Opinion
Docket No. 2634.
1945-03-2
D. BRUCE FORRESTER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
John H. McEvers, Esq., and John W. Reed, Esq., for the petitioner. Gene W. Reardon, Esq., for the respondent.
1. Petitioner received certain stock, the consideration in part being his agreement to pay $500 per month to his father for life, thereafter to his mother for life. Held, the cost basis of the stock was in part the actual amount spent in such payments, and not the cost of an annuity which would have produced the same payments; held, further, that the remainder of the cost basis was represented by face value of an obligation, on open account, assumed by petitioner.
2. On liquidation of a corporation, petitioner as a stockholder, owning one-half of the stock, received from the corporation one-half of the cash on hand, also $1,275 made available by deductions of a like amount from cash distributions to the two other stockholders for debts they owed the corporation. Held, that the $1,275 was received in the liquidation; held, further, that $11,915.97 received for assigning to others petitioner's half interest in an account distributed in kind, was not received in liquidation.
3. Petitioner owed a corporation $84,152.92, due without interest on June 1, 1957. In 1938 his wife, with her own assets and a loan procured by her from a bank, without petitioner's financial assistance, purchased petitioner's account from the corporation at its discount value, $28,759.34. Held, petitioner realized no profit on the transaction.
4. Petitioner and other stockholders of a corporation paid to a trustee amounts necessary to discharge obligations and expenses of the corporation in connection with liquidation. The money was expended by the trustee for that purpose in other years. Held, petitioner, on the cash basis, may not deduct the amount paid by him to the trustee in computing gain from the liquidation.
5. Held, that Forrester Box Co., 25 B.T.A. 128, is res adjudicata on the question of amount of accumulated earnings and profits of the corporation at time of liquidation. John H. McEvers, Esq., and John W. Reed, Esq., for the petitioner. Gene W. Reardon, Esq., for the respondent.
This proceeding involves a deficiency of $35,445.15 in income tax for 1938. The issues are whether the Commissioner erred:
1. In determining that petitioner's basis for 150 shares of stock of the Forrester Box Co., acquired in an exchange in 1922, was $49,554.02, the cost of stock of the Forrester-Nace Box Co. given up in the exchange.
2. In failing to determine that 150 other shares of stock of the Forrester Box Co., acquired in October 1926, had a cost basis of $48,235.85.
3. In determining that the basis for petitioner's 300 shares of stock of the Forrester Box Co. should be reduced by $11,219.50 for a distribution made by the corporation in 1929.
4. In holding that at the time of its liquidation in December 1938 the Forrester Box Co. had accumulated earnings and profits of $81,197.86.
5. In determining that petitioner received cash of $28,231.56 in the liquidation of the Forrester Co.
6. In determining that gain of $55,393.58 was realized by petitioner from the sale by the Forrester Box Co. to petitioner's wife of an obligation of $84,152.92 owed by petitioner to the corporation.
7. In not allowing as a deduction from fair market value of the property received by petitioner in December 1938 in liquidation of the Forrester Box Co. The amount of $2,738.58 for Federal taxes and other expenses of the corporation which were subsequently paid by petitioner.
Substantially all of the facts are embodied in a stipulation of facts, which is incorporated herein by reference as part of our findings of fact.
FINDINGS OF FACT.
Petitioner kept his books and filed his returns on the cash basis. His return for the taxable year was filed with the collector for the sixth district of Missouri.
The Forrester-Nace Box Co., hereinafter referred to as the Nace Co., from the time of its incorporation in 1901 under the laws of Missouri, until 1935, was engaged in the business of manufacturing and selling wooden boxes, with its principal business in Kansas City, Missouri.
The General Box Corporation was organized March 15, 1922, under the laws of Delaware, pursuant to a plan of December 15, 1921, for the consolidation of various corporations and businesses, including the Nace Co. as of March 1, 1922. In April 1922 the General Box Co. was organized under the laws of Delaware for the purpose of carrying out the plan of consolidation. Its stock was issued to the General Box Corporation.
Petitioner and his father each owned 250 shares of the stock of the Nace Co. and the remaining 500 outstanding shares were held by Bruce E. Nace. These stockholders desired to have a corporation in existence to transact a box manufacturing business in the event the merger was unsuccessful and to take title to a portion of the assets and assume some of the liabilities of the Nace Co. On December 5, 1922, pursuant to a resolution adopted by the stockholders and directors of the Nace Co., the Forrester Box Co., hereinafter referred to as the Forrester Co., was organized under the laws of Missouri with an authorized capital stock consisting of 600 shares of common to acquire a portion of the assets of the Nace Co. as of March 1, 1922. On December 7 and 8, 1922, the Nace Co. transferred a portion of its assets to the Forrester Co., including an account receivable known as ‘B.E. Nace and D. Bruce Forrester-Empire Development Company account,‘ of a fair market value of $7,164.49, life insurance, buildings, land, and machinery and equipment of a fair market value of $380,780.63, and the Forrester Co. assumed liabilities of the Nace Co. in the amount of $13,939.71.
On February 28, 1922, the Nace Co. had earnings and profits accumulated after February 28, 1913, of $199,044.43.
On December 7, 1922, the Forrester Co. issued one-half of its 600 shares of stock to Bruce E. Nace, and 150 shares each to petitioner and his father. On December 8, 1922, these individuals surrendered to the Nace Co. for cancellation and redemption a like number of shares of stock of that company, pursuant to action taken by the stockholders of the corporation for a reduction of capital stock. The cost basis of the stock surrendered by petitioner was $49,554.02. On December 8, 1922, in accordance with the plan of consolidation, Bruce E. Nace and petitioner and his father assigned to the General Box Co. as of February 28, 1922, all of their remaining holdings of stock of the Nace Co., consisting of 400 shares, this being all of the outstanding stock of the Nace Co. The Nace Co. and its stockholders did not report any gain or claim any loss arising out of the exchanges and transactions completed in 1922.
In 1923 the Forrester Co. sold for $7,164.49 the account receivable acquired from the Nace Co. and in its return in that year claimed a loss deduction of $102,449.47 on account of the sale, which deduction was disallowed by the Commissioner. Upon appeal, the Board held the transaction in which the Forrester Co. took over part of the assets and liabilities of the Nace Co. was not a reorganization and that the former purchased the assets for shares of its stock. Forrester Box Co., 25 B.T.A. 128. No appeal was taken from the Board's decision. At the time the case was heard, petitioner owned 50 percent of the stock of the Forrester Co. and was its vice president, treasurer, and general manager, and had charge of the litigation for the corporation. Petitioner employed counsel for the Forrester Co., assisted counsel in obtaining the necessary documentary evidence for preparation of the case for hearing, and testified at the hearing.
On October 22, 1926, petitioner acquired from his father 150 shares of stock of the Forrester Co. and 1,563 shares of stock of the General Box Co. in exchange for an assumption by him of a liability of his father to the Forrester Co. in the amount of $36,100.85 for withdrawals and an agreement of petitioner to pay his father $500 a month for life, and upon his death a like amount to petitioner's mother, if living, for the remainder of her life. The cost of such an annuity from a standard life insurance company would have been $39,646.50. Of the consideration paid by petitioner for the stock, $22,365 was the cost of the General Box Co. stock. The discount value of the indebtedness of $36,100.85 considered as due June 1, 1957, and using 6 percent as a discount factor, was on October 22, 1926, $6,545.31; on December 23, 1935, $11,007.82; and on December 6, 1938, $12,337.49.
The land, buildings, machinery, and equipment transferred by the Nace Co. to the Forrester Co. on December 7 and 8, 1922, was immediately leased by the latter to the former pursuant to the plan of consolidation, for a term of ten years commencing as of March 1, 1922, and the lessee continued in possession of the property until July 1, 1929, on which date the lessor sold the machinery and equipment to the General Box Co. The leases were canceled. The activities of the lessor consisted primarily of the collection of rent under the lease. In its return for 1929 the Forrester Co. reported gain of $31,285.91 from the sale of machinery and equipment, this being the amount received in 1929 on the sale price. No deduction was claimed for depreciation on machinery and equipment. On December 21, 1929, the Forrester Co., on the assumption that the alleged gain of $31,285.91 constituted an addition to surplus, declared and paid a dividend of $38,000, one-half of which was received by petitioner in 1929 and reported in his tax return for that year. In March 1932 petitioner filed a claim for refund, alleging that $19,000 was a return of capital. The Commissioner reduced the profit reported by the Forrester Co. on the sale to $14,979.69; allowed depreciation on the property in the amount of $3,322.79; and determined net income to petitioner of $17,110.92. Subsequently, the Commissioner determined that of the $19,000 dividend reported by petitioner, $11,219.50 constituted a distribution of capital and made a refund to petitioner on that basis.
During 1935, the Forrester Co. received $12,000 from the sale to the General Box Co., and, following Forrester Box Co., supra, reported no gain from the payments. The Commissioner held that the property was received in a nontaxable reorganization, and, as the adjusted cost basis was zero, that the amount received constituted capital gain, and that the Forrester Co. was not entitled to depreciation on the buildings. The resulting deficiency was made the subject of a proceeding before the Board of Tax Appeals, which held that Forrester Box Co., supra, was res adjudicata of the character of the transactions in 1922. Forrester Box Co., 43 B.T.A. 657. Upon appeal, the decision was affirmed in part and remanded to the Board for further findings with respect to depreciation allowable on the machinery and equipment. Forrester Box Co. v. Commissioner, 123 Fed.(2d) 225. On July 3, 1942, the Board entered its decision upon remand, determining a deficiency on the basis of certain allowable depreciation, and a resulting profit of $47,147.66 on the sale; otherwise the decision was in accordance with the opinion of the Board as announced in 43 B.T.A. 657. The decision of the Board upon remand was not appealed. At the time the appeal was taken from the determination of the deficiency, petitioner was vice president, treasurer, and general manager of the Forrester Co. and owned 50 percent of its stock.
On December 23, 1935, Bruce E. Nace and petitioner each owned 50 percent of the outstanding stock of the Forrester Co., and owed the corporation on open accounts $69,734.82 and $84,152.92, respectively. The amount owed by petitioner consisted of $48,052.07 of advances or loans and the indebtedness of $36,100.85 assumed by petitioner on October 22, 1926. The Forrester Co. did not charge or collect interest on the open accounts. By the terms of an agreement executed on December 23, 1935, the maturity date of the debts was extended to June 1, 1957, and the 300 shares of stock each debtor of the Forrester Co. owned was pledged as security for payment of his indebtedness.
At the time of his death on March 10, 1938, Bruce E. Nace still owed the Forrester Co. the entire amount of $69,734.82. Since the debt was not payable until June 1, 1957, and did not bear interest, the probate court allowed the claim of the Forrester Co. for payment of the debt in full for only $23,831.94, its discount value.
During the early part of December 1938 petitioner informed his wife that his indebtedness of $84,152.92 to the Forrester Co. could be purchased for $28,759.34, its discount value on December 8, and suggested to officers of the corporation that the account be sold to her. Petitioner did not arrange to purchase the debt directly from the Forrester Co. because of his belief that it would complicate his Federal income tax problems. After Mrs. Forrester discussed the matter with Arthur Mag, an attorney who handled tax and other legal matters for petitioner and the Forrester Co., petitioner, a brother, and a close friend, she concluded to purchase the account. Petitioner informed his wife that if she purchased the account he would make sufficient payments on the account within 30 days to enable her to pay off a loan to purchase the indebtedness. Mrs. Forrester had an account with the First National Bank of Kansas City, and a company of which she was a substantial stockholder also had an account at the bank. Arthur Mag communicated with an officer of the bank and arranged for a loan to Mrs. Forrester to make the purchase. On December 6, 1938, she executed and delivered to the bank a financial statement, in which were listed assets consisting of cash of $1,000 and stock of a value of $45,000, and obtained a loan from the bank for $28,500 on her note payable 30 days thereafter with interest at the rate of 5 percent per annum. Petitioner assumed no liability to the bank for payment of the loan. On December 6, 1938, the board of directors of the Forrester Co., which consisted of petitioner, Howard F. Nace, and Helen Nace Satterlee, petitioner not participating, authorized the sale of the account to petitioner's wife for $28,759.34 cash, the discount value on December 8, 1938, of the account discounted at 6 percent. On December 8, 1938, petitioner's wife purchased the account from the Forrester Co. for $28,759.34, and received an assignment of the indebtedness from the corporation.
On December 8, 1938, the stockholders and directors of the Forrester Co. adopted a plan for the complete liquidation of the corporation. Immediately thereafter the corporation distributed all of its assets to its stockholders in complete liquidation. At the time of its liquidation the corporation had cash of $30,081.18. In exchange for his 300 shares of stock, petitioner received assets of a value of $107,902.56, including cash of $16,315.59 and some real estate and an assignment of a one-half interest in the corporation's claim against the estate of Bruce E. Nace, which had been allowed by the probate court in the amount of $23,831.94. Promptly thereafter petitioner assigned his interest; in the claim, by endorsement on the instrument executed by the corporation, to Howard F. Nace and Helen Nace Satterlee, owners of the remaining stock of the Forrester Co., and received therefor in 1938 the sum of $11,915.97. Each of the other two stockholders owed the corporation $1,275. The amount of cash distributed to them in the liquidation proceedings was reduced by the amount of their indebtedness and, accordingly, they received cash distributions of only $13,765.59.
The stockholders of the Forrester Co. were required to pay, and paid, a total of $5,475.52 to a trustee during the years 1938 to 1943, inclusive, with directions to pay unpaid obligations of the Forrester Co. and expenses in connection with the settlement thereof, and return any balance to the contributors pro rata. The contributions were paid out by the trustee during the years 1939 to 1943, inclusive. Petitioner contributed as a transferee and paid out $2,738.58 of the sum of $5,475.52. The amount was used to pay income taxes of the Forrester Co. and expenses incurred in connection therewith.
On December 8, 1938, petitioner gave A. Tickamyer, an employee in the office of Arthur Mag, his note for $84,152.92, payable June 1, 1957, without interest, and secured the note by a deed of trust upon one-half of the real estate distributed to him in liquidation of the Forrester Co. The payee endorsed the note to petitioner's wife without recourse. The transaction was handled in that manner by reason of the fact that it was necessary for petitioner's wife to execute the deed of trust. Since receiving the assignment, note, and deed of trust, the instruments have been in the safe deposit box of petitioner's wife, to which petitioner does not have access. The plan carried out for the sale of the account to Mrs. Forrester was suggested by Arthur Mag.
Petitioner has made the following payments on the note:
+--------------------------+ ¦December 13, 1938 ¦$25,000¦ +------------------+-------¦ ¦January 3, 1939 ¦4,000 ¦ +------------------+-------¦ ¦December 29, 1942 ¦5,000 ¦ +------------------+-------¦ ¦December 30, 1943 ¦4,500 ¦ +--------------------------+
On December 14, 1938, petitioner's wife paid $25,000 on the note she gave the bank, and the balance on January 4, 1939.
The gain realized by petitioner's wife as the result of payments made on the note in 1939, 1942, and 1943 was reported in Federal income tax returns filed by her for those years.
OPINION.
DISNEY, Judge:
Most of the issues herein relate to the gain realized or loss sustained by petitioner upon the liquidation in December 1938 of the Forrester Co. In his return for 1938, he reported a loss of $39,597.06, computed as follows, of which one-half was claimed as a deduction:
+---------------------------------------------------+ ¦Receipts ¦ ¦ ¦$107,902.56¦ +-------------------+--------+----------+-----------¦ ¦Cost of stock: ¦ ¦ ¦ ¦ +-------------------+--------+----------+-----------¦ ¦150 shares acquired¦12/7/22 ¦$94,530.90¦ ¦ +-------------------+--------+----------+-----------¦ ¦150 shares acquired¦10/22/26¦52,968.72 ¦ ¦ +-------------------+--------+----------+-----------¦ ¦ ¦ ¦ ¦147,499.62 ¦ +-------------------+--------+----------+-----------¦ ¦Loss ¦ ¦ ¦39,597.06 ¦ +---------------------------------------------------+
The parties agree that the liquidating dividends received by petitioner in cash and other assets had a value of $107,902.56, as reported by petitioner in his return. In his determination of the deficiency, the respondent held that the stock acquired in 1922 had a cost basis of $49,554.02, an amount equal to petitioner's cost of the Nace Co. stock exchanged therefor; that the shares acquired in 1926 had a basis of $25,515, an amount equal to the fair market value thereof; that the total cost should be reduced by $11,219.50 for a capital distribution in the December 1929 dividend; and that as the Forrester Co. had earnings and profits accumulated since February 28, 1913, of $81,197.86, and petitioner owned one-half of the stock of the corporation, of the resulting gain, an amount equal to 50 percent of the earnings, or $40,598.93, was taxable to petitioner as a dividend, petitioner having elected to receive the benefits of section 112(b)(7) of the Revenue Act of 1938. The adjustments made by the respondent in the cost basis of the stock are in issue.
Petitioner concedes upon brief that the 150 shares of stock acquired in 1922 had a cost basis of $49,554.02, as determined by the respondent.
Cost of 150 Shares Acquired October 22, 1926.
The parties are now in agreement that the basis for these shares is cost, but differ on how the cost should be determined. They have stipulated that the stock of the General Box Co. acquired in the same transaction had a cost basis of $22,365. In his petition, petitioner alleged that his cost was $48,235.85. Upon brief he contends that the stock had a cost of $53,382.35, computed as follows:
+----------------------------------------------------+ ¦Cost of annuity for his father and mother¦$39,646.50¦ +-----------------------------------------+----------¦ ¦Liability assumed for his father ¦36,100.85 ¦ +-----------------------------------------+----------¦ ¦ ¦75,747.35 ¦ +-----------------------------------------+----------¦ ¦Less cost of General Box Co. stock ¦22,365.00 ¦ +-----------------------------------------+----------¦ ¦ ¦53,382.35 ¦ +----------------------------------------------------+
The difference of $5,146.50 in the cost bases is due to a present contention that the cost of the annuity, which constituted part of the consideration paid, was $39,646.50, an amount which petitioner would have had to pay a standard life insurance company for a like annuity, rather than $34,500, the amount actually paid to the annuitants under the contract prior to their deaths.
Upon brief, respondent contends that petitioner's cost of the annuity contract was $34,500, or, if it was the greater amount of $39,646.50, as contended by petitioner, then that adjustments reducing it to the lower amount are necessary on account of actualities, and he concedes that the cost basis for the stock is $48,235.85 ($34,500 plus $36,100.85, minus $22,365), if we agree with his position that petitioner is taxable on gain realized from the acquisition of the account in 1938 for less than its face amount. Respondent contends, in the alternative, for a cost of $18,680.31 by using as cost of the liability assumed its discount value of $6,545.31 on October 22, 1926, and that if we consider the transactions in December 1935 and 1938 respecting the account as a reduction of the purchase price of the stock, the cost should be adjusted on the basis of the discount value of the account when the transactions occurred.
In Mastin v. Commissioner, 28 Fed.(2d) 748, affirming 7 B.T.A. 72, there was a transfer of stock in consideration of an agreement of the transferee to pay living expenses of the transferors for the remainder of their lives. It was held that no loss could be determined until the transaction was completed at the time of the deaths of the transferors and that the payments made by the transferee were capital expenditures for the stock. The facts in Citizens National Bank v. Commissioner, 122 Fed.(2d) 1011, are very similar to those here. There the bank in 1920 received title to a piece of improved real property for its agreement to pay the owner $200 a month for life. The bank sought to deduct the payments in 1936 as rent or a loss, or, in the alternative, a portion of the payments applicable to the grantor's interest in the building, which was demolished in 1923. One of the grounds advanced by the bank for an expense or a loss deduction of the entire payments was that its agreement constituted a contract to pay an annuity of a specified value and as the payments prior to 1936 exceeded such amount, the payments in 1936 constituted an expense or a loss to it and gain to the recipient. The Court said:
* * * In the instant case the theory is purely fictitious and bears no actual relation to the transaction between the parties. The relation in this instance is entirely contractual. The bank bargained to purchase and Frank Baird to sell the right to the possession of the premises during the life of Baird. Nothing in the contract relates to the market value nor to Baird's life expectancy. The parties were at liberty to pay and receive any price agreed upon whether more or less than market value. The amount agreed upon, although payable in installments contingent as to number during life, was a capital investment and is not deductible either as a business expense under Sec. 23(a) nor as a loss under Sec. 23(f) of the Act. * * *
Here, there is no indication that the parties bargained on the basis of what an annuity of $500 a month for the lives of petitioner's parents would cost from a standard life insurance company. The arrangement was simply an agreement to pay the amount without regard to cost. Cf. May Rogers, 31 B.T.A. 994; Anna L. Raymond, 40 B.T.A. 244. As the survivor of petitioner's father and mother died before the taxable year, we know petitioner's capital outlay and need not apply a theoretical method to ascertain his entire cost. Petitioner elected to obligate himself to pay the amount rather than purchase an annuity contract to relieve him of the liability and is bound by his choice of possible plans. See Helvering v. Butterworth, 290 U.S. 365.
The case of Helvering v. American Chicle Co., 291 U.S. 426, does not support petitioner's view. There the question was whether the purchase by the corporation of bonds, payment of which it had assumed in the purchase of all of the assets of a corporation, at less than their face amount resulted in taxable gain, or required an adjustment of the cost of the assets. The court, from the meager facts, held that the difference was taxable as gain. Here, there is no cost basis to adjust, as petitioner never paid out $39,646.50 for an annuity contract, or possible gain to tax on account of any assumption of liability. The question is simply petitioner's cost. He paid out $34,500 under his agreement and the final payment discharged his liability for all time. His actual outlay of $34,500 constitutes his cost.
The indebtedness of $36,100.85 assumed by the petitioner was an open account for withdrawals made by his father. The unconditional assumption by petitioner of the liability was part of his cost of the stock. F. Tinker & Sons Co., 1 B.T.A. 799; Farmers Cotton Oil Co., 27 B.T.A. 105; Cherokee Co., 41 B.T.A. 1212; Johnson Motor Co. v. United States, 6 Fed.Supp. 122. In 1935, nine years after petitioner assumed the debt, the maturity date of the obligation for withdrawals made by petitioner himself and of the debt of another stockholder was extended to June 1, 1957.
Neither the extension of the maturity date nor the sale of the account by the corporation (hereinafter discussed) altered petitioner's liability to pay at maturity the entire debt. Though, because of such extension of time, the $36,100.95 debt had, at the time of the liquidation in December 1938 a discount value of only $12,337.49,
such reduction in value came through an extension granted in 1935, so that any taxable gain or gift realized thereby
Respondent argues in the alternative for a base of $6,545.31, the discount value on October 22, 1926, of the $36,100.85; but at that date the debt was on open account. It was not until 1935 that the extension was granted, so no discount value may be set for October 22, 1926.
may not be included in our consideration of the taxable year 1938. There was no reduction in purchase price and no adjustment of base. The petitioner's vendor was dead, and the only transaction was with petitioner's creditor, not the vendor of the stock. We hold that the assumption of liability, in the amount of $36,100.85, constituted a part of petitioner's basis in the stock.
Commissioner v. Coastwise Transportation Corporation, 62 Fed. (2d) 332; Helvering v. American Dental Co., 318 U.S. 322.
Reduction of Basis for Stock by $11,219.50.
In December 1929 petitioner received a dividend of $19,000 from the Forrester Co. Subsequently, the respondent made a refund to petitioner upon the ground that $11,219.50 of the dividend was a return of capital, and in determining the deficiency for 1938 he reduced the basis of petitioner's stock by that amount. The parties agree that if the earnings and profits of the Forrester Co. available for distribution as a taxable dividend on December 8, 1938, should be computed without regard to the profits of the Nace Co. at the time of the transfer in 1922, the basis should be reduced by $11,219.50. Petitioner concedes that if the Forrester Co. had a deficit in its accumulated earnings and profits at the time it was liquidated, respondent's action was proper. Such a conclusion has been reached under the next issue.
It follows from the conclusions reached by us and the concessions of petitioner that the cost basis to petitioner of his 300 shares of stock of the Forrester Co. is $49,554.02 plus $34,500, and $36,100.85, less $22,365 and $11,219.50, or $86,570.37.
Earnings and Profits of Forrester Co.
In determining that at the time of its liquidation the Forrester Co. had accumulated earnings and profits of $81,197.86 since February 28, 1913, the respondent held that there should be included a pro rata portion of the earnings of the Nace Co. from March 1, 1913, to the time of the transfer in 1922 of a portion of its assets to the Forrester Co. The parties have stipulated that, if the transfer in 1922 was a taxable exchange, or, if the earnings and profits of the Forrester Co. available for distribution as a taxable dividend should be determined without reference to the accumulated earnings and profits of the Nace Co., the Forrester Co. had a deficit of $119,540.23 on December 8, 1938, in profits and earnings, and if the exchange was nontaxable and the Forrester Co. was required to take into account a pro rata portion of the profits of the Nace Co., there were earnings and profits of $39,206.99 on December 8, 1938. The question of whether the Forrester Co. had accumulated earnings and profits available for distribution as a taxable dividend is by agreement of the parties made to depend upon whether or not the 1922 transfer was a taxable exchange. Petitioner contends that Forrester Box Co., 25 B.T.A. 128, is res adjudicata of the question.
In that case, involving a loss on the disposition in 1923 of an account receivable acquired in the December 1922 transfer from the Nace Co., we held that the transaction by which the Forrester Co. acquired part of the assets, including the account receivable in controversy, and liabilities of the Nace Co., did not constitute a reorganization under section 202 of the Revenue Act of 1921, and that the petitioner purchased the assets from the Nace Co. for its stock. One of the issues in Forrester Box Co., 43 B.T.A. 657, was the basis for depreciation on buildings acquired in the 1922 transfer. We held that Forrester Box Co., 25 B.T.A. 128, was res adjudicata of the question of whether the 1922 transaction was a taxable exchange.
In the Forrester Box Co. cases, supra, the identical parties were involved. Here, a stockholder of the Forrester Box Co., not the corporation, is the petitioner. Notwithstanding such difference in parties, is the case of the corporation res adjudicata of the issue here? The question turns upon whether petitioner, owner of half of the stock of Forrester Co. at the time of the litigation, is in privity with the corporation. Tait v. Western Maryland Ry. Co., 289 U.S. 620.
In Jahnke Service Co., 20 B.T.A. 837 (847), we held that a holding of the Board determining the tax liability of a transferor corporation, in the absence of fraud or collusion in proceedings, was conclusive upon its transferee-stockholder. We said in part: ‘It is also well settled that a corporation represents its stockholders in all matters within the scope of its corporate powers transacted in good faith by its officers.‘ Like conclusions were reached in J. E. Duval, 21 B.T.A. 137, and Isaac M. Green, 26 B.T.A. 719. The rule does not differ where there is more than one stockholder. Nova M. Carney, 22 B.T.A. 721. In First National Bank of Chicago v. Commissioner, 112 Fed.(2d) 260, the rule was applied against a transferee-trustee for income tax liability of the estate of the deceased grantor.
Respondent, upon brief, infers that the established rule as to stockholder-transferees does not apply to the instant situation. The authorities are to the contrary. In Hawkins v. Glenn, 131 U.S. 319, the Court said:
* * * We understand the rule to be otherwise, and that the stockholder is bound by a decree of a court of equity against the corporation in enforcement of a corporate duty, although not a party as an individual, but only through representation by the company.
A stockholder is so far an integral part of the corporation that, in view of the law, he is privy to the proceedings touching the body of which he is a member. Sanger v. Upton, 91 U.S. 56.
Other statements of the same Court are to the same effect: Marin v. Augedahl, 247 U.S. 142, in which prior cases of the Court are cited, including Bigelow v. Old Dominion Coffee Co., 225 U.S. 113 (141), and in which the Court said:
But under the law of Kansas and the general law a stockholder is represented by the corporation to all actions against the corporation for corporate liabilities. The stockholder is by the very law of corporate existence an integral part of the corporation and is bound by a judgment against it in respect of any matter within the scope of corporate powers.
34 C.J. 1026, on the subject of res adjudicata, says:
A stockholder is so in privity with, and represented by, the corporation that he is bound by a judgment against the corporation in so far as it deals with corporate rights and liabilities and affects the stockholders as a body. * * *
Obviously, here the judgment affected the stockholders as a body.
The case of Pressed Steel Car Co., a memorandum opinion entered by this Court on August 16, 1944, cited by the respondent, contained no issue on the conclusiveness of a prior ruling and is not controlling.
We hold that the case of Forrester Box Co., 25 B.T.A. 128, is res adjudicata of the question of whether the 1922 transfer from the Nace Co. to the Forrester Co. was a taxable transaction. Accordingly, pursuant to the stipulation, on December 8, 1938, the Forrester Co. had a deficit of accumulated profits and earnings on December 8, 1938, in the amount of $119,540.23.
Cash Distribution Received in Liquidation.
This question was put in issue by stipulation of the parties, and is important to them because of the limitation imposed by section 112(b)(7)(E)(ii) of the Revenue Act of 1938 on the amount of recognizable gain in corporate liquidations within the month of December 1938.
Petitioner contends that he received $15,040.59, and respondent contends that he received $28,231.56, or $16,315.59, plus $11,915.97.
The parties stipulated that the corporation had $30,081.18 of cash on hand at the time of its liquidation. Of this amount, petitioner received a check for $16,315.59 and the other two stockholders received checks aggregating $13,765.59. The difference of $2,550 is due to payment of a debt of $1,275 owed by each of the minority stockholders in making the cash distributions. The adjustment made $1,275 available for distribution to petitioner in addition to his pro rata share of the $30,081.18, or $15,040.59. The distribution was made by the corporation as though the stockholders had paid their debts in cash. It is clear that petitioner received $16,315.59 in cash directly from the corporation.
The Forrester Co. assigned to its stockholders its claim against the estate of Bruce E. Nace, which the probate court had allowed in the amount of $23,831.94. By endorsement on the instrument of transfer, dated December 8, 1938, petitioner acknowledged receipt from the other stockholders of $11,915.97, and assigned his one-half interest in the claim in consideration of such payment. The payment was received from the assignees in 1938.
Respondent's argument is that petitioner, in substance, received the amount of $11,915.97 from the corporation. We disagree. The claim of $23,831.94 was a chose in action in the hands of the corporation, and, unlike the indebtedness of $2,550, could not be reduced to cash by the simple method of deducting it from the cash contributions made to the debtor-stockholders. Instead, the corporation made distribution in kind and left to the transferees the matter of reducing it to cash. Petitioner sold his rights in the claim to the other co-owners for cash. The cash he so received came to him by virtue of such disposition of his interest in the claim, without any act on the part of the corporation or the money passing through its treasury. In fact, its interest in the claim ceased upon delivery of the assignment to its stockholders, and it no longer had any rights in or control over the disposition of the claim. What petitioner received for his interest in the claim came to him from third parties, not from the Forrester Co. Accordingly, we hold that the petitioner received only $16,315.59 in cash in the liquidation of the Forrester Co.
Petitioner's Indebtedness to Forrester Co.
In 1926 petitioner assumed a debt of $36,100.85 of his father to the Forrester Co. for withdrawals. Subsequently, he received or borrowed $48,052.07from the corporation. In 1935 the corporation extended the maturity date of the debt of $84,152.92 to June 1, 1957, and received petitioner's 300 shares of its stock as security for the account. Like action was taken in respect to the debt of $69,734.82 owed by Bruce E. Nace, the other stockholder, in an open account for withdrawals. Nothing was paid on the accounts thereafter by either debtor.
After the death of Bruce E. Nace, the Forrester Co. filed a claim against his estate for the full amount of the decedent's debt. The probate court having jurisdiction over the estate allowed the claim in the amount of $23,831.94, its discount value. The claim as so allowed was transferred to the corporation's stockholders upon liquidation. The debt of petitioner was transferred to his wife for its discount value of $28,759.34, prior to the liquidation.
In his determination of the deficiency, respondent taxed petitioner on income of $55,393.58 ($84,152.92 less $28,759.34) realized from the corporation's disposition of his account. Upon brief, respondent argues, in substance, that we should treat the transaction as one in which petitioner was the purchaser of his account for $55,393.58 less than the amount owed, and resulting in taxable income to him in that amount under United States v. Kirby Lumber Co., 284 U.S. 1, and Helvering v. American Chicle Co., supra. Petitioner's position is that there was a bona fide sale of the claim to his wife, without a release of any of his liability.
The Forrester Co. was owned and, therefore, controlled by petitioner and Helen Nace Satterlee and Howard F. Nace, children and heirs of William F. Nace. The probate court had fixed the value of the corporation's claim against the estate of William F. Nace at the discount value of the debt and the heirs were the logical persons to acquire the claim for its value, and thereby obtain a release of the stock securing its payment to surrender in the liquidation proceedings. The ruling of the probate court fixed the value to the corporation of its claim against petitioner, and, under the circumstances, the willingness of the Forrester Co. to dispose of the account at such value is not open to criticism. It was under no compulsion to search the market for a price greater than the value of the claim, or to distribute the claim to petitioner or all the stockholders pro rata. If it had made such a distribution, the distributee or distributees would not have been required to include the property in a computation of taxable gain in the liquidation proceedings at an amount greater than its value.
There is evidence of record to indicate that petitioner was apprehensive of tax liability in 1938 growing out of the disposition by the corporation of its claim against him. Taxpayers are not obliged to so conduct their affairs as to incur or increase their income tax liability, and a transaction may not be disregarded because it resulted from an honest effort to reduce taxes to a minimum. Such designs must be carefully scrutinized, especially where, as here, the taxpayer's wife is concerned, to ascertain whether the transaction is real. Charles E. Mitchell, 32 B.T.A. 1093.
Respondent does not contend that Mrs. Forrester had no right to contract for her own account. She employed such legal right by borrowing funds with which to purchase the account without the credit of her husband and thereafter received from petitioner a note for the indebtedness secured by real property received by him in the liquidation. In December 1938 and January 1939 petitioner, as he agreed to, paid a total of $29,000 on his note and thereafter in 1942 and 1943 made additional payments of $5,000 and $4,500, respectively, although his note was not payable until 1957. These payments are evidence of good faith. The gain to the payee resulting from payments received in excess of her cost basis was reported for income tax purposes.
Petitioner did not avoid any liability in the transaction. The result was nothing more, in substance, than a substitution of creditors. If the payee of the note does not pursue all of her remedies for payment of the note upon maturity, it will not be because of her legal inability to do so. Petitioner did not reduce his liability.
Moreover, even if we assume, as the respondent contends, that the petitioner himself was the purchaser of his own obligation, under the circumstances here there would be no gain. The debt was due June 1, 1957, bore no interest, and on the date of purchase its discount value was $28,759.34. At this figure it was purchased. A stranger would have made no profit on purchasing it at that figure; and neither could the petitioner, paying all the obligation was worth. Cases such as United States v. Kirby Lumber Co., supra, and Helvering v. American Chicle Co., supra, do not involve the element of future maturity with no interest charge, and are not logically applicable here.
Expenses of Forrester Co. Paid by Petitioner After Liquidation.
Petitioner and other stockholders of the Forrester Co., as transferees of its assets, agreed to pay to a trustee amounts necessary to discharge obligations of the Forrester Co. at the time of its liquidation and expenses incident thereto. Amounts aggregating $2,738.58 were contributed to the trustee by petitioner during the years 1938 to 1943, inclusive, and were used by the trustee during the years 1939 to 1943, inclusive, to pay such expenses.
The question is whether petitioner's share of the expenses is deductible in computing his gain from the liquidation of the Forrester Co. Petitioner kept his books and filed his return on the cash basis. None of the amounts contributed by him were paid out by the trustee in 1938, the taxable year, and it does not appear whether any of the obligations of the corporation accrued in 1938. Amounts paid under circumstances prevailing here are deductible as losses in the year of payment. John T. Furlong, 45 B.T.A. 362; Koppers Co., 3 T.C. 62. Cases in point relied upon by petitioner have not been followed by this Court since the Furlong case. On this issue we sustain the respondent.
Decision will be entered under Rule 50.