STATE OF WISCONSIN
TAX APPEALS COMMISSION
JOHN AND FRANCES (deceased) DEBELAK
11901 W. Hayes Avenue
West Allis, WI 53227,
WISCONSIN DEPARTMENT OF REVENUE
P.O. Box 8907
Madison, WI 53708,
11901 W. Hayes Avenue
West Allis, WI 53227,
WISCONSIN DEPARTMENT OF REVENUE
P.O. Box 8907
Madison, WI 53708,
|DOCKET NO. 01-I-50
DECISION AND ORDER
THOMAS M. BOYKOFF, COMMISSIONER:
This case comes before the Commission on a partial stipulation of facts submitted by the parties and after a December 5, 2001 trial in Waukesha, Wisconsin. Attorney Gregory J. Ricci represents petitioners. Attorney Michael J. Buchanan represents respondent, Wisconsin Department of Revenue ("Department"). At the trial, the Department waived the personal appearance of John Debelak. Both parties filed post-trial briefs.
Having considered the entire record and the briefs of the parties, the Commission finds, concludes, and orders as follows:
FINDINGS OF FACT
As part of its Findings of Fact, the Commission adopts the parties' partially stipulated facts, making non-substantive format changes and deleting references to exhibits, as follows:
Stipulated Jurisdictional Facts
1. Under date of May 29, 1997, petitioners filed their 1996 Wisconsin income tax return,(1) along with a copy of their 1996 federal income tax return. Petitioners reported the sale of Debelak Brothers, Inc., ("Debelak Brothers") as a capital loss on December 31, 1996 and calculated the loss on an attachment to their federal Schedule D as follows:
Sales price: 700,514
Loss: $ 730,118
2. Under date of March 11, 1998, petitioners filed an amended 1996 Wisconsin income tax return, along with an amended 1996 federal income tax return. The sale of Debelak Brothers was reported on their federal Schedule D as a short-term capital loss of $730,118 and described, on an attachment to Schedule D, as a short-term capital loss, a "Non Business Bad Debt," a "Demand laon [sic] to debtor," and as a "Debt written off as worthless."
3. Under date of November 22, 1999, the Department issued an assessment to petitioners of $27,977.54, consisting of income tax, interest, and penalties, for income tax years 1996, 1997, and 1998 (the "period under review").(2) Referring to the claimed bad debt deduction, the Department's assessment explanation read, in part:
Forgiveness of debt, to a related party, is not considered a bad debt for tax purposes. . . . [After its sale,] it appears that Debelak Bros. Inc. will have the ability to repay a portion if not all of the remaining debt. . . .
The Department concluded that the debt was not worthless, and that the proper way to characterize the amount claimed as a bad debt was as a long-term capital loss on petitioners' 1996, 1997, and 1998 income tax returns.
4. Under date of January 21, 2000, petitioners filed a petition for redetermination with the Department objecting, in part, to the assessment.
5. Under date of January 22, 2001, the Department denied the petition for redetermination and stated that petitioners have "not established that the nonbusiness debt owed you by Debelak Bros., Inc. was completely worthless in 1996. A voluntary cancellation by a creditor of a debt owed by a debtor does not give rise to a bad debt deduction. . . . "
Additional Stipulated Facts
6. Until February 27, 1997, Mr. Debelak was the president of and owned 100% of the corporate stock of Debelak Brothers. Debelak Brothers was engaged in the plumbing and heating contracting business in Wisconsin, with its principal place of business located at 1100 West Bruce Street, Milwaukee.
7. Between December 31, 1993 and December 31, 1996, Mr. Debelak made 19 cash advances(3) to Debelak Brothers in varying amounts, ranging from $10,000 to $300,000, totaling $1,731,039. These advances were reflected on financial statements of Debelak Brothers covering 1994 and 1995, prepared by CPAs, and were identified as "an unsecured loan payable to [the corporation's] shareholder." In the 1996 statement, the advances were identified as "SHAREHOLDER ADVANCE." In Debelak Brothers' 1993 through 1996 federal corporate franchise/income tax returns, the advances appear on Schedules L, page 4, line 18 ("Other current liabilities (attach Schedule 6)"),(4) rather than on line 19 ("Loans from stockholders"). None of these advances were evidenced by a written document, secured by any collateral, or had any written interest rate or repayment terms. Mr. Debelak did not demand repayment of or commence legal action to collect any of these advances. These Schedules L also state that $155,000 of common stock was issued as capital stock.
8. From March 31, 1995 to January 11, 1996, petitioner received six repayments of advanced amounts, totaling $300,407.11.(5)
9. Until February 27, 1997, petitioners' son John E. ("Jed") Debelak ("Jed Debelak") was an officer and employee of Debelak Brothers.
10. Under date of February 27, 1997, an "Asset Purchase Agreement" ("Agreement") and "Promisory Note" were executed by Debelak Brothers, as seller, and Jed Debelak for DBI Acquisition Corp. ("DBI"), as purchaser.(6) Shortly after this transaction, DBI changed its name to Debelak, Inc. Debelak Brothers' business, stock, and other assets were not advertised for sale to the general public.
11. The Agreement provided, in part, for the sale of accounts receivable; cash in the liabilities and obligations of the seller but not "any debt or other obligation of the Seller to John Debelak or John Debelak doing business as Mill Investments, a sole proprietorship . . ."; inventory, licenses, and permits; and "Purchased Assets" which included "the Equipment" and "all other assets and properties . . . used in the conduct of the business."
12. After the February 27, 1997 purchase and sale, DBI operated its plumbing and heating contracting business out of the same headquarters, using mostly the same employees, and using the same telephone number of Debelak Brothers. The number and size of projects were reduced, but the business continued to operate.
13. After the transfer under the Agreement, Debelak Brothers was not dissolved, and it continued doing some business. Despite the Agreement, approximately $368,000 of property used in the plumbing and heating contracting business did not transfer to DBI. This property included service trucks, vans, hand tools, office furniture and fixtures, and "some items of machinery and equipment." The real property on which the business was located also did not transfer. Much of the above personal property was owned by Mr. Debelak d/b/a Mill Investment Company and was leased to Debelak Brothers and to DBI.
14. The record is unclear as to precisely which items of personal property that were used directly in the plumbing and heating contracting business were transferred under the February 27, 1997 Agreement. The Agreement defines "Purchased Assets" to include the "Inventory . . ."; "Equipment . . ."; and "all other assets and properties, whether tangible or intangible, or interests therein, used in the conduct of the Business." These terms are not defined with greater specificity.
15.Items not covered by the term "Purchased Assets" are also listed in the Agreement, and some of these items create ambiguities. For example, Purchased Assets includes "cash in corporate bank accounts" and excludes "all cash on hand and in banks, cash equivalents, marketable securities and other investments." The Agreement also transfers "the Books and Records" and excludes "the Excluded Books and Records", without further explanation.
16.The purchase price under the Agreement was the book value of the Purchased Assets as of December 31, 1996, "as determined by Kanisar & Spindler S.C., which written determination shall be delivered to John Debelak and Attorney William Fitzhugh Fox prior to the execution" of the Agreement. The "written determination" with a list of assets is not in the record.
17.At the February 27, 1997 closing of the transaction, DBI paid Mr. Debelak $10,000 and executed a promissory note for $690,514 in which payment terms were provided. Among its obligations under the promissory note, DBI was required to make $2,000 monthly payments of principal only, not interest, until January 1, 1999 "to help [DBI] out in the first few years." These payments on and after January 1, 1999 include both principal and interest. In addition, DBI was obligated to make annual payments of principal beginning on April 1, 1998, and each year thereafter, equal to 30% of DBI's cash flow from its operations from the preceding year ending December 1, less the amount of principal included in the $2,000 monthly payments.
18.In a letter dated September 18, 1997, the CPA who worked on Mr. Debelak's behalf on the February 27, 1997 transaction wrote a letter to Gregory Ricci, Mr. Debelak's attorney. The CPA wrote that he prepared a restated balance sheet for Debelak Brothers as of December 31, 1996 that "reflects the discharge of indebtedness by John Debelak", and that this discharge relates to the book value of the assets which DBI purchased. He stated the book value "is what can be expected to be realized by Debelak Bros., Inc. based upon the sale of those assets. Any amounts advanced by John Debelak in excess of this asset sale has been included as the discharge of indebtedness."
Was it proper for the Department to disallow all or a portion of petitioners' non-business bad debt deduction of $730,118 which they claimed on their 1996 Wisconsin individual income tax return?
CONCLUSION OF LAW
The Department properly disallowed the entire non-business bad debt deduction of $730,118 petitioners claimed on their 1996 Wisconsin individual income tax return.
If petitioners are correct that Mr. Debelak's cash advances to Debelak Brothers were a loan,(7) was the 1996 non-business bad debt deduction proper?
The stipulated facts provide that Mr. Debelak made 19 cash advances to Debelak Brothers between December 31, 1993 and December 31, 1996 totaling $1,731,039. ( Fact 7.) The parties further stipulated that from March 31, 1995 to January 11, 1996, Mr. Debelak received six repayments of advanced amounts totaling $30,407.11. (Fact 8.) Mr. Debelak's un-repaid advances, therefore, equaled $1,430,631.89 on December 31, 1996. The parties further stipulated that Mr. Debelak's advances were non-business debts. (Fact 3 and statement of the issue.)
Section 166 of the Internal Revenue Code, subsection (d), titled "NONBUSINESS DEBTS," states in part:
where any nonbusiness debt becomes worthless within the taxable year, the loss . . . shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year.
Section 166(d)(1)(B). [Emphasis added.]
This provision is interpreted by Treas. Reg. § 1.166-5(a)(2),which reads, in part, as follows:
If, in the case of a taxpayer other than a corporation, a non-business bad debt becomes wholly worthless within the taxable year, the loss resulting therefrom shall be treated as a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year . . . A loss on a nonbusiness debt shall be treated as sustained only if and when the debt has become totally worthless, and no deduction shall be allowed for a nonbusiness debt which is recoverable in part during the taxable year. [Emphasis added.]
Petitioners argue that, although Debelak Brothers owed Mr. Debelak $1,430,631.89 on December 31, 1996, petitioners' reduction of their income by a claimed non-business bad debt on their 1996 income tax return equaling $730,118 was proper even though the entire debt was not "totally worthless." After the claimed deduction, Debelak Brothers still owed Mr. Debelak $700,513.89 based on his cash advances. Petitioners concede that the entire amount of the advances were not worthless. Therefore, petitioners' argument fails, and, under the applicable I.R.C. and Treas. Reg., the Department's disallowance of the claimed bad debt deduction was proper.
Petitioners argue that their non-business bad debt is a proper deduction under I.R.C. § 166 because it became worthless in 1996. This is repetitious, and does not account for the exact language of § 166 and the interpreting regulation cited above to the effect that the entire debt must be worthless in the year it is deducted.
Petitioners speculate that the Department's position may be based on the contention that Mr. Debelak's cash advances were not "debts" and, instead, were contributions to capital. They then assert that the Department "offers no support for this position." (Petitioners' Reply Brief, p. 1.) This does not recognize the long-standing principle that assessments of the Department are presumptively correct, and the burden of proof is not on the Department, but is on the person challenging them as incorrect. Department of Taxation v. O. H. Kindt Manufacturing Company, 13 Wis. 2d 258 (1961) and Woller v. Dep't of Taxation, 35 Wis. 2d 227 (1976).
To rebut the Department's position, one of petitioners' witnesses - a CPA "opined during the hearing . . . that the worthless debts were in fact uncollectible." (Petitioners' Initial Brief, unnumbered third page.) That witness did so testify, but did not address whether the entire debt was worthless in 1996. In addition, the testimony was only an opinion, which does not bind the Commission. No facts in the record demonstrate that the total of the amounts owed Mr. Debelak were worthless in 1996.
Petitioners also assert that they have shown that the amount deducted by petitioners was worthless. However, the record does not so demonstrate. Even if a portion of a non-business bad debt were deductible, they have only shown that the corporation wrote off the portion on its books and that its CPA witness believes that it was proper. Sufficient facts underlying and supporting this conclusion are not in the record. However, this issue need not be further explored. Petitioners have only shown that Debelak Brothers wrote off the amount as worthless, without a factual basis as to why; that Debelak Brothers' business had declined between 1993 and 1996 (but the corporation still functioned); and that their CPA witness believed the partial debt was worthless.
Petitioners further assert that "each Advance stands on its own and represents a separate loan," some of which were totally worthless in 1996. (Petitioners' Reply Brief, p. 6.) This assertion, however, is not supported in the record. It is not shown that each cash advance was treated on Debelak Brothers' books or other records as a separate loan. Nor is any repayment directly tied to any specific cash advance. The record also does not support the claim that any individual advance was uncollectible.
Further, petitioners' argument of a partial worthless debt on December 31, 1996 is contradicted by two significant facts: (1) On December 31, 1996, Mr. Debelak made an additional cash advance to Debelak Brothers of $160,000; and (2) when the corporation's sale was consummated on February 27, 1997, Mr. Debelak accepted a note from the purchaser in the amount of $690,514. These facts contradict petitioners' assertions that Debelak Brothers and its successor were financially weak and unable and unlikely to eventually repay the amount claimed as a non-business bad debt.
In conclusion, it was proper for the Department to disallow petitioners' entire non-business bad debt deduction of $730,188 on their 1996 Wisconsin income tax return. For a non-business bad debt to be deductible, the Internal Revenue Code and its regulations are clear that the entire debt must be worthless.(8) That was not so here.
IT IS ORDERED
That respondent's action on petitioners' petition for redetermination is affirmed.
Dated at Madison, Wisconsin, this 22nd day of October, 2002.
WISCONSIN TAX APPEALS COMMISSION
Don M. Millis, Commission Chairperson
Thomas M. Boykoff, Commissioner
Richard F. Raemisch, Commissioner
ATTACHMENT: "NOTICE OF APPEAL INFORMATION"
1 Although the agreement transferring Debelak Brothers was not signed until February 27, 1997, the Department did not object to petitioners' reporting this transaction on their 1996 income tax return. William Fox, Mr. Debelak's attorney, testified that, on December 30, 1996, the terms of the agreement were known, and it was just a matter of getting the terms written into a formal agreement. Transcript pp. 49-50.
3 In the parties' Partial Stipulation of Facts, exhibits are referred to as stating the dates and amounts Mr. Debelak "claims represent advances he made to Debelak Brothers, Inc.," (Fact 11) and dates and amounts Mr. Debelak "claims represented repayments he received from Debelak Brothers, Inc." (Fact 12.) The testimony and exhibits are sufficient for the Commission to find, as facts, that these advances and repayments were made.
6 A supplemental "DBI Acquisition Corp. Assumption Agreement" was also executed by the parties. Under this supplemental agreement, DBI agreed to assume the defense and be responsible for all defense costs of a pending lawsuit. It is not relevant to the issue before the Commission.
7 The parties' briefs extensively argue whether Mr. Debelak's cash advances were loans or contributions to capital. It is not necessary to resolve this disagreement because the case is decided on other grounds.