Kast v. Comm'r of Internal Revenue

• Decision Date: 29 June 1982
• Docket Number: 22428-81,29083-81,Docket Nos. 13643-81,2661-81,29082-81,14902-81,14903-81,1035-82.
• Citation: 78 T.C. 1154
• Parties: FRANCIS X. KAST and ANNE E. KAST, et al.,1 PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

78 T.C. 1154

FRANCIS X. KAST and ANNE E. KAST, et al.,1 PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 13643-81

14902-81

14903-81

22428-81

2661-81

29082-81

29083-81

1035-82.

United States Tax Court

Filed June 29, 1982.

1. Cases of the following petitioners are consolidated herewith: Kenneth G. Heinz and Patricia B. Heinz, docket No. 14902-81; James E . Dahl and Louann J. Dahl, docket No. 14903-81; John E. Heffernan and Mary P. Heffernan, docket No. 22428-81; Warren H. Schumann and Maria T. Schumann, docket No. 26661-81; John J. Heck and Lois R. Heck, docket No. 29082-81; Martin Drobac and Becky K. Drobac, docket No. 29083-81; and Edward Durbin and Betty L. Durbin, docket No. 1035-82.

Each petitioner in 1976 exercised his option to purchase stock of his employer, K Corp., such option having been granted to him pursuant to a qualified stock option plan adopted by the employer. The option price was $7 per share; in 1976, at the time the options were exercised, the stock had a fair market value of $13.25 per share. In 1977, K Corp. adopted a plan of liquidation and, pursuant to such liquidation, each petitioner as a shareholder in 1977 received a distribution of $15.30 per share and further distributions in 1978 and 1979. Each petitioner had voted against the adoption of the plan of liquidation of the corporation. Held: Each petitioner failed to hold the shares acquired under the option the requisite 3 years from the date of his exercise of the option. Sec. 422(a)(1). Since sec. 331(a) provides that amounts distributed in liquidation of a corporation shall be treated as in payment in exchange for the stock, a disposition of each petitioner's shares occurred in 1977 within the definition of sec. 425(c). Secs. 421(a) and (b), 422(a), and 425(c) make no distinction between a “voluntary” as opposed to an “involuntary” disposition . Brown v. United States, 427 F.2d 57 (9th Cir. 1970), which holds to the contrary, is not followed as to petitioners in docket No. 26661-81, since appeal in such case does not lie to the Ninth Circuit Court of Appeals. Accordingly, the motion for summary judgment will be denied as to petitioners in docket No. 26661-81. However, as to petitioners in the other dockets, all of which cases are appealable to the Ninth Circuit Court of Appeals, an appropriate order will be entered granting the motion for summary judgment in favor of such petitioners on the basis of the rule of this Court enunciated in Golsen v. Commissioner, 54 T.C. 742 (1970), affd. on other grounds445 F.2d 985 (10th Cir. 1971). Julian N. Stern, for the petitioners.

Donna I. Epstein, for the respondent.

OPINION

SCOTT , Judge:

On November 30, 1981, petitioners in the case of Francis X. Kast and Anne E. Kast, docket No. 13643-81, filed a motion for summary judgment which was set for hearing at San Francisco, Calif., on March 8, 1982. When the case was called for hearing, respondent filed a motion to consolidate the remaining above-entitled cases with the Kast case and consider the motion as going to all the cases. There was no objection on the part of any of petitioners since the facts in all these cases are substantially the same. The parties also agree that the Court may accept the facts as set forth in an affidavit in the Kast case submitted with petitioners' motion for summary judgment as being the facts in all the other cases, with the exception of the address of each petitioner, which is as alleged in the petition filed by each petitioner and admitted in the answers filed by respondent, and the number of shares of stock with respect to which each petitioner exercised an option which is material in each case only in the determination of the amount of the deficiency, if any.

We will therefore find the facts of the Kast case only, since the differences in the number of shares of stock owned by each petitioner are not material to the consideration of the motion for summary judgment. ² The issues raised by petitioners' motion for summary judgment are (1) whether payment received by each petitioner as a liquidating distribution with respect to shares of stock in Kaiser Industries Corp. (the corporation) which he had acquired pursuant to a qualified stock option is a disposition of his stock as defined in section 425(c),³ and (2) if so, whether such disposition was a disqualifying disposition within the meaning of sections 421 and 422.

Each petitioner, except Warren H. Schumann and Maria T. Schumann, docket No. 26661-81, resided in California at the time of the filing of the petition. Petitioners Warren H. Schumann and Maria T. Schumann resided in Sao Paulo, Brazil, at the time of the filing of their petition with the Court. Each petition involves a deficiency determined by respondent for the calendar year 1977. Each docket involves a husband and wife who filed a joint Federal income tax return with the Internal Revenue Service Center, Fresno, Calif., for the calendar year 1977.

On May 27, 1976, each petitioner-husband (petitioner) exercised a qualified stock option that had been granted to him on September 7, 1973, to acquire a specified number of shares of common stock of the corporation. The option price was $7 per share. The price of the shares on the American Stock Exchange on the date of the exercise of the option was $13.25 per share.

On April 20, 1977, stockholders of the corporation, by majority vote, adopted a plan of complete liquidation. Each petitioner voted against adoption of the plan. Following adoption of the plan, the corporation distributed to each petitioner pro rata cash and assets having a fair market value of $14.30 per share on June 3, 1977, and $1 per share on October 3, 1977. Additional distributions were made pro rata to each petitioner by the corporation in 1978, 1979, and 1980 in the respective amounts of $3, $0.75, and $1.90 per share. The corporation retained a portion of its assets through April 11, 1980, when the balance of the corporation's assets amounting to $19,951,416, subject to any liabilities, was distributed to Touche, Ross & Co. as liquidation agent. The shares of the corporation held by each petitioner as a result of exercise of the qualified stock option were not redeemed in 1977 or at any time thereafter. Shares of the corporation were freely bought and sold through 1977 and thereafter and continued to be listed and traded on the American Stock Exchange until March 21, 1980.

Section 421(a) provides (with an exception not here pertinent) that if a share of stock is transferred to an individual pursuant to the exercise of a qualified stock option, and certain requirements in respect of such transfer are met, no income shall result to the individual at the time of the transfer of the shares to him. Section 421(b) provides that if the transfer of a share of stock to an individual pursuant to his exercise of an option would meet these requirements except for a failure to meet any of the holding period requirements, any increase in the income of such individual or deduction from the income of the employer corporation for the taxable year in which such option is exercised attributable to such disposition, shall be treated as an increase in income or a deduction from income in the taxable year of such individual or the employer corporation in which such disposition occurs.

Section 422(a) provides (with an exception not here pertinent) that section 421(a) shall apply with respect to the transfer of a share of stock to an individual pursuant to his exercise of a qualified stock option if no disposition of such share is made by the individual within a 3-year period beginning after the transfer of such share.

Section 425(c) provides that, except for a joint tenancy acquisition, the term “disposition,” as used in sections 421 through 425, includes a sale, exchange, gift, or a transfer of legal title, but does not include (1) a transfer from a decedent to an estate or a transfer by bequest or inheritance; (2) an exchange to which section 354, 355, 356, or 1036 (or so much of sec. 1031 as relates to sec. 1036) applies; or (3) a mere pledge or hypothecation. ⁴

Petitioners' first position in this case is that they did not make a disposition of their shares of stock within the meaning of section 421(b), 422(a), or 425(c) since they made no sale, exchange, gift, or transfer of legal title of their stock in the year 1977, the year here involved. In support of this position, petitioners point out that their shares of stock still remained outstanding and, even as of 1980, shares of the corporation were traded on the American Stock Exchange. It is respondent's position that, because of the provisions of section 331(a),⁵ a disposition did occur since that section provides that “Amounts distributed in partial liquidation of a corporation * * * shall be treated as in part or full payment in exchange for the stock.”

Petitioners argue that section 331 was put into the Code in the twenties solely to change the character of the income received in such a distribution from ordinary income to capital gain. Petitioners point out that, absent this provision, such distributions would be considered dividends taxable as ordinary income because they would be a “distribution of property made by a corporation to its shareholders” under the provision of section 316(a)(1). Petitioners cite certain statements in S. Rept. 398, 68th Cong., 1st Sess. (1924), 1939-1 C.B. (Part 2) 266, 274, in support of their position. In this report, the reason given for the provision (which subsequently became sec. 331) treating a distribution in full or partial liquidation as a payment in part or in full for the stock is that where a corporation liquidates and distributes its assets to its shareholder, the shareholder in effect surrenders his interest in the corporation and receives money in lieu thereof. According to petitioners, the extension of the provision to distributions in partial liquidation was...