Sanders v. Fox

Decision Date20 March 1958
Docket NumberNo. 5718-5720.,5718-5720.
Citation253 F.2d 855
PartiesRobert V. SANDERS and Nancy Ritter Sanders, Appellants, v. Charles I. FOX, Director of Internal Revenue, Appellee. Kimball J. CRANNEY and Janice J. Cranney, Appellants, v. Charles I. FOX, Director of Internal Revenue, Appellee. N. V. SANDERS and Clover J. Sanders, Appellants, v. Charles I. FOX, Director of Internal Revenue, Appellees.
CourtU.S. Court of Appeals — Tenth Circuit

C. Preston Allen, Salt Lake City, Utah (Albert R. Bowen and Thornley K. Swan, Salt Lake City, Utah, were with him on the brief) for appellants.

James P. Turner, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Harry Baum and David O. Walter, Attys., Dept. of Justice, Washington, D. C., and A. Pratt Kesler, U. S. Atty., Salt Lake City, Utah, were with him on the brief), for appellee.

Before MURRAH, LEWIS and BREITENSTEIN, Circuit Judges.

LEWIS, Circuit Judge.

Appellants, owners of all the issued stock of the Clover Club Foods Company,1 have entered into an agreement with the corporation for the redemption of their stock under a plan funded by insurance carried upon the lives of the stockholders. The insurance premiums, paid by the corporation, have been assessed against appellants as constructive dividends constituting ordinary income. The validity of this assessment is the sole question here presented. The cases, consolidated as involving the same facts and identical issues of law, reach us upon appeal from the District Court for the District of Utah, the trial court having denied claim to refund upon taxes so assessed and paid for the years 1949, 1950 and 1951. The controversy arises from stipulated facts. See 149 F.Supp. 942.

Clover Club Foods Company, a Utah corporation manufacturing potato chips, at all pertinent times had four stockholders, present appellants: N. V. Sanders, his wife Clover J. Sanders, their son Robert V. Sanders and K. J. Cranney. N. V. Sanders was president of the corporation and his wife was vice president, secretary and treasurer. Robert V. Sanders was employed by the corporation as a general worker. Cranney was the sales manager. Each drew salary from the corporation and held stock interest which varied during the three years in question. In 1949, N. V. Sanders and his wife owned 43% each of the issued stock; in 1950, 40% each and in 1951, 37% each. Robert V. Sanders and Cranney each held 7% in 1949, 10% in 1950 and 13% in 1951.

On March 23, 1949, the corporation and its four stockholders executed a "Stock Purchase Agreement." The agreement was funded by insurance taken out upon the lives of the stockholders through individual policies closely, although not exactly, proportionate in amount to the corporate interest of the stockholder. The policies were deposited with the corporation with all lifetime benefits reserved, by endorsement of the policies2 and by contract provision,3 to the corporation. Each shareholder deposited with the corporation his corporate stock, endorsed in blank but without surrender of the right to sell or vote the stock or receive dividends thereon. The shareholder had the exclusive right to name the beneficiary of the insurance proceeds payable at death.

Upon the death of a stockholder the corporation agreed to deliver the policy to the named beneficiary for collection. Thereupon the corporation would transfer to itself as much of the company stock standing in the name of the deceased as could be purchased at a pre-determined price from the insurance proceeds. The fair market price of the stock was to be determined from time to time by unanimous vote of the stockholders (or by arbitration if necessary) and the redemption price was designated in the agreement:

"At the death of a Stockholder, the Adjusted price to be paid for his stock shall be the greater of the following: (1) the value thereof, (as set by the stockholders) plus a percentage of the cash surrender value, as of the day prior to his death, of all the insurance policies (including those on his life) equal to the percentage of all the shares of stock of the Corporation which were then owned by him, or (2) the amount of said insurance proceeds payable under the terms of the said policy or policies on decedent\'s life."

If the insurance payment was not sufficient to buy all of the deceased's stock at the adjusted price the corporation had a sixty-day option to do so from funds available in current earnings or surplus. Shares not so purchased remained the property of the record owner as reflected upon the company books subject to a secondary option to purchase upon the part of the surviving stockholders.

The corporation provisionally4 agreed to pay the insurance premiums as they became due and has paid total premiums for the years designated in the following amounts: 1949, $4,072.08; 1950, $4,591.77; 1951, $5,279.20.

As the agreement required, these premiums were paid from current earnings and surplus "so that rights of corporation creditors will not be prejudiced by use of corporate funds for payment of such premiums." The premium payments have not been claimed by the corporation as a tax deduction but have been carried as an asset on the company balance sheet. No formal dividends have been declared or paid for the tax years in question although earned surplus in 1949 was $84,587.77, in 1950, $122,289.80 and In 1951, $140,853.33. The outstanding stock was valued at $225,148 in 1949 and 1950 and at $285,124 in 1951.

Other provisions in the "Stock Purchase Agreement" determine the rights of the parties when a stock purchase is not consummated by the contingency of the death of a stockholder. Should the corporation be unable to make premium payments from earnings or surplus the agreement terminates and the corporation becomes sole beneficiary of the insurance and its value becomes an ordinary asset of the company. See note 4, ante. If during his lifetime, the stockholder desires to sell his stock he has such right subject to the corporation's first right of refusal at the adjusted price set in the agreement. The agreement terminates if the corporation does not purchase and the company becomes beneficiary of all the insurance and vested with all the incidents of ownership in the policies. If the corporation does purchase, the company becomes the beneficiary of the particular policy covering the life of the withdrawing stockholder and might, at company option, allow such stockholder to purchase the insurance at its then cash value.

Considered apart from tax incidents, stock redemption plans between a closely held corporation and its stockholders, buy-out agreements such as here considered, may present advantages to both company and stockholder. Continuity of stock control, management and the concomitant security given company personnel and creditors may benefit the corporation. Assurance of a sale of stock at an agreed price where otherwise such stock might be unmarketable gives comfort to the stockholder. These and other benefits as intangibles are admittedly without tax significance. But where, as here, the benefits are presently set by contract a present or potential tax impact becomes apparent. Appellants urge that the instant agreement presents but a potential tax against company, surviving stockholders, estate, or insurance beneficiary upon actual redemption of the stock. And since under the posture of the case presented no eventuality possible under the stock purchase agreement did occur during the years 1949, 1950 or 1951 except the continuing payment of insurance premiums by the corporation we agree that our present inquiry is limited to whether or not a taxable incident occurred to appellants during the years in question by such payments.

The trial court, placing reliance upon the reasoning of the Tax Court in Casale v. C. I. R., 26 T.C. 1020, since reversed, 2 Cir., 247 F.2d 440, 441, concluded that the premium payments constituted, in effect, a division of profits by the corporation and were taxable as constructive dividends to appellants. To support the holding, appellee urges that the test of taxability lies in an analysis of the benefits flowing to corporation and stockholder, and, pointing out that the stockholder (beneficiary) under the instant agreement cannot receive less and may receive considerably more than the actual value of his stock, asserts that the agreement is essentially for the benefit of the stockholder. We believe the correct rule must limit the analysis to those benefits "presently realized" for the purpose of present inquiry.

Although the term "constructive dividend" is not known to the Internal Revenue Code5 tax consequences have been recognized far beyond the rudimentary doctrine that gain is realized only through an exchange of cash. Helvering v. Brunn, 309 U.S. 461, 60 S.Ct. 631, 84 L.Ed. 864. As stated in Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 146, 85 L.Ed. 75, 131 A.L.R. 655:

"* * * (T)he rule that income is not taxable until realized has never been taken to mean that the taxpayer, even on the cash receipts basis, who has fully enjoyed the benefit of the economic gain represented by his right to receive the income, can escape taxation because he has not himself received payment of it from his obligor. The rule, founded on administrative convenience, is only one of postponement of the tax to the final event of enjoyment of the income, usually the receipt of it by the taxpayer, and not one of exemption from taxation where the enjoyment is consummated by some event other than the taxpayer\'s personal receipt of money or property. * * * This may occur when he has made such use or disposition of his power to receive or control the income as to procure in its place other satisfactions which are of economic worth."

Thus, in determining whether or not taxable income accrued to the stockholder, the courts regard the substance of the transaction, Jones v. Dawson, 10 Cir., 148 F.2d 87, and a...

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6 cases
  • Lynch v. Commissioner
    • United States
    • U.S. Tax Court
    • March 31, 1983
    ...of the policy, no dividend results from the payment of such premiums by the corporation. See Sanders v. Fox 58-1 USTC ¶ 9415, 253 F. 2d 855 (10th Cir. 1958); Lewis v. O'Malley 44-1 USTC ¶ 9137, 140 F. 2d 735 (8th Cir. 1944). The finding of a constructive dividend turns on whether a present ......
  • State v. Johnson
    • United States
    • Mississippi Supreme Court
    • February 29, 1960
    ...States, D.C.Wash.1942, 44 F.Supp. 417, affirmed 9 Cir., 139 F.2d 69; Davis v. United States, 6 Cir., 1955, 226 F.2d 331; Sanders v. Fox, 10 Cir., 1958, 253 F.2d 855; Paster v. C. I. R., 8 Cir., 1957, 245 F.2d 381, certiorari denied 355 U.S. 876, 78 S.Ct. 139, 2 L.Ed.2d 108; Finley v. Commis......
  • Wortham Machinery Company v. United States
    • United States
    • U.S. District Court — District of Wyoming
    • May 10, 1974
    ...301 F.2d 803 (3rd Cir. 1962); Greenspon v. Commissioner of Internal Revenue, 229 F.2d 947 (8th Cir. 1956). But see Sanders v. Fox, 253 F.2d 855 (10th Cir. 1958). In looking at the realities of the situation, it is obvious that "The corporation payment benefitted the Norrises because they we......
  • Mountain State Steel Foundries, Inc. v. CIR
    • United States
    • U.S. Court of Appeals — Fourth Circuit
    • November 7, 1960
    ...281 F.2d 488. 15 Emeloid Co. v. Commissioner, 3 Cir., 189 F.2d 230; see, also, Prunier v. Commissioner, 1 Cir., 248 F.2d 818; Sanders v. Fox, 10 Cir., 253 F.2d 855. 16 26 U.S.C.A. § 302 et seq. 17 26 U.S.C.A. § 303. 18 See Pelton Steel Casting Co. v. Commissioner, 7 Cir., 251 F.2d 278. ...
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