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#2112





IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF KANSAS

In Re:

PETROLEUM PRODUCTS, INC.,

DEBTOR(S)

NO. 86-41309-11

CHAPTER 11

In Re:  

PETROLEUM PRODUCTS (MIDWEST), INC.,

DEBTOR(S)

NO. 86-41308-11

CHAPTER 11

MEMORANDUM OF DECISION

This matter is before the Court for decision following a trial on the debtors' objection to the claim of the Internal Revenue Service (IRS). The IRS appears by United States Attorney Lee Thompson, and by Martin M. Shoemaker and Charles Kennedy, Trial Attorneys in the Tax Division of the Department of Justice. The debtors appear by counsel Mark G. Ayesh. The Court has heard the evidence and reviewed the relevant pleadings, and is now ready to rule.

The parties briefed many issues and resolved a number either before or during trial. Their disputes mainly concern the debtors' income tax liability, but one concerns their liability for excise taxes. The income tax matters remaining to be resolved by the Court question the propriety of certain accounting maneuvers and of certain deductions claimed as business expenses. The excise tax matters concern the debtors' possible liability for heavy vehicle highway use taxes. The IRS audited the debtors' income tax liability for their 1976 through 1982 fiscal years, and its revenue agents created a number of categories for items which they concluded should increase the debtors' taxes. The government offered into evidence their report about each category now in dispute, and the Court will address the disputes in the order in which the reports were offered. The revenue agents' categories were: (1) cost of goods sold, (2) bad debt expense, (3) office supplies, (4) professional fees, (5) entertainment and promotion, (6) dues and subscriptions, (7) travel, (8) townhouse and condominium expenses, (9) personal expenses of the stockholders, (10) other nondeductible expenses, (11) depreciation, (12) pension plan, (13) auto expenses, (14) other deductions, (15) charitable contributions, (16) accrued bonuses, and (17) other income. The agents' organization is somewhat confusing because some types of items appear in more than one category and the category labels do not always describe all types of items included in the category. The excise tax matters make an eighteenth category.

When the IRS disallowed the accounting and deduction items in the seventeen income tax categories and recalculated the debtors' income taxes, their liability increased substantially. The categories are largely factually independent, and the Court will discuss each in turn, reciting the relevant facts immediately before explaining its conclusions about the proper tax treatment of the items in each category.

All references to the Internal Revenue Code (I.R.C.) are to the current I.R.C. unless otherwise indicated.

I. GENERAL BACKGROUND INFORMATION

The debtors are the successors to and affiliates of a number of corporations. During the time periods at issue, they and some other corporations were part of a consolidated group for tax purposes, meaning that they filed tax returns and paid their taxes as if they were a single entity. Some of the transactions now in dispute actually involved either predecessors or affiliates of the debtors, but can and will be discussed for purposes of this opinion as if only the debtors were involved.

Both debtors were and still are owned by Martin M. Burke and his wife Datha. Mr. Burke has always been president of the companies, and Mrs. Burke has held some offices as well. Three of their children were also involved in the businesses. Many of the Burke family's expenses were paid by the debtors and little effort was apparently made to document which were business expenses and which were non-business family expenses.

The IRS revenue agents who audited the debtors' tax returns disallowed many of the debtors' deductions for a lack of required documentation. The tax audit was performed between 1984 and 1987. In 1990, the debtors' main office was damaged by fire. The debtors claim the fire destroyed many of their records and precluded them from providing further documentation at trial. They have offered no explanation for their failure to produce for the revenue agents' inspection any such documents they might have had at the time of the audit.



II. RESOLVING THE DISPUTES

1. COST OF GOODS SOLD

A. Facts

An independent accounting firm audited the debtors' books in 1982 and discovered a $500,000 discrepancy between the debtors' records and its actual debts to certain secured lenders. According to the debtors' chief financial officer, an investigation followed and the accounting firm decided to attribute the debt to a line of credit from the Mercantile Credit Corporation and plug it into the debtors' cost of goods sold. Adding the $500,000 to the cost of goods sold which had previously been shown on the debtors' books reduced their income for the year by that amount. This sum equals slightly less than one-half of one percent of the debtors' cost of goods sold for the year. When it audited the debtors between 1984 and 1987, the IRS disallowed the adjustment.

The debtors generally used their line of credit with Mercantile to purchase inventory, although they could and sometimes did use the line for other purposes. When they drew on the line, the debtors placed the money in a general account. Since their investigation led them to conclude the extra money came from Mercantile and they could not otherwise determine how they had spent the money, the debtors think it was logical to plug the unaccounted-for borrowing into their cost of goods sold. They believe this even though an inventory of their on-hand product had been taken and reconciled, and revealed no substantial discrepancies in their records of inventory purchases.

The debtors have never been able to locate any record connecting the extra funds to purchases of inventory. One of their in-house accountants tried without success to locate such records during the IRS audit. A fire in the debtors' office building in 1990 destroyed many of their records, and they suggested at trial that this precluded them from producing records to substantiate their claim that they used the extra money to purchase inventory.

B. Conclusions

The $500,000 was borrowed and apparently placed in the debtors' general account. From that point on, they cannot trace it to any specific transaction or transactions. Though money in the general account was used for many purposes, the debtors contend the adjustment to cost of goods sold should be allowed simply because they primarily used funds they borrowed from Mercantile to purchase inventory. The Court finds that the debtors have provided insufficient evidence to support their treatment of the discrepancy. Reinschmidt v. Commissioner, 28 F.2d 660 (5th Cir. 1928). The deduction from 1982 income is disallowed.

2. DEDUCTION FOR BAD DEBT

A. Facts

Over a period stretching from November of 1979 to February of 1980, the debtors arranged to buy essentially all the assets of another company, Nebraska Propane, Inc. (NPI). At the same time, evidenced by the same documents which specified the arrangements for the purchase, the debtors engaged in what they characterize as a separate transaction to loan NPI $642,000 for use in its operations. The purported loan was guaranteed by two of NPI's stockholders, and the guarantee was secured by a piece of real property they owned. Apparently the debtors intended to form a new corporation to hold the purchased assets and two of NPI's officers were to receive stock in that corporation. This stock was to be pledged to secure the guarantee as well.

The purported loan is documented from its inception at $300,000 through several additional advances which resulted in the $642,000 total. Payments applied to the loan are generally documented but nothing presented to the Court indicates any specific source of the funds paid. The debtors claim NPI defaulted on the loan, and they made some effort to collect. Their records reflect receipt of all but $252,331. They deducted this amount as a bad debt at the end of their fiscal year on June 30, 1980. The IRS contends that the debtors' loan to NPI was part of the purchase transaction, while the debtors contend that it was a separate matter and was appropriately written off as a bad debt after all payments were properly credited and their valid collection efforts failed.

A major consideration in the debtors' purchase appears to have been NPI's gas purchase contracts and allocations. NPI also owed the debtors a large receivable. Apparently NPI was not generating sufficient revenues to pay its operating expenses as they came due. Designing the purchase transaction so that the debtors gave it an operating loan rather than simply taking over its assets sooner raises doubts about the validity of the loan, especially when, only four to five months after the last addition to the loan balance, the debtor wrote off more than one-third of the loan as uncollectible. Some of the evidence suggests that the debtors did take over the assets in December of 1979, and the later additions to the so-called loan to NPI were simply payments made on NPI's debts so its creditors would not try to recover the assets the debtors had bought.

The debtors wound up owning a share of the real property which secured the loan to NPI, and they produced no evidence to show its value. At the time of the IRS audit, a corporate officer prepared an explanation of the NPI transaction in which he indicates he thought the debtors accepted the share in the real property in full satisfaction of whatever balance remained on NPI's debt. The only evidence of the efforts the debtors made to collect from the guarantors personally was the testimony of a corporate officer who merely said that an unspecified amount was recovered and that the debt was written off after unspecified efforts were made to collect. No evidence was presented to indicate whether the new corporation mentioned in the parties' agreement was ever formed to hold NPI's assets, whether it issued the stock that was to be additional collateral for the guaranty, and if so, whether the debtors made any attempt to foreclose on it.

B. Conclusions

The Court need not decide whether the loan to NPI was merely a part of the overall purchase agreement or an independent transaction. The debtors have not produced sufficient evidence of the value of the real property and the stock, if any, that secured the guarantee and the lack of value of the personal guarantee itself to be allowed to deduct a part of the loan as a bad debt. They have failed to satisfy the requirements for taking a bad debt deduction that are established by §166 of the Internal Revenue Code and related regulations. See Newman v. Commissioner, 43 T.C.M. 474 (1982). The deduction is disallowed.

3. OFFICE SUPPLIES

A. Facts

The debtors took some deductions for "office supplies" for their fiscal years ending June 30, 1980, and June 30, 1982, to which the IRS objects. The IRS disallowed $3,185 for 1980 and $36,650 for 1982. The deductions consisted of: (1) $161.31 paid for artwork from Hong Kong, $2,516.87 paid for crystal glassware from Ireland, and the cost of other household goods of limited value used in a Houston townhouse owned by the debtors; (2) miscellaneous entertainment expenses incurred at Shady Oaks Country Club in Fort Worth; (3) the cost of personal items bought for the debtors' president and his family; (4) over $33,000 paid for furniture and interior design for a Houston townhouse; (5) the cost of a safe used in space the debtors leased to another company; and (6) $25 paid to a son of the debtors' president for running errands for the company. The debtors admit that payments of $186.76 for shirts and household items and $1,707.75 for jewelry were for Mr. Burke's personal use and should not have been deducted.

The debtors' accounting system treated items costing $5,000 or less as expenses rather than capital expenditures even when they would more appropriately be considered capital items.

B. Conclusions

The Court believes the IRS should not have disallowed the deduction for the $25 paid to Mr. Burke's son. It was unnecessary to document such a small item. See I.R.C. §274(d) and related regulations. The deduction for money spent at Shady Oaks Country Club is insufficiently documented and the IRS was correct to deny it completely. As the debtors concede, the purchases for personal use were of course improperly deducted. The debtors also concede the furniture and interior items should have been capitalized. All the other items were appropriately denied treatment as business expenses, pursuant to I.R.C. §162 and §274 and related regulations. Instead, these items should have been treated as capital expenditures and depreciated or amortized over the period appropriate to their asset type.

The Court cannot accept the debtors' assertion that I.R.C. §446 authorized them to transform capital expenditures into current expenses simply by consistently treating those under a certain amount that way in their accounting system. Section 446 declares that taxpayers may do their accounting on a cash or accrual basis, or using certain other approved methods, and that they must compute their taxable income using the same method they use in keeping their books. However, the Court does not believe it means taxpayers can treat some or all capital expenditures as current expenses so long as they do so consistently. Instead, I.R.C. §§162 and 263 and related regulations control when items must be capitalized rather than expensed.

After conceding the furniture and design items should have been capitalized rather than deducted as current expenses, the debtors appear to ask the Court to determine that they can add these costs to their basis in the Houston townhouse for purposes of depreciating and computing gain or loss on it. Determination of the debtors' possible liability for future taxes lies beyond the Court's jurisdiction over this tax dispute. The debtors' request in this regard must be denied without prejudice.

4. PROFESSIONAL FEES AND EXPENSES

A. Facts

The IRS disallowed a number of deductions for professional fees and expenses which the debtors had claimed for fiscal years ending in 1979 through 1982. These included deductions for over $101,000 in fees and expenses paid to a Byron Smith. The debtors contend they incurred these fees and expenses in the ordinary course of their business by hiring Mr. Smith to perform design and decorating work on three business properties they owned. They admit that they should have treated their payments to Mr. Smith as capital expenses rather than deducting them as current expenses. The IRS also contends one of the three business properties, the Houston townhouse, was an entertainment facility under I.R.C. §274, and that the debtors failed to present additional evidence required to establish that they could treat Mr. Smith's fees and expenses as capital expenditures for that facility. The debtors deducted $1,251.55 for an insurance policy on Mr. Smith's life which the IRS disallowed. The IRS also disallowed $15,867 in deductions for certain court reporting fees, a management fee, and attorney fees which the debtors allegedly incurred in connection with their acquisition of two banks. Although the debtors attributed all the legal fees in quesiton to the acquisition of the banks, the testimony at trial indicated that the attorney fee statement did not distinguish between work done specifically on the bank acquisitions and other general work done for the debtors. The debtors admit that they could not legally acquire banks under the laws of the State of Kansas. The debtors do not contest the disallowance of another $47,700 in fees they paid to two other companies and deducted.

The Houston townhouse consisted of a living room, dining room, kitchen, and five bedrooms. Each bedroom had a desk, telephone, and a private bath. The facility was not used for social events. Before they bought it, the debtors had leased a smaller facility farther from downtown Houston. The debtors' chief office was in Hutchinson, Kansas, but they also maintained a permanent office in Houston staffed by area residents. Employees visiting that office stayed at the townhouse, and the debtors also allowed business associates to use it while they were visiting either the debtors' office or Houston in general. The townhouse was frequently used for lodging during each month of the years in question. A former employee who scheduled use of the townhouse substantiated these facts. Since the debtors thought the townhouse was a lodging facility, they did not keep the type of records for it necessary to obtain deductions for an entertainment facility.

The debtors presented no documentary evidence that they paid for or were the beneficiaries of the policy that insured Mr. Smith's life. Mr. Burke owned the insurance policy. He claimed he held it as a nominee for the debtors. No documentary evidence of this nominee status was presented to the IRS during the audit, and none was presented to the Court at trial. The debtors claim that any evidence which existed may have perished in the fire which occurred after the audit. This cannot explain their failure to produce it during the audit.

B. Conclusions

The debtors are entitled to treat Mr. Smith's charges for improving the Houston townhouse the same as those for the other two facilities. His services were obtained to benefit both the debtors. However, Mr. Smith's bills for design and decorating are not deductible in the year incurred but must be capitalized. The debtors have not shown that they are entitled to deduct the cost of the insurance on Mr. Smith's life. The debtors cannot deduct the fees incurred for court reporting, management and attorneys in regard to the acquisition of the banks. They were prohibited by law from owning the banks. The deductions were therefore not ordinary and necessary business expenses and could not be deducted. Even if the fees qualified as ordinary and necessary business expenditures for the debtors, the costs incurred in buying an asset like a bank must in any event be capitalized as part of the purchase price and not deducted. Ernest Smith v. Commissioner, 5 T.C.M. (CCH) 7 (1946).

5. ENTERTAINMENT AND PROMOTION

A. Facts

For fiscal years 1981 and 1982, the IRS disallowed $20,828 in deductions in this category. To investigate these items, the revenue agent reviewed all the claimed expenses that were more than $750 and sampled those that were less than $750 and determined a percentage to disallow based on those he actually reviewed. The debtors have not objected to this procedure. In addition, the agent disallowed all claimed expenses incurred at Shady Oaks Country Club in Forth Worth, Texas. The debtors have not mentioned these expenses in their brief, although they do argue in another section that they should have been able to deduct at least a portion of their dues for the club. It appears the debtors thought the Shady Oaks membership would be an entree to other clubs and otherwise be good for business, but it failed to live up to their expectations. Instead, Mr. Burke's children made primary use of it while they were in school in Forth Worth.

In reviewing these deductions, the agent was looking for documentation that would satisfy the requirements of I.R.C. §§162 and 274. Section 162 provides that expenses may be deducted only if they served an ordinary and necessary business purpose. Section 274 provides that deductions of more than $25 which are claimed for entertainment, travel, meals, and gifts must be substantiated by evidence which corroborates the taxpayer's statement of the expense and shows its amount, date, and business purpose, and the identity of the person involved. For most of the disallowed expenses, the agent concluded the debtors had failed to provide adequate corroborating evidence, often because they provided no documentation at all. The debtors contend that many of the undocumented deductions they claimed for amounts over $25 actually consisted of multiple expenses of $25 or less.

B. Conclusions

The Court is convinced that the debtors have adequately substantiated a few of the expenses included in this category. The agent allowed all the debtors' costs in conducting a golf tournament except for $37.53 incurred by and reimbursed to Mr. Burke's son. He also allowed all the expenses of putting on a party in the Houston Astrodome except for $663.21 paid for Mr. Burke's children to travel to help with the party. While such expenses are somewhat suspect, the Court believes they would have been allowed if incurred by company employees who were not related to Mr. Burke and should be allowed since all other expenses of the tournament and party were. For a $353.78 expense paid to Ampcoa Auto Parking in Houston, the name of the recipient sufficiently corroborates Mr. Burke's testimony that this was paid for parking for the debtors' Houston office. Finally, the debtors had documented paying $115.30 to Guy's Market in Houston for "meat seasoning." The amount paid and the name of the recipient adequately substantiate Mr. Burke's testimony that the meat seasoning was bought to give to business associates in Houston.

The Court concludes the remaining items in this category were properly disallowed because the debtors offered only the testimony of their officers to try to prove them and that is insufficient to satisfy the requirements of the Tax Code for these types of expenses.

6. DUES AND SUBSCRIPTIONS

A. Facts

For their 1981 and 1982 fiscal years, the debtors deducted membership dues and other charges incurred at Shady Oaks Country Club in Fort Worth, Texas, and for Prairie Dunes Country Club and the Hutchinson Town Club in Hutchinson, Kansas. The revenue agent reviewed the amounts paid to these clubs. He concluded Shady Oaks was used solely for personal reasons, primarily by Mr. Burke's children who were attending college in Fort Worth at the time. For the other two clubs, he arrived at admittedly subjective estimates of the percentage of business use the debtors had made of them: 20% for Prairie Dunes and 80% for the Town Club. For 1981, he disallowed $4,128.92 and for 1982, $1,675.00.

Mr. Burke testified that he considered all costs incurred at both Shady Oaks and Prairie Dunes to be business expenses since he did not play golf or swim at either club. He indicated he told his children to "use up the minimum" at Shady Oaks (the Court believes this means the club required members to incur a certain amount in charges each month, and would bill them that minimum whether or not they actually incurred that much) if he saw that it was not otherwise going to be used. Mr. Burke made a vague reference to having had a reception there with sixty people, but did not describe any other business use of the membership. As he did in discussing deductions in other categories, Mr. Burke indicated he believes when he and members of his family ate meals at these clubs, they were having business meals since they were all active in the business and might have discussed business during the meal. In their brief, the debtors assert that 75% of their use of Shady Oaks and Prairie Dunes and 100% of their use of the Town Club was for business purposes. Although Mr. Burke clearly felt the revenue agent had underestimated the debtors' business use of these memberships, the Court notes that neither he nor anyone else ever stated that the specific percentages asserted in the debtors' brief (or any others) would be more accurate.

B. Conclusions

The debtors' evidence has not convinced the Court that the revenue agent's estimates of the percentage of their use of these memberships should be changed. The Court believes it cannot be an ordinary and necessary expense for a business to buy a country club membership so that the owner's family could have a place to go eat and discuss business, or merely to be seen by other members of the social and business community. The deductions at issue in this category were properly disallowed.



7. TRAVEL

A. Facts

The IRS disallowed deductions for travel expenses which the debtors claimed for fiscal years 1980 through 1982. By year, the amounts disallowed were $54,456 and $23,415, and $24,777. The IRS determined that the debtors had failed to satisfy the documentation requirements of I.R.C. §274 and a related regulation, 26 C.F.R. 1.274-2(c)(7)(ii), especially for trips out of the United States. These provisions require taxpayers to provide proof beyond their own statements to show that expenses were incurred and to show which travel activities were undertaken for business purposes and which were not. For domestic travel, expenses such as airfare are fully deductible so long as the primary purpose of the trip was business, but for foreign travel, such expenses are deductible only to the extent the activities of the trip concerned business matters. Consequently, the records for foreign trips must show what percentage of the trip had a business purpose.

At trial, the debtors submitted four exhibits and Mr. Burke's testimony to try to establish their right to claim these travel deductions. Exhibit FF contains notes prepared by Mr. Burke in which he tries to explain what all the disallowed expenses were for. Exhibit HH is a sample of a rodeo invitation which the debtors had printed on handkerchiefs and sent to a number of business associates, and Exhibit GG is a list of those they invited. Exhibit II consists of some receipts and other documents which the debtors kept to try to satisfy the requirements of §274 and related regulations. Although these items concern only a small portion of the disallowed travel expenses, they are apparently the only ones the debtors are now able to find. Nevertheless, they are items which were not presented to the IRS during the audit. The documents demonstrate a broad range of compliance success, from those that clearly provide sufficient information to satisfy §274 to those that clearly do not. Mr. Burke also testified that to the extent any of his or his family's personal expenses were paid for by the debtors, his account receivable was charged and he would reimburse the companies. The debtors contend that these exhibits and Mr. Burke's substantiating testimony are sufficient to satisfy the documentation requirements for travel expenses. They suggest that Exhibit II shows that they routinely retained the necessary proof of their travel expenses and claimed only appropriate deductions, so the Court should assume the expenses were properly documented and claimed when the debtors' tax returns were filed.

Mr. Burke testified that many of the travel expenses were incurred when he and his wife attended business conventions in Europe and Canada. This travel included personal side trips, but no documentation was provided that would separate the business and personal aspects of the travel. A number of other trips also combined business and personal matters, and the debtors' evidence is insufficient to enable the Court to ascertain what percentage of the foreign trips was attributable to business, and whether the primary purpose of domestic trips was business. For instance, in March of 1982, it appears that Mr. Burke traveled to Denver for over one week, but he could merely assert that on such trips he would generally visit a company called Total Petroleum. The Court can only conclude the trip was primarily personal.

Mr. Burke explained that he actually used several airplane tickets which had been reserved in the names of members of his family. On occasions when he knew he would need to fly somewhere but was uncertain what time he would be able to leave, he made a practice of booking two or more tickets at different times. He believed the airlines had computers that would cancel the extra reservations if he made them all in his own name, so he used family member names. Then he would use whichever ticket turned out to be convenient, and the unused tickets would be returned for refunds.

B. Conclusions

Though the debtors presented some testimony and documentation at trial, the evidence was insufficient to satisfy the requirements of §274 and related regulations for deduction travel expenses. The debtors appear to be asking the Court to review the small sampling of documents they provided, match them up with Mr. Burke's testimony about specific travel expenses, determine that they satisfy §274, and then extrapolate from them that all the other travel expenses were appropriately deducted. This approach has two major flaws. First, the documents provided may adequately document some of the expenses they relate to, but certainly not all. Consequently, the Court could not logically conclude that the debtors probably had adequate documentation for the other expenses at any time or that they deducted only proper expenses. Second, and more importantly, the Tax Code and regulations require each deduction to be properly documented and explained. The debtors claimed hundreds of deductions and their sampling of receipts is just too small and inconclusive to support the deductions. The debtors simply failed to supply adequate documentation to the revenue agents during the audit, and the limited reconstruction they supplied at trial was likewise deficient. This was particularly true of expenses related to the trips to attend conventions in Europe and Canada, which the debtors' personnel combined with side trips for personal purposes. In addition, a few purchases listed in this category were for office furnishings or similar items which should have been treated as capital expenditures rather than current expenses.

The Court is convinced that the debtors may be entitled to the deductions they claimed for tickets which were purchased in other names but used by Mr. Burke under his double-booking practice. For the double-booked ticket charges which the IRS disallowed, the Court cannot tell whether Mr. Burke's trip was otherwise documented to have been primarily for corporate business. If so, the airfare should be deductible. In the debtors' brief of proposed findings and conclusions, these possibly deductible items are listed under item 30 on page 75, item 33 on page 76, and item 60 on page 79. The parties will have to review the records to see whether the IRS's audit accepted as business trips any of the trips for which Mr. Burke used these tickets.

8. TOWNHOUSE AND CONDOMINIUM EXPENSES

A. Facts

For the debtors' 1981 fiscal year, the IRS disallowed deductions they had taken relating to a condominium located in Vail, Colorado. For their 1982 tax year, the IRS disallowed deductions relating to the Vail condominium and the Houston townhouse discussed in section 4, "Professional Fees and Expenses." For the Vail condo, the deductions totalled $20,585 for 1981 and $61,012 for 1982. For the Houston townhouse, the deductions totalled $9,196. The IRS classified both assets as entertainment facilities. The debtor concedes the Vail property falls into that category, but contends the Houston property was a lodging facility. More extensive records must be kept to substantiate deductions for an entertainment facility than for a lodging facility. As explained above, the court finds that the Houston townhouse was a lodging facility.

The evidence about the debtors' use of the Vail condominium was largely general assertions with no supporting documentation. The only testimony of specific business entertainment occurring there was supplied by Linda West. She said she could remember two occasions when business activities were conducted in the condo, but was unable to recall the specific dates. One of the occasions she remembered was in February of 1983, a year not covered by the IRS audit. The debtors kept a guest register for the condo, but it contained only the names of visitors, the dates they stayed, and for some, the company they worked for.

The Burkes used the condo for a number of family outings, and these were certainly not likely to be business meetings, despite Mr. Burke's efforts to suggest that most of his family's activities were business-related because they all participated in the businesses to one degree or another. Nothing presented about Mr. and Mrs. Burke's visits demonstrated a specific business purpose for any of them.

The debtors claimed they offered customers who bought more than a certain amount of product the chance to stay at the condo. However, they produced no evidence to show that any customer actually took advantage of the offer. Nothing presented indicated that any customers stayed at the condo on any date for this or a similar reason. Even if some of the visitors were customers, which seems likely since some indicated they worked for other oil companies, the debtors have not shown they had any representative on the premises with whom the customers could have talked about business.

B. Conclusions

As indicated, the Court believes the Houston townhouse was a lodging facility, not an entertainment facility. The depreciation deduction for it will be allowed.

The debtors concede the Vail condominium was an entertainment facility. In order to justify any deductions for expenses relating to an entertainment facility, taxpayers must satisfy the requirements of I.R.C. §274. The logbook the debtors entered into evidence fails to demonstrate any business purpose for the Vail property and, importantly, does not corroborate any of the specific expenses the debtors deducted relating to the condominium. The evidence fails to support any of the claimed deductions. General testimony about the intended use of a facility is insufficient to corroborate a business purpose for the specific expenses claimed. The IRS properly disallowed the deductions.

9. PERSONAL EXPENSES OF THE STOCKHOLDERS

A. Facts

For the debtors' fiscal years ending in 1978 through 1982, the revenue agents determined the debtors had taken deductions totalling $166,163.92 for items which were actually personal expenses of the Burke family. The deductions were disallowed pursuant to I.R.C. §262, which expressly states that no deduction shall be allowed for personal, living, or family expenses. Such expenses would probably also fail to satisfy §162's limitation on deductions to those ordinarily and necessarily paid or incurred in carrying out the taxpayer's trade or business.

Mr. Burke testified about all these expenses, agreeing that large portions of the deductions were improperly claimed. The IRS states in its proposed findings and conclusions the amounts it thought he agreed should not have been deducted, but the Court finds the amounts are somewhat different than the IRS's figures. Mr. Burke conceded that all $31,246.36 disallowed for the debtors' fiscal year ending in 1978 was for his family's personal expenses. He conceded that $45,136.49 of the $50,750.33 disallowed for fiscal year 1979 was for personal expenses. He conceded that $23,981.15 of the $32,442.18 disallowed for 1980 was for personal expenses. He conceded that $6,174.90 of the $12,452.72 disallowed for 1981 was for personal expenses. He conceded that $5,132.21 of the $39,272.33 disallowed for 1982 was for personal expenses. Thus, he conceded the revenue agents correctly concluded the debtors should not have deducted $111,671.11 of these expenses. This leaves only $54,492.81 in question, and the remainder of the Court's discussion will concern only those expenses.

In their fiscal year ending in 1982, the debtors deducted $2,375.30 for an air conditioning and furnace system that was installed at the Burkes' home. According to the revenue agents' notes and Mr. Burke's testimony at trial, the debtors needed such a system for a retail outlet and the two-year-old system at the Burkes' house was about the right size. So the debtors took the one from the Burkes' house and had it installed at their retail outlet, and bought a new, larger one and had it installed at the house. Mr. Burke considered this an even trade. So far as the Court can tell, the amount deducted was for the entire cost of buying and installing the system at the Burkes' house. It may also include the cost of disconnecting the old system and installing it at the retail outlet.

The debtors claimed many deductions for medical expenses for members of the Burke family. Mr. Burke testified that at some unspecified time the board of directors of one of the debtors (apparently he, his wife, and their four children were the only directors of both debtors) were informed by some unspecified person that since that corporation had no employees other than the board of directors, the corporation could pay for the directors' medical expenses as a bona fide employment benefit. He indicated he did not know whether it was true that the corporation had no employees. No such benefits were provided to anyone but the Burke family. The debtors rely on I.R.C. §162 and Treasury Regulation 1.162-10 as authority for this program. The IRS contends that I.R.C. §105 and related regulations required that such benefits be provided to all employees under a formal, nondiscriminatory medical reimbursement plan, and that the debtors had no plan, or if they did, the plan was discriminatory since it provided benefits only to the Burke family.

For their fiscal year ending in 1982, the debtors deducted $16,581.70 they had paid for ad valorem taxes on properties Mr. Burke owned. The revenue agents' report says the stockholder offered no explanation for these expenses. At trial, Mr. Burke testified that he had leased the properties to the debtors under "net net" leases, meaning that the debtors were obliged to pay for taxes, maintenance, and insurance. He did not indicate why this information was not conveyed to the revenue agents during the audit. No copies of any leases were offered to show that the debtors had agreed to be liable for the taxes.

The debtors paid the premiums for certain life insurance policies on Mr. and Mrs. Burke. The revenue agents disallowed the deductions taken for these premiums because the debtors were not the beneficiaries on the policies, as required by Treasury Regulation §1.537-3(b). Instead, Mr. and Mrs. Burke were the beneficiaries of the policies. At trial, the Court had thought Mr. Burke was claiming some of the premiums should have been deductible because some of the policies provided "key man" coverage, that is, would pay the debtors benefits in the event Mr. or Mrs. Burke died. However, in their proposed findings and conclusions, the debtors indicate they agree that none of the premiums were deductible.

A number of the claimed expenses are for repairs to company cars. As will be discussed more fully in section 13, "Automobile Expenses," Mr. and Mrs. Burke and two of their children were supplied with company cars which they used for personal purposes as well as for company business. In the materials for this section, it appears that a third child may have used another company car in 1982. None of the family members kept any records to show how much personal use they made of the cars. As explained in section 13, the Court finds that the revenue agents' estimates of the percentage of business use for each car are the most accurate made available to the Court. The agents concluded that Mr. Burke used his car for the debtors' business 75% of the time, Mrs. Burke 25%, and the children 10%. The agents' report for this category lists car repair expenses the debtors paid and identifies whose car was repaired. For all but a few repairs in the 1982 fiscal year, the identity of the driver of the car was not questioned. With respect to the questioned repairs, the agents stated that Zane Burke, one of the Burke's younger children, was the driver of a 1975 Fiat in 1982, but Mr. Burke seemed to indicate he thought that was mistaken. However, he did not indicate who he thought was using that car then. The agents' conclusion is the only evidence of the driver's identity available to the Court.

For 1979, the debtors deducted $1,563.71 for repairs to cars the Burkes' daughter used. For 1980, they deducted $4,953.72 for repairs to cars the Burkes' daughter used. For 1981, they deducted $1,041.91 for repairs to cars Mrs. Burke used and $1,874.84 for repairs to cars the Burkes' children used. For 1982, they deducted $784.26 for repairs to cars Mrs. Burke used, and $1,474.62 for repairs to cars two of the Burkes' sons used.

B. Conclusions

The Court has some problems with the debtors' deduction of the air conditioning and heating system. First, such a system is a capital expenditure that would have to be depreciated over some number of years, not deducted in full as a current expense. Second, the Court cannot accept Mr. Burke's assertion that the debtors made an even trade by receiving a two-year-old system in return for a larger new one. In addition, had they simply bought a system and had it installed at their outlet, the debtors would have incurred a single installation charge rather than one disconnection and two installation charges. If the debtors and the IRS can agree what a reasonable value for the two-year-old system was and what a single installation charge would have been, then they should be allowed to depreciate those amounts over the appropriate period. If not, the entire deduction was properly disallowed.

The debtors' evidence about their alleged medical reimbursement plan was unclear. Mr. Burke said the debtors' board of directors was told one of the debtors could set up such a plan because it had no employees other than its board of directors, but he did not know whether that debtor actually had no other employees. All the medical reimbursements which the debtors deducted were for members of the Burke family. I.R.C. §105(h) indicates that such plans cannot discriminate in favor of highly compensated individuals as to eligibility or benefits. If the debtor which adopted the plan had any employees other than its board of directors, then it was discriminatory. The debtors have failed to show that they had a formal, nondiscriminatory plan in effect. These deductions were properly disallowed.

The debtors have failed to establish that they were obliged to pay ad valorem property taxes on properties they had leased from Mr. Burke. The deductions they took for those amounts were properly disallowed. The debtors were not entitled to deduct the life insurance premiums they paid on policies on which they were not the beneficiaries. As indicated, they appear to have recognized that now.

The debtors should have been allowed to deduct the cost of repairs to company cars used by the Burke family to the extent of the percentages the revenue agents determined they used them for business purposes. This means 25% of the costs of repairing Mrs. Burke's cars and 10% of the costs of repairing the childrens' cars was deductible.

The debtors have failed to convince the Court that any of the remaining amounts in this category were deductible. The IRS properly disallowed them.

10. OTHER NONDEDUCTIBLE EXPENSES

For the debtors' 1980 fiscal year, the IRS disallowed $51,867 in miscellaneous deductions in a category called "other nondeductible expenses." The deductions were separated into six subcategories: $5,901.75 for artwork; $1,677.52 for expenses applicable to other entities; $20,000 for cash advances; $3,374.63 for undocumented entertainment expenses; $16,304.97 for Burke family personal expenses; and $4,608.39 for expenses with no receipts.

A. Artwork

1. Facts

The debtors had a policy of treating works of art that cost $5,000 or less as current expenses rather than capital acquisitions. This subcategory includes several such purchases. The debtors treated them as current expense deductions in the year of purchase.

2. Conclusions

As discussed more thoroughly in section 3, "Office Supplies," artwork is a capital asset. I.R.C. §263. As discussed more thoroughly in section 11, "Depreciation," although many capital assets may properly generate depreciation deductions, artworks ordinarily have no determinable useful life and so cannot be depreciated. I.R.C. §167. The debtors presented no evidence to show that any of these artworks had a determinable useful life. This deduction was properly denied.

B. Expenses Applicable to Other Entities

1. Facts

The debtors deducted $100 and $600 for certain repairs done to a part of a building which they leased to the Hutchinson Travel Agency. Mrs. Burke owned the travel agency. The revenue agents disallowed these expenses on the ground they were applicable to the travel agency, an entity outside the debtors' consolidated group. The repairs were made due to the debtors' obligations as a landlord. The remaining $977.52 in this subcategory was a fee for consulting work in connection with the debtors' acquisition or ownership of stock in a bank. As mentioned in section 4, "Professional Fees," Kansas law prohibited the debtors from owning this stock.

2. Conclusions

The debtors should have been allowed to deduct the $700 they spent to repair the premises they leased to Hutchinson Travel Agency. A landlord can properly deduct such expenses without regard to its relationship to its tenant. I.R.C. §162. As discussed more fully in section 4, charges the debtors incurred in connection with an illegal acquisition of bank stock cannot be ordinary or necessary expenses of their business. The only fees related to their bank stock transactions which might be considered ordinary would be those incurred to discover the prohibition against their ownership of the stock and they failed to identify those fees.

C. Cash Advances

1. Facts

The debtors deducted $4,000 in cash advances they made to Mr. or Mrs. Burke and $16,000 in cash advances they made to the president of a company in their consolidated group. These advances were made in lump sums ranging from $100 to $5,000. As a general rule, the debtors' employees kept adequate records of their business uses of such advances. However, no documentation was presented to the revenue agent to substantiate the propriety of deducting these advances. Deductions for expenses of less than $25 need not be supported by documentation. Seeking to draw a camel through the eye of a needle, the debtors assert that their officers used all these advances while travelling to pay expenses of less than $25. Nevertheless, they claimed the deductions in lump sums as noted above. In addition, the sampling of receipts which the debtors did present, Exhibit II, includes many items that cost more than $25. Some of the advances were used during European trips. As explained in section 7, "Travel," the debtors' documentation for those trips was inadequate.

2. Conclusions

The IRS properly disallowed the deductions for these cash advances due to the absence of supporting documentation. The debtors have indicated the advances were used on trips, but the amounts are so large that the Court simply cannot believe they were usually spent in dribs and drabs of $25 or less. The only evidence the debtors offered to show how they normally documented such expenses include many receipts for expenditures of more than $25. Furthermore, some of the advances were used on foreign trips, for which the debtors' records routinely failed to make possible a calculation of the percentage of the trip spent on personal rather than business matters. The debtors have given the Court no reason to believe the cash advances were all used for business matters on these trips, even if the Court were willing to assume they were spent no more than $25 at a time.



D. Undocumented Entertainment Expenses

1. Facts

The revenue agent disallowed $3,374.63 in this subcategory because the debtors failed to document the business purpose of the entertainment expenditures and the business relationship the debtors had with the people entertained. Entertainment expenses are subject to the requirements of I.R.C. §274, discussed above in section 7, "Travel." This statute and related regulations require taxpayers to provide proof in addition to their own statements to show that such expenses were incurred and to show that the entertainment activities were undertaken for business purposes. Mr. Burke testified that $2,381.32 charged for meals at the Hutchinson Town Club was all for meetings with his managers, that $172.88 at the Lancers Club in Wichita, Kansas, was incurred during meetings with business associates from Tulsa, Oklahoma, and that $485.22 for meals at the Bulls and Bears Club in Wichita was for meals or meetings with an attorney. The debtors produced no other evidence to support Mr. Burke's testimony.

2. Conclusions

While Mr. Burke may very well be right in his explanations of these expenses, his testimony alone is not enough to satisfy the requirements of I.R.C. §274 and related regulations. The IRS properly disallowed the deductions.



E. Personal Expenses

1. Facts

Many of the deductions at issue in this subcategory involved travel expenses. As discussed earlier in section 7, Mr. Burke made a practice of booking more than one airline ticket for days when he would be flying somewhere so that he could choose on the day of the flight what time he would actually leave. The extra tickets would be reserved in a family member's name to avoid the possibility that the airlines would cancel them if they discovered Mr. Burke had more than one ticket in his name on the same day. Consequently, the receipts for many of the flights he took show that the ticket he used was booked in a family member's name. Several of these double-bookings are included in this subcategory. They are identified in the debtors' proposed findings and conclusions as items 7, 9, and 11 on page 102. A similar item, identified as item 14 on page 103 of the debtors' brief, is for two airfares charged in Mr. Burke's and his son's names, which Mr. Burke said he and an employee not related to him used. The evidence presented did not indicate whether other expenses incurred on any of these trips were allowed as proper business deductions.

One of the deductions was $696 airfare for Mr. Burke to go to Paris, France. He testified that he went to Paris twice, once to meet with representatives of a company and to look for "office fixtures," and again to interview a man the debtors later hired and to look for more office fixtures. He said a $180 deposit for a hotel room in Paris was for the first trip. He could not remember a trip to New York that generated airfare for him and his son, so he conceded it could be his personal expense. He said a $498 charge for airfare for him and his son to and from Atlanta was for him to attend an LP gas convention; he did not mention who used the second ticket. Charges totalling $3,074 were incurred to send Mr. Burke's thirteen-year-old son to various places in the Orient, along with one of the debtors' officers, at a time when the debtors were trying to "get involved" with companies there. Mr. Burke said he sent his young son because the people there "are great big on families." A charge of $413.49 was for repairing the company car which Mr. Burke's daughter used.

A number of items the debtors deducted had been charged on credit cards and varying degrees of information were available for them. For most of them, the charge slip at least showed the name of the business where the charge was incurred. Fewer of them included any description of the purchase. Mr. Burke admitted many of these charges were for personal items. Although the charges were incurred in 1979 and 1980, eleven to twelve years before the trial, he attempted to add information, apparently based on his memory alone, about the ones he felt the debtors should have been allowed to deduct.

2. Conclusions

While Mr. Burke may very well be right in his explanations of these expenses, his testimony alone is not enough to satisfy the requirements of I.R.C. §274 and related regulations for most of them. The Court is convinced that the debtors should have been allowed to deduct the airfares for tickets he used, even though they were booked in the names of his family members, so long as his other expenses for the trips involved were allowed as business deductions. Otherwise, the deductions were properly disallowed.



F. Expenses with No Receipts

The revenue agents disallowed $4,608.39 in this subcategory for expenses which the debtors claimed but had no receipts to substantiate. The debtors do not appear to be claiming that any of these deductions should have been allowed. If they are, their effort must fail because they have provided no evidence to show the charges were deductible.

11. DEPRECIATION

A. Facts

The IRS disallowed depreciation deductions totalling $70,753 and $93,566 for the debtors' fiscal years 1981 and 1982. The deductions were disallowed because: (1) they were taken for goodwill; (2) they were taken for capital assets with no determinable life; (3) improvements on leaseholds to or from related parties were depreciated on less than a fifteen-year basis; and (4) improvements on property leased to a company that was not a member of the debtors' consolidated group were depreciated.

The revenue agents' report does not specify how they determined that the debtors were depreciating goodwill or what transaction involved the alleged purchase of goodwill. The government's witness did not address this question. The debtors' witnesses indicated they believed the agents thought the purported asset arose from the debtors' purchase of Nebraska Propane, Inc. They stated categorically that no goodwill was purchased and that the available records of the transaction support that position.

Besides following a practice of deducting as a current expense the cost of capital assets purchased for less than $5,000, the debtors claimed depreciation deductions for various artworks they used to decorate their offices which they had treated as capital assets. These included a Leroy Nieman painting that cost about $3,000 and a sculpture that cost about $6,600, as well as other less expensive items (the $5,000 expensing policy was not always followed, it seems). Mr. Burke testified that many of his business trips included searches for artworks to be used in the debtors' offices. One of debtors' officers testified that many of the artworks in question were removed from their original area of display, but not necessarily disposed of, within a year of their purchase. The debtors did not offer evidence to show that the value of these artworks as office decorations declined over time.

The debtors made a number of leasehold improvements which they depreciated over periods of five years or less. The debtors were the tenants under these four leases. The IRS rejected the short terms applied by the debtors and instead insisted such improvements had to be depreciated over a fifteen-year period. The debtors admit that one of the leases was owned by Mr. Burke, an owner and officer of the debtors. Only one of the leases was shown to have been owned by an unrelated third party and to have terminated at the end of a short term. Except for that one, the testimony was somewhat conflicting about the ownership of the various leased properties. The debtors' witnesses did not know whether the lease with the third party had a renewal option. Though the debtors claim many of their records were destroyed in the office fire, the fire, as indicated previously, occurred several years after the audit which led the IRS to disallow the accelerated depreciation of the leases. The leases were not shown to the revenue agents during the audit, nor were they presented at trial. Though the debtors' copies of the leases may have been unavailable at trial or even before, the debtors made no showing that copies of the leases were not available from other sources.

For one other leasehold improvement, the debtors used a fifteen-year period for depreciating improvements, but calculated their deduction by using a factor of .07, while an IRS engineer insisted they had to use .06666. The revenue agents adopted the engineer's recommendation in their report. This change would apparently decrease the allowable deduction from $2,176 to $2,072, a total of $104. The factor to use is calculated by dividing one by the length of the depreciation term, fifteen years. The quotient is .06 followed by additional 6's as long as one wishes to add them. The normal practice with such a result would be to round the last 6 to a 7. Rounding to two decimal places would give the factor the debtors used while the IRS's factor should probably be rounded so that a 7 appears in the last position. The parties have not mentioned this adjustment in their briefs.

The IRS disallowed all depreciation deductions the debtors claimed for an improvement they provided for the Hutchinson Travel Agency, a business owned by Mrs. Burke, an officer and shareholder of the debtors. The revenue agent's report was the only evidence presented about this deduction. The travel agency was not part of the debtors' consolidated group. The IRS contends that capital purchases made for companies not within this group are not ordinary and necessary business expenditures for the debtors.

B. Conclusions

The revenue agent's failure to indicate how or where in the debtors' records he found goodwill being depreciated makes analysis of this matter difficult. Ordinarily, taxpayers have the burden to prove they are entitled to the deductions they claim. Still, they can hardly be expected to respond to allegations that unspecified deductions were improperly taken. The debtors' witness stated that he ascertained that the revenue agent was referring to the debtors' purchase of Nebraska Propane, and denied that the debtors bought any goodwill in that transaction. It is difficult to say that any further response was required. The Court concludes that there is no evidence that the debtors purchased and depreciated goodwill. Therefore, the IRS's disallowance of this depreciation item was inappropriate. The debtors' deduction will be reinstated.

Various rulings and case law indicate that works of art have no determinable useful life and so are not depreciable. Rev. Rul. 68-232, 1968-1 C.B. 79; Treas. Reg. §1.167(a)(1); Thompson v. United States, 477 F.2d 164 (7th Cir. 1973) (adopting district court decision on this point, 338 F.Supp. 770, 777-79 (N.D. Ill. 1971)); see also 26 U.S.C.A. §167. The debtors' officers have called the items in question "artwork," and the Court certainly considers a Leroy Nieman painting and a $6,600 sculpture to be works of art. Although the revenue agents' report indicates the debtors were claiming depreciation deductions for these items based on a three-year useful life, in their brief, the debtors appear to be arguing they should be allowed to deduct the full cost of the items in the year of purchase as current expenses. They seem to suggest the items had a useful life of one year for them, because they displayed them for about a year. For this argument to have any chance of success, the Court believes the debtors would have had to show that they threw the artworks away as worthless at the end of the year. No evidence suggested they followed any such practice. The depreciation for these items was properly disallowed.

At the relevant time, I.R.C. §168 provided that leases had to be depreciated over fifteen years unless the lease term was shorter than the useful life of the asset; if so, the lease could be depreciated over the term of the lease. However, at the same time, §178 provided that leases with related parties had to be depreciated over fifteen years even if their term was shorter than that. The debtors depreciated four disputed lease improvements over their purported terms, all five years or less. While the evidence was not as clear as one might have wished, the Court concludes that three of the four leases were with related parties. The IRS correctly determined these three had to be depreciated over fifteen years. The one lease which apparently was with a third party might have qualified for depreciation pursuant to I.R.C. §169 over the life of the lease, except the debtors failed to prove that the term of the lease was less than fifteen years. The debtors' officer testified that the original term of the lease was five years, but he could not remember whether it had a renewal option. Renewal options must be included in a lease's useful life for depreciation purposes, so the debtors did not establish that this lease could properly be depreciated over less than 15 years. The debtors' failure to produce a copy of this third-party lease cannot be explained by the fire that destroyed many of their records. They produced no evidence to show that the third-party lessor did not have a copy of the lease. The IRS appropriately required depreciation of all four leases over 15 years.

The parties have not mentioned the propriety of the IRS's adjustment of the depreciation factor for the other lease. They are directed to determine for themselves whether any law required the debtors to carry the factor out to five decimal places rather than rounding it off at two. The Court assumes they will not need a ruling to accomplish this.

The debtors did not indicate in their brief of proposed findings and conclusions whether they still insist that they were entitled to claim depreciation deductions for the improvement they provided to Hutchinson Travel Agency. The IRS contends improvements made to the premises of an entity that is not in a taxpayer's consolidated group may not be depreciated. The Court agrees. The disallowance was appropriate.

12. PENSION PLAN

A. Facts

At some time, the debtors established a pension plan and sought an IRS determination that contributions to the plan would be exempt from tax. In November of 1982, they sent a letter to the IRS indicating that they proposed to adopt certain amendments to their plan. The IRS then sent them a letter dated December 10, 1982, indicating that the plan was qualified for tax exempt status, assuming that the proposed amendments were adopted by March 11, 1983. The debtors never adopted the amendments, and the IRS subsequently disqualified their plan from the favored tax treatment they had sought. As a result, the IRS disallowed deductions the debtors had claimed for fiscal years 1980, 1981, and 1982 in the amounts of $170,772, $164,999 and $159,869, respectively. The debtors have also failed to produce or reconstruct books or records demonstrating how their plan operated for the years in question.

The IRS has assessed penalties against the debtor for failing to file certain reports, known as Form 5500 reports, which are required of qualified plans. The parties agree that if the debtors' plan was properly disqualified, these penalties should be eliminated from the IRS's claim against the debtors.



B. Conclusions

The debtors sought a favorable determination that their plan was qualified for tax exempt treatment. I.R.C. §§401(a) and (b), and 6058, and their related regulations require taxpayers who seek such treatment for their pension plans: (1) to adopt any required remedial amendments within 91 days of an IRS final determination letter; (2) to file certain reports with the IRS; and (3) to keep sufficient records to substantiate the information they are required to supply to the IRS. The IRS's letter of December 10, 1982, was a final determination letter and indicated the plan would be qualified so long as the debtors adopted, within 91 days of the letter, the amendments which they had proposed to make. The debtors did not adopt the amendments. They filed with the IRS none of the annual reports required for their plan to be qualified. They have also presented no records demonstrating how the plan operated for the years in question. The debtors' plan was not qualified, and the IRS properly disallowed the questioned deductions. However, the penalties for failing to file Form 5500 reports must be eliminated from the IRS's claim.

13. AUTOMOBILE EXPENSES

A. Facts

During their fiscal years from 1978 through 1982, the debtors deducted all the expenses and all the possible depreciation for four cars that were used by Mr. Burke, his wife, and two of their children. All four family members were officers of the debtors. However, the children were in their teens or early twenties and spent substantial parts of these years attending Texas Christian University in Fort Worth, Texas. Mrs. Burke owned at least one business of her own that was not a part of the debtors' consolidated group. Neither the family nor the debtors kept any records to indicate what percentage of their use of the cars was for personal rather than business purposes. It appears no one in the family owned a personal car during some or all of these years.

During the IRS audit, the revenue agents reviewed various repair records for the cars and spoke to Mr. Burke and others to try to determine how much the cars were used for personal reasons. They indicated that Mr. Burke was evasive and unwilling to offer much information about the use of the cars. Based on the limited information available, the agents concluded that Mr. Burke used his car for the debtors' business 75% of the time, Mrs. Burke 25%, and the children 10%. The agents disallowed deductions for 1978 through 1982 in the amounts of $1,137, $3,335, $19,864, $14,012, and $8,293, respectively.

At trial, Mr. Burke testified that he believed the agents' figures were too low, and that more accurate estimates would be that he used his car for the debtors' business 90% of the time, his wife used hers for the debtors at least 75% of the time, and one of the children used his for business 50% of the time. He agreed with the estimate of the other child's use. Thus, Mr. Burke admitted that the debtors were not entitled to deduct 100% of the expenses and possible depreciation for the cars as they did. He did not indicate that he ever discussed with his wife or children their use of the cars to arrive at the percentage business-use he claimed. He seems to believe nearly every trip he took, with the possible exception of the drive from his home to the debtors' office and back, had some business purpose. He asserted that his wife acted for the debtors in his absence, and spent a considerable amount of her time on their business. Of course, she had a business or two of her own which must have occupied some of her time and she, too, had to drive from home to the debtors' office and back. Mr. Burke based his idea that one child used his car on business 50% of the time only on the fact that the child spent a lot of time driving and doing errands for the debtors. Furthermore, since Mr. Burke considered dining out with his wife and his children to be business meals because they might discuss business or see business associates while they ate, he may believe the drive to and from the restaurant or club was a business trip as well.

B. Conclusions

The debtors had absolutely no basis for deducting 100% of the expenses and depreciation for the cars the Burke family used. Based on his review of repair records and discussions with Mr. Burke and others at the time of the audit, the revenue agent estimated the percentage of business and personal use of each car. Although they have been forced to admit that their initial deductions were unjustified, the debtors now insist that the Court should substitute Mr. Burke's estimates, offered at trial in 1991, for those arrived at by the agent. Mr. Burke did not explain how he arrived at his estimates. While he would probably remember something about his use of his own car, the Court is not convinced he would necessarily have much idea how his wife and children used theirs, especially since the children were away at college for much of the relevant time. The Court is not convinced that a college-age child spent substantial amounts of driving time on corporate rather than personal business, especially while he was going to college in a city where the debtors had no offices. Even Mr. Burke's ideas about his use of his own car may be skewed. It appears he felt his drive from home to work and back was a business trip since he had an office at home. Similarly, since he believed that dining out with his wife was a business trip because they might discuss business or at least might see and be seen by business associates, he apparently believed use of a car to drive to dinner had a business purpose. The Court concludes that the debtors' initial deductions were unsupportable, that the debtors have presented no credible evidence of the percentage of business and personal use that should be applied, and that the revenue agent's estimate should be adopted. The IRS properly disallowed the portions of the debtors' claimed automobile expense deductions.

14. OTHER DEDUCTIONS

This category includes two deductions that the IRS disallowed: a $3,533.58 penalty the debtors paid to the American Association of Railroads, and $532.32 claimed for various gifts the debtors made to business associates. The IRS is now satisfied that the debtors have established the propriety of deducting the American Association of Railroads penalty because it was a surcharge on their use of the railroad system rather than a fine imposed by a government entity, which would be nondeductible under I.R.C. §162(f). In its initial proposed findings and conclusions, the IRS continued to assert that the $532.32 gift deduction should be disallowed. However, in its reply brief, filed a short time later, the IRS reversed its position. Therefore, the gift deduction will be allowed.



15. CHARITABLE CONTRIBUTIONS

A. Facts

Sometime before June 1980, some of the debtors' money was used to buy stock in two banks. The stock was issued in Mr. Burke's name. Later, the debtors discovered that Kansas law prohibited them from owning the stock. During the debtors' fiscal year ending in 1980, the stock was transferred from Mr. Burke's name to the Burke Foundation, a qualified charity. Based on this transfer, the debtors claimed a charitable contribution of $269,900. During the audit, the IRS investigated this deduction, concluded the debtors had never owned the stock, and so disallowed the deduction. The revenue agents' report indicated the debtors had claimed $269,900 as the deduction and both sides have used that figure in their briefs, but on Exhibit K, an independent auditor's report for that year, the contribution is listed as $232,861. The Court is uncertain which of the two figures is correct.

Later, the Burke Foundation discovered that, like the debtors, it was prohibited from owning the bank stock. In 1982, the stock was transferred back into Mr. Burke's name. Mr. Burke testified that he held the stock at all times relevant here only as a nominee, first for the debtors and then for the Burke Foundation. Sometime before the IRS's audit but after these transactions, it appears Mr. Burke became the true owner of the stock rather than a nominee holder and, in exchange, his notes payable to the debtors increased substantially. No written documentation of Mr. Burke's nominee status exists. However, the bank stock was listed as a corporate asset until 1980 when the corporate records indicate it was transferred as a gift.



B. Conclusions

The debtors' money was used to buy the bank stock, but the debtors were prohibited from owning it. The transaction costs incurred in arranging the purchase were claimed as business expenses on the debtors' taxes, although, as discussed above, the Court agrees with the IRS that those deductions were improperly taken. The deductions were disallowed, however, not because the debtors did not pay them, but because expenses incurred in arranging a prohibited acquisition cannot be said to have been reasonable and necessary expenses of a taxpayer's business. The Court is convinced that the debtors tried to sanitize the transaction by placing the stock in a nominee's name. The Court is also convinced that the debtors later donated some of the stock to the foundation created by Mr. Burke, the debtors' president and primary stockholder. Given this history, it is hardly surprising the parties again adopted the nominee approach when they discovered the foundation also was not permitted to own the stock.

The Court concludes the debtors have shown that, during the time periods relevant to this case, the following events occurred. They bought and owned the bank stock, but gave the stock to Mr. Burke to hold as their nominee. They then transferred the stock to the Burke Foundation in 1980, with Mr. Burke again holding the stock as a mere nominee. While Mr. Burke's nominee status was not directly documented, the use of the debtors' money and the treatment of the purchase in the debtors' records show the transactions occurred as the debtors allege. Since the IRS disallowed the deduction solely because it concluded the debtors had never owned the bank stock, a position the Court has rejected, the debtors' deduction for a charitable contribution should be allowed. The parties should recognize that the Court is not addressing the proper tax treatment of the transfers that occurred after the end of the debtors' 1980 fiscal year. The Court has also not considered the impact of the Foundation's inability to own the stock since the IRS has not alleged that this fact has any effect on the tax treatment of the debtors' dealings with the bank stock.

16. ACCRUED BONUSES

A. Facts

In their 1980 fiscal year, the debtors deducted $164,000 which they claimed accrued that year as bonuses payable to an employee named Homer Barber. No such bonuses were reported on Mr. Barber's Form W-2, "Wage and Tax Statement," for 1980. The debtors' records show that $100,000 of the bonus actually accrued in 1979 rather than 1980. No corporate record presented showed that any additional $64,000 bonus was ever awarded to Mr. Barber at any time. In 1987, Mr. Barber filed a claim against the debtors' bankruptcy estates for $100,000. He has never been paid any part of the $100,000 bonus.

If Mr. Barber ever earned a $64,000 bonus, it was not paid to him in cash. The debtors' corporate officers testified that such a bonus was paid by giving Mr. Barber equity in a facility known as an isomerization plant which the debtors were building during some of the tax years in issue. No documentation of this exchange was presented. The bankruptcy schedules the debtors filed in these cases report that all the debtors' stock is owned by Mr. and Mrs. Burke. Mr. Barber was not called to testify.



B. Conclusions

The debtors did their accounting on an accrual basis, so they could and should properly have claimed employee bonuses as expenses in the year they became liable for them even though they had not actually paid them yet. Mr. Barber made a claim against the debtors only for the $100,000 bonus. The corporate records that were produced at trial show that $100,000 was awarded to him, but none of them show that the additional $64,000 was ever awarded. Although it has never been paid, the $100,000 bonus accrued in 1979 when it was awarded, not in 1980. The debtors did not report either bonus on Mr. Barber's W-2 for 1980. The debtor's schedules do not show that Mr. Barber owned any stock in the debtors. The debtors contend that Mr. Barber's failure to include the $64,000 in his claim supports their theory that this bonus was exchanged for equity in the debtors. However, it supports equally well the theory that the $64,000 bonus was never awarded. Neither the bonus nor the exchange for equity was documented in the corporate records. Mr. Barber was not asked to testify about the alleged arrangement for paying the $64,000 bonus.

The Court concludes that the $100,000.00 bonus accrued in 1979, not 1980, and thus was improperly deducted in 1980. There was no evidence that it has ever been paid. No credible evidence was presented to show that the $64,000 bonus was awarded, when it accrued, or that it was paid. Based on the evidence presented, the Court must conclude that the IRS properly disallowed the deductions.



17. OTHER INCOME

A. Facts

During their 1982 fiscal year, the debtors had on hand some isobutane which they had obtained at a cost well below the then market price. At the time, federal regulations prohibited the debtors from selling this isobutane for more than a certain amount over their cost. The market price was well above the price the debtors were permitted to charge. The debtors arranged to exchange the isobutane for two retail outlets owned by Empire Petroleum (Empire). Apparently, Empire was free to sell the isobutane at a higher price than the debtors were. The debtors' accountants debited the cost of goods sold for the actual cost of the transferred isobutane. Presumably, they credited that amount plus the debtors' permissible markup to the sales receipts account. Then, trying to enter the difference between the market value of the isobutane and the debtors' permissible sales price so that it would show up as income but not as income from the sale of inventory, they entered the $215,000 on the debtors' books as a note payable. Sometime later, the debtors' independent accountants changed this treatment by debiting the notes payable account and crediting the retained earnings account.

During the IRS audit, the revenue agents determined that the debtors had received $215,000 worth of petroleum products along with the retail outlets and had mistakenly debited this amount from their cost of goods sold account. Accordingly, the agents concluded that when the notes payable and retained earnings accounts were later adjusted, this mistaken debit from the cost of goods sold account should have been removed. Otherwise, when the debtors later sold the petroleum products and debited their cost against the cost of goods sold account, they would have twice reduced their reported income by the $215,000 cost of the products. The agents concluded the debtors owed tax on an additional $215,000 of income for their 1982 fiscal year.

B. Conclusions

The revenue agents misconstrued this transaction. The cost of goods sold account was properly charged because the debtors in fact transferred goods in exchange for assets which they entered on their books. There is no evidence to support the agents' conclusion that the debtors received petroleum products along with the retail outlets. Instead, since they could not report on their books that they sold the isobutane for more than their cost plus allowed markup, the debtors sought another way to report the difference between that amount and the actual value of the assets they received in the exchange. They simply tried to show on their books what they believed was the true value of the isobutane without reporting a profit for sale or exchange which would have violated the regulations that governed their sale of the goods. The note payable entry was a poor choice because no one was ever going to pay the debtors that amount and a note payable cannot reasonably be listed as an asset indefinitely. The retained earnings account was a better place to enter the $215,000 since credits to that account could remain there indefinitely, and would still count as income for the 1982 fiscal year. The debtors will never have another $215,000 from this transaction to deduct from their cost of goods sold account because they did not receive any petroleum products from Empire. The IRS improperly attributed the additional $215,000 in income to the debtors for 1982.

18. EXCISE TAX

A. Facts

The IRS's proof of claim also included alleged unpaid heavy vehicle highway use taxes, a type of tax known as an excise tax. The IRS claimed the debtors owe $11,372.99 in principal, plus penalty and interest to the petition date, for this tax that should have been paid in July of 1982. It also claimed they owe $100 plus $149.85 in interest for this tax for July of 1985. Finally, it claimed they owe $1,237.50 plus $0.58 in interest for this tax for July of 1986. The government entered into evidence certificates of assessment for these taxes.

The debtors responded by offering the testimony of a Darrell Gaston, who began to work for them in 1985, and certain documents which he had prepared. Mr. Gaston said he had obtained license tags for the debtors' vehicles and knew the July 1986 taxes had to have been paid because he could not have obtained the tags without "a paid copy." He agreed that the July 1985 tax was owed. Finally, he indicated he had prepared Exhibit D, a list of the debtors' rolling stock with certain information about the vehicles, and concluded that the debtors probably did not owe any highway use taxes for 1982. Mr. Gaston's list includes vehicles identified as tractors, trucks, trailers, automobiles, and bobtails. The list states that two tractors and one trailer had been sold, the tractors in 1984 and the trailer at an unspecified time, and that he was still checking for information about one truck and one trailer. The Court surmises that Mr. Gaston uses "tractors" to refer to semitrailer tractors and "trailers" to refer to the semitrailers that would be pulled by those tractors. No weights are given for seven tractors or any of the trailers. Weights are given for a number of tractors, but Mr. Gaston did not explain whether the numbers he gave are for the tractor alone, or for the

tractor plus a trailer plus a load. The Court is uncertain what he means by "bobtails" but numbers that may be weights are given for these vehicles. No weights are given for any of the other listed vehicles.

Copies of the debtors' 1985 and 1986 returns for this tax were presented into evidence. At least one of these copies includes some of the instructions for completing the return. These instructions indicate vehicles are subject to the tax if their "taxable weight" is 55,000 pounds or more; "taxable weight" means the unloaded weight of the vehicle, plus the unloaded weight of any trailer or semitrailer customarily used with the vehicle, plus the weight of the maximum load customarily carried on the vehicle and trailer.

B. Conclusions

Standing alone, the fact the debtors were able to obtain license tags for their heavy vehicles in 1986 is not sufficient to convince the Court that they actually paid the highway use tax owed on the vehicles. Vehicles can be exempted from the tax if the owner expects to drive them less than 5,000 miles during the tax year, so perhaps license tags can be obtained by telling the license issuers that the vehicles are exempt. Other, more nefarious methods of obtaining a tag may be possible as well. Furthermore, direct evidence of payment should have been available to the debtors. Their 1990 fire does not explain why they could not obtain bank or other records held by third parties that would have proved they had paid the taxes. In the absence of such evidence, the Court must conclude the debtors have not paid the taxes.

Similarly, Mr. Gaston's testimony and his list are not sufficient to convince the Court that the debtors did not owe any highway use tax in 1982. Since he did not begin working for the debtors until 1985, Mr. Gaston had no personal knowledge about their 1982 rolling stock, and he gave no indication what records he checked to compile his list. Even if it does include all vehicles the debtors owned that year, his list includes remarks stating it is incomplete for some vehicles, and the list does not contain sufficient information about any of the other vehicles to show clearly whether they were subject to the tax. Quite simply, the debtors have failed to show the IRS's assessment for the 1982 taxes was incorrect.

Consequently, the IRS's claims for these taxes will be allowed.

III. THE FUTURE OF THIS PROCEEDING

At trial, the parties indicated they did not expect the Court to calculate the debtors' tax liability based on its resolution of their many disputes. Instead, they would do the calculating. They should do that now, confer with one another, and present an order fixing the amount of the IRS's claims within sixty days. If they are unable to agree on such an order, they should submit pleadings indicating their new disputes within that same period.

The foregoing constitutes Findings of Fact and Conclusions of Law under Rule 7052 of the Federal Rules of Bankruptcy Procedure and Rule 52(a) of the Federal Rules of Civil Procedure. As indicated, the parties are to submit a proposed judgment based on this ruling, which will be entered on a separate document as required by FRBP 9021 and FRCP 58.

Dated at Topeka, Kansas, this ____ day of March, 1995.











_________________________________

JAMES A. PUSATERI

CHIEF BANKRUPTCY JUDGE

 

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