68 T.C. 544 (1977), 2754-74, Cocker v. C.I.R.

Docket Nº:2754-74-2756-74.
Citation:68 T.C. 544
Opinion Judge:IRWIN, Judge:
Party Name:JOHN COCKER III AND DOROTHY COCKER, ET AL.,[1] PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Attorney:Steve C. Horowitz and Joseph B. Alala, Jr., for the petitioners. Frank D. Armstrong, Jr., for the respondent.
Case Date:July 25, 1977
Court:United States Tax Court
 
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Page 544

68 T.C. 544 (1977)

JOHN COCKER III AND DOROTHY COCKER, ET AL.,[1] PETITIONERS

v.

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Nos. 2754-74-2756-74.

United States Tax Court

July 25, 1977

Petitioners entered into an agreement in 1964 to exchange stock in one corporation for stock in another corporation in a transaction qualifying as a reorganization under sec. 368(a)(1)(B). The agreement called for two distributions of the acquiring corporation's stock: the first in 1964 on the date of the agreement, and the second in 1969. No provision was made for the payment of interest on the second distribution. Petitioners actually received three distributions under the agreement: one in 1964, one in 1969, and one in 1971. Held, a portion of the stock received by petitioners in 1969 and 1971 is taxable as interest income under the provisions of sec. 483. Catterall v. Commissioner, 68 T.C. 413 (1977), and Solomon v. Commissioner, 67 T.C. 379 (1976), followed.

Page 545

Steve C. Horowitz and Joseph B. Alala, Jr., for the petitioners.

Frank D. Armstrong, Jr., for the respondent.

IRWIN, Judge:

Respondent determined deficiencies in petitioners' Federal income tax for the calendar years 1969 and 1971 as follows:

Deficiencies
Docket
No. 1969 1971
2754-74 John Cocker III and Dorothy Cocker $20,526.10 $24,973.93
2755-74 F. Hoyt Cunningham, Jr., and Helen
Cunningham 168.90 209.71
2756-74 Mary C. Parker 257.40 175.59
The three dockets have been consolidated for purposes of trial, briefing, and opinion. The only issue we have to decide is whether any portion of the Walter other adjustments in the received by certain of the petitioners pursuant to a plan of reorganization under section 368(a)(1)(B) of the Internal Revenue Code of 1954[2] constitutes interest income under section 483. Petitioners in docket No. 2754-74 have conceded the correctness of respondent's of filing their petitions in notice of deficiency (except to the extent the computation of the medical expense deduction hinges on the outcome of the section 483 issue). Respondent made no other adjustments in the notices of deficiency in the two remaining dockets. FINDINGS OF FACT Most of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. Petitioners John Cocker III and Dorothy Cocker, husband and wife, and Mary C. Parker (formerly Mary Elva Cocker) resided in Clover, S.C., at the time of filing their petitions in Page 546 this Court. Petitioners F. Hoyt Cunningham, Jr., and Helen Cunningham, husband and wife, resided in Gastonia, N.C., at the time of filing their petition. All the petitioners filed Federal income tax returns for the years in issue with the Director, Southeast Service Center, Chamblee, Ga. Cocker Machine & Foundry Co., Inc. (hereafter referred to as Cocker), was a corporation organized under the laws of the State of North Carolina, and was engaged in the manufacture of textile machines in Gastonia, N.C. Walter Kidde & Co., Inc. (hereafter referred to as Kidde), was organized under the laws of the State of New York, and has its principal place of business in Belleville, N.J. Kidde is a national and international conglomerate with businesses in the fields of safety security and protection, aerospace systems and equipment, merchandising equipment, consumer products, and textile machinery. On July 1, 1964, the shareholders of Cocker entered into an ‘ Agreement and Plan of Reorganization’ (hereafter referred to as the agreement or reorganization agreement) with Kidde. Under the terms of the agreement, Kidde acquired all of the outstanding capital stock of Cocker in exchange solely for common stock of Kidde having a par value of $2.50 per share. The above agreement was executed on July 3, 1964, at which time there were 1,867 shares of Cocker stock issued and outstanding. Kidde issued 78,361 shares of its common stock (having a fair market value at that time of $18 per share) in exchange for all the outstanding Cocker stock. The parties to this exchange determined that the book value of the Cocker stock on July 3, 1964, was $1,410,498. Respondent adjusted this value to $1,429,177 after audit without objection from petitioners. The names of the Cocker shareholders at the time of the exchange, the number of Cocker shares relinquished by such shareholders, and the number of Kidde shares received in the exchange are as follows:
Number Number
of of
Kidde shares Cocker shares
Name of shareholder received given
John Cocker III 48,183 1,148
Dorothy Cocker 3,274 78
John C. Bodansky 2,099 50
F. Hoyt Cunningham 839 20
Wachovia Bank & Trust Co., as executor and trustee, and
John Cocker III, as trustee named under the last will
and testament of Mary Lovett Cocker, deceased 20,860 497
Wachovia Bank & Trust Co., and Kattie Moore Rankin
Cunningham, as co-executors named under the last will
and testament of James W. Cunningham 839 20
First Union National Bank, as general guardian for Mary
Elva Cocker, a minor 1,763 42
First Union National Bank, as general guardian for Ann
Elise Cocker, minor 504 12
Totals 78,361 1,867
Page 547 The above distribution of Kidde stock on July 3, 1964, had a total fair market value of $1,410,498 and will hereafter sometimes be referred to as the ‘ first distribution.’ A ‘ second distribution’ was provided for in paragraph 2.2 of the reorganization agreement as follows: 2.2 Second Distribution. The second distribution by KIDDE of KIDDE STOCK (valued at the average closing price per share during the period of 30 market days prior to the end of the period ending December 31, 1968) shall be in an amount determined, and shall be delivered, as follows: a. The aggregate net earnings before income taxes but after intercompany eliminations of COCKER and the present Kidde Textile Machinery Division (excluding exceptional items of a non-recurring nature aggregating in excess of $100,000) determined in accordance with generally accepted accounting principles applied on a basis consistent with prior periods for the three years most favorable to COCKER STOCKHOLDERS of the four years beginning January 1, 1965, and ending December 31, 1968, will be reduced by $600,000; b. 48% of the amount resulting from the computation set forth in Subparagraph ‘ a’ above shall constitute the basis of the second distribution; but, c. in no event shall this second distribution when added to the amount of the first distribution be less than $1,800,000 nor more than $2,400,000. d. The foregoing computation shall nevertheless be subject to adjustment for liabilities and claims aggregating in excess of $25,000 not shown or adequately reserved for on the audited COCKER Balance Sheet dated July 3, 1964 which are ascertained at any time during the period between July 3, 1964 and the second distribution (that is to say, such liabilities and claims shall be deducted from the amount of the second distribution) subject, however, to the following: (i) The deduction for such liabilities and claims shall be limited so that in no event will the value of the second distribution, when added to the value of stockholders' equity shown on the COCKER Balance Sheet dated July 3, 1964, be less than $1,500,000. The shares of KIDDE STOCK constituting such second distribution shall be delivered to the COCKER STOCKHOLDERS or their personal representatives, heirs, or distributees in the same proportion as the first distribution Page 548 within 30 days after the delivery of the audited report of COCKER's Certified Public Accountants with the financial statements of COCKER (the Balance Sheet as of December 31, 1968 and the Statement of Operations for the period ended December 31, 1968) attached thereto. Fractional shares shall be rounded so that each COCKER STOCKHOLDER will receive KIDDE STOCK to the nearest whole share. No cash or other property excepting KIDDE STOCK shall be distributed to the COCKER STOCKHOLDERS. The Cocker shareholders and Kidde disagreed over the number of shares of Kidde stock to be distributed under paragraph 2.2 of the agreement. This disagreement focused on the amount of the contingent or undisclosed liabilities to be offset against the minimum purchase price (see subparagraph (d) of paragraph 2.2 in the agreement). On May 19, 1969, the Cocker shareholders instituted a lawsuit in the Superior Court of Gaston County, N.C., seeking a mandatory injunction compelling Kidde to comply with paragraph 2.2 of the reorganization agreement and deliver the stock and financial statements prescribed therein.[3] On July 3, 1969, Kidde distributed 4,049 shares of its $2.50 par value common stock to the Cocker shareholders. The Cocker shareholders accepted the stock distributed under protest and without prejudice to their rights under the agreement. On the date of this distribution the fair market value of Kidde stock was $41.25 per share, giving a total value for the distributed stock of. $167,021.25. Petitioners in docket No. 2754-74 received 3,737 shares of the stock distributed with a total fair market value of $154,151.25. Petitioner F. Hoyt Cunningham, Jr., in docket No. 2755-74 received 43 shares with a value of $1,773.75, and petitioner Mary C. Parker in docket No. 2756-74 received 91 shares with a value of $3,753.75. The following reflects the allocation of shares of Kidde stock among the Cocker shareholders in the July 3, 1969, distribution:
Number of
Name shares Value
...

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