Opinion
Docket No. 75848.
1961-03-16
ESTATE OF ARTHUR H. SQUIER, DECEASED, NATIONAL STATE BANK OF NEWARK, EXECUTOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Benjamin Alpert, Esq., for the petitioner. Chapman H. Belew, Jr., Esq., for the respondent.
Held, even after applying the constructive ownership rules of section 318, I.R.C. 1954, with respect to the stock owned by the estate of majority stockholder of closely held corporation, there still remained a substantial minority interest outstanding, and redemption of portion of the estate's stock to pay State and Federal death taxes was not, in the circumstances of this case, essentially equivalent to the distribution of a taxable dividend under section 302. Thomas G. Lewis, 35 T.C. 71, distinguished. Benjamin Alpert, Esq., for the petitioner. Chapman H. Belew, Jr., Esq., for the respondent.
Respondent determined a deficiency in petitioner's income tax for the calendar year 1955 in the amount of $23,590.89. The issue is whether and to what extent the acquisition by Squier, Schilling and Skiff, Inc., of 737 shares of its common stock in 1955 from the estate of Arthur H. Squier was a redemption essentially equivalent to a dividend within the meaning of section 302 of the Internal Revenue Code of 1954.
FINDINGS OF FACT.
The stipulation of facts is incorporated herein by this reference.
Petitioner, the Estate of Arthur H. Squier, filed its United States Fiduciary Income Tax Return for the calendar year 1955 with the district director of internal revenue at Newark, New Jersey.
Arthur H. Squier died January 21, 1954. Prior to his death he was president and a director of Squier, Schilling and Skiff, Inc., a Delaware corporation organized on February 1, 1946, and engaged in the industrial supply business, furnishing cutting tools, abrasives, bearings, and machine parts to manufacturers. Its business offices were in Newark, New Jersey.
On the date of decedent's death, the corporation's 4,905 shares of $100-par-value common stock, being all the stock issued and outstanding, were owned as follows:
+------------------------------------------------+ ¦Name ¦Relationship to ¦Shares¦Percent¦ +----------------+----------------+------+-------¦ ¦ ¦Arthur H. Squier¦ ¦ ¦ +----------------+----------------+------+-------¦ ¦Arthur H. Squier¦ ¦2,457 ¦50.09 ¦ +----------------+----------------+------+-------¦ ¦Ruth B. Squier ¦Wife ¦448 ¦9.13 ¦ +------------------------------------------------+
Ruth S. Clynes, as trustee for Daughter Thomas Henry Clynes III Grandchild 200 4.08 Otto Schilling None 1,800 36.70 Total 4,905 100.00
Otto Schilling is not related to either the Squier or the Clynes families directly or indirectly.
The decedent's will, executed July 3, 1952, made Ruth B. Squier, Ruth S. Clynes, and Thomas Henry Clynes III beneficiaries under two testamentary trusts. The National State Bank of Newark was named sole executor of the will and trustee of both testamentary trusts.
On August 6, 1952, the decedent entered into an agreement entitled ‘Stock Purchase Agreement’ with Otto Schilling and the corporation. The agreement provided that upon the death of Arthur H. Squier or Otto Schilling their executors or administrators, at their options, could offer to sell to the corporation any number of shares of the corporation not to exceed 30 percent of those shares standing in their name as of the date of death, and the corporation would purchase such shares so offered at book value less 10 percent as of the end of the month preceding death. The agreement set no time limit for the exercise of the option.
Shortly after the decedent's death, Frederick R. Wilson, chief trust officer of the executor, was elected a director of the corporation to serve in decedent's place and he continued in that capacity until November 15, 1955. Wilson had come to know the decedent in 1944 when the decedent went to his office in the National State Bank of Newark and told him he wanted to name the bank executor of his will and trustee of certain testamentary trusts, provided Wilson would find it convenient to serve as a member of his corporation's board of directors so that he could become familiar with the business prior to the decedent's death. Wilson agreed and served as a member of the board from 1944 until the middle of 1949 when he resigned due to the pressure of other business. He did not serve on the board again until his election in 1954 to represent the interests of petitioner.
Soon after her husband's death, Ruth B. Squier demanded of Wilson that he (acting for the executor and petitioner, then the majority stockholder in the corporation) name her son-in-law, Thomas Clynes, the new president of the corporation. Wilson felt that Clynes did not have the necessary maturity or experience to manage the corporation. In addition, Wilson feared if Clynes were made president, Howard Begg, who had been general manager of the corporation for a number of years prior to the decedent's death, ‘would take strenuous exception’ and might leave the corporation. Begg had not been on very friendly terms with the decedent before the latter's death nor with Ruth B. Squier, but Wilson considered Begg the best man for the corporation's presidency. Wilson did not yield to Ruth B. Squier's wishes, and Howard Begg was appointed the new president. As a result, there was considerable friction and strained relations during the following months between Wilson on the one hand acting for petitioner and Ruth B. Squier and the Clynes' interests on the other. However, since Wilson and Otto Schilling were good friends, Wilson could count on Schilling's support on most corporate decisions.
On April 21, 1954, the executor, Otto Schilling, and the corporation amended the Stock Purchase Agreement of August 6, 1952, to provide that the option to redeem available under the 1952 agreement was to be exercised within 7 months from the date of death, thereby giving the executor the right to exercise such option on or before August 21, 1954.
On August 9, 1954, the executor notified the corporation by letter of its intention to exercise the option available to it under the agreement of August 6, 1952. This decision was dictated by the petitioner's cash requirements to meet its outstanding debts and New Jersey inheritance tax and Federal estate tax liabilities, coupled with the fact that the stock in the corporation was the only sizable asset which the petitioner owned outright. In order that petitioner might retain control of the corporation as long as possible, the actual redemption of the stock was postponed until the New Jersey tax came due in January of 1955. On January 19, 1955, the executor transferred 117 shares to the corporation and received $21,972.60. On March 22, 1955, shortly before the Federal estate tax came due, the executor transferred 620 shares to the corporation and received $116,436. After each redemption, the corporation retired the shares redeemed. The total of 737 shares which petitioner had redeemed by the corporation in the two separate redemptions was the full 30 percent of its stockholdings in the corporation which it was entitled to have redeemed under the agreement of August 6, 1952.
After the redemptions of January 19, 1955, and March 22, 1955, the corporation's remaining outstanding 4,168 shares of $100-par-value common stock were owned as follows:
+------------------------------------------------------------------------+ ¦Name ¦Shares¦Percentage¦ +------------------------------------------------------+------+----------¦ ¦Petitioner ¦1,720 ¦41.27 ¦ +------------------------------------------------------+------+----------¦ ¦Ruth B. Squier ¦448 ¦10.75 ¦ +------------------------------------------------------+------+----------¦ ¦Ruth S. Clynes, as trustee for Thomas Henry Clynes III¦200 ¦4.80 ¦ +------------------------------------------------------+------+----------¦ ¦Otto Schilling ¦1,800 ¦43.18 ¦ +------------------------------------------------------+------+----------¦ ¦Total ¦4,168 ¦100.00 ¦ +------------------------------------------------------------------------+
Petitioner filed its Federal estate tax return on April 20, 1955. A recapitulation of this return shows the following:
+----------------------------------------------------------------------------+ ¦Gross estate: ¦ ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Real estate—residence—jointly owned ¦ ¦$55,000.00¦ +----------------------------------------------------+------------+----------¦ ¦Checking account—jointly owned ¦ ¦2,917.85 ¦ +-----------------------------------------------------------------+----------¦ ¦2,457 shares Squier, Schilling & Skiff, Inc., at $175 per share--¦429,975.00¦ +-----------------------------------------------------------------+----------¦ ¦Net salary due decedent ¦ ¦1,692.59 ¦ +----------------------------------------------------+------------+----------¦ ¦Life insurance proceeds (paid-up policies): ¦ ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Beneficiary: ¦ ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Estate ¦$20.80 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Ruth B. Squier—wife ¦74,606.09 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Jeannette Squier—sister ¦30,648.16 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦ ¦ ¦105,275.05¦ +----------------------------------------------------+------------+----------¦ ¦Miscellaneous property ¦ ¦844.95 ¦ +----------------------------------------------------+------------+----------¦ ¦Total ¦ ¦595,705.44¦ +----------------------------------------------------+------------+----------¦ ¦Deductions: ¦ ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Funeral and administration expenses: ¦ ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Executor's commission ¦$15,000.00 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Attorney's fees ¦12,000.00 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Ruth B. Squier—reimbursement ¦1,372.19 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Surrogate ¦750.00 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦ ¦29,122.19 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Debts of decedent: ¦ ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Ruth B. Squier—miscellaneous ¦365.77 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Ruth B. Squier—demand note ¦24,084.00 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦ ¦24,449.77 ¦$53,571.96¦ +----------------------------------------------------+------------+----------¦ ¦ ¦ ¦542,133.48¦ +----------------------------------------------------+------------+----------¦ ¦Less: ¦ ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Marital deduction ¦271,066.74 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦Specific exemption ¦60,000.00 ¦ ¦ +----------------------------------------------------+------------+----------¦ ¦ ¦ ¦31,066.74 ¦ +----------------------------------------------------+------------+----------¦ ¦Net estate ¦ ¦211,066.74¦ +----------------------------------------------------+------------+----------¦ ¦Tax ¦ ¦54,020.02 ¦ +----------------------------------------------------+------------+----------¦ ¦Credit for State taxes ¦ ¦2,905.60 ¦ +----------------------------------------------------+------------+----------¦ ¦ ¦ ¦51,114.42 ¦ +----------------------------------------------------------------------------+
Insurance proceeds payable under policies of insurance naming Ruth B. Squier beneficiary were duly paid to her in accordance with the terms of each policy. In addition, Ruth B. Squier received $11,350 in 1954 and $6,250 in 1955 from the corporation under agreements providing for payments to widows of deceased employees.
Following the redemptions of petitioner's stock early in 1955, Otto Schilling became ill and was less active in the affairs of the corporation. Wilson feared the complications which might arise within the corporation when Otto Schilling fully retired or in the event of Schilling's death, and hence Wilson had various meetings with the corporation's shareholders in which he tried to persuade them to consider selling all of their stock to a purchaser interested in acquiring the corporation. Wilson succeeded in convincing them this course of action would be best, and in May or June of 1955 they authorized him to try to find a purchaser and to negotiate a sale of their stock. Negotiations were subsequently entered into with Alban Corporation, and its offer was accepted by all the shareholders. On September 1, 1955, the executor entered into an agreement with Alban Corporation to sell the 1,720 shares of the corporation remaining in its hands for $175 per share, making a total price of $301,000. On November 15, 1955, the shares were sold in accordance with this agreement. There had been no negotiations between Alban and the executor or any other stockholder of the corporation prior to 1955.
At all times herein involved the earnings and profits of the corporation were in excess of $138,408.60. The corporation paid dividends regularly from 1950 through September 30, 1955, prior to its sale, in the sum of $2 per share per annum. Its annual net profits after taxes, the cash dividend distributions, and the accumulated earned surplus, for the years ended December 31, 1950, through December 31, 1954, and for the 9 months ended September 30, 1955, were as follows:
+--------------------------------------------------------+ ¦Year ¦Net profit ¦Dividend paid¦Accumulated ¦ +---------------+-----------+-------------+--------------¦ ¦ ¦after taxes¦ ¦earned surplus¦ +---------------+-----------+-------------+--------------¦ ¦1950 ¦$139,659.19¦$9,810 ¦$254,927.14 ¦ +---------------+-----------+-------------+--------------¦ ¦1951 ¦123,946.33 ¦9,810 ¦369,063.47 ¦ +---------------+-----------+-------------+--------------¦ ¦1952 ¦83,817.16 ¦9,810 ¦443,070.63 ¦ +---------------+-----------+-------------+--------------¦ ¦1953 ¦99,786.99 ¦9,810 ¦533,047.62 ¦ +---------------+-----------+-------------+--------------¦ ¦1954 ¦80,903.24 ¦9,810 ¦604,140.86 ¦ +---------------+-----------+-------------+--------------¦ ¦1955 (9 months)¦92,982.66 ¦6,562 ¦625,852.92 ¦ +--------------------------------------------------------+
The actual cash receipts, disbursements, and investments of the executor for the period from the date of the decedent's death, January 21, 1954, to November 15, 1955, were as follows:
+--------------------------------------------------------------+ ¦CASH RECEIPTS ¦ +--------------------------------------------------------------¦ ¦ ¦ ¦¦ +--------------------------------------------------+----------+¦ ¦1954 balance of salary and refunds ¦$1,763.34 ¦¦ +--------------------------------------------------+----------+¦ ¦3/11/54 to 9/12/55—Dividends Squier, Schilling & ¦ ¦¦ +--------------------------------------------------+----------+¦ ¦Skiff, Inc ¦7,804.00 ¦¦ +--------------------------------------------------+----------+¦ ¦1/19/55—Redemption Squier, Schilling, & Skiff, Inc¦21,972.60 ¦¦ +--------------------------------------------------+----------+¦ ¦3/22/55—Redemption Squier, Schilling, & Skiff, Inc¦116,436.00¦¦ +--------------------------------------------------+----------+¦ ¦Total ¦147,975.94¦¦ +--------------------------------------------------+----------+¦ ¦ ¦ ¦¦ +--------------------------------------------------------------+
DISBURSEMENTS 1/8/54—Real estate appraisal $150.00 2/16/54 to 11/4/55—Surrogate expense 65.25 1/9/55—New Jersey inheritance tax deposit 16,000.00 1/25/55—Reimbursed Ruth B. Squier funeral and medical expense $1,372.19 1/25/55—Reimbursed Ruth B. Squier debt 365.77 3/8/55—Accountants' fees 915.83 4/13/55—Federal estate tax payment 51,114.42 4/20/55—Payment to Ruth B. Squier debt and interest 24,449.77 6/21/55—Lawyers' fees 6,000.00 9/1/55—Photostating expense 169.95 Total 100,603.18
INVESTMENTS 4/14/55—Purchase U.S. Treasury Bills $39,834.18 7/14/55 Matured—U.S. Treasury Bills $39,834.18 7/14/55—Purchase U.S. Treasury Bills $39,837.60 10/13/55 Matured—U.S. Treasury Bills 39,837.60 10/13/55—Purchase U.S. Treasury Bills $39,771.60
On November 15, 1955, the executor would have been entitled to $15,000 representing commission on corpus and $750 representing payments on account of counsel had it accounted on that date. These sums were eventually allowed on December 2, 1958.
Of the $138,408.60 received by the petitioner for the redemption of the 737 shares of stock of the corporation, the respondent has determined that $89,276.47 is to be considered as a distribution in full payment thereof under the applicable provisions of section 303 of the Internal Revenue Code of 1954. The amount of $89,276.47 as so determined by the respondent consists of the following:
+----------------------------------------------+ ¦Federal estate tax ¦$52,416.25¦ +-----------------------------------+----------¦ ¦New Jersey inheritance tax ¦7,738.03 ¦ +-----------------------------------+----------¦ ¦Funeral and administration expenses¦29,122.19 ¦ +-----------------------------------+----------¦ ¦Total ¦89,276.47 ¦ +----------------------------------------------+
The balance of $49,132.13 was determined by the respondent to be a dividend.
The redemption of 737 shares of petitioner's stock in the corporation was not essentially equivalent to a dividend.
OPINION.
RAUM, Judge:
The contentions of the parties have revolved largely around the applicability of our recent decision in Thomas G. Lewis, 35 T.C. 71.
We are satisfied that had this case arisen under section 115(g) of the 1939 Code, rather than under section 302 of the 1954 Code, the redemptions herein would not be treated as essentially equivalent to the distribution of a taxable dividend. Does the 1954 Code require a different result here? In the Lewis case we found that the 1954 Code did call for a holding that the redemption there considered was essentially equivalent to a taxable dividend. Our conclusion was based to a significant extent upon the fact that when the attribution rules of section 318 were applied the estate in that case would have to be treated as the sole owner of 100 percent of the corporate stock, and that an appraisal of the record facts upon that assumption called for a finding that the redemption was essentially equivalent to a taxable dividend.
We do not reach the same conclusion on this record, even after applying the attribution rules of section 318. In this case, a substantial minority interest, not covered by the attribution rules, was held by Otto Schilling, and it rose from 36.70 percent before the redemptions in controversy to 43.18 percent thereafter. Moreover, the record herein reveals a sharp cleavage between the executor and members of the Squier family, and in spite of the attribution rules as to stock ‘ownership,‘ the redemptions herein in fact resulted in a crucial reduction of the estate's control over the corporation. Accordingly, notwithstanding the attribution rules, the redemptions in this case did result in a substantial dislocation of relative stockholdings in the corporation and also in fact brought about a significant change in control. We think these circumstances serve to distinguish the Lewis case. In addition, there are certain other considerations which to some degree further differentiate this case from Lewis. Thus, unlike the Lewis case where there was a history of failure to pay dividends over a long period, the corporation in the present case had annually declared a dividend (albeit a conservative one) for a number of years prior to the redemptions. Moreover, the redemptions herein did not result in a pro rata distribution since Otto Schilling's large minority interest received nothing— a circumstance that was absent in the Lewis case upon application of the attribution rules. Taking the entire record into account we are satisfied that even after applying the attribution rules here the redemptions in controversy were not essentially equivalent to the distribution of a taxable dividend.
Decision will be entered for the petitioner.