The opinion of the court was delivered by: LEVET
Opinion, Findings of Fact and Conclusions of Law
In this action the United States of America seeks collection of corporate income taxes allegedly due from the defendant 58th Street Plaza Theatre, Inc. ("Plaza") for the period 1943 through 1949. The United States also asks judgment against Leo Brecher ("Leo"), Walter Brecher ("Walter"), Vivian Pack ("Vivian"), and Leo and Walter Brecher as Executors of the Estate of Jeannette Brecher ("Jeannette"
), alleged transferees of the corporate defendant while the corporation was insolvent.
The answer to the amended complaint consists of (1) certain denials, (2) allegations that certain tax deficiencies are barred by the statute of limitations, and (3) claims that, contingent upon a holding that individual defendants were transferees for the corporation, defendants are entitled to certain offsets and recoupments.
The action was tried to the court without a jury.
After hearing the testimony of the parties, examining the exhibits, the pleadings and the proposed findings of fact and conclusions of law submitted by counsel, this court makes the following Findings of Fact and Conclusions of Law:
Plaza, Its Corporate Structure, Stockholders, Directors, Officers and Control
1. Defendant Plaza, a domestic corporation with its principal place of business in the Borough of Manhattan, City and State of New York, was incorporated on January 13, 1930 under the laws of the State of New York with an authorized capital stock consisting of 2,000 shares without par value. (Stip., P3).
2. The stockholders of Plaza were Leo, his wife Jeannette, and their children, Walter and Vivian. Their stockholdings at the dates relevant to this action were:
Jean- Wal- Vi-
Leo nette ter vian
6/21/39 to 2/28/42 1550 425 0 0
2/28/42 to 1/4/43 1050 425 250 250
1/4/43 to 10/1/53 1050 25 450 450
400 of 425 shares owned by Jeannette were a gift from Leo. All of the shares owned by Walter and Vivian were acquired as gifts from their parents, Leo and Jeannette. (Stip., PP9, 16, 17, 20)
3. At all times relevant herein (i.e., from 6/21/39 to 10/5/53), the directors of Plaza were Leo, Jeannette and Frank Schiffman. (Ex. 60) Mr. Schiffman, an officer but not a stockholder of Plaza, was an associate of Leo in various other enterprises. (60-63)
4. Leo was responsible for the formation of Plaza and at all times relevant herein he was Plaza's principal and controlling stockholder, officer and director. Leo was primarily responsible for operation and management of Plaza and he made all important decisions. He was fully familiar with all its affairs. (7-9)
The Lease by Walter Reade to Leo
5. On June 21, 1939, Leo leased from Walter Reade certain premises on 58th Street near Madison Avenue, New York City, which were occupied by a motion picture theatre known as the Plaza Theatre. The lease, for a period of 20 years commencing September 1, 1939, provided for an annual rental of $30,000 per year plus 15% of annual box office receipts in excess of $225,000 plus all taxes and fire insurance premiums on the property in excess of $7,500 per year. (Ex. 3; Stip., PP11-12; 11-12)
6. Pursuant to the provisions of said Reade-Brecher lease, Leo paid Reade a security deposit of $40,000 in cash, plus an additional $10,000 by means of twenty-four promissory notes, making a total security deposit of $50,000. Such security deposit was recoverable by subsequent deductions from the rent. (Ex. 3, P13; 101)
7. During the period from September 1, 1939 to February 28, 1942, Plaza occupied and operated the theatre for Leo and paid rent to Reade, as well as those of the aforesaid notes made by Leo to Reade for security deposit which became due during said period. (Stip., P14; 11-12) Leo, as the principal officer of Plaza, personally managed the theatre operations. (15) During this period Plaza also reimbursed Leo for the $40,000 security deposit which he had given to Reade. (99, 101-102)
Assignment of Lease by Leo to Plaza
8. On February 28, 1942, Leo, with the approval of Plaza's board of directors (Ex. 60; 62-64), sold the Reade-Brecher lease to Plaza for $200,000, payable $1,200 per month without interest. (Stip., P15; Ex. 4; 14) Plaza operated the theatre. As original lessee, Leo remained personally liable on the Reade-Brecher lease. (78)
9. Leo received $1,200 per month from Plaza as installment payments on the sale of the lease, and he claimed that these payments were taxable at capital gain rates. Plaza claimed the right to amortize the $200,000 cost of the leasehold over its remaining term, from February 28, 1942 to September 1, 1959, at the rate of $11,428.56 per annum. (Stip., P30)
Plaza Subleases to Jeannette
10. On December 29, 1942, Plaza subleased the theatre to Leo's wife, Jeannette, for a term of five years commencing January 1, 1943. Under the terms of the sublease, Jeannette was to pay a fixed rental of $40,000 per year, plus 15% of the amount by which the box office receipts exceeded $225,000 in each year, plus $15,000 per annum out of the profits from the operation of the theatre (if earned) and all taxes and fire insurance premiums on the property in excess of $7,500 per year. (Ex. 5; Stip., P18; 16)
11. The sublease from Plaza to Jeannette was in effect from January 1, 1943 to November 15, 1945. During that period, Jeannette paid the sublease rentals to Plaza; Plaza paid the lease rentals to Reade and paid the $1,200 monthly installment to Leo.
12. During the period January 1, 1943 to November 15, 1945, corporate earnings were taxable at war-time excess profits tax rates. (Exs. 9, 10, 11) Individual earnings were not subject to excess profits taxes although they were subject to graduated surtaxes.
13. During the period January 1, 1943 to November 15, 1945, Leo remained personally liable on the Reade-Brecher lease. (78) He continued to manage the theatre operations as he had done from September 1, 1939 to December 31, 1942. During the above period, however, he managed as an employee of his wife, Jeannette, for which she paid him a salary of $6,000 per annum. (Stip., P21) Leo was still president of Plaza.
14. During the entire period of its existence, the Jeannette sublease served no business purpose of Plaza but was merely a family arrangement (a) to provide Jeannette with increased income; (b) to avoid the payment of high taxes by Plaza; and (c) to divert corporate assets from Plaza.
The Sublease to The Partnership
15. On November 16, 1945, the sublease to Jeannette was terminated, and the theatre was subleased to a partnership known as "58th St. Plaza Theatre Co." The new partnership was composed of Jeannette, Leo, Walter and Vivian as equal 25% partners under a written partnership agreement. (Ex. 12) The partners each contributed $6,250 (totalling $25,000), which was paid by the partnership to Plaza as a security deposit. (38-39) The partnership paid the theatre rental to Plaza and Plaza paid it to Reade. This sublease to the partnership was in effect from November 16, 1945 through December 31, 1948, but no written assignment of the existing sublease to the partnership or written cancellation of the existing sublease or a new sublease was produced at the trial. (32-37)
16. The amount of theatre earnings received by the four stockholders during the period of the partnership, less credit for the book value as of January 1, 1949, of theatre fixtures purchased by the partnership and surrendered to Plaza on January 1, 1949, is as follows (Ex. 15):
Year Jeanette Leo Walter Vivian
1943 $ 40,096.64
10/31/46 9,275.18 $9,275.18 $9,275.18 $ 9,275.18
10/31/47 1,324.03 1,324.03 1,324.03 1,324.03
10/31/48 1,987.81 1,987.81 1,987.81 1,987.81
12/31/48 447.28 447.28 447.28 447.28
fixture values) (3,174.46) (3,174.46) (3,174.46) (3,174.46)
$124,475.69 $9,859.84 $9,859.84 $9,859.84
17. During this partnership period, Plaza's operating profits, after rent to Reade and operating expenses, were as follows:
$69,915.95 (Ex. 14)
18. During this partnership period, Leo remained personally liable under the Reade-Brecher lease (58) and he personally managed the theatre as an employee of the partnership. Leo's son, Walter, handled the advertising, wrote the programs, prepared displays, booked the shorts, hired and fired the help, purchased the equipment and attended to maintenance, all under Leo's direction. (211, 212) At that time, Leo also operated other theatres (45) and appears to have been largely a consultant and troubleshooter, although he said he was the "boss." (46) Neither Jeannette nor Vivian made any material contributions to the theatre's operation. (45) Walter and Leo each received salaries of $5,000 per annum and each partner received 25% of the profits. (47) At some time in 1948, Plaza returned to the partnership the $25,000 security deposit which the partnership had contributed at the commencement of the sublease. (57)
19. A fair preponderance of the credible evidence indicates that as a husband, parent, as well as the principal controlling officer, director and stockholder of Plaza, Leo made the decision to cancel the sublease to Jeannette and to effectuate the new sublease to the partnership.
20. The sublease to the partnership served no business purpose of the corporation, Plaza, and merely brought about (in a manner similar to the Jeannette sublease) a distribution of the theatre's earnings to the family members (191) and should be treated, for tax purposes, in the same way as the sublease to Jeannette as determined by the Tax Court in its 1951 decision hereinafter mentioned.
21. The sublease arrangements, described above, transferred corporate assets, namely the theatre earnings, to Jeannette and to the partnership at the later period. Plaza received no consideration whatsoever for the transfers. The transactions were not at arms' length and were approved by director and officers who were personally interested therein.
The Partnership Sells Its Rights Under The Sublease Back to Plaza
22. The partnership continued during the years 1946, 1947 and 1948. On January 1, 1949, the partnership, controlled by Leo (41, 42, 46), sold its rights under the sublease back to Plaza for a sum of $25,000, which was to be paid by Plaza over the return of the security deposit. Of the $25,000, $15,000 was paid to the partnership ($7,500 in 1949, $6,000 in 1950 and $1,500 in 1951). (Stip., P29; 55-59) On January 1, 1949, Plaza resumed operation of the theatre under the Reade-Brecher lease; Leo and Walter still managed the theatre.
23. On and after January 1, 1943, after payment of sums to Leo, to Jeannette, to Walter, to Vivian, or to the partnership, Plaza was in no position to pay any substantial tax assessments. Plaza's current assets, consisting of cash and accounts receivable, were at all times insufficient to pay its accruing tax liabilities and interest thereon, as shown by the following schedule:
Year Ending Accrued Tax
(December 31) Current Assets Liability and Interest
1943 $ 2,843.03 (Ex. 9) $ 34,404.43 (Ex. 62)
1944 4,100.23 (Ex. 10) 65,939.69 (Ex. 62)
1945 10,865.41 (Ex. 11) 99,439.22 (Ex. 62)
1946 41,979.71 (Ex. 23) 114,843.22 (Ex. 62)
1947 27,508.71 (Ex. 24) 126,952.49 (Ex. 62)
1948 13,701.51 (Ex. 25) 136,085.19 (Ex. 62)
1949 48,327.62 (Ex. 26) 144,222.08 (Ex. 62)
1950 54,274.83 (Ex. 27) 151,067.66 (Ex. 62)
1951 24,650.00 (Ex. 28) 157,930.60 (Ex. 62)
1952 11,128.30 (Ex. 29) 165,583.09 (Ex. 53, p. 2)
1953 (Oct. 1) 1,752.16 (Ex. 30) 176,112.80 (Ex. 53, p. 2)
24. In a statement annexed to Plaza's 1946 tax return (Ex. 23, p. 3) Leo admitted that Plaza lacked funds to pay the outstanding tax deficiencies with interest. He further admitted that he was aware of this situation at the time of the various distributions by the corporation to the individual defendants. (24, 55, 59, 60-61, 72-74)
25. In spite of Plaza's financial situation, the $1,200 month installment payments to Leo were continued during the period from January 1, 1943 through October 1, 1953 - at a time when Plaza was insolvent and indebted to the United States for taxes and interest due. Although in 1946, 1947, 1948 and 1949 no payments were made from Plaza to Leo on account of the $200,000 purchase price of the Reade-Brecher lease, Plaza paid $14,400 to Leo on account of this obligation in 1950. (Ex. 59) The payment of $14,400 to Leo in 1950 was made with full knowledge that Plaza was unable to pay the tax deficiency claimed by the Internal Revenue Service and with full knowledge of the decline in Plaza's business that had commenced in 1947.
Dividend Paid in January 1949
26. In December 1948 Plaza declared a dividend of $5.00 per share to its stockholders (Leo, $5,250; Jeannette, $125; Walter, $2,250; Vivian, $2,250) which was payable in 1949. The dividend, totalling $9,875, was paid in January 1949. (Stip., P32; 54) Plaza's minute book reflects a meeting of its Board of Directors on December 24, 1948 authorizing the dividend. Leo, Jeannette and Mr. Schiffman voted unanimously to approve. (Ex. 60; 67) The dividend of $9,875 was declared, paid and accepted with full knowledge that Plaza was unable to pay the tax deficiency claimed by the Internal Revenue Service (55) and with full knowledge of the decline in its business that had commenced in 1947. (187-188)
Dividend Paid in January 1950
27. In 1950, Plaza declared and paid a dividend of $7.50 per share to its stockholders (Leo, $7,875; Jeannette, $187.50; Walter, $3,375; Vivian, $3,375) which totalled $14,812.50. (Stip., P32; 59-61) Though the minute book of Plaza contains no minutes of any meeting of the directors authorizing the 1950 dividend (67), Leo testified that it was declared by the Board of Directors and that he participated. (60) The 1950 dividend of $14,812.50 was declared, paid and accepted with full knowledge that Plaza was unable to pay the tax deficiency claimed by the Internal Revenue Service (60-61), and with full knowledge of the decline in its business that had commenced in 1947.
28. Tax deficiencies for 1942 and 1943 were asserted by the Internal Revenue Service and were protested by Plaza, Leo and Jeannette. The dispute ultimately went to the Tax Court. During the pendency of this proceeding, the subsequent years, 1944-1949, were held in abeyance. (Exs. 31-34) On February 27, 1951, the Tax Court rendered its decision, 58th Street Plaza Theatre, Inc. [CCH Dec. 18,138], 16 T.C. 469, in which it held:
(a) That Leo was entitled to report the $1,200 monthly payments received from Plaza in 1942 and 1943 as capital gains;
(b) That Plaza was entitled to amortize the $200,000 cost of the leasehold over its remaining life and to deduct amortization charges of $9,523.80 for 1942 and $11,428.56 for 1943; and
(c) That the Internal Revenue Service properly determined that Jeannette's 1943 net profits from her operation of the theatre under the sublease were taxable, first, as income of Plaza, and, second, as a dividend from Plaza to Jeannette, since the sublease "* * * served no business purpose of Plaza but was a family arrangement to give Jeannette increased income at the expense of Plaza and without payment of taxes thereon by Plaza." (16 T.C. at 473) The court recognized that the sublease was intended to result in a large reduction in the excess profit taxes of the corporation (16 T.C. at 476) and, thus the court held that $40,096.60 was profit to Plaza and a dividend to Jeannette.
29. On March 18, 1952, the Tax Court decision was affirmed by the United States Court of Appeals for the Second Circuit. 58th Street Plaza Theatre Inc. v. Commissioner, 195 F.2d 724 (2nd Cir. 1952). On October 13, 1952, the United States Supreme Court denied certiorari (344 U.S. 820, 73 S. Ct. 17, 97 L. Ed. 638).
Tax Assessments by I.R.S. Against Plaza
30. Following the Tax Court decision, the Internal Revenue Service completed its pending audits of Plaza for the years 1944 through 1949. It applied the Tax Court ruling on the effect of the sublease to the years 1944 through 1948, as well as 1943. (Exs. 31-34) It made small adjustments for 1949. (Ex. 31, p. 12) Taxes were assessed against Plaza and notice and demand for payment thereof was made, as follows (Stip., P4):
Date of and
Year Tax Principal Interest Assessment Demand
1943 Income $ 1,674.88 $ 745.87 8/17/51 8/28/51
Excess profits 28,142.62 12,869.27 8/17/51 8/28/51
excess profits 4,586.93 2,042.49 8/17/51 8/28/51
1944 Income 3,210.16 1,656.40 10/21/53 10/28/53
Excess profits 23,429.45 12,089.28 10/21/53 10/28/53
excess profits 3,261.46 1,682.87 10/21/53 10/28/53
1945 Income 2,829.89 1,290.39 10/21/53 10/28/53
Excess profits 25,866.37 11,794.71 10/21/53 10/28/53
excess profits 1,318.75 601.35 10/21/53 10/28/53
1946 Income 10,120.00 3,929.47 9/ 4/53 9/14/53
1947 Income 5,969.34 1,959.66 9/4/53 9/14/53
1948 Income $ 2,582.78 $ 692.93 9/4/53 9/14/53
1949 Income 1,389.65 293.84 9/4/53 9/14/53
Totals $114,382.28 $51,648.53
31. None of the foregoing assessments has been paid, with the exception of the sum of $1,644.51. (Stip., P42) Plaza did not protest any of the assessments or seek to litigate the years 1944-1949 in the Tax Court. Plaza conducted no operations after October 1, 1953 and has no funds whatsoever to pay the outstanding tax assessments.
32. In 1951, following the Tax Court decision, Plaza paid Leo $57,600 on account of the $200,000 purchase price of the Reade-Brecher lease. (Ex. 59) Leo, as principal officer, director and stockholder, was principally responsible for authorizing this payment. It was made with full knowledge that Plaza was unable to pay the tax claims of the Internal Revenue Service, that its business was still declining, and that the Tax Court had upheld the Internal Revenue Service's position. (72-74)
Plaza Reassigns the Lease to Leo
33. On November 5, 1952, less than one month after the Supreme Court's denial of certiorari, Plaza reassigned the Reade-Brecher lease to Leo. Simultaneously, Leo entered into an agreement with Plaza providing that Plaza could operate the theatre as his licensee and could retain the net income therefrom so long as Plaza paid the rent to Reade and $1,200 per month to Leo on account of assignment of the Reade-Brecher lease to Plaza on February 28, 1942. (Stip., P36; Ex. 22; 76-79)
34. The effect of the November 5, 1952 transaction was to put Plaza's principal asset, the Reade-Brecher lease, out of the direct reach of Plaza's principal creditor, the United States, and into the possession or control of Leo, who was personally liable on the lease but was at most a general unsecured creditor of Plaza with respect to the balance due him from Plaza on account of the assignment of the lease. Although Leo testified that his purpose was to insure that the landlord Reade could not exercise his right to cancel the lease by reason of the insolvency of the "legal owner and holder" of the lease (Ex. 3, P24; 76-77), there was no evidence that Reade was likely to cancel. In fact, Reade had never been notified of the assignment to Plaza (167) and Leo remained personally liable to Reade as original lessee. (78, 166)
35. The November 5, 1952 agreement referred to in Finding 33 was signed by Leo individually and, on behalf of Plaza, by Leo as president. The minute book of Plaza contains no minutes of any meeting of the directors approving the transaction. (79)
Leo Licenses the Theatre to Plaza
36. From November 5, 1952 to October 1, 1953, Plaza operated the theatre as Leo's licensee. Leo and Walter managed the theatre. (79-80) During the period November 5, 1952 to October 1, 1953, Plaza fully complied with the license agreement. (Ex. 22) It paid Leo $14,400 in 1952 and $10,800 in 1953 on account of the leasehold assignment. It paid the rent to Reade. (Ex. 59; 81)
Plaza Surrenders Leasehold Rights to Leo
37. On October 1, 1953, though Plaza had complied with the license agreement, Plaza surrendered to Leo all its rights in the Reade-Brecher lease. (Ex. 36; 102-105) On that date, Plaza discontinued all operation of the theatre. Leo took over the Reade-Brecher lease and thereafter operated the theatre for his own account. (88) The surrender to Leo of the Reade-Brecher lease and cancellation of the license agreement transferred Plaza's principal assets to its controlling officer, director and stockholder at a time when Plaza was heavily indebted to the United States for taxes. This transfer was made with full knowledge of Plaza's inability to pay its taxes and left it with virtually no assets. (82-83)
At All Times from January 1, 1943 Through December 31, 1948, Plaza Was Insolvent in the "Bankruptcy" Sense - That Is, Its Liabilities, Including Accrued Taxes and Interest, Exceeded Its Assets
38. (a) On the basis of Plaza's balance sheet book value (see tax returns, Exs. 9, 10, 11, 23, 24) and the accrual of the taxes ultimately assessed, plus interest, Plaza's liabilities exceeded its assets as follows:
Date Surplus (Deficit)
December 31, 1943 $ 3,838.02
December 31, 1944 (22,324.67)
December 31, 1945 (48,925.07)
December 31, 1946 (55,059.44)
December 31, 1947 (58,149.38)
December 31, 1948 (70,766.97)
(See also Exs. 62, 114, 115)
(b) In addition to other assets shown on the balance sheet of Plaza, the Reade-Brecher lease was carried at its $400,000 cost less amortization, and the fixtures installed in the theatre by Plaza were carried at cost less depreciation. (Exs. 9, 10, 11, 23, 24, 25)
(c) The fair market value of Plaza's interests retained in the Reade-Brecher lease during the above period, January 1, 1943 through December 31, 1948, was not equal to its book value since the fair market value is properly measured by the capitalized value of the yearly net income Plaza received from the lease itself. In effect, this was the excess of rental income from the two subleases over the rental payments on the Reade-Brecher lease. Thus, the maximum income that Plaza could derive from the theatre pursuant to the sublease was $25,000 per annum, which was composed of $10,000 based on the receipt of $40,000 annually, less the $30,000 payable as rental to Reade, plus $15,000 out of the profits from the operation of the theatre. (16, 17) I find that the fair market value of Plaza's interest in the said lease, capitalized at the rate of 15% (121), was as follows:
December 31, 1943 $148,850
December 31, 1944 146,175
December 31, 1945 143,100
December 31, 1946 139,575
December 31, 1947 135,500
December 31, 1948 104,660
(d) After adjustment of the balance sheets of Plaza to reflect the fair market value of Plaza's retained interest in the Reade-Brecher lease and substitution of the same in place of the book values of the theatre and theatre fixtures, I find that the liabilities of Plaza, including accrued taxes and interest, exceeded its assets as follows:
December 31, 1943 ($38,053.97)
December 31, 1944 (52,244.18)
December 31, 1945 (63,889.83)
December 31, 1946 (61,648.90)
December 31, 1947 (57,130.28)
December 31, 1948 (88,904.31)
39. The proof offered by defendants to demonstrate that Plaza was solvent during the above period (see Ex. B; 196-208, 220-224) is deficient since it was predicated upon the assumption that the fair market value of the Reade-Brecher lease was measured by capitalizing the total theatre earnings, including the earnings received and retained by the sublessees. (Stip., [*] 51, 60, 61, 164) During this period, however, Plaza had transferred the right to such theatre earnings to the sublessees and did not regain it until the cancellation of the second sublease on January 1, 1949.
At All Times During the Period from January 1, 1949 Through October 1, 1953, Plaza Was Insolvent in the "Bankruptcy" Sense
40. (a) Based upon Plaza's balance sheet book values (see Exs. 26, 27, 28, 29, 30) and upon the totals of the accrued taxes plus interest assessed, Plaza's liabilities exceeded its assets during this period as follows:
December 31, 1949 ($ 74,175.62) (Ex. 62)
December 31, 1950 (100,165.14) (Ex. 62)
December 31, 1951 (108,668.63) (Ex. 62)
December 31, 1952 (128,570.93) (Ex. 29)
October 1, 1953 (219,833.31) (Ex. 30)
The deficits of December 31, 1952 and October 1, 1953, as set forth above, were admitted on Plaza's federal income tax returns. (Exs. 20, 30)
(b) Defendants' proof offered to demonstrate that Plaza was solvent during 1949 and 1950 is inadequate. ...