Fred E. Hudspeth v. Commissioner of Internal Revenue Service

PRELIMINARY STATEMENT

This ease presents questions concerning the proper interpretation of the tax benefit rule and Federal Rule of Evidence 408. We hold that the tax court properly construed the tax benefit rule. However, the tax court erroneously excluded certain evidence that should have been admitted under the bias exception to Federal Rule of Evidence 408.

FACTS

The appellants are shareholders of Hud-speth Pine, Inc., which, during the period relevant to the present case, was a validly electing Subchapter S corporation pursuant to Subchapter S of the Internal Revenue Code. I.R.C. § 1361 et seq.

At all relevant times, taxpayers/appellants John and Floreine Hudspeth owned 75% of the stock and bonds issued by Hud-speth Pine, Inc.; taxpayers/appellants Fred and Margaret Hudspeth owned the remaining 25% of the stock and bonds issued by Hudspeth Pine. (Hereinafter, appellants will be referred to collectively as “Taxpayers.”)

In 1966, the Taxpayers’ basis in their Hudspeth Pine stock and bonds were as follows:

In the 1967 tax year, Hudspeth Pine suffered a tax loss of $613,683.45. Taxpayers John and Floreine Hudspeth’s pro rata share of this 1967 Hudspeth Pine loss was…