T.C. Memo. 1999-23
UNITED STATES TAX COURT
WILLIAM N. AND BETH ANN KATSAROS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 25679-96. Filed January 29, 1999.
William N. Katsaros, pro se.
Christian A. Speck, for respondent.
MEMORANDUM OPINION
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7443A and Rules 180, 181, and 182.1
Respondent determined a deficiency in petitioners' 1992
Federal income tax in the amount of $6,288, plus an addition to
1
All section references are to the Internal Revenue Code in
effect for the year in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
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tax under section 6654 in the amount of $217 and an accuracy-
related penalty under section 6662(b)(1) in the amount of $130.
After concessions by both parties,2 the issues for decision
are: (1) Whether certain corporate distributions to William
Katsaros constitute loans, or compensation for services; and (2)
whether petitioners are liable for an accuracy-related penalty
under section 6662.
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by reference. At the time the petition was
filed, petitioners resided in Santa Rosa, California.
Petitioners are husband and wife. References to petitioner are
to William Katsaros.
Background
In 1991, petitioner and his father acquired an escrow
company in Hawaii called Hawaii Island Escrow, Inc. (HIEI).
Petitioner's father contributed most of the capital for the
acquisition of HIEI and took 90 percent of the stock in the
corporation. Petitioner received 10 percent of the stock of HIEI
and was named president of the corporation. Although petitioner
2
Petitioners concede they had additional rental income in
the amount of $2,363 and income from a cosmetology business in
the amount of $1,033 and owe self-employment tax on the
cosmetology income. Respondent concedes petitioners are not
liable for the estimated tax penalty in the amount of $217, and
that petitioners are not liable for the $2,119 in FICA tax
determined in the notice of deficiency.
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had been living and working in California, the decision was made
for him to relocate to Hawaii to operate the business.
The corporation failed to thrive, and petitioner agreed to
forgo his formal monthly salary until the financial status of the
corporation improved. HIEI made $16,750 in "loan" payments to
petitioner, however, from January through May 1992 to cover his
living expenses while his salary was suspended. HIEI continued
to suffer financial hardship, and the corporation was terminated
on May 18, 1992. The corporation distributed an additional
$10,950 to petitioner between May 18 and September 7, 1992, the
day petitioner left Hawaii and returned to California.
Petitioners contend the payments from HIEI are tax-free loan
proceeds, and therefore they did not include the $27,700 in
income. Respondent reclassified the payments as income and
adjusted petitioners' taxable income to include the $27,700 as
money received as compensation for services.
Discussion
For petitioners to exclude the amounts received from HIEI as
loans, they must prove that at the time of each distribution,
petitioner unconditionally intended to repay the amounts
received, and HIEI unconditionally intended to require repayment.
Rule 142(a); Haag v. Commissioner, 88 T.C. 604, 616 (1987). If,
however, the parties actually intended the distributions to
compensate petitioner for his services, as respondent contends,
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the payments will be includable in income under section 61(a)(1).
Paula Constr. Co. v. Commissioner, 58 T.C. 1055, 1059 (1972),
affd. without published opinion 474 F.2d 1345 (5th Cir. 1973).
Because petitioner is a shareholder of HIEI, it is also
possible that the distributions might be considered to be
constructive dividends. Constructive dividends can be identified
when value passes from the corporation to the shareholder without
the shareholder's giving something of substantially equivalent
value in return. United States v. Smith, 418 F.2d 589, 593 (5th
Cir. 1969). Neither party alleges the distributions are
constructive dividends, and we find that the record does not
support such a finding. See Alterman Foods, Inc. v. United
States, 505 F.2d 873, 875 (5th Cir. 1974). We therefore limit
our analysis to whether there was the requisite intent for the
payments to constitute compensation for services, or whether, as
petitioners contend, the distributions were bona fide loans.
We note that we have always examined transactions between
closely held corporations and their shareholders with special
scrutiny. Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324,
1339 (1971), affd. without published opinion sub nom. Jiminez v.
Commissioner, 496 F.2d 876 (5th Cir. 1974). As previously
stated, in deciding whether the payments were disguised
compensation for services, we look to the intent of the parties.
Paula Constr. Co. v. Commissioner, supra at 1059. Whether such
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intent has been demonstrated is a factual question to be decided
on the basis of the particular facts and circumstances of the
case. Id.; Electric & Neon, Inc. v. Commissioner, supra at 1340.
Before November 1, 1991, petitioner was entitled to a
monthly salary from HIEI. According to petitioner, in lieu of
this salary, the corporation agreed to provide him with enough
money to cover his living expenses. From January to May 1992,
the corporation distributed on average approximately $3,350 per
month to petitioner. From May to September 1992, the corporation
distributed approximately $2,738 per month to petitioner.
While receiving these payments, petitioner continued to
perform the same professional services for the corporation as he
had before November 1, 1991. Petitioner used the money to
sustain himself and his family until the corporation recovered
financially. If ever the corporation reached stable financial
ground, petitioner testified that he expected HIEI to fulfill its
salary obligation to him and collect repayment of the "loans".
Petitioner knew, however, that HIEI was financially
insecure. In fact, the corporation was insolvent at the time the
distributions were made. Some of the distributions, $10,950,
were made after the corporation had terminated its operations.
It seems apparent, therefore, that whether HIEI would ever regain
financial stability sufficient to resume paying petitioner's
salary was questionable at best. Thus, when the distributions
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were made, petitioner was aware that he might never receive
additional payment from HIEI for his services in excess of the
"loan" payments.
Petitioners submitted a purported copy of HIEI's minutes
from a corporate meeting stated to have been held in October
1991. Petitioners also submitted a letter from HIEI's treasurer,
Thomas A. Rohde, and a copy of the promissory note allegedly
executed by petitioner. These three documents were submitted by
petitioners to support their contention that the distributions
were loans.
We decline to admit the letter from HIEI's corporate
treasurer into evidence on the basis of hearsay. Fed. R. Evid.
801(c). We do, however, admit the promissory note but find that
it carries little or no weight. The note was executed after the
close of the taxable year 1992 and offers little as far as
demonstrating petitioner's intent at the time the distributions
were made.
As for the corporate minutes, even if we were to admit the
document under the business record hearsay exception found in
rule 803(6) of the Federal Rules of Evidence, we do not find that
the document is helpful to petitioners' case. The minutes
reflect that petitioner agreed to forgo his monthly salary of
$4,000. While the distributions did not exactly match the amount
of his salary forgone, we note that petitioner's monthly salary
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of $4,000 is the pretax value. After the income tax is deducted,
the $4,000 would be reduced and would come closer to matching the
distributions received by petitioner and treated as tax-free loan
proceeds. Furthermore, the minutes are not dated and are not
signed by petitioner, who claims he prepared the minutes after
the meeting. Rather, the minutes allegedly contain the signature
of his father (who did not appear at trial), who bears the same
name as petitioner. Thus, even if we were to admit the document,
we would give it little weight. Accordingly, we find that the
$27,700 in distributions is includable in petitioners' income
under section 61(a)(1) as compensation for services.
We also find that petitioners are liable for the accuracy-
related penalty under section 6662(b)(1) as stated in the notice
of deficiency. Petitioners did not produce any evidence
regarding the penalty, and the record does not indicate that the
penalty has been conceded by respondent.
To reflect the foregoing,
Decision will be entered
under Rule 155.