Barnes Motor & Parts Company v. United States

Citation309 F. Supp. 298
Decision Date17 February 1970
Docket NumberCiv. No. 1113.
CourtU.S. District Court — Eastern District of North Carolina
PartiesBARNES MOTOR & PARTS COMPANY, Plaintiff, v. UNITED STATES of America, Defendant.

Thomas L. Norris, Jr., N. A. Townsend, Jr., of Poyner, Geraghty, Hartsfield & Townsend, Raleigh N. C., for plaintiff.

Warren H. Coolidge, U. S. Atty., Raleigh, N. C., Myron C. Baum, G. Thaddeus Williams, Tax Division, Department of Justice, Washington, D. C., for defendant.

OPINION AND ORDER

SUMMARY

LARKINS, District Judge.

The issues in this action relate to the statutory limitations on the availability of Subchapter S (Title 26 U.S.C.A. §§ 1371 through 1377) elections to small business corporations, specifically, the one-class-of-stock and the affiliated-group requirements, and the applicability of the laches principle to the conduct of government agents. The action was filed by the plaintiff on March 25, 1969, as a suit to recover Internal Revenue taxes paid for the years 1963 through 1966. This Court has jurisdiction of the subject matter under Title 28 U.S.C.A. § 1346(a) (1). The issues are before the Court upon the parties' cross motions for summary judgment filed with appropriate exhibits and affidavits pursuant to the provisions of Rule 56 of the Federal Rules of Civil Procedure. This Court is of the opinion that the plaintiff is not entitled to any recovery for the reasons given in this opinion.

FINDINGS OF FACT

The plaintiff is a North Carolina corporation with its principal place of business in Wilson, North Carolina. During all of the taxable years in question, the plaintiff was an accrual-basis taxpayer, filed its federal income tax returns in Greensboro with the District Director of Internal Revenue for the District of North Carolina and used a taxable year ending December 31.

The plaintiff was organized on February 16, 1925, under the name of Barnes Motor Company with an authorized capital of $50,000 consisting of 500 shares of capital stock with a par value of $100 per share. On January 3, 1928, its Articles of Incorporation were amended to change the name of the corporation to Barnes Motor & Parts Company. On January 2, 1941, the Articles of Incorporation were again amended to increase the authorized capital to $100,000 and to provide for 300 shares of $100 par value preferred stocks and 200 shares of $100 par value "Class A Non-voting Common Stock" in addition to the previously authorized 500 shares of $100 par value common stock. The corporate charter shows that the "Class A" common differs from the original voting common only as to the voting rights of the shareholders. The plaintiff has never issued any of its authorized preferred stock.

Subsequent to January 2, 1941, the plaintiff issued the following certificates for 180 shares of its "Class A" common stock:

                            Certificate        Name of         Number of
                           Number         Shareholder         Shares  
                             16         R. E. Kirkland          50
                             17         R. E. Kirkland          50
                             18         R. E. Kirkland          20
                             21         R. E. Kirkland          20
                             19         K. M. Banks             20
                             20         Sarah N. Harrell        20
                

The certificates evidencing the shares came from the plaintiff's regular common stock book and differed from the voting common stock certificates in that the words "Class A" were written in ink on the faces of the certificates. On September 18, 1944, K. M. Banks sold his 20 shares to R. E. Kirkland. A new certificate issued upon the transfer of these 20 shares came from the plaintiff's common stock book and had the words "Class A" written on the certificate in ink.

The plaintiff alleges that since the transfer of Banks' shares to R. E. Kirkland in 1944, all 180 shares of the "Class A" stock have been treated as voting common stock for all purposes. The six certificates originally having the words "Class A" written on their faces have been cancelled, the first on December 16, 1952, two more in January, 1953, and the remaining three on October 28, 1964, and the stock certificates issued in their places were the plaintiff's regular common stock certificates without the "Class A" designations. It is the plaintiff's contention that even if shares of the "Class A" non-voting common stock were ever validly issued, such shares were converted to voting common stock in 1944 or shortly thereafter.

In 1955, Barnes Motor & Parts Company of Raleigh, Inc. (the Raleigh Corporation) was organized as a subsidiary of the plaintiff to carry on the activities formerly carried on by the Raleigh branch of the plaintiff. Upon the organization of the Raleigh Corporation, its manager purchased 12½% of the stock, and the remaining 87½% was purchased by the plaintiff. The plaintiff owned 87½% of the Raleigh Corporation from July 1, 1955, until December 31, 1959. On that date the plaintiff acquired the remaining 12½% of the outstanding stock. It held 100% of the stock from December 31, 1959, until September 29, 1961, at which time it transferred 60% of the outstanding stock in the Raleigh Corporation to its stockholders. It transferred the remaining 40% of the stock to that corporation's new manager on or about June 25, 1962. Therefore, since June 25, 1962, the stockholders of the plaintiff have owned 60% of the outstanding stock of the Raleigh Corporation and its manager has owned the remaining 40%.

Following the enactment of the Small Business Corporations Act in 1958, the plaintiff decided to file an election under Subchapter S of the Internal Revenue Code. Prior to filing such an election, the plaintiff and its stockholders conferred with their accountant, who advised them that the plaintiff could properly make the Subchapter S election. The plaintiff then made a timely election to be treated as a small business corporation beginning with the taxable year 1958.

On or about February 18, 1963, R. E. Kirkland, one of the plaintiff's stockholders, died. Thereafter, on or about March 18, 1963, within the time prescribed by the Federal Tax Regulations, the executor of the estate of R. E. Kirkland filed with the office of the District Director of Internal Revenue in Greensboro a "Statement of Consent to Election by New Shareholders," whereby he consented to the corporation's election to be treated as a small business corporation. The remaining stockholders did not file a consent to the election in 1963 because they believed that the election made by the plaintiff for 1958 and subsequent years, to which they had already consented, constituted a valid and proper election and that no further action was necessary.

In 1964, the plaintiff organized another subsidiary corporation, Barnes Motor & Parts Company of Smithfield, Inc. (the Smithfield Corporation). Upon incorporation, the manager of the new subsidiary purchased 100 shares of stock, and the plaintiff purchased 350 shares. The manager's employment was terminated after about 1½ years, and, at this point, it was determined that the Smithfield Corporation should be liquidated as of the end of the calendar year 1965. Therefore, pursuant to a plan of liquidation, the plaintiff purchased the manager's stock on October 6, 1965. The assets of the Smithfield Corporation were transferred to the plaintiff, and Articles of Dissolution of the Smithfield Corporation were filed as of December 31, 1965.

The plaintiff has filed an information return, Form 1120-S, each year since 1958, and the returns have been accepted by the Internal Revenue Service until an audit in 1967. The stockholders reported their respective pro rata portions of the taxable income of the plaintiff on their individual federal income tax returns for each of the years after 1958 and paid the appropriate income tax thereon.

After examining the plaintiff's federal income tax returns for the taxable years ended December 31, 1963, December 31, 1964, December 31, 1965, and December 31, 1966, the Commissioner of Internal Revenue determined that the plaintiff's election in 1958 to be treated as a small business corporation under Subchapter S had not been a valid election because of the plaintiff's failure to meet the statutory requirements and that consequently the plaintiff was not entitled to be treated as a small business corporation for any of the taxable years under examination. Therefore, on or about April 12, 1968, deficiencies were assessed against the plaintiff in the following amounts:

                        Year       Income Tax       Interest         Total
                        1963        $20,076.84     $ 4,910.85     $ 24,987.69
                        1964         17,663.50       3,260.73       20,924.23
                        1965         26,814.03       3,341.10       30,155.13
                        1966         26,850.26       1,734.60       28,584.86
                                    __________     __________     ___________
                                    $91,404.63     $13,247.28     $104,651.91
                                    __________     __________     ___________
                

The plaintiff paid the assessed deficiencies and the interest on or about April 22, 1968, and, on or about August 12, 1968, within two years after payment of the assessments, filed a timely claim for refund of the amounts paid. On November 27, 1968, the Commissioner of Internal Revenue notified the plaintiff that all of the claim for refund had been disallowed in full. As a result of the Commissioner's denial of the claim for a refund, this action was brought to recover the deficiencies and interest paid in April 1968.

CONCLUSIONS OF LAW

Subchapter S of the Internal Revenue Code (26 U.S.C.A. §§ 1371 through 1377) was passed by Congress in 1958 to enable individuals operating a small business to minimize the importance of tax considerations in choosing a form of business organization. The statute does this by permitting certain small corporations to avoid the corporate tax and elect to "pass through" their earnings or net operating losses to...

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