383 U.S. 687 (1966). We feel

A-109

that the record as a whole justifies us

in finding that the altercations in

question grew out of efforts on the part

of the involved family members

(misguided as they may have been in some

situations) to protect and further

business interests of Ocean Sands.

Although not entirely free from doubt,

we hold, under the authority of Tellier

, that except for the $50 in 1968 (as to

the purpose of which no evidence was

introduced), and disputed legal expenses

were deductible as ordinary and

necessary business expenses.

Cleaning and repairs. Included in

the amount disallowed for 1968 and 1969

were the amounts (estimated by

petitioners) of $8000 and $10000,

respectively, representing the cost of

replacing green lumber used for beams in

the 1966 and 1967 construction. The

A-110

beams had started to sag by 1968.

Because this occurred so soon after the

original construction, we hold that the

beam replacement was an integral part of

the original construction, and must be

capitalized as part of the cost of

structure. Driscoll v. Commissioner ,

16 Under

147 F.2d 493 (Sth Cir. 1945).

the rule of Cohan, supra, the Court

sustains the petitioners as to 50% of

the balance of the claimed 1968 and 1969

expenditures under this heading.

Rent. Ocean Sands paid $2500 to

Sea Star in each of the years 1969

through 1973 for necessary additional

parking space. Although the payments

were loosely handled, the Court is

persuaded that the said amounts were

indeed paid, were reasonable in amount,

and are deductible as ordinary and

A-111

necessary expenses of Ocean Sands for

the years at issue.

Interest expense. Respondent has

conceded on brief that Ocean Sands is

entitled to deductions for 1971, 1972

and 1973 in the respective amounts of

$4500, $6586.66 and $3302.49, over and

above the amounts allowed in the notices

of deficiency. Such concessions will be

given effect in the Rule 155 computation

in these cases.

Linen expense. On its 1971 return

Ocean Sands deducted $16,738.29, and

respondent disallowed $7,490.81 of that

amount. However at trial petitioner

conceded that because of a clerical

error, the deduction was overstated by

$10,000. Accordingly we allow a

deduction of $6,738.29 for 1971.

A-112

All remaining expense items. As to

all remaining Ocean Sands expense

adjustments set forth in the above

schedule for the years 1971, 1972 and

1973 (including all items set forth in

the n “ices of deficience in which

respondent increased the amounts claimed

as deductions on the returns), we note

that in contrast to his total

disallowance of Sea Fin expenses (see

page 81, infra), respondent allowed

Ocean Sands deductions to the extent

substantiated. In these circumstances,

and in view of the fact that the

testimony amounts to little more than

bare affirmance of the figures shown on

the returns (see Hall, supra), we do not

feel warranted in applying the rule of

Cohan, supra . Accordingly, as to all

such remaining items, there being no

credible evidence in the record to rebut

the presumption of correctness of

A-113

respondent's determinations, we sustain

those determinations. Included in this

holding is respondent's allowance of

additional depreciation for repair

expense items disallowed and capitalized

for the years 1971.

Kona Kai East (Colony Corp.)

The expense of Colony Corp.

disallowed in the notices of deficiency

were as follows:

A-114

>

Expense Deductions Dissallowed--Colony Corp.

1972 1973

Salary expense $ 2,815.57 $

Repair expense 2,916.79 3,158.46

Taxes expense 6,636.17

Interest expense 19,575.00 12,380.00

Professional fees 854.00

Insurance expense 1,540.00

Operation equipment 7,780.00

A-ll4a

4 eh

Salary expense for 1972. The

respondent disallowed $6815.47 of the

claimed $8205 deduction. The Court Is

satisfied that expenses for maid service

and other services not chargeable to the

construction costs of the Kona Kai East

were paid during 1972 in excess of

$1389.43 allowed by the respondent. In

view of the lack of records and the

inexactitude of the testimony, this

Court believes the rule Cohan, supra,

should be applied to this item. The

Court accordingly concludes that $3000

additional allowance should be made for

this item and that it is deductible for

1972 as an ordinary and necessary

business expense. For 1973 respondent

has allowed more than the amount claimed

on the return. This additional

allowance as well as other additional

allowances set forth in the notices of

deficiency will be given effect in the

A~115

Rule 155 computations in these cases.

Taxes expenses for 1972.

Respondent disallowed $6,636.17 of

$11,113 taxes expense claimed on the

return. Petitioners' evidence include

proof that in 1972 more than $16,000 was

paid out of loan proceeds by First

Colonial Bank for property taxes,

penalties and interest. We cannot tele

how much of these payments was allocable

to penalties or to “interest” which

might have been in the nature of a

penalty and which accordingly would not

constitute a deductible "tax" under

section 164 of the Code. 2’

Colony

Corp. had acquired the properties in

1961 and of the total amount proven,

over $10,000 was attributable to the

years 1962 to 1968. Some of the

reattributable to the years 1969 through

1971. We are left in the dark as to how

A~-116

to apportion these payments. With the

record as it is, and in view of the fact

that respondent increased Colony Corp.'s

tax deduction for 1973 by $7452.24

(likewise unexplained in the record), we

f find ourselves unable to disturb

respondent's determinations as to these

items. Accordingly we sustain such

determinations.

Interest expense. Respondent has

conceded on brief, and we accordingly

hold, that Colony Corp. is entitled to

deduct interest for 1972 and 1973 in the

respective amounts of $19,975 and

$11,475 over and above interest

deductions allowed in the notices of

deficiency.

Professional fee expense for 1972.

Petitioner deducted $1800 paid for legal

fees in connection with the $300,000,

ten year loan for construction of the

A-117

Kona Kai East. Respondent allowed $946

of the deduction and disallowed the

rest. We hold that the remaining $854

should be amortized over the period of

the loan. See Lovejoy v. Commissioner ,

18 B.T.A. 1179 (1930). The Court

expects the parties to to take this

determination into account in their

computation under Rule 155.

All remaining expense items. In

the absence of any persuasive evidence

to the contrary, we sustain the

remaining adjustments with respect to

Colony Corp.'s expense deductions

(including respondent's allowances of

depreciation on capitalized items).

Repairs. The Court finds no

evidence in the record to rebut

respondent's partial disallowances for

the years 1965-1969. As to 1971-1973,

respondent disallowed the Sea Fin

A-118

repairs items in the full amounts

claimed. Under the rule of Cohen,

. Supra, and based upon the record as a

whole, the Court find that Sea Fin is

entitled to repairs deductions for 1971l-

1973 in the amounts of 50% of the

deductions claimed on the returns for

those years.

Rents. The Chaplains is 1968 and

1969 and Sea Fin in 1972 paid $3000 rent

to Chattel. In 1968 $5500 was claimed

by the Chaplains as a rent deductions,

apparently including an added $2500 paid

to Sea Star. There is no question that

Chattel and Sea Star were separate

corporate entities, that the lots on the

oceanfront were owned by those

corporations, and that such lots were

made available to the Colony Motel and

trailer park guests and tenants for

ocean bathing access. Although the

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rental payments were handled in the

usual loose way in which the Chaplains

handled many of their geinndaa

transactions, the Court is satisfied

that such rents were paid, were

reasonable in amount, and are deductible

as ordinary and necessary business

expenses under section 162.

Repaving expense. As set forth in

the business depreciation findings and

opinion herein, (see page 68, supra )

the $29,010.58 claimed expense will be

disallowed, and that amount will be

depreciated over a five year period.

Management fees and clerical and

supervisory fees. Respondent disallowed

these items in full. The Court is

satisfied that each of these fees for

the years 1971, 1972 and 1973 were paid

by Sea Fin to Elsie and Suzanne, that

they performed substantial services for

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Sea Fin, and that the amount involved

are not unreasonable. Respondent has

not pleaded the applicability of section

482 of the Code to the possible

allocation of any salaries or fees to

other controlled corporations. The

claimed deductions forsuch services are

accordingly allowed in full.

Sundries expenses and supplies.

These items were likewise disallowed in

full by respondent. On the basis of the

record in its entirety, the Court is

convinced that some portion of the

claimed expenses is allowable under the

rule of Cohan, supra. We hold that 50%

of the amounts claimed for each of the

said items is properly deductible under

section 162, except that with respect to

the $16,055.86 supplies, expense claimed

in 1972, only 20% is deductible. It my

be that some portion of the remaining

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soo

balance of this claimed expenditure

represents a depreciable asset in Sea

Fin's hands. However, there is no

evidence in the record which would

support a finding as to the cost basis

of such asset. In reaching these

conclusions we have again taken into

account the complete lack of records,

and the weakness of other proof,

coupled, however, with our conviction

that some approximation is justified

under the record as a whole.

Legal fee expenses. The disallowed

legal fees were incurred for the

organization of Sea Fin in 1971 and for

defense of title in litigation in 1972.

These clearly were capital expenditures

and the disallowances by respondent are

sustained. See section 1.263(a)-2,

Income Tax Regs. and section 248 of the

Code.

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Interest expense. Petitioners

could have attempted some corroboration

of the 1971, 1972 and 1973 interest

items. In the absence of any proof,

other than affirmation of the returns,

respondent's disallowances are

sustained.

Auto expense. Again respondent

disallowed the claimed 1972 and 1973

expenses of Sea Fin in toto. We are

convinced that some such expenses are

allowable, and under the Cohan rule, our

best approximation is that 50% of such

Claimed expense constituted ordinary and

necessary business expenses and should

be allowed in each of these years. We

so hold.

Miscellaneous expense. No proof

was offered on this $3688 item (which

was disallowed for 1973). We sustain

respondent's determination.

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=

Professional fee. This item,

claimed for 1973, totaled $1365. Of

that amount, $1000 was the balance due

on legal fees, referred to above, for

defense of title, and accordingly

improperly claimed as a deduction. The

$365 balance was paid by Sea Fin for

accounting services, and is deductible

as an ordinary and necessary business

expense.

Other rental expense for 1971. In

reporting the income from the service

station for 1971, Wilson and Elsie

Claimed “other expenses" (in addition to

depreciation) totaling $2148.79 and

consisting of interest ($868.12), taxes

$1035.67) and insurance ($245).

Respondent disallowed these amounts in

toto. We find that valid expenses were

incurred in the production of the rental

income from the service station. In the

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absence of records as to the amount of

such expenses, we apply Cohan, supra,

and hold that out of the claimed total

of $2,148.79, petitioners are entitled

to deduct $1000.

Sea Star and Chattel

In the case of Sea Star and Chattel

Corporations, the items of disallowance

consist of tax expense in the years 1971

through 1973 for Sea Star and 1971 and

1972 for Chattel and interest expense

for each corporation in 1971. The

record is devoid of any proof as to

these items, and we have no alternative

but to sustain respondent's

determinations.

Respondent adjusted Ocean Sands'

net operating loss carryover from 1965

and 1966, claimed on the 1967 return in

the amount of $19,053.95. Respondent

accepted the claimed net operating loss

of $4,285.20 for 1965 but reduced the

1966 loss to $9,370.35. Accordingly,

respondent disallowed the loss carryover

deduction for 1967 to the extent of that

1966 reduction ($5398.40).

Net operating loss deductions were

also claimed by Ocean Sands for 1969 and

1971. The deduction claimed for 1971 in

the amount of $68,963,46 included in

part a claimed 1970 net operating loss.

The year 1970 is not at issue here, but

respondent contends that full

disallowance of the claimed carryover to

1971 is justified by a recomputation of

Ocean Sands' 1970 net income based upon

reconstruction of that year's gross

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receipts by the comparable motels method

used in other years.

Petitioner Ocean Sands has

introduced no evidence'establishing the

losses which it carried over from 1965,

1966 and 1970 (other than the tax

returns and such proof as exists in the

record as to weaknesses in respondent's

methods of reconstructing gross

receipts). We cannot conclude that

Ocean Sands incurred such losses merely

from the fact that its returns reflected

losses. The fact that the government

may have accepted or acquiesced in the

returns for years not at issue does not

relieve petitioner from its burden of

proof as to actual existence and amount

of the losses sought to be carried

over. 18

It is our view, nevertheless, that

respondent should be required to

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recompute the 1970 net operating loss of

Ocean Sands, taking into account this

Court's determination that the Kona Kai

had an average of 40 room available for

rent in 1970 and that it had gross

receipts of $123,216 that year. 19

Subject to that exception, and in the

absence of proof, we sustain

respondent's determination as to Ocean

Sands' net operating loss deduction.

Sea Star and Chattel

For 1971, 1972 and 1973 Sea Star

claimed net operating loss deductions of

$16,751.62, $14,419 and $9830,

respectively.. For 1971 and 1972 Chattel

claimed net operating loss deductions of

$22,531 and $318, respectively.

Respondent disallowed all such

deductions in full. There is complete

absence of proof on these claimed

deductions and we must accordingly

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sustained respondent's determinations.

FRAUD PENALTIES,

CORPORATE PETITIONERS

(OCEAN SANDS, COLONY

CORP., AND SEA FIN)--

FINDING OF FACT AND

OPINION

Respondent contends that at least a

part of the deficiencies in income tax

of Ocean Sands and Sea Fin in 1971

though 1973, and of Colony Corp. in 1972

and 1973, was due to fraud with intent

to evade tax within the meaning of

section 6653(b) 7°. In his answers

respondent alleges as his basis for

fraud that gross receipts were

understated, that adequate records were

not maintained, and that petitioners

produced incomplete records in response

to respondent's requests. Respondent

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has not affirmatively alleged fraud in

connection with overstated deductions.

The burden of establishing fraud,

by clear and convincing avidence, is

upon respondent. Section 7454(a); Rule

142(b), Tax Court Rules of Practice and

Procedure; Foster v. Commissioner , 487

F.2d 902, 903 (6th Cir. 1973), affg. a

Memorandum Opinion of this Court; Fox v.

Commissioner , 61 T.C. 704 (1974). To

established fraud the Commissioner must

show that the taxpayer intended to evade

taxes, which he knew or believed he

owed, by conduct intended to conceal,

mislead or otherwise prevent the

collection of such taxes. Stoltzfus v.

United States , 398 F.2d 1002, 1004 (3d

Cir. 1968), cert. denied 393 U.S. 1020

(1969); Powell v. Granquist , 252 F.2d

56, 60 (9th Cir. 1958). However, in

sustaining his burden of proof,

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respondent is not required to prove the

precise amount of the underpayment

resulting from fraud, but only that "any

part" of the underpayment is

attributable thereto. See Estate of

Brame v. Commissioner , 25 T.C. 834

(1956), affd. per curiam 256 F.2d 343

(5th Cir. 1958).

The presence or absence of fraud is

a factual question to be determined by

an examination of the entire record.

Mensik v. Commissioner , 328 F.2d 147,

150 (7th Cir. 1964), affg. 37 T.C. 703

(1962), cert. denied 379 U.S. 827

(1964); Otsuki v. Commissioner , 53 T.C.

96, 105-106 (1969). Since fraud can

seldom be established by direct proof of

intention, the taxpayer's entire course

of conduct can often be relied on to

establish circumstantially such

fraudulent intent. Stove v. Commissioner

A-131

, 56 T.C. 213, 223-224 (1971); Otsuki v.

Commissioner , supra. A corporation, of

course, acts through its officers and

authorized employees.

Considering the entire record, we

conclude that respondent has proven that

a part of each of the deficiencies of

Ocean Sands for 1971 through 1973 and of

Colony Corp. for 1972 and 1973 was due

to fraud. The basic factor which

indicates fraud is a consistent pattern

of substantial understatement of gross

receipts by these petitioners. According

to our findings, Oceans understated its

gross receipts by 16% in 1971, 27% in

1972 and 14% in 1973. Colony Corp.

understated its gross receipt by 38% in

1972 and 28% in 1973. When all the

years at issue in these consolidated

cases are considered, there appears a

pattern of understatement of gross

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receipts for six years in the case of

Ocean Sands and two years in the case of

Colony Corp. Both of these businesses

were operated by the same individuals.

The officers of petitioners (Ocean

Sands and Colony Corp.) must have known

that they were underreporting income.

Thus, operating statements of Ocean

Sands for 1972 and 1973, which were

signed by Suzanne as president of the

corporation and presented to creditors

or potential creditors, show gross

receipts of nearly twice the amounts

reported on the tax returns for those

years, which were also signed by

Suzanne. See Romm v. Commissioner , 245

F.2d 730 (4th Cir. 1957), cert. denied

355 U. S. 862 (1957). In addition, the

amounts reported on the returns were

frequently not sufficient to cover both

the expenses reported and the debt

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reduction payments of principal which

were made by Ocean Sands and Colony

Corp. We cannot accept petitioners’

story that m money to cover the

shortfall consistently came from Wilson.

Aside from the fact that Elsie invested

in the family business the proceeds of

gifts from her father-in-law, the

standard answer at trial, when a

question was raised as to source of

funds, was that Wilson had loaned the

money. We find it incredible that the

need for cash over the years at issue

was satisfied solely or primarily by

Wilson. It is our view that at least a

substantial part of the apparent cash

flow deficit was illusory. There is no

evidence that it actually existed. In

fact, for most. part, these years were

times of apparent prosperity during

which additional expansion and building

was planned and carried out. Under such

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on

NT

circumstances we are convinced that the

underreporting of income was

intentional.

Although mere understatement of

income, standing alone, is not

sufficient to carry respondent's burden

of proof, a consistent pattern of

substantial and intentional

underreporting is by itself strong

evidence of fraud. Merritt v.

Commissioner , 301 F.2d 484, 487 (Sth

Cir. 1962), affg. a Memorandum Opinion

of this Court. See also Holland v.

Commissioner , 348 U.S. 121, 139, (1954).

Such repeated understatements, coupled

with other so-called "badges of fraud,"

constitute clear and convincing evidence

that the understatements are the product

of an intent to evade tax. Merritt v.

Commissioner , supra; Vannaman v.

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Commissioner , 54 t.C. 1011, 1018-1019

(1970).

Petitioners' officers’ refusal to

cooperate with the revenue agents in

their investigation is such an

additional badge of fraud. See Millikin

vy. Commissioner ,298 F.2d 830, 836 (4th

Cir. 1962); Granat v. Commissioner , 298

P.2d 397, 398 (2d Cir. 1962); Klassie v.

United States , 289 F.2d 96, 103 (8th

Cir. 1961). Petitioners did not return

the agents' calls, did not appear at

requested meeting, and refused to

produce books and records, except under

threat of a court order. Even after

they did produce records, petitioners

continued to be uncooperative. For

example, when Agent Graubics requested

to see certain records a second time, he

found a portion of them were missing.

We have attempted in our general

A-136

OY dete

findings to explain some of the reasons

for the non-cooperative attitude of

petitioners, especially Wilson, and we

have tried to the best of our ability to

give due weight to those reasons in

evaluating the intent of petitioners for

fraud purposes. Nevertheless, we are

convinced the failure to cooperate was

conduct intended to conceal and to

prevent the collection of taxes, and

therefore is an indication of fraud.

See Stoltzfus v. United States, supra.

We have already determined that

petitioners failed to keep complete

books and records and that their

bookkeeping system was wholly

inadequate. Such failure to keep

records usual in business transactions

is a further badge of fraud, (

Baumgardener v. Commissioner , 251 F.2d

311, 314 (9th Cir. 1957),) especially

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where, as here, the taxpayer knows his

records are inadequate. “2

Yet another badge of fraud in these

cases is the history of repeated

incidents, including a series of fires

(two of which are highly suspicious), in

which records were allegedly destroyed.

Cf. Estate of Beck v. Commissioner , 56

T.C. 297, 365 (1971). Moreover,we are

convinced that some of the records which

petitioners claim were burned were not

actually destroyed. For example,

certain Sea Fin records, allegedly

consumed in the December 9, 1975, fire,

and later reported to police by Elsie as

stolen, were actually in the possession

of Mr. Fine, attorney for Suzanne and

Chappy. Nevertheless, none of these

records were producted at trial. Such

inconsistent explanations of the failure

to produce records are themselves

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indications of fraud. Gromacki v.

Commissioner , 361 F.2d 727, 732 (7th

Cir. 1966).

Finally, the extent to which

petitioners dealt in cash and the manner

in which they handled the cash are

further factors in our determination.

See Gromacki v. Commissioner , supra.

Although we have described in our

present in the case of Sea Fin, the

underlying factors of a pattern of

substantial understatement has not been

established. With Sea Fin, the

discrepancies between our findings and

the amounts reported are relatively

small in comparison with the

discrepancies found with respect to

Ocean Sands and Colony Corp.

Recognizing the inherent imprecision in

the method of reconstruction we have

used, we consider the amounts reported

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by petitioner Sea Fin as being on the

borderline of a reasonable zone of error

for which we must make allowances in

determining fraud, where the burden is

on respondent. Based upon our findings

of Sea Fin's gross receipts, Sea Fin

underreported those gross receipts by 5%

in 1971, 7% in 1972 and 5% in 1973.

Resolving our doubts in favor of Sea

Fin, we do not feet warranted under the

circumstances in labeling these

differences as “substantial” for fraud

purposes. Accordingly, Sea Fin's case

lacks a foundation for an inference of

fraud. Whatever other badges of fraud

may be present in Sea Fin's case (like

those which bolstered a finding of fraud

with respect to Ocean Sands and Colony

Corp.), they are, standing by

themselves, insufficient proof of fraud.

We conclude that respondent has failed

to carry his burden of “clear and

A-140

convincing" proof with respect to the

fraud penalities against Sea Fin.

VI. GAIN ON TRANSFER

OF REAL PROPERTY TO

SEA FIN BY WILSON AND

ELSIE--FINDINGS OF

FACT AND OPINION

In docket no. 5979-76, respondent

asserted that the joint return of Wilson

and Elsie for 1971 failed to report a

capital gain on the sale by Elsie of

motel and trailer park land to Sea Fin.

Respondent alleges that the sale price

was $540,000, that petitioners had a

basis of $216,100, and that they

realized $323,900 gain (before the 50%

reduction under section 1202 of the

Code). This omission is asserted by

respondent both for deficiency and for

fraud penalty purposes.

A-141

On January 11, 1972, two deed to

Sea fin were executed by Elsie, Wilson,

and Gussie Mae Chaplin (wilson's mother)

transferring the real property occupied

by the Colony Motel and Trailer Park and

the Phillips 66 service station. The

deeds recited a consideration of $10 and

"other good and valuable consideration."

No other assets appear to have been

transferred to Sea Fin on its original

incorporation. On January 15, 1971, a

deed of trust was executed by Sea Fin to

Melva V. Baugh (Wilson's sister) as

trustee with power of sale. This deed

of trust purportedly secured the payment

of $540,000 evidenced by 90 identical

$6000 promissory notes payable to —

bearer, with interest as set forth in

the notes. Accordingly to the deed of

trust, eight of the notes were to mture

each year until January 19, 19862, at

A-142

Ke,

which time the last ten notes would

mature.

In January 1976 Melva V. Baugh ran

newspaper ads for a cash foreclosure

sale under the Sea Fin deed of trust and

on January 22, 1976, she executed a

trustee's deed of Sea Fin's motel,

trailer park and service station

property to Big Ten Holdings, Ltd.

Gussie Mae Chaplain, who had been the

bider at the foreclosure sale and had

assigned her interest to Big Ten

Holdings, joined as grantor in that

deed. The latter corporation was owned

or controlled by the Chaplain family or

by some members of the family. The

January 22, 1976, deed recited that the

consideration was $585,000, representing

the original $540,000 face amount of the

promissory notes plus accrued interest

"exceeding the sum of $45,000."

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As indicated in our general

findings of fact, the inter-personal

relationships within the Chaplain

family, as well as the relationships

between the Chaplains and certain

outsiders, have been characterized

historically and upon to the present in

arguments, feuds and hostilities which

at intervals have had a tendency to

erupt violently. Divorces of the

Chaplain children have been one

contributing factor to such hostilities.

Chappy's divorce, which had occurred or

was pending at or about beginning of

1971, raised fears in the minds of

Wilson and Elsie that in case of

Chappy's death (leaving one child as his

heir) they might find themselves in

partnership with in-laws toward whom

they were very hostile. It was this

fear which led to the incorporation of

Sea Fin and the transfer to it of the

A-144

motel, trailer park and service station

properties.

The record contains no clear

indication as to the purpose for the

issuance of the $540,000 trust deed

bearer notes. None of the parties placed

such notes or any copies of them in

evidence. There is a doubt as to

whether such notes ever existed. There

is likewise a serious doubt, if the

bearer notes did exist, as to who were

the beneficial owners thereof.

Furthermore, it is not clear whether

such notes (if they did exist)

constituted consideration furnished by

Sea Fin for the transfer of the motel,

trailer park and service state

properties (a transfer which occurred

four days prior to the date of the deed

of trust), or whether they were issued

for some other purposes.

A-146

The foreclosure sale under the deed

of trust occurred shortly after one of

the above mentioned violent intra-family

eruptions. On January 8, 1976, Chappy

and Suzanne, in culmination of an

argument with their parents (during the

course of which they were locked out and

physically restrained from entering the

Kona Kai offices), commenced a lawsuit

demanding that Sea Fin issue stock to

them for services they had performed, in

accordance with alleged prior

agreements.

In filing the lawsuit they also

claimed ownership of the alleged $540,00

in bearer notes (which they had never

seen) and prayed for the appointment of

a receiver and other equiable relief.

Sea Fin's first return (1971) and

subsequent returns carry over the basis

of the motel, trailer park and service

A-147

station improvements which had been

claimed on Wilson and Elsie's joint

return for prior years.

Based upon the entire record, the

Court finds that, although title to the

property which was transferred to Sea

Fin on January 11, 1971, was recorded in

Elsie's name, it was owned beneficially

by Elsie together with other members of

the Chaplain family in undefined

proportions; that the stock of Sea Fin

was owned benefically by Elsie together

with other members of the Chaplain

family in proporations which were

likewise undefined, but which were the

same as the proportions in which the

transferred property was benefically

owned; 22 that the alleged bearer notes

secured by the January 15, 1971, deed of

trust (if any such notes existed)

constituted either stock and securities;

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and that such notes (if any existed)

were beneficially owned in the same

proportions in which the transferred

property was benefically owned.

Based upon these findings, section

351 of the Code mandates non-recognition

of gain on the disputed transfers to Sea

23 We have found that the

Fin.

beneficial ownership of Sea Fin and of

the purported notes was in the same

persons and in the same proportions as

was the beneficial ownership of the

properties transferred to Sea Fin on

January 11, 1971. Indeed, respondent

concedes that each of the individual

petitioners was the beneficial owner of

a “substantial portion" of the stock.

The only remaining question on this

score is whether the purported notes

constituted stock or securities. If

they were either "stock" or

A-149

"securities," the result would be the

same. Section 351 would preclude the

recognition of gain. 24

It appears that the properties

themselves were the only substantial

assets that were transferred to Sea Fin

on its incorporation in 1971 and that no

cash was contributed to the corporation.

It likewise appears that the historical

profit margin attributable to the

business assets transferred to Sea Fin

was insufficient to provide for the

ratable payment of $540,000 in notes,

over an ll year period. (For this

purpose we are using the figure shown on

Wilson and Elsie's individual returns,

which we view as being closer to reality

than the respondent's reconstructed

figures.) Accordingly, it seems clear

that the payment of the purported notes

“was dependent upon and at the risk of

A-150

(Sth Cir. 1956), cert. denied 352 U.S.

826 (involving the tax character of 89

notes which matured serially over a

period between the 5th and 9th year

after they were issued at the time the

obligor corporation was organized):

The test as to whether notes

are securities is not a mechanical

determination of the time period of

the note. Though time is an

important factor, the controlling

consideration is an over-all

evaluation of the nature of the

debt, degree of participation and

continuing interest in the

business, the extent of proprietary

interest compared with the

similiarity of the note to a cash

payment, the purpose of the

advances, etc. It is not necessary

for the debt obligation to be the

equivalent of stock since section

112(b)(5)(the 1939 Code predecessor

of section 351) specifically

includes both, ¢stock" and

"securities." (22 T.C. at 751.)

In contrast with the facts in both

(Aqualane Shores, Inc. and Camp Wolters

Enterprises, Inc.), the transferee

corporation herein (Sea Fin)

consistently used a carried-over basis,

A-151

rather than a new, “stepped up” basis

for depreciation of the transferred

property. If would of course have been

to its tax advantage to use a stepped-up

basis if (as was attempted but cejeeend

by the Courts in the cited cases) the

Chaplains and their advisors had viewed

the 1971 transfers as genuine purchases

rather than a mere continuance of the

business in corporate form. Although

the intent of the parties has lees

weight than the objective facts, it is

nevertheless a factor which, when added

to the factors outlined above, leads the

Court to the conclusion that the

purported bearer notes were, at most,

"securities" as that word is used in

section 351 of the Code. Accordingly,

we hold that the January 11, 1971,

transfers of properties to Sea Fin

qualified for no recognition of gain

under section 351. The Court sustains

A-152

the petitioners with respect to this

adjustment.

VII. DIVIDEND INCOME

AND FRAUD, INDIVIDUAL

PETITIONERS~- FINDINGS

OF FACT AND OPINION

The principal issue in the

individual cases for 1971 and subsequent

years stems from respondent's

determination that dividends were

received (and not reported) from Ocean

Sands, Colony Corp. and Sea Pin.

Although respondent determined that sonic

such dividends were in the form of

gratuitous use by individual family

members of corporate property, the

alleged cash dividends account for by

far the greater part of the asserted

deficiencies.

A-153

1 ~ eee

General Dividends Based on Reconstructed

Corporate Income

In general, respondent

reconstructed the gross receipts of the

corporations. Then, being unable to find

such reconstructed income in the

corporate treasuries, respondent

asserted that the amounts of such gross

receipts in excess of the amounts

reported had been distributed as

dividends to the individual family

members. Because the Chaplains never

disclosed to the respondent the

proportionate stock ownership of the

three corporations, respondent, (to

protect the revenue) asserted the full

amount of each corporation's alleged

unreported gross receipts against each

of the individual parties. Thus he

determined dividends from a corporation,

in years in which Elsie and all three

A-154

children were involved, in quadruple the

amount of the respective corporation's

increase of gross receipts. The

individual family receipts. The

individual family members are still at

war with each other as to the

apportionment among them of the stock of

each of the corporations. The Court

believes that nothing in evidence herein

establishes the basis for a finding as

to such apportionment. However,

respondent, on brief, would have the

Court find that for fraud purposes for

the years at issue Elsie owned at least

40% of each corporation's stock; that

Chappy and Jerry each owned at least 20%

of Ocean Sands and 20% of Colony Corp.;

that Chappy and Jerry owned 12-1/2% and

10% of Sea Fin, respectively; and that

Linda owned at least 5% of Ocean Sands,

8% of Colony Corp. and 12-1/2% of Sea

It is to be noted that on brief

respondent has lowered his sights and

now contends that the individual

petitioners received the alleged

unreported cash receipts in at least the

percentages above indicated, rather than

100% each as determined in the notices

of deficiency. Additionally, in

determining the amounts of such alleged

cash dividends, respondent (on brief)

has reduced the amount of cash available

for distribution by the sum of capital

cash expenditures and loan reductions

during the respective taxable years.

Thus, by way of example, the notice of

deficiency to Wilson and Elsie and the

affirmative allegations in respondent's

answer of 1973 alleged cash dividends

from Ocean Sands in the amount of

$93,850. (The same $93,850 was asserted

by respondent as 1973 cash dividends to

Chappy, Jerry and Linda, each.) On

A-156

brief, after allowing for capital cash

expenditures and loan reduccions

totaling $40,745, and after an amended

reconstruction and downward adjustment

of gross receipts, respondent's new

figure for earnings available for

distribution is reduced from $93,850 to

$7,517. This figure is the apportioned

among the family members in accordance

with their alleged stock ownership. For

example, 40% of $7,517, or $3006 (as

compared with the $93,850 claimed in

respondent's notice of deficiency and

answer), is now claimed as the minimum

cash dividend received by Elsie in 1973

from Ocean Sands. Respondent, although

thus lowering his sights for fraud

purposes, still adheres to the original

theory of 100% distribution of available

profits to each of the determined

individuals.

A-157

The Court is not persuaded that

there were any cash dividends by the

three corporations during the years at

issue, except in the relatively minor

instance hereinbelow set forth (at page

120 et seq.) With that exception, the

Court finds that no such cash dividends

were distributed to the individual

petitioners. Respondent bases his

argument principally upon his

reconstruction of the corporate gross

receipts, the looseness of the corporate

accounting and fiscal methods, the

availability to the individual of cash

in the corporate safes, and the frequent

practice of one corporation paying the

expenses of another of the commonly

controlled corporations and permitting

its facilities to be used by another

corporation. 7°

The Court agrees with

respondent that all these factual

elements were present in these cases.

A-158

Notwithstanding the loose practices

(which the court in no way condones),

there is a lack of evidence that

substantial sums were actually

distributed, and the record as a whole

supports the individual petitioners’

staunch denials that any substantial

distributions were made. the weakness

of respondent's case on the dividends

issue is underscored by the huge

discrepancies between the cash dividend

figures he asserts for fraud purposes

and the figures he asserts for

deficiency purposes. Although

respondent inserts “at least" before the

figures he is now claiming for fraud

purposes, we take it that these figures

are all that he really thinks he has

proven. We know of no case involving

discrepancies of any such magnitude and

view the existence of such discrepancies

as an admission of weakness on the cash

A-159

dividend issues. As a further admission

of weakness with respect to the bulk of

the alleged cash dividends, we note

respondent's statement on brief (after a

discussion of certain specific, and

mostly relatively minor, cash dividend

assertions):

There is also some indication

that some of the cash was actually

distributed to the individual

petitioners. Each one of them

testified that there was an

understanding within the family

that everyone would be paid as soon

as the corporations started earning

money .***

"Some indication" is not strong enough

to overcome petitioners’ prima facie

case created by their believable denials

of substantial cash distributions, nor

does it come close to the clear and

convincing evidence needed to prove

fraud.

A-160

We point out that our inability to

find any basis in the record

establishing the proportionate ownership

of the corporations would not in itself

preclude a finding that a dividend had

been paid, especially in the case of

non-formal distributions by family owned

corporations.. Such distributions may

constitute dividends, even though they

are not distributed pro rata. 58th

Street Plaza Theatre, Inc. v.

Commissioner , 16 T.C. 469 (1951), affd.

195 F.2d 724 (2d Cir. 1952), cert denied

344 U.S. 820. We further note that the

facts herein are distinguishable from

those in the cases cited to us by

respondent for the proposition that

there is a constructive dividend when a

closely held corporation has unreported

cash receipts and when there is an

absence of evidence that such receipts

were expended fe sereorate purposes.

In those cases relied upon by respondent

there were specific findings that the

shareholder having dominion over the

corporate funds received or retained

such funds or diverted them to his own

use. Clark v. Commissioner , 266 F.2d

698 (9th Cir. 1959); Chesbro v.

Commissioner , 21 T.C. 123 (1953), affd.

225 F.2d 674 (2d Cir. 1955), cert.

denied 350 U.S. 995 (1956); Nash Miami

Motors, Inc. v. Commissioner , T.C.

Memo. 1964-230, affd. 358 F.2d 636 (5th

Cir. 1966), cert. denied 385 U.S. 918

(1966). We can make no such finding

here. On the contrary, were are

persuaded that, with the exception noted

below, such corporate cash and bank

accounts as were available for

distribution were in fact retained by

the corporations.

A-162

With respect to the loose handling

of inter-corporate financial

transactions, as above noted, the only

situation in which respondent is asking

the Court to find a derivative dividend

from inter-corporate “transfers” us the

acquisition in 1973 by Sea Fin of

laundry equipment which was used to a

large extent in providing laundry

services for Ocean Sands and Colony

Corp. Chappy's testimony on the laundry

equipment was to the effect that Sea Fin

bought the equipment (and presumably

continued to own it), that the other

corporations had to buy their initial

linen, that Sea Fin made the equipment

purchases because the other corporations

did not have the money to do so, and

that it was contemplated that after a

period of time the other corporations

could pay their share of the operating

costs. Although in this situation

A-163

respondent might have sought to employ

his reallocation authority under section

27 it is the Court's view

482 of the Code

that derivation benefits to the

stockholders from the laundry dealings

were indirect and speculative and not of

such nature as to support respondent's

constructive dividend contention. See

Rushing v. Commissioner , 52 T.C. 888,

894 (1964), affd. 441 F.2d 593 (5th Cir.

1971).

Special Cash Distributions

Removal of cash from safe by

Suzanne and Chappy. As noted above, in

addition to his general position that he

amounts of the alleged unreported gross

receipts were constructively distributed

to the individual family members,

respondent contends that certain

specific cash transactions constituted

dividends. The largest of such

: A-164

transactions was the removal in 1974 by

Suzanne and Chappy of slightly over

$50,000 from the safes at the Kona Kai

And kona Kai East. They did not know

the total amount taken until they

counted it while driving to Elizabeth

City, North Carolina. At Elizabeth

City, on November 7, 1974, Suzanne and

Chappy opened two joint savings accounts

in the amount of $20,000 each at First

Union National Bank and separate savings

accounts in the amount of $15,000 each

at Wachovia Bank & Trust Company. They

gave as their address on these accounts

a post office box in Elizabeth City.

The address cards of the Wachovai

accounts had the work "caution" typed or

printed opposite the hearing "business

and address." Suzanne and Chappy also

rented a safe deposit box on November 7

at Washovia in which they placed the

remaining cash and the passbooks.

A-165

Suzanne and Chappy testified that their

purpose in all of this was to establish

new banking relationships as a basis for

loans to the corporations from the

respective banks. They also testified

that the removal of funds to Elizabeth

City was to avoid the danger of

attachments.

One week after the accounts had

been opened, Suzanne and Chappy (in the

company of their parents) began in the

withdrawal of the funds. Most of the

funds had been withdrawn by the end of

1974. The balances were withdrawn in

1975. It was Suzanne's uncontradicted

testimony that the funds so withdrawn

were used in the construction of the

Kona Kai addition which was being built

during that period.

The Court does not believe the

t f

story o Susanne, apd Chagey as to their

purpose in removing and transporting the

cash. A much more likely inference is

that they had decided that they had

received enough promises of compensation

for their labors someday in the future

and that it was time for self-help.

They were the two who subsequently were

locked out of the Kona Kai office and

who commenced the litigation referred to

above at page 100, et seq. The Court

also infers from the fact that their

parents accompanied them on their

subsequent trips to Elizabeth City that

they were discovered (or perhaps they

"“confessed"). In either event, within 7

days after they removed the cash, they

commenced(with their parents guidance)

to return the funds.

As stated in James v. United States

, 366 U.S. 213, 219 (1961),

A-167

When a taxpayer acquires earnings,

lawfullly or unlawfully, without

the consensual recognition, express

or implied, of an obligation to

repay and without restriction as to

their disposition, “he has received

income which he is required to

return, even though it may still be

claimed that he is not entitled to

the money, and even though he may

still be adjudged liable to restore

its equivalent."

The Second Circuit points out in Gilber

v. Commissioner , 352 R.2d 478 (2d Cir.

1977), revg. a Memorandum Opinion of

this Court, that the James rule does not

apply where there is a “consensual

recognition *** of an obligation to

repay." We have concluded that the most

reasonable inference to be drawn from

the testimony that that before the end

of 1974 such consensual recognition

existed. This inference is supported by

the substantial withdrawal of the funds

before the end of 1974 and the

completion of such withdrawal in 1975,

coupled with the use of the withdrawn

A-168

funds in the construction of the Kona

Kai addition. In the years at issue

(1974) most of the funds were restored,

and Suzanne and Chappy had acknowledged

their obligation to restore the balance.

Although we do not condone their

actions, we hold that this set of

transactions did not constitute a

dividend to Suzanne and Chappy.

Sea Fin funds used by Linda for

real estate purchase and other purposes.

The next largest alleged cash dividend

was in the form of a Sea Fin check for

$11,000 drawn by Linda in April 29,

1974, to herself. After a recess in the

trial, Linda corrected her previously

conflicting testimony and admitted that

she had used this money, along with some

funds of her own, to buy a lot in

Virginia Beach. The purchase price of

the lot was $14,000. The lot was sold

A-169

“4

on October 2, 1974, for $17,000, with a

check for net proceeds to Linda in the

amount of $15,216.04. Linda cashed the

check and gave $10,000 to Suzanne and

$1000 to Elsie in part payment of Sea

Fin salaries due to them. The $11000

check from Sea Fin was a loan to Linda,

which she thus repaid out of the

proceeds of the sale of the lot. The

money may have been borrowed from a bank

by Sea Fin for purposes of funding such

loan.

In making these findings the Court

has taken into account Linda's

conflicting testimony and has also taken

into account the probability that her

memory was jogged during the recess.

Linda was truly confused and somewhat

frightened during her testimony, and

demonstrated a genuine lack of recall as

to details. But based upon our

A-169

observation of Linda and her demeanor

and reaction during the trial, this

Court feels that she is naive and is the

least business-oriented and the least

sophisticated of all the Chaplain family

members. The Court concludes that her

explanation of the $11,000 loan

transaction and repayment in the same

year--albeit typical of the looseness

pervading the Chaplain financial

transactions--was the truth.

Respondent determined in the

notices of deficiency and in his answers

on file herein that Linda received cash

dividends from Sea Fin in 1972, 1973 and

1974 in the respective amounts of

$35,343, $22,792 and $202,215. These

are the same amounts as asserted against

other member of the family, based on

respondent's reconstruction of gross

receipts for said years. The Court has

A-170

rejected such determinations, as

hereinabove set forth. Nevertheless,

the record herein persuades the Court

that Linda did receive, for her own

benefit or for the benefit of her

immediate family, payments from Sea Fin

which were not reported by her as either

dividends or as salary. The single, most

significant payment in this category was

a $4000 Sea Fin check, dated February

28, 1972, payable to cash. Based upon

the record, it is probable that Linda

used this amount to supplement the cash

which, as we found above, she had

borrowed from Sea Fin for the purchase

of a lot. However, the record is silent

as to whether the $4000 was a loan or

whether it was ever repaid to Sea Fin.

Linda's only explanation was that "it

was something for the business." It is

well settled that payments made by a

corporation for the economic benefit of

A-171

a stockholder may constitute dividends

to the stockholder. American Properties,

Inc. v. Commissioner , 28 T.C. 1100,

1115 (1957), affd. per curiam 262 F.2d

150 (9th Cir. 1958). Linda has failed

to carry her burden of proof on this

score, and we hold that the 1974 $4000

was a dividend to Linda.

Respondent also determined that

Linda received but failed to report

$5200 salary for Sea Fin in 1972 and

1973. (Our disposition of this

determination if this section of our

Opinion is for purposes of coherence,

since it is so closely related to the

adjustments discussed above). Many Sea

Fin checks in evidence are drawn to

cash, to Linda, or to other non-business

payees, such as the nursery school

attended by Linda's child. We do not

understand respondent to be asserting

A-172

that the portion of these amount was

reportable as dividend income and the

balance as salary. However, the record

convinces the Court that Linda was

compensated on an "ad hoc” basis for her

services to Sea Fin. Part of the

compensation was in the form of direct

payments to her and part in the form of

payments to others on her behalf. She

has filed to rebut the presumption of

correctness of respondent's

determination. Welch v. Helvering , 290

U.S. lll, 115 (1933). We accordingly

find that $5200 salary from Sea Fin was

omitted in Linda's returns for 1972 and

1973.

Non-cash Dividends

Respondent has alleged non-cash

dividends attributable to the free use

of corporate apartments or rooms and the

free use of corporate automobiles by the

A-173

various family members.

The automobiles in question were

used intermittently for both business

and personal purposes. We are convinced

by the testimony of Elsie that she and

Wilson had the use of a single passenger

automobile, not two. We attribute no

portion of their use of a pickup truck

to personal expenses. Otherwise, in the

absence of proof persuading us to the

contrary, the Court finds that in each

case 50% of the automobile use was for

personal purposes, and, with the

expection of Wilson and Elsie,

respondent's determinations are

sustained to that extent. We have

determined that Wilson and Elsie had the

use of only a single passenger vehicle;

accordingly only 25% of respondent's

determinations as to them (set forth

above) are sustained. In reaching this

A-174

result, the Court has applied the rule

of Cohan v. Commissioner , 39 F.2d 540

(2d Cir. 1930).

During the years 1971 through 1974

Wilson and Elsie, Jerry and Chappy lived

rent-free for substantial periods in

various apartments and other

accommodations owned by the corporate

petitioners. In dealing with this

issue, the Court has applied the

standard set forth in section 119 of the

Code, which provides for the exclusion

from income of an employee the value of

lodging furnished by the employer for

the convenience of the employer where

"the employee is required to accept such

lodging on the business premises of his

employer as a condition of his

employment." We find the cases of

Chappy and Jerry, who lived for

substantial periods of time at the

A-175

Colony Motel, that since they performed

most of the maintenance work for the

trailer park, there was an implied

requirement that one or the other of

them be on the business premises at all

times. However, we do not feel justified

in finding that both were required to be

or actually were on the premises on the

Colony Motel and Trailer Park at all

hours. Accordingly, applying the rule

of Cohan, supra, and taking into account

their periods of residence on other

business premises where they were

required to live, we hold that 50% of

the amounts set forth in the table above

is excludable under section 119 and that

respondent's determinations are

sustained as to the remaining 50% of

each such adjustment (excluding, of

course, the 1971 and 1972 adjustments to

Cappie's returns which were conceded by

respondent) . 78

A-176

With respect to Wilson and Elsie,

we are unable to find any implied

requirement that they be on the premises

of the Kona Kai East or any other place

they resided, notwithstanding that each

of them performed general services for

the motels. As to the amounts set forth

in the above determination, these

petitioners have not carried their

burden of proving the incorrectness of

respondent's determination. Rule 142(a)

of this Court's Rules of Practice and

Procedure. We accordingly sustain

respondent's above determinations with

respect to Wilson and Elsie's lodging.

Fraud

As to those cash and non-cash

dividend adjustments which we have

sustained in this section of our >

Opinion, we conclude that the fraud

penalty should not be applied. If

A-177

negligence penalties had been asserted,

there is little question that in view of

the extremely loose practices of the

family members if their financial

dealing and in their use of corporate

facilities, they would have been

sustained. But evidence of a failure to

report income, standing alone, is not

ordinarily sufficient to establish

fraud. Merritt v. Commissioner , 301

F.2d 484 (5th Cir. 1962), affg. a

Memorandum Opinion of this Court. The

amounts involved in those instances

where we have sustained respondent's

determinations were relatively minor in

comparison to the very substantial

amounts of cash dividends which

respondent asserted, but as to which we

have expressed our disagreement even for

deficiency purposes. The issue of fraud

is one of fact to be determined upon a

consideration of the entire record.

A-178

Stratton v. Commissioner , 54 T.C. 225

(1970). Respondent's burden is to

establish fraud by clear and convincing

evidence. Sec. 7454(a); Imburgia v.

Commissioner , 22 T.C. 1002 (1954).

Based upon the conduct of the

individuals involved and the surrounding

circumstances (see Stone v. Commissioner

, 56 T.C. 213, 223-224 (1971)), we hold

that respondent has not carried that

burden in proving grand in the cases of

any of the individual petitioners.

VIII. MISCELLANEOUS ISSUES

AND FRAUD, INDIVIDUAL

PETITIONERS-~-FINDINGS OF

FACT AND OPINION

Wilson and Elsie

Dependency deduction, 1971. On

their joint return for 1971 Wilson and

Elsie claimed Linda as a dependent.

A-179

Respondent disallowed the dependency

deduction. The record contains no proof

of the amount of Linda's total support

in 1971 nor the amount contributed to

such support by Wilson and Elsie. Linda

cannot qualify as a dependent in the

absence of proof that Wilson and Elsie

provided over half of her support.

Section 152(a). Because petitioners

have failed to carry their burden of

proof, respondent's determination on

this issue is sustained. Vance v.

Commissioner, 36 T.C. 547, 549 (1961).

William J. Newton III and Linda

William's wages, 1972. In addition

to the determination as to Linda's

salary (which we dealt with above at

page 121) respondent determined that

petitioners had caused Lyn construction

Corporation (William Newton's then

employer) to issue a false W-2 form

A-180

which understated his wages by

$12,204.48, and had fraudulently omitted

this amount from their return. On

brief, respondent has conceded that the

Lyn construction W-2 was correct, and

that petitioners reported the full

amount.

Rental income and expenses, 1973.

For 1973 in addition to Linda's salary

adjustment respondent determined that

the Newton's had received rental income

of $2340. Respondent included this

amount in the alleged fraudulent

understatement of income for 1973. No

rental income was reported on

petitioners’ 1973 return. Petitioners

had constructed a duplex, which was

completed in February 1973. They rented

out half of it for a portion of 1973.

Respondent's $2340 figure was based upon

12 months' rental at $195 per month. On

A-181

brief respondent has reduced the claimed

omission to $1755 (9 months rental at

$195 per month), but argues that the

Court should allow no deductions in view

of the fact that the only support for

deductions is Linda's uncorroborated

testimony. Linda testified that the

1973 "expenses" for one-half the duplex

were as follows:

Interest $ 860

Repairs 25

Property tax 170

Utilities 72

Depreciation 425

$1552

We find in the absence of records

that the Newton's rental receipts from

the duplex in 1973 totaled $1755. We

think it would be unrealistic to accede

to respondent's request that no

deductions be allowed. It is clear that

valid expenses must have been incurred,

even though the wae BP of such expenses

A-

have not been established. We do,

however, feel compelled to sustain the

disallowance of depreciation in full,

since there is not a shred of evidence

in the record as to the cost of the

property, the allocation of cost between

land and improvements, or the useful

life of the duplex itself. See Farmer's

Life Insurance Company v. Commissioner,

27 B.T.A. 423, 429 (1932); Delsanter V.

Commissioner, 28 T.C. 845, 863 (1957).

As to the remaining expenses, applying

the rule of Cohan, supra, we find and

hold that petitioners are entitled to

deductions totaling $450 against the

$1755 rental receipts. We further find

and hold that the resulting omission of

$1255 net rental receipts for 1973 was

not due to fraud. Our determination is

based upon all the facts and

circumstances and results particularly

because the Court feels that additional

A-183

offsetting deductions, though not

actually proved, were susceptible of

proof in this situation. Respondent has

not alleged the section 6653(a) penalty

for negligence.

Rental expense, 1974. The

depreciation and other expenses relative

to the duplex sive again at issue for

1974. The rental income for that year

was reported on the Newton's return and

is not at issue. The deductions claimed

on the return were:

Depreciation $1700.00

Taxes 169.83

Repairs 177.27

Insurance 48.00

Interest 1008.87

Advertising 13.25

Water 77.14

Sewer 43.32

For the reasons set forth above

with respect to 1973, we must sustain

respondent's full disallowance of

depreciation. And for the same reasons,

A-184

we hold that the Newtons were entitled

to total deductions of 4600 for the

other claimed expense items (which

respondent disallowed in full). Cohan

v. Commissioner, 39 F.2d 540 (2d Cir.

1930).

Capital gain, 1974. In 1974 the

Newtons also reported a short term

capital gain in the amount of $1068.04

on the sale of the vacant lot acquired

in part through Linda's $11,000 loan

transaction, described above at page

119. On their 1974 returns, the Newtons

claimed a cost basis for such lot in the

amount of $15,931.96 and a gross sales

price of $17,000. Respondent disallowed

the $15,931.96 cost basis in full for

lack of substantiation. On brief,

respondent has conceded that the Newtons

properly reported the short term capital

gain on their lot sale.

A-185

IX. NEGLIGENCE PENALTIES

(WILSON AND ELSIE, AND

OCEAN SANDS)--FINDINGS OF

FACT AND OPINION

Respondent determined in his

statutory notices that Wilson and Elsie

and Ocean Sands were liable for

additions to tax (in 1965 through 1969

for the individuals, 1967 through 1969

for the corporation) for negligence

29 The burden of

under section 6653(a).

proof with respect to this issue is upon

petitioners. Marcello v. Commissioner,

380 F.2d 499, 506 (5th Cir. 1967).

Petitioners have offered no reasons

for their underpayments of tax for these

years, but instead insist that their

returns are correct as filed. In

addition to this absence of proof, there

is overwhelming evidence in the record

that petitioners’ underpayments were due

A-186

to negligence We have discussed much of

this evidence as factors in our

determination of the fraud issues with

respect to Ocean Sands and Colony Corp.,

and we need not repeat it here. As to

Wilson and Elsie our findings indicate

that they omitted substantial portions

of their income tax 1965 through 1969

(see page 55), and that their books and

records for those years were wholly

inadequate. It is sufficient to note

that, absent countervailing evidence by

petitioner, either failure to keep

adequate records (Marcello v.

Commissioner, supra) or a pattern of

substantial underreporting of income

(Anders v. Commissioner, 68 T.C. 474,

493 (1977) alone is a sufficient basis

for

Petitioners contend that assessment

of deficiencies against Wilson and Elsie

A-187

for the years 1965, 1966 and 1967, and

against Oceans Sands for 1967 are barred

by the statute of limitations. The

deficiency notices for these years were

dated March 10, 1972. Section 6501 of

the Code provides that, as a general

rule, no tax may be assessed more than

three years after the return was filed.

(The deficiency notices for the years

after 1967 were therefore timely under

the three-year statute.) However, if a

taxpayer omits from gross income a

properly includable amount which is more

than 25% of the amount reported, the

period for assessment is extended to six

years. Section 650l(e). As it relates

to a trade or business, “gross income"

means the total of amounts received from

the sale of goods or services, without

reduction for the cost of such goods or

services. Section 301.650l(e)-l,

Proceed. and Admin. yo - Where

A-188

respondent relies on an exception (such

as the substantial omission exception)

to the usual three-year limitation

period, he has the burden of proving

that the exception applies. Stratton v.

Commissioner, 54 T.C. 2551° 289 (1970);

Reis v. Commissioner, 1T.C. 9 (1942),

affd. 142 F.2d 900 (6th Cir. 1944).

We hold that respondent has met his

burden. He has proven that Wilson and

Elsie had gross income which exceeded

the amount indicated on their returns by

$33,029 in 1965, $37,045.84 in 1966 and

$35,408.70 in 1967. Their gross income

(gross receipts from the Colony Motel

and Trailer Park combined with gross

rental income from the service station),

as reported for those years, were

$67,159, $56,809.16 and $46,648.50, |

respectively. Respondent has also shown

that Ocean Sands had gross income of

A-189

$62,010 in 1967, while only $29,106.51

was reported. In each case more than

25% was omitted; the six year period

therefore applies, and assessment is not

barred by the statute of limitations.

To reflect the foregoing findings

and the Court's determinations with

respect thereto, as well as to reflect

respondent's concessions,

Decisions will be entered for the

respondent in docket Nos. 5141-76, 5142-

76 and 4929-77;

Decisions will be entered under Rule

155 in docket Nos. 4261-72, 4262-72,

4728-75, 5139-76, 5140-76, 5143-76,

5976-76, 6602-76, 7352-76, 4927-77,

4928-77, 4930-77, 7489-77, 7509-77,

7510-77, 7560-77, 8027-78, 8028-78, and

8029-78.

A-190

FOOTNOTES

2 In exerting our best efforts to

achieve fair and just results in these

cases, the Court has attempted--so far

as humanly possible--to separate out and

disregard the multitudinous charges and

countercharges generated by emotionalism

and by venom among the parties, and to

confine its holdings to the merits of

the cases. This has been an exceedingly

difficult exercise in judicial

objectivity.

3 Statutory references are to the

Internal Revenue Code of 1954, as

amended, unless otherwise indicated.

‘ The 14 were the New Castle, Aeolus,

Bel Harbour, La Plaza, Empress, Holiday

Sands, Sea Hawk, Sea Gull, Aloha, Sand

Castle, Saxony, Idlewhyle, Royal Clipper

and Belvedere.

? See also Howse v. Commissioner ,

T.C. Memo. 1941-225 (national average

percentage mark-up employed by member-

retailer of National Sporting Goods

Association used to determine

petitioner's mark-up); D & H Bagel

Bakery Inc. v. Commissioner , T.C. Memo

-100 (comparable bakeries used to

determine bagel prices).

6 On brief petitioner's counsel

alleges that this is a misrepresentation

of Suzanne's ee eny However, this

A-

admission is clearly reflected on the

record (see page 2882 of the

transcript).

7 We note that the expense deductions

upon which respondent's reconstruction

was based included, in all but one year,

amounts expended for cleaning as well.

Such cleaning expenses should not

properly be included in respondent's

computation, and we have taken this fact

into account also.

8 Petitioners’ counsel erroneously

asserts on brief that this witness

testified that there were 144 spaces in

1965.

9 Service was provided to 12

additional trailer lots during the years

1963 though 1973, but we are unable to

detemine from the VEPCO records exactly

when service to these lots was

initiated.

10 During the period March through

December, 1964.

il Petitioners' counsel emphatically

warns the Court against making

approximations in arriving at its

findings herein, stating that "This

approach is highly improper and should

be rejected outright." Suffice to say

that in the numerous instances in this

Opinion where we have applied that rule

we have been as generous as possible

towards the petitioners. Indeed, were

A-192

it not for the existence of the Cohan

rule, given the weaknesses and

ambivalence in the proof in this case,

we would have been forced to make

deteminations which would, without

doubt, have resulted in substantially

larger deficiencies..

12 Although the $35,000 depreciation

base for the service station was carried

froward on the individual returns

through 1971 (notwithstanding the

transfer to Sea Fin in January 1971),

the service station disappears from the

returns and from respondent's

disallowances after 1971. The record

affords no explanation.

13 The returns showed 1967 at the

acquisition date of the sewer line, but

1970 appears to have been the year in

which it was placed in service.

14 Petitioners' opening brief states,

"Upon the government stipulating the

cost of certain improvements at the

Colony -Motel and trailer park there is

not any dispute between the Service and

the depreciation as set forth on the

taxpayers' tax returns for

depreciation." However, the respondent

stipulated only the cost of the service

station and equipment. In addition, we

note that the most substantial of the

“other” items of depreciation,

disallowance of which we have sustained

in the above paragraph, is the

“automotive equipment" claimed to have

been acquired by Sea Fin in 1973 for

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$37,909. There is no evidence in the

record concerning this item.

15 The all-pervasive atmosphere of

intense hostility which characterized

the relationship between the parties to

these cases effectively precluded a

meaningful stipulation between the

parties in accordance with our Rule 91,

let alone any realistic attempt to

settle the multitudinous issues

involving miscellaneous deductions.

This has placed a heavy and unnecessary

burden upon the Court.

a6 See also Barfield v. Commissioner ,

a Memorandum Opinion of this Court dated

May 14, 1952.

17 see sec. 1.162-21(a) and

(b)(a)(ii), Income Tax Regs.; Achelis v.

comms satoner , 28 B.T.A. 244, 246-247

3); Powell v. Commissioner , T.C.

Memo 1967-32 (Texas statute).

18 Cf. Macri eerboraticn Vv.

Commissioner , T.C. Memo. 1976-273;

Moyer v. Commissioner , T.C. Memo 1976-

0, cit. pet carian ses F.2d 152 (3d

Cir. 1977).

19 This figure was computed in the

same manner as the figures for other

years, i.e. by applying a 15% discount

to the average receipts per room of the

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comparable motels for each month in

1970.

20 Section 6652(b) provides in part as

follows:

(b) Fraud - If any part of any

underpayment (as defined in subsection

(c)) of tax required to be shown on a

return is due to fraud, there shall be

added to the tax an amount equal to 50

percent of the underpayment.**

21 see also Webb v. Commissioner , T.

C. Memo. 1966-81, affd. 394 F.2d 366

(Sth Cir. 1968).

22 In our view, beneficial ownership

of both the real property and the stock

was in accordance with an oral agreement

of the parties. (We do not here

determine the nature of that agreement. )

Although in many states a parol trust in

real property is restricted by the

statute of frauds, in Virginia such a

trust may be established and enforced.

Young v. Holland , 117 Ya. 433, 84 S.E.

637 (1915). Neither does the Virginia

verson of the statute of frauds pose any

problem to a parol trust in personal

property. Ri n's Administrator v.

Riggan , 93 Va. 78, 24 S. E. 920 (1896).

23

SEC. 351. TRANSFER TO CORPORATION

CONTROLLED BY TRANSFEROR.

(a) General Rule--No gain or loss

shall be recognized if property is

transferred to a corporation by one or

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more persons solely in exchange for

stock or securities in such corporation

and immediately after the exchange such

person or persons are in control (as

defined in section 368(c)) of the

corporation. For purposes of this

section, stock or securities issued for

servicds shall not be considered as

issued in return for property.

24 The result would also be the same

insofar as basis to Sea Fin is

concerned.. Section 362 of the Code.

25 see also Nye v. Commissioner , 50

T.C. 203, 212 et seq. (1968), where

partnership assets were transferred to a

corporation in exchange for a 10-year

promissory note. The Court held the

note to be a security within the meaning

of sec. 35l(a). The Court also held

that the original stock purchase and

asset transfer were parts of a single

transaction to which sec. 351 applies.

26 Respondent does not, however, ask

the Court to include such intercorporate

transactions as shareholder dividends

with the exception of amounts expended

by Sea Fin in 1973 for laundry

facilities and linens which were used in

substantial part by Ocean Sands and

Colony Corp.

a7 Compare Rubin v. Commissioner , 429

F.2a 650 (2d Cir. 1970), revg. 51 T.C.

251 (1968), which holds that where

section 482 is adequate to deal with the

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allocation of income and deductions

between commonly controlled entities,

resort to that section is clearly

superior to the use of the assignment of

income doctrine (which would have

required the shareholder to pay taxes on

money he never received).

26 The Cohan rule as here applied

reflects the Court's best estimate of

the periods of residence on other

business premises where Chappie and

Jerry were required to live compared

with the time they were required to stay

at the Colony Motel and Trailer Park.

It does not reflect an effort to

segregate the value of the meals and

lodging between their personal and

business aspects.

29 SEC. 6653. FAILURE TO PAY TAX.

(a) Negligence or Intentional

Disregard of Rules and Regulations With

Respect to Income or Gift Taxes.--If any

part of any underpayment (as defined in

subsection (c)(1) of any tax imposed by

subtitle A or by chapter 12 of subtitle

B (relating to income taxes and gift

taxes) is due to negligence or

intentional disregard of rules and

regulations (but without intention to

defraud), there shall be added to the

tax an amount equal to 5 percent of the

underpayment.

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UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

No. 81-1467

Ocean Sands Holding Corporation,

a Virginia corporation,

Appellant,

Vv.

Commissioner of Internal Revenue,

Appellee.

No. 81-1468

Sea Fin Holding Corporation,

a Virginia corporation,

Appellant,

Vv.

Commissioner of Internal Revenue,

Appellee.

No. 81-1469

Ocean Sands Holding Corporation

a Virginia corporation,

Appellant,

Vv.

Commissioner of Internal Revenue,

Appellee.

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No. 81-1470

Chattel Corporation,

a Virginia corporation,

Appellant,

Vv.

Commissioner of Internal Revenue,

Appellee.

No. 81-1471

Sea Star Corporation,

a Virginia corporation,

Appellant,

Vv.

Commissioner of Internal Revenue,

Appellee.

No. 81-1472

Colony Holding Corporation,

a Virginia corporation,

Appellant,

Vv.

Commissioner of Internal Revenue,

Appellee.

-147

William J. Newton, III, and

Linda G. Thornton, formerly

Linda G. Newton,

Appellants,

Ve

Commissioner of Internal Revenue,

A-198

Appellee.

No. 81-1474

Russell W. Chaplain, Jr.,

and Mary H. Chaplain,

Appellants,

Vv.

Commissioner of Internal Revenue,

Appellee.

No. 81-1475

Colony Holding Corporation,

a Virginia corporation,

Appellant,

v.

Commissioner of Internal Revenue,

Appellee.

No. 81-1476

Sea Star Corporation,

a Virginia corporation,

Appellant,

Vv.

Commissioner of Internal Revenue,

Respondent.

No. 81-1477

Sea Pin Holding Corporation,

a Virginia corporation,

Appellant,

v.

Commissioner of Internal Revenue,

A-199

Appellee.

No. 81-1478

William G. Chaplain and

Sandra B. Chaplain,

Appellants,

Vv.

Commissioner of Internal Revenue,

Appellee.

No. 81-1479

Russell W. Chaplain, Jr.,

and Mary H. Chaplain,

Appellants,

Vv.

Commissioner of Internal Revenue,

Appellee.

No. 81-1480

William J. Newton, III,

and Linda G. Thornton,

Appellants,

ve

Commissioner of Internal Revenue,

Appellee.

No. 81-1481

William G. Chaplain

and Sandra B. Chaplaic,

Appellants,

v.

. Commissioner of Internal Revenue,

A- 200

oe 2-5. yogibet Ree

5 7

Appellee.

No. 81-1482

William J. Newton, III, and

Linda G. Thornton, nee

Linda G. Chaplain, formerly

Linda G. Newton,

Appellants,

Ve.

Commissioner of Internal Revenue,

Appellee.

No. 81-1566

Russell W. Chaplain and

Elsie B. Chaplain,

Appellants,

Ve

Commissioner of Internal Revenue,

Respondent.

Appeals from the United States Tax

Court. Judge Featherston, Tax Court

Judge.

Submitted: October 29, 1982

Decided: February 11, 1983

Before SPROUSE, ERVIN, and CHAPMAN,

Circuit Judges.

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(H. Thomas Padrick, Jr., and Carter R.

Anderson, Jr.(Anderson & Padrick), on

brief for Appellants Ocean Sands

Holding Corporation, Sea Fin Holding

Corporation, Chattel Corporation, Sea

Star Corporation, and Colony Holding

Corporation. William J. Newton, III,

Linda G. Thornton, Russell W. Chaplain,

Jr., Mary H. Chaplain, William G.

Chaplain, Sandra B. Chaplain, Russell

W. Chaplain, and Elsie C. Chaplain,

Appellants Pro Se. Glenn L. Archer,

Jr., Assistant Attorney General,

Michael L. Paup, Ann B. Durney, and

Stanley S. Shaw, Jr., Attorneys, Tax

Division, United States Department of

Justice, on brief for t' e Appellee.)

PER CURIAM:

Five corporate taxpayers and eight

individual taxpayers appeal the Tax

Court's decisions, determining

deficiencies in and additions to tax

for various years between 1965 and

1974. For the reasons which follow, we

now affirm.

Taxpayer's contention that the

Tax Court erred in consolidating the

cases for trial is without merit. We

believe that the consolidation order

was properly based on the common issues

presented. Tax Ct. R. 14l(a). Taxpayers

consistently have maintained that all

of the corporate stock was issued to

Elsie Chaplain with beneficial

ownership in the children. Moreover,

the record is replete with testimony

A-202

indicating that the individual

taxpayers treated their enterprise as

one large family enterprise. Although

taxpayers complain that they were

prejudiced by the consolidation, they

offer no facts from which we can

conclude that the Tax Court abused its

discretion. Cohen v. Commissioner, 176

FPF. 2d 394 (1 Cir. ,

We are also unpersuaded by

taxpayer's argument that the Tax

Court's decision to terminate

discovery, rather than to impose

sanctions, deprived them of access to

information which they needed for trial

and that they were entitled to this

information under the Freedom of

Information Act, see 5 U.S.C. Section

552. Taxpayers provide no explanation

for the considerable delay in entering

into stipulations and discovery, see

Tax Ct. R. 70(a), and make no showing

that the court abused its discretion.

See Eisele v. Commissioner, 580 F. 2d

805 (5th Cir. 1978). Moreover, the

Freedom of Information Act was not

intended to be a means of circumventing

the Tax Courtr's discovery rules, which

provide the proper method of obtaining

such information in litigation before

the Tax Court. Williams v. Internal

Revenue Service, 345 F. Supp. 591, 594

(D. Del. 1972).

As to the remaining issues

presented, we believe that the Tax

Court set out a thorough analysis and

that nothing taxpayers argue in this

appeal alters the validity of that

court's judgment.

A-203

Accordingly, since the facts and

legal argument are adequately presented

in the briefs and record and since the

decisional process would not be

significantly aided, we dispense with

oral argument and affrim the decision

on the reasoning of the Tax Court.

Ocean Sands v. Commissioner, 80-243

T.C. Memo (Oct. ’ ).

AFFIRMED

A-204