Schneller v. Commissioner

T.C. Memo. 1996-62

UNITED STATES TAX COURT

JOSEPH P. AND MARILYN SCHNELLER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 497-94. Filed February 15, 1996.

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

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

respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS, Judge: Respondent determined a deficiency in

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

and an accuracy-related penalty pursuant to section 6662(a) in the
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amount of $26,676 for such year.1 Respondent reflected this

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

The principal unagreed item involves respondent’s

determination that petitioners realized forgiveness of indebtedness

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

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

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

essentially as shareholder loans. Also in dispute is the section

6662 accuracy-related penalty. The writeoff followed the

settlement of a tax examination for years 1982-84. In the

settlement, the parties agreed that petitioners’ withdrawals from

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

as dividends rather than shareholder loans. Petitioners maintain

that such withdrawals constitute dividend income in the year of

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

rise to a taxable event. Accordingly, the issues we must decide

are:

(1) Whether, as a result of the settlement agreement for

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

corporate advances written off in 1990 were loans. We hold that

respondent is not.

(2) Whether petitioners realized discharge of indebtedness

1
Petitioners made income tax payments for 1990 totaling
$138,748 after filing their petition in this Court to stop the
accrual of interest.
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income in 1990. We hold that they did.

(3) Whether petitioners are liable for the accuracy-related

penalty pursuant to section 6662. We hold that they are.

All section references are to the Internal Revenue Code in

effect for the year under consideration. All Rule references are

to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

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

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

Background

Petitioners, husband and wife, resided in Bowling Green,

Kentucky, at the time they filed their petition. They timely filed

a joint Federal income tax return for 1990, the year under

consideration.

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

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

engages in the pickup and delivery of packages for overnight

carriers. Joseph P. Schneller (petitioner) started Delivery in

1963 with a single truck. At its peak, Delivery operated 250

trucks and delivered freight nationwide. For all periods relevant

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

the secretary of Delivery.

Delivery has been a subchapter C corporation from its

inception. Corporate income tax returns (Forms 1120) were filed
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for Delivery through 1989. All such returns for periods bearing on

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

capacities as corporate officers.

Delivery was a union company. After a bout of trouble with

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

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

owned by petitioners), which today operates the business formerly

conducted by Delivery.

Delivery underwent a reorganization in 1990 and filed its

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

Inc.

Shareholder Loan Accounts

From time to time, commencing at dates prior to 1976,

petitioner made withdrawals from Delivery. Some of the withdrawals

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

was included in petitioners' income. In 1979, Delivery's

stockholders adopted a resolution ratifying all existing loans,

advances, and investments and authorized the corporation to

continue such transactions. As part of the resolution, petitioner

agreed to repay the amounts on demand.

In 1982, petitioner sold his interest in a waste management

company for $800,000. He did not use any of the proceeds to repay

his withdrawals from Delivery.

In September 1984, petitioner was advised by his accountant,
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James Luscombe,2 that interest-bearing notes should be prepared to

evidence the loans, advances, and investments. Petitioner did not

follow this advice although petitioners did agree to the accrual of

interest for the year 1984.

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

Delivery’s related corporate returns were selected for examination

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

included an analysis of Delivery’s shareholder loan accounts. The

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

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

Throughout the examination, petitioners (through their

representatives)4 insisted that their withdrawals from Delivery

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

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

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

2
From 1963 through 1987, Mr. Luscombe prepared all of
the financial statements and corporate tax returns for Delivery,
as well as petitioners’ individual tax returns. The financial
statements were prepared monthly from records delivered to Mr.
Luscombe by Mrs. Schneller. Following petitioners’ move from
Kansas City to Kentucky, petitioners retained William B. Arthur,
Jr. to perform the accounting and tax work for Delivery and
themselves. The first return Mr. Arthur prepared in 1990 was the
1988 corporate return for Delivery.
3
The examination centered around the examiner’s
determination that the Schnellers underreported their income for
years 1982-84, as well as the examiner’s proposal to assert the
fraud addition to tax.
4
James Baker, an attorney, and Mr. Arthur represented
petitioners with respect to the 1982-84 tax examination.
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further concluded that the majority ($81,896) of the increase

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

to 1982. All issues arising from that examination (for both

petitioners and Delivery) were ultimately settled by execution of

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

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

Kansas City Appeals Office on June 1, 1990.

Shortly after the settlement, petitioners’ accountant (Mr.

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

earnings. The $527,428 represented the balances in the following

12 accounts (which reflected withdrawals either by or for the

benefit of petitioners):

Title Amount

Joe Schneller $ 70,125
Farm 163,694
S & S Oil 16,646
Jim Schneller 11,500
Cattle 34,967
Oil wells 3,700
Barnard Realty 46,031
Transportation management 5,585
Payable to Marilyn Schneller (23,856)
Insulating coating 54,656
BG Beer 8,200
Investment-BG Beer 136,180
TOTAL $527,428

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

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

grounds that the 12 accounts had consistently been carried on the

corporate books as loans, and petitioners never included any part

of the $476,363 in their personal income. Petitioners were solvent
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both before and after the writeoff of the 12 accounts. Before the

writeoff neither petitioners nor their corporation gave any

indication that the accounts would not be repaid. Since the date

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

account balances involved, nor has Delivery in any other way

asserted that petitioners still owe the balances. Nor have

petitioners in any way indicated that they still consider

themselves indebted to the corporation for those balances.

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

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

previous dividends. Delivery's accountant (Mr. Arthur) knew that

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

during the audit of years 1982 through 1984. Mr. Arthur also knew

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

he was aware that characterizing the amounts as dividend income was

advantageous to petitioners. The purported dividend income

involved years now closed by the statute of limitations.

OPINION

Preliminarily, we note that petitioners claim that

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

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

written off should not go untaxed. We find this argument to be

without merit. The revenue agent credibly testified that he had

sufficient evidence concerning the distributions at issue to make

his determination. Petitioners offered no evidence to contradict
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the agent’s testimony. Instead, petitioners proved only that the

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

shareholder distribution.

A deficiency determination generally is afforded a presumption

of correctness unless it is without any foundation. United States

v. Janis, 428 U.S. 433, 440-441 (1976). The agent had the results

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

accounts and the entries charging them off, and the applicable

individual and corporate returns. The documents showed that

interest had been computed on the pre-1982 shareholder loan

balances and the portion of the 1982 through 1984 account increases

that was treated as loans. Hence, there was a sufficient basis for

the agent’s determination in this case.

Issue 1. Estoppel

The first issue for decision is whether respondent is

estopped, as petitioners contend, from asserting that the corporate

advances written off in 1990 were loans. As the basis for this

argument, petitioners rely on their settlement with the IRS for

years 1982-84, wherein the IRS and petitioners characterized

approximately 38 percent of the additions to the accounts at issue

as dividends with the remainder as loans. We believe petitioners’

estoppel argument to be without merit.

A settlement agreement is binding only with respect to the

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

402, 405-406 (2d Cir. 1994), affg. T.C. Memo. 1993-480. The
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applicable Forms 870-AD petitioners and respondent executed address

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

account increases as dividends. The forms have no application to

other years.

Issue 2. Discharge of Indebtedness Income

Each of the parties is taking a position contrary to that

taken in connection with the 1982-84 examination. Respondent

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

loans and as such, the writeoff gave rise to discharge of

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

maintain that the items written off should be characterized as

dividends. Respondent further contends that petitioners are

estopped by the duty of consistency from denying that the character

of the corporate advances was that of loans. We agree with

respondent.

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

from the discharge of indebtedness. The discharge of a debt below

face value accords the debtor an economic benefit functionally

equivalent to income. Babin v. Commissioner, 23 F.3d 1032, 1034

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

The shareholder accounts at issue were carried on Delivery's

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

were written off in 1990. Further, Delivery's stockholders (that

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

advances, and investments, and authorized the corporation to
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continue such transactions. And petitioner agreed to repay the

amounts on demand. Petitioners' accountant (Mr. Luscombe) advised

petitioners that interest-bearing notes should be prepared to

bolster their position that the amounts were loans. Petitioners

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

and 1984 returns. Further, the increases in the accounts were not

included in petitioners' income except certain amounts stemming

from the 1982 through 1984 audit.

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

and 1990. Repayments are evidence that corporate advances

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

(1974). Repayments suggest that withdrawals were made with an

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

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

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

A debt is discharged when it becomes obvious that the debt

will not have to be repaid. Cozzi v. Commissioner, 88 T.C. 435,

445 (1987). Cash withdrawals from a corporation by a stockholder

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

action was taken canceling or charging off such accounts against

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

1965), affg. per curiam T.C. Memo. 1963-294. In this case, the

discharge took place in 1990 when Delivery charged off the accounts

against retained earnings. In sum, we hold that as a result of the

1990 writeoff, petitioners realized income from the discharge of
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indebtedness in that year.

Even assuming, arguendo, that the character of the amounts

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

still believe respondent should prevail on the grounds that

petitioners are precluded by the duty of consistency from denying

that the amounts were loans. See Bartel v. Commissioner, 54 T.C.

25 (1970).

Petitioners consistently maintained that the shareholder

accounts represented loans, not dividends. The accounts were

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

was resolved. That was the first time petitioners had taken the

position that the amounts received in prior years were dividends.

The statute of limitations had closed on those prior years.

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

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

of the Government. See Commissioner v. Liberty Bank & Trust Co.,

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

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

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

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

Issue 3. Accuracy-Related Penalty

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

percent accuracy-related penalty for underpayment of tax

attributable to negligence or disregard of rules or regulations.

Sec. 6662(a) and (b)(1). Petitioners contend that they should not
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be liable for the accuracy-related penalty because they did not

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

Mr. Arthur.

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

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

avoid liability for negligence additions to tax.” Bollaci v.

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

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

(5th Cir. 1979)). Taxpayers have a duty to read a return and make

sure all income items are included. Magill v. Commissioner, 70

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

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

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

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

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

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

Petitioners claim that they were completely ignorant of what

appeared on their tax returns, which were prepared by an

accountant. We do not believe them. We observed petitioner while

testifying and found him to be financially astute. Despite

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

nationwide company.5 Obviously, petitioners knew about the

writeoff. In our opinion, both petitioner and his wife possessed

5
Petitioner attempted to portray himself as a “country
bumpkin”, but we believe he was “sly as a fox”.
 -13-

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

flowing to them by Mr. Arthur’s acts. They could have objected to

the writeoff but either affirmatively acquiesced in it or purposely

chose to be silent. Accordingly, we conclude that petitioners had

no reasonable cause for omitting income realized from the discharge

of indebtedness. We therefore hold that the underpayment of tax

was due to petitioners’ negligence and disregard of rules or

regulations.

To reflect the foregoing,

Decision will be entered

for respondent.