## Facts

- Leon H. Perlin was the sole shareholder and controlling officer of Leon H. Perlin Company, Inc., a Virginia construction corporation.
- Perlin became involved with a real estate development venture through Middle Plantation of Williamsburg, Inc. (MPW), controlled by a third-party developer.
- In connection with MPW’s attempt to acquire and develop a large tract of land, Perlin and/or the corporation advanced funds; the litigation centered on $494,101 of unsecured advances made by the corporation to MPW.
- MPW’s development failed, and the parties later entered a third-party transaction in which Realtec Incorporated acquired interests connected to the property and settled outstanding claims.
- Under the Realtec arrangement, Perlin personally received $750,000 cash in 1984 and a $250,000 contingent promissory note, payable in ten years, with no stated interest; the note was prepayable at any time and payable only if a specified value condition was met.
- The Realtec consideration extinguished both Perlin’s personal claims and claims attributable to the corporation’s advances, but the consideration was directed to Perlin rather than paid to the corporation.
- On the 1984 individual return, the Perlins treated the transaction as an installment sale and included $750,000 cash plus $100,000 as a discounted value for the contingent note; the corporation claimed a bad-debt deduction for worthlessness of the $494,101 advances in its fiscal year ending May 31, 1984.
- The Commissioner determined (i) corporate income tax deficiencies (including disallowance of the bad-debt deduction), (ii) an individual income tax deficiency (including a constructive dividend to Perlin), and (iii) an installment-sale recomputation increasing the selling price by using the note’s face amount.

## Issues

1. Whether the corporation proved the $494,101 of unsecured advances to MPW became worthless in the fiscal year ended May 31, 1984.
2. Whether Perlin received a constructive dividend in 1984 by personally receiving consideration that, in substance, paid for corporate claims or rights.
3. Whether installment-sale pricing required including the contingent note’s $250,000 face amount (rather than a discounted value) under the price-interest recomputation rule in Temp. Treas. Reg. § 15A.453-1(c)(2)(ii).

## Decision

- The court held the corporation failed to prove the unsecured advances became worthless in the fiscal year ended May 31, 1984; the bad-debt deduction was disallowed.
- The court held Perlin received a constructive dividend in 1984 to the extent Realtec’s consideration represented payment for corporate claims diverted to him personally.
- The court applied Temp. Treas. Reg. § 15A.453-1(c)(2)(ii) and required inclusion of the contingent note’s full $250,000 face amount in computing the maximum selling price for installment-sale purposes.
- Deficiencies were sustained subject to computations to be entered under Tax Court Rule 155.

## Legal Principles

- A bad-debt deduction for worthlessness requires proof that the debt became worthless in the specific year claimed, shown by identifiable events establishing no reasonable prospect of recovery.
- The taxpayer bears the burden to substantiate entitlement to deductions, including the timing of worthlessness.
- A constructive dividend arises when a corporation confers an economic benefit on a shareholder (directly or indirectly) without expectation of repayment; form does not control where transaction substance shows diversion of corporate value.
- When a sole shareholder controls negotiations and directs consideration to himself for the surrender of corporate claims, the diverted value may be treated as a dividend to the shareholder to the extent of the corporation’s earnings and profits.
- Under Temp. Treas. Reg. § 15A.453-1(c)(2)(ii), installment-sale computations may require treating stated sale price components as including unstated interest; where a contingent note is prepayable at face, its face amount is included in the maximum selling price rather than a taxpayer-selected discounted value.

## Conclusion

The Tax Court denied the corporation’s claimed bad-debt deduction for failure to prove worthlessness in the year claimed, treated the shareholder’s receipt of third-party consideration for corporate claims as a constructive dividend, and required using the full face amount of a prepayable contingent note in installment-sale pricing under the price-interest recomputation rule.


Perlin v. Commissioner, T.C. Memo. 1993-79 (1993)