STATE OF WISCONSIN
TAX APPEALS COMMISSION
GAYLE R. DVORAK
GAYLE R. AND NORENE M. DVORAK
3635 S. Bainbridge Drive
Bloomington, IN 47401,
WISCONSIN DEPARTMENT OF REVENUE
P.O. Box 8907
Madison, WI 53708,
|DOCKET NO. 00-I-01
DOCKET NO. 00-I-02
DECISION AND ORDER
THOMAS M. BOYKOFF, COMMISSIONER:
These cases were heard in Waukesha, Wisconsin, on March 7, 2001. Gayle R. Dvorak ("Mr. Dvorak") represents both petitioners, and Deputy Chief Counsel Robert J. Hackman represents respondent, Wisconsin Department of Revenue ("Department"). At the trial, the Department waived the personal appearance of Norene M. Dvorak. Both parties have filed post-hearing briefs.
Having considered the entire record and the briefs of the parties, the Commission finds, concludes, and orders as follows:
FINDINGS OF FACT
1. Under date of February 27, 1989, the Department issued an assessment to both petitioners for $10,015.36, consisting of income tax and interest, for tax year 1986. Under the same date, the Department issued an assessment to Mr. Dvorak for $30,714.73, consisting of income tax and interest, for tax years 1982 through 1985.
2. Under date of April 26, 1989, petitioners appealed both assessments by filing petitions for redetermination with the Department.
3. Under date of November 2, 1999,(1) the Department granted in part and denied in part both petitions for redetermination, whereupon petitioners filed timely petitions for review with this commission.
4. Mr. Dvorak has been a certified public accountant since 1972.
5. Prior to and during the period under review,(2) Mr. Dvorak had business interests in four corporations (DRI, Inc.; DRI Two, Inc.; DRI Three, Inc.; and DRI Four, Inc., hereafter "DRI", "DRI 2", DRI 3", and "DRI 4") and one partnership (Parkview Heights Partnership, hereafter "Parkview Heights") which are the subject of several issues in these cases.
6. Most of the disputes regarding the four corporations relate to whether Mr. Dvorak has substantiated adjustments to his bases in the corporations, specifically additions to his initial investments. The Department also adjusted petitioners' gain on the sale of their personal residence which they reported on their 1986 income tax return, adjusted the total itemized deductions which they claimed on their 1983 income tax return, and added $83,500 to their 1985 income tax return for the asserted cancellation of a debt.
7. DRI was incorporated in May 1981 and filed income taxes as a Subchapter S corporation. This corporation's shareholders were Mr. Dvorak, William F. O'Donnell, Leo C. Talsky, Lawrence Bavaratti, and Harold Lardinois. DRI owned and operated a radio station in Mississippi.
8. Mr. Dvorak's initial investment in DRI, like the other investors', was a $20,000 stock purchase and a $6,000 loan. He has no checks or receipts to verify this. Subsequently, he purchased a radio tower and had it transported to Mississippi for use by the corporation. He claims to have paid for the tower by check, but does not have the check to verify the purchase. He also invested other money in DRI, but has no check or promissory note to verify any of the amounts. The Department has determined Mr. Dvorak's basis in this corporation as $26,000. Mr. Dvorak asserts that the basis is more, but has not substantiated a higher amount.
9. On Schedule E ("Supplemental Income Schedule") of their 1981 through 1985 federal Forms 1040, petitioners claimed total losses of $30,825 from DRI. The Department disallowed losses exceeding the $26,000 basis. Petitioners also reported on Schedule D ("Capital Gains and Losses") of their 1985 income tax return that they sold Mr. Dvorak's shares of DRI for $1, with a basis of $11,239, for a loss of $11,238. Because the Department had allowed $26,000 in losses on Schedule E, it adjusted Mr. Dvorak's basis to zero. With a basis of zero and a reported sale price of $1, the Department disallowed the long-term capital loss reported and recomputed Mr. Dvorak's gain as $1.
10. DRI 2 was also incorporated in 1981, filed income taxes as a Subchapter S corporation, and owned a radio station in Mississippi. Mr. Dvorak, the corporate president, made an initial investment by purchasing $12,500 of stock and by giving a $5,500 note. Other shareholders were Mr. O'Donnell, Mr. Talsky, and Mr. Lardinois.
11. The Department determined that Mr. Dvorak's basis in this corporation was $18,000. Mr. Dvorak asserted that his basis had increased and that he made additional cash contributions by check, but he could not substantiate either assertion.
12. On Schedule E of their 1982 through 1985 federal Forms 1040, petitioners claimed losses from this corporation of almost $33,000. The Department disallowed losses exceeding the $18,000 basis. Petitioners also reported on Schedule D of their 1985 income tax return that Mr. Dvorak sold his shares of DRI 2 for $1, with a negative basis of $896, for a gain of $897. Because the Department had allowed $18,000 in losses on Schedule E, it adjusted Mr. Dvorak's basis to zero. With a basis of zero and a reported sale price of $1, the Department recomputed Mr. Dvorak's gain as $1.
13. DRI 3 was incorporated in 1982, filed income taxes as a Subchapter S corporation, and operated a radio station in Mississippi. Mr. Dvorak was the corporate president, and the other shareholders were Elmer Miller, William Mikitch, and Mr. Lardinois. The record is unclear as to Mr. Dvorak's initial investment. At an unspecified time, he invested $7,500 and purchased a used car for the corporation. The Department established Mr. Dvorak's basis in this corporation as $7,500. Mr. Dvorak asserted that his basis was larger but could not substantiate a higher amount.
14. On Schedule E of their 1983 through 1985 federal Forms 1040, petitioners claimed total losses from this corporation of $23,421. The Department disallowed losses exceeding the $7,500 basis. Petitioners also reported on Schedule D that Mr. Dvorak sold his shares of DRI 3 for $1, with a basis of $7,806, for a loss of $7,805. Because the Department had allowed $7,500 in losses on the Schedules E, it adjusted Mr. Dvorak's basis to zero. With a basis of zero and a reported sale price of $1, the Department disallowed the long-term capital loss reported by Mr. Dvorak and recomputed a gain of $1.
15. DRI 4 was another corporation which owned a radio station and filed income taxes as a Subchapter S corporation. Mr. Dvorak used his own funds to purchase some small pieces of equipment for the corporation. He claims to have invested $37,500. The Department established a zero basis for Mr. Dvorak because he did not substantiate any investment in this corporation.
16. On Schedule E of their 1983 through 1985 federal Forms 1040, petitioners claimed total losses of $89,262 from this corporation. The Department disallowed all the losses because petitioners had not substantiated any basis in the corporation. On Schedule D of their 1985 income tax return, petitioners reported the sale of Mr. Dvorak's stock in this corporation as $1, with a $5,954 basis, and claimed a capital loss of $5,953. The Department disallowed this capital loss and recomputed the gain on the transaction as $1.
17. Mr. Dvorak had a 20% partnership interest in Parkview Heights. On their 1982 through 1985 income tax returns, petitioners claimed losses arising from this partnership. On Schedule E of their 1985 federal Form 1040, petitioners claimed a $7,438 loss from the partnership. The Department disallowed all but $428 of this amount. The Department did not recognize the partnership's claimed $38,880 interest paid on a loan as a valid deduction on the partnership return. Petitioners asserted that, except for $3,830, the interest was paid by the partnership's including it, or rolling it over, into a refinanced loan. The Department disallowed the rolled-over interest deduction to the partnership because none of the partners paid any of it. Mr. Dvorak's disallowed share of the partnership's claimed interest expense was $7,438. The Department allowed Mr. Dvorak's $428 share of the partnership's $3,830 interest expense, which was actually paid by the partnership.
18. In August 1980, Mr. Dvorak sold 25% of his 20% partnership interest in Parkview Heights to a pension plan for $62,500. As the pension plan required, Mr. Dvorak agreed to indemnify and hold the plan harmless for any losses it may have incurred from this partnership interest. Mr. Dvorak made no payments to the pension plan under this indemnification agreement.
19. In July 1985, Mr. Dvorak sold the remainder of his partnership interest to another party for $25,000. On Schedule D of their 1985 income tax return, petitioners included $62,500 in Mr. Dvorak's basis in the partnership, which he reported as $9,388, and reported a $15,612 gain on the sale. The Department disallowed the $62,500 in the basis computation and recomputed Mr. Dvorak's gain as $78,985.35.
Itemized Deductions in 1983
20. On their 1983 income tax return, petitioners claimed as itemized deductions $20,893 interest paid on their home mortgage, $510 interest paid to Elwood F. Dvorak, $2,487.66 interest paid to Lowell T. Dvorak, and $428.20 interest paid to Richfield State Bank, for a total of $25,048 of interest payments. The Department disallowed these deductions on the basis that petitioners could not substantiate any of them.
Cancellation of Debt in 1985
21. Mr. Dvorak borrowed funds several times from Mr. Lardinois and executed promissory notes totaling $83,500. These notes were secured by Mr. Dvorak's stock in the DRI corporations and in another corporation, Packaging Services & Supplies, Inc. Because Mr. Dvorak defaulted on the notes, Mr. Lardinois took possession of the stock and sold it in August 1985. The Department added $83,500 (the total of the cancelled debts) to petitioners' 1985 income.
Sale of Personal Residence in 1986
22. Petitioners purchased their residence in Mequon, Wisconsin, which included servants' quarters, for $90,000 in 1975. In 1985, petitioners sold the servants' quarters for $32,968. On their 1985 income tax return, petitioners reported a $25,000 basis, depreciation of $7,000, an adjusted basis of $18,000, and a total gain of $14,968.
23. On their 1986 income tax return, petitioners reported that they sold their personal residence on January 3, 1986 for $170,790. They reported a basis in the residence of $109,902 and a gain of $60,888. However, in an August 22, 2000 interrogatory, petitioners contended that this sale is exempt from taxation because it was sold at a foreclosure sale. (Exhibit 38, answer to interrogatory no. 7 g.) In its action on petitioners' petition for redetermination, the Department adjusted the gain to $90,000.
CONCLUSIONS OF LAW
1. Petitioners did not overcome the presumptive correctness of the Department's actions on their 1982 through 1986 income tax returns regarding the bases of and deductions attributable to the 4 DRI corporations and Parkview Heights, interest deductions taken on their 1983 tax return, and a gain on the sale of their personal residence in 1986.
2. Mr. Dvorak improperly added $62,500 to his basis in Parkview Heights Partnership, after executing an indemnification agreement to pay any losses arising out of that partnership up to $62,500 and then not being required to pay anything under the indemnification agreement.
3. Mr. Dvorak improperly deducted his portion of the unpaid interest on the refinancing of Parkview Heights Partnership, after the principal and unpaid interest was rolled over into a refinanced loan.
4. Petitioners failed to prove that the Department incorrectly added $83,500 to their 1985 income after Mr. Dvorak's loan to Mr. Lardinois in that amount was cancelled in 1985 in exchange for Mr. Dvorak's stock in the DRI corporations and in Packaging Services & Supplies, Inc.
This case is primarily one of substantiation, or perhaps more appropriately described as a lack of substantiation. The Department issued two assessments in February 1989 to petitioners, which petitioners asked the Department to reconsider. Petitioners then signed 20 extension agreements(3) allowing the Department additional time to act, in addition to the original 6 months allowed under Wis. Stat. § 71.88(1)(b). These extensions also gave petitioners additional time to locate documents to substantiate their assertions. Finally, on November 2, 1999, the Department acted on the appeals by granting them in part and denying them in part. Petitioners then filed timely appeals with the Commission.
This commission has long recognized the Wisconsin Supreme Court pronouncement that income tax assessments of the Department are presumptively correct, and the burden of proving them incorrect rests with the people assessed. See Department of Taxation v. O. H. Kindt Manufacturing Co., 13 Wis. 2d 258 (1961); Woller v. Dep't of Taxation, 35 Wis. 2d 227 (1967); and Margaret J. Dye v. Wisconsin Dep't of Revenue, Docket No. 00-I-49, p. 8 (WTAC March 26, 2002).
The Commission clearly stated its views on the presumption of correctness and on the burden of proof in O'Donnell et al. v. Wisconsin Dep't of Revenue, Wis. Tax Rptr. (CCH) ¶ 400-089 (WTAC 1994)(4) as follows:
Under I.R.C. § 1012, and Treas. Reg. § 1.1012, et seq., the [Department] properly disallowed increases of $20,000 each in the petitioners' bases in DRI shares as a result of advances of funds which they claimed were made during 1983 by Harold Lardinois to DRI.
The primary basis for our conclusion is the absence of any documentation in this case to substantiate the form or substance of any advance made by Lardinois to DRI in 1983. Testimony by interested parties which is not corroborated by other evidence will not overcome the presumption of correctness of respondent's assessment. Havas v. Comm'r, 73-2 USTC ¶ 9561 (9th Cir. 1973). [Emphasis in original.]
Mr. Dvorak has failed to substantiate the following items in petitioners' 1982 to 1986 income tax returns: deductions attributable to, and increases in the bases of, the 4 DRI corporations and Parkview Heights; interest deductions taken on their 1983 tax return; and a lower gain on the 1986 sale of their personal residence.
At the trial of these cases, Attorney Carl L. Dubin testified on behalf of Mr. Dvorak. He stated that his income tax returns had been audited by the Department relating to Parkview Heights on an interest deduction he had claimed, and that the circuit court reversed the Commission at that time on the Department's Parkview Heights adjustment, resulting in no change to the portion of the tax return involving Parkview Heights. However, no information was provided on Mr. Dubin's case which might be precedent for the Commission in acting on the instant cases.(5)
Mr. Dubin also testified that, between 1982 and 1987, he loaned money to Mr. Dvorak and that he believed the money "ultimately went to those [DRI corporations'] radio stations." (Transcript, p. 45.) Mr. Dubin further testified that, in 1985, he transferred his entire interest in Parkview Heights to Mr. Dvorak and William S. Wolf to repay his loans from them. Mr. Dubin's testimony did not prove that money he loaned Mr. Dvorak was invested in any of the DRI corporations. Nor did his testimony relate directly to Mr. Dvorak's basis in Parkview Heights. The testimony is not probative of or relevant to Mr. Dvorak's attempt to substantiate his bases in the DRI corporations or in Parkview Heights.
Petitioners assert that the Department "used time as their ally and sat on this matter while the FBI(6) and [petitioners'] attorney . . . mishandled and lost all the financial information" about the 4 Subchapter S corporations at issue in the assessments. Petitioners further assert that, since the assessments were issued, they have "moved [their] residence four times and [Mr. Dvorak's] office five times. . . ."
(Petitioners' Initial Brief, p. 1.) The accusation is that the Department intentionally delayed action on petitioners' petitions for redetermination, with the hope and expectation that petitioners' records would be lost or misplaced and, therefore, not be available for petitioners to substantiate entries on their 1982 through 1986 income tax returns.
This assertion, however, ignores some basic facts. First, petitioners voluntarily signed 20 extension agreements over an 11 year period. Second, both parties benefited from the extensions. Besides giving the Department additional time to act on petitioners' appeals, the extensions also gave petitioners additional time to search for their tax records. Petitioners make no allegation of coercion. At any time, petitioners could have refused to sign an extension agreement, to move their cases forward. They cannot now benefit from the lengthy time period which they voluntarily permitted to occur.(7)
Mr. Dvorak asserts that the DRI corporations' losses should be restored to the amount claimed on petitioners' income tax returns. However, he provides no substantiation for additions to his bases in the corporations or for corporate deductions. The Commission has held that a taxpayer's self-serving testimony must generally be substantiated by other proof. Zablocki v. Wisconsin Dep't of Revenue, Wis. Tax Rptr. (CCH) ¶ 400-516 (WTAC 2000). See, Treas. Reg. 1.274-5T. The claimed DRI corporations' losses were not substantiated.
Mr. Dvorak argues that the IRS assessed him personally for $108,000 of unpaid withholding taxes of three DRI corporations and that this amount should be added to the bases of his investment in the corporations. Mr. Dvorak has offered no proof that he paid any part of the IRS assessment. Cases have held that if a taxpayer does not personally pay any corporate indebtedness, no increase in the basis is permitted. See, Ley v. Comm'r, 66 T.C.M. 113, 117 (1993), and Leavitt Est. v. Comm'r, 89-1 U.S.T.C. ¶ 9332, at p. 87,856 ("To increase the basis in the stock of a subchapter S corporation, there must be an economic outlay on the part of the shareholder.")
Mr. Dvorak argues that his sale of 25% of his 20% partnership interest in Parkview Heights for $62,500 and an indemnification to hold the purchaser harmless for any losses it may have occurred from this partnership interest authorizes him to add $62,500 to his basis in that partnership. Cases have held to the contrary when there is no economic outlay under the indemnification agreement, as in this case. See, Leavitt Est. supra and Brand v. Comm'r, 81 T.C. 821, at p. 3984 (1983).
Mr. Dvorak also asserts that by refinancing a Parkview Heights' loan and rolling over the unpaid interest on the prior loan, he may deduct his share of that unpaid interest against partnership income. This defies logic. Merely becoming obligated for the interest, rather than paying it, does not authorize the claimed deduction. The "economic outlay" analysis in Leavitt Est. supra applies here, as well.
Mr. Dvorak disagrees with the Department's assertion that he realized income on the cancellation of his $83,500 debt in 1985. A cancellation of debt occurred when he gave his stock in the DRI corporations and in Packaging Services & Supplies, Inc., to Mr. Lardinois. These were pledged as security for his debt.
Section 61(a)(intro) and (12) of the Internal Revenue Code provides:
(a) GENERAL DEFINITION. Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
* * *
(12) Income from discharge of indebtedness; . . .
See, I.R.C. Reg. § 1.61-12. Petitioners provided no evidence in the record of the value of the stock exchanged for the debt forgiveness, which may have offset some or all of the taxable debt forgiven.
The Department's actions on petitioners' petitions for redetermination are affirmed.
Dated at Madison, Wisconsin, this 30th day of April, 2002.
WISCONSIN TAX APPEALS COMMISSION
Don M. Millis, Commission Chairperson
Thomas M. Boykoff, Commissioner
Richard F. Raemisch, Commissioner
ATTACHMENT: "NOTICE OF APPEAL INFORMATION"
1 Petitioners signed 20 extension agreements between 1989 and 1999 which granted the Department additional time to act upon their appeals, in addition to the 6 months provided under Wis. Stat. § 71.88(1)(b). Although Norene M. Dvorak did not sign the October 18, 1993 and the April 29, 1994 agreements, the Department treated her assessment as if she had signed them.
5 In Carl L. and Sari L. Dubin v. Wisconsin Dep't of Revenue, Wis. Tax Rptr. (CCH) ¶ 400-145 (Milw. Co. Circuit Ct. July 18, 1995), the Court reversed an oral decision of the Commission and held that petitioners presented sufficient evidence that proceeds from a loan were used for construction of a residence. Therefore, interest paid on the loan was deductible on their 1986 Wisconsin income tax return. In the instant cases, the Department does not dispute the validity of interest paid on a home loan to the Dvoraks.
6 In about 1986, Mr. Dvorak was the subject of an FBI-initiated federal grand jury investigation into his expenditures relating to the DRI corporations. Mr. Dvorak was represented by counsel and gave his records to his attorney, who, it seems, gave them to either the FBI or to the grand jury. (Transcript, p. 72, line 12, to p. 75, line 5.) Mr. Dvorak stated that the records were not returned to petitioners. Mr. Dvorak has not proven that the records were given or that any attempt to recover them was made.
7 Nothing in the statutes authorizes sanctions by the Commission against the Department for failing to comply with the six-month limitation to act on a petition for redetermination in § 71.88(1)(b). "The Dane County Circuit Court's decision in Department of Revenue v. Vonasek & Schieffer, Inc., Wis. Tax Rptr. (CCH) ¶ 202-754 (Dane Co. Cir. Ct. 1986), rev'g in part, Wis. Tax Rptr. (CCH) ¶ 202-630 (WTAC 1985), held that respondent's failure to act on a petition for redetermination within six months did not bar respondent's assessment against taxpayers. Vonasek & Schieffer involved § 77.59(60)(a), Stats., which is identical in material respects to § 71.88(1)(b), Stats." Pfister Corp. v. Wisconsin Dep't of Revenue, Wis. Tax Rptr. (CCH) ¶ 400-302 (WTAC 1997); the decision subsequently was vacated by stipulation of the parties, but the quoted language is still a valid statement of the law.