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In early January of 1997, 1998, and 1999, petitioner Martin
Higbee, as president of the corporation, signed successive
interest-bearing promissory notes payable on demand to Martin
Higbee, as an individual. On November 24, 1999, Cactus Quail
Enterprises, Inc. filed with the Arizona secretary of state an
Application for Registration of Trade Name to register its name.
The Office of the secretary of state responded by advising the
corporation that it "is not in good standing".
An employee of the Commissioner's Ogden Service Center
(Service Center), in a letter dated March 2, 2000, wrote the
corporation in care of petitioner Suzanne Higbee to advise that
"According to our records, you have not been accepted as an S-
Corporation." The letter informs the corporation to file a Form
1120, U.S. Corporation Income Tax Return, in lieu of a Form
1120S, or to apply for "relief for a late S-Corporation
election".
The Commissioner issued to petitioners a statutory notice of
deficiency dated September 15, 2000, for 1997 and 1998
disallowing the deductions for S corporation losses claimed on
their joint Federal income tax returns, making mechanical
adjustments to their itemized deductions, and asserting the
accuracy-related penalties under section 6662(a).
Petitioners' accountant, Mr. Preiser, in a letter to the
Service Center dated December 7, 2000, refers to Forms 1040X,
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