DocketNumber： Docket Nos. 4779-62, 4780-62
Judges： Kern
Filed Date： 4/21/1966
Status： Precedential
Modified Date： 11/14/2024
In 1946 petitioners, Leon and Lucile, husband and wife, who were coowners of a partnership caused the organization of a corporation, Jewelry, to which they transferred the partnership assets in exchange for the assumption of the partnership liabilities and the issuance to them in equal amounts of Jewelry's capital stock (designated as class A stock) and notes totaling in par and face value the net value of the partnership assets so transferred. In 1947 the notes were capitalized by the issuance to Leon and Lucile of class B stock of Jewelry which had at that time voting rights and some preference over class A stock. In 1956 Jewelry had financial difficulties and in a bankruptcy proceeding a composition with creditors was arranged under chapter XI of the Bankruptcy Act, whereby approximately $ 189,000 of its debts were discharged. Some 3 days before the entry of the order effecting this discharge and in contemplation thereof, Jewelry caused an appraisal of its assets to be made. It credited an amount purporting to be equivalent to the amount of its forgiven debts (less certain adjustments) to an account designated "Contributed capital" on *115 its balance sheet and included in certain expense items on its income statement amounts totaling the amount of the write-downs of its assets to fair market value resulting from the appraisal thereof. As part of the arrangement under chapter XI, Leon was required to contribute $ 25,000 to Jewelry, a part of which ($ 15,000) he borrowed from a bank on his personal notes secured by stock in Thiokol Corp. owned by him. Jewelry was required to borrow and did borrow from the same bank $ 100,000 on its note of which Leon and substantial friends of his were guarantors. In 1958 all distinctions between the class A and class B stock of Jewelry were obliterated by appropriate corporate action. In the latter part of that year a plan was evolved by Leon and Lucile and their advisors for Leon to contribute some of this Thiokol stock to Jewelry, for Jewelry to sell the stock which had tremendously increased in value and from the proceeds to pay the $ 50,000 balance on its note to the bank, for Jewelry to distribute the balance of the proceeds to Lucile, for Lucile in return therefore to surrender her stock in Jewelry for redemption, and for Lucile to pay Leon's $ 15,000 note to the bank from *116 such distribution. Accordingly, in the early part of 1959 Leon duly endorsed and transferred to Jewelry and Jewelry accepted 700 shares of his Thiokol stock, and Jewelry authorized the sale of the 700 shares by its broker. The management of the sale was left to Leon. Sales of 638 shares of this stock were made by Jewelry in the early part of April 1959, and certificates for these shares were eventually transferred on the stock record books of Thiokol from the name of Leon to the names of those purchasing the stock from Jewelry. On May 4, 1959, the brokers at Leon's request had the certificate for the remaining 62 shares still in Leon's name changed to three certificates; one for 32 shares in Leon's name and two for 15 shares in the names of his son and spouse and daughter and spouse, respectively. After Leon had donated the 700 shares of Thiokol stock to Jewelry and shortly before the sales of the 638 shares by Jewelry, Thiokol voted a 3 for 1 split of its stock, the new stock to be issued to the stockholders of record of Thiokol as of April 20, 1959, when Leon was still the stockholder of record of the 700 shares. The new Thiokol stock distributable on account of the 638 shares *117 sold by Jewelry were delivered in due course to the purchasers thereof, while the new stock (124 shares) distributable on account of the 62 shares not sold by Jewelry were received by Leon on April 30, 1959, and were retained by him. The distributions by Jewelry to Lucile (of the excess of the proceeds from its sales of the 638 shares of Thiokol stock over the amount required for the payment of its bank note) in the total amount of $ 31,328 were charged to an account receivable on its books under Lucile's name. Immediately after the receipt of the distributions Lucile made the payments therefrom contemplated by the plan. In the latter part of 1959 (after June 30, but before December 31) Lucile surrendered all of her stock in Jewelry for redemption at its par value of $ 29,000, which amount was credited to her account by Jewelry as of December 31. The balance of $ 2,328 contained in her account owing to Jewelry was never paid. No interest was charged thereon and no security therefor was asked or given. At the time of the distribution, Lucile served as a salaried officer of Jewelry. She continued to serve in this capacity through the year ended June 30, 1962. Respondent determined *118 deficiencies against Leon on the grounds that the capital gains realized on sales of the Thiokol stock were taxable to him, that the distributions to Lucile were taxable to him, and that the 62 shares of Thiokol stock constituted a distribution to Leon from Jewelry, and in the case of Lucile, on the ground that the distributions from Jewelry received by her constituted income taxable to her. At the trial respondent conceded that Jewelry sold the Thiokol stock, and gains therefrom were not taxable to Leon.
1. Respondent's notices of deficiency were valid and presumptively correct in spite of inconsistencies and confession of error as to one ground.
2. Earnings and profits of Jewelry increased by amount of its debts forgiven in bankruptcy proceeding in excess of amount available for reduction of basis of its assets; and such amounts and Jewelry's earnings and profits are determined.
3. Under various provisions of sections 301, 302, 316, and 318,
4. Sixty-two shares of Thiokol stock issued to Leon and his donees pursuant to his instructions of May 4, 1959, and 124 shares of Thiokol *119 stock received by him on April 30, 1959, as a split of such stock held in his name on books of Thiokol and retained by him constituted dividend distributions to Leon from Jewelry and value of such stock determined as of such dates.
*67 Respondent originally determined a deficiency in the income tax liability of petitioner Leon R. Meyer (hereinafter sometimes referred to as Leon) for the year 1959 in the sum of $ 40,101.55 and a deficiency in the income tax liability of petitioner Lucile H. Meyer (hereinafter sometimes referred to as Lucile) for the year 1959 in the sum of $ 17,402.09.
The statement attached to the notice of deficiency addressed to Leon indicated the increase of his taxable income as disclosed in his return by the addition thereto of the following items: (1) Capital gains totaling $ 39,766.39, realized from the sale of 638 shares of Thiokol stock made in the name of Meyer Jewelry Co., a corporation of which most of the stock was owned by Leon and Lucile (sometimes hereinafter referred to as Jewelry) and to which the Thiokol stock had been transferred *120 by Leon shortly before its sale as a contribution to Jewelry's capital; (2) an alleged distribution to Leon from Jewelry on April 13, 1959, of $ 7,920.50, representing the value on that date of 62 shares of Thiokol stock originally included in the Thiokol stock contributed by Leon to Jewelry but which was eventually reissued in the names of and delivered to Leon and/or his nominees; and (3) the *68 alleged "payments to [Leon], or on [his] behalf," of $ 31,328.17 by Jewelry, representing payments made by Jewelry to Lucile, the wife of Leon and a principal stockholder of Jewelry, a large part of which payments were used by her shortly after their receipt by her to make payments to Leon or in satisfaction of Leon's obligations. Because of these increases in Leon's taxable income respondent disallowed a deduction claimed by Leon as a medical expense.
The statement attached to the notice of deficiency addressed to Lucile indicated the increase of her taxable income as disclosed in her return by the addition thereto of the payments made to her by Jewelry in the total amount of $ 31,328.17.
These cases were consolidated for hearing and opinion.
At the trial herein respondent conceded error in *121 adding to Leon's taxable income the capital gains derived from the sale of the 638 shares of Thiokol stock made by Meyer Jewelry Co. At the close of the hearing respondent moved for leave to amend his answer to conform to the proof by allegations to the effect that the Thiokol stock alleged to have been received by Leon from Jewelry was received by him on April 30, 1959, and May 4, 1959, in the amounts of 124 and 62 shares, respectively, and the total value of such stock on these dates was $ 10,013. A written amendment to the answer was later filed by respondent to this effect with the leave of the Court.
FINDINGS OF FACT
Petitioner Leon R. Meyer is a resident of Johnson County, Kans., whose separate income tax return for the calendar year 1959 was filed with the district director of internal revenue at Kansas City, Mo.
Petitioner Lucile H. Meyer is a resident of Johnson County, Kans., whose separate income tax return for the calendar year 1959 was filed with the district director of internal revenue at Kansas City, Mo.
Meyer Jewelry Co. was incorporated in the State of Missouri on July 29, 1946. The authorized capital stock of Jewelry at the date of its incorporation was: 1,250 class *122 A shares -- $ 100 par value, and 1,250 class B shares -- $ 100 par value. As of the date of incorporation, both classes of shares authorized by the articles of incorporation of Jewelry had equal rights and preferences, with the exception that the class A shares had voting rights and class B shares were nonvoting. However, changes could be made as to voting rights and preferences by the passage of "Special By-Laws."
Jewelry commenced business with a capital of $ 500 received from the cash payment for five initially subscribed class A shares. Leon paid in $ 200 for two shares; Lucile paid in $ 200 for two shares; and one Sol Silberman paid in $ 100 for one share.
The one share of class A $ 100 par value stock acquired by Sol Silberman was held as nominee, one-half share for Leon and one-half share *69 for Lucile. The cost basis attributable to Leon and Lucile individually of each of said one-half share is one-half of $ 100 or $ 50. Lucile's one-half share was eventually transferred to Jack Becker on December 24, 1958.
Prior to the incorporation of Jewelry, a partnership had conducted a jewelry business known as Meyer Jewelry Co. The partners were Leon R. Meyer and Lucile H. Meyer, each *123 having a 50-percent interest.
On August 1, 1946, a special combined meeting of stockholders and directors of Jewelry was held at which a plan of reorganization of Meyer Jewelry Co., the partnership, was discussed. The plan involved the dissolution of the partnership as of the close of business July 31, 1946, the transfer to the newly formed corporation by the partners of all of the assets (except cash of $ 2,743.13), subject to the liabilities, both as shown on the closing partnership statement, the transfer and assignment of a lease, and the issuance and delivery to Leon of 297 1/2 shares of the class A stock of the corporation and the same number of shares of such stock to Lucile. In addition, there were to be issued and delivered to each of the former partners negotiable promissory notes in the aggregate face amount of $ 25,000, payable in 10 years from date with interest at 4 percent, payable semiannually.
Pursuant to an agreement entered into on the same date between Leon and Lucile as parties of the first part and Jewelry as party of the second part the following steps were taken: Leon and Lucile transferred all of the partnership assets (except cash of $ 2,743.13) subject to *124 liabilities, both as shown on the closing partnership statement, to the corporation, and the corporation assumed all of the liabilities, issued to Leon 297 1/2 shares of its class A stock with a par value of $ 100 and to Lucile 297 1/2 shares of the same class A stock, and issued to each, negotiable promissory notes in the aggregate face amount of $ 25,000, payable in 10 years from date thereof with interest at 4 percent, payable semiannually. The five notes of Leon's photostatic copies of which were admitted in evidence, all bear the notation on the reverse side: "Interest to and including Sept. 30, 1947/Received/Leon R. Meyer/Pay to order of/Meyer Jewelry Co./Leon R. Meyer/Cancelled 9/30/47/ Meyer Jewelry Co./ By ." The five notes of Lucile, photostatic copies of which were also admitted in evidence, bear the notation on the reverse side: "Cancelled 9/30/47/ By Leon R. Meyer, Pres./Meyer Jewelry Co."
The partners' closing investment in the partnership as of July 31, 1946, was:
| Leon R. Meyer | $ 56,121.57 |
| Lucile H. Meyer | 56,121.56 |
| 112,243.13 |
*70 The assets of the partnership transferred to the corporation totaled $ 315,899.22 ($ 318,642.35 - $ 2,743.13) and the liabilities assumed by the *125 corporation totaled $ 206,399.22. From the closing partnership investment account and assets, $ 2,743.13 was retained by the partners prior to transfer of assets and property to the corporation. The assets transferred were carried at their cost to the partnership on its books as reflected in the balance sheet of the partnership attached to the minutes of the corporation dated August 1, 1946, and in the agreement entered into by Leon, Lucile, and the corporation dated August 1, 1946.
The combined cost basis of class A $ 100 par value stock and notes issued to Leon and Lucile, at the incorporation of Jewelry and upon acquisition of the net assets received by the Meyers in dissolution of the partnership, was as follows:
| Leon R. Meyer | |
| 300 shares -- class A -- $ 100 par value stock | $ 30,000 |
| $ 25,000 aggregate face value 10-year negotiable notes, | |
| 4-percent interest | 25,000 |
| 55,000 | |
| Lucile H. Meyer | |
| 300 shares -- class A -- $ 100 par value stock | $ 30,000 |
| $ 25,000 aggregate face value 10-year negotiable notes, | |
| 4-percent interest | 25,000 |
| 55,000 | |
On September 30, 1947, a combined meeting of stockholders and directors of Jewelry was held. At the meeting the officers of the corporation were authorized to issue *126 250 class B shares to Leon and 250 class B shares to Lucile in exchange for their notes of the corporation, exclusive of unpaid interest, subject to the provisions of the special bylaws of the corporation adopted at the same meeting. These special bylaws provided for a priority of dividends to the class B shares of $ 6 per share in respect of each fiscal year, and made the class B shares subject to redemption at any time at the par value thereof, on compliance with the restrictions and limitations of the laws of Missouri. Moreover, the right to vote was granted to the class B shares. The purpose of this exchange was to improve the balance sheet of the corporation for credit purposes by the capitalization of what appeared on its balance sheet as a $ 50,000 liability to Leon and Lucile.
Pursuant to these minutes, 250 shares of class B ($ 100 par value) stock were issued to Leon and the same number of shares of the same stock to Lucile in exchange for the notes described above being $ 25,000 of notes payable to each.
No dividends were ever paid by Jewelry on any of its capital stock during the period 1946 through 1958.
*71 On May 31, 1956, an involuntary bankruptcy petition was filed in *127 the U.S. District Court for the Western District of Missouri at Kansas City, Mo., against the Meyer Jewelry Co. Thereafter, Jewelry filed an answer denying that it was insolvent. On June 18, 1956, Jewelry filed a debtor's petition stating that it was unable to pay its debts as they mature, proposing an arrangement with its unsecured creditors, and praying for a proceeding in accordance with chapter XI of the Bankruptcy Act (
Among provisions included in the terms of the loan by Commerce Trust Co. to Jewelry were the following: Leon was to put not less than $ 25,000 into Jewelry as working capital; Leon was to guarantee payment of the note to Commerce Trust Co.; Leon and Lucile were to pledge as surety for the guaranty of Leon all issued and outstanding capital stock of Jewelry, except such part thereof, not to exceed 25 percent, as might be distributed to key employees of Jewelry, including Richard Burstein and Louis S. Meyer; and the corporation was to deliver to Commerce Trust Co. the written guaranty of six individuals in Kansas City, Mo., designated by name.
The loan by Commerce Trust Co. was to bear interest at 5 percent, payable quarterly, and was to be evidenced by a 90-day note, renewable not to exceed 19 extensions, provided the corporation was operating on a satisfactory basis. A payment of $ 10,000 was to be made on this note at the end of the second quarter, and thereafter $ 5,000 per quarter *129 was to be paid thereon. The loan of $ 100,000 to Jewelry was completed, and Lucile consented to the pledge of her shares of stock in Jewelry.
In order to raise the $ 25,000 required to be contributed as working capital, Leon obtained $ 10,000 by cashing in a certain life insurance policy, under which Lucile was beneficiary, and borrowed an additional $ 15,000 from Commerce Trust Co. secured by 798 shares of *72 stock of Thiokol Corp. (now Thiokol Chemical Corp.), sometimes hereinafter referred to as Thiokol. At that time the 798 shares of Thiokol stock thus pledged had a fair market value of approximately $ 30,000. Subsequently, as hereinafter noted, the value of this stock greatly increased in value and the number of shares held in pledge increased by reason of stock dividends, stock splits, and the exercise of rights to purchase by Leon.
In June of 1956, Leon paid to Jewelry the sum of $ 25,000, as required by the proposed arrangement, in exchange for which there was issued to him under date of July 3, 1956, a certificate for 250 shares of class B stock of the corporation.
On July 3, 1956, the court confirmed the arrangement proposed by Jewelry and accepted by a majority in number *130 of each class of affected creditors. The order confirming the arrangement recited the fact that Jewelry had paid into the bankruptcy court the sum of $ 103,953.54.
On July 10, 17, and 19, 1956, the court entered its orders of distribution reflecting the amount of the claims against Jewelry incurred prior to April 17, 1956, and the amounts to be distributed to these creditors in full and final discharge of these claims.
According to the distribution orders of the court, Jewelry had incurred unsecured claims prior to April 17, 1956, in the total amount of $ 271,121.71, of which the creditors were paid 30 percent thereof or $ 81,336.29 *131 satisfaction of unsecured debts incurred subsequent to April 17, 1956.
In anticipation of the bankruptcy proceeding, Jewelry's accountant credited an account designated "Contributed capital" on the balance sheet in the amount of $ 178,211.16. This figure purports to represent the total amount of debts discharged, less the $ 7,500 payment to the Jewelers Board of Trade and certain estimated tax and administrative expenses. *73 and certain other assets *132 were as follows:Insurance claim pending $ 4,795.79 Bad debt reserve 7,219.17 Bad debt expense 10,886.84 Accounts receivable $ 18,956.75 Notes receivable 3,945.05
The net reduction in accounts and notes receivable as reflected by these journal entries is $ 10,886.84. *133
The reductions were then reflected in the amounts at which these assets were carried on the balance sheet of Jewelry. These entries were executed 3 days prior to and in anticipation of the bankruptcy order and reflected the reappraisal of the assets in question to their respective fair market values.
The income statement of Jewelry for the year ended June 30, 1956, which was submitted in evidence, contains the following items taken as expenses: "Bad debts $ 18,106.01," "Discounts allowed $ 7,486.99," "Taxes $ 6,910.15," and "Miscellaneous $ 8,678.58." Across the face of the income statement is the penciled notation "65,000 Invtry writeoff." Loss for year ended June 30, 1956 ($ 132,582.37) Loss for year ended June 30, 1957 (16,147.89) Loss for year ended June 30, 1958 (69,941.20) Taxable income for year ended June 30, 1959, including reported taxable gain of $ 81,228.17 on sale of 638 shares of Thiokol Chemical Corp. stock 66,007.10 Taxable income for year ended June 30, 1960 2,492.13
*74 *134 The Federal income tax returns filed by Jewelry for the years ended June 30, 1955, through June 30, 1960, indicate that Jewelry made the following charitable contributions which were not taken as deductions because of the 5-percent limitation of section 170(b)(2) of the 1954 Code:
| Year ended | |
| June 30 | Contributions |
| 1955 | $ 1,090.88 |
| 1956 | 780.00 |
| 1957 | 452.50 |
| 1958 | 587.03 |
| 1959 | 425.00 |
| 1960 | 375.00 |
The loss for the year ended June 30, 1956, includes the $ 64,000 write-down in inventory which was reflected on its books by debits in that amount to "Cost of sales" and corresponding credits to "Inventory." This $ 64,000 write-down in inventory was reflected in the "Cost of Sales" entry on the income statement of Jewelry for the year ended June 30, 1956. Although the net reduction of accounts and notes receivable by the journal entries was $ 10,886.84 (see fn. 6,
On December 24, 1958, Lucile transferred by gift class A shares of Jewelry to the individuals listed below, all of whom were employees of Jewelry as follows: Jack Becker -- 50 shares class A, $ 100 par value; Richard C. Burstein -- 50 shares class A, $ 100 par value; Louis S. Meyer -- 30 shares class A, $ 100 par value. Louis S. Meyer and Richard C. Burstein are respectively the son and son-in-law of Leon and Lucile; Jack Becker is unrelated to the Meyers. Included in the transfer to Jack Becker on December 24, 1958, was the one-half share originally held as nominee for Lucile by Sol Silberman.
On February 13, 1959, Lucile transferred by gift the following shares of class A stock of Jewelry to the same individuals: Jack Becker -- 50 shares class A, $ 100 par value; Richard C. Burstein -- 50 shares class A, $ 100 par value; Louis S. Meyer -- 30 shares class A, $ 100 *136 par value. Included in the transfer to Jack Becker on February *75 13, 1959, were the two shares issued to Lucile on July 30, 1946, for cash at the original incorporation.
The holdings of class A and class B stock of the corporation on April 1, 1959, were as follows:
| Class A Stock $ 100 Par Value | ||
| Number | Par | |
| of shares | value | |
| Leon R. Meyer | 300 | $ 30,000 |
| Lucile H. Meyer | 40 | 4,000 |
| Jack Becker | 100 | 10,000 |
| Richard C. Burstein | 100 | 10,000 |
| Louis S. Meyer | 60 | 6,000 |
| Total outstanding | 600 | 60,000 |
| Class B Stock $ 100 Par Value | ||
| (Identical with class A stock as of Sept. 22, 1958) | ||
| Leon R. Meyer | 500 | 50,000 |
| Lucile H. Meyer | 250 | 25,000 |
| Total outstanding | 750 | 75,000 |
| Total stock | 1,350 | 135,000 |
Prior to April 1, 1959, and beginning in the latter part of 1958, a plan was evolved to eliminate the bank indebtedness of Jewelry to Commerce Trust Co. This liability was still outstanding due to the loan of $ 100,000 by Commerce Trust Co. made in June of 1956. This loan enabled the chapter XI bankruptcy arrangement to be carried out. The plan also envisioned the elimination of the capital investment of Lucile in Jewelry by means of a distribution to her of cash and the surrender and cancellation of the stock certificates of Jewelry owned and held by her. The *137 price to be paid to Lucile in redemption of her stock was not agreed upon at this time, but it was assumed that she would be paid either the book value ($ 37,337.50) or par value ($ 29,000) of the shares. The feasibility of this plan was predicated on the increase in value of the Thiokol stock of Leon held by Commerce Trust Co. as collateral securing Leon's note for $ 15,000 and the availability of such stock or a considerable part of it to Leon and, through him, to Jewelry.
Pursuant to the plan to eliminate the indebtedness of Jewelry to Commerce Trust Co. which then amounted to $ 50,000 and to provide funds with which the company could make a distribution of cash to Lucile, Leon on or before April 1, 1959, contributed to Jewelry as a capital contribution 700 shares of the 1,848 shares of Thiokol stock which at that time was held as collateral by Commerce Trust Co.*76 to secure the note executed by Leon for $ 15,000. The 1,848 shares of Thiokol then held as collateral by the bank represented the 798 shares originally pledged by Leon as proliferated by stock dividends, stock splits, and the exercise by him of rights to purchase additional shares. During the period 1956 to 1959 this *138 stock had tremendously increased in value.
On April 1, 1959, the board of directors of Jewelry adopted a resolution to the effect that it was the "owner of 700 shares of the capital stock of Thiokol" identified by 13 certificate numbers; authorized the president or treasurer of the corporation to sell the shares of stock or any part of them; authorized Commerce Trust Co. or any broker selected by Commerce Trust Co. to handle the sale of said shares on behalf of the corporation; and authorized Commerce Trust Co. to receive the remittance or remittances issued in the name of the corporation and to deposit such remittance or remittances to the account of the corporation in the Commerce Trust Co. Leon was president and a director of Jewelry.
On April 2, 1959, Commerce Trust Co. delivered, as shown by its receipt, certificates representing 700 shares of Thiokol stock to Stern Bros. & Co., Kansas City, Mo., brokers, with endorsements from Leon to Jewelry and stock powers to Stern Bros. & Co. attached to the certificates executed by Jewelry with all endorsements guaranteed by the bank, the instructions of the bank to Stern Bros. & *139 Co., written by one of its assistant cashiers, being in part:
We understand Mr. Meyer has instructed you in regard to selling this stock. We also understand that it is to be sold sometime this month.
As funds are received, check should be made payable to the Meyer Jewelry Company and delivered to the Commerce Trust Company, attention the writer or Harry Wuerth.
On April 2, 1959, Stern Bros. & Co. issued a letter of instruction to the United States Corporation, Stock Transfer Department, Jersey City, N.J., requesting that 13 certificates of Thiokol stock aggregating in total 700 shares (which were enclosed in the letter) be reissued in its name in seven 100-share certificates. Stern Bros. & Co. received from the transfer agent six certificates for 100 shares each, certificate number 3671 for 38 shares and certificate number 3672 for 62 shares of Thiokol stock. These eight certificates were transferred on the books of Thiokol Chemical Corp. to the name of Stern Bros. & Co. on April 27, 1959.
On various dates from April 6, 1959, through April 13, 1959, Stern Bros. & Co. effected sale of 638 shares of stock of Thiokol on the New York Stock Exchange for the account of Jewelry. The dates and *140 *77 prices, net after commissions and charges, at which the shares were sold were:
| Date | Number of | Trade price | Net proceeds |
| shares | |||
| 1959 | |||
| Apr. 6 | 100 | 131 | $ 13,038.14 |
| Apr. 7 | 100 | 127 | 12,638.71 |
| Do | 100 | 126 7/8 | 12,626.22 |
| Do | 100 | 127 1/4 | 12,663.68 |
| Apr. 8 | 100 | 128 | 12,738.57 |
| Apr. 9 | 100 | 128 3/4 | 12,813.45 |
| Apr. 13 | 38 | 127 3/4 | 4,809.40 |
The sales of the 638 shares of Thiokol stock by Stern Bros. & Co. were made at Leon's request.
The income tax return of Jewelry for the year ended June 30, 1959, indicates that the basis of the 638 shares of Thiokol stock sold during that period for $ 81,328.17 was $ 100.
On or about April 15, 1959, Commerce Trust Co. received from Stern Bros. & Co. its check payable to the order of Jewelry in the amount of $ 76,518.77, representing the proceeds of the sale of 600 shares of Thiokol stock. Upon receipt of this check the treasurer of Jewelry endorsed the check on behalf of Jewelry and the same was deposited to the account of Jewelry in the bank on April 15, 1959.
On or about May 1, 1959, Commerce Trust Co. received a second check from Stern Bros. & Co., payable to the order of Jewelry in the amount of $ 4,809.40, representing the proceeds of the sale of 38 shares of Thiokol stock. This check was similarly endorsed *141 on behalf of Jewelry by its treasurer and deposited to the account of Jewelry in the Commerce Trust Co.
On May 4, 1959, Stern Bros. & Co. transmitted by letter to the United States Corporation, Stock Transfer Department, Jersey City, N.J., certificate 3672 for 62 shares of stock of Thiokol. This was the same certificate 3672 for 62 shares received from United States Corporation in response to the letter dated April 2, 1959, from Stern Bros. & Co. to United States Corporation. Pursuant to said letter of instruction dated May 4, 1959, from Stern Bros. & Co., which was written at Leon's request, 30 of these 62 shares were transferred on the records of the transfer agent on May 7, 1959, to the following individuals: Louis S. Meyer (the son of petitioners) and Mrs. Betty Lee Meyer, J/T/R/S (15 shares); Richard C. Burstein and Mrs. Suzanne Burstein (the daughter of petitioners), J/T/R/S (15 shares); and 32 of these 62 shares were reissued in the name of Leon Meyer.
Shares of Thiokol stock were split in April of 1959, when two additional shares were issued for each share outstanding in order to *78 accomplish a 3 for 1 split. The split was effective as of record date April 20, 1959, and the *142 distribution of the additional shares was on April 30, 1959. The stock sold "Ex-dividend" on May 1, 1959. The sales of 638 shares of Thiokol stock effected on various dates from April 6 to April 13, 1959, carried with the shares sold the additional shares produced by the stock split so that Leon as the record owner was required to deliver the additional shares resulting from the split to the purchasers in the trades effected by Stern Bros. & Co. Leon retained the 124 shares distributed to him pursuant to the split on April 30, 1959, as the record owner of the 62 shares which had not been sold. The books of Jewelry contain no account receivable from Leon on account of his receipt of the 62 or the 124 shares of Thiokol stock, and no payment has ever been made by him to Jewelry on account thereof.
The parties have stipulated that the high and low bids for Thiokol stock on April 20, April 27, May 4, and May 7, 1959, were as follows:
| High | Low | |
| Apr. 20 | $ 149.75 | $ 146.00 |
| Apr. 27 | 162.00 | 154.50 |
| May 4 *143 | 53.75 | 59.75 |
| May 7 | 69.87 1/2 | 62.00 |
The sale of the 638 shares of stock of Thiokol executed by Stern Bros. & Co., brokers, on various dates from April 6, 1959, through April 13, 1959, was for the account of Jewelry, a corporation, and represented sales by and on behalf of Jewelry and not the sales of property owned by Leon.
On April 15, 1959, Jewelry used the sum of $ 50,000 from the proceeds ($ 76,518.77) of the sale of 600 shares of stock of Thiokol to satisfy the balance of $ 50,000 remaining on the $ 100,000 note evidencing the loan of June 1956 by Commerce Trust Co. to Jewelry.
On April 18, 1959, Jewelry issued its check drawn on its account at Commerce Trust Co. to the order of Lucile in the amount of $ 26,518.77. The amount of this check represented the difference between $ 76,518.77 paid to Jewelry, being the proceeds of the sale of 600 shares of Thiokol stock, and the $ 50,000 paid by Jewelry in satisfaction of its obligation to Commerce Trust Co. On May 1, 1959, Lucile received a second check from Jewelry in the amount of $ 4,809.40. This check equaled the proceeds from the sale of 38 shares *144 of Thiokol stock for the account of Jewelry. The sum of these two payments is $ 31,328.17. Jewelry made debit entries on an account receivable in *79 its books entitled "Mrs. Lucile Meyer" in the amounts and at the time of these payments. Prior to these entries this account reflected small debits never in excess of $ 75 with balances due never in excess of $ 311. No interest was charged on this receivable, no note was ever given for any indebtedness shown thereon, and no formal security was given for the repayment of any balance.
No formal restrictions were imposed on Lucile with regard to her use of the money received by her from Jewelry. It was the intention of all of the parties concerned that these payments or a part of them would ultimately constitute a distribution to Lucile in redemption of all of her stock in Jewelry at a price later to be decided upon representing either the par value or book value of such stock. Lucile delivered her stock for redemption to the general counsel of Jewelry who kept its stock records in the late summer or early fall of 1959. Sometime between June 30 and December 31, 1959, the parties agreed that the price to be paid to Lucile in redemption of *145 her stock should be its par value, $ 29,000, rather than its book value, which according to Jewelry's income tax return for the year ended June 30, 1959, was $ 37,337.50.
On December 31, 1959, an entry was made on the books of the corporation, crediting the ledger account receivable designated "Mrs. Lucile Meyer" with the sum of $ 29,000 and debiting or reducing capital stock accounts in the total amount of $ 29,000, the individual entries being debits to an account labeled "Capital Stock -- Common 'A' -- $ 4,000.00" (40 shares) and "Capital Stock -- Common 'B' -- $ 25,000.00" (250 shares). The difference of $ 2,328.17 between the total of the two payments to Lucile from the proceeds of the sales of the Thiokol stock ($ 31,328.17) and the $ 29,000 credited to her account in connection with the redemption of her stock continued to be carried in her account with Jewelry as a receivable, this ledger account showing a debit balance of not less than $ 2,472.89 as of December 31, 1959, and not more than $ 2,623.86, the latter figure representing the balance as of May 25, 1961, the date of the last entry therein. Amounts recorded as debits to this account were not represented by notes from *146 Lucile, did not require any interest to be paid by her, were not payable at a fixed maturity date, were not secured by any of Lucile's assets, and, so far as the record discloses, were never paid.
Two factors contributing to the delay in the submission by Lucile of the 40 shares of class A stock and 250 shares of class B stock for redemption and cancellation were the absence of Lucile on a foreign trip, hereinafter referred to in greater detail, and the summer vacation of counsel for the company, who acted as keeper of the stock records.
*80 After the redemption, the stock ownership of the Meyer Jewelry Co. was as follows:
| Number of | Percentage of | |
| shares ownership | ||
| Leon R. Meyer | 800 | 75.47 |
| Jack Becker | 100 | 9.435 |
| Richard C. Burstein | 100 | 9.435 |
| Louis S. Meyer | 60 | 5.66 |
| Total | 1,060 | 100.00 |
The original and remaining cost basis of Lucile in the 40 shares of class A $ 100 par value stock and 250 shares of class B $ 100 par value stock of Jewelry was $ 29,000. No distributions had ever been made *147 by the corporation in the form of a return of capital.
At the Community State Bank, Kansas City, Mo., petitioners maintained two joint bank accounts. One account was entitled "Leon Meyer or Lucile Meyer," referred to in these findings as joint bank account A. The other account was entitled "Lucile Meyer or Leon Meyer," referred to in these findings as joint bank account B. Bank statements and canceled checks on joint bank account A were sent to Leon. Bank statements and canceled checks on joint bank account B were sent to Lucile.
On April 20, 1959, Lucile deposited the $ 26,518.77 check of Jewelry dated April 18, 1959, payable to her, in joint bank account B. Lucile drew a check on joint bank account B, dated April 18, 1959, payable to Commerce Trust Co. in the amount of $ 15,000. This check was utilized on April 20, 1959, to pay the note executed by Leon to the Commerce Trust Co. in the amount of $ 15,000, which was then secured by 1,148 shares of Thiokol stock and which had been secured by 1,848 shares of such stock prior to the execution (with the consent of the bank) of the plan already detailed in our findings, which plan was predicated on the withdrawal by Leon of 700 of these *148 shares, his contribution of these shares to Jewelry and its sale thereof.
Lucile drew a check upon joint bank account B, dated April 19, 1959, payable to the Community State Bank in the amount of $ 8,000. This check was utilized on April 20, 1959, to pay three notes executed by both Leon and Lucile in the total amount of $ 8,000.
Lucile drew a check upon joint bank account B, dated April 18, 1959, in the amount of $ 3,000 to the order of Leon. On April 20, 1959, this check was deposited to joint bank account A.
On May 4, 1959, Lucile deposited in joint bank account B the check for $ 4,809.40 of Jewelry received by her on May 1, 1959.
*81 On May 1, 1959, Lucile drew a check dated May 1, 1959, upon joint bank account B in the amount of $ 4,000 to the order of Leon. On May 4, 1959, this check was deposited to joint bank account A.
Prior to 1959, the customary family practice was that Lucile would advance to Leon the estimated expenses of vacation trips taken by them. After the trip, Leon would return to Lucile any of the advanced funds which were not spent.
In the early part of 1959 the health of Leon had not been good. He had severe hypertension and also had undergone a cataract operation. *149 Following this operation a trip to Sarasota, Fla., had been taken by the Meyers. The trip was paid for by Lucile. Following the trip to Florida the doctor recommended that Leon take a long vacation. Later in 1959, Leon and Lucile were invited by friends of many years standing to join them on a trip to Europe. Leon objected to taking such a trip, but Lucile strongly advanced an opposite view. The outcome of the family discussion was that both Leon and Lucile went to Europe.
The checks drawn by Lucile upon joint bank account B to the order of Leon for $ 3,000, dated April 18, 1959, and $ 4,000, dated May 4, 1959, and deposited in joint bank account A were transferred and used for the purposes of financing the trip to Europe by Leon and Lucile.
Of the checks totaling $ 7,000, described above, the approximate sum of $ 6,000 was used for the purpose of the trip to Europe. The amount not spent was returned to Lucile. No formal requirements were imposed upon Lucile to use any part of the moneys received by her from Jewelry to finance the trip to Europe.
Neither Leon nor Lucile have ever filed with respondent the agreement prescribed in section 302(c)(2)(A)(iii) of the 1954 Code and specifically *150 described in
At the time of the distribution to Lucile here involved and throughout the fiscal years of Jewelry ended June 30, 1959, 1960, 1961, and 1962, Lucile received the sum of $ 7,500 a year as vice president of Jewelry, devoting part of her time to the business in each of those years.
OPINION
With regard to the payments made by Jewelry to Lucile in the total amount of $ 31,328.17, respondent argues with great vigor that they constituted distributions of dividends to her which were includable as such in her taxable income. In the alternative and with much less vigor, respondent argues that they constituted similar income of Leon since these payments to Lucile were either used by her immediately after their receipt for the satisfaction of Leon's obligations or were paid over to Leon.
*82 With regard to the 186 shares of Thiokol stock which were finally issued in the names of and delivered to Leon and to his donees (his son and daughter-in-law and his daughter and son-in-law), respondent argues that they constituted dividends distributed to Leon by Jewelry and as such were taxable to him at their fair market value at the date of issuance.
Petitioners *151 in their voluminous briefs have advanced many arguments with regard to both procedural and substantive questions. As to some of the procedural questions, these arguments repeat with elaboration the arguments of counsel at or shortly after the trial herein and have been decided by Judge Fisher. As to the others, petitioners particularly press their contentions that respondent's determinations of deficiency herein have been in some way vitiated or deprived of their presumption of correctness because (1) respondent's determination that Leon in reality owned and sold the 638 shares of Thiokol stock and derived capital gains thereby, rather than Jewelry (as to which respondent conceded error at the trial) was inconsistent with his determination in Leon's case that the distribution by Jewelry of a part of the proceeds to him constituted taxable income and with his determination in Lucile's case that it constituted income taxable to her and (2) respondent's determination in Leon's case that the distribution by Jewelry of $ 31,328.17 was made to him or for his benefit was inconsistent with his determination in Lucile's case that the same distribution was made by Jewelry to her and should *152 be added to her taxable income. Petitioners argue not only that these inconsistencies cause the respondent's determination to lose the presumption of correctness normally attaching to determinations of deficiency but also that these inconsistencies indicate such arbitrariness and capriciousness on the part of respondent as to render them invalid. We disagree. Respondent may take inconsistent positions for the purpose of protecting the revenue without causing his determinations to lose their presumptive correctness. See
The fact that respondent has conceded error with regard to one of his grounds for deficiency, as stated in the deficiency notice addressed to Leon, does not affect the validity of the other grounds in view of our opinion that the ground abandoned by respondent though conceded to be erroneous was not arbitrary or unreasonable in the light of the facts available to respondent. See
We turn now to *154 a consideration of the substantive issues presented.
The first one to be considered is whether respondent erred in his determination that the payments of $ 31,328.17 made by Jewelry to Lucile constituted taxable income of Lucile.
Respondent first contends that they constituted dividend distributions made to Lucile by Jewelry in the fiscal year of Jewelry ended June 30, 1959, during which Jewelry had current net earnings in the approximate amount of $ 66,000 and cannot be considered as having been made in redemption of her stock in Jewelry, which redemption was accomplished much later in the calendar year 1959 and in Jewelry's fiscal year 1960 when its income was only in the amount of $ 2,500. Respondent further contends that in the event we find that the payments were made to Lucile as a step in the ultimate redemption of her stock in Jewelry's fiscal year 1960, they were nevertheless equivalent to the distribution of a dividend and that Jewelry's accumulated earnings and profits in its fiscal year 1960 were in excess of such payments.
Petitioners contend that these payments were made to Lucile as a step in the ultimate redemption of her stock in Jewelry's fiscal year 1960; that the *155 distributions to Lucile were not equivalent to the distribution of a dividend; that in any event Jewelry had no accumulated earnings and profits in that year and its income available for the payment of dividends was not in excess of $ 2,500; and that to the extent of $ 25,000, these payments should be considered as the payment to Lucile on account of the notes of Jewelry for which 250 shares of its class B stock were exchanged in 1947 and with regard to which her basis was $ 25,000.
If respondent be correct in his contention that the distributions to Lucile in April and May of 1959 did not constitute a step in the redemption *84 of her stock and that the surrender and redemption of her stock which occurred in December 1959 was only conceived and executed at this much later time for the sole purpose of effecting a tax advantage, then there would be little question but that the distributions would be taxable as dividends to Lucile in their full amount under
However, after a careful consideration of the record herein, we have concluded that in spite of the considerable lapse in time between the payments to Lucile by Jewelry and the surrender and redemption of her stock, they were parts of one planned transaction, and the payments to her constituted a step in the redemption of her stock which was accomplished in Jewelry's fiscal year 1960. See
We have chosen to characterize the distribution to Lucile as having occurred in Jewelry's *158 fiscal year ended June 30, 1960, because we believe that at the time the payments were made to her, they constituted bona fide accounts receivable of Jewelry. These accounts were to be paid upon the redemption of Lucile's stock when the price per share was agreed upon. At the time the payments were made to Lucile, the parties *85 anticipated that the redemption of her stock would take place several months later, a fact which convinces us that the open account receivable was subject to an informal obligation on her part to redeem her stock in return for the
This conclusion forces us to the consideration of other questions, most of which are difficult and one of which has been described in some opinions by even more forceful adjectives. See
The first of these is a general question which involves subsidiary questions. It is whether the redemption of Lucile's stock by Jewelry was essentially equivalent to the payment of a dividend. If it was not, then the payments would be considered as "a distribution in * * * full payment in exchange for the stock." See sec. 302(a) and (b)( 1),
We are compelled to consider the application of section 302(b)(1) because sections 302(b)(2), *162 302(b)(3), *86 provisions of section 302(c)(1) *163 which make section 318(a) *164 *165 *166 applicable "in determining the ownership of stock for purposes of * * * [sec. 302]." The exception provided in section 302(c)(2)(A) *167 does not apply here since immediately after the distribution to Lucile, here in question, she was and continued to be for at least 2 years, a salaried officer of Jewelry. In this connection it should also be noted that Lucile did not file, and so far as the record here discloses has never filed, the agreement *161 called for by section 302(c)(2)(A) (iii). Cf.
*87 The reason for our conclusion with regard to the inapplicability of sections 302(b)(2) and 302(b)(3), as read in the light of section *88 318(a)(1), is readily apparent upon examination of the stock ownership of Jewelry prior and subsequent to the redemption. On April *168 1, 1959 (prior to the redemption), the stock ownership of Jewelry was as follows:
| Number of | Percentage | |
| shares of ownership | ||
| Leon R. Meyer | 800 | 59.26 |
| Lucile H. Meyer | 290 | 21.48 |
| Jack Becker | 100 | 7.41 |
| Richard C. Burstein | 100 | 7.41 |
| Louis S. Meyer | 60 | 4.44 |
| Total | 1,350 | 100.00 |
After the redemption, the stock ownership of Jewelry was as follows:
| Number of | Percentage | |
| shares | of ownership | |
| Leon R. Meyer | 800 | 75.47 |
| Jack Becker | 100 | 9.435 |
| Richard C. Burstein | 100 | 9.435 |
| Louis S. Meyer | 60 | 5.66 |
| Total | 1,060 | 100.00 |
Applying the rule of section 318(a)(1), ownership of Leon's (her husband) and Louis' (her son) stock in Jewelry is attributed to Lucile. Consequently, her percentage of ownership before and after the redemption was 85.18 and 81.13 percent, respectively. This percentage shift is not large enough to constitute a "substantially disproportionate redemption" under section 302(b)(2), the minimum of which must be 20 percent. Moreover, it is clear that there has not been a complete "termination of [Lucile's] interest" *169 in Jewelry within the meaning of section 302(b)(3) and the statutory framework pertinent thereto.
Turning, then, to a consideration of section 302(b)(1) and a resolution of the question whether the distribution to Lucile was or was not "essentially equivalent to a dividend," it is appropriate to consider certain criteria which the courts have determined to be pertinent to this question. In
It is recognized in the case law and in the regulations that the question whether a distribution is essentially equivalent to a dividend depends on the facts and circumstances of each case.
Among these criteria are: Did the corporation adopt any plan of contraction of its business activities; did the transaction actually result in a contraction of the corporation business; did the initiative for the corporate distribution come from the corporation or the shareholders; was the proportionate ownership of stock by the shareholders changed; what were the amounts, frequency, and significance of dividends in the past; was there a sufficient accumulation of earned surplus to cover distribution or was it partly from capital; and was there a bona fide corporate business purpose for the distribution?
In the instant case Jewelry did not have any plan to contract its business, the transaction did not result in any contraction of its business, the initiative for the corporate distribution did not come from the corporation but came from the stockholders, there had been no dividends in the past, and there was no bona fide corporate business purpose for the distribution.
In considering as a criterion in the application of section 302(b)(1) the question of whether the transaction resulted in a change in the proportionate ownership of stock by the shareholders or, as it is referred to in
*90 Thus, all of the criteria available for our guidance on this subject *173 (with the exception of the availability of earnings and profits of Jewelry from which dividends could be paid, a matter hereinafter to be discussed) point to a conclusion that the payments made by Jewelry to Lucile as steps in the redemption of her stock were essentially equivalent to a dividend, and we so hold subject to our resolution of several troublesome problems pertaining to the availability of earnings and profits from which a dividend distribution could be made.
The net effect of the transaction (see Because we have concluded that the distributions to Lucile were made in Jewelry's fiscal year ended June 30, 1960, as a part of the redemption of her stock in that fiscal year, we must consider whether there were sufficient earnings *174 and profits available at that time to support respondent's determination that these distributions were dividends. In this connection the principal question is what effect the cancellation of indebtedness of Jewelry under a chapter XI arrangement under the Bankruptcy Act confirmed on July 3, 1956, had on its earnings and profits account. Petitioners argue that the effects of the chapter XI proceeding which canceled indebtedness in the amount of $ 189,785.42 were to produce a zero balance in the earnings and profits account of Jewelry and create a "Contributed capital" account in the amount of $ 179,746.36, Respondent argues that because the cancellation of indebtedness had the effect of freeing certain assets from the encumbrance of liabilities, *91 this fact must be reflected in the earnings and profits account of Jewelry. His position, as summarized on brief, is as follows: Since the earnings and profits *175 account was decreased when the debts were incurred, the entries made at the time of the deduction should be corrected by restoring to earnings and profits the amount of debts forgiven in the arrangement proceeding in order to reflect the correct accumulated earnings and profits of the corporation. The resolution of this problem is crucial to a characterization of the distributions received by Lucile, because if we follow petitioners' contentions with respect to the cancellation of indebtedness issue, there would have been earnings and profits available to Jewelry in the fiscal year ended June 30, 1960, only to the extent of its current earnings of that year in the amount of $ 2,117.13. Petitioners' argument proceeds along the following lines: that both the relevant sections of the Bankruptcy Act *177 and respondent's own regulations *178 provide that no income shall be realized in connection with a cancellation of indebtedness pursuant to a bankruptcy proceeding. Petitioners maintain that the proper treatment of such cancellation would be either to create a "Contributed capital" account in such amount or to set off the deficit existing prior to the chapter XI proceeding and carry the excess *176 in a capital surplus account. *92 Petitioners contend that two items, the $ 7,500 payment to the Jewelers Board of Trade and an alleged $ 2,539.06 payment for estimated tax and administrative expenses, should *179 be deducted from the total amount of debts discharged, $ 189,785.42. Petitioners therefore argue that $ 179,746.36 is the correct amount to be reflected on the corporate balance sheet. Respondent, on the other hand, questions the propriety of these deductions and urges that the $ 189,785.42 figure be used. *180 However, it appears to us unnecessary to decide this question since it will be seen from our resolution of the issue as to whether there were sufficient earnings and profits to support the $ 31,328.17 distribution to Lucile, that even if we were to reduce the cancellation of indebtedness figure by the total amount of the deductions herein at issue, $ 10,039.06, the result would be the same. The precise question which we face is whether the cancellation of corporate indebtedness pursuant to a chapter XI proceeding may, in whole or in part, be considered as generating earnings and profits. While the Bankruptcy Act ( However, both *94 Exhibits submitted by the petitioners and oral testimony establish the fact that on June 30, 1956, 3 days prior to the formal approval of the bankruptcy arrangement, the inventory and fixed assets were written down in the amount of $ 64,000, and the accounts and notes receivable were similarly adjusted downward in the net amount of $ 10,886.84 to reflect the fair market value of these assets. Although *187 this write-down in the total amount of $ 74,886.84 was executed 3 days prior to the formal entry of the bankruptcy order, we believe that it was done in anticipation of that order, and may be considered by us as fixing the fair market value of the assets of Jewelry as of the time of the forgiveness of its indebtedness pursuant to the bankruptcy proceedings at their book value, minus the total amount of such write-downs. It is significant that the regulations provide for such a reduction of basis, for the effect of such a rule is to defer recognition of any gain realized upon the cancellation of indebtedness until the property with the reduced basis is sold or otherwise disposed of. In view of this postponement in the recognition of gain, we choose to follow the reasoning in the The present case must be distinguished from situations where fully realized income which is exempt from tax, such as interest on state bonds, is included in earnings and profits. See This method of treating the profit is comparable to the treatment accorded nontaxable exchanges governed by the so-called reorganization provisions in section 112 of the Code, where recognition is similarly postponed. In both situations, the earnings and profits are affected, not at the time of the original unrecognized transaction, but at the time that the gains or losses are actually taken into account in computing taxable income. True, the result with respect to section 112 transactions, dealing with sales and exchanges, is specifically called for by Respondent calls our attention to Among the items entering into the computation of corporate earnings and profits for a particular period are all income exempted by statute, income not taxable by the Federal Government under the Constitution, as well as all items includible in gross income under section 61 or corresponding provisions of prior revenue acts. Gains and losses within the purview of section 1002 or corresponding provisions of prior revenue acts are brought into the earnings and profits at the time and to the extent such gains and losses are recognized under that section. Interest on State bonds and certain other obligations, although not taxable when received by a corporation, is taxable to the same extent as other dividends when distributed to shareholders in the form of dividends. However, in the instant case the book value of Jewelry's assets was written down in the amount of $ 74,886.84 to reflect a fair market value of the total assets, at or about the time of the cancellation, in the total amount of $ 325,400.04, while the total cancellation of indebtedness was $ 189,785.42. No further reduction of basis is allowable under We cannot accept petitioners' argument that the amount of discharged indebtedness or any part thereof be placed in a "Contributed capital" account. Since the creditors whose debts were discharged were not shareholders of Jewelry and had no intention of making any investment in Jewelry, it appears obvious to us that the discharge of the *98 debts owing to them cannot be considered as "Contributed capital." See Petitioners' exhibits indicate the fact that on Jewelry's income statement for the fiscal year ended June 30, 1956, the $ 64,000 inventory write-down was carried into the "Cost of Sales" account. Moreover, a total amount of $ 18,106.01 was noted in the income statement under "Expenses: Bad debts." With regard to this latter item, we have already found that this figure represents the two debits of $ 10,886.84 and $ 7,219.17 to "Bad debt expense" and "Bad debt reserve," respectively. Our explanation of the nature of the 1956 *198 debit to the bad debt reserve in the amount of $ 7,219.17 contained in our findings, footnote 6, The remaining question for our consideration with regard to the earnings and profits of Jewelry is whether the $ 64,000 inventory write-down and the $ 10,886.84 ($ 18,106.01 - $ 7,219.17) accounts or notes receivable write-down to fair market value made pursuant to the chapter XI arrangement can still be regarded as expenses (as petitioners contend) for the year ended June 30, 1956, in view of our holding that such write-downs must be reflected in the appropriate assets and liabilities accounts. *199 While these write-downs might be regarded as expenses from an accounting standpoint, our resolution of the problem prevents these write-downs from entering into the profit and loss computations for this year, for to do so in combination with our holding that they must serve to reduce the amount of discharged liabilities which would otherwise have been included in earnings and profits would give them double effect on such earnings and profits. The reason for this is apparent upon comparison of petitioners' contentions with respect to the balance sheet effects of the bankruptcy and our own. Petitioners argue that the proper balance sheet treatment of these events is to create an account designated "Contributed capital" in the *99 total approximate amount of the discharged debts and reduce the "Liabilities" account by the same amount. Since this operation merely involves a change of classification on the right side of the balance sheet, both the left and right sides thereon would still be "in balance." However, petitioners have reduced the figures at which various assets were carried on the left side of the balance sheet by $ 74,886.84, the total amounts of the alleged write-down of the *200 assets to their fair market values. In order to compensate for this reduction on the "assets" side of the balance sheet, petitioners have regarded these write-downs as expenses for the year ended June 30, 1956. By designating these write-downs as expenses, petitioners have increased the loss for the year ended June 30, 1956, and consequently have decreased the earnings and profits account. Our resolution of this issue has rejected the creation of a "Contributed capital" account in the amount of the discharged debts. We have held that the excess of the amount of discharged debts over the allowable basis reductions should be placed in the earnings and profits account. We have therefore effected the following operations upon the balance sheet: A reduction on the left (assets) side by the amount of allowable basis write-downs, a reduction on the right side (the liability account) by the amount of the discharged debts, and an increase on the right side of the earnings and profits account in the amount by which the discharged debts exceed the allowable basis reductions. These three steps leave the accounts "in balance." While this conclusion has the result of decreasing the amounts of *201 "expenses" and loss for the year ended June 30, 1956, as used by petitioners in their computations on brief by $ 74,886.84 with a consequent decrease in the deficit of Jewelry's earnings and profits in the same amount, it has no material effect *202 We therefore conclude that the net loss and the deficit as reported for this year were overstated in the amount of $ 82,106.01 ($ 74,886.84 +$ 7,219.17). Since Jewelry's income statement indicates that the deficit *100 as of June 30, 1956, was ($ 111,392.14), Since the prebankruptcy deficit does survive the chapter XI proceeding, Because Jewelry's income tax return indicates that there was income during the fiscal year ended June 30, 1960, in the *204 amount of $ 2,492.13, and disallowed charitable contributions in the amount of $ 375 due to the 5-percent rule, it is apparent that there were more than sufficient earnings and profits of Jewelry in that year to cover the $ 31,328.17 distribution to Lucile. Hence, we reiterate our holding that such distribution *101 was a dividend within the meaning of The record indicates that the difference of $ 2,328.17 between the total of the payments to Lucile ($ 31,328.17) and the $ 29,000 credited to her account in connection with the redemption of her stock continued to be carried in her account with Jewelry as a receivable. This ledger account showed a debit balance of not less than $ 2,472.89 as of December 31, 1959, and not more than $ 2,623.86, the latter figure representing the balance as of May 25, 1961, the date of the last entry therein. As we have noted in our findings, Petitioners further argue that in any event the redemption of Lucile's stock is not essentially equivalent to a dividend to the extent of $ 25,000 under the terms of section 302(b)(1). Petitioners base this contention on the theory that $ 25,000 of the $ 31,328.17, which Lucile received from Jewelry, represented no more than the ultimate repayment of the $ 25,000 liability to Lucile which the corporation incurred in 1946 in the form of five 10-year notes of $ 5,000 each. These notes were issued to Lucile as part of the consideration *206 paid to her at the time the partnership known as Meyer Jewelry Co. assumed corporate form. In support of this argument, petitioners call our attention to Petitioners attempt to bring the instant situation within the rule of the above cases on the ground that the $ 50,000 of liabilities which Jewelry incurred to Leon and Lucile in 1946 were capitalized into 500 shares of class B stock in 1947 only to improve the balance sheet of the corporation so as to obtain a more favorable credit rating. They argue that the liability was still regarded as remaining outstanding and as such, $ 25,000 of the total amount paid to Lucile during the year 1959 represented repayment of this debt. We neither agree with petitioners' analysis of the transaction nor do we believe that either of the two cases supports petitioners' position. *102 The notes were converted into 500 shares of class B stock in 1947, a year after the corporation was organized. The $ 100 par class B stock carried with it the right to vote and a $ 6 per share noncumulative dividend preference. It could have been redeemed "at the option of the Board of Directors *207 at any time at the par value thereof." In spite of this recital in the amendment to the articles of incorporation, there is nothing in the record which would suggest that this $ 50,000 "investment" was ever treated in any manner other than that of ordinary equity capital. While the interest may have been paid on the five notes totaling $ 25,000 due Leon up until their conversion into class B stock, there is no similar indication that any interest was ever paid to Lucile. *208 ordinary common stock of Jewelry. Given the complete failure of Jewelry to adhere to the terms of the notes or to the 250 class B shares held by Lucile by making any payments thereon for such a long period of time, the failure of Lucile to make any demands for such payments, the absence of any agreement, either explicit or implicit, that the class B shares would be redeemed when Jewelry was financially able to do so, the fact that Lucile was a 50-percent stockholder in Jewelry and participated in its management during the period 1946 to 1959, the ultimate obliteration of the class B distinction in the capital structure of the corporation, the fact that the distributions to Lucile were treated by all of the *209 parties as in redemption of all of Lucile's stock without reference to any part of such stock taken by her 11 years prior thereto in exchange for her notes, and the testimony of Lucile and Leon concerning the motives prompting the distributions to Lucile which made no reference to the repayment of any debt but which as we construe it was to the effect that the distributions to Lucile in redemption of her *103 stock were made for the purpose of enabling Lucile to withdraw her capital investment therefrom, we are convinced that all of Lucile's stock represented an ordinary equity investment at the time it was redeemed. See In view of our conclusion, petitioners' citation of In view of the above, we reject petitioners' contention that the distributions in redemption of Lucile's common stock which occurred in late 1959 or any part thereof, should be considered as constituting, either directly or indirectly, the repayment of a $ 25,000 debt owing to her from Jewelry. Respondent determined that on April 13, 1959, Leon received a taxable distribution of $ 7,920.50 from Meyer Jewelry Co., consisting of 62 shares of Thiokol stock having a value of $ 127.75 per share, which he failed to report as income. At the conclusion of the trial, respondent submitted a motion for leave to file an amended answer. Such motion was subsequently granted. In his amended answer, respondent asserted that Leon received a taxable distribution from Jewelry in the amount of *211 $ 10,013, representing the fair market value of 124 shares of Thiokol received on April 30, 1959, at a fair market value of $ 52.375 per share, and 62 shares of Thiokol received on May 4, 1959, at a fair market value of $ 56.75 per share. Petitioners' primary contention with respect to this issue is that Leon contributed only 638 presplit shares of his Thiokol stock to Jewelry's capital and retained title to 62 shares. Consequently, it is urged by petitioners that Leon did not receive a distribution of 62 shares of Thiokol stock on April 13, 1959. In response to respondent's amended answer, petitioners argue that for the same reason Leon did not receive distributions of 124 and 62 shares of Thiokol stock on April 30 and May 4, 1959, respectively. Petitioners, on brief, concede that "The record indicates that Leon on or after May 4, 1959 received 32 [split] shares out of 62 shares of *104 Thiokol held by Stern Brothers & Co.," having a fair market value of no more than $ 53.75 per share, the lowest selling price for that date. However, petitioners argue that respondent, having pleaded new matter, has not sustained his burden of proving either that the receipt of the stock in question constituted *212 more than a return to Leon of his own property or that the shares had a value greater than $ 53.75 per share as of the date of delivery. With respect to petitioners' assertion that respondent has pleaded new matter and must bear the burden of proof, we are convinced that notwithstanding the question as to which party bears the burden of proof as to this issue, the record clearly supports respondent's assertions that all 700 of the presplit shares of Thiokol were given to Meyer Jewelry Co. by Leon on or about April 1, 1959, as a capital contribution, including the 62 shares which were not sold on behalf of Jewelry. Whether the stock was transferred to Jewelry depends upon all the attendant facts and circumstances, including the intent of the parties. The record shows that the 700 presplit shares of Thiokol were identified by 13 certificates issued in the name of Leon R. Meyer. At the time of contribution these certificates had been endorsed by Leon to Jewelry. The minutes of Jewelry's board of directors meeting dated April 1, 1959 (at which Leon acted as chairman), state that the stock certificates representing the 700 shares were endorsed by Leon to Jewelry; that Jewelry is the "owner of 700 shares of the capital stock of Thiokol"; the stock powers attached to the 13 certificates were all executed by Jewelry before delivery to Stern Bros. & Co., brokers; and the instructions to the broker were that all checks representing proceeds of sale of the 700 shares should be made payable to Jewelry. The record also shows that from the period April 6 through April 13, 1959, 638 of these shares were sold by a broker, Stern Bros. & Co., on behalf of Meyer Jewelry Co. In order to facilitate this sale and to transfer the shares into a street name, the broker, on April *214 2, 1959, issued a request to the stock transfer agent of Thiokol Chemical Corp. to reissue the 700 shares in the name "Stern Brothers & Company." The shares were actually transferred on the books of Thiokol Chemical Corp. on April 27, 1959. In the meantime, a stock dividend *105 had been declared by Thiokol providing for two additional shares to be issued for each share presently held, in order to effect a 3 for 1 split of the stock. The stock record date for determining the proper parties entitled to this dividend was April 20, 1959. The payment date for the stock dividend was April 30, 1959. Therefore, on April 20, 1959, according to the stock record books of the Thiokol Chemical Corp., the proper party to receive the stock dividend was Leon Meyer. The stock dividend on the 638 shares which had been sold during the period April 6 through April 13, 1959, although received by Leon Meyer, had to be returned to Stern Bros. & Co. for transfer to the respective purchasers of the 638 shares. Leon did receive, however, on April 30, 1959, the stock dividend of 124 additional shares on the 62 shares which had not been sold by Meyer Jewelry Co. The original 62 shares (now one-third of the *215 value existing prior to the split) were first received by Stern Bros. in a street name. Of this amount, 30 shares were reissued in accordance with Leon's request to Stern Bros. & Co. on May 4, 1959, to various members of his family, and 32 shares were reissued to himself. Pursuant to this instruction of Leon, these transfers were noted on the records of the stock transfer agent on May 7, 1959. Although Meyer Jewelry Co. did not physically receive any of the 124 shares resulting from the split of the original 62 shares, this factor alone is not determinative if the intention of the parties is otherwise. On April 20, 1959, the effective record date of the stock split, Leon was still the record owner on the books of Thiokol of the 62 shares to be split. It is petitioners' position that the 124 additional shares produced by the split came directly to Leon and not via a distribution from Jewelry. We find no merit in this argument since the record shows that on April 20, 1959, Leon was not only the record holder, per Thiokol's books of the 62 unsold shares but was also the record holder of the other 638 shares already sold by Jewelry's broker. The sale of 638 shares of Thiokol sold from April 6 to April 13, 1959, carried with the shares sold the additional shares produced by the stock *106 split so that the record owner was required to deliver the additional shares resulting from the split to the purchaser in the transaction effected by Stern Bros. & Co. for the account of Jewelry. We believe that this situation is equally applicable to the 62 remaining presplit shares. They had been owned for nearly 3 weeks by Meyer Jewelry Co. If they had been sold in *217 the interim, the purchaser would have been entitled to the 124 shares arising from the split. In our opinion, Meyer Jewelry Co. was acting in its own behalf, and not as an agent of Leon, with respect to the 700 shares. Leon's interest in the 700 shares, including the 62 shares unsold, arose solely from Thiokol's delay in performing a ministerial, bookkeeping act. Leon's position was tantamount to that of a nominee. Hence, he had no legal or equitable right to retain any of the 1,400 split shares received by virtue of that position. When Leon, apparently acting in his official capacity as president and controlling stockholder of Jewelry, chose to retain the 124 and 62 split shares, he received in substance a distribution of such property from his corporation. Respondent's amended answer alleges a fair market value of the 124 Thiokol shares, which Leon received on April 30, 1959, in the amount of $ 52.375 per share. The parties stipulated orally that the split Thiokol stock sold on the New York Stock Exchange on April 30, 1959, at a high of $ 53.875 per share and a low of $ 51 per share. With respect to the 62 presplit shares of Thiokol, petitioners admit that Leon received 32 of *218 these shares on or about May 4, 1959, and that the fair market value thereof was the lowest selling price obtained on the New York Stock Exchange for the split Thiokol stock on the latter date. On that date, the parties have likewise stipulated that Thiokol stock sold on the exchange at a low of $ 53.75 per share and at a high of $ 59.75. Notwithstanding the question as to which party should assume the burden of proof with respect to the fair market value of the Thiokol stock on the two distribution dates, we find that the record supports respondent's determinations. Where stock is listed and freely marketed in substantial amounts on a recognized exchange, the mean price between the two extreme trading prices on a given date is regarded as the fair market value for that date. In our computations of the earnings and profits of Jewelry, we have subtracted $ 9.72 in order to recognize the effects of the above distribution to Leon. Section 312(a)(3) of the 1954 Code *220 from Jewelry's earnings and profits for the year ended June 30, 1959, in our computations.
Respondent contends that petitioners' position is squarely opposed to the above regulation. Although income from discharge of indebtedness is included in the definition of gross income by section 61(a)(12) of the 1954 Code, *194 at the time of the discharge by virtue of the relevant provisions of the Bankruptcy Act because of and only to the extent of its use in the reduction of the basis of the debtor's assets, and further, that to the extent it was not so used, it is fully realized income even though exempt from tax, such as interest on State bonds and proceeds from life insurance, which *97 are included in earnings and profits. $ 189,785.42 Discharged indebtedness 74,886.84 Allowable basis deductions 114,898.58 Deficit as of June 30, 1956 ($ 29,286.13) Amount of discharge of indebtedness income includable in earnings and profits as of July 3, 1956 114,898.58 Loss from operations, fiscal year ending June 30, 1957 (16,147.89) Loss from operations, fiscal year ending June 30, 1958 (69,941.20) Gain from operations, fiscal year ending June 30, 1959 Nondeductible contributions (June 30, 1957 - June 30, 1959) (1,464.53) 64,056.21 Less: Disallowed excess of charitable deductions above 5 percent of taxable income, fiscal year ending June 30 -- 1957 $ 452.50 1958 587.03 1959 425.00 1,464.53 Earnings and profits as of July 1, 1959 62,591.68
1. These cases were heard by Judge Morton P. Fisher and briefs were duly filed. Judge Fisher died on Feb. 11, 1965. These cases, not having been disposed of, were reassigned to Judge John W. Kern on Mar. 2, 1965, and notice was given to the parties that any request for rehearing or reargument might be presented to him within 30 days. No such requests have been received.↩
2. According to the proposed arrangement, the tax claims amounted to $ 4,967.12.↩
3. Although 30 percent of $ 271,121.71 is $ 81,336.51, the court orders employed the figure as indicated. Nothing in the record explains this discrepancy.↩
4. Although this figure was used on Jewelry's balance sheet as of June 30, 1956, petitioners' computations on brief result in the figure $ 179,746.36 ($ 189,785.42 - ($ 7,500+$ 2,539.06)). There is nothing in the record to explain this discrepancy. While these computations include the reduction of $ 2,539.06 for "Tax and Administrative expenses -- Est.," there is nothing in the record to support this latter figure.↩
5. Described in the journal of Jewelry as "materials," "mountings," and "shop" with respective write-downs of $ 50,000, $ 8,000, and $ 6,000.↩
6. We believe the net reduction in the accounts and notes receivable to be $ 10,886.84. The debit to "Insurance claim pending" is an increase in an asset account and the companion credits indicate that the insurance claim was reclassified by taking it out of accounts or notes receivable. The debit to "Bad debt reserve" normally indicates a reduction in a liability account set up to estimate uncollectible accounts receivable. As such, this entry is not a write-down in an asset account arising out of an expense or a forgiveness of indebtedness. The corresponding credit might well indicate that certain amounts estimated uncollectible proved collectible in part. While we would not go so far as to attribute income to Jewelry because of this entry, we find no justification for treating the $ 7,219.17 debit as an asset write-down.
7. Despite this notation, the journal entries indicate total write-downs of $ 64,000. See fn. No. 5,
8. It appears that the $ 18,106.01 figure is the sum of the following two debits in the journal: $ 10,886.84 to "Bad debt expense" and $ 7,219.17 to "Bad debt reserve."↩
1. After 3 for 1 split the parties have also stipulated that on Apr. 30, 1959, "the old stock of Thiokol Chemical Corp., prior to split, was selling at a low of $ 153.75 and a high of $ 161.50, and the split stock was selling at a low of $ 51 per share and a high of $ 53.87 1/2 per share."
1. Includes ownership in both class A and class B shares which are deemed to be of the same and identical class as a result of an amendment of the special bylaws of the corporation at the stockholder meeting of Sept. 22, 1958.↩
9.
(a) General Rule. -- For purposes of this subtitle, the term "dividend" means any distribution of property made by a corporation to its shareholders -- (1) out of its earnings and profits accumulated after February 28, 1913, or (2) out of its earnings and profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.↩
10. 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.↩
11. Sec. 302(b)(2). Substantially disproportionate redemption of stock. -- (A) In General. -- Subsection (a) shall apply if the distribution is substantially disproportionate with respect to the shareholder. (B) Limitation. -- This paragraph shall not apply unless immediately after the redemption the shareholder owns less than 50 percent of the total combined voting power of all classes of stock entitled to vote. (C) Definitions. -- For purposes of this paragraph, the distribution is substantially disproportionate if -- (i) the ratio which the voting stock of the corporation owned by the shareholder immediately after the redemption bears to all of the voting stock of the corporation at such time, is less than 80 percent of -- (ii) the ratio which the voting stock of the corporation owned by the shareholder immediately before the redemption bears to all of the voting stock of the corporation at such time. For purposes of this paragraph, no distribution shall be treated as substantially disproportionate unless the shareholder's ownership of the common stock of the corporation (whether voting or nonvoting) after and before redemption also meets the 80 percent requirement of the preceding sentence. For purposes of the preceding sentence, if there is more than one class of common stock, the determinations shall be made by reference to fair market value. (D) Series of Redemptions. -- This paragraph shall not apply to any redemption made pursuant to a plan the purpose or effect of which is a series of redemptions resulting in a distribution which (in the aggregate) is not substantially disproportionate with respect to the shareholder.↩
12. SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.
(b) Redemptions Treated as Exchanges. --
* * * * (3) Termination of shareholder's interest. -- Subsection (a) shall apply if the redemption is in complete redemption of all of the stock of the corporation owned by the shareholder.↩
13. Sec. 302(b)(4). Stock issued by railroad corporations in certain reorganizations. -- Subsection (a) shall apply if the redemption is of stock issued by a railroad corporation (as defined in section 77(m) of the Bankruptcy Act, as amended) pursuant to a plan of reorganization under section 77 of the Bankruptcy Act.↩
14. Sec. 302(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.
15. 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 (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and (ii) his children, grandchildren, and parents. (B) Effect of adoption. -- For purposes of subparagraph (A)(ii), a legally adopted child of an individual shall be treated as a child of such individual by blood. (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. (B) Trusts. -- Stock owned, directly or indirectly by or for a trust shall be considered as being owned by its beneficiaries in proportion to the actuarial interest of such beneficiaries in such trust. Stock owned, directly or indirectly, by or for a beneficiary of a trust shall be considered as being owned by the trust, unless such beneficiary's interest in the trust is a remote contingent interest. For purposes of the preceding sentence, a contingent interest of a beneficiary in a trust shall be considered remote, if, under the maximum exercise of discretion by the trustee in favor of such beneficiary, the value of such interest, computed actuarially, is 5 percent or less of the value of the trust property. Stock owned, directly or indirectly, by or for any portion of a trust of which a person is considered the owner under subpart E of part I of subchapter J (relating to grantors and others treated as substantial owners) shall be considered as being owned by such person; and such trust shall be treated as owning the stock owned, directly or indirectly, by or for that person. This subparagraph shall not apply with respect to any employees' trust described in section 401(a) which is exempt from tax under section 501(a). (C) Corporations. -- If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, then -- (i) such person shall be considered as owning the stock owned, directly or indirectly, by or for that corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation; and (ii) such corporation shall be considered as owning the stock owned, directly or indirectly, by or for that person. (3) Options. -- If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option, and each one of a series of such options, shall be considered as an option to acquire such stock. (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. (C) Option rule in lieu of family rule. -- For purposes of this paragraph, if stock may be considered as owned by an individual under paragraph (1) or (3), it shall be considered as owned by him under paragraph (3).↩
16. SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.
(c) Constructive Ownership of Stock. --
* * * * (2) For determining termination of interest. -- (A) In the case of a distribution described in subsection (b)(3), section 318(a)(1) shall not apply if -- (i) immediately after the distribution the distributee has no interest in the corporation (including an interest as officer, director, or employee), other than an interest as a creditor, (ii) the distributee does not acquire any such interest (other than stock acquired by bequest or inheritance) within 10 years from the date of such distribution, and (iii) the distributee, at such time and in such manner as the Secretary or his delegate by regulations prescribes, files an agreement to notify the Secretary or his delegate of any acquisition described in clause (ii) and to retain such records as may be necessary for the application of this paragraph. If the distributee acquires such an interest in the corporation (other than by bequest or inheritance) within 10 years from the date of the distribution, then the periods of limitation provided in sections 6501 and 6502 on the making of an assessment and the collection by levy or a proceeding in court shall, with respect to any deficiency (including interest and additions to the tax) resulting from such acquisition, include one year immediately following the date on which the distributee (in accordance with regulations prescribed by the Secretary or his delegate) notifies the Secretary or his delegate of such acquisition; and such assessment and collection may be made notwithstanding any provision of law or rule of law which otherwise would prevent such assessment and collection.↩
1. Includes ownership in both class A and class B shares which are deemed to be of the same and identical class as a result of an amendment of the special bylaws of the corporation at the stockholder meeting of Sept. 22, 1958.↩
17. Including the three deemed pertinent in
18. See Moore, "Dividend Equivalency -- Taxation of Dividends in Redemption of Stock,"
19. See fn. 4,
20.
Except as provided in
* * * *
In determining the basis of property for any purposes of any law of the United States or of a State imposing a tax upon income, the basis of the debtor's property (other than money) or of such property (other than money) as is transferred to any person required to use the debtor's basis in whole or in part shall be decreased by an amount equal to the amount by which the indebtedness of the debtor, not including accrued interest unpaid and not resulting in a tax benefit on any income-tax return, has been canceled or reduced in a proceeding under this chapter, but the basis of any particular property shall not be decreased to an amount less than the fair market value of such property as of the date of entry of the order confirming the arrangement. Any determination of value in a proceeding under this chapter shall not be deemed a determination of fair market value for the purposes of this section. The Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, shall prescribe such regulations as he may deem necessary in order to reflect such decrease in basis for Federal income-tax purposes and otherwise carry into effect the purposes of this section. * * *
21.
(b)
(i) A plan of corporate reorganization confirmed under Chapter X of the Bankruptcy Act (11 U.S.C., ch. 10);
(ii) An "arrangement" or a "real property arrangement" confirmed under Chapter XI or XII, respectively, of the Bankruptcy Act (11 U.S.C., ch. 11, 12); or
(iii) A "wage earner's plan" confirmed under Chapter XIII of the Bankruptcy Act (11 U.S.C., ch. 13).
(2) For adjustment of basis of certain property in the case of cancellation or reduction of indebtedness resulting from a proceeding under the Bankruptcy Act, see the regulations under section 1016.↩
22. While the record supports the petitioner with respect to the fact of the $ 7,500 payment, there is no indication that the tax and administrative expenses in connection with the chapter XI proceeding were in the amount of $ 2,539.06. Even if we were to assume that both payments were in fact made, it is extremely doubtful whether there is justification for deducting them from the amount of the debts discharged and considering such deductions in any computations we might make with regard to the earnings and profits of Jewelry. The income statement for the year ended June 30, 1956, contains expense entries for "Taxes" and "Miscellaneous" in the respective amounts of $ 6,910.15 and $ 8,678.58. If, as we believe, petitioners have the burden of proof on this issue, they have not borne the burden of proving that these items were not reflected in the corporate income statement as of June 30, 1956.
23.
(a) In addition to the adjustments provided in section 1016, further adjustment is required in the case of a cancellation or reduction of indebtedness in any proceeding under chapters X, XI, or XII of the Bankruptcy Act (11 U.S.C. ch. 10, 11, and 12) and corresponding provisions of prior law. For exceptions to the above rule see sections 372, 373, 374, and 1018. Furthermore, no such further adjustment will be made in the case of a "wage earner" as that term is defined in section 606(8) of the Bankruptcy Act (
(1) In the case of indebtedness incurred to purchase specific property (other than inventory or notes or accounts receivable whether or not a lien is placed against such property securing the payment of all or part of such indebtedness, which indebtedness shall have been canceled or reduced in any such proceeding, the cost or other basis of such property shall be decreased (but not below its fair market value) by the amount by which the indebtedness so incurred with respect to such property shall have been canceled or reduced;
(2) In the case of specific property (other than inventory or notes or accounts receivable) against which, at the time of the cancellation or reduction of the indebtedness, there is a lien (other than a lien securing indebtedness incurred to purchase such property) the cost or other basis of such property shall be decreased (but not below its fair market value) by the amount by which the indebtedness secured by such lien shall have been canceled or reduced;
(3) Any excess of the total amount by which the indebtedness shall have been so canceled or reduced in such proceeding over the sum of the adjustments made under subparagraphs (1) and (2) of this paragraph shall next be applied to reduce the cost or other basis of the property of the debtor (other than inventory and notes and accounts receivable, but including property covered by such subparagraphs) as follows: the cost or other basis of each unit of property shall be decreased (but not below its fair market value) in an amount equal to such proportion of such excess as the adjusted basis (after adjustment under subparagraphs (1) and (2) of this paragraph) of each such unit of property bears to the sum of the adjusted bases (after adjustment under such subparagraphs) of all the property of the debtor other than inventory and notes and accounts receivable;
(4) Any excess of the total amount by which such indebtedness shall have been so canceled or reduced over the sum of the adjustments made under subparagraphs (1), (2), and (3), of this paragraph shall next be applied to reduce the cost or other basis of any units of property covered by such subparagraphs which have a remaining basis (after adjustment under such subparagraphs) greater than their fair market value, as follows: the cost or other basis of each such unit of property shall be decreased (but not below its fair market value) in an amount equal to such proportion of such excess as the remaining basis of each such unit bears to the sum of the remaining bases of such units. The process shall be repeated until the cost or other basis of each unit of the property covered by subparagraphs (1), (2), and (3) of this paragraph is reduced to its fair market value or the amount by which the indebtedness shall have been canceled or reduced is exhausted, taking into account in the successive steps only those units of property having, after the preceding adjustment, a remaining basis greater than their fair market value; and
(5) Any excess of the total amount by which the indebtedness shall have been so canceled or reduced over the sum of the adjustments made under subparagraphs (1), (2), (3), and (4) of this paragraph shall next be applied to reduce the cost or other basis of inventory and notes and accounts receivable as follows: the cost or other basis of inventory or notes or accounts receivable, as the case may be, shall be decreased (but not below its fair market value) in an amount equal to such proportion of such excess as the adjusted basis of inventory, notes receivable or accounts receivable, as the case may be, bears to the sum of the adjusted bases of such inventory and notes and accounts receivable. The process shall be repeated until the adjusted bases of inventory, notes receivable, and accounts receivable are reduced to their fair market value or the amount by which the indebtedness shall have been canceled or reduced is exhausted, taking into account in the successive steps only those units of property having, after the preceding adjustment, a remaining basis greater than their fair market value.
(b) For the purposes of this section:
(1) Basis shall be determined as of the dates of entry of the order confirming the plan, composition, or arrangement under which such indebtedness shall have been canceled or reduced;
(2) Except where the context otherwise requires, property means all of the debtor's property, other than money;
(3) No adjustment shall be made by virtue of the cancellation or reduction of any accrued interest unpaid which shall not have resulted in a tax benefit in any income tax return;
(4) The phrase "indebtedness incurred to purchase" includes (i) indebtedness for money borrowed and applied in the purchase of property and (ii) an existing indebtedness secured by a lien against the property which the debtor, as purchaser of such property, has assumed to pay; and
(5) The term "fair market value" has reference to such value as of the date of entry of the order confirming the plan, composition, or arrangement under which such indebtedness shall have been canceled or reduced.
(c) Any determination of value in a proceeding under the Bankruptcy Act (
(d) The basis of any of the debtor's property which shall have been transferred to a person required to use the debtor's basis in whole or in part shall be determined in accordance with the provisions of this section.↩
24.
(1) Effect on Earnings and Profits of Gain or Loss and of Receipt of Tax-Free Distributions. -- The gain or loss realized from the sale or other disposition (after February 28, 1913) of property by a corporation -- (1) for the purpose of the computation of earnings and profits of the corporation, shall be determined, except as provided in paragraph (2), by using as the adjusted basis the adjusted basis (under the law applicable to the year in which the sale or other disposition was made) for determining gain, except that no regard shall be had to the value of the property as of March 1, 1913; but (2) for the purpose of the computation of earnings and profits of the corporation for any period beginning after February 28, 1913, shall be determined by using as the adjusted basis the adjusted basis (under the law applicable to the year in which the sale or other disposition was made) for determining gain. (1) No such increase shall be made in respect of the part of such distribution which (under such law) is directly applied in reduction of the basis of the stock in respect of which the distribution was made. (2) No such increase shall be made if (under such law) the distribution causes the basis of the stock in respect of which the distribution was made to be allocated between such stock and the property received.
25. SEC. 61. GROSS INCOME DEFINED.
(a) General Definition. -- Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
* * * * (12) Income from discharge of indebtedness;↩
26. The legislative history of the pertinent sections of the Bankruptcy Act indicates that the intention of Congress was to provide exemption from taxation of the income received in such a situation, conditioned on an equivalent basis reduction which would result in the realization of income from a later sale or exchange of such assets if they were sold or exchanged at a price in excess of their reduced basis. See S. Rept. No. 1916, 75th Cong., 3d Sess., p. 39.↩
27.
(a)
28. This is not the case with regard to the $ 7,219.17, which we found to be an improperly taken expense. Since it is neither an expense nor a reduction of the basis of assets, we have subtracted this amount from the expenses for the year ended June 30, 1956. This subtraction has the effect of increasing both income for the year ended June 30, 1956, and existing earnings and profits as of that date.↩
29. Whether the $ 74,886.84 is employed as a basis reduction and offsets the amount of discharged debts otherwise includable in earnings and profits ($ 189,785.42 - $ 74,886.84), or whether it is regarded as an expense for the fiscal year ended June 30, 1956, thereby increasing the deficit in earnings and profits as of June 30, 1956, with no offset effected upon the total amount of discharged debts includable in earnings and profits (-$ 74,886.84 +$ 189,785.42), the effect upon the computation of the earnings and profits is exactly the same.
30. This figure includes subtractions for charitable contributions of $ 1,090.88 and $ 780 made in the years ended June 30, 1955, and June 30, 1956, and disallowed because of the 5-percent-limitation rule of sec. 170(b)(2).↩
31. Cf.
1. After reduction of $ 9.72 for dividend distribution to Leon. See our discussion,
2. Excess charitable contributions not deducted in computing taxable income because of the 5-percent ceiling should reduce earnings and profits. See
32. The five notes of Leon's, photostatic copies of which were admitted in evidence, all bear the notation on the reverse side: "Interest to and including Sept. 30, 1947/ Received/ Leon R. Meyer/ Pay to order of/ Meyer Jewelry Co./ Leon R. Meyer/ Canceled 9/30/47/ Meyer Jewelry Co./ By
33. SEC. 312. EFFECT ON EARNINGS AND PROFITS.
(a) General Rule. -- Except as otherwise provided in this section, on the distribution of property by a corporation with respect to its stock, the earnings and profits of the corporation (to the extent thereof) shall be decreased by the sum of --
* * * * (3) the adjusted basis of the other property, so distributed.↩
34. SEC. 362. BASIS TO CORPORATIONS.
(a) Property Acquired by Issuance of Stock or as Paid-in Surplus. -- If property was acquired on or after June 22, 1954, by a corporation --
* * * * (2) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain recognized to the transferor on such transfer.↩
35. See sec. 305(a) and 307(a), 1954 Code. When the stock dividend is not includable in gross income, an allocation of basis takes place.↩