Parker Oil Co. v. Commissioner , 58 T.C. 985 ( 1972 )

Feathekston,

concurring: I agree with the Court’s conclusion that the settlement and proxy agreements of December 30, 1966, as amended, did not cause a termination of Parker Oil’s subchapter S election. I also agree that Rev. Rul. 63-226, 1963-2 C.B. 341, goes beyond the statute, but I think these results can be reached without declaring section 1.1371-1 (g), Income Tax Regs., invalid in any respect. Rather, I think the regulation should be so interpreted as not to apply to the facts of this case.

The provision in section 1371(a) (4), limiting subchapter S eligibility to corporations not having “more than one class of stock,” in my view, is addressed to the nature and character of the stock as such. The same is true with respect to section 1.1371-1 (g) of the regulations which states that “a difference as to voting rights * * * will disqualify a corporation.” Notwithstanding Rev. Rul. 63-226, I do not think either of these provisions refers to a proxy, an agreement whereby a shareholder authorizes someone else to vote his stock. See Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, ch. 6, p. 7 (3d ed. 1971). Such an agreement does not affect the voting rights conferred by the stock; it merely specifies who will exercise those rights.

In the instant case, the certificate of incorporation expressly provides that “There shall be but one class of stock.” Neither the December SO, 1966, settlement agreement nor the proxy agreement purports to alter this provision. Indeed, as I read the applicable Alabama statute (Ala. Code tit. 10, sec. 21(32) (Supp. 1969)) neither instrument could have done so; that statute contemplates that the voting rights of stock are to be defined in the certificate of incorporation and contains no suggestion that they may be defined in any other way.

Insofar as here pertinent, the settlement and proxy agreements, as amended by the agreement of March 2,1967, merely authorized M. N. Brown to vote the 5 shares which Annie Laura Parker conveyed to Don W. Parker in settlement of the dispute. It is true that the proxy was described as irrevocable and was endorsed on the stock certificate, but that endorsement did not affect the nature and character of the voting rights conferred by the stock — it merely designated a person to exercise those rights. It is also true that the corporation was nominally a party to the settlement agreement, but that agreement called for no formal corporate action with respect to the voting rights of the 5 Shares. It was an agreement between the shareholders as such. Significantly, when the proxy agreement was modified on March 2, 1967, to eliminate Henderson’s proxy rights, the corporation was not even a party to the amendment, and the amendment was not endorsed on the certificate. This suggests that the proxy was irrevocable only in the sense that it was to remain in effect as long as the shareholders as such so agreed. Moreover, under the settlement agreement, the 50 shares of stock owned by Wilmer and Annie Laura Parker were to elect two directors and the other 50 shares were to elect two directors; the only effect of the settlement agreement, signed by all the shareholders, in this respect was to designate M. N. Brown as one of the directors to be elected by Don W. Parker’s 50 shares. I do not think these facts fall within either the statute or the regulation here in controversy.

In applying the regulation on voting rights, it is important that eligibility for subchapter S treatment is limited to closely held corporations, i.e., corporations with 10 or less shareholders. In a real sense, closely held corporations are “essentially partnerships.” As between themselves, their stockholders frequently operate the corporate business as if they were partners, working out various kinds of arrangements for managing corporate affairs. These arrangements may include, for example, agreements providing that each shareholder will vote for the other as a director, or that each will have a veto power as to the election of directors, or that shares of two or more shareholders will 'be pooled or voted together. These agreements are particularly useful in. situations like the one in the instant case where misunderstandings which have arisen between the shareholders can be resolved only by advance arrangements as to how the directors are to be selected and how the stock will be voted.

State laws have recognized the need for special arrangements between the shareholders of closely held corporations.¹ The New York statute, for example, provides that shareholders may agree in writing that “in exercising any voting rights, the shares held by them shall be voted as therein provided, or as they may agree, or as determined in accordance with a procedure agreed upon by them.” N. Y. Bus. Corp. sec. 620(a) (1963). I see no reason why such practical arrangements between shareholders should disqualify a corporation for subchapter S treatment. See Note, “Stockholder Agreements and Subchapter S Corporations,” 19 Tax L. Rev. 398 (1964).

As pointed out by the Court, the only real justification for the “one class of stock” requirement of section 1371 (a) (4) is to facilitate the pass-through of dividends and liquidating distributions. None of the legislative materials that I have found gives any substantive clue as to why the voting rights provision was incorporated in the regulation or how differences in voting rights would complicate the administration of subchapter S. In these circumstances, I think the regulation should be narrowly construed.

I would limit the applicability of the regulation to situations where the differences in voting rights are defined in the manner prescribed by the applicable State law; this is all the court did in Pollack v. Commissioner, 392 F. 2d 409 (C.A. 5, 1968). I do not think the disputed regulation applies to a proxy agreement even though it is intended to remain in effect until the shareholders change their minds.

Deennen, Dawson, Tannenwald, and Qtjealx, JJ., agree with this concurring opinion.

1 N.Y. Bus. Corp. sec. 620(a) (1963) ; Conn. Gen. Stat. Ann. sec. 33-339 (1958) ; S.C. Code Ann. sec. 12-16.15 (Supp. 19T1) ; Tex. Bus. Corp. Act art. 2.30 B (Supp. 1972) ; Model Business Corporation Act Ann. 2d sec. 34 (1971).