United States Tax Cases (1913-1999), [97-2 USTC ¶50,905], U.S. District Court, Dist. Ore., Dennis R. Maze and Beatrice V. Maze, husband and wife, Plaintiffs v. United States of America, Defendant , Summary judgment: Genuine issues of material fact: Capital gains and losses: Small business stock:, (Oct. 10, 1997), (Oct. 10, 1997)
[97-2 USTC ¶50,905] Dennis R. Maze and Beatrice V. Maze, husband and wife, Plaintiffs v. United States of America, Defendant
U.S. District Court, Dist. Ore., Civ. 96-1000-JE, 10/10/97
[Code Secs. 1244 and 7402 ]
Summary judgment: Genuine issues of material fact: Capital gains and losses: Small business stock: Evidence.--The government was denied summary judgment on the issue of an individual’s entitlement to a deduction against ordinary income for a loss on the worthlessness of small business stock because genuine issues of material fact existed regarding the stock’s qualification as Code Sec. 1244 stock. The government contended that the taxpayer would not be able to substantiate the three requirements for obtaining tax benefits under Code Sec. 1244 . However, with respect to the “small business” requirement, the record supported an inference that the aggregate funds of the corporation that issued thestock did not exceed $1 million on the issue date. With respect to the requirement that qualifying stock be issued for money or other property, the taxpayer produced enough evidence to raise a question of fact as to whether he gave the corporation money in exchange for the stock. Finally, the government failed to satisfy its burden of showing that there was no genuine issue of material fact concerning whether the corporation satisfied the gross receipts test. BACK REFERENCES: ¶32,500.32 and 42,205.105
Gregory Byrne, 1001 S.W. 5th Ave., Portland, Ore. 97204, for plaintiffs. Kristine Olson, United States Attorney, Portland, Ore. 97204, Barbara Johnson, Department of Justice, Washington, D.C. 20530, for defendant.
OPINION AND ORDER
Jelderks, Magistrate Judge:
Plaintiffs Dennis Maze and his wife Beatrice filed a complaint pursuant to 26 U.S.C. §7402 seeking a refund of federal income taxes paid. Plaintiffs claim that $7,698 1 was improperly collected by the Internal Revenue Service (“IRS”) in 1989. Plaintiffs assert they are entitled to a deduction against ordinary income for a loss on the worthlessness of small businessstock pursuant to 26 U.S.C. §1244. Before the court is defendant’s motion (# 26) for summary judgment.
BACKGROUND
Both parties filed concise statements of material fact pursuant to Local Rule 220-9(a) & (b). Pursuant to subsection (f) of that rule, material facts in the defendant’s concise statement that are not expressly controverted are deemed admitted.
In the spring of 1986, plaintiff Dennis Maze (“Maze”) became involved with Pacific Trailer Works, Inc., (“PTW”), a Washington corporation. Maze became involved by making an initial alleged investment of $30,000. Maze claims that he received 6,375 shares of stock for this alleged investment. At his deposition, Maze testified the share price was $4.72 for a total alleged investment of $27,000. Def. Exh. G, p. 13. Maze admitted at his deposition that the amount of money he thought he paid for stock was not reflected in the paperwork. Id. 2
In January of 1986, PTW’s board of directors adopted a section 1244 stock offer plan. Pl. Exh. 1. Defendant submitted a document called the “Corporate Record Sheet” from PTW which purportedly shows the amount of stock held by Maze pursuant to the section 1244 plan. Def. Exh. C, at 6. That document states 6,375 shares of common stock were issued to Maze on November 15, 1988. 3 However, the document is not dated.
On May 10, 1986, PTW held a special stockholder’s meeting dealing with the execution of the “ ‘Offer to Purchase Common Shares of Stock in [PTW],’ directed to ‘BBR & D, a Washington partnership. . . .’ ” Def. Concise State. at ¶4. Maze was an individual partner of BBR & D. However, the stock purchase offer provided the stock could be purchased as a block by the partnership or in equal shares by the four individual partners. Def. Exh. C, at 4. The record shows individual stock certificates were issued to the four partners of BBR & D for 6,375 shares each. Id. at 7-10. In fact, Maze stated the partnership was never formed.
At the May, 1986 meeting, Maze was also elected as a director and officer of PTW, with the authority to secure lines of credit for the corporation. Also on May 10, 1986, Maze and another listed partner of BBR & D, Richard Durban, executed the offer to purchase PTW stock. The other two partners, Milton Buswell and Robert Blancarte, executed the purchase offeron May 27 and July 14, 1986, respectively.
The stock purchase offer, through which Maze and the other partners bought the stock, provided that the purchaser 4 could buy 25,500 shares of unissued common stock at $4.31 per share. The purchaser was to pay for the shares by the following means: cancellation of $25,299 in debt owed to the partnership by PTW; 5 $60,000 in cash upon closing; and a $24,605.36 promissory note to be paid in full by September 1, 1986. Def. Exh. C, at 3-5.
On May 10, 1986, a promissory note was executed by Maze on behalf of BBR & D listing the individual partners. The note promised to pay PTW $24,605.36 without interest onSeptember 1, 1986. The note states it is paid “FOR VALUE RECEIVED. . . .” Def. Exh. C, at 5 (emphasis in original).
Between May 13, 1986, and August 21, 1987, plaintiffs wrote three personal checks made payable to PTW. The amounts of the three checks were as follows: $1,600 on May 13, 1986; $20,000 on May 15, 1986; and $10,000 on August 21, 1987. Def. Exh. D, at 1-2. Maze also stated in an affidavit that he made a cash loan to PTW in the Fall of 1988 for $10,000.
On October 21, 1986, Maze executed a continuing guarantee to First Interstate Bank (“FIB”) which personally guaranteed PTW’s credit line. In June of 1989, Maze executed a promissory note to FIB on behalf of PTW as a officer/director and in his individual capacity. When PTW ceased operations, FIB was its only secured creditor. In March of 1991, Maze and three others executed a promissory note to FIB in the amount of $138,190.73 in their individual capacities. PTW is listed as a Corporate Maker but plaintiffs dispute that PTW signed the note because they claim it was defunct. This note appears to be a continuation of an earlier promissory note.
Equipment that belonged to PTW was sold in March of 1992 for $27,871.28, with the amount applied against the promissory note referenced above. In January of 1993, plaintiffs filed an amended individual tax return for 1989. This return claims an ordinary loss in the amount of $30,000 in relation to the PTW stock.
STANDARD
Summary judgment should be granted if there are no genuine issues of material fact and the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c). If the moving party shows there are no genuine issues of material fact, the non-moving party must go beyond the pleadings and designate facts showing an issue for trial. Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986). A scintilla of evidence, or evidence that is merely colorable or not significantly probative, does not present a genuine issue of material fact. United Steelworkers of America v. Phelps Dodge, 865 F.2d 1539, 1542 (9th Cir.), cert. denied, 493 U.S. 809 (1989).
The substantive law governing a claim determines whether a fact is material. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986); see also T.W. Elec. Service v. Pacific Elec. Contractors, 809 F.2d 626, 630 (9th Cir. 1987). Reasonable doubts as to the existence of a material factual issue are resolved against the moving party. T.W. Elec. Service, 809 F.2d at 631. Inferences drawn from facts are viewed in the light most favorable to the non-moving party. Id. at 630-31.
Summary judgment is not appropriate if the credibility of witnesses is at issue. Securities and Exchange Comm. v. Koracorp Industries, Inc., 575 F.2d 692, 699 (9th Cir.), cert. denied, 439 U.S. 953 (1978). Credibility issues can only be resolved through an evidentiary hearing or a full trial. Id.
DISCUSSION
Defendant argues it is entitled to summary judgment for two reasons. First, it argues that plaintiffs have failed to establish their entitlement to section 1244 benefits because the stockdid not qualify as section 1244 stock. Second, defendant argues it is entitled to summary judgment because the stock in question did not become worthless in 1989.
Because of a concession by defendant the court must only address the first contention noted above. In its reply memorandum in support of its motion for summary judgment, defendant stated: “the United States concedes that the assertions set forth in the Declaration of Johansen at paragraphs 3, 4 and 5, when broadly construed in Plaintiffs’ favor, may create an issue of fact as to the year the stock in question became worthless.” Because plaintiffs are entitled to have all inferences drawn in their favor, the court concludes there is a genuine issue of fact concerning the year the stock became worthless. Therefore, defendants are not entitled to summary judgment on that issue.
Section 1244 of the Internal Revenue Code allows individuals who invest in small businesses to treat a loss on qualifying stock issued to the individual or a partnership as anordinary loss instead of a capital loss. Warner v. Commissioner [68-2 ustc ¶9589], 401 F.2d 162, 163 (9th Cir. 1968). See also, 26 U.S.C. §1244(a). The statute is very specific in its requirements on qualifying stock. Warner [68-2 ustc ¶9589], 401 F.2d at 163.
Section 1244 stock is defined as stock in a domestic corporation if:
(A) at the time such stock is issued, such corporation was a small business corporation,
(B) such stock was issued by such corporation for money or other property (other than stock and securities) 6, and
(C) such corporation, during the period of its 5 most recent taxable years ending before the date the loss on such stock was sustained, derived more than 50 percent of its aggregate gross receipts from sources other than royalties, rents, dividends, interests, annuities, and sales or exchanges of stocks or securities. 7
26 U.S.C. §1244(c)(1). Section 1244 defines a small business corporation as one whose: aggregate amount of money and other property received by the corporation for stock, as a contribution to capital, and as paid-in surplus, does not exceed $1,000,000. The determination under the preceding sentence shall be made as of the time of the issuance of the stock in question but shall include amounts received for such stock and for all stocktheretofore issued.
In addition to the requirements on the face of the statute, there is specific record keeping requirement for those wishing to take advantage of section 1244. The regulations impose requirements upon both the corporation and the stockholder. A plan to issue stock under section 1244 must appear in the records of the corporation. 26 C.F.R. §1.1244(e)-1(a)(1). That provision of the regulations also has several discretionary types of records that should be kept to show the following:
(I) The persons to whom stock was issued, the date of issuance to these persons, and a description of the amount and type of consideration received from each;
(ii) If the consideration received is property, the basis in the hands of the shareholder and the fair market value of the property when received by the corporation;
(iii) The amount of money and the basis in the hands of the corporation of other property received for its stock, as a contribution to capital, and as paid-in surplus;
(iv) Financial statements of the corporation, such as its income tax returns, that identify the source of the gross receipt of the corporation for the period consisting of the five most recent taxable years of the corporation, or, if the corporation has not been in existence for 5 taxable years, for the period of the corporation’s existence;
(v) Information relating to any tax-free stock dividend made with respect to section 1244 stock and any reorganization in which stock is transferred by the corporation in exchange for section 1244 stock. . . .
26 C.F.R. §1.1244(e)-1(a)(2). That section also states:
A person who claims an ordinary loss with respect to stock under section 1244 must have records sufficient to establish that the taxpayer is entitled to the loss and satisfies the requirement of section 1244. . . .
In addition, a person who owns section 1244 stock in a corporation shall maintain records sufficient to distinguish such stock from any other stock he may own in the corporation.
Id. at 1.1244(e)-1(b).
For purposes of section 1244, stock is deemed issued when it is paid for, not when a stock certificate is physically issued. Morgan v. Commissioner [CCH Dec. 28,131], 46 T.C. 878, 890-91 (1966). Section 1244 is construed “very strictly against the taxpayer.” Rookard v. United States [71-1 ustc ¶9457], 330 F.Supp. 722, 724 (D. Or. 1971). Additionally, the recordkeeping requirements outlined in 26 C.F.R. §1.1244(e)-1 are mandatory. Wong v. Commissioner [CCH Dec. 49,831(M)], 67 T.C.M. (CCH) 2911, at * 6 (1994). “Strict compliance with the requirements of section 1244 and regulations is necessary in order to obtain the benefit of section 1244.” Id. (quoting Mogab v. Commissioner [CCH Dec. 35,148], 70 T.C. 208, 212 (1978). In determining whether plaintiffs are entitled to the special loss provisions of section 1244, the court is mindful that it must look to the substance of the transactions in question and not strictly the form. Hollenbeck v. Commissioner [70-1 ustc ¶9236], 422 F.2d 2, 4 (9th Cir. 1970). When the transaction claimed as one under section 1244 is merely to secure a tax benefit for the taxpayer and not to economically benefit the corporation, section 1244 treatment is not allowed. Id. at 5-6.
“[A] qualifying 1244 plan must provide evidence that the stock is being issued with §1244 in mind.” Rickey v. Commissioner [74-2 ustc ¶9616], 502 F.2d 748, 755 (9th Cir. 1974). This requirement fulfills section 1244’s purpose of bringing in outside investments to small businesses that were stimulated by the tax benefit of section 1244. Id.
Essentially, defendant argues that plaintiffs are not entitled to the benefit of section 1244 because the multiple financial relationships between PTW and Maze preclude plaintiffs from differentiating section 1244 stock from Maze’s other interests in the corporation. See Def. SJ Mem. at 12. In other words, defendant alleges that plaintiffs cannot substantiate the three requirements for obtaining the tax benefit in section 1244. The court will deal with the three requirements separately.
First, defendant argues plaintiffs cannot meet the “small business” requirement of section 1244. Defendant asserts that plaintiffs cannot prove that PTW had under $1,000,000 in money and property on the date the stock was issued. Plaintiffs assert that Maze’s stock was issued on November, 15, 1986, the date on the certificate. However, the checks that Maze asserts reflect his payments for the stock are the May 15, 1986, check for $20,000 and the August 21, 1987, check for $10,000. Maze Aff. at 2. Maze asserts the excess was either paid-in capital or debt. Id. See also Pl. Opp. Mem. at 3. Thus, the stock was not fully paid for until August 21, 1987, and cannot be considered to have issued until that date regardless of what the certificate says. Morgan [CCH Dec. 28,131], 46 T.C. at 890-91. Thus, the inquiry is whether the corporation had under $1,000,000 in money and other property as of August 21, 1987.
The only evidence in the record involving the financial well being of PTW are two balance sheets dated January 31, 1987, and July 31, 1988. The net capital on the dates were $70,835 and negative $82,238.91, respectively. The requirements of section 1244 mandate that a taxpayer prove the aggregate amounts of money received by the corporation when thestock was issued do not exceed $1,000,000. The court believes the record supports an inference that PTW did not have aggregate amounts of money exceeding $1,000,000 on the date the stock was issued. Whether plaintiffs can establish this element at trial is not for the court to decide. However, defendant has not shown, as a matter of law, that PTW’s aggregate amount of money at the time the stock was issued exceeded $1,000,000, thus disqualifying plaintiffs from the benefit of section 1244.
Defendant also argues that plaintiffs cannot satisfy the second element of section 1244 which requires qualifying stock to be issued for money or other property. Defendant seems to base its argument on what it characterizes as Maze’s multiple financial relationships with PTW and his lack of documents differentiating section 1244 stock from his other interests in the corporation. The regulations implementing section 1244 require the taxpayer to have records showing his or her entitlement to the benefits therein and distinguishing section 1244stock from other stock. 26 C.F.R. §1.1244(e)-1(b). The record before the court does not indicate that Maze had any other type of stock in PTW.
While, the corporate records before the court, for the purposes of this motion are sparse, there is no showing that Maze gave anything but money to PTW. There are three checks issued to PTW by plaintiffs for over $30,000. There are also other financial relationships between Maze and PTW in his capacity as an officer or director. No authority before the court precludes plaintiffs from taking advantage of section 1244 solely because of these relationships. While plaintiffs will have the burden of proof at trial on this issue, they have offered enough evidence to raise a question of fact regarding whether Maze gave money for the stock that was issued. Thus, defendants are not entitled to summary judgment on this issue.
Lastly, section 1244 requires the corporation, during the five years preceding the date the loss on the stock was sustained, to derive more than 50% of its aggregate gross receipts from sources other that royalties, rents, dividends, interests, annuities, and sales or exchanges of stock. 26 U.S.C. §1244(c)(1)(C). In its reply brief at pages 8-9, defendant asserts that plaintiffs have brought forth no evidence concerning gross receipts, and thus, they have failed to satisfy the gross receipts test.
Defendant is correct in stating that no evidence of gross receipts is before the court. However, defendant seems to misplace the burden for purposes of summary judgement. It is the defendant’s burden to show there is no genuine issue of material fact concerning the gross receipts test. Maze states in his affidavit that PTW was in business to manufacture trailers. Defendant has offered no evidence that any gross receipts of PTW were derived from the sources listed above. Whether plaintiffs can satisfy this element at trial is a question for the fact finder. Accordingly, defendant is not entitled to summary judgment on this issue.
CONCLUSION
Because genuine issues of material fact remain as to the elements of satisfying section 1244, defendant’s motion (#26) for summary judgment is DENIED. | Footnotes | | | 1 | Plaintiffs’ complaint states the figure at $8,405. However, plaintiffs assert in their Concise Statement of Material Facts on page 1 that the refund requested is $7,698. | 2 | Maze claimed the actual amount he paid to PTW was $31,500, but the amount for stock was, contrary to his belief, only $27,476.25. Pl. Opp. Mem. at 3. Plaintiffs claim the additional money paid to PTW was paid in capital or debt, and not subject to deduction under section 1244. Id. | 3 | Plaintiffs assert this date is a typographical error because the stock certificate bears the date of “11/15/86.” Pl. Opp. Mem. at 3, n. 1. | 4 | The purchase offer states the purchaser is the Washington partnership. However, the shares were actually sold in equal portions to the four individual “partners.” | 5 | The parties did not explain how PTW could owe approximately $25,000 to the partnership when, according to Maze, the partnership was never formed. | 6 | “Stock issued in consideration for cancellation of indebtedness of the corporation shall be considered issued in exchange for money or other property unless such indebtedness is evidenced by a security, or arises out of the performance of personal services.” 26 C.F.R. §1.1244(c)-1(d). | 7 | Defendant concedes for purposes of its motion that PTW was a domestic corporation. See Def. Reply Brief at 5. | |
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