Summary
In Noonan, the U. S. Tax Court stated that the "bones of the corporations were without flesh [where the] record is devoid of any evidence that the corporations engaged in any substantive business purpose" other than the sole purpose of federal tax savings.
Summary of this case from Jones v. Department of RevenueOpinion
Docket Nos. 3029-67 3030-67 3080-67— 3083-67.
1969-09-2
LLOYD F. NOONAN AND BARBARA M. NOONAN, ET AL.,1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Robert H. Walker, for the petitioners. Martin A. Schainbaum and Neil J. Murphy, for the respondent.
Robert H. Walker, for the petitioners. Martin A. Schainbaum and Neil J. Murphy, for the respondent.
The corporate petitioners received distributive shares of income as limited partners in partnerships of which the individual petitioners were general partners. Held, the amounts which corporate petitioners received are taxable to the corporations' sole shareholders, who are the individual petitioners herein.
FAY, Judge:
Respondent determined deficiencies in petitioners' Federal income taxes as follows:
+---------------------------------------------------------------------------+ ¦Docket ¦Petitioner ¦TYE ¦Amount ¦ +-------+---------------------------------------------+----------+----------¦ ¦No. ¦ ¦ ¦ ¦ +-------+---------------------------------------------+----------+----------¦ ¦3029-67¦Lloyd F. Noonan and Barbara M. Noonan ¦12/31/63 ¦$28,725.87¦ +-------+---------------------------------------------+----------+----------¦ ¦3030-67¦Wilfred H. Winkenbach and Gertrude Winkenbach¦12/31/63 ¦29,308.38 ¦ +-------+---------------------------------------------+----------+----------¦ ¦3080-67¦L.F. Noonan, Inc ¦( 7/31/62 ¦3,521.09 ¦ +-------+---------------------------------------------+----------+----------¦ ¦ ¦ ¦( 7/31/63 ¦3,329.96 ¦ +-------+---------------------------------------------+----------+----------¦ ¦3081-67¦Santa Fe Homes, Inc ¦( 12/31/62¦3,674.32 ¦ +-------+---------------------------------------------+----------+----------¦ ¦ ¦ ¦( 12/31/63¦4,603.22 ¦ +-------+---------------------------------------------+----------+----------¦ ¦3082-67¦W.H. Winkenbach, Inc ¦( 7/31/62 ¦1,025.38 ¦ +-------+---------------------------------------------+----------+----------¦ ¦ ¦ ¦( 7/31/63 ¦797.80 ¦ +-------+---------------------------------------------+----------+----------¦ ¦3083-67¦Linda Lloyd, Inc ¦( 7/31/62 ¦1,025.38 ¦ +-------+---------------------------------------------+----------+----------¦ ¦ ¦ ¦( 7/31/63 ¦1,132.78 ¦ +---------------------------------------------------------------------------+
Two issues are presented for decision. The first is whether the income derived by the corporate petitioners is taxable to the individual petitioners, who are the corporations' sole shareholders. If our answer to the first issue is negative, the second issue must be considered. That issue is whether a single exemption from corporate surtax should be divided equally among these corporations.
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly.
Barbara M. Noonan and Lloyd F. Noonan (hereinafter referred to as Noonan) are husband and wife. They resided in Alameda, Calif., at the time their petition in this case was filed. They filed a joint Federal income tax return for the calendar year 1963 with the district director of internal revenue, San Francisco, Calif.
Gertrude Winkenbach and Wilfred H. Winkenbach (hereinafter referred to as Winkenbach) are husband and wife. They resided in Oakland, Calif., at the time their petition in this case was filed. They filed a joint Federal income tax return for the calendar year 1963 with the district director of internal revenue, San Francisco, Calif.
L. F. Noonan, Inc. (hereinafter referred to as Noonan, Inc.), Linda Lloyd, Inc. (hereinafter referred to as Lloyd, Inc.), W. H. Winkenbach, Inc. (hereinafter referred to as Winkenbach, Inc.), and Santa Fe Homes, Inc. (hereinafter referred to as Santa Fe), are all California corporations. Their principal places of business were all at 4939 Broadway, Oakland, Calif., when their petitions were filed.
At that same address was located the Superior Tile Co. of Oakland (hereinafter referred to as Oakland), which was a partnership. There were four general partners, two of whom were Noonan and Winkenbach. Oakland was engaged in the business of installing ceramic tile.
In 1959 the partners of Oakland formed a limited partnership, Superior Tile Co.— Santa Clara (hereinafter referred to as Santa Clara). In 1961 the partners of Oakland formed a second limited partnership, Superior Tile Co.—Sacramento (hereinafter referred to as Sacramento). Santa Clara and Sacramento had similar structures of ownership. In each partnership Noonan and Winkenbach were general partners with each of them having a 2-percent partnership interest. Each of the partnerships had four limited partners, all of whom were corporations. Noonan, Inc., and Santa Fe were limited partners of Santa Clara. Lloyd, Inc., and Winkenbach, Inc., were limited partners of Sacramento. Each of these corporations held with respect to capital, as well as profits and losses, a 23-percent interest in their respective partnerships. Noonan was the sole shareholder of both Noonan, Inc., and Lloyd, Inc. Similarly, Winkenbach was the sole shareholder of Winkenbach, Inc., and Santa Fe.
Noonan incorporated Noonan, Inc., in August 1959, and paid $6,000 in cash to the corporation for his shares of stock. Noonan incorporated Lloyd, Inc., in December 1960 with $10,500 of original capital.
Winkenbach incorporated Winkenbach, Inc., in December 1960 with $10,500. In August 1959 he had acquired all the stock of Santa Fe, whose capitalization was $6,000.
All petitioners during the taxable years involved herein were on the cash method of accounting. During the calendar years 1962 and 1963 Santa Clara and Sacramento utilized an accrual method. The net taxable income of Santa Clara was $132,954.77 in 1963. Sacramento's net taxable income for 1963 was $58,875.98.
The formation of the limited partnerships, Santa Clara and Sacramento, with the corporate petitioners herein as limited partners, was pursuant to advice of a tax accountant. The parties did not consult an attorney. It was the understanding of Noonan and Winkenbach that by going into partnership with their own wholly owned corporations they would save taxes. They anticipated such savings because most of the income from the partnerships otherwise attributable to them would be taxed at lower rates to their corporations. In 1963 Noonan and Winkenbach were in higher income tax brackets than the corporate petitioners which they controlled.
During the years in issue, Noonan, Inc., Lloyd, Inc., Santa Fe, and Winkenbach, Inc., paid no salaries or dividends. Their mailing addresses were the same as either the Noonans, Winkenbachs, or Oakland. The companies had neither telephones nor listings in telephone directories. Harry Mullarky, an employee of the partnerships, kept all books of the corporations.
OPINION
The primary issue in this case is whether amounts which the corporate petitioners received and reported on their Federal income tax returns should be taxable to the corporations' sole shareholders, who are the individual petitioners herein. Such amounts represented the corporations' distributive shares of income as limited partners in partnerships of which the individual petitioners were general partners.
Respondent's position with respect to this issue rests on two alternative theories. The first is that the corporations should not be recognized as entities for Federal tax purposes. The second theory is that Noonan and Winkenbach, as general partners of the same partnerships in which the corporate petitioners were limited partners, were not adequately compensated. Consequently, the amounts taxed to the corporations should be instead taxed to Winkenbach and Noonan as compensation for their services to the partnerships.
If we do not hold for respondent on the first issue under either theory, we are asked to consider a second issue. That issue is whether each corporate petitioner is entitled to only one-quarter of an exemption from the corporate surtax.
The question presented is one of substance versus form. Numerous court decisions have set out the ground rules which make it clear that a taxpayer may adopt any form for the conduct of business and that such form cannot be ignored merely because it results in tax savings.
There is no dispute that the corporate petitioners were properly organized under California law. It does not follow, however, that such corporations will necessarily be recognized as entities for Federal tax purposes. In Aldon Homes, Inc., 33 T.C. 582, 597 (1959), we stated:
However, to be afforded recognition the form the taxpayer chooses must be a viable business entity, that is, it must have been formed for a substantial business purpose or actually engage in substantive business activity. Moline Properties, Inc. v. Commissioner, 319 U.S. 436; Jackson v. Commissioner, (C.A. 2, 1956) 233 F.2d 289. Escaping taxation is not a substantive business activity. National Carbide Corp. v. Commissioner, 336 U.S. 422, footnote 20, citing National Investors Corp. v. Hoey, supra.
We have reaffirmed our position in Perry R. Bass, 50 T.C. 595, 600 (1968). In that case the Court distinguished three cases: Gregory v. Helvering, 293 U.S. 465 (1935); William C. Hay, 2 T.V. 460 (1943), affd. 145 F.2d 1001 (C.A. 4, 1944), certiorari denied 324 U.S. 863 (1945); and Commissioner v. Smith, 136 F.2d 556 (C.A. 2, 1943), reversing 40 B.T.A. 387 (1939). It stated that these cases involved corporations which were mere skeletons, whereas the corporation with which it was immediately concerned had significant flesh on its bones. In the instant case, at least insofar as the years here in issue are concerned, the bones of the corporations were without flesh. The record is devoid of any evidence that the corporations engaged in any substantive business purpose. They were ‘mere paper corporations that existed in form only for the purpose of obtaining the tax benefits available by splitting the income’ of partnerships in which they had limited interests. Shaw Construction Co., 35 T.C. 1102, 1117 (1961), affd. 323 F.2d 316 (C.A. 9, 1963).
We note that the individual petitioners have offered only one business or personal reason for organizing corporations as limited partners. Their reason was that they did not want to contend with buy-out problems which would arise upon the death of an individual partner. Even if we assume that this reason was not an afterthought, we are unable to see how such a reason could obviate that problem inasmuch as Noonan and Winkenbach were general partners.
Petitioners place considerable emphasis upon our holding in Charles Turner, T.C. Memo. 1965-101. We do not consider the Turner decision to be precedential with respect to the case at bar. The facts in that case are obviously distinguishable if for no other reason than the fact that the corporation involved therein engaged in various business activities.
We of course recognize the long-established general rule that the corporate entity will be respected except ‘in exceptional situations where it otherwise would present an obstacle to the due protection or enforcement of public or private rights.’ New Colonial Co. v. Helvering, 292 U.S. 435, 442 (1934). In applying this rule in the instant case we are compelled to conclude that for Federal tax purposes these corporations clearly fit the exception to the rule because we feel that the only reason for their existence was to achieve tax savings.
Since we hold that Noonan, Inc., Lloyd, Inc., Winkenbach, Inc., and Santa Fe are not to be recognized for Federal tax purposes, we need not decide the second issue presented for decision, to wit, whether a single exemption from corporate surtax should be split equally among these corporations.
Decisions will be entered under Rule 50.