Commissioner of Internal Revenue v. Fink, 86-511

• Decision Date: 22 June 1987
• Docket Number: No. 86-511,86-511
• Citation: 483 U.S. 89,107 S.Ct. 2729,97 L.Ed.2d 74
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Peter R. FINK, et ux
• Court: U.S. Supreme Court

483 U.S. 89

107 S.Ct. 2729

97 L.Ed.2d 74

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

v Peter R. FINK, et ux.

No. 86-511.

Argued April 27, 1987.

Decided June 22, 1987.

Syllabus

In an unsuccessful effort to increase the attractiveness of their financially troubled corporation to outside investors, respondents voluntarily surrendered some of their shares to the corporation, thereby reducing their combined percentage ownership from 72.5 percent to 68.5 percent. Respondents received no consideration for the surrendered shares, and no other shareholders surrendered any stock. The corporation eventually was liquidated. On their 1976 and 1977 joint federal income tax returns, respondents claimed ordinary loss deductions for the full amount of their adjusted basis in the surrendered shares. The Commissioner of Internal Revenue disallowed the deductions, concluding that the surrendered stock was a contribution to the corporation's capital, and that, accordingly, the surrender resulted in no immediate tax consequences and respondents' basis in the surrendered shares should be added to the basis of their remaining shares. The Tax Court sustained the Commissioner's determination, but the Court of Appeals reversed, ruling that respondents were entitled to deduct their basis in the surrendered shares immediately as an ordinary loss less any resulting increase in the value of their remaining shares.

Held: A dominant shareholder who voluntarily surrenders a portion of his shares to the corporation, but who retains control of the corporation, does not sustain an immediate loss deductible for income tax purposes. Rather, the rule applicable to contributions to capital applies, so that the surrendering shareholder must reallocate his basis in the surrendered shares to the shares he retains, and deduct his loss, if any, when he disposes of the remaining shares. This rule is not rendered inapplicable simply because a stock surrender is not a contribution to capital in the strict accounting sense, or because, unlike a typical contribution to capital, a surrender reduces the shareholder's proportionate interest in the corporation. Where, as here, a closely held corporation's shares are not traded on an open market, a stock surrender to that corporation often will not meet the requirement that an immediately deductible loss must be actually sustained during the taxable year, since there will be no reliable method of determining whether the surrender has resulted in a loss until the shareholder disposes of his remaining shares. Moreover treating stock surrenders as ordinary losses might encourage shareholders in failing corporations to convert potential capital losses to ordinary losses by voluntarily surrendering their shares before the corporation fails, thereby avoiding the consequences of the rule requiring capital loss treatment for stock that becomes worthless. Similarly, shareholders might be encouraged to transfer corporate stock rather than other property to the corporation in order to realize a current loss. Pp. 95-100.

789 F.2d 427 (CA 6 1986), reversed.

POWELL, J., delivered the opinion of the Court, in which REHNQUIST, C.J., and BRENNAN, WHITE, MARSHALL, and O'CONNOR, JJ., joined. WHITE, J., filed a concurring opinion, post, p. ----. SCALIA, J., filed an opinion concurring in the judgment, post, p. ----. BLACKMUN, J., concurred in the result. STEVENS, J., filed a dissenting opinion, post, p. ----.

Alan I. Horowitz, Washington, D.C., for petitioner.

Matthew J. Zinn, Washington, D.C., for respondents.

Justice POWELL delivered the opinion of the Court.

The question in this case is whether a dominant shareholder who voluntarily surrenders a portion of his shares to the corporation, but retains control, may immediately deduct from taxable income his basis in the surrendered shares.

I

Respondents Peter and Karla Fink were the principal shareholders of Travco Corporation, a Michigan manufacturer of motor homes. Travco had one class of common stock outstanding and no preferred stock. Mr. Fink owned 52.2 percent, and Mrs. Fink 20.3 percent, of the outstanding shares.¹ Travco urgently needed new capital as a result of financial difficulties it encountered in the mid-1970's. The Finks voluntarily surrendered some of their shares to Travco in an effort to "increase the attractiveness of the corporation to outside investors." Brief for Respondents 3. Mr. Fink surrendered 116,146 shares in December 1976; Mrs. Fink surrendered 80,000 shares in January 1977. As a result, the Finks' combined percentage ownership of Travco was reduced from 72.5 percent to 68.5 percent. The Finks received no consideration for the surrendered shares, and no other shareholder surrendered any stock. The effort to attract new investors was unsuccessful, and the corporation eventually was liquidated.

On their 1976 and 1977 joint federal income tax returns, the Finks claimed ordinary loss deductions totaling $389,040, the full amount of their adjusted basis in the surrendered shares.² The Commissioner of Internal Revenue disallowed the deductions. He concluded that the stock surrendered was a contribution to the corporation's capital. Accordingly, the Commissioner determined that the surrender resulted in no immediate tax consequences, and that the Finks' basis in the surrendered shares should be added to the basis of their remaining shares of Travco stock.

In an unpublished opinion, the Tax Court sustained the Commissioner's determination for the reasons stated in Frantz v. Commissioner, 83 T.C. 162, 174-182 (1984), aff'd, 784 F.2d 119 (CA2 1986), cert. pending, No. 86-11. In Frantz the Tax Court held that a stockholder's non pro rata surrender of shares to the corporation does not produce an immediate loss. The court reasoned that "[t]his conclusion . . . necessarily follows from a recognition of the purpose of the transfer, that is, to bolster the financial position of [the corporation] and, hence, to protect and make more valuable [the stockholder's] retained shares." 83 T.C., at 181. Because the purpose of the shareholder's surrender is "to decrease or avoid a loss on his overall investment," the Tax Court in Frantz was "unable to conclude that [he] sustained a loss at the time of the transaction." Ibid. "Whether [the shareholder] would sustain a loss, and if so, the amount thereof, could only be determined when he subsequently disposed of the stock that the surrender was intended to protect and make more valuable." Ibid. The Tax Court recognized that it had sustained the taxpayer's position in a series of prior cases.³ Id., at 174-175. But it concluded that these decisions were incorrect, in part because they "encourage[d] a conversion of eventual capital losses into immediate ordinary losses." Id., at 182.⁴

In this case, a divided panel of the Court of Appeals for the Sixth Circuit reversed the Tax Court. 789 F.2d 427 (1986). The court concluded that the proper tax treatment of this type of stock surrender turns on the choice between "unitary" and "fragmented" views of stock ownership. Under the "fragmented view," "each share of stock is considered a separate investment," and gain or loss is computed separately on the sale or other disposition of each share. Id., at 429. According to the "unitary view," "the 'stockholder's entire investment is viewed as a single indivisible property unit,' " ibid. (citation omitted), and a sale or disposition of some of the stockholder's shares only produces "an ascertainable gain or loss when the stockholder has disposed of his remaining shares." Id., at 432. The court observed that both it and the Tax Court generally had adhered to the fragmented view, and concluded that "the facts of the instant case [do not] present sufficient justification for abandoning" it. Id., at 431. It therefore held that the Finks were entitled to deduct their basis in the surrendered shares immediately as an ordinary loss, except to the extent that the surrender had increased the value of their remaining shares. The Court of Appeals remanded the case to the Tax Court for a determination of the increase, if any, in the value of the Finks' remaining shares that was attributable to the surrender.

Judge Joiner dissented. Because the taxpayers' "sole motivation in disposing of certain shares is to benefit the other shares they hold[,] . . . [v]iewing the surrender of each share as the termination of an individual investment ignores the very reason for the surrender." Id., at 435. He concluded: "Particularly in cases such as this, where the diminution in the shareholder's corporate control and equity interest is so minute as to be illusory, the stock surrender should be regarded as a contribution to capital." Ibid.

We granted certiorari to resolve a conflict among the Circuits,⁵ 479 U.S. 960, 107 S.Ct. 454, 93 L.Ed.2d 401 (1986), and now reverse.

II

A.

It is settled that a shareholder's voluntary contribution to the capital of the corporation has no immediate tax consequences. 26 U.S.C. § 263; 26 CFR § 1.263(a)-2(f) (1986). Instead, the shareholder is entitled to increase the basis of his shares by the amount of his basis in the property transferred to the corporation. See 26 U.S.C. § 1016(a)(1). When the shareholder later disposes of his shares, his contribution is reflected as a smaller taxable gain or a larger deductible loss. This rule applies not only to transfers of cash or tangible property, but also to a shareholder's forgiveness of a debt owed to him by the corporation. 26 CFR § 1.61-12(a) (1986). Such transfers are treated as contributions to capital even if the other shareholders make proportionately smaller contributions, or no contribution at all. See, e.g., Sackstein v. Commissioner, 14 T.C. 566, 569 (1950). The rules governing contributions to capital reflect the general principle that a shareholder may not claim an immediate loss for outlays made to benefit the corporation. Deputy v. Du Pont, 308 U.S. 488, 60...