Iowa School of Men's Haristyling, Inc. v. Commissioner

MEMORANDUM OPINION

FAY, Judge: This case is before us on respondent's Motion for Ruling that Petitioner's Statement Pursuant to I.R.C. § 534(c) is Insufficient to Shift the Burden of Proof to Respondent. The sole issue presented is whether petitioner's statement, submitted pursuant to section 534(c), ¹ is sufficient to place the burden of proof on respondent with regard to the reasonableness of accumulated earnings and profits.

At the time the petition was filed, petitioner was an Iowa corporation with its principal place of business and headquarters located in Des Moines, Iowa. Respondent determined that petitioner was liable for accumulated earnings tax in the amount of $ 17,123 for the year ended December*650 31, 1986.

Rule 142(a) provides that petitioner generally bears the burden of proof for issues before this Court. However, an exception is provided when the determined deficiency arises, in part, from the imposition of the accumulated earnings tax under sections 531-537. ² Under Rule 142(e), either party may move this Court to fix the burden of proof regarding the reasonableness of accumulations upon which the accumulated earnings tax is based. ³ Respondent has so moved and, therefore, in the Court's opinion, it is appropriate to resolve this motion prior to the time of trial in order that the parties are properly prepared to litigate this case. ⁴Rule 142(e); Chatham Corp. v. Commissioner, 48 T.C. 145 (1967).

*651 Respondent has the burden of proof on the reasonableness of accumulations if either of two conditions is satisfied. Under section 534(a), the burden is on respondent if (1) notification is not provided in accordance with section 534(b); or (2) if adequate notice is provided under section 534(b) and petitioner files a statement of grounds in compliance with the requirements of section 534(c), in which event respondent has the burden respecting the grounds set forth in the statement. The parties are in agreement that respondent provided notification in accordance with section 534(b), and, therefore, the current motion addresses solely the sufficiency of grounds under section 534(c).

Section 534(c) provides in part: "the taxpayer may submit a statement of the grounds (together with facts sufficient to show the basis thereof) on which the taxpayer relies to establish that all or any part of the earnings and profits have not been permitted to accumulate beyond the reasonable needs of the business." ⁵ The section 534(c) statement must set forth both the grounds and the facts relied upon to place the burden on respondent. American Metal Products Corp. v. Commissioner, 34 T.C. 89, 99 (1960),*652 affd. on other grounds 287 F.2d 860 (8th Cir. 1961).

This Court has frequently stated the requirement of section 534(c) as follows:

petitioner's statement must constitute more than mere notice of an intent to prove the reasonableness of the accumulation. Rather, the taxpayer must show its hand by stating with clarity and specificity the grounds on which it will rely to prove reasonable business needs, and by setting out the facts (not the evidence, but more than conclusions of law) that, if proven, support the alleged business needs for the accumulations.

Hughes, Inc. v. Commissioner, 90 T.C. 1, 17 (1988), (quoting Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 8.08 at 8-33 (4th ed. 1979)).

"The corporation's statement must 'show its hand' and disclose the corporation's litigation theory to respondent". Myco Industries, Inc. v. Commissioner, T.C. Memo. 1992-147.*653 However, the statement "must outline only the basic facts necessary to notify respondent of the bases of the grounds asserted." Soros Associates International, Inc. v. Commissioner, T.C. Memo. 1982-79 (fn. ref. omitted). "It is the informative quality, not the number, of the facts set forth in a section 534(c) statement which determines sufficiency." Id.

Even though the focus is on informative quality and not purely quantity, the facts stated and relied upon in the 534(c) statement must be substantial, material, definite, and clear, rather than general or vague. Chatham Corp. v. Commissioner, supra at 147; Bremerton Sun Publishing Co. v. Commissioner, 44 T.C. 566, 581 (1965); Rutter v. Commissioner, 81 T.C. 937, 947 (1983), affd. on this issue, revd. in part and remanded sub nom. J.H. Rutter Rex Manufacturing Co. v. Commissioner, 853 F.2d 1275, 1282-1284 (5th Cir. 1988). Simple broadbased assertions are not sufficient.

On August 9, 1991, respondent, pursuant to section 534(b), sent by certified mail a notification *654 informing petitioner that the proposed statutory notice of deficiency included an amount with respect to the accumulated earnings tax imposed by section 531 for the taxable year 1986. Within the 60-day response time, petitioner on October 4, 1991, sent its section 534(c) statement to respondent. Sec. 1.534-2(d)(2), Income Tax Regs.

In its section 534(c) statement, petitioner set forth 4 individual grounds to justify its accumulation of earnings and profits during 1986. It is the sufficiency of this October 4, 1991, statement which is at issue. ⁶ This list of reasons were as follows:

1. Taxpayer intended and intends to expand its business to the westside of Des Moines at an estimated cost of $ 350,000. Between 1976 and 1982 four corporate entities related to Taxpayer expanded their operations or started new schools in other cities before the downturn in students and customers occurred.

2. Taxpayer, beginning in 1983, had a downturn in gross receipts from customer hair services and enrollment at Taxpayer's barbering and hairstyling school. Two similar schools in the Des Moines area (Americana and Salvador's) went bankrupt or out of business from 1980 to 1988. Taxpayer held*655 in excess of $ 200,000 of earnings to cover the downturn in sales and students. See attached Schedule A.

3. The Federal government proposed and was preparing to decrease loans and grants to students attending trade schools, such as Taxpayer. This reduction caused uncertainty to trade schools, including Taxpayer.

4. Due to the decline in and cyclical nature of its hair services business, Taxpayer believed that it had to diversify its student-related business; thus, Taxpayer entered the real estate business which has proven to be profitable. ⁷

*656 Each ground will be separately reviewed. By reviewing each asserted ground individually, we may impose the burden of proof on respondent with respect to some grounds and on petitioner with respect to other grounds. Hughes, Inc. v. Commissioner, supra at 18; Myco Industries, Inc. v. Commissioner, supra; Soros Associates International, Inc. v. Commissioner, supra.

As a first ground, petitioner states that it was reasonable to accumulate $ 350,000 for the future expansion of its business. Respondent contends that petitioner's statement concerning the intended expansion of its business fails to relate any substantial, material, definite, and clear facts or details concerning the anticipated expansion of the business. We agree.

Other than referencing the fact that competitors had expanded, petitioner provides no other detailed information. Petitioner's proposed or pending construction expansion plans are not set forth, nor is any reference made to actual expansion that was implemented. No specific plans have been provided, nor has justification for the amount of the accumulation*657 been provided. Petitioner has submitted no information from which computations could be made as to the costs of expansion. This is merely a vague and general allegation which is insufficient.

As a second ground, petitioner states it was reasonable to accumulate $ 200,000 to cover a downturn in sales and students. An exhibit was attached as Schedule A to the section 534(c) statement outlining gross receipts from customer work and tuition for the years 1979 through 1989. Respondent contends petitioner's statement is vague, indefinite, and irrelevant. We agree.

Although petitioner has attempted here to provide some formal documentation for its asserted ground, we find it is still insufficient. The broad and vague outline of gross receipts from student tuition and customer work does not provide this Court with sufficient factual information to support the asserted ground. Additionally, the information provided in the schedule does not relate, in any significant way, to the need to accumulate $ 200,000 of earnings and profit.

As a third ground, petitioner indicates accumulations were necessary because the Federal government proposed and was preparing to decrease loans and grants*658 to students attending trade schools. Respondent again challenges this contention as being vague and general and not substantial, material, definite, or clear. We agree.

No information was provided as to the number or percentage of students who received Federal loans or grants, nor was any information provided showing what action was proposed by the Federal government and when such a plan would be implemented and effective. No factual information was provided as to the actual implementation of such a Federal plan. Again, this is merely a vague and general statement that does not satisfy the section 534(c) requirements.

As a fourth ground, petitioner indicates that it sought to diversify its student-related business by entering into the real estate business. Respondent contends and we agree this again is too vague a statement to satisfy the requirements of section 534(c).

The section 534(c) statement submitted in the current proceeding is very similar to the one submitted in Capital Sales, Inc. v. Commissioner, 71 T.C. 416, 435 (1978), revd. on other grounds sub nom. Simon v. Commissioner, 644 F.2d 339 (5th Cir. 1981),*659 in which we determined that such a broad and vague statement was not effective to place the burden of proof on respondent. ⁸ With respect to each ground, petitioner's statement did not include facts sufficient to support and show the basis for the ground or reason relied on. "Section 534 and our cases emphasize the need for the taxpayer to present sufficient facts to support the grounds alleged." Rutter v. Commissioner, 81 T.C. 937, 939 (1983), affd. on this issue, revd. in part and remanded sub nom. J.H. Rutter Rex Mfg. Co. v. Commissioner, 853 F.2d 1275 (5th Cir. 1988).

*660 A delicate balance must be reached between two competing factors. First, petitioner is not required to state facts sufficient to carry the burden of proof, with regard to the reasonable business needs for accumulations of earnings and profits, which it may never have at trial. Soros Associates International, Inc. v. Commissioner, T.C. Memo. 1982-79. However, respondent must be given a sufficient factual basis upon which she could proceed at trial. Id.

In the instant case, we find petitioner has not set forth sufficient factual information with respect to any of the asserted grounds to satisfy the requirement of section 534(c). ⁹ Accordingly, the burden of proof to show that petitioner's earnings and profits were permitted to accumulate beyond its reasonable business needs is on petitioner.

*661 Respondent's motion will be granted.

An appropriate order will be issued.