CITATION:
R.V.J. CEZAR CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent, and RESTITUTO T. AND VIRGENCITA P. CEZAR, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
T.C. Memo 2010-173, Docket Nos. 30125-08, 30144-08, Filed August 4, 2010.
At issue for the Tax Court:
- whether the transfer of a lot and improvements thereon constituted a taxable constructive dividend to the taxpayers,
- whether the dividend should have caused the Corporation distributing the property to recognize income, and
- whether the Taxpayers and Corporation were liable for accuracy-related penalties related to their failure to recognize the dividend.
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E-Flash Takeaway
The court's ruling in Cezar demonstrates the importance of accurate record keeping and professional tax advice, both for corporations and individuals. Tax practitioners can use the ruling as a marketing tool for small business owners who believe they can or should do it themselves. |
Lot and House Transferred to Taxpayers
Restituto Cezar owned R.V.J. Cezar Corporation ("Corporation") which built houses on a speculative basis. The Corporation built a spec home which was transferred to Mr. Cezar and his wife, Virgencita, ("Taxpayers") via quitclaim deed. During audit, Mr. Cezar maintained that the lot and improvements were corporate assets. The lot and improvements had a fair market value of $920,000, construction costs were $502,000, and the Taxpayers assumed the Corporation's mortgage of $57,227 on the date of transfer.
The IRS determined that the distribution of the lot and improvements from the Corporation was a constructive dividend. Accordingly, the Cezars received a qualified dividend and long-term capital gains as a result of the dividend, and their failure to report these made them liable for an accuracy-related penalty.
Additionally, the Corporation failed to report gross income from the distribution of lot and improvements. The IRS assessed an additional accuracy-related penalty as a result of the understated gross income.
Constructive Dividend Determination
The Cezars conceded they received the lot as a constructive dividend. However, they argued the improvements were not constructive dividends because they owned the improvements. Their argument was that they paid for the construction materials and did all the work to construct the improvements, so they owned the improvements.
The Tax Court disagreed, citing the Taxpayers' inability to produce supporting documents indicating the Corporation owned the improvements, inability to produce the agreement between the Taxpayers individually and the Corporation allowing the Cezars to construct improvements on the Corporation's lot, and Mr. Cezar's statements during audit that the lot and improvements were corporate assets. Finally, the court noted that the Corporation had never sold lots and improvements separately and that it was unlikely a buyer would want to buy a lot but not the improvements (or vice versa).
Corporation's Recognition of Income
The Cezars conceded that the constructive dividend caused the Corporation to recognize taxable income, insofar as the fair market value of the property received exceeded the Corporation's basis in the property. Because the Cezars and the Corporation were unable to document the Corporation's basis, the Tax Court determined the Corporation recognized additional unreported income.
Accuracy-Related Penalties
The Tax Court determined that both the Cezars and the Corporation were liable for an accuracy-related penalty under § 6662 for failure to keep accurate financial records and substantial understatement of income tax, respectively. Accordingly, the Taxpayers were required to pay the additional penalty.
