Benjamin v. Comm'r of Internal Revenue
| Decision Date | 30 September 1976 |
| Docket Number | Docket Nos. 3286-71,3287-71. |
| Parties | BLANCHE S. BENJAMIN, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTEDWARD B. BENJAMIN, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
William C. Gambel, for the petitioners.
Paul H. Waldman, for the respondent.
Starmount, a North Carolina corporation, owned between 3,000 and 4,000 acres of land bordering on Greensboro, N.C. Prior to 1964, its outstanding stock consisted of 4,732 shares of class A preferred, 7,255 shares of class B preferred, 3,518 shares of class C preferred, and 1,000 shares of common stock. Voting and management control of the corporation was vested entirely in the class A and class B preferred stock. Petitioner Blanche S. Benjamin owned all of the class A and class B preferred stock. Her three sons, their wives, and her grandchildren owned 2,550 shares of the class C preferred and all of the common stock. On Dec. 9, 1964, Starmount redeemed 2,000 shares of the class A voting preferred stock held by Blanche for $200,000. After the redemption of 1964, Blanche continued to own all of the outstanding voting (class A and class B preferred) stock and to control the management of Starmount until 1968 when Starmount redeemed all of the remaining preferred stock held by Blanche for in excess of $1 million. Held, (1) The redemption of 2,000 shares of Starmount class A voting preferred stock in 1964 from the petitioner Blanche S. Benjamin was ‘essentially equivalent to a dividend’ within the provisions of sec. 302(b)(1) of the Internal Revenue Code of 1954. United States v. Davis, 397 U.S. 301 (1970).
Held, further, on the basis of the facts set forth and the authorities discussed in our opinion herein: (2) The assessment of the deficiency determined by the respondent herein against the petitioner Blanche S. Benjamin and her husband Edward B. Benjamin is not barred by limitations under sec. 6501(e); (3) the deficiency determined against the petitioners was not the product of an invalid record inspection under sec. 7605(b); (4) having filed joint returns the petitioners are jointly and severally liable for any tax due (sec. 6013(d)), and the fact that the amount paid in redemption was on stock owned by the wife and was community income is not material; (5) amounts expended by Starmount for the upkeep and maintenance of petitioners' residence ‘Starmount Farms' are includable in petitioners' taxable income; however (6) the amounts paid by the corporation for the country club dues of their sons are not includable in petitioners' taxable income.
Respondent determined the following deficiencies in petitioners' Federal income taxes:
+---------------------+
¦Year ¦Deficiency ¦
+------+--------------¦
¦ ¦ ¦
+------+--------------¦
¦1961 ¦1 $32,219.05 ¦
+------+--------------¦
¦1964 ¦79,531.28 ¦
+---------------------+
An addition to tax under section 6651(a) of the Internal Revenue Code 2 was also asserted against petitioners. However, the parties have by stipulation eliminated that question from our inquiry.
The issues remaining for decision are: (1) Whether a redemption in 1964 of 2,000 shares of Starmount Corp. class A preferred voting stock from petitioner Blanche S. Benjamin, the majority shareholder, was ‘essentially equivalent to a dividend’ under section 302(b)(1); (2) whether petitioner Blanche S. Benjamin realized constructive dividends in 1964 when the Starmount Corp. paid her sons' country club dues and a portion of the maintenance expenses on petitioners' North Carolina residence; (3) whether the assessment of a deficiency against Blanche S. Benjamin and/or Edward B. Benjamin is barred by the statute of limitations contained in section 6501(a); and (4) whether the deficiency determination against petitioners was the product of an invalid second inspection of their ‘books of account’ prohibited by section 7605(b).
The Court granted the parties' joint motion to consolidate the two cases for trial, briefing, and opinion.
Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by reference.
Petitioners, husband and wife, were residents of New Orleans, La., at the time their separate petitions were filed. Petitioners filed a joint Federal income tax return for 1964 with the District Director of Internal Revenue in New Orleans. On said return no entry or notation was made of a $200,000 distribution received during that year from Starmount Corp. (hereinafter Starmount or the corporation) in exchange for 2,000 shares of class A voting preferred stock owned by Blanche S. Benjamin. Apparently the petitioners considered this distribution a nontaxable return of capital.
The parties have stipulated that petitioners' gross income as stated on their 1964 joint income tax return was less than $694,168.50 but not less than $453,075.40. The record presents no evidence as to whether the income was separate or community income.
The petitioners have presented extensive records concerning Starmount Corp. and the events leading to the 1964 partial redemption, the basic transaction at issue here, as well as a 1968 redemption which completely terminated Blanche S. Benjamin's interest in Starmount. We summarize below so much of the facts as are considered relevant and material to our inquiry and, in addition, present a brief sketch of the history of Starmount only for purposes of gaining a better perspective of the transaction involved herein.
Emanuel Sternberger, father of petitioner Blanche S. Benjamin (hereinafter Blanche) was the founder of Revolution Cotton Mills. Revolution was a corporation engaged in the textile manufacturing business in North Carolina. Prior to 1924 the majority stock interest in Revolution was held by Emanuel Sternberger, his wife, and two daughters, Blanche and Emelia. When Mr. Sternberger died in 1924, he bequeathed his Revolution stock to his wife and daughters.
In 1926 Emanuel Sternberger's heirs sold their stock interest in Revolution to certain minority shareholders. Mrs. Sternberger and the two daughters received as partial payment for their stock certain notes formerly held in the investment portfolio of Revolution. These notes were the obligation of Alfred Scales, a North Carolina businessman, and are hereinafter referred to as the Scales notes. These interest-bearing notes were secured by mortgages on 3,000 to 4,000 acres of land bordering on Greensboro, N.C. With the proceeds from the sale of their stock, including a portion of the Scales notes, Blanche and Emelia each funded separate trusts with Central Union Trust Co. of New York (predecessor of Manufacturers Hanover Bank) as trustee.
In 1928 Mrs. Emanuel Sternberger died intestate and her heirs, Blanche and Emelia, inherited their mother's estate. Each placed all or a portion of their inheritance, including the remaining Scales notes, in separate trusts with the Bank of New York & Trust Co. as trustee. Thereafter, a portion of the corpus of all four trusts consisted of the Scales notes secured by mortgages on the North Carolina property.
Emelia died on January 3, 1929, without any decedents surviving. In accordance with the terms of the agreements creating Emelia's two trusts, Blanche became the income beneficiary and her children the remaindermen of Emelia's two trusts.
The economic disaster which struck this nation in 1929 apparently cast its shadow on Blanche and her prior financial planning. In that year, Alfred Scales defaulted on his note obligations and foreclosure proceedings on the mortgaged property were instituted. The trustees expended funds from the corpus of each trust in clearing all intervening liens and in satisfying foreclosure expenses.
Blanche and the trustees formed a North Carolina corporation, Starmount, on April 10, 1929, to take title to the foreclosed property. In exchange for the defaulted Scales notes held in trust, the trusts received new notes issued by Starmount worth $1,153,135.77 (the approximate 1929 value of the entire tract of land) and 1,000 shares of Starmount no-par common stock. The new notes and stock of Starmount were distributed to the trusts in proportion to their respective holdings of the defaulted notes.
Attempts were made to sell the unimproved property subsequent to incorporation. Such attempts proved fruitless and no sales of even a portion of the property occurred until 1938. For this reason, Blanche agreed to personally lease the land so that the trusts would receive income from the Starmount securities. In addition, Blanche thereafter financed some capital expenditures and paid certain recurring charges such as ad valorem and franchise taxes.
In 1933 Blanche and the trustees agreed that a restructuring of the corporation would be beneficial particularly for North Carolina tax purposes. A recapitalization was designed whereby the Starmount debt would be exchanged for an equity interest in the form of three classes of preferred stock. Consequently, the Starmount notes previously held by the trusts were exchanged for a proportionate amount of new preferred shares. The preferred shares were issued and exchanged with the trusts on the basis of 1 share for $100 of debt. Each class of preferred stock represented a specific debt or expenditure previously incurred as shown below.
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¦ ¦Number of shares ¦Number of shares ¦
+---------------+------------------+------------------¦
¦New preferred ¦authorized ¦issued ¦
+---------------+------------------+------------------¦
¦ ¦ ¦ ¦
+---------------+------------------+------------------¦
¦Class A ¦7,500 ¦4,682* ¦
+---------------+------------------+------------------¦
¦Class B ¦8,000 ¦7,255**...To continue reading
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