Bowen v. Comm'r of Internal Revenue

• Citation: 78 T.C. 55
• Decision Date: 20 January 1982
• Docket Number: Docket No. 12745-79.
• Parties: ROBERT R. BOWEN and ELIZABETH S. BOWEN, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

78 T.C. 55

ROBERT R. BOWEN and ELIZABETH S. BOWEN, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 12745-79.

United States Tax Court

Filed January 20, 1982.

Husband and wife each owned stock in a publicly held corporation. Their combined ownership enabled the husband to retain control over the corporation despite an approximate 35-percent stock ownership by the wife's brother. In 1973, the wife sold her stock to her husband on the installment basis. The installment payments were to be made over a period of 40 years with a “balloon” payment due at the end of that period. Subsequently, in late 1974, the husband sold to a Canadian corporation a portion of the shares purchased from his wife. This sale also was on the installment basis. In computing gain on the second sale, the husband received the benefit of the stepped-up basis obtained as a result of the interspousal purchase. Held: The interspousal sale was not a “sham.” The wife parted with direct and indirect control over the stock and the economic benefits therefrom. Rushing v. Commissioner, 441 F.2d 593 (5th Cir. 1971), affg. 52 T.C. 888 (1969). Additionally, the spouses each had independent nontax reasons for entering into the installment transaction. Wrenn v. Commissioner, 67 T.C. 576 (1976). Respondent's contention that the interspousal sale was for less than fair market value is, in this context, not supportive of his contention that the sale was a “sham.” James H. Sheehan and John S. Ball, for the petitioners.

Ben G. Reeves, for the respondent.

STERRETT , Judge:

By statutory notice dated June 8, 1979, respondent determined deficiencies in petitioners' Federal income taxes of $158.20 and $10,724.42 for the taxable years 1973 and 1975, respectively, and an addition to tax for negligence or intentional disregard of rules or regulations in the amount of $536.22 for the 1975 taxable year. The issues presented for decision are: (1) Whether a sale of stock between petitioner-husband and petitioner-wife was a bona fide transaction entitled to recognition for Federal income tax purposes; (2) if not, whether the basis of a portion of such stock subsequently resold by husband was correctly computed by respondent; and (3) whether petitioners are liable for the addition to tax under section 6653(a), I.R.C. 1954, for the taxable year 1975.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.

Petitioners Robert R. Bowen and his wife Elizabeth S. Bowen resided in Ponte Vedra Beach, Fla., at the time of filing the petition herein. They filed joint Federal income tax returns for the taxable years 1973 and 1975 with the Internal Revenue Service Center at Chamblee, Ga. The returns were prepared in accordance with the cash receipts and disbursements method of accounting.

In June of 1964, Telfair Corp. (hereinafter Telfair) was incorporated by James R. Stockton, Sr., father of petitioner Elizabeth S. Bowen, and by two family-related trusts. The corporation was formed for the principal purpose of acquiring the stock of Moore Dry Kiln Co. of Oregon (hereinafter Moore-Oregon), which manufactures and installs dry kilns and custom design systems for the treating and handling of forest products. In order to purchase the Moore-Oregon stock, it was necessary for Telfair to borrow approximately $2,200,000 from the Morgan Guaranty Trust Co. of New York on a demand note. The note was later refinanced on a long-term basis with the Gulf Life Insurance Co. and with other financial institutions located in Jacksonville, Fla.

In 1968, 3,000 shares of Telfair stock were issued and outstanding. One thousand shares were owned by James R. Stockton, Sr., 1,000 shares were held in a revocable trust for the benefit of James Stockton, Jr., Mr. Stockton's son, and 1,000 shares were held in a revocable trust for the benefit of Elizabeth S. Bowen, Mr. Stockton's daughter.

On or about June 25, 1968, James R. Stockton, Sr., sold his 1,000 shares to his son and to his daughter's husband, petitioner Robert R. Bowen, with each acquiring 500 shares. The sale was structured as a private annuity transaction with Mr. Stockton receiving in consideration for his shares the right to receive annual annuity payments for the remainder of his lifetime. However, James R. Stockton, Sr., died on February 11, 1969, before any payments had been made on the annuity. Consequently, because they were not required to surrender any value in exchange for the stock they received from Mr. Stockton, Sr., James Stockton, Jr., and Robert R. Bowen each had a zero basis in their respective 500 shares.

After the sale by James Stockton, Sr., of his stock, James Stockton, Jr., owned one-half (or 1,500 shares), Elizabeth S. Bowen owned one-third (or 1,000 shares), and Robert R. Bowen owned one-sixth (or 500 shares) of the total 3,000 shares of Telfair that were then issued and outstanding.¹ James Stockton, Jr., held the office of president of the corporation, and, being the largest shareholder, he had the ability to form Telfair's policies and control its direction at that time. Mr. Bowen was secretary-treasurer of the company, while Mrs. Bowen took no part in the affairs of Telfair.

l In the late 1960's, Telfair's forest products business experienced a period of growth, thereby creating a need for additional working capital. Such capital was not readily available to Telfair since it was a privately held company owned exclusively by related shareholders. Therefore, the shareholders began to consider the prospect of merging with a publicly held company for purposes of raising the additional capital through public stock sales.

l A natural candidate for the contemplated merger was Industrial-America Corp. (hereinafter sometimes referred to as Industrial-America), a corporation for which Mr. Bowen had worked in an executive capacity since the 1950's. Industrial-America, a Florida corporation, was essentially a holding company consisting of a conglomeration of some 8 to 10 corporations. It was engaged directly and through its subsidiaries in a variety of business ventures, including renting, insurance, sewer and water utility service, and the sale of shell homes. Its controlling shareholder was Mr. R. Eugene Orr, who had supported and had been somewhat responsible for Mr. Bowen's swift rise in the organization. Industrial-America's stock was, and, with the exception of certain “lettered stock” discussed below, continues to be, traded in the over-the-counter market.

l After negotiations, an agreement of merger was executed between Telfair and Industrial-America on October 23, 1968, with Industrial-America designated as the continuing entity. In order to obtain a private letter ruling from the Internal Revenue Service that the merger would qualify as a nontaxable reorganization, the parties were obligated to fulfill certain requirements. First, Industrial-America was required to assume Telfair's total outstanding indebtedness. Second, James Stockton, Jr., and Mr. and Mrs. Bowen were required to purchase additional but previously unissued shares of Industrial-America common stock, and Industrial-America was required to apply the resultant sales proceeds to the payment of liabilities assumed from Telfair. These requirements were fulfilled in the subsequent nontaxable reorganization.

l In early 1969, Industrial-America acquired substantially all of Telfair's assets and assumed Telfair's liabilities pursuant to the plan of reorganization. On or about March 25, 1969, Telfair was liquidated.

l In the reorganization, the three shareholders of Telfair collectively received 856,662 shares of Industrial-America stock in exchange for their conveyance to Industrial-America of the assets of Telfair. They also purchased an additional 254,564 shares of Industrial-America stock at a price of $10 per share. In both transactions, the Industrial-America stock was received by each of the shareholders in proportion to their former stock holdings in Telfair Corp. Accordingly, of the total 1,111,226 shares of Industrial-America stock acquired by the three shareholders, James Stockton, Jr., acquired one-half, or 555,613, Mrs. Bowen acquired one-third, or 370,409 shares, and Mr. Bowen acquired one-sixth, or 185,204 shares. The stock acquired had a par value of $1.25 per share. The combined holdings of James Stockton and the Bowens only constituted approximately 70 percent of Industrial-America's issued and outstanding stock, however, due to the fact that there were continuing shareholders from the premerger ownership of Industrial-America. One of the continuing shareholders was Mr. Orr, the former controlling shareholder of Industrial-America, whose stock ownership in the corporation slipped from 50 percent to 121;2 percent as a result of the merger. Mr. Orr remained on the board of directors after the merger.

The following chart reflects the number of Industrial-America shares held by James Stockton, Jr., and Mr. and Mrs. Bowen immediately after the reorganization, the basis per share, the total basis, and the manner in which the shares were acquired:

+-----------------------------------------------------------------------------+
                ¦Mrs. Bowen                                                                   ¦
                +-----------------------------------------------------------------------------¦
                ¦                                            ¦           ¦           ¦        ¦
                +--------------------------------------------+-----------+-----------+--------¦
                ¦                                            ¦Number     ¦Basis      ¦Total   ¦
                +--------------------------------------------+-----------+-----------+--------¦
                ¦Acquired                                    ¦of shares  ¦per share  ¦basis   ¦
                +--------------------------------------------+-----------+-----------+--------¦
                ¦                                            ¦

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