Opinion
Docket No. 24847.
1951-03-2
ESTATE OF BENTLEY W. WARREN, DECEASED, IRVIN McD. GARFIELD, BENTLEY W. WARREN, JR., AND LYDIA M. LOFGREN, EXECUTORS, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
James D. Dow, Esq., for the petitioner. William C. W. Haynes, Esq., for the respondent.
The decedent taxpayer held preferred stock in a corporation, the ordinary and liquidating dividends thereon being guaranteed by another corporation. As full and final cash distribution in liquidation in 1939, preferred stockholders received 25 cents on each share of stock and thereafter the only remaining asset of the preferred stockholders was their guaranty claim. In 1944, decedent sold his claim against the guarantor and used as his basis for computing capital gain or loss his original cost of the stock (reduced by the cash liquidating dividend), relying on section 113 of the Internal Revenue Code. Held, there was an exchange of the taxpayer's preferred stock at the time of corporate liquidation in 1939 and the basis of decedent's capital asset which he acquired in the liquidation is the value of the guaranty claim distributed upon liquidation of the corporation, as provided by section 115 (c), I.R.C. Held, further, the value of the guaranty claim received upon liquidation of the holding company was 75 cents per share, or $433.50 for 578 shares of preferred stock. Respondent's computation of gain upon the sale in 1944 of taxpayer's claim is sustained. James D. Dow, Esq., for the petitioner. William C. W. Haynes, Esq., for the respondent.
The Commissioner has determined an overassessment in petitioner's income tax for the year 1939 in the amount of $1,453.21. This overassessment is primarily due to the allowance by the Commissioner of a net long term capital loss as a deduction from the net income as disclosed by the return of petitioner's decedent for the taxable year 1939. This adjustment is explained in the deficiency notice, as follows:
+----------------------------------------------------------------------------+ ¦(b) Net long-term capital loss ¦ ¦$10,479.38 ¦ +----------------------------------------------------------------------------¦ ¦Taxable loss on stock of Springfield Railway Companies has been computed and¦ +----------------------------------------------------------------------------¦ ¦allowed as follows: ¦ ¦ ¦ +------------------------------------------------------------+---------------¦ ¦Cost of 629 shares acquired from 1919 to 11-22-37 ¦$21,487.75 ¦ +------------------------------------------------------------+---------------¦ ¦Less: Cash received ¦$157.25 ¦ ¦ +------------------------------------------------+-----------+---------------¦ ¦Fair market value of claim ¦471.75 ¦ ¦ +----------------------------------------------------------------------------+
629.00 ---------- Loss 20,858.75 Loss taken into account (50% of $20,858.75) 10,479.38
Petitioner has not appealed from this overassessment and we would have no jurisdiction of it even if the estate of decedent had appealed from it. Our only purpose in giving the details of this overassessment is to better explain the circumstance of the determination of the deficiency which the Commissioner has made for the year 1944.
The Commissioner has determined a deficiency in the income tax of Bentley W. Warren, deceased, of $5,287.84 for the year ended December 31, 1944. The part of the adjustment which is complained of in this proceeding is explained in the deficiency notice as follows:
Year 1944
It has been determined that you realized a long-term capital gain of $5,466.47 (50% of $10,932.94) in 1944 in lieu of the long-term capital loss of $2,430.00 (50% of $4,860.17) claimed in your 1944 return, Form 1040, in respect of the sale of your claim against the New York, New Haven and Hartford Railroad Company under certain guaranty which has been assumed by it as successor of The Consolidated Railway Company, for the redemption of the preferred stock of Springfield Railway Companies— 1926, at $105.00, plus accrued and unpaid dividends. It has further been determined that the cost basis of the said claim was $433.50, its value in 1939 as evidenced by actual sales of similar claims by other former preferred stockholders of the Springfield Railway Companies— 1926 in that year. Accordingly, the gain from the sale of your claim in 1944 has been recomputed as follows:
+---------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦ ¦Amount of ¦ +------+----------+------------+------------+----------+--------------¦ ¦ ¦ ¦ ¦ ¦ ¦gain taken ¦ +------+----------+------------+------------+----------+--------------¦ ¦ ¦ ¦ ¦ ¦ ¦into account ¦ +------+----------+------------+------------+----------+--------------¦ ¦Sold ¦Acquired ¦Sale price ¦Cost basis ¦Gain ¦50% ¦ +------+----------+------------+------------+----------+--------------¦ ¦Claim ¦1939 ¦$11,366.44 ¦$433.50 ¦$10,932.94¦$5,466.47 ¦ +---------------------------------------------------------------------+
The estate of Bentley W. Warren, deceased, the petitioner, contests the foregoing adjustment by an appropriate assignment of error.
FINDINGS of fact.
Most of the facts have been stipulated and as stipulated are adopted as a part of these findings.
Bentley W. Warren, hereinafter referred to as decedent, died on February 27, 1947, and his estate is represented in this proceeding by his duly qualified executors. Decedent's return for the year 1944 was filed on the case basis with the collector of internal revenue for the district of Massachusetts.
During the period February 20, 1919, to February 19,1926, decedent bought 578 shares of preferred stock of the Springfield Railway Companies, sometimes hereinafter referred to as the holding company, at a total cost of $21,231.25. From time to time thereafter, up to and including November 22, 1937, decedent bought 51 additional shares at a total cost of $256.50, which shares were held by him until his death in 1947. At the time of liquidation of the Springfield Railway Companies the value of the 578 shares of preferred stock was $433.50. The preferred stockholders received 25 cents per share as their part of the cash liquidating dividend paid by the corporation, decedent receiving $144.50 in 1939 on his 578 shares.
It has been stipulated that:
In 1944 the taxpayer sold for $11,366.44 the certificates representing his 578 preferred shares of Springfield Railway Companies— 1926, which shares had an original cost of $21,231.25. Said certificates at that time and at all times after the liquidation of Springfield Railway Companies— 1926 represented solely a claim against The New York, New Haven & Hartford Railroad Company on its guaranty.
Warren held shares of preferred stock issued by the Springfield Railway Companies, a Massachusetts business trust, which for the purposes of this proceeding may be considered as a corporation. The holding company was formed on March 15,1905, by a majority of the capital stockholders of the Springfield Street Railway Company, an operating street railway. These stockholders became subscribers to the preferred and common stock of the holding company and their shares of capital stock in the operating company were surrendered in payment of their subscription obligations to the holding company. On this same date the holding company entered into a contract with The Consolidated Railway Company, whereby the latter guaranteed the preferred stock of the holding company as to ordinary and liquidating dividends. Omitting formal parts, the contract agreement contains the following provisions:
Said The Consolidated Railway Company hereby guarantees the payment of said dividends of four per cent. on par value of the preferred stock issued by said Springfield Railway Companies as fixed and determined by said declaration of trusts and any extension or renewal thereof.
Said The Consolidated Railway Company further guarantees that upon any liquidation whether incident to the dissolution or not of the trust above referred to, it will pay to the holders of the preferred shares of the said Companies One Hundred and Five Dollars per share and accumulated dividends. The Consolidated Railway Company agrees to attach and execute the guaranty above set out on each certificate for preferred shares issued by the Railway Companies. Said The Consolidated Railway Company also guarantees and agrees to pay in cash to the Treasurer of the Springfield Railway Companies the sums required to restore any impaired value in the property and securities, other than those of the Springfield Street Railway Company, held by said Springfield Railway Companies, which obligation is more fully set forth in clause seven of said declaration of trust. The said Companies hereby agrees that The Consolidated Railway Company, or its successors or assigns, shall have the right on any dividend day, having previously given to the Secretary of said Springfield Railway Companies at least ninety days notice in writing of its intention so to do, to purchase and acquire all the shares of the preferred stock of said Companies at the price of One Hundred and Five Dollars per share.
Upon receipt of such notice, said Springfield Railway Companies promises and agrees to call upon preferred shareholders for the surrender of their certificates forthwith or before the next dividend day, and to have ready for delivery upon the next dividend day, and upon payment therefor at the rate of One Hundred and Five Dollars per share, to deliver all said preferred shares which have been so surrendered to it to said The Consolidated Railway Company, or its successors or assigns. In the event that any shareholder shall refuse or neglect to deposit with said Companies the certificate of preferred shares as requested within twenty days after the money for his shares has been deposited with the Companies, his title and ownership in the shares of stock represented by the certificate held by him shall thereupon be forfeited and shall vest in said Companies, and said Companies shall thereupon issue to said The Consolidated Railway Company, or such person or corporation as it may designate, a certificate or certificates for such shares and said Springfield Railway Companies shall hold for the benefit of said shareholder or shareholders the sum per share paid to it by said The Consolidated Railway Company.
On each certificate of preferred stock the following endorsement was placed:
Guaranty Agreement.
Cumulative semi-annual dividends amounting to four per cent. (4%) per annum upon the par value of the outstanding Preferred shares of the Springfield Railway Companies and in the event of liquidation, the payment of the sum of one hundred and five (105) dollars per share and any accrued and unpaid dividends thereon together with interest on any such accrued and unpaid dividends thereon at the rate of four per cent. (4%) per annum, are guaranteed, and will be paid by the undersigned in accordance with the terms and provisions of a certain indenture made between the Springfield Railway Companies and the undersigned, dated the fifteenth day of March, 1905.
In consideration of this guaranty The Consolidated Railway Company reserves the right to require the Trustees to call this certificate, and the shares represented thereby on Jan. 1, 1906, or on any dividend date thereafter upon payment or tender to the Trustees of one hundred and five (105) dollars per share and any accrued and unpaid dividends thereon, together with interest on the same at four (4) per cent. per annum; and in that event to require said Trustees to have this certificate surrendered and a new certificate for a like number of shares issued in lieu thereof to The Consolidated Railway Company
THE CONSOLIDATED RAILWAY COMPANY,
By . . .
The instrument creating the holding company granted to the trustees the authority to call in the outstanding shares of preferred stock in its entirety, and with certain limitations the trustees could issue additional shares of preferred stock. The holding company was managed by seven trustees with the preferred shareholders being allowed to select three of the trustees.
The Consolidated Railway Company, the guarantor, merged in 1909 with The New York, New Haven and Hartford Railroad Company and the latter became liable on all the obligations of The Consolidated Railway Company, including its guaranty of the Springfield Railway Companies' preferred stock. Thereafter each new certificate of preferred stock issued by the holding company bore the guaranty indorsement of The New York, New Haven and Hartford Railroad Company.
On February 15, 1926, the holding company's existence expired by virtue of the provisions contained in the Agreement and Declaration of Trust, which created the holding company. A new holding company was formed to succeed and to continue business under the same terms and conditions for an additional term of 10 years and was thereafter known as Springfield Railway Companies— 1926. The guaranty continued and the status of the preferred stockholders of the holding company was in no way affected by the renewal of the trust agreement.
For several years the guarantor furnished funds necessary to enable the holding company to make payment of dividends on its preferred stock. Funds so furnished were paid by the guarantor to the holding company and not directly to the preferred stockholders.
Proceedings under section 77B of Bankruptcy Act for the reorganization of The New York, New Haven and Hartford Railroad Company were commenced in the Federal District Court of Connecticut in 1935, Docket No. 16,562. On April 4, 1936, the president of the holding company filed proof of claim in the reorganization proceeding, based upon the guaranty. On October 20, 1938, the president of the holding company joined with three trustees of the holding company (those trustees elected by preferred stockholders) and filed a petition with the District Court for instructions with respect to the proof of claim. By court order all the petitioners for instructions were ordered to sell all the capital stock of the Springfield Street Railway Company held by the holding company. The stock was sold and the proceeds were distributed, as provided by the court order. Shortly thereafter the holding company declared its common stock worthless, recalled the shares and cancelled them. On June 21, 1939, the trustees distributed the net proceeds from the sale of stock to the holders of preferred stock by check and enclosed therewith their letter advising the holders of preferred stock of their claim against the guarantor. This letter reads, in part, as follows:
The sale of the stock of Springfield Street Railway Company, about which you were advised in our letter of April 8, 1939, has been made and approved by the Court. It produced the net sum of $262.76. After the payment of all charges and expenses of the association, and the reservation of $1,000 for final charges and expenses as authorized by the Court, there remains in the hands of your Trustees 25 cents a share available for distribution among the preferred shareholders, check for which is enclosed.
The shares of preferred stock of Springfield Railway Companies— 1926 now represent only the claim against The New York, New Haven and Hartford Railroad Company upon its guaranty, which it is expected the Court will allow in accordance with its order of February 10, 1939, of which you have already received a copy, in the amount of $106.75 per share, with such allowance for interest as may be determined. (It is of course not to be understood that the claim is to be satisfied by payment in cash of this amount. It is probable that under whatever plan of reorganization of the New Haven Railroad is approved, the holders of such claims will receive stock of the reorganized railroad company.) The certificates for the preferred shares should be retained in order to establish the shareholders' rights to their claims against the New Haven Railroad, which, as stated in our letter of April 8, 1939, are to be hereafter determined in the New Haven reorganization proceedings.
On July 10, 1939, there was allowed in the District Court of the United States for the District of Connecticut as an unsecured claim against The New York, New Haven and Hartford Railroad Company, the claim of the preferred stockholders of the Springfield Railway Companies— 1926 based on the guaranty contained on the back of their preferred shares. The order of the court allowing this claim reads, in part, as follows:
That there is allowed upon the proof of claim (No. 94) filed herein on April 4, 1936 by the President of Springfield Railway Companies— 1926 as a common claim against the estate of the Principal Debtor an amount of $106.75 for each of the 30,261 preferred shares of said association outstanding in the hands of the public, said allowance to be for the amount and benefit of the holders of said shares as their respective rights, titles and interests may be established and determined hereafter in these proceedings as provided by paragraph 5 of Order No. 45 herein, the question of interest upon said allowance being hereby reserved for later determination.
It has been stipulated that:
The obligation of The New York, New Haven & Hartford Railroad Company on the guaranty was an unsecured debt of the said company which at no time became worthless.
* * * Upon the liquidation of Springfield Railway Companies— 1926 no instrument of transfer of the guaranty to the preferred stockholders was executed.
On May 24, 1948, a notice of partial distribution of common stock of The New York, New Haven and Hartford Railroad Company under plan of reorganization was sent out. This notice states, among other things, as follows:
The District Court of the United States for the District of Connecticut, by order entered April 5, 1948, has authorized an initial distribution of one (1) share of new Common Stock (par value $100) of the Company for each One Hundred Dollars ($100) of allowed claim to the holders of unsecured claims allowed in the reorganization proceedings of the Company.
The initial distribution of Common Stock will be made to holders of the following:
6. Springfield Railway Companies— 1926— Preferred Shares.
Attached to this notice of partial distribution was a table of distribution, the part of which is here pertinent is as follows:
+-----------------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦Number of ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦ ¦ ¦ ¦shares of ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦ ¦ ¦ ¦common ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦ ¦ ¦ ¦stock ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦ ¦ ¦Amount ¦distributable ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦ ¦ ¦of claim ¦per $1,000. ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦ ¦ ¦allowed ¦bond, ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦ ¦ ¦per ¦debenture ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦ ¦ ¦$1,000. ¦or share of ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦Principal amount ¦ ¦bond, ¦stock or per ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦of bonds, ¦Total ¦debenture ¦$1,000. of ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦debentures, or ¦amount ¦or per ¦allowed ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦number of ¦of ¦share of ¦claims not ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦shares of stock ¦claim ¦stock ¦represented ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦exchangeable ¦ ¦ ¦by ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦ ¦ ¦ ¦ ¦securities ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦Springfield ¦ ¦ ¦ ¦ ¦ ¦Railway ¦29,338 shares ¦$3,131,831.50¦$106.75 ¦1.0675 ¦ ¦Companies, ¦ ¦ ¦ ¦ ¦ +----------------+------------------+-------------+-----------+---------------¦ ¦1926—Preferred ¦ ¦ ¦ ¦ ¦ ¦shares. ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
OPINION.
BLACK, Judge:
The question which we have to determine is whether when decedent in 1944 sold for $11,366.44 the certificates formerly representing 578 of his preferred shares of Springfield Railway Companies— 1926, he had a capital loss, 50 per cent of which he was entitled to take into account as a deductible loss from his income tax return, as petitioner contends, or whether he had a long term capital gain, 50 per cent of which he must take into account in arriving at his net income in 1944 as the Commissioner has determined. The facts are not in dispute. The difference between the parties arises from the legal interpretation to be given to these facts. At various times prior to February 19, 1926, decedent had acquired 578 preferred shares of Springfield Railway Companies— 1926 at an aggregate cost of $21,231.25. As has already been stated in 1944 decedent sold his claim against the railroad company represented by these shares for $11,366.44. This sale was, of course, a gain or loss transaction under section 111, I.R.C. Both parties are agreed on that fact. The dispute between them is as to what basis decedent was entitled to use in 1944 when he sold his claim represented by these 578 shares. Petitioner contends that the basis to be used is the original cost of the stock, $21,231.25, reduced by a liquidation distribution of 25 cents per share which decedent received in 1939 from a liquidation of the holding company. Respondent contends that decedent's basis for computing his gain or loss on the sale in 1944 was $433.50.
Respondent bases this contention on the fact that in 1939 the holding company was completely liquidated and that what decedent received in the liquidation for his preferred shares in the holding company was 25 cents per share in cash and his claim against the guarantor, The New York, New Haven and Hartford Railroad Company. He has computed decedent's loss for 1939 on his entire 629 shares of preferred stock and has determined an overassessment for that year.
We have given the details of this overassessment in our preliminary statement, although we have no jurisdiction over it in this proceeding. In the manner above stated the Commissioner has determined a cost basis of $433.50 for the part of petitioner's claim represented by the 578 shares which petitioner sold in 1944 and has arrived at a capital gain of $10,932.94, fifty per cent of which he takes into account instead of the capital loss claimed by decedent on his return.
The liquidation of a corporation gives rise to gain or loss to the stockholders whose stock is liquidated. Section 115 of the Internal Revenue Code, so provides.
Petitioner does not contend that the liquidation of decedent's preferred stock in the holding company in 1939 comes within any of the nonrecognition provisions of section 112, I.R.C. That being true, section 111 is applicable to the liquidation which took place. Section 111, I.R .c., is printed in the margin.
SEC. 115. DISTRIBUTIONS BY CORPORATIONS* * *(c) DISTRIBUTION IN LIQUIDATION.— Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 11, but shall be recognized only to the extent provided in section 112. * * *
SEC. 111. DETERMINATION OF AMOUNT OF, AND RECOGNITION OF, GAIN OR LOSS.(a) COMPUTATION OF GAIN OR LOSS.— The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.(b) AMOUNT REALIZED.— The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.(c) RECOGNITION OF GAIN OR LOSS.— In the case of a sale or exchange, the extent to which the gain or loss determined under this section shall be recognized for the purposes of this chapter, shall be determined under the provisions of section 112.
The facts which are given in our findings of fact show clearly that the holding company was completely liquidated in 1939. It was not a partial liquidation which took place. While the outstanding shares of preferred stock of the holding company, part of which petitioner owned, were not surrendered and cancelled, nevertheless these shares no longer represented preferred stock. They were simply evidence of the claim which the former owners of preferred stock retained against the guarantor railroad company. What did petitioner's decedent receive in 1939 in liquidation of his preferred stock? He received 25 cents per share in cash and in addition an unsecured claim against The New York, New Haven and Hartford Railroad Company for $105 redemption price of each share, plus a small amount of accumulated dividends.
This claim was evidently of small value in 1939 because at that time the railroad company was going through a 77B Bankruptcy Reorganization in the United States District Court for the District of Connecticut. The Commissioner has determined in his deficiency notice that decedent's claim as represented by the 578 shares of preferred stock here in question had a fair market value in 1939 on the date of liquidation of the holding company of $433.50. Petitioner does not dispute this valuation. It contests the Commissioner's determination on other grounds which we have heretofore states. This claim which decedent owned against the railroad company after the liquidation of the holding company was, ‘property (other than money) received‘ as those terms are used in section 111, I.R.C. When decedent sold 578 shares of preferred stock in the holding company in 1944, he really was not selling preferred stock. There really was no preferred stock any longer existing in the holding company. It had long since been dissolved.
What decedent sold in 1944 was his claim against the railroad company. That claim had a basis of cost to petitioner of $433.50 and his gain or loss on the sale must be determined on that basis. To hold otherwise, it seems to us would be to disregard the provisions of section 115(c), I.R.C., relating to distributions in complete liquidation of a corporation and that we are not at liberty to do. See Robert J. Boudreau, 45 B.T.A. 390, affd. 134 Fed. (2d) 360. In the Boudreau case, we said among other things, as follows:
Section 115(c) of the Revenue Act of 1934 provides that amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and the gain or loss to the distributee resulting from such exchange shall be determined under section 111. The letter section provides that the gain shall be the excess of the amount realized over the basis, and ‘The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.‘ Section 112 provides: ‘Upon the sale or exchange of property, the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.‘ None of the exceptions has any application to this case. * * * After citing and commenting upon the applicable statutes, we went on to say:
The petitioners in this case were the owners of the stock of the Jim Oil Col. which had cost them $50 per share. There was a complete and final liquidation of the Jim Oil Co. in the taxable year. Rights to oil payments solely from a fraction of the oil produced under a lease were distributed to the petitioners in that liquidation. That property must ‘be treated as in full payment in exchange for the stock.‘ The gain is the excess of the fair market value of that property over the basis of $50 per share. (citing cases) * * *
In affirming our decision in the Boudreau case, the Fifth Circuit said:
Under the express provisions of the applicable statutes, when there is complete liquidation of a corporation, stockholders are accountable for the difference between the cost basis of their stock and the fair market value of the property received in exchange for it. Secs. 111, 112(a), 115(c), Revenue Act of 1934, 26 U.S.C.A.Int.Rev.Acts, page 691, 692, 703, and Treasury Regulations 86 for 1934. The ‘fair market value‘ of property is a question of fact, ‘and only in rare and extraordinary cases will property be considered to have no fair market value‘. ‘t.‘r. 86, 1934, Art. 111-1.
Decedent's loss in the liquidation of the holding company occurred in 1939 as the Commissioner has determined and it is in that year that petitioner's decedent must take his loss on his preferred shares in the holding company.
We think the Commissioner has used the correct basis in determining the gain from the sale in 1944 and we sustain his determination.
Decision will be entered for the respondent.