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Howard P. Blount and Dolly H. Blount, Petitioners v. Commissioner of Internal Revenue, RespondentBlount v. CommissionerDocket No. 5519-66March 26, 1969, Filed
United States Tax Court *162Decision will be entered for the respondent .The petitioner and his family owned 40 percent of the outstanding stock in a corporation; two other family groups, headed by his brother and brother-in-law, owned most of the balance of the stock. The petitioner, his brother, and his brother-in-law entered into an agreement with the company, which provided for their retirement with a pension, and further provided that each of them could, at his election, have up to a certain stated amount of his stock redeemed by the corporation each year. This plan was not designed to effectuate any valid business purpose of the corporation.
Held , the redemptions of the petitioner's stock pursuant to this agreement were essentially equivalent to dividends.Robert V. Hunter , for the petitioners.Stephen M. Miller , for the respondent.Simpson,Judge .SIMPSON*1024 The respondent determined deficiencies in the petitioners' income tax as follows:
TYE Deficiency 12/31/60 $ 3,078.46 12/31/61 3,624.99 12/31/62 2,141.22 12/31/63 2,264.65 The sole question for decision is whether the distributions by the Blount Lumber Co. to the petitioners in redemption of their stock were taxable as a dividend. The petitioners have conceded *163 another issue raised by the statutory notice of deficiency, and the third issue, relating to the deduction of medical expenses, depends solely on our resolution of the principal issue.
FINDINGS OF FACT
Some of the facts have been stipulated, and those facts are so found.
The petitioners, Howard P. Blount and Dolly H. Blount, are husband and wife, who resided in Lacona, N.Y., at the time the petition was filed in this case. They filed joint income tax returns for the taxable years 1960 through 1962 with the district director of internal revenue, Syracuse, N.Y., and for the taxable year 1963, with the district director of internal revenue, Buffalo, N.Y.
The Blount Lumber Co. was organized in 1908 by Howard's father, and since that time has been engaged in various phases of the lumber business, including production of hardwood flooring and millwork. Howard's father died in 1932, leaving majority control of the capital stock to Howard's mother. She became president of the company but was inactive in its operations.
The company's operations were controlled by Howard, by H. Floyd Blount, his brother, and by H. Wallace Parker, Howard's brother-in-law and husband of his and Floyd's sister. *164 Prior to the death of Howard's mother in 1954, Howard and Floyd were vice presidents, and Wallace was treasurer; each had responsibility for parts of the company's operations. Since at least 1950, substantially all the stock in the company has been owned by Howard, Floyd, and Wallace, or members of their respective families.
The period prior to 1953 was marked by a high degree of dissension and disagreement among the men, particularly between Howard and Floyd. Their disagreements were of both a business and a personal nature and produced concern over the future of the company by the children of Howard, Floyd, and Wallace, who hoped to take over the company, and by T. B. Lundgren and H. J. Hoit, two key men in the company's operations. One concern was that such disagreements would lead to the company's stock falling into outside hands.
*1025 As of February 2, 1953, the company had authorized capital stock consisting solely of 3,000 shares of common stock, of which 2,420 shares were outstanding. On that date, a voting trust was created to obviate the possibility that Howard, Floyd, or Wallace would transfer his stock to an outsider or that two of the three would join forces to vote out *165 the third. Each of the three family groups transferred a number of shares to the trust, to be voted by the trustee, Wendell Sprague, with the result that just over 50 percent of the company's outstanding shares was held by the trust. The voting trust was to, and did, continue until February 1, 1963, when it was dissolved.
After the death of his mother in 1954, Howard became president of the company; he continued to hold that position until his retirement. During this period, Floyd was vice president, Wallace was treasurer, and Theodore B. Lundgren was secretary. During the late 1940's and early 1950's, Howard's son, George R. Blount, Floyd's son, F. Thomas Blount, and Wallace's son, Robert E. Parker, became active in the affairs of the company. Although Howard, Floyd, and Wallace each had other children, some of whom worked for the company part or full time during the 1950's, it was decided, after some disagreement, that only one child from each family group should have a significant part in the ownership and management of the company. As of January 1, 1960, George, Thomas, Robert, their fathers, and Lundgren comprised the company's board of directors.
In the late 1950's, those *166 active in the company expressed concern with three problems regarding the company's ownership and management: (1) That the shares of stock held by the children who were not active in the company should not be transferred to outsiders; (2) that means be provided for George, Thomas, and Robert to take over the ownership as well as the managerial responsibility from their fathers; and (3) that provision be made for the retirement of Howard, Floyd, and Wallace. On March 12, 1960, the company's stockholders elected a new board of directors, comprised of the members of the old board plus H. J. Hoit. Howard was elected chairman of the board. The newly constituted board elected Floyd as president and Robert as vice president. Wallace continued as treasurer and Lundgren as secretary.
On July 12, 1960, Howard, Floyd, and Wallace entered into an agreement with the company which had the stated purpose of providing for their retirement. It provided in pertinent part:
1. Howard P. Blount, H. Floyd Blount and H. Wallace Parker each agrees to retire from the active management of the corporation and its subsidiary, Blount-Parker Corp., not later than December 31st preceding his 68th birthday. Following *167 his retirement, until his death, the corporation agrees that it and/or its subsidiary will pay to each man so retired an annual salary of $ 7,500.00 in recognition of his long and faithful service to such corporations; except that Howard P. Blount shall be paid an annual salary of $ 10,000.00 in each of his first two years following retirement, and $ 7,500.00 per year thereafter.
*1026 Howard demanded and received under the agreement a larger payment for the first two years after retirement because the agreement required him to retire sooner than the others. In accordance with the terms of the agreement, Howard, who became 68 years old on February 2, 1960, retired from the company on December 31, 1959. *168 maximum to be at the election of the seller. Thereafter, until the death of the survivor of them, the corporation agrees to purchase from Howard P. Blount and Dolly H. Blount, his wife, or either of them, up to fifteen (15) shares of such stock in all, in each year, the actual number of shares up to such maximum to be at the election of the seller. In each case, the price to be paid for such stock shall be determined as hereinafter set forth.
The plan contained identical provisions for the redemption of stock held by Floyd and Wallace and their wives -- up to 20 shares could be redeemed in the first 2 years following retirement, and up to 15 shares in each year thereafter. In all cases, the redemption price of the stock was to be an amount equal to three-quarters of its book value at the close of the year preceding the redemption.
Pursuant to this agreement, the company redeemed shares held by Howard in the following amounts:
Number of Proceeds of Year shares redeemed redemption 1960 20 $ 11,441.80 1961 *169 80 12,152.80 1962 60 9,157.80 1963 60 8,923.80 A second stated purpose of the plan was to provide a means for the disposition of some of the stock held by Charles H. Blount, Floyd's son, who was also a party to the agreement. To this end, it provided that Charles could, at his option, redeem up to 10 shares of stock in each of 1960 and 1961, the redemption price to be three-quarters of the book value of such shares at the close of the year preceding the redemptions.
Also on July 12, 1960, the stockholders, in a special meeting, pursuant to a "plan of recapitalization," authorized the company to provide for the issuance of nonvoting preferred stock, in exchange for the common stock then held by those children who were not active in the operation of the company and by the William W. Parker Co., whose *1027 stock was owned by William W. Parker and his wife. The exchange so authorized was at the option of each shareholder, except that each could exchange no more than 225 shares of the common stock under this plan. Pursuant to this authorization, certain of the shareholders exchanged common shares for preferred shares as follows:
1960 *170 1961 1962 Jean B. Culver 80 39 24 Charles H. Blount 133 John A. Parker 27 James B. Parker 27 In 1964, some of the preferred stock issued in exchange for the common was redeemed by the company. After this redemption, the nonactive children and the William W. Parker Co. had the following stock interests:
Common Preferred Jean B. Culver None None Charles H. Blount None 640 John A. Parker None None James B. Parker None None William W. Parker 40 None William W. Parker Co 172 None The following table shows the ownership, including beneficial ownership in the shares held in the voting trust, of the outstanding common stock of the company as of July 12, 1960, and December 31, 1960, 1961, 1962, and 1963:
*171Shareholder 7/12/60 12/31/60 12/31/61 Howard P. Blount family group Howard P. Blount (petitioner) 493 1,856 1,697 Dolly H. Blount (petitioner) 135 540 540 George R. Blount (son) 272 1,088 1,128 Jean B. Culver (daughter) 71 Total 971 3,484 3,365 H. Floyd Blount family group H. Floyd Blount 410 1,600 1,561 Charles Blount (son) 133 40 Ednah T. Blount (wife) 72 288 48 F. Thomas Blount (son) 133 572 851 H. Floyd Blount Trust 207 828 828 Total 955 3,328 3,288 H. Wallace Parker family group H. Wallace Parker 211 844 844 Florence B. Parker (wife) 80 256 256 William W. Parker Co. 43 172 172 Robert E. Parker (son) 102 408 408 William W. Parker (son) 10 40 40 J. A. Parker (son) 19 J. B. Parker (son) 19 Total 484 1,720 1,720 T. B. Lundgren 5 20 20 H. J. Hoit 5 20 20 Total shares outstanding 2,420 8,572 8,413 Shareholder 12/31/62 12/31/63 Howard P. Blount family group Howard P. Blount (petitioner 1,578 1,478 Dolly H. Blount (petitioner) 540 540 George R. Blount (son) 1,163 1,203 Jean B. Culver (daughter) Total 3,281 3,221 H. Floyd Blount family group H. Floyd Blount 1,506 1,451 Charles Blount (son) Ednah T. Blount (wife) 48 48 F. Thomas Blount (son) 906 961 H. Floyd Blount Trust 828 828 Total 3,288 3,288 H. Wallace Parker family group H. Wallace Parker 769 769 Florence B. Parker (wife) 256 256 William W. Parker Co. 172 172 Robert E. Parker (son) 433 433 William W. Parker (son) 40 40 J. A. Parker (son) 25 25 J. B. Parker (son) 25 25 Total 1,720 1,720 T. B. Lundgren 20 20 H. J. Hoit 20 20 Total shares outstanding 8,329 8,269 *1028 The following table shows the net changes in common stock ownership for each of the company's shareholders:
7/31/60 to 12/31/60 to 12/31/61 to 12/31/62to 12/31/60 12/31/61 12/31/62 12/31/63 Howard's family Howard -116 ( -29) -159 -119 -100 Dolly 0 0 0 0 George 0 +40 +35 +40 Jean -284 ( -71) 0 0 0 Total -400 (-100) -119 -84 -60 Floyd's family Floyd -40 ( -10) -39 -55 -55 Charles -492 (-123) -40 0 0 Ednah 0 -240 0 0 Thomas +40 (+10) +279 +55 +55 H. Floyd Blount Trust 0 0 0 0 Total -492 (-123) -40 0 0 Wallace's family Wallace 0 0 -75 0 Florence -64 ( -16) 0 0 0 Parker Co 0 0 0 0 Robert 0 0 +25 0 William 0 0 0 0 J. A -76 ( -19) 0 +25 0 J. B -76 ( -19) 0 +25 0 Total -216 ( -54) 0 0 0 T. B. Lundgren 0 0 0 0 H. J. Hoit 0 0 0 0 Grand total -1,108 (-277) -159 -84 -60 Howard's salary from the company for the years 1955 through 1959 was as follows:
Year Salary 1955 $ 11,000 1956 11,000 1957 11,000 1958 13,000 1959 9,000 Amounts received by Howard as retirement salary or pension payments and in redemption for his stock in 1960 through 1963 were as follows:
Salary (pension Year payments under Stock Total July 12, 1960, redemptions agreement) 1960 $ 5,000 $ 11,441.80 $ 16,441.80 1961 5,000 12,152.80 17,152.80 1962 7,500 9,157.80 16,657.80 1963 7,500 8,923.80 16,423.80 The difference between the $ 5,000 pension payment made to Howard by the company in 1960 and 1961 and the $ 10,000 to which he was *1029 entitled in those years under the 1960 retirement agreement was paid by the Blount-Parker Corp., a subsidiary of the company. After his retirement, *173 Howard no longer had any active role in the running of the company. He attended two directors' meetings between his retirement and 1963 and performed no compensable services for the company in that time.
The company's taxable income for 1955 through 1963 was as follows:
Year ended June 30, 1955 $ 169,675.38 Period ended Dec. 31, 1955 87,573.84 Year ended Dec. 31 -- 1956 102,738.65 1957 29,857.76 1958 31,873.12 1959 182,553.91 1960 59,489.16 1961 74,271.92 1962 (29,547.73) 1963 15,899.51 Its accumulated earnings and profits
Year ended June 30, 1955 $ 930,683.60 Period ended Dec. 31, 1955 976,672.09 Year ended Dec. 31 -- 1956 1,033,278.44 1957 1,057,822.80 1958 1,083,088.03 1959 1,225,617.71 1960 1,263,507.14 1961 1,263,880.55 1962 1,236,997.69 1963 1,240,645.78 The company declared and *174 paid formal dividends on its common stock in the 1940's totaling $ 8,000 in each of 3 years and $ 12,500 in each of 2 years. It has never declared and paid any other cash dividends on its common stock. The only formal dividends paid during 1961 to 1963 were paid on the preferred stock. Such payments totaled $ 7,142.50 in 1961, $ 7,380 in 1962, and $ 7,470 in 1963.
During the late 1950's and early 1960's, certain areas of the company's business were declining, while another, the millwork division, was expanding.
For each of the taxable years 1960, 1961, 1962, and 1963, Howard reported the difference between the amount received from the company in redemption of his company stock and his basis in that stock *1030 as long-term capital gain. In his statutory notice of deficiency, the respondent determined that amounts received in payment for the redeemed stock constituted dividend income.
OPINION
The question that we must decide is whether the redemptions of Howard's stock pursuant to the retirement agreement are to be treated as sales of such stock or whether the amounts which he received for the stock are to be treated as dividends. The answer turns on whether the redemptions are essentially *175 equivalent to dividends within the meaning of
section 302(b)(1) of the Internal Revenue Code of 1954 .Estate of Arthur H. Squier , 35 T.C. 950">35 T.C. 950 (1961)2 C.B. 5">1961-2 C.B. 5 ;Thomas G. Lewis , 35 T.C. 71">35 T.C. 71Ralph L. Humphrey , 39 T.C. 199">39 T.C. 199Beatrice Levin , 47 T.C. 258">47 T.C. 258385 F. 2d 521 (C.A. 2, 1967).]In the ordinary case, "the indispensable first step in * * * [determining dividend equivalency] is whether the redemption of stock has caused a meaningful change in the position of the shareholder with relation to his corporation and the other shareholders."
Bradbury v.Commissioner , 298 F. 2d 111, 298 F.2d 111">116It is true that Howard, Floyd, or Wallace could choose to have the maximum allowable amount of his stock redeemed although the others did not. The effect might be a change in his proportional ownership of the corporation. However, such a change would result from the elections made by the principal owners, and since they all had the same rights under the retirement plan, the fact that they might exercise their rights differently is not indicative *178 that the redemptions were sales rather than dividends.
The accumulated earnings and profits and the lack of dividends distributed by the corporation are also indicative that the redemptions were essentially equivalent to dividends. For the years 1955 through 1963, the corporation had substantial accumulated earnings and profits -- many times the amount of the redemptions. No formal dividends have been paid on the common stock since the 1940's, and only a relatively small amount was paid as dividends on the preferred stock, which was held only by people who owned no common stock.
The petitioners' principal argument is that the redemptions were motivated by a substantial business purpose. There is a difference of opinion among the courts as to the relevancy of a business purpose. In some cases, the courts have found that a redemption was a sale because it was motivated by a business purpose.
Perry S. Lewis , 47 T.C. 129 (1966)John A. Decker , 326">32 T.C. 326286 F. 2d 427 (C.A. 6, 1960). On the other hand, the Second Circuit has said that the business purpose test has been "minimized" in importance (McGinty v.Commissioner , 325 F. 2d 820, 822 (1963))Levin v.Commissioner , 385 F. 2d 521, 526 (1967))Hasbrook v.United States , 343 F. 2d 811, 814 (1965))The petitioners argue that there were three business purposes for the retirement agreement and its provision for the redemption of the stock: (1) So that the stock would not be sold to outsiders; (2) so that control of the company could pass from Howard, Floyd, and Wallace to their sons; and (3) so that Howard, Floyd, and Wallace *1032 would retire from the management of the company. We can not see how the redemption provisions of the plan would insure, or even significantly promote, the accomplishment of the first two claimed objectives. Howard, Floyd, and Wallace were under no compulsion to sell their stock to the corporation; so far as the record shows, they could sell it to anyone, including outsiders. Indeed, because of the limitations in the agreement, if any of them wished to sell a substantial amount of his stock at any one time, some of it would have to be sold to outsiders, unless *180 the corporation voluntarily purchased more than was required under the retirement agreement. As to the stated objective of transferring control from one generation to the other, the agreement is not going to achieve such result very promptly. The members of the older generation were not required to dispose of their stock; and even if Howard and his wife redeem each year the maximum amount of stock allowable under the plan, it would take more than 40 years for their stock to be completely redeemed. In addition, no provision was made for transferring the stock into the hands of the younger generation. If the owners of the company truly wished to prevent sales of the stock to outsiders and to transfer control to the younger generation, they could have adopted far more effective means of accomplishing those objectives. The provisions of the retirement agreement would contribute so little toward the effectuation of such purposes that we cannot believe that they were the true reasons for the provisions.
The record does support a finding that a purpose of the redemption feature of the plan was to provide the retired shareholders with the means of obtaining cash supplements to their pensions. *181 However, this purpose could have been accomplished more directly by having the plan provide for increased pensions; it constitutes no corporate business purpose for the redemption.
Beatrice Levin, supra .Since the petitioners have conceded other issues raised by the notice of deficiency,
Decision will be entered for the respondent .Footnotes
1. Floyd and Wallace were both younger than Howard, and Wallace retired from the company in 1963. The record does not disclose Floyd's age or when he was to retire and attain the redemption rights under the plan.↩
1. On Dec. 28, 1960, the company's common stock was split 4 for 1. The redemptions for 1961 and subsequently are stated in terms of number of shares after the split.
1. The number of shares shown redeemed in 1961 and 1962 reflects the 4-for-1 stock split in December 1960.
1. Figures shown for 12/31/60 and subsequently reflect the 4-for-1 stock split of Dec. 28, 1960.↩
2. The stock in this corporation was owned by William W. Parker and his wife.↩
2. Discrepancies between this and the foregoing table and information given earlier, concerning changes in stock ownership occurring because of the recapitalization plan and retirement agreement, may be due to transfers of stock between family members.↩
1. The common stock was split 4 for 1 on December 28, 1960. The figures in parentheses represent changes in terms of the old stock while the figures not in parentheses state the change in terms of the new stock.↩
3. The amounts shown in the table were stipulated as "earned surplus and undivided profits," but the parties appear to agree that the amounts shown represent "accumulated earnings and profits" within the meaning of the internal revenue laws.↩
4. This table does not reflect the transfer of $ 750,000 from earned surplus and undivided profits to capital stock upon the 4-for-1 stock split in 1960.↩
5. All statutory references are to the Internal Revenue Code of 1954.↩
6. We do not mean to say that the redemptions before us, standing alone, worked the kind of meaningful change which indicates a sale rather than a dividend. The respondent correctly observes that Howard's stockownership (including stock attributed to him by sec. 318) remained largely unchanged during the years before us -- ranging between 40.7 and 39 percent of the outstanding stock of the Blount Lumber Co.↩
Document Info
Docket Number： Docket No. 5519-66
Citation Numbers： 51 T.C. 1023, 1969 U.S. Tax Ct. LEXIS 162
Judges： Simpson
Filed Date： 3/26/1969
Precedential Status： Precedential
Modified Date： 10/19/2024