55 T.C. 543 (1970)
ESTATE OF E. BROOKS GLASS, JR., DECEASED, THE FIRST NATIONAL BANK OF BIRMINGHAM AND GRACE K. GLASS, EXECUTORS, TRANSFEREE OF ASSETS OF FIDELITY SERVICE INSURANCE COMPANY, PETITIONER
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
United States Tax Court
December 21, 1970
Paul Johnston, for the petitioner.
Robert W. Goodman, for the respondent.
Petitioner, president and owner of all issued stock of Fidelity, decided to retire and gave Skinner, a lawyer, an option to purchase all of his stock for $1,500,000. Skinner was unable to raise the necessary funds but arranged a transaction with another life insurance company, which when coupled with the sale of one-fourth of the stock to Skinner and the redemption by Fidelity of Glass' remaining shares, would result in payment to Glass of the option price. On May 28, 1962, Fidelity, pursuant to Skinner's plan, executed a reinsurance agreement with United, also a life insurance company, under which United reinsured all of Fidelity's policies, purchased many of Fidelity's assets, and assumed all of Fidelity's liabilities. United also unilaterally agreed by a separate agreement, with certain limitations, to give Fidelity 2 percent of its gross premium income for 20 years, but this agreement was not executed by Fidelity and was not even known about by Fidelity's officers, directors, or stockholders. On May 29, 1962, as previously understood and agreed to, Glass sold 250 of his 1,000 shares of Fidelity to Skinner; his remaining 750 shares were redeemed by Fidelity on the following day. Six months later Skinner sold his 250 shares of Fidelity to United. Three weeks after it purchased this stock United liquidated Fidelity and filed an application to dissolve Fidelity. Respondent determined that Fidelity recognized a gain on the sale of its insurance business on May 28, 1962, and included certain other amounts in Fidelity's taxable income for 1961 and 1962 due to the termination of Fidelity as an insurance company at the end of May 1962. Petitioner contends that respondent's determinations were incorrect due to the alleged applicability of sec. 332, I.R.C. 1954, and the related carryover provisions of sec. 381, I.R.C. 1954. He argues also that the substance of the above transactions differed from the form, urging (1) that United was the real purchaser in interest of Glass' 250 shares of Fidelity on May 29, 1962, (2) that United became the sole owner of Fidelity upon redemption of Glass' remaining shares, (3) that the 2-percent override agreement was invalid and not part of the consideration paid by United for the acquisition of Fidelity's assets, and (4) that the transfer of assets and liabilities pursuant to the reinsurance agreement constituted the first stage of a series of distributions in complete liquidation of Fidelity within the meaning of sec. 332. Held: For the purposes of this case, the substance of each transaction, except for the override agreement, was consistent with its form, and the reinsurance agreement constituted a sale of Fidelity's insurance business as determined by respondent. Secs. 332 and 381 were not applicable. However, the substance of the 2-percent override agreement was different from its purported form and its value, $500,000 was not consideration to Fidelity for the sale of its business. Held, further, petitioner is liable as a transferee in equity of Fidelity for the deficiencies and the addition to tax determined by respondent, but only to the extent of the gain on the sale computed without reference to the value of the override agreement.
Respondent determined the following deficiencies and addition to tax were due from Fidelity Service Insurance Co.:
|| Income tax
|| penalty, sec.6651
Respondent further determined that the petitioner's decedent was liable for the above amounts as a transferee in equity of the assets of Fidelity. Petitioner concedes the respondent's determination with respect to the taxable year ended December 31, 1960. The issues remaining for our determination are as follows: (1) Whether the transfer of assets and liabilities pursuant to the reinsurance agreement between Fidelity and United Security Life Insurance Co., Inc., was a sale of assets as determined by respondent, or whether it was, in substance, the first stage of a series of distributions in complete liquidation of Fidelity within the meaning of section 332, I.R.C. 1954. The amount realized from the determined sale is also in dispute. (2) Whether the petitioner's decedent was a transferee in equity of Fidelity's assets within the meaning of section 6901, I.R.C. 1954. FINDINGS OF FACT The parties have stipulated certain facts, which together with the attached exhibits, are incorporated herein by this reference. The initial petitioner in this case was E. Brooks Glass, Jr., whose residence address at the time his petition was filed with this Court was Birmingham, Ala., and whose last residence address was Linden, Ala. Subsequent to Glass' death on October 1, 1967, his estate was substituted as the petitioner. During the years 1960, 1961, and until the latter part of May 1962, Fidelity Service Insurance Co. (hereinafter referred to as Fidelity) was a corporation engaged in the life insurance business with its principal office at 7 Office Park, Birmingham, Ala. Fidelity duly Page 545
filed a Form 1120 L, U.S. Life Insurance Company Income Tax Return, for each of the years 1960 and 1961 with the office of the district director of internal revenue, Birmingham, Alabama. On November 11, 1964, S. P. Keith, as agent, filed a Form 1120, U.S. Corporation Income Tax Return, for the year 1962, naming Fidelity as the taxpayer, with the office of the district director of internal revenue, Birmingham. E. Brooks Glass, Jr., began his business career in about 1940 with the Department of Insurance of Alabama, as an insurance examiner. Shortly thereafter he was promoted to deputy insurance commissioner, and following the death of the incumbent in 1941 he was named acting superintendent of insurance. His duties consisted of conducting audits of insurance companies and supervising the examination of all types of insurance companies operating in Alabama. His specialty related primarily to life insurance companies. After serving for several years as acting insurance superintendent, Glass resigned in the latter part of 1945 and became secretary of the Pioneer Life & Casualty Insurance Co. of Gadsden, Ala. This company was primarily engaged in the life insurance business, writing ordinary life and industrial policies. After a few months, the management of Pioneer decided to specialize in ordinary life insurance and to abandon the industrial business. As a result of this decision, Glass and two associates bought the industrial business from Pioneer and organized a company known as Memorial Service Insurance Co. In 1946 Glass was appointed director of the Alabama Department of Commerce, which included the bureaus of insurance and banking. Upon accepting this appointment, he sold his interest in Memorial. Glass occupied this position until his resignation in 1951. Following his resignation from the Alabama Department of Commerce, Glass acquired in January 1951, an insurance business originally incorporated in 1937 as the Vice Funeral Home & Insurance Co., Inc. Glass' aggregate cost basis applicable to the stock in this company amounted to $405,500. Following acquisition of this stock, Glass became president and treasurer of the company, which position he held until May 1962, when he disposed of his stock under circumstances explained hereinafter. On July 6, 1953, the name of the company was changed to Fidelity Service Insurance Co. At the end of the year 1959 the total capitalization of Fidelity consisted of 1,000 shares of outstanding common stock with a par value of $100 per share. During the years 1960, 1961, and until May 29, 1962, Glass was the owner of all the 1,000 shares of outstanding common stock of that company except for qualifying shares. Grace K. Glass, Lois C. Pochran, B. K. Graham, and Lois Graham each held one Page 546
qualifying share. During that same period of time Glass had control of the qualifying shares of stock of Fidelity that he did not own directly. During the year 1961, Glass investigated the possibility of placing some of the Fidelity stock on the market, primarily for the purpose of establishing its value in case of his death. During the course of this investigation, Fidelity's books were examined by Glass' broker, the Equitable Securities Corp. As a result of the examination, Equitable took the position that a public offering of the stock would not be feasible unless there was a substantial increase in the authorized capital and in the number of outstanding shares. The latter requirement did not appeal to Glass since it would have substantially decreased his proportionate interest in the company, and would have left him with something less than complete control over the management of the company. Later during 1961, Glass felt that his health was becoming impaired as a result of the pressures encountered in operating Fidelity, and decided to retire from the business if he could dispose of his stock in a satisfactory manner. In this regard Glass had occasion to speak with Thomas E. Skinner, an attorney who had been retained by Fidelity since 1951. Skinner expressed some interest in purchasing Fidelity, and on September 27, 1961, wrote a letter to Glass in which he reaffirmed his interest and stated that Glass...