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noncash transactions, made by issuing, endorsing, or canceling
notes, and recorded only by journal entries. These were
Machise's payments, in 1984, 1985, and 1986, of $473,458 as
deferred payments of the compensation fee, plus interest (the 10-
percent late charge). The payments took the form of demand notes
executed by Machise. These payments were recorded as passing
through MIT 82, as compensation fee income or as a return of
advances under the employee leasing agreement. The payments
exited as capital distributions to the partners. The payments,
which took the form only of endorsements to the Machise demand
notes, then passed from the partners as payments on their notes
to Machise, which reported them as income.
For the year 1987, MPC, which had succeeded to the interests
of Machise, assumed the responsibility of making its payments.
The books of MIT 82 reflect that, in 1987, MPC transferred
$473,458 to MIT 82.
The Pettisanis' Deductions of Interest Payments
Each year, Fred treated as deductible interest some part of
the $473,458 amount that was applied against the partners' note
obligations to Machise. The partners in MIT 82, following
instructions from BBPA, accordingly filed individual income tax
returns (Forms 1040) on which they claimed their pro rata shares
of the resulting deductions.
Frank and Lucille Pettisani claimed Schedule E interest
deductions of $20,000, $18,921, $17,733, $16,427, and $21,697 on
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