Opinion
Docket No. 24285.
1952-02-29
JOHN T. ROBERTS AND FLORENCE V. ROBERTS, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Stanley Worth, Esq., and Edward S. Smith, Esq., for the petitioners. Stephen P. Cadden, Esq., for the respondent.
Redemption of entire block of corporate stock formerly owned by petitioner's brother, and bequeathed by him to petitioner, the surviving shareholder, held, on all facts, not a distribution essentially equivalent to a dividend under section 115(g), Internal Revenue Code. Stanley Worth, Esq., and Edward S. Smith, Esq., for the petitioners. Stephen P. Cadden, Esq., for the respondent.
Petitioners attack respondent's determination of a deficiency in income tax of $77,068.90 for 1944. Two adjustments are not now contested. The issue remaining in controversy is whether a redemption of corporate stock constituted a distribution essentially equivalent to a dividend under section 115(g), Internal Revenue Code. Some of the facts have been stipulated.
FINDINGS OF FACT.
The stipulated facts are hereby found accordingly.
Petitioners, husband and wife, reside in Baltimore, Maryland, and filed a joint income tax return for 1944 with the collector for the district of Maryland.
From 1921 to March 21, 1932, petitioner John T. Roberts, hereinafter called Hollie, conducted a partnership engaged in the wholesale plumbing and heating supply business in Baltimore, Maryland. Petitioner had a 75 per cent interest and Hollie had a 25 per cent interest in that partnership.
On March 21, 1932, J. T. Roberts & Brother, Inc., hereinafter called the Corporation, was organized as a corporation under the laws of Maryland with an authorized capital stock of $200,000, consisting of 2,000 shares of common stock with par value of $100 each. On March 31, 1932, the capital stock of the Corporation was exchanged for the assets of the partnership. Five hundred shares were issued to Hollie, and petitioner became the beneficial owner of the remaining 1,500 shares. Petitioner owned those shares throughout the period March 31, 1932, to December 31, 1944. The Corporation continued in the same business, and acquired an excellent reputation, for which petitioner was largely responsible.
On October 3, 1943, Hollie died. By his last will Hollie made a specific bequest to petitioner of any shares of stock of the Corporation owned by him at the time of his death. By an order entered June 27, 1944, by the Orphans' Court of Baltimore City, Hollie's executor was directed to transfer 500 shares of the Corporation's stock to petitioner. Under date of July 26, 1944, the executor transferred to petitioner a certificate for 500 shares of the Corporation's capital stock. The stock certificate book of the Corporation shows the issuance to petitioner of certificates number 4 and 5 for 50 shares each and certificate number 6 for 400 shares. They represented transfers of shares originally owned by Hollie. Three certificates were issued at that time because petitioner thought he might wish to make gifts of some portion of the stock to members of his family, although no such gifts were made prior to December 31, 1944. The 500 shares of capital stock of the Corporation owned by Hollie were finally determined in the Federal estate tax proceeding in Hollie's Estate to have a fair market value at date of death of $92,000. That value was agreed to by an internal revenue agent, Hollie's executor, and petitioner on December 31, 1944.
Prior to Hollie's death, the business had been run by petitioner and Hollie. Upon Hollie's death petitioner considered his son to be the logical person to take over some of his burdens. The latter had been employed by the Corporation for two years prior to the War and was in military service from 1941 to 1946. Upon his discharge in 1946, he joined petitioner in the conduct of the business, and since that time he has assumed a major portion of the responsibility.
During the war the business of the Corporation was adversely affected by Government regulations which restricted supplies for the distributing and manufacturing aspects of the business. During the period 1941 to 1944 the difficulties of operating increased. Petitioner never considered selling his shares to anyone but the Corporation because he wanted to keep the stock in the family.
On December 26, 1944, the Corporation's board of directors, at a special meeting, voted to acquire from petitioner 500 shares of its capital stock. The minutes of that meeting state, in part, as follows:
* * * A motion made by the President to purchase 500 shares of Capital Stock of J. T. Roberts & Bro. Inc. at the price of $184.00 per share. The 500 shares above mentioned being the original 500 shares registered in the name of Hollie V. Roberts. Certificate No. 2 Dated March 31st 1932. Now Deceased.
Said shares being willed as a gift to John T. Roberts. The original shares being cancelled, and new ones issued in the name of John T. Roberts July 26th 1944. Certificates No. 4 (50 shares) No. 5 (50 shares) and No. 6 (400 shares)
The price of $184.00 per share for the 500 shares originally issued to Hollie V. Roberts Certificate No. 2 March 31st 1932, was agreed upon as a fair value by
Mr. Laurie H. Riggs The eXecutor of the Estate, John T. Roberts and Mr. Euhler Auditor for the U.S. Internal Revenue Department.
in the Office of Mr. Riggs December 21st 1944.
The motion was made, seconded and carried, and the purchase of the 500 shares was executed the price of $184.00 per share total $92,000.00 the object in the purchasing of the shares at this time is due to the fact, that our business is restricted due to War Regulations, and we do not need a large cash reserve, that we have on hand at this time.
Petitioner, as president, made the above motion which was his own idea, the objective being to collect the bequest of Hollie. He had no particular use for the sum of $92,000.
At the same meeting of the board of directors it was resolved that a reduction of the capital stock to 1,500 shares of common stock, with par value of $100 each, would be advisable. On the same day it was resolved at a special meeting of the Corporation's stockholders to reduce the authorized and issued capital stock in accordance with the resolution of the board of directors. On December 26, 1944, the Corporation acquired from petitioner 500 shares of its capital stock for cash in the amount of $92,000. In connection with the transaction, stock certificates numbered, 4, 5, and 6 are shown as cancelled in the Corporation's stock certificate book.
On the same date ‘Articles of Amendment and Reduction‘ relating to the certificate of incorporation were executed. They provided for a reduction of capital stock pursuant to the aforesaid resolutions. The Articles were approved by the State Tax Commission of Maryland on April 16, 1945.
The Corporation's income tax returns for the years 1939 to 1944, inclusive, reported gross sales and adjusted net income in the following amounts:
+---------------------------------+ ¦ ¦ ¦Adjusted ¦ +------+-------------+------------¦ ¦Year ¦Gross sales ¦net income ¦ +------+-------------+------------¦ ¦ ¦ ¦ ¦ +------+-------------+------------¦ ¦1939 ¦$771,539.15 ¦$28,405.48 ¦ +------+-------------+------------¦ ¦1940 ¦982,436.68 ¦47,688.21 ¦ +------+-------------+------------¦ ¦1941 ¦1,677,813.60 ¦63,888.56 ¦ +------+-------------+------------¦ ¦1942 ¦1,290,696.70 ¦106,783.50 ¦ +------+-------------+------------¦ ¦1943 ¦630,667.66 ¦49,975.21 ¦ +------+-------------+------------¦ ¦1944 ¦400,208.79 ¦13,335.56 ¦ +---------------------------------+
The Corporation's balance sheets, as reported in its 1944 income and declared value excess-profits tax return, showed as of January 1, 1944, total assets of $413,969.35, including cash of $160,378.03 and investments in obligations of the United States of $96,481.37, with an earned surplus of $169,873, and showed as of December 31, 1944, total assets of $319,512.77, including cash of $59,792.88 and investments in obligations of the United States of $106,467.58, with an earned surplus of $135,873.99.
Earnings and profits of the Corporation prior to and during 1944 were accumulated for no definite purpose. The operations of the Corporation were not impaired by reason of the transaction in controversy, and it has never followed a policy of contraction of business. The Corporation's financial position on December 26, 1944, permitted of a dividend of $92,000. The Corporation continued in the same business in subsequent years.
Between March 21, 1932, and December 31, 1943, the Corporation paid the following dividends on its capital stock: $4 per share in 1934; $16 per share in 1935; $8 per share in each year from 1936 to 1940, inclusive; $6 per share in 1941 and no dividends in 1942 and 1943. On December 28, 1944, a dividend was declared of $2 per share on the 1,500 shares outstanding, payable on December 29, 1944.
Petitioner's tax return for 1944 showed adjusted gross income of $33,475.37, consisting of salary from the Corporation of $27,900, dividends and interest totaling $5,507.78, and $67.59 from a trust. The transaction in controversy was not reported.
Respondent's notice of deficiency stated: ‘It is held that the amount of $92,000.00 paid to you by J. T. Roberts and Brothers, Incorporated, on December 27, 1944 is taxable as a dividend.‘
The payment of $92,000 to petitioner by the Corporation in the taxable year was a distribution in complete cancellation and redemption of all of that portion of the Corporation's stock bequeathed by Hollie, constituting a partial liquidation, and no the essential equivalent of the distribution of a taxable dividend.
OPINION.
OPPER, Judge:
Although not neatly presented as a matter of formalism, the essence of the present situation appears to us to be the redemption of the shares of one stockholder, the estate of petitioner's brother, and its elimination as a participant in the enterprise. That this operation would not lead to the ‘essential equivalence‘ described in 115(g) was demonstrated as long ago as Clara Louise Flinn, 37 B.T.A. 1085, acq. 1938-2 C.B. 11, where we said (1094):
* * * Here there was a complete liquidation of the holdings of but one shareholder owning a minority of the shares. The purpose was not to distribute earnings, but to bring about a separation of this one shareholder from the corporation. The remaining shareholders remained substantially unchanged in their relation to the corporation and its earnings.
To the same effect is Carter Tiffany, 16 T.C. 1443.
True, the redeemed shares appear technically to have been transferred to the other stockholder (petitioner), and the actual redemption to have resulted after he became the sole owner of all the shares. True also, the corporate resolutions do not in artistic terms refer to a partial liquidation but rather to a reduction in the corporation's need for operating capital. Nevertheless, we think it too clear for argument and have so found as a fact that it was the estate's stock, and no other, that was actually redeemed, on which such estate taxes as were due would already have been paid; and that the assets of the business were being reduced proportionally.
By any of the accepted tests this would not require the invocation of section 115(g). Nor will it lead to difficult and possibly inequitable aspects of the problem of basis which would otherwise necessarily arise. See Marie W. F. Nugent-Head Trust, 17 T.C. 817; Katcher, ‘The Case of the Forgotten Basis: An Admonition To Victims of Internal Revenue Code Sec. 115(g),‘ 48 Mich.L.Rev. 465, 469; Maloney, ‘Outline of Points to be Considered in Stock Redemptions,‘ N.Y.U. Fifth Annual Institute on Federal Taxation, 837, 842; Nolan, ‘The Uncertain Tax Treatment of Stock Redemptions, ‘ 65 Harv.L.Rev. 255, 275; cf. also Revenue Act of 1950, section 209, adding section 115(g)(3), Internal Revenue Code.
Decision will be entered under Rule 50.