Opinion
Docket Nos. 54231-54234.
1956-11-29
FLOYD C. EWING AND LEAH E. EWING, ET AL.,* PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Ian Bruce Hart, Esq., for the petitioners. Robert E. Johnson, Esq., for the respondent.
Ian Bruce Hart, Esq., for the petitioners. Robert E. Johnson, Esq., for the respondent.
INCOME TAX— DEDUCTIONS.— Held, that amounts paid by the petitioners, as transferees, in satisfaction of the transferor corporation's tax liability are deductible as capital losses, and not as ordinary losses. Arrowsmith v. Commissioner, 344 U.S. 60. Held, further, that amounts paid by them, as transferees, in satisfaction of the liability of the corporation for interest on its tax liability accrued prior to the date of transfer of assets of the corporation to them are not deductible by them as interest, but are deductible as capital losses.
The respondent determined deficiencies in the petitioners' income taxes for the taxable year ended December 31, 1951, as follows:
+-----------------------------------------+ ¦Floyd C. and Leah E. Ewing ¦$8,905.41¦ +-------------------------------+---------¦ ¦Richard K. Ewing ¦10,007.23¦ +-------------------------------+---------¦ ¦C.C. and Mary F. Ewing ¦15,596.72¦ +-------------------------------+---------¦ ¦Stanley C. and Dolores J. Ewing¦11,840.32¦ +-----------------------------------------+
The question presented for decision is whether amounts paid by the petitioners, as transferees, to satisfy tax liabilities of their dissolved corporation are deductible as capital losses or as ordinary losses.
FINDINGS OF FACT.
Some of the facts are stipulated and are incorporated herein by this reference.
The petitioners Floyd C. Ewing and Leah E. Ewing, the petitioners C. C. Ewing and Mary F. Ewing, and the petitioners Stanley C. Ewing and Dolores J. Ewing are individuals and are husband and wife, respectively. Each couple filed a joint income tax return for the taxable year ended December 31, 1951, with the collector of internal revenue for the eighteenth district of Ohio. The petitioner Richard K. Ewing is an individual and filed an income tax return for the same taxable year with the collector of internal revenue for the eighteenth district of Ohio. The wives are petitioners herein only by reason of having joined in the returns of their respective husbands. Accordingly, when the term ‘the petitioners' is used herein it refers to the male petitioners.
Ewing Chevrolet, Inc., hereinafter called the corporation, was incorporated under the laws of the State of Ohio on September 1, 1947, and during its corporate existence had its principal office and place of business in the city of Canton, Ohio. During the entire life of the corporation the following were its directors and officers: C. C. Ewing, president; F. C. Ewing, vice president; S. C. Ewing, treasurer; and R. K. Ewing, secretary.
During its life the corporation paid its four officers salaries as follows:
+-----------------------------------------------------------------------------+ ¦ ¦Period Sept. 1, 1947, to ¦Fiscal year ending ¦Period ending Aug.¦ ¦ ¦June 30, 1948 ¦June 30, 1949 ¦31, 1949 ¦ +----------+-------------------------+---------------------+------------------¦ ¦C.C. Ewing¦$50,000 ¦$60,000 ¦$10,000 ¦ +----------+-------------------------+---------------------+------------------¦ ¦F.C. Ewing¦50,000 ¦60,000 ¦10,000 ¦ +----------+-------------------------+---------------------+------------------¦ ¦Stanley C.¦27,500 ¦33,000 ¦5,500 ¦ ¦Ewing ¦ ¦ ¦ ¦ +----------+-------------------------+---------------------+------------------¦ ¦Richard K.¦22,500 ¦27,000 ¦4,500 ¦ ¦Ewing ¦ ¦ ¦ ¦ +----------+-------------------------+---------------------+------------------¦ ¦Total ¦$150,000 ¦$180,000 ¦$30,000 ¦ +-----------------------------------------------------------------------------+
Each of the petitioners, being on a cash receipts and disbursements basis, reported in his income tax return for the year of receipt, the salary received by him from the corporation and paid tax thereon. At the time of the receipt of salary none of the petitioners was aware of any reason why such salary was not his to do with as he saw fit. The salaries were received without restriction as to disposition and the petitioners used the same as their own.
On September 1, 1949, pursuant to a resolution unanimously adopted by its four stockholders, the corporation was liquidated and dissolved, the certificate of dissolution being filed with the secretary of state of Ohio on September 27, 1949. The proceedings to dissolve the corporation followed the general corporation laws then in effect in Ohio.
At the time of the dissolution of the corporation, its outstanding stock was held as follows: C. C. Ewing, 90 shares; F. C. Ewing, 75 shares; S. C. Ewing, 75 shares; and R. K. Ewing, 60 shares.
In their returns for the taxable year 1949 the petitioners reported distributions in liquidation in exchange for their stock, and capital gain thereon as follows:
+---------------------------------------------------------+ ¦ ¦ ¦ ¦Short-term ¦Long-term ¦ +----------+------+-------------+------------+------------¦ ¦ ¦Shares¦Distributions¦capital gain¦capital gain¦ +----------+------+-------------+------------+------------¦ ¦ ¦( 15 ¦$18,842.55 ¦$92.55 ¦ ¦ +----------+------+-------------+------------+------------¦ ¦C.C. Ewing¦( 75 ¦94,212.75 ¦ ¦$61,212.75 ¦ +----------+------+-------------+------------+------------¦ ¦ ¦( 39 ¦48,990.63 ¦240.63 ¦ ¦ +----------+------+-------------+------------+------------¦ ¦F.C. Ewing¦( 36 ¦45,222.12 ¦ ¦29,382.12 ¦ +----------+------+-------------+------------+------------¦ ¦S.C. Ewing¦75 ¦94,212.75 ¦ ¦51,194.25 ¦ +----------+------+-------------+------------+------------¦ ¦ ¦( 10 ¦12,561.70 ¦803.75 ¦ ¦ +----------+------+-------------+------------+------------¦ ¦R.K. Ewing¦( 50 ¦62,808.50 ¦ ¦40,808.50 ¦ +----------+------+-------------+------------+------------¦ ¦Total ¦ ¦$376,851.00 ¦ ¦ ¦ +---------------------------------------------------------+
At the time of the dissolution distribution none of the petitioners, as stockholder, director, or officer of the corporation, had any knowledge of any unpaid debts of the company, or of any audit being made or contemplated by the Internal Revenue Service involving the corporation.
A ‘30-day letter’ dated December 18, 1950, was issued to the corporation proposing deficiencies as follows:
+--------------------------------------------------------+ ¦ ¦Deficiency ¦Sec. 102 ¦ +--------------------------------+------------+----------¦ ¦ ¦income tax ¦surtax ¦ +--------------------------------+------------+----------¦ ¦Period ending June 30, 1948 ¦$36,179.85 ¦$48,537.84¦ +--------------------------------+------------+----------¦ ¦Fiscal year ending June 30, 1949¦41,554.90 ¦63,372.20 ¦ +--------------------------------+------------+----------¦ ¦Period ending Aug. 31, 1949 ¦9,455.97 ¦ ¦ +--------------------------------------------------------+
The above-proposed deficiencies in income tax were based on the following adjustments:
+-------------------------------------------------------+ ¦Period Ended June 30, 1948 ¦ +-------------------------------------------------------¦ ¦ ¦ ¦ +---------------------------------------------+---------¦ ¦Unallowable deductions and additional income:¦ ¦ +---------------------------------------------+---------¦ ¦Service contract deposits ¦$4,210.15¦ +---------------------------------------------+---------¦ ¦Repairs to building ¦3,500.00 ¦ +---------------------------------------------+---------¦ ¦Excessive salaries ¦87,500.00¦ +---------------------------------------------+---------¦ ¦ ¦ ¦ +-------------------------------------------------------+
Year Ended June 30, 1949 Unallowable deductions and additional income: Service contract deposits $4,705.00 Excessive salaries 105,000.00
Period Ended Aug. 31, 1949 Unallowable deductions and additional income: Service contract deposits 787.50 Excessive salaries 17,500.00
On the same date 30-day letters were also addressed to the petitioners C. C. Ewing, F. C. Ewing, S. C. Ewing, and R. K. Ewing proposing assessments against them in the respective amounts of $113,055.30, $94,212.75, $94,212.75, and $75,370.20, plus interest as provided by law, representing their liability, as transferees of property of the corporation, for its income and section 102 surtax for the above three taxable periods.
Protests to the proposed assessments were duly filed by the dissolved corporation as well as by each of the petitioners as transferees of the assets of the dissolved corporation. Thereafter, as the result of conferences, the respondent eliminated the section 102 surtax and also increased his allowances on account of salaries paid. Of the total amounts claimed as salary, however, he disallowed $68,750, $82,500, and $13,750 in the three periods, respectively. The other adjustments above referred to were not altered. The deficiencies finally computed by the respondent, and paid by the petitioners, were $29,054.84, $33,004.90, and $7,673.96 for the three taxable periods, respectively, or a total of $69,733.71. The revised corporate deficiencies thus were based almost entirely on the disallowance as a deduction of compensation paid to the four petitioners who were the corporate officers.
On June 18, 1951, the attorney who represented both the dissolved corporation and the petitioners mailed a letter to the office of internal revenue agent in charge, Cleveland Division, which stated in part as follows.
Conforming to the agreement which we reached with you on June 12 1951 as a result of our conferences in Cleveland we herewith return the original Form 870 of Ewing Chevrolet, Inc., a dissolved corporation, executed by the former president and secretary of the dissolved company.
Inasmuch as the dissolved corporation distributed all of its remaining assets on September 1, 1949, to C. C. Ewing, F. C. Ewing, R. K. Ewing and S. C. Ewing, the four named individuals, as transferees, will be obliged to pay the assessment made against the corporation out of their individual resources. * * *
On June 28, 1951, the petitioners C. C. Ewing, F. C. Ewing, S. C. Ewing, and R. K. Ewing, by checks in the respective amounts of $23,661.40, $19,717.83, $19,717.83, and $15,774.27, made payments to the collector of internal revenue ‘as transferee for deficiencies in taxes of Ewing Chevrolet, Inc., a dissolved corporation under adjusted assessment made against said corporation, ‘ and the collector gave receipts therefor.
The petitioners C. C. Ewing, F. C. Ewing, S. C. Ewing, and R. K. Ewing in their income tax returns for 1951 claimed deductions, as ‘Loss on Transaction Entered into for Profit,‘ in the respective amounts of $20,920.12, $17,433.43, and $13,946.73. In such returns they also claimed deductions for interest paid to the collector in the respective amounts of $2,741.28, $2,284.40, $2,284.40, and $1,827.54. Attached to the 1951 return of each petitioner was a statement that the amounts of tax and interest paid were assessed as ‘Transferee of the Assets of said dissolved Corporation’ and that the payments were deductible in full under section 23(e)(2) of the Internal Revenue Code. The amount of the corporate deficiency paid by each petitioner was less than the amount of his salary disallowed by the respondent in computing the corporate deficiency.
In determining the deficiencies involved herein, the respondent treated the payments made by the petitioners in 1951, as transferees, on the tax liability of the corporation, as long-term capital losses. He also treated as long-term capital losses the following portions of the amounts claimed by them as interest paid, since such amounts represented their liability, as transferees, for the interest accrued against the corporation on its tax liability:
+-------------------+ ¦C.C. Ewing ¦$501.20¦ +-----------+-------¦ ¦F.C. Ewing ¦417.66 ¦ +-----------+-------¦ ¦S.C. Ewing ¦417.66 ¦ +-----------+-------¦ ¦R.K. Ewing ¦334.13 ¦ +-------------------+
Thus, the respondent, in effect, held that the liability of the petitioners, as transferees, for the tax liability and interest liability of the corporation arose by virtue of the receipt by them of the assets of the corporation upon dissolution, rather than upon the payment to them of any of the salaries which he held to be excessive.
OPINION.
ATKINS, Judge:
The petitioners contend that because the liabilities of the dissolved corporation which they paid as transferees resulted almost entirely from the disallowance by the respondent as deductions of portions of salaries paid them and determined by the respondent to be excessive, because they received the salaries and paid taxes thereon as ordinary income, and because the amounts paid by them, as transferees, were less than the portions of the salaries disallowed, they are entitled to deduct the transferee liabilities paid by them as ordinary, rather than capital, losses. It is their contention that the payment of that portion of the salaries which the respondent determined to be excessive should be considered as having rendered them liable as transferees and that in effect they remitted part of their salaries when they paid the corporation's liability.
The facts, however, do not sustain the contention that it was the payment of the salaries which gave rise to the transferee liability of the petitioners. It is well settled that to hold a party liable as transferee in equity for a transferor's delinquent taxes it must be proved that the transferee received assets of the transferor and that the transferor was insolvent at the time of, or was rendered insolvent by, the transfer of the assets. J. Warren Leach, 21 T.C. 70, and James M. Denton, 21 T.C. 295. Here there has been no showing by the petitioners that the corporation was insolvent at the time the salaries were paid or that the payment of the salaries rendered the corporation insolvent. Indeed, the evidence shows that at the time of the receipt of salary none of the petitioners was aware of any reason why the salary was not his to use as he saw fit, and that even at the time of dissolution none of them as stockholder, director, or officer had any knowledge of any unpaid debts of the corporation. On brief the petitioners do not claim that the payment of salaries, when made, rendered the corporation insolvent, but rather claim that in view of the payment of salaries the corporation was rendered insolvent upon the distribution in liquidation. On brief they state that ‘During the two year period over which salaries were paid the corporation was in a gradual process of distribution and upon final dissolution, having divided such assets as remained, the taxpayer (corporation) was thereby rendered insolvent.’ This, however, is not tantamount to a contention that the salary payments constituted a series of distributions in pursuance of a complete liquidation which left the corporation insolvent. There is no evidence whatsoever to show that there was, during the years the salaries were paid, a plan of complete liquidation contemplating a series of distributions.
The respondent in determining the deficiencies herein in effect held that it was the distribution of assets upon liquidation which gave rise to the transferee liability. We think the evidence adequately supports this view. In any event the petitioners have not shown the contrary. This also was apparently the view of the attorney for the corporation and the individuals when on June 18, 1951, he addressed a letter to the internal revenue agent in charge stating that ‘Inasmuch as the dissolved corporation distributed all of its remaining assets on September 1, 1949, to’ the petitioners, they, ‘as transferees, will be obliged to pay the assessment made against the corporation out of their individual resources.’
On brief the petitioners also contend that the payment of salaries could result in transferee liabilities even though such payment did not render the corporation insolvent if there was a legal obligation to repay the salaries. They point out that there is a fiduciary relation of the corporate officers to the corporation which precludes them from wrongfully diverting the assets from the corporate purposes. However, there is no evidence here to show that there was any legal obligation on the part of these petitioners to return the salaries paid them to the corporation. The fact that the respondent determined that some portion of the salaries was in excess of the reasonable allowance for compensation contemplated by section 23(a)(1)(A) of the Internal Revenue Code of 1939, does not establish that the recipients were under a legal obligation to repay such excessive salaries to the corporation.
In Arrowsmith v. Commissioner, 344 U.S. 6, distributions in liquidation of a corporation were made to its two stockholders, the taxpayers, in 1937, 1938, 1939, and 1940. They reported their profits on these distributions as capital gains. In 1944 a judgment was rendered against the dissolved corporation. The stockholders paid the judgment for the corporation of whose assets they were transferees, and deducted the amounts so paid in their income tax returns as ordinary business losses. The Supreme Court noted that the taxpayers were required to pay the judgment because of liability imposed on them as transferees of the assets of the corporation distributed to them in liquidation and held that since the distributions to them had been treated as amounts received in exchange of their stock, resulting in capital gain, the payments which the taxpayers were required to make in a later year as transferees of the assets must be treated as capital losses, rather than ordinary losses.
Following the Arrowsmith case, we have held that whenever stockholders, who are liable as transferees by virtue of the receipt of assets of a corporation upon a taxable liquidation, thereafter pay taxes owed by the liquidated corporation, the payments constitute capital losses subject to the limitations contained in section 117(d) of the Internal Revenue Code of 1939,
rather than as ordinary losses. Arnold F. Heiderich, 19 T.C. 382; Elise Avery Johnson, 19 T.C. 465.
(d) LIMITATION ON CAPITAL LOSSES.—(2) OTHER TAXPAYERS.— In the case of a taxpayer, other than a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges, plus the net income of the taxpayer or $1,000, whichever is smaller. * * *
We see no distinction between the instant case and the Arrowsmith case, and accordingly hold that the amounts paid by the petitioners, as transferees, on account of the tax liability of the corporation, are deductible as capital losses, rather than ordinary losses. The case of Healy v. Commissioner, 345 U.S. 278, cited by the petitioners, is not in point. There the payment of excessive salary at a time when the corporation was insolvent was the transfer upon which transferee liability was predicated and paid, and the only question before the Court was whether part of the salary should be excluded from taxable income in the year of receipt, as contended by the taxpayer, or be allowed as an adjustment in the year of payment of the transferee liability. The Court held that the amount was allowable as an adjustment in the latter year. The question of whether the loss was ordinary or capital in nature was not involved.
The petitioners claimed as a deduction the interest on the corporate tax liability, whether accrued before or after the dissolution distributions. The respondent disallowed that portion of the interest which accrued on the corporate liability prior to the dissolution distributions, but held that such amount was deductible as a capital loss. Such portion of the interest disallowed was not interest on indebtedness of the petitioners and is therefore not deductible by them as interest under section 23(b) of the Internal Revenue Code of 1939.
Koppers Co., 3 T.C. 62, affd. (C.A. 3) 151 F.2d 267. Rather it, like the tax liability of the corporation, was a part of their liability as transferees, and we hold that the respondent did not err in according it the same treatment. See Arnold F. Heiderich, supra.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(b) INTEREST.— All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this chapter.
Decisions will be entered for the respondent.