460 U.S. 370 (1983), 81-485, Hillsboro Nat'l Bank v. Commissioner

Docket Nº:No. 81-485
Citation:460 U.S. 370, 103 S.Ct. 1134, 75 L.Ed.2d 130
Party Name:Hillsboro Nat'l Bank v. Commissioner
Case Date:March 07, 1983
Court:United States Supreme Court
 
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Page 370

460 U.S. 370 (1983)

103 S.Ct. 1134, 75 L.Ed.2d 130

Hillsboro Nat'l Bank

v.

Commissioner

No. 81-485

United States Supreme Court

March 7, 1983

Argued November l, 1982

CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR

THE SEVENTH CIRCUIT

Syllabus

Until 1970, Illinois imposed a property tax on shares of stock held in incorporated banks, but in 1970 the Illinois Constitution was amended to prohibit such taxes. The Illinois courts thereafter held that the amendment violated the Federal Constitution, but, pending disposition of the case in this Court, Illinois enacted a statute providing for collection of the disputed taxes and placement of the receipts in escrow. Petitioner Bank in No. 81-485 paid the taxes for its shareholders in 1972, taking the deduction for the amount of the taxes pursuant to § 164(e) of the Internal Revenue Code of 1954 (IRC), which grants a corporation a deduction for taxes imposed on its shareholders but paid by the corporation and denies the shareholders any deduction for the tax. The authorities placed the receipts in escrow. After this Court upheld the constitutional amendment, the amounts in escrow were refunded to the shareholders. When petitioner, on its federal income tax return for 1973, recognized no income from this sequence of events, the Commissioner of Internal Revenue assessed a deficiency against petitioner, requiring it to include as income the amount paid its shareholders from the escrow. Petitioner then sought a redetermination in the Tax Court, which held that the refund of the taxes was includible in petitioner's income. The Court of Appeals affirmed. In No. 81-930, respondent corporation, which operated a dairy, in the taxable year ending June 30, 1973, deducted the full cost of the cattle feed purchased for use in its operations as permitted by § 162 of the IRC, but a substantial portion of the feed was still on hand at the end of the taxable year. Two days into the next taxable year, respondent adopted a plan of liquidation and distributed its assets, including the cattle feed, to its shareholders. Relying on § 336 of the IRC, which [103 S.Ct. 1137] shields a corporation from the recognition of gain on the distribution of property to its shareholders on liquidation, respondent reported no income on the transaction. The Commissioner challenged respondent's treatment of

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the transaction, asserting that it should have included as income the value of the feed distributed to the shareholders, and therefore increased respondent's income by $60,000. Respondent paid the resulting assessment and sued for a refund in Federal District Court, which rendered a judgment in respondent's favor. The Court of Appeals affirmed.

Held:

1. Unless a nonrecognition provision of the IRC prevents it, the tax benefit rule ordinarily applies to require the inclusion of income when events occur that are fundamentally inconsistent with an earlier deduction. Pp. 377-391.

2. In No. 81-485, the tax benefit rule does not require petitioner to recognize income with respect to the tax refund. The purpose of § 164(e) was to provide relief for corporations making payments for taxes imposed on their shareholders, the focus being on the act of payment, rather than on the ultimate use of the funds by the State. As long as the payment itself was not negated by a refund to the corporation, the change in character of the funds in the hands of the State does not require the corporation to recognize income. Pp. 391-395.

3. In No. 81-930, however, the tax benefit rule requires respondent to recognize income with respect to the distribution of the cattle feed to its shareholders on liquidation. The distribution of expensed assets to shareholders is inconsistent with the earlier deduction of the cost as a business expense. Section 336, which clearly does not shield the taxpayer from recognition of all income on distribution of assets, does not prevent application of the tax benefit rule in this case. Section 336's legislative history, the application of other general rules of tax law, and the construction of identical language in § 337, which governs sales of assets followed by distribution of the proceeds in liquidation and shields a corporation from the recognition of gain on the sale of the assets, all indicate that § 336 does not permit a liquidating corporation to avoid the tax benefit rule. Pp. 395-402.

No. 81-485, 641 F.2d 529, reversed; No. 81-930, 645 F.2d 19, reversed and remanded.

O'CONNOR, J., delivered the opinion of the Court, in which BURGER, C.J., and WHITE, POWELL, and REHNQUIST, JJ., joined, and in Parts I, II, and IV of which BRENNAN, J., joined. BRENNAN, J., filed an opinion concurring in part and dissenting in part,post, p. 403. STEVENS, J., filed an opinion concurring in the judgment in part and dissenting in part, in which MARSHALL, J., joined, post, p. 403. BLACKMUN, J., filed a dissenting opinion,post, p. 422.

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O'CONNOR, J., lead opinion

JUSTICE O'CONNOR delivered the opinion of the Court.

These consolidated cases present the question of the applicability of the tax benefit rule to two corporate tax situations: the repayment to the shareholders of taxes for which they were liable, but that were originally paid by the corporation, and the distribution of expensed assets in a corporate liquidation. We conclude that, unless a nonrecognition provision of the Internal Revenue Code prevents it, the tax benefit rule ordinarily applies to require the inclusion of income when events occur that are fundamentally inconsistent with an earlier deduction. Our examination of the provisions granting the deductions and governing the liquidation in these cases leads us to hold that the rule requires the recognition of income in the case of the liquidation, but not in the case of the tax refund.

I

In No. 81-485, Hillsboro National Bank v. Commissioner, the petitioner, Hillsboro National Bank, is an incorporated bank doing business in Illinois. Until 1970, Illinois imposed a property tax on shares held in incorporated banks. Ill.Rev.Stat., ch. 120, § 557 (1971). Banks, required to retain earnings sufficient to cover the taxes, [103 S.Ct. 1138] § 558, customarily paid

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the taxes for the shareholders. Under § 164(e) of the Internal Revenue Code of 1954, 26 U.S.C. § 164(e),1 the bank was allowed a deduction for the amount of the tax, but the shareholders were not. In 1970, Illinois amended its Constitution to prohibit ad valorem taxation of personal property owned by individuals, and the amendment was challenged as a violation of the Equal Protection Clause of the Federal Constitution. The Illinois courts held the amendment unconstitutional in Lake Shore Auto Parts Co. v. Korzen, 49 Ill.2d 137, 273 N.E.2d 592 (1971). We granted certiorari, 405 U.S. 1039 (1972), and, pending disposition of the case here, Illinois enacted a statute providing for the collection of the disputed taxes and the placement of the receipts in escrow. Ill.Rev.Stat., ch. 120, ¶ 676.01 (1979). Hillsboro paid the taxes for its shareholders in 1972, taking the deduction permitted by § 164(e), and the authorities placed the receipts in escrow. This Court upheld the state constitutional amendment in Lehnhausen v. Lake Shore Auto Parts Co., 410 U.S. 356 (1973). Accordingly, in 1973, the County Treasurer refunded the amounts in escrow that were attributable to shares held by individuals, along with accrued interest. The Illinois courts held that the refunds belonged to the shareholders, rather than to the banks. See Bank & Trust Co. of Arlington Heights v. Cullerton, 25 Ill.App.3d 721, 726, 324 N.E.

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2d 29, 32 (1975) (alternative holding); Lincoln National Bank v. Cullerton, 18 Ill.App.3d 953, 310 N.E.2d 845 (1974). Without consulting Hillsboro, the Treasurer refunded the amounts directly to the individual shareholders. On its return for 1973, Hillsboro recognized no income from this sequence of events.2 The Commissioner assessed a deficiency against Hillsboro, requiring it to include as income the amount paid its shareholders from the escrow. Hillsboro sought a redetermination in the Tax Court, which held that the refund of the taxes, but not the payment of accrued interest, was includible in Hillsboro's income. On appeal, relying on its earlier decision in First Trust and Savings Bank of Taylorville v. United States, 614 F.2d 1142 (1980), the Court of Appeals for the Seventh Circuit affirmed. 641 F.2d 529, 531 (1981).

In No. 81-930, United States v. Bliss Dairy, Inc., the respondent, Bliss Dairy, Inc., was a closely held corporation engaged in the business of operating a dairy. As a cash basis taxpayer, in the taxable year ending June 30, 1973, it deducted upon purchase the full cost of the cattle feed purchased for use in its operations, as permitted by § 162 of the Internal Revenue Code, 26 U.S.C. § 162.3 A substantial portion of the feed was still on hand at the end of the taxable year. On July 2, 1973, two days into the next taxable year, Bliss adopted a plan of liquidation, and, during the month of July, it distributed its assets, including the remaining cattle feed, to the shareholders. Relying on § 336, which shields the corporation from the recognition [103 S.Ct. 1139] of gain on the distribution

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of property to its shareholders on liquidation,4 Bliss reported no income on the transaction. The shareholders continued to operate the dairy business in noncorporate form. They filed an election under § 333 to limit the gain recognized by them on the liquidation,5 and they therefore calculated their basis in the assets received in the distribution as provided

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in § 334(c).6 Under that provision, their basis in the assets was their basis in their stock in the liquidated corporation, decreased by...

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