Stein v. Commissioner , 65 T.C. 336 ( 1975 )

Shelley Stein and Ruth Stein, Petitioners v. Commissioner of Internal Revenue, Respondent

Stein v. Commissioner

Docket No. 8815-73

United States Tax Court

65 T.C. 336; 1975 U.S. Tax Ct. LEXIS 31;

November 12, 1975, Filed

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Decision will be entered for the respondent.

A corporation, which had enjoyed subch. S status in prior years, failed to qualify for the year 1969. As of Jan. 1, 1969, the undistributed taxable income for the taxable year 1968 and prior years was credited to a loans payable account in the names of its shareholders. From time to time, the shareholders subsequently withdrew sums from that account. Held: Crediting the undistributed taxable income for the taxable year 1968 to the loans payable account on Jan. 1, 1969, did not result in a distribution of money to the corporation's shareholders within 2 1/2 months after the close of the taxable year 1968. Therefore, amounts withdrawn from the loan account after Mar. 15, 1969, were not chargeable to undistributed taxable income for the taxable year 1968 under sec. 1375(f), I.R.C. 1954.

Solomon E. Star, for the petitioners.

Peter W. Mettler, for the respondent.

Quealy, Judge.

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QUEALY

The respondent determined deficiencies of $ 3,073.22 and $ 9,215.30 due from petitioners ¹ for the taxable years 1969 and 1970, respectively.

The only issue remaining for decision is whether petitioners realized income in the taxable years 1969 and 1970 as a result of withdrawals from a "loans payable account" set up by Security Printing Co., Inc.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulations and the exhibits attached thereto are incorporated herein by this reference.

Shelley Stein (hereinafter referred to as petitioner) and Ruth Stein are husband and wife who resided in Scarsdale, N. Y., at the time the petition was filed. Joint returns were timely filed for calendar years 1969 and 1970 with the District Director of Internal Revenue, Manhattan, N. Y., utilizing the cash method of accounting.

Security Printing Co., Inc. (hereinafter referred to as Security Printing) is a New York corporation which filed its corporate income tax returns on a calendar year basis. For taxable years 1959 to 1968, inclusive, petitioner owned 70 percent of the capital stock of Security Printing and his brother, Denton Stein, owned 30 percent. During those years, Security Printing elected to be taxed as a small business corporation pursuant to section 1372. ² This election was terminated for calendar year 1969, because a new shareholder failed to make a timely consent to the election as required by section 1372(e)(1). Beginning January 2, 1969, petitioner owned 66.5 percent of the stock of Security Printing.

During calendar year 1968, Security Printing realized earnings and profits of $ 26,566.87, of which the sum of $ 18,596.81 was attributable to petitioner. Petitioner reported this amount in his Federal income tax return for the taxable year 1968.

As of December 31, 1968, the undistributed taxable income of Security Printing, and the amounts attributable to each of its shareholders were as follows:

	Denton Stein	Shelley Stein	Total
Undistributed taxable income
for year ended 12/31/68	$ 7,970.06	$ 18,596.81	$ 26,566.87
Undistributed taxable income
as of 12/31/68	27,564.93	87,338.30	114,903.23

On January 1, 1969, 70 new shares were issued to Shelley Stein and 30 new shares were issued to Denton Stein. The new shares were carried in the capital accounts at $ 875 per share. A loans payable account was set up on the same date in an amount equal to the excess of the undistributed taxable income over the amounts credited to the capital stock account as shown by the following schedule:

	Denton Stein	Shelley Stein	Total
Undistributed taxable income	$ 27,564.93	$ 87,338.30	$ 114,903.23
Less: Additional capital stock	26,250.00	61,250.00	87,500.00
Credit to loans payable	1,314.93	26,088.30	27,403.23

As controlling stockholder, petitioner presumably could have withdrawn the amounts credited to his loans payable account at any time. No interest was paid by Security Printing on the amounts credited to the loans payable account.

A statement of assets, liabilities, and capital of Security Printing, as shown by its books of account as of February 28, 1969, is as follows:

Assets
Cash:
Chase Manhattan		$ 25,329.74
9th Federal		50.57
Petty cash		50.00
Accounts receivable		172,518.16
Investments at cost		16,522.67
Inventory		7,800.00
Plant and equipment	$ 315,104.63
Reserve for depreciation	190,423.43	124,681.20
Autos	6,658.57
Reserve for depreciation	2,442.90	4,215.67
Due from pension plan		1,720.06
Total assets			$ 352,888.07
Liabilities
Accounts payable		75,428.35
Accrued expenses		12,665.93
Employee taxes		3,859.90
Loans payable -- S. Stein		24,323.32
Loans payable -- D. Stein		414.93
Total liabilities			116,692.43
Capital			236,195.64

Between January 1 and March 15, 1969, petitioner withdrew $ 1,764.98 from the loans payable account. These withdrawals were treated by the respondent as distributions of money made within 2 1/2 months of the close of the taxable year 1968 and were not in excess of petitioner's share of the undistributed taxable income of Security Printing for that taxable year. Between March 16 and December 31, 1969, petitioner withdrew an additional $ 5,271.37 from the loans payable account. In the taxable year 1970, petitioner withdrew the sum of $ 15,880.46 from the loans payable account. The petitioner's proportionate share of the earnings and profits of Security Printing for each of the taxable years 1969 and 1970 exceeded the amounts withdrawn by the petitioner from the loan account in each of said years. In his individual income tax returns for the taxable years 1969 and 1970, petitioner did not include the amounts withdrawn from the loan account in those years.

OPINION

The petitioner owned 70 percent of the stock of Security Printing. For the taxable years 1959 to 1968 inclusive, Security Printing qualified as a corporation electing to be taxed under subchapter S. That election was terminated for the taxable year 1969. No election was filed for the taxable year 1970.

As of January 1, 1969, Security Printing issued an additional 100 shares of capital stock at a stated value of $ 875 per share, thereby crediting $ 87,500 to the capital account. The remaining undistributed taxable income, which had been reported as income by the stockholders of Security Printing during the period that it qualifed as a subchapter S corporation, was credited to a loans payable account showing a balance due petitioner of $ 26,088.30.

From time to time, petitioner withdrew funds from the loans payable account. Between March 16 and December 31, 1969, petitioner's withdrawals amounted to $ 5,271.37. During the taxable year 1970, petitioner's withdrawals amounted to $ 15,880.46. Petitioner seeks to exclude such withdrawals from taxable income as representing amounts previously reported for the taxable years that Security Printing qualified as a subchapter S corporation. Respondent has treated such withdrawals as the payment of dividends chargeable to the earnings and profits of Security Printing for the taxable years in which funds were withdrawn, in accordance with sections 301(c)(1) and 316(a).

Petitioner contends that the amounts credited to the loan account as of January 1, 1969, were the equivalent of distributions within the 2 1/2-month period following the close of the taxable year 1968 to which section 1375(f) is applicable, and are thereby chargeable to the amounts previously reported by petitioner under subchapter S. Respondent contends that section 1375(f) is inapplicable since the mere crediting of the allocable earnings and profits to the loan account did not meet the requirement of a "distribution of money" for purposes of that section. ³

The question thus presented for decision is whether a distribution of Security Printing's earnings and profits for the taxable year 1968 was effected on January 1, 1969, when the loans payable account was set up on its books. In his regulations, the respondent has limited the phrase "distribution of money" in section 1375(f) so as to exclude not only a distribution of property other than money, but any obligation of the corporation which constitutes such property. Sec. 1.1375-6(a)(2)(iii), Income Tax Regs. These regulations have been sustained by the courts. McKelvy v. United States, 201 Ct. Cl. 557">201 Ct. Cl. 557, 478 F.2d 1217">478 F.2d 1217 (1973); C. D. Fountain, 59 T.C. 696">59 T.C. 696 (1973); Randall N. Clark, 58 T.C. 94">58 T.C. 94 (1972).

The petitioner did not present in evidence the resolution of the board of directors of Security Printing or any other proof with respect to the authorization by the directors or the stockholders for the capitalization of a portion of the undistributed taxable income and credit of the balance to the loans payable account. There is no proof that Security Printing ever declared a cash dividend. Even if, however, the record did show that a dividend was declared payable in money with the understanding, expressed or implied, that the amount thereof would be loaned back to the corporation, the distribution would not qualify as a distribution of money made within 2 1/2 months of the prior taxable year. McKelvy v. United States, supra.Petitioner's problem in meeting the requirements of section 1.1375-6(a)(2)(i), Income Tax Regs., undoubtedly stems from the fact that as of January 1, 1969, it was not contemplated that Security Printing would lose its status as a subchapter S corporation. There was no reason to firm up the distribution at that time. When such status was lost to Security Printing, by inadvertance or otherwise, it was too late. The balance remaining in the loans payable account on March 15, 1969, had not been distributed in money.

The petitioner argues that the mere setting up of the loans payable account resulted in the realization of income by the petitioner as of January 1, 1969, under the doctrine of constructive receipt as set forth in section 1.451-2(a), Income Tax Regs. However, petitioner's right to withdraw the amounts credited to his account seems to have been predicated solely on the fact that he owned 70 percent of the stock of Security Printing. No evidence was presented with respect to any agreement, understanding, or resolution which spelled out either the purpose of the loans payable account or the right of the petitioner to withdraw such funds. Finally, the fact that income may be realized under the doctrine of constructive receipt, in accordance with section 1.451-2(a), Income Tax Regs., may not result in an actual distribution of money as required by section 1375(f) and the regulations governing the applicability of that section. See Attebury v. United States, 430 F.2d 1162 (5th Cir. 1970).

Finally, petitioner contends that the withdrawal of $ 5,271.37 received in 1969 and the withdrawal of $ 2,220.12 of the $ 15,880.46 received in 1970 constituted repayment of a loan from petitioner to Security Printing. Petitioner arrived at this amount by taking the difference between the amount of the loans payable account and petitioner's share of Security Printing's subchapter S income for the taxable year 1968. No evidence was presented at trial to account for the source of these funds. Since the evidence presented was not inconsistent with the fact that the loans payable account was formed from undistributed taxable income accumulated prior to taxable year 1968, plus the income of taxable year 1968, petitioner has not met his burden of proof with respect to this contention. Respondent's determination is presumptively correct. Rule 142(a), Tax Court Rules of Practice and Procedure.

In our opinion section 1375(f) mandates that any distribution made within 2 1/2 months of the close of the taxable year 1968 be actually distributed in money, rather than merely reflected in the books of the corporation, in order to constitute a distribution of "undistributed taxable income." Since the current earnings and profits for taxable years 1969 and 1970 exceeded the amounts withdrawn after March 15, 1969, the distributions are dividends taxable under section 301(c). The respondent's determination must, therefore, be sustained.

Decision will be entered for the respondent.

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Footnotes

• 1. Ruth Stein is a party to this action solely by virtue of having filed a joint income tax return with her husband for the years in question.↩

• 2. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩

• 3. SEC. 1375. SPECIAL RULES APPLICABLE TO DISTRIBUTIONS OF ELECTING SMALL BUSINESS CORPORATIONS.

  (f) Distributions Within 2 1/2-Month Period After Close of Taxable Year. --

  (1) Distributions considered as distributions of undistributed taxable income. -- Any distribution of money made by a corporation after the close of a taxable year with respect to which it was an electing small business corporation and on or before the 15th day of the third month following the close of such taxable year to a person who was a shareholder of such corporation at the close of such taxable year shall be treated as a distribution of the corporation's undistributed taxable income for such year, to the extent such distribution (when added to the sum of all prior distributions of money made to such person by such corporation following the close of such year) does not exceed such person's share of the corporation's undistributed taxable income for such year. Any distribution so treated shall, for purposes of this chapter, be considered a distribution which is not a dividend, and the earnings and profits of the corporation shall not be reduced by reason of such distribution.

  (2) Share of undistributed taxable income. -- For purposes of paragraph (1), a person's share of a corporation's undistributed taxable income for a taxable year is the amount required to be included in his gross income under section 1373(b) as a shareholder of such corporation for his taxable year in which or with which the taxable year of the corporation ends. * * *↩