Burke v. Commissioner

T.C. Memo. 1997-237

UNITED STATES TAX COURT

DATHA D. BURKE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

MARTIN M. BURKE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 14139-89, 15957-92. Filed May 22, 1997.

Mark G. Ayesh, for petitioners.

Michael L. Boman, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge: These cases are before the Court, consolidated

for trial, briefing, and opinion. See Rule 141. Datha D. Burke

petitioned the Court to redetermine respondent's determination of

deficiencies in her 1979 through 1982 Federal income taxes.
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Respondent reflected this determination in a notice of deficiency

issued to Mrs. Burke on March 23, 1989. Martin M. Burke

petitioned the Court to redetermine respondent's determination of

deficiencies in his 1979 through 1982 Federal income taxes.

Respondent reflected this determination in a notice of deficiency

issued to Mr. Burke on January 12, 1988.

Respondent determined the following deficiencies and

additions thereto:

Datha D. Burke: Docket No. 14139-89

Additions to Tax
Sec. Sec. Sec. Sec.
Year Deficiency 6653(a) 6653(a)(1) 6659 6661

1979 $65,086 $3,254 --- --- ---
1980 151,493 7,575 --- --- ---
1981 69,030 --- $3,452 --- ---
1982 483,767 --- 24,188 $61,950 $69,317

Martin M. Burke: Docket No. 15957-92

Additions to Tax
Sec. Sec. Sec. Sec.
Year Deficiency 6653(a) 6653(a)(1) 6659 6661

1979 $68,798 $3,440 --- --- ---
1980 161,063 8,053 --- --- ---
1981 88,298 --- $4,415 --- ---
1982 422,140 --- 21,107 $111,688 $12,462

Respondent also determined that petitioners were liable for

additions to their 1981 and 1982 taxes under section 6653(a)(2),

and that their 1982 income tax liability was subject to an

increased rate of interest under section 6621(c).

The petitions are silent on the appropriateness of the

additions to tax and increased rate of interest determined by
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respondent. Petitioners' counsel also did not identify these

items as issues in either his opening or closing argument at

trial. Nor does petitioners' post-trial brief address these

items. We consider petitioners to have conceded these items.

See Rule 34(b)(4); Ducommun v. Commissioner, 732 F.2d 752,

753-754 (10th Cir. 1983); Frederick v. Commissioner, 101 T.C. 35,

36 n.4 (1993); Jarvis v. Commissioner, 78 T.C. 646, 658 n.19

(1982); see also Merlino v. Commissioner, T.C. Memo. 1993-10

200.

Following this and other concessions, we are left to decide

the following issues for 1982:

1. Whether petitioners received a $413,000 dividend on the

cancellation of debt owed by Mr. Burke to Burke Energy Corp.

(BEC), petitioners' wholly owned corporation. We hold they did.

2. Whether petitioners underreported by $331,593 their

taxable capital gain on the sale of certain property. We hold

they did.

Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the year in issue. Rule

references are to the Tax Court Rules of Practice and Procedure.

Dollar amounts are rounded to the nearest dollar. Although

respondent determined separate tax liabilities for petitioners

for each of the subject years, we refer to their 1982 liabilities

as a joint liability because they filed a joint 1982 Federal

income tax return.
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FINDINGS OF FACT1

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

The stipulated facts and exhibits submitted therewith are

incorporated herein by this reference. Petitioners are husband

and wife, and they resided in Hutchinson, Kansas, when they

petitioned the Court. They filed a 1982 Form 1040, U.S.

Individual Income Tax Return, using the filing status of "Married

filing joint return". They each owned 50 percent of BEC's stock

during the relevant years. BEC was the parent company of a

consolidated group of corporations engaged in the business of

wholesaling and retailing natural gas liquids.

Mr. Burke owed BEC approximately $853,000 in 1982, and

petitioners devised a plan to reduce this debt. Under the plan,

Mrs. Burke would transfer her interest in two parcels of property

to Mr. Burke in exchange for his interest in certain stock, and

Mr. Burke would transfer the property to BEC in reduction of the

debt. The parcels were located in Hutchinson, Kansas, one at

A & Walnut (Walnut property) and the other at 707 North Main

1
After the Court filed the parties' opening briefs,
petitioners notified the Court that they did not intend to file
the second brief. We assume that petitioners do not object to
respondent's proposed findings of fact, except to the extent that
petitioners' proposed findings of fact are clearly inconsistent
therewith, in which case we have resolved the inconsistencies
based on our understanding of the record as a whole. See Estate
of Jung v. Commissioner, 101 T.C. 412, 413 n.2 (1993); see also
Estate of Freemen v. Commissioner, T.C. Memo. 1996-372;
Sutherland v. Commissioner, T.C. Memo. 1996-1; Houser v.
Commissioner, T.C. Memo. 1995-330.
 - 5 -

(North Main property). The stock consisted of Mr. Burke's

holdings in Maize State Bank (Maize Bank) and University State

Bank of Wichita (University Bank). (We refer collectively to the

stock of Maize Bank and the stock of University Bank as the

Bank Stock.) Mr. Burke had financed the purchase of some of the

Bank Stock through BEC.

On June 20, 1982, petitioners executed two contracts to

exchange the property for the Bank Stock. One contract provided

that Mrs. Burke sold the North Main property to Mr. Burke for

$250,000, consisting of 29,341 shares of Maize Bank and his

assumption of a $5,294 debt owed by her. The second contract

provided that Mrs. Burke sold the Walnut property to Mr. Burke

for $675,000, consisting of 20,000 shares of Maize Bank, 23,500

shares of University Bank, and his assumption of a $150,638 debt

owed by her. Mrs. Burke deeded the properties to Mr. Burke on

June 25, 1982, and Mr. Burke assumed the liabilities set forth in

the contracts. Mr. Burke never transferred the Bank Stock to

Mrs. Burke.

On June 25, 1982, Mrs. Burke's basis in the North Main

property was $8,850, and the property was worth $250,000.

Mrs. Burke's basis in the Walnut property was $72,426, and the

property was worth $262,000.2 Mr. Burke's basis in his Maize

2
The parties dispute the admissibility of Exhibit 5, an
appraisal report proffered by petitioners to establish the fair
market value of the Walnut property. We hold that the exhibit is
(continued...)
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Bank stock was $5.92 per share, and each share was worth $8.34.

Each share of Mr. Burke's University Bank stock was worth $1.89.

On June 29, 1982, Mr. Burke and BEC executed two contracts

under which Mr. Burke transferred the properties to BEC in

exchange for its assumption of the liabilities which he assumed

from Mrs. Burke and its cancellation of debt owed by him. One

contract provided that Mr. Burke sold the North Main property to

BEC for $250,000, consisting of BEC's assumption of the $5,294

debt and its cancellation of his $244,706 debt. The second

contract provided that Mr. Burke sold the Walnut property to BEC

for $675,000, consisting of its assumption of the $150,638 debt

and its cancellation of his $524,362 debt. One day later,

Mr. Burke deeded the properties to BEC, and BEC assumed $155,932

of debt and canceled Mr. Burke's debt of approximately $853,000

(instead of the total canceled debt of $769,068 shown in the

contracts). Following the transaction, BEC claimed a $925,000

basis in the properties and apportioned this basis as follows:

Asset Acquisition Cost
Land:
Walnut property $231,250

Buildings:
Walnut property 507,180
North Main property 186,570

On Schedule D (Capital Gains and Losses) of their 1982

Form 1040, petitioners reported that, on June 30, 1982, they had

2
(...continued)
inadmissible and do not rely on it.
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sold real estate acquired on January 1, 1982, and realized a

$16,690 gain on the sale. They reported that their selling price

was $853,086 and that their basis was $836,396.

Respondent determined that the North Main property was worth

$250,000 when BEC canceled Mr. Burke's debt, the Walnut property

was worth $262,000 at that time, and BEC paid petitioners

$925,000 for the properties. Respondent determined that the

effect of petitioners' transfer of the properties to BEC was that

petitioners received a $413,000 dividend from BEC, and realized a

capital gain of $430,724. Respondent determined that $189,574 of

the capital gain was attributable to the Walnut property and

$241,150 to the North Main property. Applying the long-term

capital gains deduction under section 1202 to part of the

$430,724 capital gain, respondent calculated petitioners' taxable

gain at $348,283, rather than the $16,690 amount that they had

reported on their 1982 tax return.

OPINION

We must determine whether petitioners failed to report

income on BEC's cancellation of Mr. Burke's debt. Petitioners

argue that they did not, relying on the interpretation of

discharge of indebtedness income set forth in Bowers v.

Kerbaugh-Empire Co., 271 U.S. 170 (1926). Petitioners allege

that they, on behalf of BEC, purchased the Bank Stock, and that

State banking regulators later forced BEC to transfer the stock

to Mr. Burke. Petitioners allege that BEC recorded a receivable
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from Mr. Burke equal to the Bank Stock's original cost because

the value of the stock was "uncertain and extremely doubtful".

Petitioners allege that the Bank stock became worthless in or

around 1984, and that they never received any benefit from their

ownership of the stock. Petitioners argue that the substance of

the facts surrounding the cancellation of Mr. Burke's debt is

analogous to Kerbaugh-Empire Co., although the form that they

employed to effectuate this cancellation is not. Respondent

argues that the form used by petitioners controls this case, and,

even if it does not, BEC's cancellation of Mr. Burke's debt is a

taxable event. Petitioners bear the burden of proof. Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

We agree with respondent that BEC's cancellation of

Mr. Burke's debt is a taxable event. Petitioners' brief is aimed

primarily at their claim that the instant facts resemble the

facts of Bowers v. Kerbaugh-Empire Co., supra, and that Kerbaugh-

Empire Co. entitles them to exclude the amount of canceled debt

from income. To support their position, petitioners rely mainly

on Mr. Burke's testimony, which was brief. We are unpersuaded.

We find most of Mr. Burke's testimony unbelievable. It was

general and conclusory in nature, and most of it is unsupported

by other evidence in the record. Under the circumstances, we are

not required to rely on this testimony, and we do not. United

States v. Hager, 969 F.2d 883, 888 (10th Cir. 1992); United
 - 9 -

States v. Leach, 749 F.2d 592, 600 (10th Cir. 1984); Tokarski v.

Commissioner, 87 T.C. 74, 77 (1986).

From the credible evidence in the record, we find that

petitioners overvalued the Walnut property when they transferred

it to BEC, and that they are now looking for a way to mitigate

the taxes that are due on account of this overvaluation.

Petitioners purchased the properties from third parties and

transferred the properties to BEC mainly for a cancellation of

Mr. Burke's debt. Such a transfer is a taxable event. Property

that is transferred in cancellation of debt may generate gain

from a sale or exchange under section 1001, measured by the

excess of the property's fair market value over its adjusted

basis. Sec. 1001; see also Gehl v. Commissioner, 102 T.C. 784,

785 (1994), affd. without published opinion 50 F.3d 12 (8th Cir.

1995); Danenberg v. Commissioner, 73 T.C. 370, 380-381 (1979);

Estate of Delman v. Commissioner, 73 T.C. 15, 28 (1979); Bialock

v. Commissioner, 35 T.C. 649, 660 (1961).

For purposes of computing petitioners' gain or loss on the

transfer of the properties to BEC, petitioners are considered to

have realized an amount equal to the fair market value of the

properties at the time of the transfer. Sec. 1.1001-2(c),

Example (8), Income Tax Regs.; see also Marcaccio v.

Commissioner, T.C. Memo. 1995-174. Given the fact that the

aggregate value of the properties was $512,000 ($262,000 +

$250,000) and that their aggregate basis was $81,276 ($72,426 +
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$8,850), we sustain respondent's determination that petitioners

realized a $430,724 capital gain ($512,000 - $81,276) on this

transfer. Petitioners do not challenge respondent's application

of section 1202 to this gain. We sustain respondent's

determination that $348,283 of this capital gain is taxable to

petitioners, and that petitioners underreported $331,593 of this

gain ($348,283 - $16,690).

The amount of consideration that exceeded the properties'

fair market value also is income to petitioners. To the extent

that a corporation cancels its shareholder's debt without

consideration, the cancellation may be treated as a distribution

to the shareholder, which, in turn, may be treated as a dividend

to the shareholder to the extent of the corporation's earnings

and profits (E+P). Secs. 61(a)(12), 301(a), (c)(1); United

States v. Kirby Lumber Co., 284 U.S. 1 (1931); Shephard v.

Commissioner, 340 F.2d 27 (6th Cir. 1965), affg. per curiam T.C.

Memo. 1963-294; Haber v. Commissioner, 52 T.C. 255, 262 (1969),

affd. 422 F.2d 198 (5th Cir. 1970); sec. 1.301-1(m), Income Tax

Regs. The same is true when a corporation assumes its

shareholder's debt, without receiving adequate consideration.

See Old Colony Trust Co. v. Commissioner, 279 U.S. 716 (1929);

Tennessee Sec., Inc. v. Commissioner, 674 F.2d 570 (6th Cir.

1982), affg. T.C. Memo. 1978-434; Enoch v. Commissioner, 57 T.C.

781 (1972); American Properties, Inc. v. Commissioner, 28 T.C.

1100 (1957), affd. per curiam 262 F.2d 150 (9th Cir. 1958).
 - 11 -

Given the fact that BEC "paid" petitioners $925,000 in

consideration for property worth $512,000, and that petitioners

do not dispute that BEC had enough E+P to characterize the

$413,000 difference as a dividend, we sustain respondent's

determination that petitioners received a $413,000 dividend on

the transfer.3

In reaching our holdings herein, we have considered all

arguments made by petitioners for contrary holdings and, to the

extent not discussed above, find them to be irrelevant or without

merit.

To reflect the foregoing,

Decisions will be entered

under Rule 155.

3
We recognize that the amount of debt canceled by BEC
exceeded the amount recited in the contract. Respondent has not
attempted to tax this excess amount.