Lewis v. Commissioner

Thomas G. Lewis and Florence Beyer Lewis, Petitioners, v. Commissioner of Internal Revenue, Respondent. Charles O. Walgran and Edna G. Walgran, Petitioners, v. Commissioner of Internal Revenue, Respondent

Lewis v. Commissioner

Docket Nos. 70795, 70796

United States Tax Court

35 T.C. 71; 1960 U.S. Tax Ct. LEXIS 48;

October 20, 1960, Filed

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">*48

Decisions will be entered under Rule 50.

1. Held, estate of majority stockholder of closely held family corporation deemed to own all of corporation's stock upon application of constructive ownership rules of section 318, I.R.C. 1954.

2. Held, further, redemption of portion of estate's stock in cancellation of decedent stockholder's indebtedness was a redemption essentially equivalent to a dividend under section 302, I.R.C. 1954.

C. Walter Randall, Jr., Esq., for the petitioners.

Frederick A. Levy, Esq., for the respondent.

Raum, Judge.

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RAUM

">*71 In these consolidated proceedings respondent determined deficiencies in income tax for the taxable year 1954 as follows: Thomas G. and Florence Beyer Lewis, $ 1,156.96; Charles O. and Edna G. Walgran, $ 994.16.

The issue is whether the acquisition by Beyer & Fortner, Inc., of 51 shares of its stock from the estate of Eva L. Beyer was a redemption essentially equivalent to a dividend within the meaning of section 302 of the 1954 Code.

FINDINGS OF FACT.

The stipulated facts are herein incorporated by this reference.

The petitioners Thomas G. and Florence Beyer Lewis, husband and wife residing in Lewisburg, Pennsylvania, filed a joint income tax ">*49 ">*72 return for the taxable year 1954 with the district director of internal revenue at Scranton, Pennsylvania. Petitioners Charles O. and Edna G. Walgran, husband and wife also residing in Lewisburg, Pennsylvania, filed a joint income tax return for the taxable year 1954 with the same district director.

Eva L. Beyer, hereinafter referred to as Eva, was the mother of petitioners Florence Beyer Lewis and Edna G. Walgran and of a third daughter, R. B. Fortner. At the time of her husband's death at some undisclosed date prior to 1943, Eva succeeded him as president of Beyer & Fortner, Inc., hereinafter referred to as B & F, Inc., a Pennsylvania corporation engaged in business as a fuel oil and gasoline distributor with offices in Lewisburg, Pennsylvania. Eva died on August 8, 1954. The officers of B & F, Inc., during 1954 were: President, Eva, until her death; vice president, Florence Beyer Lewis; treasurer, Charles O. Walgran; secretary, Edna G. Walgran. The presidency was vacant after Eva's death.

Until 1943 Eva performed services for the corporation and was paid a salary. In 1943, as a consequence of the war, gasoline rationing reduced the volume of the corporation's business; and the ">*50 salary of Eva was discontinued. However, beginning that same year and continuing annually until the time of Eva's death, B & F, Inc., advanced sums for her benefit and treated these advances as loans on its books. At the time of her death, Eva's indebtedness to B & F, Inc., amounted to $ 20,435.54, based upon the following advances during the years 1943-1954:

1943	$ 325.00
1944	770.00
1945	600.00
1946	1,050.00
1947	2,150.74
1948	2,069.92
1949	2,020.22
1950	2,082.81
1951	1,720.87
1952	2,716.01
1953	3,207.42
1954	1,722.55
Total	20,435.54

These advances were used by Eva to pay her living expenses during this period.

After 1943 Eva performed no substantial services to the corporation, although up until 1947 she did attend board meetings and stockholders meetings and signed corporate checks. In 1947 her health became such that she could no longer attend meetings, and she ceased to perform any services for the corporation. She was, nevertheless, still the elected president of the corporation, without salary.

Eva died testate, naming her three daughters as coexecutrices. Under her will she left bequests of $ 100 to each of seven grandchildren, specifically left her B & F, Inc., stock to her three daughters in equal ">*51 shares, and left the residue to the same three daughters in equal shares.

">*73 Eva's total gross estate consisted of United States Treasury bonds and cash valued in the aggregate at $ 2,943.45, jewelry and household furnishings valued at $ 265, and 156 shares of B & F, Inc., capital stock. These shares were valued at $ 40,964.04 for Pennsylvania inheritance tax purposes in the return filed for the decedent's estate, which valuation was increased to $ 46,800 (i.e., $ 300 per share) by the State taxing authorities after audit of the return.

The coexecutrices sold the bonds, jewelry, and household furnishings and paid inheritance taxes in the amount of $ 447.85, funeral expenses of $ 615.68, and administration expenses of $ 1,209.03. No Federal estate tax was paid. They also paid the seven cash legacies and certain debts of the decedent aggregating $ 149.74.

On September 20, 1954, the executrices transferred to the corporation 51 shares of the 156 shares of B & F, Inc., stock held in the estate, and the books of the corporation showed that this transfer was accepted in full satisfaction of the decedent's $ 20,435.54 indebtedness to the corporation. Certificates representing ownership of ">*52 the remaining 105 shares were issued to the three daughters (35 shares to each) on the same day, at their request.

The book value of a share of the corporation's stock at January 1, 1954, was $ 401.74.

The corporation's 1954 balance sheet as per its income tax return audit was as follows:

	At 1/1/54	At 12/31/54
Assets
Cash	$ 3,911.60	$ 2,106.43
Accounts Rec. (Net Trade)	27,010.40	38,737.51
Inventories	12,564.66	13,505.38
Prepaid expenses & supplies	684.88	584.18
Bldgs. & equip. (Net of Dep.)	40,177.91	43,204.49
Land	14,000.85	14,000.85
Cash Value Life Insurance	17,778.90	11,182.48
Accounts Rec. (Officers)	24,689.15	5,903.90
Total	$ 140,818.35	$ 129,225.22
Liabilities & capital
Accounts Payable	$ 9,884.98	$ 17,598.42
Notes & Mtges Payable	6,900.00
Accrued Expenses	10,341.91	9,511.34
Common Stock	28,300.00	23,200.00
Paid-In Surplus	1,442.67
Earned Surplus	83,948.79	78,915.46
Total	$ 140,818.35	$ 129,225.22

In arriving at the yearend surplus figure, a reduction of $ 13,892.57, occasioned by the September 20, 1954, transaction, was taken into account by the corporation. The accumulated earnings and profits of the corporation (accumulated after February 28, 1913) at September 20, 1954, exceeded the amount of Eva's indebtedness.

The board ">*53 of directors of B & F, Inc., on September 20, 1954, was composed of three members: Charles O. Walgran, Thomas G. ">*74 Lewis, and Florence B. Lewis. The other two executrices, Edna G. Walgran and R. B. Fortner, also attended the meeting of the board on that day but had no vote. After some discussion concerning the proposed redemption, during which Thomas G. Lewis at first suggested that the $ 300 valuation used for the Pennsylvania inheritance tax should be used for purposes of the redemption, the board finally accepted a valuation of approximately $ 400 per share urged by the executrices. The minutes of the board meeting, with respect to the transaction, contain the following record:

The matter of adjusting the indebtedness of Eva L. Beyer and/or her estate was brought to the attention of this Board with the following motion. T. G. Lewis moved that the purchase of 51 shares of B & F, Inc. stock from the executrices of the Estate of Eva L. Beyer at a price of $ 20,435.54 be approved and that the purchase price be used to cancel the debt of Eva L. Beyer to the firm. Seconded by E. G. Walgran. Motion Passed.

After the purchase the corporation held the 51 shares as treasury stock.

On its ">*54 1954 corporate income tax return, B & F, Inc., showed a loss on the purchase of the treasury stock in question of $ 15,335.54. This loss did not affect the corporation's tax liability for 1954.

Immediately prior to the purchase, and immediately following it, the capital stock of B & F, Inc., was held as follows:

Stockholder	Prior	Subsequent
Charles O. Walgran	70	70
Edna G. Walgran (his wife)		35
L. B. Fortner	45	45
R. B. Fortner (his wife)		35
Thomas G. Lewis	1	1
Florence B. Lewis (his wife)	11	46
Estate of Eva L. Beyer	156
Corporate treasury		51
Total	283	283

B & F, Inc., paid no dividends whatsoever during the period 1935-1954, inclusive. The business operations of the corporation were not curtailed at the time of or in the period immediately following its acquisition of the 51 shares of stock from the decedent's estate.

In 1955 Thomas G. Lewis purchased the Fortners' combined 80 shares of stock in B & F, Inc., at $ 350 per share.

No income tax return was filed for the estate of Eva L. Beyer for the year 1954; nor did the petitioners include in the gross income reported in their 1954 income tax returns any amount on account of the transfer of the 51 shares of stock to the corporation in consideration of the cancellation ">*55 of the decedent's indebtedness. After audit of their returns, however, they conceded that to the extent that the indebtedness satisfied exceeded the estate's basis of the 51 shares (assumed to be $ 300 per share), there was a realized capital gain; and they agreed to treat such gain as though it had been distributed one-third ">*75 to each daughter, for income tax purposes, in 1954. After computation by petitioners of the amount of such gain, the additional tax occasioned by their computations was paid by them on or about April 30, 1957.

Respondent determined that the redemption of stock of B & F, Inc., from the estate of Eva L. Beyer in 1954 was essentially equivalent to a dividend and resulted in ordinary income to the estate in that year in the amount of $ 20,435.54. The share of such income allocable to petitioners Florence Beyer Lewis and Edna G. Walgran was $ 6,811.84 each. The deficiency notice to each was based on the failure of each set of petitioners to include such alleged dividend income in their 1954 returns.

The September 20, 1954, transaction whereby the estate of Eva L. Beyer transferred to B & F, Inc., 51 shares of capital stock in satisfaction of the estate's indebtedness ">*56 to the corporation was a redemption which was essentially equivalent to a dividend.

OPINION.

Over a period of years, beginning prior to 1943 and continuing until her death in 1954, Eva L. Beyer owned 156 shares out of a total of 283 shares of stock of Beyer & Fortner, Inc. The remaining shares were owned by her three daughters or their husbands in unequal amounts. She was president of the corporation, but ceased taking salary in 1943 by reason of a temporary decline in the corporate business due to the war. Her poor health prevented her from playing any active part in the enterprise after 1947, and she never did receive any salary from 1943 until her death. Her needs for living expenses during this period were met by loans from the corporation. The amounts were modest, aggregating $ 20,435.54 over the entire period of some 11 or 12 years. No dividends were paid at any time, although the corporation did have accumulated earnings and profits. At her death the liquidation of her indebtedness to the corporation presented a serious problem, since the value of her estate, apart from the 156 shares, was considerably less than the amount of the indebtedness. The problem was solved by ">*57 having the corporation redeem 51 of her shares valued at a price that was sufficient to repay the loans; the remaining 105 shares were then promptly distributed in equal amounts of 35 shares to each of the three daughters. No other shares were redeemed and the total holdings of the families of the three daughters, being unequal prior to the redemption and distribution, remained unequal thereafter, but in different proportions. The Commissioner determined that on these facts there was a redemption essentially equivalent to a dividend under sections 301 and 302 of the 1954 Code.

Had this case arisen under the predecessor provisions of the 1939 ">*76 Code, ^{1960 U.S. Tax Ct. LEXIS 48">*58 might have been possible to find that the redemption was not essentially equivalent to the distribution of a taxable dividend, in view of the fact that shares of only one stockholder were redeemed, resulting in a disturbance of the proportionate holdings of the various stockholders. Although such a dislocation of the relative holdings would not necessarily be fatal to the Government's position, it would nonetheless be a factor, which when considered against the factual background of this case, could tip the scales in petitioners' favor.}

However, the problem before us must be considered in terms of the 1954 Code. Pertinent excerpts from sections 301">*59 and 302 are set forth in the margin. ^{1960 U.S. Tax Ct. LEXIS 48">*60 ">*61} The general statutory framework, with the many confusing cross references, makes the study and application of these provisions a most exasperating task. Nevertheless, after threading our way through these provisions we finally come to rest, at least temporarily, in section 302(b)(1), which, in general, was intended to incorporate the preexisting law embodied in section ">*77 115(g)(1) of the 1939 Code. ^{1960 U.S. Tax Ct. LEXIS 48">*62} The words "in general" must be stressed, for the new provisions were not made fully coextensive with the old. Not only did paragraphs (2), (3), and (4) of the new section 302(b) single out and remove three specific types of redemptions from the more general test contained in section 302(b)(1) and the old section 115(g)(1), ^{1960 U.S. Tax Ct. LEXIS 48">*63} but section 302(c) of the 1954 Code made the constructive ownership rules of section 318(a) applicable (with certain exceptions not pertinent here) to the redemption tests. Thus, a new dimension has been added to the 1939 Code approach, and it is that new dimension, based upon section 318(a), that moves us to sustain the Commissioner herein. The pertinent provisions of that section are set forth below. ^{1960 U.S. Tax Ct. LEXIS 48">*64}

">*78 Applying the constructive ownership rules of section 318(a), we must conclude that the stock owned by the husbands of the three daughters is to be attributed to the daughters themselves under paragraph (1)(A) (i); that the stock thus attributed to them must be treated under paragraph (4) as "actually owned by" them; and that therefore their own stock plus the stock thus attributed to them must in turn be attributed to the estate under the second sentence of paragraph (2)(A). As a consequence of the foregoing, the estate must be treated as owning all the shares that were really owned by the daughters and their husbands, with the net result that the estate is to be regarded as owning 100 per cent of the stock.

Accordingly, we are required by the 1954 Code to appraise the facts of this case in the light of an assumption that the estate owned all of the stock. And, with that assumption in mind, we conclude that the ">*65 redemption herein was essentially equivalent to a distribution of a dividend. For, the picture thus presented is one of corporate withdrawals from time to time by a dominant stockholder for her needs, where the corporation has never declared a dividend although having sufficient accumulated earnings and profits to do so, followed finally by a cancellation of the indebtedness in exchange for stock upon the death of that stockholder when only her estate had an interest in the enterprise, when such cancellation and redemption could not possibly have any economic effect upon any stockholder-corporation relationship, and when there was no plan either to contract the corporate enterprise or to use the redeemed shares in any manner for a corporate purpose. In these circumstances, and taking into account all other evidence before us, we conclude and find that the redemption herein was essentially equivalent to a dividend. Cf. Ferro v. Commissioner, 242 F.2d 838 (C.A. 3), affirming T.C. Memo. 1956-94; Genevra Heman, 32 T.C. 479">32 T.C. 479; Samuel H. Kessner, 26 T.C. 1046">26 T.C. 1046, affirmed per curiam 248 F.2d 943 (C.A. 3); James F. Boyle, 14 T.C. 1382">14 T.C. 1382, affirmed 187 F.2d 557 (C.A. 3), certiorari denied 342 U.S. 817">342 U.S. 817.

Decisions ">*66 will be entered under Rule 50.

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Footnotes

• 1. I.R.C. 1939:

  SEC. 115. DISTRIBUTIONS BY CORPORATIONS.

  (g) Redemption of Stock. --

  (1) In general. -- If a corporation cancels or redeems its stock * * * at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.↩

• 2. I.R.C. 1954:

  SEC. 301. DISTRIBUTIONS OF PROPERTY.

  (a) In General. -- Except as otherwise provided in this chapter, a distribution of property (as defined in section 317(a)) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c).

  * * * *

  (c) Amount Taxable. -- In the case of a distribution to which subsection (a) applies --

  (1) Amount constituting dividend. -- That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income.

  SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.

  (a) General Rule. -- If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.

  (b) Redemptions Treated as Exchanges. --

  (1) Redemptions not equivalent to dividends. -- Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.

  (2) Substantially disproportionate redemption of stock. -- * * *

  (3) Termination of shareholder's interest. -- * * *

  (4) Stock issued by railroad corporations in certain reorganizations. -- * * *

  (5) Application of paragraphs. -- In determining whether a redemption meets the requirements of paragraph (1), the fact that such redemption fails to meet the requirements of paragraph (2), (3), or (4) shall not be taken into account. * * *

  (c) Constructive Ownership of Stock. --

  (1) In general. -- Except as provided in paragraph (2) of this subsection, section 318(a) shall apply in determining the ownership of stock for purposes of this section.

  (2) * * * [Not relevant to this case.]

  (d) Redemptions Treated as Distributions of Property. -- Except as otherwise provided in this subchapter, if a corporation redeems its stock (within the meaning of section 317(b)), and if subsection (a) of this section does not apply, such redemption shall be treated as a distribution of property to which section 301 applies.

  (e) Cross References. -- * * *↩

• 3. See S. Rept. No. 1622, 83d Cong., 2d Sess., pp. 233-234:

  Paragraph (1) of subsection (b) provides that subsection (a) will apply if the redemption is not essentially equivalent to a dividend.

  The test intended to be incorporated in the interpretation of paragraph (1) is in general that currently employed under section 115(g)(1) of the 1939 Code * * *.

  * * * *

  Unlike the House bill, however, section 302 does not provide specific statutory guides governing the tax consequences of every stock redemption. In lieu of the approach in the House bill, your committee intends to revert in part to existing law by making the determination of whether the redemption is taxable as a sale at capital gain rates or as a dividend at ordinary income rates dependent, except where it is specifically provided otherwise, upon a factual inquiry * * *.

  * * * *

  Subsection (b) of Section 302 states three conditions in paragraphs (1), (2), (3), and (4), the satisfaction of any one of which will result in the treatment of the redemption as a distribution in full or part payment in exchange for the stock. In general↩, under this subsection your committee intends to incorporate into the bill existing law as to whether or not a [redemption] is essentially equivalent to a dividend under section 115(g)(1) of the 1939 Code, and in addition to provide three definite standards in order to provide certainty in specific instances. [Emphasis supplied.]

• 4. The parties agree that the redemption in this case does not qualify under paragraphs (2), (3), or (4), and that the case can be decided in petitioners' behalf only under paragraph (1).

• 5. I.R.C. 1954:

  SEC. 318. CONSTRUCTIVE OWNERSHIP OF STOCK.

  (a) General Rule. -- For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable --

  (1) Members of family. --

  (A) In general. -- An individual shall be considered as owning the stock owned, directly or indirectly, by or for --

  (i) his spouse * * * and

  (ii) his children, grandchildren, and parents.

  * * * *

  (2) Partnerships, estates, trusts, and corporations. --

  (A) Partnerships and estates. -- Stock owned, directly or indirectly, by or for a partnership or estate shall be considered as being owned proportionately by its partners or beneficiaries. Stock owned, directly or indirectly, by or for a partner or a beneficiary of an estate shall be considered as being owned by the partnership or estate.

  * * * *

  (4) Constructive ownership as actual ownership. --

  (A) In general. -- Except as provided in subparagraph (B), stock constructively owned by a person by reason of the application of paragraph (1), (2), or (3) shall, for purposes of applying paragraph (1), (2), or (3), be treated as actually owned by such person.

  (B) Members of family. -- Stock constructively owned by an individual by reason of the application of paragraph (1) shall not be treated as owned by him for purposes of again applying paragraph (1) in order to make another the constructive owner of such stock.↩