AMERICAN PROPERTIES, INC., ET AL.,[FN1]
PETITIONERS,
versus
COMMISSIONER OF INTERNAL REVENUE,
RESPONDENT.
Docket Nos. 57748-57751.
Filed August 30, 1957
Tracy Griffin, Esq., and Kenneth P. Short,
Esq., for the petitioners.
Gordon N. Cromwell; Esq., for the
respondent.
Held, that the activities of the corporate
petitioner in constructing, maintaining, and operating racing
boats did not constitute the carrying on
of a trade or business, but were incident to the personal hobby of
its sole stockholder, and the corporation
is not entitled to deduct amounts expended by it as ordinary and
necessary business expenses, or to take
deductions for depreciation on the boats.
Held, further, that the amounts expended
by the corporation are properly taxable to the individual petitioners,
since such expenditures were solely for
the personal benefit of the individual petitioner who was
the sole stockholder.
Held, further, that the individual
petitioners omitted certain salary income from their returns, and that the
respondent properly determined additions
to tax on account thereof, pursuant to section 293(a), I.R.C.
1939.
ATKINS, Judge:
The respondent determined deficiencies in
income tax and additions to the tax as follows:
——————————————————————————————————————
Sec.
Petitioner Year ending Deficiency 293 (a)
addition
——————————————————————————————————————
Madeleine A. Sayres
....................Oct. 31, 1948 1,906.23 95.31
Stanley S. and Madeleine A. Sayres ..
(Oct. 31, 1949 10,400.69 (1) (Oct. 31, 1950 12,830.51 641.53
American Properties, Inc ............
(Dec. 31,1949 495.78 (1) (Dec. 31, 1950 3,601.31 (1)
——————————————————————————————————————
FN1 None.
*1101 American Properties, Inc., claims
that there has been an overpayment in its tax for the year 1949.
The principal issue is whether certain
expenditures made by the petitioner American Properties, Inc., in
1949 and 1950 in connection with
designing, constructing, and racing of speed boats constituted deductible
business expenses of the corporation, or
whether such expenditures constituted personal hobby
expenses paid by the corporation on behalf
of its stockholder, the petitioner Stanley S. Sayers, taxable
to him and his wife, the petitioner
Madeleine A. Sayres, and nondeductible by the corporation.
FINDINGS OF FACT.
The petitioners Stanley S. Sayres and
Madeleine A. Sayres are husband and wife, and the petitioner
American Properties, Inc., is Stanley S.
Sayres's wholly owned corporation. The individual petitioners
reported their income on a fiscal year basis
ending October 31. The corporation keeps its books and
reports its income on a calendar year
basis. The individuals filed separate income tax returns for the
taxable year 1948 and filed joint returns
for the taxable years 1949 and 1950. These returns and the
returns of the corporation for the years
1949 and 1950 were Petitioner filed with the collector of internal
revenue at
The petitioner Stanley S. Sayres is
referred to addition hereinafter as the petitioner, or as Sayres, and the
petitioner American Properties, Inc., is
sometimes referred to Stanley S. Sayres, hereinafter by name or
as the corporation.
Oct. 31, 1948 $1,937.39 $96.87
Madeleine A. Sayres ....................
Design, Construction, and Operation of Racing Boats
Issues.
Prior to 1931 the petitioner was engaged
in the automobile business in
he went to
to American Properties, Inc. (one of the
petitioners herein). During the years in question he owned all
the stock of the *1102 corporation except
a qualifying share, which was held by his attorney. The petitioner
also purchased stock of American
Automobile Company. During the years in question he was also
the principal stockholder of that
corporation. That company operated an automobile dealership and was
a tenant of premises owned by American
Properties, Inc.
The petitioner has always enjoyed speed
and it had been his desire to drive a boat faster than anyone had
ever done before. Prior to going to
After moving to
time prior to 1948 he purchased a used
racing boat which had previously attained a speed of 80 m.p.h.,
and he named it Slo-Mo-Shun. Thereafter he
built successively Slo-Mo-Shun II and Slo-Mo-Shun III.
In the design, construction, operation,
and maintenance of Slo-Mo-Shun III, the petitioner retained
technical assistance of experts who were
recognized as outstanding in their fields. Since Ted Jones, the
boat designer, was employed on a full-time
basis as an engineer with an airplane company, his
work for the petitioner was done at nights,
on weekends, and on holidays. Anchor
Jensen, of the
local boat-building firm, Jensen Motor Boat
Company, was the builder.
The petitioner, Jones, and Jensen watched
the 1948, Gold Cup races in
their experience with the first
Slo-Mo-Shun and Slo-Mo-Shun II and III they recognized the tremendous
room for improvement in the designing of
racing boats. At that time they also recognized the possibility
of profit to be made in the designing,
construction, and sale of racing boats. They considered the possibility
that the Navy might become interested in
the basic design of these fast boats and might become an
important customer.
Jones proceeded to design Slo-Mo-Shun IV
which would be revolutionary in the field of unlimited
hydroplane boats. He used the identical
design which he had used for years in building and racing
limited class boats. By August 1949, Jones
and the petitioner concluded that Slo-Mo-Shun IV,
which was then in the process of
construction, would prove to be far superior to boats currently
being used.
The petitioner had consulted his attorney,
his accountant, and his financial adviser, an official of the
Seattle-First National Bank, who all
agreed on the profit possibility in the designing, building, and sale
of boats. The banker advised against the
petitioner's undertaking any such business enterprise in an
individual capacity. In discussions with
the attorney the petitioner suggested that inasmuch as the
articles of incorporation of American
Properties, Inc., already contained provisions which would
authorize the construction and sale of
boats and marine supplies or engines, such corporation might
undertake the venture without the
necessity of creating a new corporation.
*1103 The minutes of a meeting of the
directors of the corporation held on August 31, 1949, contain the following:
Preliminary discussions had been had with
reference to this corporation entering the field of boat
building, ownership and management.
Counsel reported that the Articles of Incorporation were
sufficiently broad to warrant entry upon
such a program.
Mr. Sayres in connection with the Country
wide interest in power boat racing suggested that ‘Slo-
Shun III’ was in his opinion far superior
to the major racing boats; that an improvement in design had
been perfected and in his opinion
'Slo-Mo-Shun III' was by no means the last word in the field. In other
words, there would be continuous
improvement and if sufficient time was devoted to experimental and
engineering work other boats would become
obsolete and the
the Country.
He suggested that he believed if the
Company would enter the field, do the necessary experimental and
engineering work that not only was there
money to be made in the manufacture and sale of racing crafts,
but in the commercial field as well. That
he believed the Government would itself be interested in the
fastest type of boat that could be
manufactured.
It was recognized that there would be
substantial experimental cost to lay the groundwork for future
development.
He further stated that he was willing to
transfer title of Slo-Mo-Shun III to the corporation if the corporation
would continue in an endeavor to work out
improvements in design and engineering. He particularly
suggested that a new improved Slo-Mo-Shun
should be designed and built for actual racing use.
Mr. Sayres also advised that he had
substantial offers for Slo-Mo-Shun III and had no doubt of the
salability of Slo-Mo-Shun the IVth and
boats of that design and class.
It was agreed that it was to the best
interest of the corporation to enter this new field and proceed with
the construction of a new boat upon the
improved design of Slo-Mo-Shun III, all with the end in view
of when the time was propitious getting
into commercial operation.
Mr. Sayres was authorized to proceed
accordingly. At this time Slo-Mo-Shun IV was in the process of
being built. It was launched in October
1949.
At some time before October 31, 1949, the
corporation paid to the petitioner an amount of $14,690.30,
which was the amount that had been
expended by the petitioner in the construction of Slo-Mo-Shun III
and of partial construction of Slo-Mo-Shun
IV.
In 1949 there were no registration or
licensing requirements with regard to boats of this character. The
petitioner did not enter into any formal
document transferring title of either Slo-Mo-Shun III or Slo-
Shun IV to the corporation. There was no
patent on the design of these boats.
The petitioner filled out forms with the
county assessor of
property tax purposes, as of January 1,
1950 and 1951, indicating that he was the owner of Slo-Mo-Shun
IV. The petitioner left blank the part of
such forms calling for information as to whether he had
transferred title
He belonged to the Seattle Yacht Club and
has always been registered with the American Power Boat
Association as the owner of Slo-Mo-Shun IV
and V. The rules of that association provided, among other
things, that each boat entered for a
sanctioned race must be the bona fide property of the person in
whose name she is entered, who must be a
racing member of the association and a member of a club
belonging to the association; that
corporations or business concerns may not enter sanctioned races
(although they may be members of the
association) and may only enter a boat as the bona fide property
of a club member who is also a racing
member of the association, either by ownership or by charter.
On June 26, 1950, Slo-Mo-Shun IV, driven
by the petitioner on
world straightaway speed record of 160
m.p.h., breaking the 11-year-old record of 141 m.p.h. Recognizing
the capabilities of this boat and the
possibility of still further improvements of design in a
model to be built, the petitioner sought a
contractual arrangement which would include Ted Jones,
the designer, and Anchor Jensen, the
builder. However, because of disagreement as to technical
engineering principles Jones refused to
sign an agreement which would include Jensen as a party.
On July 17, 1950, an agreement was executed
'by and between AMERICAN PROPERTIES, INC.,
(and/or S. S. Sayres) party of the First
Part, and TED O. JONES, Party of the Second Part,' which
provided that whereas the first party had
financed construction of Slo-Mo-Shun III and Slo-Mo-
Shun IV and whereas second party designed
both of those boats and assisted in development,
construction, and testing the parties
agreed as follows:
The second party (Jones) agreed to work
exclusively for the first party (Sayres) in the design and
development of 'GOLD 'CUP' and 'UNLIMITED'
classes of racing boats during the existence of
the contract and a period of 1 year
thereafter; second party agreed not to disclose to others any
basic or essential features of design,
construction, or development; first party agreed that when
constructing racing boats, only second
party would be employed to design such boats and to
supervise construction, and that upon all boats sold by first
party, in whom title should always rest,
second party would receive a fee of $5,000
or 10 per cent of sale price, whichever was greater, this being
in addition to time and material charges
such as had been paid in the past; first party agreed that if Slo-
Mo-Shun IV should be sold for an amount
greater than cost, first party would pay second party 10 per
cent of actual netprofit after taxes, or a
flat sum of $5,000 whichever was greater, in which case second
party would, in consideration thereof,
design a new unlimited class racing boat for first party at no
additional fee; both parties agreed that
in event of any sale of plans and designs of Gold Cup and unlimited
boats, first party would pay second party
a fee of $2,500 together with traveling expenses *1105 and
a fee of $25 per day actually spent in
supervising construction. It
was provided that the agreement
should continue until terminated by written
notice of either party, giving 180 days' notice. It was
signed by S. S. Sayres as president of
American Properties, Inc., and in his individual capacity,
and by Jones.
On July 22, 1950, Slo-Mo-Shun IV, driven
by Ted Jones, won the Gold Cup race. Following that, Jones
was approached by others seeking boats of
the design of Slo-Mo-Shun IV. Horace Dodge sought to
have two boats built, offering $50,000 per
boat. Jones sought approval of the petitioner which was
refused.
Slo-Mo-Shun IV, driven by Lou Fageol, won
Harmsworth Trophy on August 2, 1950.
In August 1950, the Seattle-First National
Bank loaned American Properties, Inc., $26,000 to be used in
operations in connection with the boats.
No collateral was given for the loan.
In February 1951 construction of
Slo-mo-Shun V was commenced for the purpose of entering the 1951
Gold Cup races. The petitioner prevailed
upon Jones and Jensen to work together in the construction of
the boat. The boat was constructed at the premises of
the Jensen Motor Boat Company under the
supervision of Jones and with the aid of
some of Jensen's boat builders. The boat was completed by
the end of July 1951. Jones received
$5,000 for designing Slo-Mo-Shun V in addition to compensation
received on an hourly basis for its
construction.
Lou Fageol, a wealthy sportsman who was
one of the top two or three drivers in the country, drove Slo-
Mo-Shun V and won the Gold Cup in 1951.
In 1952 Slo-Mo-Shun IV, driven by Stanley
Dollar, a wealthy man of the Stanley Dollar Steamship
Lines, won the Gold Cup race. Joe Taggart,
who has had as much racing experience as Fageol, also
drove the Slo-Mo-shun boats in
competition. In 1953 and 1954 either Slo-Mo-Shun IV or Slo-Mo-Shun
V won the Gold Cup races. The Slo-Mo-Shun
boats have also won the Martini-Rossi Trophy for the
fastest heat in a Gold Cup race and the
Aaron DeRoy Plaque for the fastest over-all race average. The
petitioner's name appears on the Gold Cup
as the winner and the various trophies which were won by
Slo-Mo-Shun boats were kept at the Seattle
Yacht Club. There were no cash prizes in racing these boats.
The petitioner did not himself personally
drive any of the boats in closed course competitive races, such
as the Gold Cup or the Harmsworth races.
He did drive in speed competition, as in 1950 when he broke
the world's straightaway speed record.
About November 1, 1951, Ted Jones left
another concern. He thus ceased to operate
under the agreement of 1950. No formal notice of
termination *1106 of the contract was ever
given by either party. Because he felt restrained by the
contract of 1950, Jones did not, for a
number of years, build any boats for others of the design of
the Slo-Mo-Shun boats, although he had many
opportunities to do so. However, commencing in
January 1954, he did design a number of
boats for various individuals throughout the country,
employing the design of the Slo-Mo-Shun
boats. At the time of the hearing in this case in 1956,
there were about 20 boats eligible for competition
in the unlimited class, of which all but 4 were of
the basic Slo-Mo-Shun design.
The members of the crew of these boats
included highly skilled technicians who worked on the various
Slo-Mo-Shun boats in their spare time
since they were full-time employees of other organizations. None
of them was employed by either American
Properties, Inc., or American Automobile Company. Jones
was compensated for designing the boats and Jensen was paid for his work in building them.
The principal construction work took place
at the Jensen Motor Boat Company, but the engine work was
done at the premises of American
Properties Inc., then under lease to American Automobile Company,
where there was a machine shop for
assembling engines. The small hand tools which were used were the
properties of American Properties, Inc.
Only occasionally was equipment of American Automobile
Company used. An electric hoist which was
used was not the property of American Automobile Company.
Engines and parts were stored at these
premises.
All costs of completing and operating
Slo-Mo-Shun IV and the costs of building and operating Slo-
Shun V were borne by the corporation,
including the expenses incurred in racing them, such as traveling
expenses of the crew to
The building owned by the American
Properties, Inc., was located about 1 1/2 to 2 miles from the
nearest navigable body of water.
Slo-Mo-Shun III was moored at a dock at the petitioner's residence on
moved in December 1950, and the
Slo-Mo-Shun boats were then housed in the boathouse at such residence.
At times the boats were housed at the
Jensen Motor Boat Company, which is on
about 5 miles from the petitioner's new
residence.
Greater Seattle, Inc., a nonprofit,
publicly subscribed corporation which promoted the annual Seafair
and other sporting events, sponsored
campaigns to raise money for the operation of the Slo-Mo-Shun
boats because of the advantage to
contributed by Greater Seattle, Inc., for
this purpose was $6,912.15. This contribution, whether paid to
the petitioner in the first instance, or
to the corporation, was ultimately received by the corporation to
defray part of the expense of *1107
operating Slo-Mo-Shun IV. In subsequent years other contributions
were also received from Greater Seattle,
Inc., through campaigns for public subscription. In sponsoring
campaigns for raising money for this
purpose, Greater Seattle, Inc., held the petitioner out as the owner
of the boats. Newspaper articles also
consistently referred to the petitioner as the owner of the boats. The
official programs of the Gold Cup races
listed him as the owner.
The petitioner has never sold any of the
Slo-Mo-Shun boats or any designs therefor. After Slo-Mo-Shun
IV had been constructed, some civilian
representatives of the Navy Department examined it and
observed it in action. There was no
subsequent indication that the Navy would be interested.
In its income tax returns for the calendar
years 1949 and 1950 the corporation showed its principal
business activity as Real Estate and
Lessor of Building, respectively. It reported net income of $8,423.26
in 1949 and a net loss of $1,561.41 in
1950. Its returns show that it had surplus at December 31, 1949, of
$74,659.49 (of which $37,497.43 was earned
surplus) and at December 31, 1950, surplus of $71,260.73
(of which $34,098.67 was earned surplus ).
In the calendar year 1949 the corporation
expended $2,155.56 in operation and maintenance of the
boats, which it deducted on its corporate
tax return as business expenses. The respondent disallowed this
amount to the corporation. In addition,
the corporation expended $561.39 as additional boat expense
which it did not deduct on the corporate
return.
For the calendar year 1950 the corporation
expended $19,300.58 for operation and maintenance of the
boats and deducted on its return the
amount of $12,388.43 (after offsetting the contribution from Greater
Seattle, Inc., in the amount of
$6,912.15). In the return there was included $1,000 as income from
endorsement of an oil product. In this
situation the respondent considered that there had been claimed a
net deduction of $11,388.43, which he
disallowed.
The corporation capitalized on its books
and its returns for 1949 and 1950 the amounts expended for
construction of the boats and related
equipment (including the amount of $14,690.30 which was paid by
the corporation to the petitioner as
hereinabove stated). In the 1949 return the balance sheet at the end of
the year includes in depreciable capital
assets the amount of $18,609.16 for boats and equipment, but no
depreciation was claimed. For 1950 the
amount of capitalization of boats and equipment at year end was
$22,323.37 upon which depreciation was
taken in the amount of $5,830.84, which was disallowed by
the respondent. The respondent included as
additional income of the individual petitioners all amounts
expended by the corporation in connection
with the boats. Inasmuch as the individuals were on a fiscal
year ending October 31, whereas the *1108
corporation was on an calendar year basis, the respondent
determined the amounts which had been
expended during the taxable years of the individuals. For the
fiscal year ended October 31, 1949, the
respondent attributed additional income to the individuals in
amount of $16,401.51, consisting of
$1,149.82 of disallowed corporate expenses to October 31, 1949,
$561.39 representing additional boat
expense paid by the corporation and not deducted on the corporate
return, and $14,690.30 representing the
amount paid to the petitioner by the corporation and capitalized
on the corporate return. For the fiscal
year ended October 31, 1950, the respondent attributed additional
income to the individuals in the amount
of.$16,595.31, consisting of $1,005.74 expended by the corporation
as boat expenses from November 1 to
December 31, 1949, $7,956.50 of net expenses from January
1 to October 31, 1950, and capitalized by
the corporation.
On June 29, 1951, the corporation filed a
claim for refund of taxes for the year 1949, based upon the
carryback of a claimed net operating loss
for 1950. On August 19, 1952, the corporation filed another
claim for refund for the year 1949, based
upon a claim that it understated its net operating expenses by
the amount of $561.39 referred to hereinabove.
The activities of the petitioner and the
corporation during the years in question with respect to the boats
were not conducted with the intention of
making a profit. Such activities did not constitute the conduct
of a trade or business by either the petitioner
or the corporation.
Salary Issues.
Jen-Cel-Lite Corporation. The petitioner
was employed in some undisclosed capacity by the Jen-Cel-
Lite Corporation. At a meeting of the
board of directors of that corporation on November 19, 1949, his
salary was fixed a $4,000 for the period
July 1 to November 30, 1949, and at $800 per month thereafter.
The Jen-Cel-Lite Corporation operated on
the basis of a fiscal year ending November 30. In the joint
return of the individual petitioners for
their taxable year ending October 31, 1950, there was included
salary from Jen-Cel-Lite Corporation in
the amount of $9,600, this being at the rate of $800 per month
for 12 months. The amount which properly
should have been included as taxable income by the individuals
in the return year ending October 31,
1950, is $12,800. The respondent increased the report
income to $12,800 and determined an
addition to tax for that year under authority of section 293(a) on
account of the omission of the $3,200.
The return in question was prepared by a
public accounting firm. It was Sayres's practice to furnish such
firm with information as to *1109
deductions and interest and donations, and income items such as
dividends. The accounting firm also
audited the books and prepared the returns of American Automobile
Company and Jen-Cel-Lite Corporation. The
error of the accounting firm in failing to include the proper
amount of salary from Jen-Cel-Lite
Corporation was due to confusion resulting from the different fiscal
years of the corporation and of the
individual petitioners. The petitioner was unaware of this omission
until it was brought to his attention by
the accounting firm after the revenue agent had discovered the
omission and called it to the attention of
the accounting firm. The part of the deficiency for the taxable
year of the individual petitioners ended
October 31, 1950, which is attributable to the omission from the
joint return of the $3,200 of salary
income is due to negligence within the meaning of section 293(a) of
the Internal Revenue Code of 1939.
American Automobile Company. The American
Automobile Company operated on the basis of a fiscal
year ending April 30. At a meeting of the
board of directors of that corporation held on April 23, 1948,
the petitioner's salary as president was
fixed at $42,000 'for the year ending April 30th, 1948.' The
petitioner's annual salary had previously
been $30,000, which had been credited at the rate of $2,500
monthly. An entry was made on the books of
the corporation on April 30, 1948, crediting the petitioner
with an amount of $12,000 to reflect the
increase in salary for that fiscal year of the corporation. That
entry was never reversed and the
corporation included this amount in its deduction for salaries. The
corporation withheld tax on a total of
$48,000 and the individual petitioners took credit on their returns
for their fiscal year ended October 31,
1948, of the full amount withheld. Such salary of $42,000 was
continued through the succeeding fiscal
year of the corporation.
The proper amount of Sayres's taxable
salary from American Automobile Company for his fiscal year
ended October 31, 1948, was $48,000,
consisting of $15,000 originally credited for the first 6 months of
his fiscal year, $21,000 credited to him
at the higher rate for the last 6 months of his fiscal year, and the
amount of $12,000 credited to him on the
books of the corporation on April 30, 1948, representing a
retroactive increase in salary for the
corporations fiscal year ended April 30, 1948.
In their separate income tax returns for
their fiscal year ending October 31,1948, each individual
petitioner reported the salary from
American Automobile Company at $42,000 and each reported
$21,000 as community income. Each of these
returns was prepared by the public accounting firm which
customarily prepared the returns of the
individuals. The accounting firm committed error in including
the incorrect amount in each return. It's
error was due to failure to recognize the effect of the different
taxable years of the *1110 corporation and
the individual petitioners. The individual petitioners were not
aware of any error in their returns in
this respect until the public accountant advised them at the time of
the revenue agent's examination in
November 1951.
In determining the deficiency the
respondent increased the reported community income of each
individual petitioner by the amount of
$3,000 and determined an addition to tax pursuant to section
293(a). The part of the deficiencies for
the taxable year of the individual petitioners ended October
31,1948, which is attributable to the
omission from their returns of $6,000 of salary income is due to
negligence within the meaning of section
293(a) of the Internal Revenue Code of 1939.
OPINION.
The answers to the questions here
presented for decision depend upon whether the activities involving
the designing, construction, operation,
and racing of the speed boats constituted, in the years in controversy,
a business of the petitioner American
Properties, Inc., or whether they constituted the personal
hobby of the petitioner Sayres, sole owner
of the corporation. There can be no question that prior to the
years in controversy such activities were
purely the hobby of the individual. The record is replete with
evidence to this effect. He had an
insatiable desire for speed, and in his testimony he conceded that
racing had been his hobby. Prior to the
years in question the business of the corporation consisted of
owning and renting a building to the
petitioner's other corporation, American Automobile Company,
which operated an automobile dealership or
agency.
The parties devote much of their argument
to the question whether title to the boats was in the petitioner
or in the corporation. The evidence shows
that at a meeting of the directors of the corporation held on
August 31, 1949, the petitioner stated
that he was willing to transfer title of Slo-Mo-Shun III to the
corporation if the corporation would
continue to work out improvements in design and engineering. The
minutes recite that it was agreed that it
was to the best interest of the corporation to enter this new
field and that Sayres was authorized to
proceed accordingly. The corporation paid the petitioner
$14,960.30 purportedly as purchase price,
which was the amount that had been expended by the
petitioner in the construction of
Slo-Mo-Shun III and of partial construction of Slo-Mo-Shun
IV. Thereafter it continued to pay all
costs of construction and operation of the boats. These facts would
tend to indicate that it was the intention
to transfer title to Slo-Mo-Shun IV to the corporation. On the
other hand, there is other evidence which
tends to indicate that title did *1111 not pass. There was no
formal document transferring title and the
petitioner continued to hold himself out as the owner before
the public. He represented himself as the
owner of Slo-Mo-Shun IV during the years 1950 and 1951 in
his statements made for purposes of county
property taxes. Furthermore, he apparently continued to deal
with the boats in the same manner as he
had theretofore, including mooring or housing them at his
private residence. The boats were
registered in his name as owner on the records of the American Power
Boat Association, and in the official
programs of races his name appeared as the owner.
The question of whether title passed is
not in itself decisive of the issues presented, but is merely one of
the factors involved in the more important
question of whether the corporation did enter into a true
business venture ofexploiting these racing
boats for profit. The determination of whether the activities of
a taxpayer constitute the carrying on of a
trade or business requires an examination of facts ineach case.
Higgins v. Commissioner, 312 U.S. 212. It
has been held that whether an enterprise is conducted as a
business for profit is a matter of
intention and good faith,and all the facts in a particular case are to be
considered. Commissioner v. Field, (C.A.
2) 67 F.2d 876, affirming 26 B.T.A. 116. See also Doggett v.
Burnet, (C.A., D.C.) 65 F.2d 191; Thacher
v. Lowe, 288 F. 994; Edwin S. George, 22 B.T.A. 189.
Thus, the issues in the final analysis
turn upon the question of whether during the years in question the
petitioner and the corporation had the requisite
intent or motive of making a profit. Intention is a question
of fact to be determined not only from the
direct testimony as to intent, but a consideration of all the
evidence, including the conduct of the
parties. The statement of an interested party of his intention and
purpose is not necessarily conclusive.
Helvering v. National Grocery Co., 304 U.S. 282, affirming 35
B.T.A. 163. In B.T.A. 163. In R.L. Blaffer
& Co., 37 B.T.A. 851, affd. (C.A. 5) 103 F.2d 487, certiorari
denied 308 U.S. 576, we stated that one’s
categorical statement may be of less weight than the facts and
circumstances which affect it and that
(T)O be skeptical of the weight to be accorded an interested
witness’ statement in view of other
evidence is not the same as wholly to reject the statement as if it
were dishonest.
The petitioner testified that while
watching the Gold Cup races at Detroit in 1948, he, Jenson, and Jones
conceived the idea that there might be a
profit in the designing, construction, and sale of racing boats.
Thereafter he discussed the possibilities
with his banker and financial adviser, his attorney, and his
accountant and they all agreed that there
were profit possibilities, and the corporate form was
recommended. There was some testimony as
to profit possibilities in sale *1112 of rights to the design of
the boats, but the evidence shows that the
boat designs were not patented and the petitioner expressed
his belief that they were not patentable.
He testified that he constructed Slo-Mo-Shun IV and Slo-Mo-
Shun V primarily because there was a good
business opportunity. His attorney testified that the
petitioner entered into the corporate
venture withthe idea of its being a profit enterprise. The petitioner
testified that the further they went in
the development of these boats the more convinced he became that
there could be a commercial field
resulting from revolutionizing hydroplane racing boats. He stated that
the most startling way to do that would be
to break the straightaway record that Sir Malcolm Campbell
had held for 11 years.
While we do not doubt that the petitioner
and others held the belief that there was a profit possibility, we
do not believe, in the light of other testimony
of the petitioner and others and the conduct of the petitioner,
that there was an intention or motive of
immediately embarking upon a business venture. Rather,
we believe that the parties had in mind
merely the possibility of entering into a commercial venture at
some future time when it might be deemed
expedient to do so. The evidence shows that this never did
eventuate.
corporation held on August 31, 1949, state
that the corporation was to proceed ‘with the end in view of
when the time was propitious getting into
commercial operation.’ This left the intended time of actually
entering into business in an uncertain
state. Actually no boats were ever produced except the particular
racing boats Slo-Mo-Shun IV and
Slo-Mo-Shun V, which were not intended for sale but rather to be
entered in the Gold Cup races with a view
to winning those races, and there is no showing of any
attempts to sell any boats, to build any
for sale, to build any on a fee basis, or to sell any plans or designs
for boats. It is contended that testing
and proving the boats was a necessary preliminary step in the
business of building and sale of boats.
However, despite the fact that Slo-mo-Shun IV did establish a
new world speed record in June 1950 and
did win the Gold Cup in July of that year, the corporation,
which had no
boat-building facilities and had no
continuing contract with Jensen for building, did not proceed to
provide boat-building facilities or take
the ordinary steps which might be expected of a business organization
looking toward making a profit, such as
advertising or making other selling attempts. On the
contrary, when Slo-Mo-Shun IV won the Gold
Cup race, Jones, the designer and driver, was approached
by others seeking boats of this design and
one person offered large prices for two boats, but when Jones
relayed these offers to the petitioner the
latter told him (T)HAT we wouldn’t be building for anyone.
Jones gathered from the conversation with
the petitioner that the reason *1113 was that the petitioner did
not want any competition from other boats
of the Slo-Mo-Shun design. The petitioner testified that he
did not attempt to talk to this
prospective purchaser, but that he ‘wanted somebody to talk directly to me
about it.’ He said that he was not
interested in making a profit on Slo-Mo-Shun IV because if he had sold
it in 1950 it would have ended any hope of
‘going on with the development, continuing development
and getting into the boat business.’ He
admitted that he had stated for publication in newspapers that he
would not sell unless he had another boat
ready for competition for the Gold Cup, this being necessary
because if he failed to defend the cup it
would move out of Seattle and he would be unpopular in the
area. We note that according to Jones’s
testimony the prospective purchaser did not desire to buy Slo-
Mo-Shun IV, but wanted to have two similar
boats built, at what Jones stated was a good price. Jones
further testified in effect that the
reason no other boats were built after Slo-Mo-Shun V was because that
particular boat sufficed for the 1951
racing season and that the petitioner did not suggest the building of
any further boats.
It would seem that a ‘propitious’ time for
actively going into production and sale would have been in
1950 after winning the Gold Cup race. The
petitioner’s refusal to proceed at that time is certainly not
consistent with the claim that he was
interested in profit. On the contrary, it indicates a continuation of
the hobby for his personal pleasure and
satisfaction. In August 1951, the corporation borrowed $26,000
to be used in connection with the boats,
but this was after his refusal of offers to buy boats and cannot be
considered as indicating a profit motive.
About November 1, 1951, Jones left Seattle
and went to work for a boat designer in the east. In January
1954, he commenced building boats of the
Slo-Mo-Shun design for various individuals. The petitioner
testified that Jones’s departure was the
reason that the originally conceived idea of producing racing
boats did not ultimately materialize on a
commercial basis. No reason is given for his departure and we
think it is indicative that he was
convinced that there would be no commercialization of the boats.
It is also noted that the operation of the
Slo-Mo-Shun boats and expenses of their competition were
financed in substantial amount by public
contributions through the civic organization, Greater Seattle,
Inc. We seriously doubt that a man of the
community standing of the petitioner would have permitted
these public subscriptions on the public
understanding that the operation of the Slo-Mo-Shun boats was
a nonprofit hobby, if such had not been
the case. At various times the petitioner in interviews with the
press referred to himself as the owner of
the boats and referred to his activities as his hobby. In letters
which he addressed in 1953 to a *1114 newspaper
editorial writer in response to an editorial concerning
him and his boating activities, the
petitioner stated that he had personally spent more than $100,000 in
building and developing the Slo-Mo-shuns,
and that no tax adviser had yet been able to tell him how to
deduct these very substantial sums for
either business or
personal income tax purpose.
Upon a full consideration of all the
evidence, we are constrained to the view that during the years in
question the activities of the petitioner
and the corporation with respect to the boats were not conducted
with the intention of making a profit and
that such activities did not constitute the conduct of a trade or
business by either the petitioner or the
corporation, and we have so found as a fact. There have been a
number of cases, some of which are
referred to hereinabove, involving activities which partook to some
extent of the nature of hobbies (such as
farming, horse-racing, horse-breeding, dog raising, etc.) which
were held to constitute businesses
justifying the deduction of losses for tax purposes. However, such
cases are distinguishable in that in each the
taxpayer had definitely embarked upon business activities
with intent to make a profit. In none of
them did the taxpayer merely have in mind the thought of possibly
engaging in business activity for profit
at some future time, as is true in the instant case.
We hold that the corporation is not
entitled to deduct the cost of maintenance and operation of the boats
under section 23(a)(1) of the Internal
Revenue Code of 1939, as ordinary and necessary expenses paid or
incurred in carrying on a trade or
business and that it is not entitled to deductions for depreciation on the
boats, irrespective of whether title to
the boats was in the corporation, since section 23(1) requires, as a
condition to such depreciation deductions,
that the property be used in a trade or business.
The respondent has held that the amounts
paid by the corporation for construction, operation, and maintenance
of the boats, including the amount paid to
the petitioner in reimbursement of his previously
incurred expenditures, are taxable income
to the individual petitioners. The respondent in so holding did
not limit himself to the theory of
constructive receipt of dividends and on brief states that these expenditures
constitute a diversion of corporate funds
by the dominant stockholder for his personal benefit and
as such constitute additional income to
him, citing Davis v. United States, (C.A. 6) 226 F.2d 331, certiorari
denied 350 U.S. 965. We have hereinabove
held that the expenditures were not incident to a business
carried on by the corporation. We are
satisfied that, irrespective of whether title to the boats was in the
petitioner, such expenditures were made
for his personal pleasure or to gratify his personal or civic pride
in the accomplishments of these racing
boats. The respondent’s determination *1115 that these amounts
are taxable to the individuals is prima
facie correct and the petitioners have not shown error in his
determination. It is well settled that
payments made by a corporation on behalf of its stockholder may
constitute taxable dividends to the
stockholder. Louis Greenspon, 23 T.C. 138, affirmed on this issue
(C.A. 8) 229 F.2d 947; Oreste Casale, 26
T.C. 1020, on appeal (C.A. 2); Paramount-Richards Theatres,
Inc., v. Commissioner (C.A. 5) 153 F.2d
602. The petitioners have not shown that there were not earnings
and profits available in the corporation
out of which the amounts in question could be paid and be
properly treated as taxable dividends. The
corporate returns indicate that there were sufficient earnings
and profits available. The respondent’s
determination that the amounts in question are taxable to the
individual petitioners is approved.
The petitioners contend, alternatively,
that if the corporation was not engaged in the business then they
were, and that the amounts if taxable to
them, would also be deductible by them. As stated above, we
think that neither the corporation nor the
individual petitioners were engaged in the business. Rather, the
expenditures were in furtherance of the
private hobby of the petitioner Sayres and as such may not be
deducted in view of the provisions of
section 24(a)(1) of the Internal Revenue Code of 1939.
The individual petitioners concede that
the respondent properly increased their reported taxable income
from salary of Jen-Cel-Lite Corporation by
the amount of $3,200 for their fiscal year ending October 31,
1950. However, they dispute the
determination of an addition to tax under section 293(a) of the Internal
Revenue Code of 1939. /2/
They contest the Respondent’s
determination that for their fiscal year ending October 31, 1948, they
had additional salary income from American
Automobile Company in the amount of $6,000, and also
contest the determination of any addition
to tax for that fiscal year under section 293(a).
The petitioner Sayres testified and
contends that it was not intended that his increase in salary voted by
American Automobile Company on April 23,
1948, was to be retroactive to the beginning of the
corporation’s fiscal year which began on
May 1, 1947, but that it was intended that it should be prospective
commencing May 1, 1948. If this were true
then the increase of $1,000 per month would *1116
result in the receipt of taxable salary by
him of only $36,000 for his fiscal year ending October 31, 1948.
However, for that year there was reported
by the individual petitioners in their returns the amount of
$42,000 as salary. We have carefully examined
the resolution passed by the directors of the corporation
and we do not find it ambiguous to any
extent. It clearly increased the petitioner’s salary to $42,000 ‘for
the year ending April 30th, 1948.’
Furthermore, the petitioner was credited on the books of the corporation
with an amount of $12,000 to reflect the
increase for that
fiscal year of the corporation. It is true
that some portion of the $12,000 related to a period prior to the
commencement of the petitioner’s fiscal
year ended October 31, 1948, but nevertheless such full sum of
$12,000 first became available to him in
his fiscal year ended October 31, 1948, and must be treated as
taxable income to him in that year. Even
though there may have been some misunderstanding as to when
the increase should commence, the fact is
that the petitioner was actually credited with the $12,000, no
correction was ever made, and the
corporation deducted such full amount. Upon the record we have
concluded that $48,000 was the proper
amount of taxable salary of the petitioner from American Automobile
Company for his fiscal year ended October
31, 1948. We approve the respondent’s determination
in this respect.
The individuals contend that they should
not be held liable for an addition to tax under section 293(a)
because of the fact that they were not
aware of any omissions from their returns until 1951 when the
revenue agent discovered the errors, and
that they relied upon an accounting firm to obtain the proper
information as to salary from the two corporations.
They also state that the errors of the accounting firm
in failing to determine the proper amount
of salary income were not unreasonable but are understandable
because of the confusion arising by virtue
of the difference between the fiscal years of the corporations
and of the petitioners. The point is also
made that the individuals, and also the accountants, would not be
put on notice of omissions by an
examination of the W-2 forms furnished by the corporations because of
the fact that on such forms the data was
submitted on the basis of a different time period.
There is no question here as to the good
faith of the petitioners. Wholly aside from the question of good
faith, a taxpayer may be guilty of
negligence requiring the imposition of an addition to tax on account of
negligence. Evans v. Commissioner, (C.A.
8) 234 F.2d 586, affirming T.C. Memo. 1955-126, certiorari
denied 352 U.S. 909. It is well
established that the duty of filing accurate returns cannot be avoided by
placing responsibility upon an agent. Vern
W. Bailey, 21 T.C. 78; Harold B. Franklin, 34 B.T.A. 927;
Irving Fisher, 30 B.T.A. 433. And we have
held that taxpayers must *1117 bear the responsibility for the
failure of their agents, Hyman B. Stone,
22 T.C. 893.
Here it is admitted that $3,200 in salary
form Jen-Cel-Lite Corporation was erroneously omitted and we
have held that $6,000 of salary from
American Automobile Company was erroneously omitted. The
petitioners now contend that theincrease
in salary voted by American Automobile Company was not
intended to be retroactive, but the facts
are that Sayres was credited with the full amount of $48,000 on
the books of the corporation, that the
corporation deducted such amount and withheld tax on that
amount, and that the individual petitioners
took credit for such withholding. Furthermore, in their separate
returns they did return a total of $42,000
which includes $6,000 in excess of what they should have
returned had the increase not been
retroactive.
The fact that the individual petitioners
and the corporations operated upon the basis of different taxable
years is not a valid excuse for the
failure to exercise due diligence. This situation is not unusual. Accountants
preparing returns encounter it frequently.
Here the accounting firm certainly knew about the
different fiscal years since it audited
the books of the corporations and prepared the returns of both the
corporations and the individuals. There
should have been such an investigation made either by the
petitioners or by the accounting firm as
would have disclosed the correct amount of salary received by
the petitioner or credited to him in his
fiscal years which are in question. This was not done. One of the
members of the accounting firm testified
that the particular accountant, now deceased, who was handling
this matter failed to consult the audit
papers and that he did not reconcile the deductions taken by
the corporations for salaries with the
personal returns of the individuals. He further testified that the
accountant did not go to the files of the
American Automobile Company to see what amounts had been
credited to Sayres and therefore
overlooked the credit of $12,000 on the books of that company. He
stated that unquestionably a mistake was
made and that it came to light only when the revenue agent
made his examination. He also stated that
Sayres was of the opinion that there was negligence in the
accounting office, that these items should
have been discovered, and that the accountant did not do what
he should have done.
Under these circumstances we have
concluded and have found as a fact that the portions of the deficiencies
due to omissions of salary income were due
to negligence within the meaning of section 293(a).
The cases of R. E. Nelson, 19 T.C. 575, and
Rhett W. Moody, 19 T.C. 350, cited by the petitioners, are
not analogous. In those cases the
deficiencies were not due to negligence. They were due to *1118 the
erroneous tax treatment of certain
items, but the taxpayers had acted in good faith in reliance on the
advice of accountants who were conversant
with tax matters and who were fully apprised of the facts.
The respondent’s determinations of
additions to the tax under section 293(A) are approved.
Decisions will be entered under Rule 50.
FN1. Proceedings of the following
petitioners are consolidated herewith: American Properties, Inc.,
Docket No. 57748; Stanley S. Sayres, Docket
No. 57749; Madeleine A. Sayres, Docket No. 57750;
and Stanley S. Sayres and Madeleine
A. Sayres, Docket No. 57751.
FN2. SEC. 293. ADDITIONS TO THE TAX IN
CASE OF DEFICIENCY.
(a) NEGLIGENCE.— If any part of any
deficiency is due to negligence, or intentional disregard of rules
and regulations but without intent to
defraud, 5 per centum of the total amount of the deficiency (in
addition to such deficiency) shall be
assessed, collected, and paid in the same manner as if it were a
deficiency, except that the provisions of
section 272(i), relating to the prorating of a deficiency, and of
section 292, relating to interest on
deficiencies, shall not be applicable.
28 T.C. 1100, 1957 WL 1139 (Tax Ct.)
END OF DOCUMENT
United States Court of Appeals Ninth
Circuit.
AMERICAN PROPERTIES, INC., and The Estate
of Stanley S. Sayres, deceased, Harold L. Scott, and
A. R. Munger, Executors, and Madeleine A.
Sayres, Petitioners,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
No. 16051.
Dec. 10, 1958.
Proceeding to review decision of Tax
Court, 28 T.C. 1100, which denied corporation and its sole owner,
a powerboat racing enthusiast, right to
deduct expenses of building, maintaining and operating boats as
ordinary and necessary business expense.
The Court of Appeals held that evidence supported finding
that expenditures of corporation were not
business expenses but were dividends to owner and that
activities of owner were not conducted
with intention of making profit and did not constitute the conduct
of a trade or business but that
expenditures were for personal use and therefore neither corporation nor
owner was entitled to deduction.
Affirmed.
West Headnotes
[1] Internal Revenue 4744
220k4744 Most Cited Cases
(Formerly 220k1690)
In proceeding to review decision of Tax
Court which denied corporation and its sole owner, a powerboat
racing enthusiast, right to deduct expenses
of building, maintaining and operating boats as ordinary and
necessary expense, evidence sustained
finding that expenditures of corporation were not business expenses
but were dividends to owner. 26 U.S.C.A.
(I.R.C.1939) § 23(a)(1)(A), (e)(1, 2); Fed.Rules
Civ.Proc. rule 52(a), 28 U.S.C.A.
[2] Internal Revenue 4744
(Formerly 220k1690)
In proceeding to review decision of Tax
Court which denied corporation and its sole owner, a powerboat
racing enthusiast, right to deduct
expenses of building, maintaining and operating boats as ordinary and
necessary expense, evidence supported
finding that activities of owner were not conducted with intention
of making profit and did not constitute
the conduct of a trade or business but that expenditures were
personal and therefore owner was not
entitled to deduction. 26 U.S.C.A. (I.R.C.1939) §
23(a)(1)(A), (e)(1, 2); Fed.Rules
Civ.Proc. rule 52(a), 28 U.S.C.A.
[3] Internal Revenue 4744
220k4744 Most Cited Cases
(Formerly 220k1690)
Question of whether taxpayers'
expenditures are made with intention of making a profit is one of fact,
and finding of Tax Court thereon cannot be
set aside unless clearly erroneous. Fed.Rules Civ.Proc. rule
52(a), 28 U.S.C.A.
*151 Kenneth P. Short, Seattle, Wash., for
petitioners. Charles K. Rice, Asst. Atty. Gen., George W.
Beatty, Lee A. Jackson, I. Henry Kutz, C.
Guy Tadlock, Attys., Dept. of Justice, Washington, D.C., for
respondent.
Before ORR, CHAMBERS, and HAMLIN, Circuit
Judges.
PER CURIAM.
[1] Petitioner Stanley S. Sayres, a well
known power boat racing enthusiast, sought to deduct expenses
of building, maintaining and operating
certain of these boats as an ordinary and necessary expense of
petitioner American Properties, Inc., a
corporation of which Sayres was the sole owner. Int.Rev.Code of
1939, 23(a)(1)(A), 26 U.S.C.A. §
23(a)(1)(A). These deductions were denied by the Commissioner who
considered them not to be business
expenses, but actually dividends to Sayres as the funds in question
were expended for his own personal use.
Furthermore, Sayres as an individual was also denied a deduction
for the same amounts which were considered
dividend income to him because, just as they were not
business expenses of the corporation, they
were not
individual business expenses of Sayres,
Int.Rev.Code of 1939, § 23(a)(1)(A), nor losses incurred in a
trade or business or in any transaction
entered into for profit, Int.Rev.Code of 1939, § 23(e)(1, 2), but
were sums spent in the pursuit of his
hobby— boat racing.
The tax court upheld the Commissioner’s
determinations, finding as a fact (and petitioners do not contend
that it was not a finding of fact) that
the activities ‘with respect to the boats were not conducted
with the intention of making a profit and
that such activities did not constitute the conduct of a trade or
business by either’ Sayres or the
corporation.
[2][3] Our examination of the record
convinces us that the tax court’s findings that the expenditures in
question were personal is substantially
supported by the evidence and are not adduced from an erroneous
view of the law. Hence, they are not
clearly erroneous and cannot be set aside. This is true of all
questions of fact including the presence
or absence of a profit motive. Rule 52(a), Federal Rules of Civil
Procedure, 28 U.S.C.A. See United States
v. United States Gypsum Co., 1948, 333 U.S. 364, 68 S.Ct.
525, 92 L.Ed. 746; Higgins v. Commissioner
of Internal Revenue, 1941, 312 U.S. 212, 61 S.Ct. 475, 85
L.Ed. 783.
No contention is made that the monies here
involved are not dividend income to Sayres after it is found
that the amounts
were expended for Sayres’ personal
use.
We see no purpose in detailing the
evidence upon which the tax court based its decision. That information
can be had by reference to the said
decision. 28 T.C. 1100.
Affirmed.
262 F.2d 150, 2 A.F.T.R.2d 6292, 59-1 USTC
P 9130
END OF DOCUMENT