1 MORRIS AND ANNETTE G. ALEXANDER, ET AL.,1 PETITIONERS v. COM MISSIONER OF INTERNAL REVENUE, RESPONDENT Docket Nos. 7389-70, 7668-70, 7669-70. Filed November 26, 1973. In October 1966, X, a corporation, sold its assets to Z for cash and other consideration, including an agreement by Z to pay all of X's income tax liabilities. Most of the cash proceeds of the sale were distributed to A, and X was liquidated. Held: 1. A did not receive a liquidating distribution from X in 1966, within the meaning of sec. 331, I.R.C. 1954, in the form of the cancellation of indebtedness on an open account in the amount of $149,602; 2. A realized income in the amount of $42,500, under sec. 61, I.R.C. 1954, upon the receipt of that amount from Z pursuant to an agreement obligating him to repay the advance only from future commissions; 3. A, a distributee of X's assets within the meaning of sec. 6901 (h), I.R.C. 1954, is liable as transferee for income taxes owing at the time of X's liquidation; A is not liable for X's income taxes which became due as a result of postliquidation refunds based on the tentative allowance of net operating loss carryback adjustments to prior years; 4. In computing the amount of the loss incurred by X on the sale of its assets for the purpose of determining its income tax for its final period, $320,000 of the sales price is allocated to trade accounts receivable and $80,000 is allocable to the account due from A; and 5. The assessments of transferee liability against A are not barred by the limitations period prescribed by sec. 6901 (c) (1), I.R.C. 1954. George B. Collins, for the petitioners. Lewis M. Porter, Jr., for the respondent. FEATHERSTON, Judge: These proceedings involve deficiencies in individual income taxes and transferee liabilities for corporate income taxes determined by respondent as follows: Petitioner(s) Morris and Annette G. Alexander........ Docket No. Year Amount 7389-70 (1966 Morris Alexander, Transferee of Perma-Line Corp. of America (formerly $65, 498.55 1, 129.00 Morris Alexander, Transferee of Perma-Line Corp. of America (formerly For convenience, Morris Alexander will be referred to herein as petitioner, Perma-Line Midwest Corp. as Midwest, and Perma-Line Corp. of America as Perma-Line. 1 The proceedings of the following petitioners are consolidated herewith: Morris Alexander, Transferee of Perma-Line Corporation of America (Formerly Perma-Line Manufacturing Corporation of America), successor by merger to Perma-Line Midwest Corporation, docket No. 7668-70; and Morris Alexander, Transferee of Perma-Line Corporation of America (Formerly Perma-Line Manufacturing Corporation of America), docket No. 7669-70. The following issues are presented for decision: (1) Whether petitioner's liability of $149,602 on an open account with Perma-Line was canceled in connection with the liquidation of that corporation so that the amount of the account is taxable to him as a liquidation distribution under section 331 (a) (1); 2 (2) Whether $42,500 received by petitioner in 1966 from the purchasers of Perma-Line's assets was a nontaxable loan or a taxable advance commission payment under section 61; (3) Whether petitioner is liable as transferee for any of PermaLine's unpaid income tax liabilities which were contractually assumed by the purchasers of its assets; (4) Whether Perma-Line, in computing its loss on the sale of its assets for the purposes of its final income tax return for the period ended January 31, 1967, properly allocated $104,000 of the sales price to "Officers Loans Receivable"; and (5) Whether the period of limitations on the assessments of transferee liability, prescribed by section 6901 (c), had expired when the notices of transferee liability were issued to petitioner. FINDINGS OF FACT General Morris and Annette G. Alexander, husband and wife, were legal residents of Chicago, Ill., at the time the petitions herein were filed. They filed their joint Federal income tax return for 1966 with the district director of internal revenue, Chicago, Ill. Perma-Line Manufacturing Corp. of America was formed as an Illinois corporation in December 1960. Later it became the surviving corporation in a statutory merger with Perma-Line Midwest Corp. After the merger was completed on April 30, 1966, the corporation changed its name to Perma-Line Corp. of America. Following the merger and until its liquidation, Perma-Line's outstanding capital stock was owned as follows: 2 All section references are to the Internal Revenue Code of 1954, as in effect during the tax years in issue, unless otherwise indicated. In addition to being its principal shareholder, petitioner was PermaLine's president during this period. Perma-Line was in the business of manufacturing and installing road-marking material. Its principal product was a hot extruded thermoplastic striping material used in marking traffic lanes. Distribution of its products was effected through sales made to franchise dealers which, prior to the merger, included Midwest. By May 1, 1966, it became apparent that Perma-Line would need additional capital if its operations were to grow. From its inception through 1965, the company had experienced a steady growth in sales. After 1965 Perma-Line's business began to level off. It did not have sufficient capital to finance expanded operations, particularly funds for research and development work. Perma-Line's lack of needed operating capital was caused, to a large extent, by the difficulty it had borrowing against the receivables it held from municipalities, villages, States, and transit authorities. Those receivables were slow-paying, could not be assigned, and were subject to warranties for repairs, replacements, and servicing. Under some of Perma-Line's agreements, the municipalities retained a portion of the contract price pending completion of a guarantee period, which ranged from 18 months to 3 years. Based on Perma-Line's experience, the most that could be borrowed against these receivables was an amount equal to between 30 and 40 percent of what was due. In the case of good industrial receivables, Perma-Line could borrow between 80 and 90 percent of the face amounts thereof. During 1965 and 1966, the Pritzker and Freund families became interested in acquiring Perma-Line. These families had sufficient credit and money to provide the additional capital needed for Perma-Line's growth and expansion. On their behalf, Robert Wisener (hereinafter Wisener), an executive with over 30 years of experience in the traffic safety field, conducted a thorough investigation of the company and its possibilities for profit and growth. Based on Wisener's year-long investigation of Perma-Line, the parties reasonably anticipated that within 2 or 3 years, the business would be capable of generating annual sales of $5 million, compared with gross receipts of $1,236,155.44 during its fiscal year ended April 30, 1966, and $1,332,577.23 during the period ended October 27, 1966.3 This conclusion was premised on Wisener's finding that this industry was on the verge of a tremendous increase in business, that only one. other company-Cataphote-both manufactured and installed thermoplastic highway striping, and that with the Pritzkers' money behind 3 Approximately 80 percent of Perma-Line's gross business was done between May 1 and November 1 each year. the operation, credit to operate the business could be more readily acquired. It was also anticipated that Wisener would run the business, thus giving it the benefit of his experience in this field. Arrangement for Sale of Perma-Line's Assets The negotiations with Wisener came to fruition on October 13, 1966, when Perma-Line and petitioner, individually, entered into an agreement with Simon Zunamon (hereinafter Zunamon), nominee for the Pritzker and Freund groups, to sell substantially all of Perma-Line's assets to Zunamon and his principals under a contemporaneously created partnership to be known as Perma-Line Co. (hereinafter P-L). The transaction was to be closed on October 27, 1966, and the consideration for the sale was $150,000 in cash and the assumption of most of Perma-Line's liabilities. P-L was formed on October 13, 1966, specifically to receive the assets of Perma-Line and to continue the operation of its business. The partners in P-L and their respective percentage interests in the partnership were as follows: Seymour R. Gross, Trustee of LaSalle Trusts Nos. 1-40 (Grantor 48 Simon Zunamon, Trustee of Maurice Trusts Nos. 1-7 (Grantor S. William Pattis, Trustee of Joyce Trusts Nos. 1-7 (Grantor Joyce 24 4 Total 100 In addition to the agreement by Perma-Line to sell its assets to P-L, the following papers, some of which are described in greater detail below, were executed by the parties on October 13, 1966: 1. Zunamon signed a letter, whereby he agreed to employ petitioner at an annual salary rate of $36,000, to render technical assistance and advice to P-L for the continued operation of the business; 2. Petitioner and Zunamon executed a document entitled "Sales Contract" in which petitioner was designated as the exclusive sales agent of P-L for a period of approximately 10 years;* 3. Zunamon signed a letter to petitioner in which he agreed that petitioner could assign the sales contract agreement to any corporation in which petitioner was a majority shareholder; and 4. Petitioner and Zunamon signed a document entitled "Security Agreement" in which petitioner assigned his rights to a portion of the moneys payable to him under the sales contract as security for his liability in the total amount of $192,500. The parties have stipulated that 532-904-74-19 the notes, described below, in the amounts of $74,801.24, plus interest of 4 percent per annum, payable to the Maurice and Henry L. Freund Charitable Foundation (hereinafter Freund Foundation), and $74,801.23, plus interest of 4 percent per annum, payable to the Pritzker Foundation, were secured by this agreement. As stated in "2" above, the sales contract designated petitioner as exclusive sales agent for a period ending April 30, 1976. Under paragraph 8 of the agreement, petitioner was to receive commissions on sales made by the business as follows: Commissions shall be paid on net sales (as used herein, net sales shall mean gross sales of those products and services described in Exhibit A, less freight, cartage out, trade discounts, returns and allowances) as follows: (a) 1% of all net sales up to $1,000,000.00. (b) If net sales are in excess of $1,000,000.00 and up to $3,000,000.00, paragraph 8(a) shall be of no effect and commissions shall be paid in an amount equal to 3% of all net sales. (c) If net sales are in excess of $3,000,000.00 and up to $5,000,000.00, an amount in addition to that specified in paragraph 8(b) equal to 2% of sales in excess of $3,000,000.00 but less than $5,000,000.00. (d) If net sales are in excess of $5,000,000.00, an amount in addition to that specified in paragraph 8 (b) and (c) equal to 1% of sales in excess of $5,000,000.00. As a practical matter, the term "net sales" as used in the agreement means gross sales of the products and services covered in the agreement. Paragraph 9 further provides that: "On November 1, 1970, Manufacturer [Zunamon] shall pay to *** [petitioner] the sum of Ten Thousand ($10,000.00) Dollars for services rendered under the terms. of this Agreement." This amount was in addition to the payments petitioner was to receive under paragraph 8. The sale of Perma-Line's assets to Zunamon as nominee was completed on October 27, 1966, in accordance with the terms of the October 13, 1966, sale agreement. Among the other assets owned by PermaLine at the time the sale was closed were trade accounts receivable in the amount of $424,701.74 and accounts due from its officers in the total amount of $163,352. These trade accounts and $149,602 of the accounts due from officers were transferred then to the Pritzker Foundation. The directors of Perma-Line, at a meeting held November 14, 1966, adopted a resolution authorizing the corporation's dissolution. The proceeds of the sale of Perma-Line's assets were distributed on that date as follows: To Morris Alexander: Life insurance policy (cash surrender value). $117, 741. 14 4,375.00 122, 116. 14 |