this insurance having been sold by petitioner to the associations in Anna R. Lavin, Esq., and Edward J. Calihan, Jr., Esq., for the petitioners. Don S. Harnack, Esq., and Warren C. Seieroe, Esq., for the respondent. The respondent has determined a deficiency in income tax against the petitioners for the taxable year 1956 in the amount of $547,967.55 and an addition to tax for fraud for such year in the amount of $273,983.78. Since the deficiency relates solely to the income of Charles Oran Mensik, he will hereafter be referred to as petitioner. The questions for decision are: (1) Whether petitioner realized income as the result of payments by City Savings Association to Melvin Building Corporation in respect of the remodeling of the office building of City Savings, and if so, the amount thereof. (2) Whether the sum of $10,000 received from Melvin Building Corporation was taxable income to petitioner. (3) Whether $6,800 paid by City Savings Association on a check drawn on its bank account showing Commercial Broadcasters as payee was income to petitioner. (4) Whether gains realized by petitioner from sales of real estate and from redemption of tax certificates are taxable as long-term capital gain, or as ordinary income. (5) Whether petitioner, who sold insurance policies to his own employees and employees of City Savings Association, and to friends and relatives, waiving his commissions, is taxable on the commissions so waived. (6) Whether advertising expenses paid by petitioner on behalf of First Guarantee Savings Association and Chicago Guarantee Savings Association are deductible by petitioner as an ordinary and necessary business expense. (7) Whether an amount paid by petitioner as rent on behalf of Chicago Guarantee Savings Association is deductible as an ordinary and necessary business expense. (8) Whether refunds of premiums on insurance policies purchased by First Guarantee Savings Association and Chicago Guarantee Savings Association, but received by petitioner and retained by him, are taxable to him. (9) Whether any part of the deficiency was due to fraud with intent to evade tax. FINDINGS OF FACT. Some of the facts and some evidence have been stipulated and the stipulated facts are found as stipulated. Petitioners are husband and wife, and residents of Chicago, Illinois. They filed a joint income tax return for the year involved with the district director of internal revenue in Chicago. During 1956 petitioner was managing officer, president, and chairman of the board of directors of City Savings Association, a mutual savings and loan association, located and operating in Chicago, which received deposits of money for investment purposes, largely in real estate mortgages. The City Savings Association, sometimes referred to as City Savings, had been in existence since 1908, and petitioner had been its managing officer since about 1942. Also during 1956 petitioner was chairman of the board of directors and owner of 98.8 percent of the issued and outstanding stock of First Guarantee Savings Association, and was a member of the board of directors and owner of 98.6 percent of the stock of Chicago Guarantee Savings Association. These two associations, sometimes referred to as First Guarantee and Chicago Guarantee, were Illinois savings and loan corporations, engaged in the same business as that of City Savings, and were likewise located in Chicago. They were organized by petitioner in June of 1955. In mutual savings and loan associations such as City Savings, the depositors have a right to participation in the earnings of the association. In the case of First Guarantee and Chicago Guarantee, which were stock companies, the profits and reserves belonged to the corporations and the depositors did not have a right of participation in the earnings, but were entitled only to the interest paid on their deposits. Melvin Building Corporation, hereafter referred to as Melvin, was organized in Illinois in 1945, by Carl M. Melberg, Mary Ann Barto, and Joseph Mensik, petitioner's father. From its inception, Melvin has been in the business of acquiring land, constructing business buildings, apartment buildings, and houses thereon, and selling the land with the buildings. During 1956 the record owners of the Melvin stock were Melberg, Barto, and Irene Kunitz, petitioner's sister. Joseph Mensik, who originally owned about 47 or 48 percent of the Melvin stock, decided in February of 1951 to retire from the construction business because of his advanced age. At the suggestion of petitioner, Robert Kramer, whose wife was a sister of petitioner's wife, agreed in writing to purchase 2,325 shares of Melvin stock from Joseph Mensik. Kramer had been a vice president of Melvin since 1947. He was employed as a supervisor for the Chicago Transit Authority, a position he had held since 1939. The contract of sale, dated February 26, 1951, provided that the purchase price was to be $7,750, that Kramer was to execute a judgment note1 in the amount of the sale price, but that in the event of default the stock was to be taken in complete satisfaction of the debt without Kramer being personally liable therefor. Despite the provision in the contract that a note was to be given in payment and that "the 2325 shares of Melvin Building Corporation stock shall be held as security by the seller [Joseph Mensik], together with the judgment note for the faithful performance of this contract," petitioner supplied the money to cover the purchase price and Joseph Mensik was paid in cash. Kramer gave petitioner a judgment note in the amount so paid, with the Melvin stock as collateral. At no time did Kramer ever have possession of any of the stock certificates. The note to petitioner did not bear interest, and no payments were ever made by Kramer on it. Later in 1951, petitioner suggested that Kramer purchase two lots on a tax foreclosure. The purchase price of $2,250 was supplied by petitioner for which Kramer executed a judgment note in favor of petitioner. Like the earlier note, this one did not bear interest and Kramer made no payments on it. Within a short time, Kramer traded the lots for 1,150 additional shares of Melvin stock which likewise were held by petitioner and never came into the possession of Kramer. Under date of December 17, 1953, Kramer and Irene Kunitz, a sister of petitioner, executed an agreement for the purchase by her of the 3,475 shares of Melvin stock issued in Kramer's name. Irene Kunitz then lived in New York. She had previously borrowed funds from petitioner with which to live while her husband was ill and the Joseph Mensik estate was being settled. He had advised her to buy the stock from Kramer. She was a housewife whose only business experience had been an occasional clerical job. She moved to Chicago in September of 1954. To pay for the stock, she executed a judgment note for $10,000 at 5 percent interest, payable to petitioner, who then discharged Kramer's notes. She has made no payments of principal on her note, and her first payment of interest was on January 29, 1958. Subsequent interest payments were made on March 18, 1958, and on May 21, 1958. The certificate or certificates covering the stock were delivered to her and she posted no collateral for the note. 1 The term "Judgment note," as used hereafter, refers to a promissory note which provides that to secure payment of the amount owing, the maker irrevocably authorizes any attorney to appear for him after maturity and without process to confess judgment in favor of the holder of the note for the amount owing, together with costs and an attorney's fee. Although she thinks her ownership of Melvin stock is “a little more than half," she has never attended a stockholders meeting but she has had conversations "on it." She is a director and was a director in 1956 but has never attended a directors meeting and was never consulted about loans or purported loans by Melvin to Orville Hodge. At or about the date of the stock purchase agreement between Kramer and Irene Kunitz, Kramer resigned his position with Melvin to become a vice president and director of City Savings and with petitioner to constitute a majority of its executive committee. As a member of the executive committee, he participated in the approval of loans. Prior to accepting the City Savings job, Kramer had been employed full time by Melvin for 8 months. When petitioner organized First Guarantee, he made Kramer its president. Mary Ann Barto, who was secretary-treasurer of Melvin during the taxable year, first became associated with petitioner in 1942, when she applied for a job as his secretary. Since then, she and petitioner have participated in various business ventures, and she has acted as his nominee on many purchases of real property. She was employed as secretary of First Guarantee from June 10, 1955, when it was organized, until June 30, 1956. All of Melvin's construction work was financed either by City Savings, First Guarantee, or Chicago Guarantee. During 1956 and for several prior years, City Savings made construction loans to Melvin in amounts of from $1 to $3 million per year. In transactions in which petitioner had an interest directly or indirectly and with which Carl Melberg, Kramer, or Mary Ann Barto were involved or concerned, they were subservient to petitioner, and where Melvin was a party to such transactions, petitioner, to a substantial degree, determined and directed the manner of their treatment on Melvin's books. In his individual capacity, petitioner established and conducted an insurance-selling business, using the name of City Insurance Agency, and a business of selling money orders and cashing checks for customers of City Savings, using the name of City Currency Exchange. Using the name Allied Investment Company, he engaged in the buying and selling of real estate and in other business transactions. City Insurance Agency, City Currency Exchange, and Allied Investment Company were in fact C. O. Mensik. He was also the sole stockholder of City Safety Deposit Corporation, which leased safety-deposit boxes to customers of City Savings. The offices of City Insurance Agency. Allied Investment Company, City Safety Deposit Corporation, and City Currency Exchange were located in the building owned and occupied by City Savings. In substantial part, if not wholly, petitioner's personal business operations resulted from his relationship with the savings and loan associations. Sometime in 1955 petitioner decided to have Melvin remodel the City Savings Association Building. The remodeling work was begun in September of 1955, and, except in some minor respects, was completed about the first week in March 1956. Plans for the remodeling were prepared by an architect by the name of Bagnuolo. It was his estimate that the total cost to City Savings would be $125,000. In the course of the remodeling some items were added which had not been included by Bagnuolo in making his estimate of cost to City Savings. One such item covered the setting up of three offices on the second floor, which would require the building of partitions therefor. Petitioner was not fully satisfied with Bagnuolo's suggestions as to these rooms, and it was agreed that they would be omitted from his original estimate and would be included as the work progressed. After the work was under way, it was discovered that certain partition walls were supporting walls and when they were removed the joists sagged, and it became necessary for Bagnuolo to redesign the roof structure. He designed six or seven steel beams which when installed resolved the problem. The roof had to be shored up so the beams would fall in line. The cost, which was about $10,000, had not been estimated for by Bagnuolo. Difficulties which had not been anticipated were also encountered in installing the elevator. It became necessary to undermine the existing walls and to provide shoring and additional footings. In his estimates, Bagnuolo had allowed $11,000 to cover the cost of the elevator. A change was made in the doors, resulting in an added cost for the elevator of $5,250. Another of the items probably installed, but not estimated for by Bagnuolo, was air conditioning for the second floor. To reflect the receipts and expenses of the City Savings remodeling job, Melvin opened on its books a ledger account 6 B, entitled "City Svgs Remodeling Job." The debits to this account were supposed to include all expenses for labor, materials, and payments to subcontractors, and the credits were supposed to cover all receipts from City Savings for the remodeling job. When the work was completed, the total cost to Melvin for the City Savings project, as reflected by the 6 B account, was $124,207.26, which included a $1,000 bonus to Vernon Melberg, son of Carl Melberg and vice president of Melvin.2 Also included were payments in a total sum of $8,809.55 to one Robert Johnstone. The payments to Johnstone did not relate to the City Savings remodeling job, but were for work relating to the buildings occupied by First Guarantee and Chicago Guarantee. Elimi In verification of Account 6 B. Melvin's accountant examined the invoices and Inspected the payroll records reflecting cost to Melvin for the City Savings job. The items found were as shown by Account 6 B and their total, as reflected by the adding machine tape. was $124,207.26. |