                       130 T.C. No. 18



                 UNITED STATES TAX COURT



ALAN BECKLEY AND VIRGINIA JOHNSTON BECKLEY, Petitioners v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



 Docket No. 4722-06.               Filed June 30, 2008.



      Petitioner wife lent funds to a corporation in
 which petitioner husband was a shareholder. The
 corporation used the borrowed funds to develop a
 working model of Web-based video conferencing software.
 The corporation, however, had financial problems and
 was dissolved, and the working model was transferred to
 a second corporation in which petitioner husband was a
 shareholder. In 2001 and 2002, the second corporation
 made payments to petitioner wife. Petitioners treated
 a portion of the payments petitioner wife received as
 taxable interest income and the balance as nontaxable
 repayment of funds petitioner wife lent the first
 corporation. On audit of petitioners’ returns,
 respondent did not adjust petitioners’ treatment of the
 payments petitioner wife received from the second
 corporation as taxable interest income and as
 nontaxable repayment of loan principal, but respondent
 also treated 50 percent of the payments petitioner wife
 received as taxable constructive distributions to
 petitioner husband from the second corporation.
                               - 2 -

          Held: No portion of the payments petitioner wife
     received from the second corporation are also taxable
     to petitioner husband as constructive corporate
     distributions.



     Steven M. Cyr, for petitioners.

     Wesley F. McNamara, for respondent.



     SWIFT, Judge:   Respondent determined deficiencies in

petitioners’ joint Federal income taxes and penalties as follows:


                                         Penalty
             Year       Deficiency     Sec. 6662(a)
             2001        $10,192         $2,038
             2002          7,000          1,400


     The issue for decision is whether 50 percent of interest and

loan principal that petitioner Virginia Beckley (Virginia)

received in 2001 and 2002 also should be treated as taxable

constructive corporate distributions to petitioner Alan Beckley

(Alan).

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.
                                - 3 -
                          FINDINGS OF FACT

       Some of the facts have been stipulated and are so found.

       At the time the petition was filed, petitioners resided in

Oregon.

       On November 14, 1988, Alan and Robert Ebert (Ebert)

incorporated Computer Tools, Inc. (CT), as an Oregon corporation

for the purpose of developing computer services for graphic

designers.    Alan served as president of CT, and Ebert served as

secretary.    Alan and Ebert were each 50-percent shareholders in

CT.1

       During 1988 through 1998, CT often was short of funds for

operations and for development of business products, and CT

borrowed from Virginia at least $106,834.    Using those funds, CT

developed a working model of Web-based video conferencing

software (working model).    Because of management problems, CT was

dissolved in 1998.

       On March 17, 2000, VirtualDesign.net, Inc. (VDN), was

incorporated as a C corporation under Oregon law to succeed to

CT’s business and to continue developing business products.    From

VDN’s incorporation in 2000 until sometime in 2003, Ebert was

chief executive officer (CEO) of and a 50-percent shareholder in




       1
       The record does not indicate whether CT was incorporated
as a C or as an S corporation.
                                    - 4 -
VDN.        Alan was a VDN director and shareholder, but the record

does not establish Alan’s percentage stock ownership interest in

VDN.2

        As VDN CEO, Ebert had sole signing authority over VDN’s

corporate bank accounts.

        In 2000, CT transferred the working model to VDN.3    Although

the working model constituted a valuable asset to VDN, the record

does not indicate whether VDN paid CT any cash for the working

model.

        CT never made any repayments on the $106,834 loan it

received from Virginia; and although VDN received the working

model from CT, VDN did not execute a written loan assumption

agreement with regard to CT’s loan repayment obligation to

Virginia.        Upon CT’s dissolution, Virginia did not make a claim

against CT for repayment of the funds she lent to CT.

        When VDN acquired the working model from CT, Virginia did

not treat her loan to CT as a worthless loan, and Virginia did

not claim an ownership interest in the working model.




        2
            Petitioners claim that Alan owned only 1 percent of VDN’s
stock.       Respondent claims that Alan owned 50 percent of VDN’s
stock.
        3
       Under Or. law, after its dissolution in 1998 CT retained
the authority to conduct business appropriate to winding up and
liquidating its affairs. Or. Rev. Stat. sec. 60.637 (2007).
                                - 5 -
       In 2001 and 2002, Alan was employed by and received wages

from VDN.    Virginia was not employed by and did not perform any

services for VDN.

       In 2001 and 2002, VDN had no current or accumulated earnings

and profits, and Alan had no tax basis in his VDN stock.

       In 2001 and 2002, VDN paid Virginia $95,434 and $70,000,

respectively.    The parties have stipulated and we find that VDN

paid those funds to Virginia as payment on her loan to CT.

       In 2003, new management gained control of VDN, and Alan and

Ebert were terminated.    At a 2003 meeting of VDN’s new

management, VDN executives stated that they did not believe VDN

was obligated to pay any additional funds to Virginia and that

VDN would not do so.    VDN’s new management did not ask Virginia

to return any portion of the funds it had paid her in 2001 and

2002.

       On a Form 1099-INT, Interest Income, that VDN mailed to

Virginia and to respondent in early 2002, VDN characterized

$58,600 of the $95,434 that it had paid to Virginia in 2001 as

interest.    VDN did not report the $36,834 balance on the Form

1099-INT and treated it at the time as a nontaxable repayment of

loan principal that did not need to be reported on the Form 1099-

INT.    VDN did not report any portion of the $95,434 as a

corporate distribution to Alan.
                               - 6 -
     On a Form 1099-MISC, Miscellaneous Income, that VDN mailed

to Virginia and to respondent in early 2003, VDN reported the

$70,000 it had paid to Virginia in 2002 as nonemployee

compensation.

     No portion of the $95,434 or the $70,000 that VDN paid

Virginia in 2001 and 2002 respectively was reported to respondent

on a Form 1099-DIV, Dividends and Distributions, as a corporate

distribution to Alan.

     On its corporate Federal income tax returns for both 2001

and 2002, VDN deducted as nonemployee compensation the $95,434

and the $70,000 it paid to Virginia in each year.    VDN claimed no

interest expense deduction with regard to any portion of the

funds it paid to Virginia in 2001 and 2002.

     Consistent with the Form 1099-INT they received from VDN, on

their 2001 joint individual Federal income tax return,

petitioners reported $58,600 of the $95,434 Virginia received

from VDN in 2001 as interest income, and petitioners treated the

balance as a nontaxable repayment of loan principal.

     For purposes of their 2002 joint individual Federal income

tax return, petitioners treated the $70,000 that Virginia

received from VDN in 2002 as a nontaxable repayment of loan

principal.   Petitioners reported no interest income with respect

to the $70,000 Virginia received from VDN in 2002.
                                                   - 7 -
         Further, on their 2001 and 2002 joint Federal income tax

 returns, petitioners reported no corporate distribution from VDN

 to Alan with respect to the payments Virginia received from VDN.

         The schedule below reflects the payments Virginia received

 from VDN, VDN’s treatment of the payments to Virginia on the

 Forms 1099 VDN mailed to Virginia and to respondent, VDN’s

 treatment of the payments on its corporate Federal income tax

 returns, and petitioners’ treatment of the payments Virginia

 received from VDN on or for purposes of their joint individual

 Federal income tax returns:

                              VDN’s                   VDN’s Corporate                Petitioners’
                            Forms 1099                 Fed. Tax Returns           Fed. Tax Returns
       Payments                           Comp.                     Comp.
       Virginia    Loan       Loan       Expense    Loan    Loan   Expense    Loan       Loan     Comp.
Year   Received    Prin.       Int.      Deduct.    Prin.   Int.   Deduct.    Prin.       Int.   Income

2001    $95,434   $36,834    $58,600       --         --     --    $95,434   $36,834   $58,600       --
2002     70,000     --          --       $70,000      --     --     70,000    70,000      --         --




         On audit of VDN’s returns for 2001 and 2002, respondent

 disallowed the above compensation expense deductions claimed by

 VDN, and respondent determined that the total payments VDN made

 to Virginia in 2001 and in 2002 constituted nondeductible

 constructive distributions to Alan and to Ebert–-50 percent to

 Alan and 50 percent to Ebert.

         On audit of petitioners’s returns, respondent did not adjust

 the manner in which petitioners on their joint Federal income tax

 returns for 2001 and 2002 reported the payments Virginia received

 from VDN (i.e., for 2001 $58,600 of interest income and $36,834
                               - 8 -
of loan principal, and for 2002 no interest income).   Respondent,

however, treated one-half of the payments Virginia received from

VDN (i.e., $47,717 in 2001 and $35,000 in 2002) also as corporate

distributions taxable as capital gain to Alan.

     Under respondent’s audit theory, VDN’s payments to Virginia

on her loan to CT were made without any legal obligation to do so

and only on the basis of a personal moral obligation of Alan and

Ebert to repay Virginia.   Accordingly, respondent concludes

(1) that with respect to the payments VDN made to Virginia no

deduction was allowable to VDN (i.e., neither a compensation

expense deduction nor an interest expense deduction) and (2) that

although the payments Virginia received represented to Virginia

taxable interest income and nontaxable repayment of loan

principal, they also represented to Alan and to Ebert taxable

constructive corporate distributions.4


                              OPINION

     Where corporations pay personal expenses of shareholders,

the shareholders may be treated as having received constructive

distributions to the extent of the value thereof to the

shareholders.   Meridian Wood Prods. Co. v. United States, 725

F.2d 1183, 1191 (9th Cir. 1984); Falsetti v. Commissioner, 85

     4
       The record does not indicate whether respondent actually
audited Ebert’s returns and charged Ebert with constructive
corporate distributions with regard to any portion of the
payments VDN made to Virginia.
                                - 9 -
T.C. 332, 356-357 (1985); Magnon v. Commissioner, 73 T.C. 980,

993-994 (1980); Smith v. Commissioner, T.C. Memo. 1995-410.

Shareholders may be charged with constructive distributions even

though the corporate payments are made to third parties and not

directly to the shareholders.    Broad v. Commissioner, T.C. Memo.

1990-317; Hufnagle v. Commissioner, T.C. Memo. 1986-119; Paoli v.

Commissioner, T.C. Memo. 1985-196.

     As stated, respondent made no adjustment to Virginia’s

taxable income with respect to the payments Virginia received

from VDN; and respondent acknowledges that if CT rather than VDN

had made the payments to Virginia, petitioners’ reporting thereof

on their 2001 and 2002 joint Federal income tax returns would be

accepted without additional adjustment.

     The facts before us do not support respondent’s theory that

VDN’s payments to Virginia were made to satisfy only personal

moral obligations of Alan and of Ebert.

     Although VDN did not execute a written loan assumption

agreement, the facts establish that VDN effectively purchased the

working model from CT, that VDN assumed at least part of CT’s

obligation to repay Virginia’s loan to CT, and that VDN’s

payments to Virginia related thereto.   VDN received the working

model CT had developed with the funds borrowed from Virginia.

VDN made the payments to Virginia as payment on Virginia’s loan

to CT.   For 2001, VDN reported to Virginia and to respondent that
                                - 10 -
the payments represented interest and principal on Virginia’s

loan.

     HJ Builders, Inc. v. Commissioner, T.C. Memo. 2006-278,

illustrates a typical constructive corporate distribution to a

shareholder.     In HJ Builders, Inc., a corporation made lease

payments on an automobile used by the wife of the owner of the

corporation.     The lease payments were treated as constructive

corporate distributions to the shareholder husband.     The wife who

used the corporate automobile had no creditor or employee

relationship with the corporation which would otherwise explain

the lease payments.

        In contrast, the payments herein were made by VDN to

Virginia in connection with the precedent creditor relationship

Virginia had with CT, to which VDN at least in part succeeded.

The payments herein are explained by that financial relationship.

The facts before us do not justify a layer of taxation to

petitioners with regard to the VDN payments Virginia received

from VDN beyond the interest income that petitioners reported.

        In his posttrial brief, respondent argues for the first time

that even if VDN had agreed to repay Virginia funds CT borrowed

from her, because there was no written agreement relating to that

obligation, under Oregon’s statute of frauds VDN’s obligation

would not be enforceable.
                               - 11 -
     Generally, under Oregon’s statute of frauds an agreement to

be responsible for or to assume a debt obligation of another will

be treated as unenforceable if the agreement is not evidenced by

a writing.    Or. Rev. Stat. sec. 41.580(1)(b) (2007).   However, an

agreement to assume a debt obligation of another may be excepted

from Oregon’s statute of frauds and may be enforced if assumption

of the debt obligation was part of a purchase of the debtor’s

property.    Sandgren v. Cain Lumber Co., 264 P. 865, 866 (Or.

1928); Feldman v. McGuire, 55 P. 872, 873 (Or. 1899).

     Further, part performance--conduct between the parties that

corroborates the existence of an oral agreement--may cause an

Oregon court to enforce an oral agreement if unjust enrichment

would occur if the oral agreement were not enforced.     Tucker v.

Or. Aero, Inc., 474 F. Supp. 2d 1192, 1215 (D. Or. 2007) (oral

agreement to make royalty payments); Golden v. Golden, 541 P.2d

1397 (Or. 1975) (oral agreement for sale of home).

     Although no written agreement existed reflecting VDN’s

obligation to repay Virginia, VDN’s conduct in actually making

payments to Virginia, which related to Virginia’s loan to CT and

to CT’s transfer of the working model to VDN, establish the loan

repayment character of the payments and the principal and

interest nature thereof.
                             - 12 -
     In addition, the Form 1099-INT that VDN mailed to Virginia

and to respondent for 2001 reflected that $58,600 represented

interest on a loan.5

     When VDN acquired the working model from CT, the development

of which had been made possible by the funds Virginia lent to CT,

VDN received the benefit of Virginia’s loan, and VDN would be

unjustly enriched if VDN did not repay the loan.

     For Federal income tax purposes, the Oregon statute of

frauds does not prevent us from concluding that the funds

Virginia received from VDN in 2001 and 2002 constituted nothing

more than interest and repayment of loan principal.    No portion

of the funds Virginia received from VDN should be treated as

constructive corporate distributions and taxed as capital gain to

Alan.

     The penalties respondent determined are moot.

     To reflect the foregoing,


                                      Decision will be entered

                                 under Rule 155.




     5
       VDN’s reporting on its 2001 and 2002 Federal income tax
returns of the payments to Virginia as nonemployee compensation
appears to have been a self-serving attempt by VDN to deduct the
full amounts paid to Virginia.
