Abbott v. Commissioner of Internal Revenue, 12439

• Decision Date: 31 July 1958
• Docket Number: No. 12439,12440.,12439
• Citation: 258 F.2d 537
• Parties: J. D. ABBOTT and Kathryn Abbott, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Carl M. WOLFE and Mary E. Wolfe, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Third Circuit

258 F.2d 537 (1958)

J. D. ABBOTT and Kathryn Abbott, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Carl M. WOLFE and Mary E. Wolfe, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 12439, 12440.

United States Court of Appeals Third Circuit.

Argued April 15, 1958.

Decided July 31, 1958.

Harry Friedman, Washington, D. C. (Jerome C. Bachrach, Pittsburgh, Pa., on the brief), for petitioners.

Thomas N. Chambers, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Harry Baum, Attys., Dept. of Justice, Washington, D. C., on the brief), for respondent.

Before GOODRICH, McLAUGHLIN and STALEY, Circuit Judges.

STALEY, Circuit Judge.

Two issues are presented by these consolidated petitions to review decisions of the Tax Court. The primary issue is whether the gain realized by taxpayers on the liquidation of their corporation is capital gain, or ordinary income under the "collapsible corporation" provisions of Section 117(m) of the Internal Revenue Code of 1939, as amended, 26 U.S.C. § 117(m). A secondary issue poses the question of whether the penalty under Section 294(d) (2) for substantial underestimation of tax may be assessed in addition to the penalty under Section 294 (d) (1) (A) for failure to file a declaration of estimated tax.

In these cases the respondent Commissioner determined deficiencies in petitioners' income tax and additions for the year 1950, as follows:

                                                         Additions to Tax
                                     Deficiencies  § 294(d)(1)(A)  § 294(d)(2)
                  J. D. Abbott and
                  Kathryn Abbott      $57,031.00        ----           ----
                  Carl M. Wolfe and
                  Mary E. Wolfe        12,175.26     $1,923.19      $1,153.91
                

The Tax Court sustained the respondent's deficiency determinations, finding that petitioners' corporation was a "collapsible" corporation within the purview of Section 117(m) of the Code, and also sustained the imposition of both additions to petitioner Wolfe's tax. 1957, 28 T.C. 795. This decision was reviewed by the full Tax Court.

In late August, 1948, petitioner Wolfe and three others organized the Leland Corporation for the stated objectives of buying, selling, mortgaging, and otherwise managing improved and unimproved land, and generally the carrying on of a building and construction business. Wolfe owned 20% of the stock of Leland. Petitioner Abbott was a named incorporator, but not an original shareholder.

Abbott was engaged in a mortgage business carried on through two corporations.

Leland Corporation acquired a little more than one hundred acres of land in four purchases from September, 1948, to March, 1950. The total of the purchase price was $75,409.55, slightly more than $752 an acre. In May, 1949, Leland, considering the development of part of its land for single family residences, contracted for the installation of streets and sewers in its Plan No. 1.

Leland's Plan No. 2 provided for apartment sites and comprised 15.82 acres. This tract was sold in late October, 1949, at a gain of $23,472.75.

On November 19, 1949, Abbott acquired 75% of Leland's stock and thereafter became its controlling influence. Wolfe owned the remaining 25%.

The events which followed were recounted in the findings of the Tax Court:

"On February 15, 1950, petitioners contracted with Catarinella to sell 3 plots of land to erect apartment buildings. Petitioners agreed to `cause\' the land to be conveyed to Catarinella. Petitioners further agreed to `cause\' installation of streets, sewers, and utilities, as shown on the plan, within 1 year after an F.H.A. insurance commitment was obtained. The buyer agreed to furnish to Abbott\'s corporation all required information and material for F.H.A. mortgage insurance applications. The parties agreed that the purchase price should be immediately paid into escrow pending F.H.A. approval, after which the fund would be so held to pay for street and sewer improvements. Petitioners agreed to contract for the construction of these improvements within 60 days after F.H.A. approval was obtained. The parties conditioned the agreement on F.H.A. approval of these sites and the agreement recited that petitioners contemplated that all land in the plan would be similarly developed for apartments through F.H.A. financing.

"On February 15, 1950, petitioners contracted with a group headed by Young to sell 2 plots. The terms and provisions of this agreement conformed to those of the agreement with Catarinella.

"Young and Catarinella deposited $64,350 and $80,300, respectively, with Potter Title and Trust Company, hereafter referred to as the trust company, to be held in escrow as provided in the agreements of February 15, 1950.

"On February 21, 1950, Leland purchased 3.356 acres of land from the Baldwin School District needed to complete the plot which petitioners had agreed to sell to Catarinella 6 days previously. Leland had previously owned the remainder of the land.

"On March 6, 1950, Leland purchased 4.010 acres of land from Schwotzer. Petitioners ultimately deeded this land on July 10, 1950.

"On May 8, 1950, Leland and the township entered an agreement whereby Leland, in consideration of the approval of `Leland Heights Plan No. 3\' for recording purposes, agreed to construct the streets, sewers, and improvements shown on the entire plan according to the rules and regulations of the township. Leland further agreed to deposit $120,000 in escrow with the trust company for the completion of these improvements. Simultaneously, Leland executed a bond guaranteeing performance of its contract with the township. Petitioners signed these agreements as officers of Leland. On May 10, 1950, the trust company notified the township and the F.H.A. that it held in escrow more than $120,000 to be used for street and sewer improvements in Plan No. 3 under the contract between Leland and the township. That fund consisted of the moneys previously deposited by Young and Catarinella under the agreements with petitioners."

On May 13, 1950, before the sale of the land under the February contracts had been consummated, Leland's two stockholders voted to dissolve the corporation. They received in liquidation 84.438 acres of land, which included the land in Plan No. 3. The gain realized by Abbott through the increased market value of the land was $143,907.34; Wolfe realized a gain of $47,969.11. The gain on the liquidation of Leland was reported by the taxpayers as a long-term capital gain.

After part of the land had been conveyed to petitioners individually, they contracted in their individual capacities for the installation of streets, storm sewers, and sanitary sewers, pursuant to their several agreements. Improvements made by petitioners between May 29, 1950, and December 31, 1950, totaled $145,967.02. Most of the money in escrow was used to finance these improvements.

In several other separate transactions, taxpayers sold 35 acres of the land covered by F.H.A. commitments for a total price of $435,350. They received an average of $8,800 an acre for the land approved for F.H.A. financing or dedicated to public use. The increase in the land's value reflected the improvements made.

The Commissioner treated the gain to petitioners on liquidation of Leland as ordinary income within the "collapsible corporation" provisions of Section 117 (m). That section was added to the Code of 1939 to prevent the use of the corporate facade for the conversion of ordinary income into capital gain, and reads in part as follows:

"(m) Collapsible corporations.

"(1) Treatment of gain to shareholders. Gain from the sale or exchange (whether in liquidation or otherwise) of stock of a collapsible corporation, to the extent that it would be considered (but for the provisions of this subsection) as gain from the sale or exchange of a capital asset held for more than 6 months, shall, except as provided in paragraph (3),¹ be considered as gain from the sale or exchange of property which is not a capital asset.

"(2) Definitions.

"(A) For the purposes of this subsection, the term `collapsible corporation\' means a corporation formed or availed of principally for the manufacture, construction, or production of property, for the purchase of property which (in the hands of the corporation) is property described in subsection (a) (1) (A), for the holding of stock in a corporation so formed or availed of, with a view to —

"(i) the sale or exchange of stock by its shareholders (whether in liquidation or otherwise), or a distribution to its shareholders, prior to the realization by the corporation manufacturing, constructing, producing or purchasing the property of a substantial part of the net income to be derived from such property, and

"(ii) the realization by such shareholders of gain attributable to such property.

"(B) For the purposes of subparagraph (A), a corporation shall be deemed to have manufactured, constructed, produced, or purchased property, if —

"(i) it engaged in the manufacture, construction, or production of such property to any extent, * * *"

In sustaining the Commissioner's position that Leland was a "collapsible corporation," the Tax Court found that:

"When Leland distributed the land to petitioners, it had not realized a substantial part of the net income to be derived from the property.

"Leland was formed or availed of principally for the manufacture, construction, or production of property, with a view to (1) a distribution to petitioners, prior to the realization by Leland of a substantial part of the net income to be derived from the property; and (2) the realization by petitioners of the gain attributable to the property."

These findings are vigorously controverted by petitioners.

The tax avoidance device at which the "collapsible corporation" provisions of Section 117(m) were aimed operates as follows: The taxpayer organizes or makes use of a corporation to create the appearance of long-term capital gain in what is...