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C. IRS Determinations
The IRS determined that PKV&S was not allowed to claim bad
debt deductions of $600,000 and $400,000 on its consolidated
income tax returns for 1990 and 1991, respectively, for the cash
transfers that PK Ventures had made to the Zephyr purchasers
because it had not established that a true debtor-creditor
relationship was intended by these transfers. Furthermore, the
IRS determined that, if a debt had been intended, PKV&S had not
established that such debt had become worthless during either
1990 or 1991. Accordingly, the IRS increased PKV&S’s taxable
income by $600,000 for 1990 and by $400,000 for 1991.
The IRS determined that PK Ventures’ transfer of $400,000 to
Rose in connection with the Zephyr purchase constituted a
constructive dividend to him in 1990. Consequently, the IRS
increased the Roses’ taxable income by $400,000 for 1990 and
determined that the Roses should not have reported $400,000 of
cancellation of indebtedness income on their joint income tax
return for 1991.
Transfers to PKVI LP
A. Transfers From Unrelated Parties to PKVI LP
At the time of its organization, PKVI LP was engaged in the
acquisition of three hydroelectric projects that were located in
or near Bynum, North Carolina; Henrietta, North Carolina; and
Columbus, Georgia, respectively. A small portion of the
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