652 F.2d 675 (6th Cir. 1981), 79-1688, Long v. United States

Docket Nº:79-1688.
Citation:652 F.2d 675
Party Name:Charles L. LONG and Ruth S. Long, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
Case Date:July 06, 1981
Court:United States Courts of Appeals, Court of Appeals for the Sixth Circuit
 
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Page 675

652 F.2d 675 (6th Cir. 1981)

Charles L. LONG and Ruth S. Long, Plaintiffs-Appellees,

v.

UNITED STATES of America, Defendant-Appellant.

No. 79-1688.

United States Court of Appeals, Sixth Circuit

July 6, 1981

Argued April 16, 1981.

W. J. Michael Cody, U. S. Atty., Memphis, Tenn., William M. Holmes, Gary R. Allen and Jay W. Miller, Tax Division, Dept. of Justice, M. Carr Ferguson, Asst. Atty. Gen., Tax Division, Dept. of Justice, Washington, D. C., for defendant-appellant.

James E. Threlkeld, G. Keith Rogers, Jr., Threlkeld & Howard, Memphis, Tenn., for plaintiffs-appellees.

Page 676

Before WEICK and MERRITT, Circuit Judges, and GILMORE, U. S. District Judge. [*]

WEICK, Circuit Judge.

The government appeals in this tax refund case from the grant of summary judgment by the United States District Court for the Western District of Tennessee in favor of the taxpayer-plaintiffs, Charles and Ruth Long, husband and wife. The case concerns the propriety of the government's recapture under the provisions of Section 47(a) of the Internal Revenue Code of 1954 of a $9,867.97 investment tax credit taken by the Longs on their 1972 joint income tax return under Section 38 of the Code. On appeal, the primary issue raised concerns the validity of Treas.Reg. § 1.47-3(f) under the authority of which the Commissioner of Internal Revenue acted in imposing the recapture tax. This Regulation defines the "mere change in form" exception of Section 47(b) to the recapture requirements of Section 47(a). The district court held the regulation invalid as applied to the "particular facts" of this case, which was necessary for it to do in order to grant relief to the taxpayers. For the reasons which follow, we disagree as we hold that the regulation was valid and accordingly reverse.

I.

Charles and Ruth Long were the sole shareholders of Long Construction Company, a "Subchapter S" corporation engaged in the sand and gravel business. During the fiscal year ending October 31, 1972, the corporation purchased certain pieces of equipment which qualified as "section 38 property." 1 "Section 38 property" is defined in Section 48 of the Internal Revenue Code and refers, inter alia, to new or used ("used section 38 property") depreciable or amortizable tangible personal property and certain other tangible property used predominantly in the United States as an integral part of manufacturing, production or extraction. Under Section 38 of the Code, the purchaser of "section 38 property" is entitled to an investment tax credit, the amount of which is determined under Section 46 of the Code, which may be applied against the purchaser's income tax liability for the year of purchase. Where the purchaser, however, is a Subchapter S corporation, Section 48(e) of the Code provides that the investment credit shall be apportioned pro rata among the shareholders. Charles and Ruth Long therefore claimed the corporation's investment tax credit of $9,867.97 on their 1972 joint income tax return.

At the end of its 1972 fiscal year, the Long Construction Company was liquidated under Section 331(a) of the Internal Revenue Code. The corporate assets, including those that had qualified for an investment credit, were distributed to the shareholders, Mr. and Mrs. Long, in exchange for their stock. The business once conducted by the corporation was continued by the Longs as a proprietorship, where the section 38 property was used as it had been used by the corporation.

After an audit of the Longs' 1972 return, the Commissioner of Internal Revenue determined that the 1972 distribution in liquidation constituted an "early disposition" of section 38 property which rendered the Longs liable for a recapture tax equal to the full amount of the investment credit under Section 47(a) of the Code. 2 The

Page 677

Longs paid the $9,867.97 additional tax assessed by the Commissioner. Their claim for a refund was disallowed, and the Longs then commenced the instant action in the district court seeking a refund.

In the district court, the inquiry focused upon the applicability of section 47(b). Section 47(b) of the Code provides two specific exceptions to the recapture tax triggered by an "early disposition" of section 38 property: "(1) a transfer by reason of death, or (2) a transaction to which section 381(a) (relating to carryovers in certain corporate acquisitions) applies." 3 Sections 47(b)(1) and (2). Section 47(b) further excepts from a recapture tax transactions which involve a "mere change in the form of conducting the trade or business ..." 4 Under Treas.Reg. Section 1.47-3(f)(1)(ii), the "mere change in form" exception is applicable only if all of the following conditions are satisfied:

(a) The section 38 property ... is retained as section 38 property in the same trade or business,

(b) The transferor (or in a case where the transferor is a partnership, estate, trust, or electing small business corporation, the partner, beneficiary, or shareholder) of such section 38 property retains a substantial interest in such trade or business,

(c) Substantially all the assets (whether or not section 38 property) necessary to operate such trade or business are transferred to the transferee to whom such section 38 property is transferred, and

(d) The basis of such section 38 property in the hands of the transferee is determined in whole or in part by reference to the basis of such section 38 property in the hands of the transferor ....

In the instant case, it is undisputed that the first three of these conditions were satisfied. It is also conceded that the final condition was not. 5 The district court was therefore called upon to determine the validity of Treas.Reg. § 1.47-3(f)(1)(ii)(d). The court's conclusion that this final condition of the regulation was invalid as applied to the facts of the case rests on two determinations. First, after characterizing the liquidation of the Long Construction Company and continuation of the business as a proprietorship as a "classic example of a mere change in the form of a business," the court determined that application of the regulation was inconsistent with language of the Code. Second, the court determined that the application of the regulation to these facts was inconsistent with the purpose of the recapture tax.

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II.

As noted, Section 47(b) of the Code excepts from a recapture tax early dispositions of section 38 property which involve no more than the "mere change in the form of conducting the trade or business." The Longs have argued that this language, when given its plain meaning, includes transactions such as the one involved in this case. 6 We have recently been reminded by the Supreme Court, however, that the meaning of the Internal Revenue Code of 1954 is "anything but plain." Fulman v. United States, 434 U.S. 528, 532-33, n. 7, 98 S.Ct. 841, 845 n. 7, 55 L.Ed.2d 1 (1978). Indeed, it is for this reason that Congress has delegated to "masters of the subject" the primary task of interpreting this complex Code. National Muffler Dealers Association v. United States, 440 U.S. 472, 477, 99 S.Ct. 1304...

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