Walling v. Commissioner , 19 T.C. 838 ( 1953 )

Hugh Walling and Mary B. Walling, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent

Walling v. Commissioner

Docket No. 30370

United States Tax Court

19 T.C. 838; 1953 U.S. Tax Ct. LEXIS 240;

January 30, 1953, Promulgated

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Decision will be entered for the petitioners.

During the taxable year, assets of a partnership were conveyed to a corporation in return for stock. The conveyance was at the book value of the assets. Subsequent to the date of conveyance, the respondent made adjustments resulting in a higher book value as of the date of conveyance to the corporation. The corporation paid the difference between the book value of the assets before and after respondent's adjustment to one of the petitioners, a stockholder of the corporation and a member of the prior partnership.

Held, under all the facts, such payment was not a dividend and was not taxable income for the year in which paid.

James P. Hill, Esq., and William R. Frazier, Esq., for the petitioners.

Thomas C. Cravens, Jr., Esq., for the respondent.

Rice, Judge.

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RICE

The respondent determined a deficiency in income tax for the year 1946 in the amount of $ 4,667.30.

The sole issue is whether Hugh Walling received a dividend from the Walling Crate Company, Inc., during 1946, in the amount of $ 5,647.07.

Some of the facts were stipulated.

FINDINGS OF FACT.

The stipulated facts are so found and are incorporated herein.

Petitioners are husband and wife, residing in Leesburg, Florida. They filed a joint return for the taxable year 1946 with the collector of internal revenue for the district of Florida. The term "petitioner" as used herein means Hugh Walling.

The Walling Crate Company, Inc. (hereinafter referred to as the Corporation) is a Florida corporation with its principal place of business in Leesburg, Florida. During the taxable year it was engaged in the business of manufacturing and selling fruit and vegetable crates, boxes, and other wood products. The Corporation was organized and incorporated on September 16, 1946, under the general incorporation laws of the State of Florida. From July 1, 1942 to September 16, 1946, the business was operated as an alleged partnership under the name of Walling Crate Company (hereinafter referred to as the Company). Petitioner, his wife, and their four children were the partners in the Company. Three of their children were minors, and the petitioner had been declared their legal guardian.

In the minutes of the first meeting of the Board of Directors of the Corporation, on September 16, 1946, the following appears:

The following PROPOSAL TO EXCHANGE PROPERTY FOR STOCK of the corporation was submitted and considered:

TO THE WALLING CRATE COMPANY,

Leesburg, Florida.

September 16, 1946.

Gentlemen:

We hereby offer to sell and transfer to you in exchange for $ 217,200.00 of your capital stock to be issued equally to the undersigned, i. e., 1/6th each of $ 36,200.00 each, such stock to be fully paid and non-assessable, the partnership business heretofore operated by us known as the Walling Crate Company, consisting of the assets shown on the schedule of assets appended hereto aggregating $ 217,004.40, and also pay you cash in the amount of $ 195.60 (being $ 32.60 from each of us).

If this offer is accepted we will deliver to your corporation such instruments as are proper to properly vest you with title to such assets upon delivery of the proper stock certificates of your company.

Yours very truly,

[Signed by the partners]

The directors found that the foreging proposal should be accepted by the corporation, and was advantageous to the corporation, and upon Motion of Mary B. Walling, and unaminously [sic] carried, the proposal was accepted, and the President and Secretary was authorized and directed to issue stock of the corporation as provided in said proposal upon delivery of the necessary instruments vesting title in the corporation of the assets set forth in said schedule and upon payment to the corporation of the sum of $ 195.60.

The value of the stock issued in exchange for the various assets transferred to the Corporation represented the value of such assets as reflected by the books and records of the partnership as of September 16, 1946. The parties to the transaction intended to transfer the assets of the partnership at their book value.

Subsequent to September 16, 1946 and before December 31, 1946, an agent of the Bureau of Internal Revenue made an audit of the books and records of the partnership for the period July 1, 1942 through December 31, 1945. In the course of his audit, the revenue agent disallowed certain claimed business deductions taken on the partnership returns, on the ground that such deductions were capital expenditures and not ordinary and necessary business expenses. Such adjustments increased the book value of the assets of the partnership as of September 16, 1946, after depreciation, by the amount of $ 5,647.07. The revenue agent also disallowed the family partnership for income tax purposes for the period July 1, 1942 through December 31, 1945. The petitioner acquiesced in the disallowances and paid the deficiencies resulting therefrom.

After the above-mentioned adjustments were made, the Corporation, on December 31, 1946, placed a journal entry on its books increasing the value of such assets by the amount of $ 5,647.07, and recording a liability of the same amount to the petitioner. On December 31, 1946, the Corporation issued its check in the amount of $ 5,647.07 to petitioner. The respondent determined that the check represented dividend income to the petitioner for the year 1946.

OPINION.

The parties agree that the Corporation had sufficient earnings and profits as of December 31, 1946, to have paid a dividend in the amount of $ 5,647.07. The petitioner argues that the payment was not a dividend, but was received as partial payment for assets transferred to the Corporation at book value. The respondent argues that, on September 16, 1946, all of the assets were sold to the Corporation by the partners of the Company in return for stock; that, subsequent to that date, they had no interest in such assets; that there was no obligation on the part of the Corporation to pay the money; and, therefore, that it is taxable as a dividend under section 115 (a) of the Code. It is true that the offer to exchange the assets for the stock in the Corporation was made and accepted on September 16, 1946. The value of the assets transferred to the Corporation represented the value of such assets as reflected by the books and records of the Company as of September 16, 1946. It was the intent of the parties to transfer them at book value. Subsequent to such date, adjustments made by the respondent in the tax returns filed by the partnership for the period July 1, 1942 through September 16, 1946, disallowing certain deductions as ordinary and necessary business expenses and capitalizing the same with an allowance for depreciation, resulted in an increase in the book value of the assets as of September 16, 1946.

The action of the Corporation, recognizing this adjustment by putting journal entries on its books, as of December 31, 1946, increasing the value of such assets and recording a liability in the same amount to petitioner, was a direct result of such adjustments by the respondent. In effect, there was a reformation of the contract of September 16, 1946. While it may be true that the Corporation was not legally obligated to make such adjustment, there is no prohibition against parties to a contract amending it, and that is what occurred in this case.

The respondent, by his own action, placed the parties in a position of having conveyed assets at less than book value, which they had intended to convey at book value. The adjustments made by respondent, and acquiesced in by the contracting parties, were capital in nature. No income was created thereby, or resulted therefrom. Cf. Curran v. Commissioner, 49 F. 2d 129 (C. A. 8, 1931); Frank W. Ross, 44 B. T. A. 1 (1941); Herff & Dittmar Land Co., 32 B. T. A. 349 (1935). Nor was there any realization by the partners of any appreciation in value of partnership assets, nor any earnings therefrom which could create taxable income. The depreciated costs of the assets were established to be more than the book values upon which the parties had contracted. This unexpected difference in values, arising out of a mutual mistake of fact, was taken care of by the contracting parties by a cash payment of the difference to the transferors. It is immaterial that the money was all paid to petitioner rather than pro rata to all the stockholders. It did not constitute income to any of them, and was their capital to do with as they wished. That they were willing for petitioner to receive all of it has no effect upon the income tax liability for such money.

Under such circumstances, the respondent erred in determining that the $ 5,647.07 constituted taxable income to petitioner during the year 1946.

Decision will be entered for the petitioners.