Decisions will be entered under Rule 155.
Held: 1. On the basis of the facts in this record, advances by one of the stockholders of a corporation (T.M.) to that corporation were loans and not contributions to capital and these advances did not constitute a second class of stock under
2. Under
3. Under the facts here present the statement of shareholders' consent required by
4. T.M. may not properly accrue in income for the years ended June 30, 1965, 1966, 1967, and 1968 any amount for a claim against the bank which it was suing for lost profits;
5. T.M. is not entitled under
6. T.M. *152 realized income of $ 162,500 for its taxable year ended June 30, 1969, from settlement of its claim for lost profits;
7. T.M. realized forgiveness of indebtedness income of $ 88,550.33 for its taxable year ended June 30, 1969, since after an overall settlement of its suit against the bank and the bank's counterclaim it was solvent to that extent;
8. Petitioner Ruth Farley must include in her income for the calendar years 1968 and 1969 her community one-half interest in the dividends received by her husband;
9. Petitioners Ralph and Ingrid Brutsche as shareholders of T.M. must include in their income for the calendar year 1969 their proportionate share of the amount of T.M.'s undistributed income for its taxable year ending June 30, 1969, and petitioner Ruth Farley must include in her income for the calendar year 1969 her one-half community property interest of the proportionate share of hers and her husband in this undistributed income.
*1035 Respondent determined a deficiency in Federal income tax of petitioners Ralph L. and Ingrid Brutsche for the calendar year 1969 in the amount of *153 $ 65,615.48. Respondent determined a deficiency in the Federal income tax of Ruth L. Farley for the calendar years 1968 and 1969 in the amounts of $ 1,289 and $ 11,621, respectively. The issues for decision are (1) whether petitioner Ruth L. Farley received taxable income in the calendar years 1968 and 1969 under the New Mexico community property law by reason of dividend distributions made to her husband in those years, and (2) whether petitioners Ralph L. and Ingrid Brutsche and petitioner Ruth L. Farley are each required under
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly.
Ralph L. Brutsche and Ingrid Brutsche were residents of Santa Fe, N. Mex., at the time of the filing of their petition in this case. They filed a joint Federal income tax return on the cash basis *154 of *1036 accounting for the calendar year 1969 with the District Director of Internal Revenue, Albuquerque, N. Mex.
Ruth L. Farley was a resident of Albuquerque, N. Mex., at the time of the filing of her petition in this case. She filed on the cash basis of accounting separate Federal income tax returns for each of the calendar years 1968 and 1969 with the District Director of Internal Revenue, Albuquerque, N. Mex.
Ruth L. Farley (hereinafter Ruth) and Phillip A. Farley (hereinafter Phillip) were married during the calendar years 1968 and 1969. In 1971 they were divorced and in 1972 Phillip Farley died.
During 1960 and until October 1961, Ralph L. Brutsche (hereinafter Ralph) and Phillip were engaged as partners under the name of Thunder Mountain Construction Co. (hereinafter the partnership) in the business of building residential homes in Sante Fe, N. Mex. Ralph had been engaged in the building business for some time prior to 1960 and Phillip was a lawyer. During July 1960 the partnership executed an agreement to purchase some real property from Stamm Development Co. (hereinafter Stamm).
On March 29, 1961, Thunder Mountain Land Co., Inc. (hereinafter the corporation or Thunder Mountain), *155 was incorporated under the laws of the State of New Mexico. On July 12, 1961, its certificate was amended to change the name of the corporation to Thunder Mountain Construction Co.
The certificate of incorporation provided that the total authorized capital stock was one class of common stock, numbering 250,000 shares, that the holders of common stock were entitled to one vote per share, that Ralph, Phillip, and an attorney (hereinafter the attorney) responsible for forming the corporation subscribed to 666 shares, 333 shares, and 1 share of common stock, respectively, and that Ralph, Phillip, and the attorney were members of the corporation's board of directors and were the president, vice president, and secretary-treasurer of the corporation, respectively, until successors were elected. Between March 29 and May 1, 1961, stock certificates were issued to Ralph, Phillip, and the attorney, representing the number of shares to which each subscribed in the certificate of incorporation. The attorney was a nominal shareholder to have three incorporators and three stockholders.
*1037 During March 1961 Phillip and Ralph in anticipation of the formation of the corporation negotiated on its behalf *156 for the purchase of land from C. H. Carder Construction Co. The negotiations resulted in a proposed agreement dated in March 1961. Although negotiations continued during April 1961, the purchase agreement was never consummated.
Ralph and Phillip on behalf of the corporation negotiated for the purchase of land with Stamm during April and May 1961. These negotiations culminated in the execution of a purchase agreement dated May 26, 1961. This agreement provided that the corporation would acquire certain parcels of land that the partnership had previously agreed to buy from Stamm. The purchase agreement recited that certain of the parcels of land described therein had been conveyed by Stamm to the corporation and that the sum of $ 30,341.25 had been paid on the purchase price of those parcels. It further provided that the corporation was to pay at the time of the execution of the agreement an additional amount of $ 6,708.43 on the purchase price of the land. Paragraph 9 of the purchase agreement provided a release of Stamm for any previous obligation it had to sell the land involved to the partnership.
Phillip and Ralph executed the agreement on behalf of the corporation in their *157 capacities as officers of the corporation and as partners of the partnership executed a consent to paragraph 9 of the agreement.
On July 1, 1961, the corporation had a total of 9,000 shares of $ 1 par value common stock issued and outstanding of which Ralph and Phillip owned 6,000 shares and 3,000 shares, respectively. At that time the assets of the partnership were transferred to the corporation. Ralph's partnership capital account in the amount of $ 38,570.47 was entered on the corporation's accounting records as of June 30, 1962, as paid-in capital to the extent of $ 6,000 and a loan payable to the extent of $ 32,570.47. Phillip's subscription to 3,000 shares of common stock was entered on the corporation's accounting records as a stock subscription receivable in the amount of $ 3,000. Phillip never paid for his stock subscription.
The minutes of Thunder Mountain Construction Co. recite that the first meeting of its board of directors was held July 1, 1961.
*1038 Phillip and the corporation's accountant prepared a Form 2553, Election by Small Business Corporation, and a statement of shareholders' consent to the election. The statement was in the form of a letter dated June 23, 1961, *158 signed by Ralph and his wife, Phillip and his wife, and the attorney and his wife. The letter read: "We, the undersigned shareholders, do hereby consent to the election of Thunder Mountain Land Company, Inc. to be taxed as a small business corporation under
Note:
First assets acquired May 26, 1961; no transactions of business or issuance of stock until after May 26, 1961.
The prepared Form 2553, Election by Small Business Corporation, which Ralph signed in his capacity as president of the corporation on June 23, 1961, stated the name, Thunder Mountain Land Co., Inc., the address of the corporation, its place of incorporation, its business activity, the names and addresses of each of its six shareholders, Ralph, Phillip, and the attorney and their respective spouses, and the Internal Revenue District in which each such shareholder's return was filed. Further the Form *159 2553 represented that the corporation was not an outgrowth of any predecessor organization, that Ralph and his wife owned 6 shares, Phillip and Ruth owned 3 shares, and the attorney and his wife owned 1 share, that the number of shares issued and outstanding was 10 and that the first taxable year for which the election was effective was "May 26, 1961 to be determined."
The statement that the date the form was submitted was June 24, 1961, and the date of incorporation of Thunder Mountain was March 29, 1961, was added either by Phillip or the corporation's accountant after the form was signed by Ralph. Also the notation following the date of incorporation, "First assets acquired May 26, 1961. See Note attached.", was added by either Phillip or the accountant after Ralph had signed the form.
On June 24, 1961, the letter and the Form 2553 were mailed by Phillip or the accountant to the district office of respondent in Albuquerque and it was received by that office on June 26, 1961. *1039 The envelope in which the letter and form were mailed bears a postmark date of June 24, 1961.
By letter dated September 8, 1961, respondent's district office advised Thunder Mountain that its Form 2553 and *160 the statement of shareholders' consent were considered incomplete due to the omission of the number of shares issued to each shareholder. The letter then stated: "Please return this letter with the information requested within 20 days from date shown above, otherwise the election will not become effective." Ralph received this letter and gave it either to Phillip or the corporation's accountant.
As of May 26, 1961, the corporation had purchased and had agreements to purchase tracts of land. Thunder Mountain developed the land and built houses in the low price range. Eventually the corporation had an annual volume of sales exceeding the amount of $ 500,000. The time differential between the starting of a house and the receipt of the purchase price upon its sale required substantial borrowings by Thunder Mountain. Such financing was primarily provided by a local bank (the bank) with which the corporation had a line of credit that could exceed the amount of $ 500,000. Thunder Mountain operated its business in reliance upon that bank's representations that the corporation had that amount of credit available to it. As a consequence of a disagreement between the officers of Thunder *161 Mountain and an individual who was a large depositor at the bank, the latter contacted the bank respecting its business relationship with Thunder Mountain and in early 1965 the bank withdrew its line of credit to the corporation. Another bank from which Thunder Mountain sought to borrow funds refused its credit having received information that any extension of credit by it would be attached by a suit allegedly being brought against Thunder Mountain by one of its creditors. In July 1965 Thunder Mountain brought a suit for compensatory damages for lost profits in the amount of $ 800,000 and punitive damages in the amount of $ 1 million against the bank for its alleged breach of its oral agreement to extend its credit to the corporation and for its alleged wrongful interference in Thunder Mountain's efforts in securing other sources of credit. During the taking of depositions in connection with this suit, it developed that the depositor with whom the officers of Thunder Mountain had a disagreement, *1040 using an alias, had represented to the bank with which Thunder had tried to establish a new line of credit that he was bringing a suit against Thunder Mountain.
As a result of the discontinuance *162 of Thunder Mountain's line of credit the corporation incurred net operating losses in the amounts of $ 125,777, $ 59,685, $ 27,497, and $ 18,771, for fiscal years ended June 30, 1965, 1966, 1967, and 1968, respectively.
In the suit filed against it, the bank filed a counterclaim against Thunder Mountain for the amount of $ 161,189.77 which represented the amount of construction loans remaining owed to the bank by the corporation at the time of the law suit.
Thunder Mountain was interested in a settlement that would leave it with sufficient proceeds from which it could satisfy its creditors and remain solvent. The corporation's creditors were interested in having their claims satisfied out of the proceeds of any settlement in favor of Thunder Mountain. To facilitate a settlement that would provide Thunder Mountain with funds with which to pay them, the corporation's creditors agreed to accept the amount of $ 47,164.04 in lieu of claims in the amount of $ 87,368.87 owed to them. Having reached an agreement with its creditors that their compromised claims would be paid out of the proceeds of the anticipated settlement of the law suit, on August 13, 1968, a settlement of the law suit was *163 reached by the parties and the corporation's complaint and the bank's counterclaim were dismissed with prejudice. Simultaneously, the corporation transferred to the bank two houses and two triplexes having a basis to the corporation in the amount of $ 52,613.75 and was paid by the bank the cash amount of $ 162,500. After the payment of the settlement proceeds by the bank, the creditors were paid the amount which had been agreed upon for their claims against the corporation. Ralph received the amount of $ 32,056.06 in discharge of the total amount of the corporation's indebtedness to him.
The balance sheet of Thunder Mountain as of June 30, 1968, and June 30, 1969, reflected the following assets and liabilities: *1041
| Assets | |||
| FYE 6/30/68 | FYE 6/30/69 | ||
| Cash -- Santa Fe National Bank | $ 10.42 | $ 7.12 | |
| Stock subscription receivable, | |||
| P. A. Farley | 3,000.00 | 3,000.00 | |
| Inventories: | |||
| 2 houses in Barrio la Canada | $ 22,800.00 | ||
| 2 triplexes, 606 E. Palace | 29,813.75 | 52,613.75 | 0 |
| Claims receivable, | |||
| Albuquerque National Bank et al. | 231,730.22 | 0 | |
| Loans to shareholder; | |||
| P. A. Farley | 8,748.73 | 8,061.82 | |
| R. L. Brutsche | 7,771.66 | ||
| Investment, 2222 shares, | |||
| Western American Life Ins. | 2,222.00 | 2,222.00 | |
| Depreciable property (net) | 12,240.77 | 11,491.38 | |
| Escrowed funds, Santa Fe National Bank | 1,153.82 | 1,153.82 | |
| Total | 311,719.71 | 33,707.80 | |
| Liabilities and Capital | |||
| Accounts payable creditors | $ 87,368.87 | 0 | |
| Mortgages, notes, and interest: | |||
| Albuquerque National Bank | $ 161,189.77 | ||
| Santa Fe National Bank | 12,295.82 | 173,485.59 | $ 14,143.25 |
| Loans from shareholder, R. L. Brutsche | 31,056.06 | 0 | |
| Mortgage on 1503 Pasco, | |||
| Metropolitan Life Ins. Co. | 10,809.19 | 10,564.55 | |
| Capital stock | 9,000.00 | 9,000.00 | |
| Total | 311,719.71 | 33,707.80 | |
*164 From July 1, 1961, until June 30, 1969, Phillip was indebted to Thunder Mountain and the corporation was indebted to Ralph. The balances at the end of fiscal years ended June 30, 1961 through 1969, for amounts receivable from Phillip and amounts payable and receivable with respect to Ralph were as follows: *1042
| Receivable | Payable to | Receivable | |
| FYE June 30 -- | from Phillip | Ralph | from Ralph |
| 1961 | 0 | 0 | |
| 1962 | $ 3,150.03 | $ 23,118.15 | |
| 1963 | 627.73 | 20,233.51 | |
| 1964 | 10,442.35 | 29,388.39 | |
| 1965 | 2 5,093.53 | 27,627.57 | |
| 1966 | 11,548.73 | 24,861.87 | |
| 1967 | 8,748.73 | 30,967.91 | |
| 1968 | 8,748.73 | 31,056.06 | |
| 1969 | 8,061.82 | 0 | 3 $ 7,771.66 |
The amounts payable to Ralph were not represented by a note nor were they payable on *165 any specific date except as we have described in footnote 2 supra. At a meeting of the board of directors of Thunder Mountain on December 9, 1961, a resolution was adopted providing for borrowing by the corporation from its officers, at interest of 4 percent, the issuance of notes to evidence the loans and negotiations annually for repayment of the loans. To the extent that Phillip's or Ralph's respective share of the corporation's taxable income was not distributed or an amount in excess of their respective share was distributed to them during a taxable year, it was entered on the corporate records as money having been loaned to the corporation or money having been loaned from the corporation.
Thunder Mountain filed a U.S. Small Business Corporation income tax return (Form 1120S) for the fiscal year July 1, 1961, to June 30, 1962. At the top of the balance sheet (Schedule L) of the return was typed "First Return." The return reflected that the date of Thunder Mountain's incorporation was the spring of 1961, and that it had no assets and liabilities at the beginning of its fiscal year, July 1, 1961. The corporation received taxable income in the amounts of $ 2,473.05, $ 7,152.31, *166 and $ 15,493.35 for its fiscal years 1962, 1963, and 1964, respectively. The corporation filed U.S. Small Business Corporation income tax returns (Forms 1120S) for its fiscal years ended June 30, 1965, 1966, 1967, 1968, and 1969. The return for its fiscal year 1965 *1043 was filed in February 1967 reflecting a loss of $ 125,777. The corporation's returns for its fiscal years 1966, 1967, and 1968 were blank with an explanatory letter attached stating that the corporation had incurred an indeterminate amount of net losses.
On amended U.S. Small Business Corporation income tax returns (Forms 1120S) filed subsequent to the settlement of the law suit against the bank for each of its fiscal years 1965, 1966, 1967, and 1968, an amount equal to the amount of the loss previously reported in the amount of $ 125,777 on the original corporate return for its fiscal year 1965 and subsequently determined and reported in the amended corporate returns in the amounts of $ 59,685, $ 27,497, and $ 18,771 for its fiscal years 1966, 1967, and 1968, respectively, was accrued as an item of gross income representing a claim receivable from the bank. By accruing income in an amount equal to the amount of the *167 losses for each of the corporation's fiscal years 1965 through 1968, the amended returns for such fiscal years showed no taxable income or loss.
On its corporate balance sheet Thunder Mountain reflected the accrued income item as an annual increment to its current assets for each of its fiscal years 1965 through 1968. On the balance sheet as of June 30, 1968, an asset in the amount of $ 231,730.22 represented the corporation's claim receivable from the bank.
In its fiscal year 1969 U.S. Small Business Corporation income tax return (Form 1120S), Thunder Mountain reported gross income in the amount of $ 79,558.75, having partially offset the amount received in settlement of litigation by the amount of the accrued claim against the bank that it surrendered, computed as follows:
| Compromise of general creditor debts: | ||||
| Accounts payable, 6/30/68 | $ 87,368.87 | |||
| Amount disbursed in settlement | 47,164.04 | |||
| Net income | $ 40,204.83 | |||
| Cancellation of debt -- Albuquerque | ||||
| National: | ||||
| Amount of debt, 6/30/68 | 161,189.77 | |||
| Thunder Mountain assets surrendered | ||||
| in settlement: | ||||
| Claims vs. the bank | $ 231,730.22 | |||
| Less: cash settlement | 162,500.00 | |||
| Claims balance | 69,230.22 | |||
| Inventories: | ||||
| 2 houses in Barrio la Canada | ||||
| (1714 Veronica and | ||||
| 1621 Paseo Conq.) | 22,800.00 | |||
| 2 triplexes at 606 E. Palace | 29,813.75 | |||
| Total surrendered | 121,843.97 | |||
| Net income | 39,345.80 | |||
| Insurance refund | 8.12 | |||
| Gross Income | 79,558.75 | |||
| Legal fees | 39,513.22 | |||
| Accounting fees | 1,121.20 | |||
| Service charges, bank | 11.42 | |||
| Interest | 1,602.79 | |||
| Depreciation | 749.39 | |||
| Total Deductions | 42,998.02 | |||
| Taxable Income | 36,560.73 | |||
*168 *1044 The corporation distributed out of its earnings the amounts of $ 15,779.22 and $ 8,594.60 to Ralph and the amounts of $ 11,000 and $ 1,186.91 to Phillip during the calendar years 1968 and 1969, respectively, which it showed as from income of $ 36,560.73 received in its fiscal year 1969. Thunder Mountain also in 1969 repaid loans made to it by Ralph prior to its fiscal year 1969 in the amount of $ 31,056.06 and during its fiscal year 1969 in the amount of $ 1,000. Ralph borrowed from the corporation the amount of $ 7,771.66 during the corporation's fiscal year 1969.
In the original and amended corporate returns for 1962 and 1965 through 1969, the election as a small business corporation was noted as having been made during June 1961, the shares of stock were represented as having been owned from July 1961 by Ralph and Phillip in the approximate percentages of 66.7 and 33.3, respectively, or in the numbers of 6,000 and 3,000, respectively. These returns except for 1962 reflected that the incorporation of Thunder Mountain occurred during June 1961.
Ralph and his wife reported dividend income or their share of undistributed income from a "Subchapter S Thunder Mountain Construction Co." *169 in the amount of $ 2,167.01 in their original and amended joint return for the calendar year 1962, the amount of $ 4,703.88 in their original and amended joint return for the calendar year 1963, and the amount of $ 10,102.02 in their original joint return for the calendar year 1964. In an application signed by Ralph for an extension of time to file their joint Federal income tax return for the calendar year 1965 which was subsequently approved, the statement of the reason for the request was that:
Serious operating losses and pending litigation as a consequence of these losses has made it impossible to provide Sub-Chapter S Corporation Financial *1045 Statements and a 1965 Tax Return which is necessary for the preparation of the Individual Income Tax Return. There will be no individual income tax liability because of the large undetermined losses in the Corporation.
On their joint return for calendar year 1965 Ralph and his wife reported a loss of $ 83,627.57 as their ratable share of the net operating loss of Thunder Mountain and made a claim for refund for tax withheld and paid with respect of the calendar years 1962, 1963, 1964, and 1965. Ralph and his wife filed an amended return for *170 1965 and attached a signed statement to the effect that the reason for the delinquency in filing their return was that:
my financial affairs were inextricably bound to the operations of Thunder Mountain Construction Company * * *, a Sub-Chapter S corporation. I could not determine what my income tax position was without knowing the income position of the corporation, since income or loss flowed through to me under IRC Section #1373. * * *
This amended return for 1965 omitted the loss of Thunder Mountain previously claimed on the original return and, having already received a refund of some tax for 1962, 1963, 1964, and 1965, remitted any outstanding amount of tax due for 1962, 1963, 1964, and 1965 after accounting for the disclaimer of any loss incurred during 1965 with respect of Thunder Mountain. In their original joint Federal returns for the calendar years 1966 and 1967 Ralph and his wife did not report a loss with respect of Thunder Mountain and attached a signed statement that:
my financial affairs were inextricably bound to the operations of Thunder Mountain Construction Company * * *, a Sub-Chapter S Corporation. I could not determine whether I was entitled to a portion of *171 a corporate loss nor in what amount. I am not claiming any loss at this time, however, in order to get a return filed. * * *
Attached to the joint return of Ralph and his wife for calendar year 1967 was an application for an extension of time to file signed by Phillip in Ralph's absence stating that: "records of Sub-Chapter 'S' corporation, of which taxpayers are substantial shareholders, were in the hands of adverse parties * * * without which information individual returns of the taxpayers cannot be prepared." In their joint return for the calendar year 1968 Ralph and his wife reported dividend income from Thunder Mountain of $ 15,779. Attached to their return for that year was a signed statement that Thunder Mountain was a subchapter S corporation that had no net taxable income for its fiscal year ended June 30, 1968. In their joint return for the calendar year *1046 1969 they reported dividend income of $ 8,594.60 with respect of Thunder Mountain and checked the corresponding box applicable to a small business corporation. Attached to that return was a statement in an application for extension for time to file signed by Ralph and his wife that they were major stockholders in Thunder *172 Mountain, a small business corporation under I.R.C. subchapter S.
Ruth did not report any income or loss with respect of Thunder Mountain in her separate income tax returns for the calendar years 1968 and 1969.
In the notice of deficiency respondent determined that Thunder Mountain, an electing small business corporation, had additional undistributed income in the amount of $ 231,730.22 as a result of settlement of litigation and cancellation of indebtedness income for its fiscal year ended June 30, 1969. Accordingly, respondent determined that Ralph and his wife received additional income for their calendar year 1969 in the amount of $ 154,486.82, representing their share of the increment of the amount of $ 231,730.22 to the undistributed income of Thunder Mountain, an electing small business corporation.
Further, respondent determined that the reported income of Ralph and his wife should be increased in the amount of $ 15,528.03 insomuch as they realized a long-term capital gain of $ 31,056.06 as a result of their receiving repayment of a loan of $ 31,056.06 to Thunder Mountain, an electing small business corporation, that had a zero basis to them by virtue of respondent having allowed *173 the corporation's net operating loss in its fiscal years 1965, 1967, and 1968 to offset all or part of Ralph's and his wife's taxable income in their calendar years 1962, 1963, 1964, 1965, 1967, and 1968.
In his notice of deficiency respondent determined that Ruth received additional income for the calendar year 1968 in the amount of $ 5,500, representing her community share of dividends of $ 11,000 received in that year by her husband Phillip from Thunder Mountain. Further, respondent determined Ruth received additional income in the calendar year 1969 in the amount of $ 39,215.16 representing her community interest in their share in the amount of $ 77,243.40 of the increment as determined by respondent in the amount of $ 231,730.22 of the undistributed income of Thunder Mountain, an electing small business corporation, for its fiscal year 1969, and her community *1047 interest in the amount of dividends of $ 1,186.91 received in the calendar year 1969 from Thunder Mountain by Phillip.
OPINION
Petitioners' primary position is that Thunder Mountain was not an electing small business corporation and consequently any increase in its undistributed income for its fiscal year 1969 is not taxable *174 to them for the calendar year 1969 but to the corporation. Petitioners stated the following bases for this position:
(1) Thunder Mountain had more than one class of stock since the loans to the corporation by Ralph were equity investments, and consequently it was ineligible to elect under
(2) Even if Thunder Mountain were eligible to elect to be taxed as a small business corporation, its election was not filed within a month of May 26, 1961, the beginning of its taxable year and therefore was ineffective; and
(3) The election was ineffective since the statement of shareholders' consent filed with it omitted the number of shares of stock of Thunder Mountain issued to each shareholder and the dates on which such shares were acquired.
Petitioners argue that they are not estopped from asserting the invalidity of the corporation's election as respondent did not rely on any representation made by the corporation to his detriment since at the time of the trial of this case all facts were disclosed and respondent could at that time have issued a notice of deficiency to the corporation for its fiscal year 1969, the only year for which *175 any tax would be due from the corporation.
Petitioners contend that, if Thunder Mountain qualifies as an electing small business corporation, it did not receive any taxable income in its fiscal year 1969 from settlement of litigation with the bank and forgiveness of its indebtedness by the bank and other creditors. Petitioners argue that the corporation properly accrued claims aggregating $ 231,720 against the bank during its fiscal years 1965, 1966, 1967, and 1968 for losses it incurred during those years by virtue of the bank's discontinuing the extension of credit to the corporation during early 1965 and consequently did not receive any taxable income during its fiscal year 1969 when it received the cash proceeds in the amount of $ 162,500 pursuant to a settlement of its pending law suit against *1048 the bank. In the alternative, petitioners argue that the net operating losses were not deductible in the fiscal years during which they arose since there was a reasonable prospect for their recovery from the bank, relying on
Petitioners contend that if the corporation received income for its fiscal year 1969 from the receipt of the cash of $ 162,500 in exchange for damages it incurred, its transfer of houses with a book value of $ 52,613.75 should be offset against the receipt and the remaining $ 109,886 should be excluded from the corporation's income for its fiscal year 1969 under the tax benefit rule since its net operating losses which were deducted for its prior years did not result in any tax benefit to the corporation or its shareholders.
Respondent contends that Thunder Mountain was an electing small business corporation and that it had undistributed income in the amount of $ 231,730.22 for its fiscal *177 year 1969 from the settlement of litigation and cancellation of indebtedness by the bank and other creditors. In the alternative respondent contends that, if the book value of the corporation's assets is an accurate reflection of their fair market value, the corporation had undistributed income in the amount of $ 171,500 for its fiscal year 1969, having received gross income in the amount of $ 251,058.75 during such fiscal year consisting of the following:
| Cash proceeds of settlement of | ||||
| litigation | $ 162,500.00 | |||
| Insurance refund | 8.12 | |||
| Debt forgiveness by the bank | $ 161,189.77 | |||
| Debt forgiveness by creditors | 40,204.83 | |||
| Less: houses transferred | (52,613.75) | |||
| Net debt forgiven | $ 148,780.85 | |||
| Net book worth 6/30/68 | (222,730.22) | |||
| Cash settlement 8/68 | 162,500.00 | |||
| Net book worth before | ||||
| forgiveness | (60,230.22) | |||
| Amount realized (net book worth) | ||||
| after forgiveness of debt | 88,550.63 | |||
| Total gross income | 251,058.75 | |||
*1049 Respondent takes the position that Ralph and Phillip as shareholders of an electing small business corporation received additional taxable income during the calendar year 1969 in the amount of their proportionate share of the corporation's undistributed income for its fiscal year 1969, and that one-half of Phillip's *178 proportionate share was taxable to Ruth by virtue of the community property laws of New Mexico. Respondent also contends that Ruth received taxable income for the calendar years 1968 and 1969 to the extent of her community property one-half interest in dividend distributions in the amounts of $ 11,000 and $ 1,186.91 that Thunder Mountain made to Phillip in these years. Respondent argues that under section 446(c) the corporation cannot properly accrue in its fiscal years 1965 through 1968 amounts equal to its net operating losses for such years as a claim receivable from the bank. Further, he contends that petitioners are estopped from asserting the invalidity of the corporation's election based on their own or the corporation's misrepresentation in the Form 2553 filed by the corporation and in the statement of the shareholders' consent filed by the corporation's shareholders. In any event respondent contends the corporation's election for its fiscal year beginning July 1, 1961, was valid since it was timely and properly made on June 26, 1961, since the corporation did not have shareholders, had not acquired assets, and had not begun doing business before May 26, 1961.
Even if Ralph's advances were considered to be contributions to capital, they were not stock within the meaning of
where the instrument is a simple installment note, without any incidents commonly attributed to stock, it does not give rise to more than one class of stock within the meaning of
As we pointed out in the Stinnett case, supra, loans that are considered a contribution to capital are not necessarily to be treated as a second class of stock under
Petitioners' reliance on
Petitioners rely on
The corporation's election was filed on June 26, 1961. 10*192 The initial issue then is whether the corporation's election filed on June 26, 1961, was made within the first month of its taxable year which for a new corporation, pursuant to respondent's regulations, does not begin until after a corporation has shareholders, acquires assets, or begins doing business.
Even though the record is inadequate to determine how Thunder Mountain adopted a fiscal year ending June 30, the record is clear it did use such a fiscal year in keeping its books and filing its Federal income tax returns. Therefore, the first year of the corporation was the short taxable year ending *195 June 30, 1961. Even though the corporation apparently filed no Federal tax return for the short taxable year, it was in fact in existence and had some business transactions in this period. 12 Therefore, the corporation had a taxable year beginning on July 1, 1961, and *1056 ending on June 30, 1962, which was in fact its second taxable year even though it was its first full fiscal year. On the basis of the record in this case, we conclude that the election filed by the corporation on June 26, 1961, at which time it had assets and shareholders,
Petitioners' next contention is that the corporation's *196 election was not effective since the required statement of shareholders' consent omitted the number of shares of stock owned by each shareholder and the date on which such shares were acquired by each such stockholder in contravention of
*1058
*1059 In view of our holding that Thunder Mountain made a valid election to be a small business corporation, it is unnecessary for us to decide whether respondent's contention that petitioners are estopped from asserting the invalidity of Thunder Mountain's election is valid.
Petitioners contend that the corporation as reflected by its amended returns properly accrued claims receivable from the bank as an item of gross income in the amounts of $ 125,777, $ 59,685, $ 27,497, and $ 18,771 for its taxable years ended June 30, 1965, 1966, 1967, and 1968, respectively. In the alternative, petitioners contend that the corporation's net operating losses in the amounts of $ 125,777, $ 59,685, $ 27,497, and $ 18,771 which were attributable to its taxable years ending June 30, 1965, 1966, 1967, and 1968, respectively, were not deductible in such taxable years, since such losses were in the nature of casualty losses under
Respondent contends that the claims receivable may not be properly accrued for the corporation's taxable years ending June 30, 1965, 1966, 1967, and 1968. He also contends that the corporation's net operating losses are deductible with respect of the taxable year in which they arose since such losses are not in the nature of casualty losses and that the shareholders of the corporation to the extent allowable under
Petitioners recognize that any amount the corporation received from the bank in settlement of the lawsuit against the bank was an item of gross income to the corporation rather than a recovery of capital and that the income was ordinary income. It is well settled that when a claim is settled, the amount received takes the character of the item that gave rise to *206 the claim. Thunder Mountain's claim against the bank was founded on its loss of its anticipated profits. Since these profits would have been ordinary income if the corporation had received them in the first instance, the amount received in settlement of the claim for these profits is ordinary income. The issue here is not the nature of the *1060 receipts but is the taxable year for which the corporation received the income.
An accrual basis taxpayer 14 must include an item in gross income for the taxable year in which all events have occurred that fix the right to receive such income and the amount thereof with reasonable accuracy.
Petitioners' reliance on
An accrual basis taxpayer may deduct an expense for the taxable year in which all events necessary to determine both the fact and the amount of the liability have occurred.
Petitioners contend that the corporation received no income during its taxable year 1969 from the forgiveness of indebtedness by its creditors in the amount of $ 40,204.83 and by the bank in the amount of $ 161,189.77. Petitioners argue that the corporation realized no economic gain from the forgiveness of indebtedness since it was insolvent before and after *211 such forgiveness. Petitioners rely on such cases as
In the alternative respondent contends that, if we find the value of the corporation's assets have been established, the corporation received income from the forgiveness of its indebtedness and settlement of litigation in the amount of $ 251,050.63, consisting of the amount of $ 162,500 cash received from the bank and the amount of $ 88,550.63 representing the net solvency of the corporation after its receipt of the cash proceeds, the cancellation of its indebtednesses, and the transfer of its houses.
On brief respondent argues that the corporation's balance sheet did not accurately reflect *212 the fair market value of the corporation's assets and liabilities before the cancellation of its indebtednesses. However, respondent conceded at the trial of this case that he had no disagreement with the amounts shown on the balance sheet as representing the value of the corporation's assets and liabilities prior to the cancellation of the corporation's indebtednesses and settlement of the litigation and that the corporation had liabilities, exclusive of any amount for its shareholders' paid-in capital, in excess of assets, exclusive of the accrued claim against the bank, to the extent of $ 222,730.22. Petitioners agree that, if we concluded the corporation could not properly accrue a claim for damages against the bank, *1063 $ 222,730.22 was the amount by which its liabilities exceeded its assets prior to the settlement of its suit against the bank. It is apparent from the record in this case that the corporation was insolvent to the approximate extent of $ 222,730.22 before the settlement of its litigation with the bank and the cancellation of the corporation's indebtednesses. 15*213
It is well settled that gross income includes income from the discharge of indebtedness.
This Court stated in
The principles enunciated by these cases are these: Where an insolvent debtor turns over all or part of his property to his *214 creditors in full or partial satisfaction of his debts, if the debtor remains insolvent he realizes no taxable gain. On the other hand, where an insolvent debtor, by reason of the transaction in question, becomes solvent he realizes taxable gain in the amount of the assets freed from the claims of creditors, i.e., to the extent by which the transaction renders him solvent.
See
The cancellation by the corporation's creditors and the bank of its indebtednesses, the transfer of houses, and the payment of cash proceeds were interdependent. Each was a part of an overall integrated arrangement. After the overall arrangement was completed, the corporation had assets in excess of its liabilities, other than the shareholders' paid-in capital, in the amount of $ 88,550.63.
Petitioners argue that the corporation did not realize any income from the cancellation of its indebtednesses since it remained insolvent after the cancellation, but concede that by virtue of the cash proceeds it received, the corporation realized income to the extent of its net worth after the completion of the *1064 overall transaction or, in the alternative, in the amount of *215 $ 109,886.25 which it states is the net amount it received for its lost profits, the cash amount of $ 162,500 having been offset by the cost of the homes transferred. Respondent argues that the corporation realized income in the amount of $ 88,550.63 upon the cancellation of its debts which he computes as having been offset by the cost of the homes transferred. He argues that the corporation realized income in the additional amount of $ 162,000 from the settlement of the litigation for lost profits.
We conclude that the corporation realized income in the amount of $ 162,500 as such amount was received in settlement of a claim for lost profits. 16Amounts that are in substitution of an amount which would have been an item of income are income.
*1065 The corporation was clearly insolvent before the bank forgave the corporation's indebtedness to it. The more difficult question is whether the corporation was solvent after the forgiveness and if so the amount of such solvency. This turns on whether the amount of cash proceeds received in settlement of the damages for lost profits sustained by the corporation is treated as an asset of the *218 corporation in determining its net solvency after the cancellation of its indebtedness. Inasmuch as the parties have stipulated that on August 13, 1968, the lawsuit was dismissed and simultaneously the corporation transferred its houses to the bank and was paid by the bank the amount of $ 162,500, we find that the cash proceeds were not received after the cancellation of the corporation's indebtedness to the bank, but at the same time. There is no evidence to the contrary. Therefore, such amount is properly includable as an asset of the corporation in the determination of the corporation's net worth immediately following the cancellation of its indebtedness to the bank. It follows from this conclusion that the corporation was solvent to the extent of $ 48,345.80 after the bank's compromise of its loans to the corporation and the corporation's transfer of the houses to the bank. We conclude on the basis of the facts presented in this record that the corporation realized the amount of $ 48,345.80 from the cancellation of its indebtedness to the bank as the corporation was rendered solvent to that extent after the completion of the transaction that canceled its indebtedness to the *219 bank. See
*1066 Petitioners argue that under section 111 and respondent's regulations thereunder the corporation is not required to include in its gross income for its fiscal year 1969 any amount that it recovered that year which was attributable to its deductions from gross income for *220 its fiscal years 1965, 1966, 1967, and 1968 since it did not receive any tax benefit from the deductions for such years. Initially, we note that an electing small business corporation may not receive a tax benefit under any circumstances as it is not subject to income tax. Such corporation's shareholders derive the tax benefit from any deductions by the corporation as such deductions reduce their pro rata share of the corporation's undistributed income or the corporate losses are passed through to them to the extent allowable under
A net operating loss results from an excess of deductions over adjusted gross income. It is not a loss that results from an expense but a loss that results from the proportionate amounts of gross income and deductions. Here the suit which was settled involved a claim for loss of income that Thunder Mountain had sustained by the withdrawal of the bank's credit. The effect of the withdrawal was to reduce Thunder Mountain's anticipated gross income to a proportionately greater extent than its expenses and such reduction resulted in its having an excess of deductions representing its expenses over income for its fiscal year ending June 30, 1965, and subsequent years. 18*223 The overall settlement and payment of $ 162,500 to Thunder Mountain by the bank in settlement of claims for lost profits based on the amounts of its net operating losses were plainly not attributable to its actual expenses, either singularly or in the aggregate, that it claimed as deductions in its returns for 1965 and subsequent years.
This Court stated in
We are unable to find a common denominator between any item sold by the petitioner at a loss in the earlier year and then involved in a gain in the subsequent year. We conclude that the facts of this case do not bring it within the tax benefit doctrine as expanded by
Cf.
The record shows that Thunder Mountain distributed *224 from its available earnings the amounts of $ 11,000 and $ 1,186.91 during the calendar years 1968 and 1969, respectively, to Phillip. Under local law, these distributions were presumptively community property,
We hold that Thunder Mountain was an electing small business corporation and that under
Decisions will be entered under Rule 155.
Footnotes
1. All references are to the Internal Revenue Code of 1954, unless otherwise stated.↩
2. We note this stipulated fact fails to include promissory notes of the corporation dated June 7, 1965, in the amounts of $ 50,000 payable on or before Dec. 31, 1967, bearing interest at the rate of 4 percent per annum, that were issued to Ralph and Phillip, respectively. Apparently this debt was repaid before the end of the corporation's fiscal year 1969 or was not a bona fide loan.↩
3. We note this figure is the indebtedness after a previous repayment of Ralph's loan of $ 1,000 made to the corporation during its fiscal year 1969.↩
4.
SEC. 1372 . ELECTION BY SMALL BUSINESS CORPORATION.(a) Eligibility. -- Except as provided in subsection (f), any small business corporation may elect, in accordance with the provisions of this section, not to be subject to the taxes imposed by this chapter. Such election shall be valid only if all persons who are shareholders in such corporation --
(1) on the first day of the first taxable year for which such election is effective, if such election is made on or before such first day, or
(2) on the day on which the election is made, if the election is made after such first day,↩
consent to such election.5.
SEC. 1371 . DEFINITIONS.(a) Small Business Corporation. -- For purposes of this subchapter, the term "small business corporation" means a domestic corporation which is not a member of an affiliated group (as defined in section 1504) and which does not --
(1) have more than 10 shareholders;
(2) have as a shareholder a person (other than an estate) who is not an individual;
(3) have a nonresident alien as a shareholder; and
(4) have more than one class of stock.↩
6. Petitioners do not argue that the incorrect information furnished on the Form 2553 with respect to the number of shares owned by the corporation's shareholders invalidated the corporation's election.↩
7.
Sec. 1.1371-1(g), Income Tax Regs. , which was promulgated byT.D. 6432, 1 C.B. 317">1960-1 C.B. 317 , 321, that was published in24 Fed. Reg. 10294 on Dec. 19, 1959, provided as follows:(g) Classes of stock. -- A corporation having more than one class of stock does not qualify as a small business corporation. In determining whether a corporation has more than one class of stock, only stock which is issued and outstanding is considered. Therefore, treasury stock and unissued stock of a different class than that held by the shareholders will not disqualify a corporation under
section 1371(a)(4) . If the outstanding shares of stock of the corporation are not identical with respect to the rights and interest which they convey in the control, profits, and assets of the corporation, then the corporation is considered to have more than one class of stock. Thus, a difference as to voting rights, dividend rights, or liquidation preferences of outstanding stock will disqualify a corporation. However, if two or more groups of shares are identical in every respect except that each group has the right to elect members of the board of directors in a number proportionate to the number of shares in each group, they are considered one class of stock. If an instrument purporting to be a debt obligation is actually stock, it will constitute a second class of stock.Sec. 1.1371-1(g), Income Tax Regs. , which was amended byT.D. 6904, 1 C.B. 219">1967-1 C.B. 219 , that was published in31 Fed. Reg. 16527 on Dec. 28, 1966, provided as follows:(g) Classes of stock. A corporation having more than one class of stock does not qualify as a small business corporation. In determining whether a corporation has more than one class of stock, only stock which is issued and outstanding is considered. Therefore, treasury stock and unissued stock of a different class than that held by the shareholders will not disqualify a corporation under
section 1371(a)(4) . If the outstanding shares of stock of the corporation are not identical with respect to the rights and interest which they convey in the control, profits, and assets of the corporation, then the corporation is considered to have more than one class of stock. Thus, a difference as to voting rights, dividend rights, or liquidation preferences of outstanding stock will disqualify a corporation. However, if two or more groups of shares are identical in every respect except that each group has the right to elect members of the board of directors in a number proportionate to the number of shares in each group, they are considered one class of stock. Obligations which purport to represent debt but which actually represent equity capital will generally constitute a second class of stock. However, if such purported debt obligations are owned solely by the owners of the nominal stock of the corporation in substantially the same proportion as they own such nominal stock, such purported debt obligations will be treated as contributions to capital rather than a second class of stock. But, if an issuance, redemption, sale, or other transfer of nominal stock, or of purported debt obligations which actually represent equity capital, results in a change in a shareholder's proportionate share of nominal stock or his proportionate share of such purported debt, a new determination shall be made as to whether the corporation has more than one class of stock as of the time of such change.Respondent issued a Technical Information Release No. 875 on Dec. 28, 1966, with respect to the amendment of
sec. 1.1371-1(g), Income Tax Regs. , which provided in part as follows:"The Internal Revenue Service stated that, although it considered the original regulation to be a permissible application of existing law, it has modified the application of
section 1371(a)(4) of the Code on the basis of experience with the statute. That experience has demonstrated that the requirement of the Code relating to one class of stock is, in effect, met as long as the owners of the equity capital in the corporation have no greater rights among themselves, as a result of purported debt obligations which actually represent equity capital, in the control, profits, and assets of the corporation than they would have as owners of the nominal stock of the corporation. In such cases, the rights and interests of each shareholder in the control and profits are proportionate to his rights and interests in the assets of the corporation."The Revenue Service said that the modified application of the one class of stock requirement will be followed in the disposition of all cases which are pending."↩
8.
SEC. 1372 . ELECTION BY SMALL BUSINESS CORPORATION.(c) Where and How Made. --
(1) In general. -- An election under subsection (a) may be made by a small business corporation for any taxable year at any time during the first month of such taxable year, or at any time during the month preceding such first month. Such election shall be made in such manner as the Secretary or his delegate shall prescribe by regulations.↩
9.
Sec. 1.1372-2(b)(1), Income Tax Regs. , provides as follows:(b) Time of making election -- (1) Taxable years beginning on or after September 3, 1958. For taxable years beginning on or after September 3, 1958, the election shall be filed either (i) during the first month of such taxable year, or (ii) during the month preceding such first month. In the case of a new corporation whose taxable year begins after the first day of a particular month, the term "month" means the period commencing with the beginning of the first day of the taxable year and ending with the close of the day preceding the numerically corresponding day of the succeeding calendar month or, if there is no such corresponding day, with the close of the last day of such succeeding calendar month. For purposes of this subparagraph, the first month of the taxable year of a new corporation does not begin until the corporation has shareholders or acquires assets or begins doing business, whichever is the first to occur.
10. The parties stipulated that "On June 26, 1961, Thunder Mountain Land Company, Inc. filed its election under Int. Rev. Code of 1954,
§ 1372 ." We note that if, as the parties at times appear to assume, June 25, 1961, was the last date for Thunder Mountain to file its election, under the facts here the stipulated date of the filing of the election would be an incorrect legal conclusion since Form 2553 was mailed on June 24, 1961. See sec. 7502;Joseph W. Feldman, 47 T.C. 329">47 T.C. 329 , 332-333 (1966). However, since we have found the corporation had shareholders by May 1, 1961, an election filed June 24, 1961, would have been untimely, seeNick A. Artukovich, 61 T.C. 100↩ (1973) , for Thunder Mountain's first year of existence.11.
Sec. 1372(c) provides for a corporation to make its election during the "month" before or after the beginning of any taxable year.Sec. 1.1372-2(b)(1), Income Tax Regs. , provides that in the case of a new corporation whose taxable year begins after the first day of a particular month, the term "month" means the period commencing with such first day and ending with the day preceding the numerically corresponding day of the succeeding calendar month or, if none, the last day of such succeeding calendar month and that the first month of a taxable year of a new corporation does not begin until the corporation has shareholders, or acquires assets, or begins doing business.Since the beginning of a new corporation's taxable year in the middle of the month may not coincide with its having shareholders, or acquiring assets, or beginning business, respondent's regulations are ambiguous with respect of determining the period for which a new corporation may elect. We construe them to mean that a new corporation may make its election during the period commencing with the date it has shareholders, acquires assets, or begins doing business and ending on the day preceding the numerically corresponding day of the succeeding calendar month or, if none, the last day of such succeeding calendar month.↩
12. See
sec. 1.6012-2(a), Income Tax Regs.↩ , which requires that a return be filed by a corporation in existence during any portion of a taxable year except "If a corporation has received a charter but has never perfected its organization and has transacted no business and has no income from any source" it may be relieved of filing a return by the district director upon a proper showing.13.
Sec. 1.1372-1 [Income Tax Regs.] Election by small business corporation.(a) Eligibility. Under
section 1372 , an eligible small business corporation may elect not to be subject to the taxes imposed by chapter 1 of the Code (other than the tax imposed by section 1378 for taxable years beginning after April 14, 1966). The qualifications of a small business corporation must be met as of the first day of the first taxable year of the corporation for which the election is to be effective and on the date of election, unless the election is made after such first day, in which case the qualifications need not exist prior to the date of election. For example, the existence of a corporate shareholder or a nonresident alien as a shareholder prior to the date of election does not preclude qualification. However, if the election is made for a taxable year beginning before September 3, 1958, the qualifications must be met on such date and on each day after such date and before the date of election. The election by a small business corporation is valid only if all the shareholders in the corporation on the first day of the first taxable year for which the election is to be effective, or on the date of election, whichever is later, consent to such election. See§ 1.1372-3 , relating to shareholders' consent.Sec. 1.1372-3 [Income Tax Regs.] Shareholders' consent.(a) In general. The consent of a shareholder to an election by a small business corporation shall be in the form of a statement signed by the shareholder in which such shareholder consents to the election of the corporation. Such shareholder's consent is binding and may not be withdrawn after a valid election is made by the corporation. Each person who is a shareholder of the electing corporation must consent to the election; thus, where stock of the corporation is owned by a husband and wife as community property (or the income from which is community property), or is owned by tenants in common, joint tenants, or tenants by the entirety, each person having a community interest in such stock and each tenant in common, joint tenant, and tenant by the entirety must consent to the election. The consent of a minor shall be made by the minor or by his legal guardian, or his natural guardian if no legal guardian has been appointed. The consent of an estate shall be made by the executor or administrator thereof. The statement shall set forth the name and address of the corporation and of the shareholder, the number of shares of stock owned by him, and the date (or dates) on which such stock was acquired. The consents of all shareholders may be incorporated in one statement. The consents of all persons who are shareholders at the time the election is made shall be attached to the election of the corporation. If the election is made before the first day of the corporation's taxable year for which it is effective, the consents of persons who become shareholders after the date of election and are shareholders on such first day shall be filed with the internal revenue officer with whom the election was filed as soon as practicable after such first day. The consent referred to in the preceding sentence will be considered timely if it is filed on or before the last day prescribed for making the election. Where a consent is filed after the date of election, a copy of the consent shall also be filed with the return required to be filed under section 6037. In the case of a shareholder in a community-property State whose spouse has filed a timely consent to an election under
section 1372(a) for a taxable year beginning before January 1, 1961, the time for filing the consent of such shareholder shall not expire prior to May 15, 1961; in the case of a shareholder in a community-property State whose spouse has filed a timely consent to an election undersection 1372(a) for a taxable year beginning after December 31, 1960, and on or before October 26, 1962, the consent of such shareholder shall be considered timely if it is filed on or before the last day prescribed for making the election. An election undersection 1372(a) will not be valid if any of the consents are not timely filed. However, see paragraph (c) of this section for extension of time for filing consents. In addition, an election which was timely filed for any taxable year beginning before March 1, 1960, and which would be valid but for the fact that the consent of any shareholder of the corporation was not filed or was defective in any manner, will not be invalid if --(1) A proper consent is filed by such shareholder after December 19, 1959, and on or before March 1, 1960.
(2) All shareholders of the corporation who previously filed timely and proper consents file new consents within the period mentioned in subparagraph (1) of this paragraph, and
(3) The shareholders show to the satisfaction of the district director with whom the election under
section 1372(a) was filed that the failure to file timely and proper consents was not due to an intention to avoid making a valid election.* * *
(c) Extension of time for filing consents. An election which is timely filed for any taxable year and which would be valid, or would not have terminated, except for the failure of any shareholder to file a consent within the time prescribed in paragraph (a) or (b) of this section will not be invalid, or will not be treated as having terminated, for such reason if --
(1) It is shown to the satisfaction of the district director or director of the service center that there was reasonable cause for the failure to file such consent and that the interests of the Government will not be jeopardized by treating such election as valid, or as not having terminated,
(2) Such shareholder files a proper consent to the election within such extended period of time as may be granted by the Internal Revenue Service, and
(3) New consents are filed within such extended period of time as may be granted by the Internal Revenue Service, by all persons who were shareholders of the corporation at any time during the taxable year with respect to which the failure to consent would (but for the provisions of this paragraph) cause the corporation's election to be invalid or to terminate, and by all persons who were shareholders of the corporation subsequent to such taxable year and prior to the date on which an extension of time is granted in accordance with this paragraph.↩
14. Both parties argue on the assumption that Thunder Mountain filed its tax returns on an accrual basis and the returns are filed in such a way as to indicate that this assumption is correct.↩
15. Respondent does not contend that Ralph's loans in the amount of $ 31,056.06 as of June 30, 1968, were in fact contributions to the corporation's capital. His notice of deficiency treats such loans as bona fide indebtedness and as his determination is presumptively correct, we consider these loans to in fact be loans. We do not consider petitioners' argument with respect to Ralph's advances to the corporation being considered as contributions to its capital for purposes of constituting a second class of stock under
sec. 1371↩ to be a concession with respect of such amounts constituting a contribution to capital for all purposes. In any event we held petitioners' contention in this respect not to be established by the record.16. The corporation's complaint sought in part damages for dissipation of its goodwill. However, petitioners do not contend that the cash proceeds were in fact compensation for its goodwill.↩
17. The evidence in this regard consists of the following stipulations:
"The bank filed a counterclaim for $ 161,189.77, which was the balance owed (representing construction loans) to the bank by the corporation at the time of the law suit.
"On August 13, 1968, a settlement of the law suit was reached and the corporation's complaint dismissed with prejudice and the bank's counterclaim for $ 161,189.77 was dismissed with prejudice. Simultaneously, the corporation transferred to the bank two houses and two triplexes, having a basis to the corporation of $ 52,013.75, and was paid by the bank the sum of $ 162,500.00 in cash."
From these stipulations and the balance sheets of Thunder Mountain, it is clear that the corporation did not deny its indebtedness of $ 161,189.77 to the bank but merely did not pay that indebtedness either because of its pending suit or because of lack of funds. On the basis of the facts here it might be concluded that the bank paid to Thunder Mountain $ 271,076.02 for lost profits ($ 162,500 + $ 161,189.77 = $ 323,689.77 - $ 52,613.75 = $ 271,076.02) since the dropping of the counterclaim for an indebtedness which was not challenged except for an allegation that the bank owed the corporation more than that amount for lost profits was in effect a payment by the corporation of the debt and a payment by the bank to the corporation of the same amount as lost profits. However, since respondent makes no such contention but in effect concedes that the dropping of the counterclaim for transfer of the houses was a forgiveness of indebtedness of $ 108,576.02, we have accepted respondent's position in this regard.
18. With respect of its fiscal year ended June 30, 1965, Thunder Mountain reported a net operating loss of $ 125,776.84. It received income in the amount of $ 57,389.33 which was composed of gross receipts of $ 69,615.81 and rent of $ 2,642.24, that was adjusted for a loss of $ 14,868.72 from the sale of land. It claimed deductions in the amount of $ 183,166.17 which was composed of amounts paid for compensation of officers of the corporation of $ 27,040; taxes of $ 6,829.81; interest of $ 29,519.66; depreciation of $ 6,118.50, and miscellaneous expenses of $ 113,658.20, which included the costs of building permits, insurance, freight, accounting, advertising, commissions, legal counsel, equipment rentals, repairs, telephone, tools, office supplies, etc.