S Corporation Denies Unreported Income

Deitsch Plastic states that it is a private corporation owned by members of the Deitsch family and that individual members of the Deitsch family also own Flocktex. Prior to 1991, Dietsch Plastic had a written agreement with Flocktex to provide services in return for a percentage of Flocktex's revenues from exports. This agreement was terminated in 1990. Deitsch Plastic, however, received and reported income as a purchasing and shipping agent for Flocktex.

After the agreement between Deitsch Plastic and Flocktex was terminated, Flocktex paid the percentage of its net sales to a family partnership of Flocktex's shareholders. Deitsch Plastic states that all of the additional income being allocated to Deitsch Plastic by the IRS was reported by the family partnership and the net income after expenses was passed through as income to the partners and reported by them as net income on their individual returns for 1995.

Period and Amount at Issue: 1995 -- amount to be determined

Code Sections: 61, 1361, 704

PETITION FOR READJUSTMENT OF S CORPORATION ITEMS UNDER CODE SECTION 6244

The petitioner hereby petitions for a redetermination of the adjustments set forth by the Commissioner of Internal Revenue in the Commissioner's Notice of Final S Corporation Administrative Adjustment dated November 23, 1999, for the taxable year ended December 31, 1995, and as a basis for the petitioner's case alleges as follows:

1. The petitioner is Joseph Deitsch whose address is 610 Ellsworth Avenue New Haven, Connecticut 06511.

2. The petitioner Joseph Deitsch is the Tax Matters Person of Deitsch Plastic Company, Inc. ("Deitsch Plastic").

3. a. Deitsch Plastic is a Connecticut corporation whose mailing address is 14 Farwell Street West Haven, Connecticut 06516.

b. Deitsch Plastic's taxpayer's identification number is 06-0756000.

c. The corporate income tax return (Form 1120S) for the period involved was filed with the Office of the Internal Revenue Service at Andover, Massachusetts.

4. The Notice of Final S Corporation Administrative Adjustment, including so much of the statement and schedules accompanying the notice as is material, is attached and marked Exhibit A, was mailed to the petitioner on November 23, 1999, and was issued by the Office of the Internal Revenue Service, Connecticut-Rhode Island District Office, at 135 High Street-Stop 190 Hartford, Connecticut 06103-1185.

5. The adjustments, most of which are in dispute, were determined by the Commissioner for the tax year ending December 31, 1995, in the net amount of $2,144,964.

6. The Commissioner committed the following errors in adjustments set forth in said Notice of Final S Corporation Administrative Adjustment:

a. The Commissioner erred determining that during the taxable year 1995 Deitsch Plastic had unreported income for services allegedly provided to Flocktex Industries, Ltd. ("Flocktex") in the amount of $2,100,000.00, AND TO THE EXTENT THAT SUCH AMOUNTS ARE INCLUDED AS A DEEMED DIVIDEND FROM DEITSCH PLASTIC, NOT PROPERLY OFFSETTING THEM TO THE EXTENT OF DEITSCH PLASTIC'S ACCUMULATED ADJUSTMENT ACCOUNT;

b. The Commissioner erred in determining there was an $89,768 built-in gains tax to be recognized in the tax year 1995; and

c. IN THE ALTERNATIVE. THE COMMISSIONER ERRED IN NOT ALLOWING AS DEDUCTIONS EXPENSES AGAINST THE UNREPORTED INCOME.

7. The facts upon which the petitioner relies, as the basis of the petitioner's case, are as follows:

a. Deitsch Plastic, a Connecticut corporation, was founded in the 1950's as a manufacturer of plastic coated fabrics;

b. At all times Deitsch Plastic was a private corporation owned by members of the Deitsch family;

c. Flocktex, an Israeli corporation, was established in 1974, in Kiryat Malachi, Israel as a manufacturer of flocked fabrics;

d. Flocktex was at all times owned by individual members of the Deitsch family who contributed all shareholder capital to the corporation;

e. Prior to 1991, Deitsch Plastic had a written agreement with Flocktex ("the Agreement"), entered into as of January 14, 1980, to provide services to Flocktex for which it would receive a percentage of Flocktex's revenues from exports;

f. Either party with thirty (30) days written notice could terminate the Agreement;

g. The Agreement was terminated by Flocktex by written notice dated January 9, 1990;

h. Deitsch Plastic performed no services for Flocktex after 1990, except as a purchasing and shipping agent for Flocktex of raw materials for which it was paid, and with all such payments being reported as income on Deitsch Plastic's income tax returns. This purchasing agent function was not one of the services set forth in the Agreement. None of the raw materials were produced or processed by Deitsch Plastic;

i. After the Agreement was terminated, Flocktex paid the percentage of its net sales to a family partnership ("the Partnership") of Flocktex's shareholders; j. All of the additional income being allocated to Deitsch Plastic by the Commissioner, as reflected in subparagraph 6a. above, was reported by the Partnership and the net income after expenses, was passed through as income to the partners. The claimed expenses were not allowed in the allocation of income to Deitsch Plastic;

k. The partners of the Partnership reported the Partnership net income on their individual income tax returns for 1995;

l. Deitsch Plastic converted from a C corporation to an S corporation as of January 1, 1995. At that time there was a built in gain on inventory of $256,480 that was realized but not reported due to the claimed 1995 net operating loss;

m. The determination of a tax being due in 1995 on the built in gain is the result of the adjustment to income made by the Commissioner; and

n. In the event that the Commissioner's adjustment to income is allowed in part or in full, Deitsch Plastic would have sufficient amounts in its accumulated adjustment account so that there would be little or no deemed taxable dividend to its shareholders.

WHEREFORE, the petitioner prays that this Court may hear this case and determine that the adjustments in dispute for the tax year ended December 31, 1995 are not applicable, and grant the petitioner such other and further relief to which it may be entitled.

Dated: February 3, 2000

[Editor's Note: The attachment has been omitted. However, this document in its entirety can be obtained through our Tax Analysts' Access Service as Doc 2000-5486 (15 pages).]