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On December 21, 1989, in advance of the above actions, the
NAC Corporation board of directors (consisting of petitioner
Donald J. Peracchi as the sole director) "acknowledged and
accepted" as capital contributions the above-mentioned parcels of
real property, and the Capital Note "to offset the difference
between the allocated liability and the basis in the buildings
located at 5118 E. Clinton Way [the Clinton Way Property]."
The following table reflects the computation of the net
amount of petitioners' contribution to capital if the Capital
Note is taken into account at face value:
Item Contributed Fair Market Value
to Capital or Face Value Encumbrance Net Amount
Clinton Way Property $1,870,000 $1,386,654.50 $483,345.50
Fresno/Herndon Property 1,200,000 161,558.28 1,038,441.80
Capital Note 1,060,000 1,060,000.00
Total 4,130,000 1,548,212.78 2,581,787.30
Petitioners made no payments on the Capital Note during
1989, or at any time thereafter until March 15, 1992, when they
made an interest payment of $233,200. The IRS audit of
petitioners' 1989 income tax return had been under way for almost
a year, having commenced during April, 1991.
In February, 1990, management of NALICO was advised by Ernst
& Young, NALICO's independent certified public accountants, that
under Chapter 9 of the National Association of Insurance
Commissioner's Accounting Practices and Procedures Manual for
Life and Accident and Health Insurance Companies (NAIC Manual),
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