Carrington v. CIR

• Decision Date: 23 April 1973
• Docket Number: No. 72-1644.,72-1644.
• Citation: 476 F.2d 704
• Parties: Walter R. CARRINGTON and Ada Raye Carrington, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

476 F.2d 704 (1973)

Walter R. CARRINGTON and Ada Raye Carrington, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 72-1644.

United States Court of Appeals, Fifth Circuit.

April 23, 1973.

Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, Richard Farber, Attys., Tax Div., Dept. of Justice, Lee H. Henkel, Jr., Acting Chief Counsel, Chris J. Ray, Atty., Internal Revenue Service, Washington, D. C., for respondent-appellant.

E. Richard Criss, Jr., Austin, Tex., for petitioners-appellees.

Before BROWN, Chief Judge, and MOORE^* and RONEY, Circuit Judges.

MOORE, Circuit Judge:

This is an appeal by the Commissioner of Internal Revenue (the Commissioner) from a decision of the Tax Court (C. Moxley Featherston, Judge)¹ that there was no deficiency in the Federal income tax for the taxable year 1966 paid by appellees, Walter R. Carrington and Ada Raye Carrington (collectively referred to as Carrington). The tax deficiency assessed was $5,573.71 and was based upon the Commissioner's increase in Carrington income of $10,959.80, which the Commissioner claimed was an unreported dividend. In his deficiency notice, the Commissioner asserted that "redemption by Cardinal Construction Company of 51 shares of its stock which you had contributed to St. Matthews Episcopal Church was equivalent to a dividend to you of $10,959.80 in 1966."

The background facts are not complicated. Carrington was a member of the vestry, the governing body, of the Church and a member of a committee created for the purpose of acquiring a new rectory. Carrington was the sole stockholder of two corporations, Cardinal Construction Company (Cardinal) and Day Realty Company (Day). Cardinal and Day as a partnership (Cardinal-Day Enterprises) owned a residence suitable for a rectory.

The stipulation of facts states:

The purpose of the various integrated transactions involving the real property described in paragraph 9, above, was to place the property in the hands of St. Matthews Episcopal Church at the maximum tax benefit to petitioners, Walter R. Carrington and Ada Raye Carrington. (Par. 16, Appendix at 26.)

As the Tax Court recognized, there were several ways in which the transaction could have been handled, each with its own tax consequences. Carrington "was entitled to choose the method most favorable to him tax-wise. Gregory v. Helvering, 293 U.S. 465, 469 55 S.Ct. 266, 79 L.Ed. 596 (1935); Granite Trust Co. v. United States, 238 F.2d 670, 675 (1st Cir. 1956)."²

The method selected was as follows:

On December 19, 1966, Carrington transferred fifty-one of the one hundred outstanding shares of Cardinal stock, of which he was the owner, to the Church.

On December 23, 1966, Cardinal-Day conveyed the residence to Cardinal subject to an outstanding mortgage of $30,600.

On December 27, 1966, Cardinal redeemed the fifty-one shares of its stock held by the Church and, as consideration therefor, conveyed the residence subject to the mortgage to the Church.³ The value (undisputed) of the residence was $41,559.80. The equity ($41,559.80 less the mortgage of $30,600) accounts for the $10,959.80 which the Commissioner claims was dividend income chargeable to Carrington.

Cardinal did not reissue the fifty-one shares and on June 30, 1967, Cardinal was liquidated.

The Commissioner argues that Carrington's gift of stock "although complete in form, must be disregarded for tax purposes because it was merely an intermediate step in the taxpayer's overall plan" to transfer the residence to the Church "without the imposition of a dividend tax on the distribution" (Gov't Br. at 9). In other words, because several steps were required to accomplish the transfer, the Commissioner would regard the redemption as if made while Carrington was the owner of all the Cardinal stock.

There is no doubt that in any "step transaction" situation careful analysis of the transaction as a whole must be made to distinguish between proper tax avoidance and illegal tax evasion.

The Commissioner argues that to arrive at the "substance" of this transaction we should refuse to recognize the transfer of the Cardinal stock to the Church and the subsequent redemption of that stock eight days later. Having done this, says the Commissioner, the exchange of the fifty-one shares for the rectory may then be regarded as a redemption by Carrington, the sole Cardinal shareholder, which distribution, under United States v. Davis, 397 U.S. 301, 307, 90 S.Ct. 1041, 25 L.Ed.2d 323 (1970) would be included in Carrington's gross income for 1966.

Kanawha Gas & Util. Co. v. Commissioner, 214 F.2d 685 (5th Cir. 1954) contains a frequently cited exposition of the problems posed by a transaction which has involved a "step transaction".

In determining the incidence of taxation, we must look through form and search out the substance of a transaction. citations omitted This basic concept of tax law is particularly pertinent to cases involving a series of transactions designed and executed as parts of a unitary plan to achieve an intended result. Such plans will be viewed as a whole regardless of whether the effect of so doing is imposition of or relief from taxation.

214 F.2d at 691

See also Commissioner v. Court Holding Co., 324 U.S. 331, 334, 65 S.Ct. 707, 89 L.Ed. 981 (1945).

It is, of course, elementary that Carrington had "the legal right * * * to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits * * *." Gregory v. Helvering, supra, 293 U.S. at 469, 55 S. Ct. 266 at 267; Knetsch v. United States, 364 U.S. 361, 365, 81 S.Ct. 132, 5 L.Ed.2d 128 (1960); Rupe Investment Corp v. Commissioner, 266 F.2d 624, 629 (5th Cir. 1959). Thus the mere fact that the transactions here questioned were concededly designed to limit Carrington's tax liability establishes nothing with regard to the question of the proper taxation of these transactions.

There have been several cases which have presented situations analogous to that which we face here. In Stuart A. Rogers, 38 T.C. 785 (1962), the taxpayer made a gift to a church of a $10,000 equity in a stand of timber. As an accommodation to the church, the taxpayer arranged the sale of the church's timber in conjunction with his sale of other timber. In deciding that the taxpayer had received no income from this sale of the church's timber, the Tax Court said:

The test seems to be simple: Did the donor part with title to the property producing the income? If he did, then the sale by the donee does not result in taxation to the donor.

* * * * * *

This gift, when delivered and accepted, gave the donee the indefeasible right to the first $10,000 to be realized from the timber stand. * * * The subsequent sale thereof does not cause realization of income by him. 38 T.C. at 789

In Rogers, supra, the Tax Court relied in part on our holding in Campbell v. Prothro, 209 F.2d 331 (5th Cir. 1954). In that case one hundred calves were donated to a charitable organization without actually being separated from the taxpayer's remaining cattle. Upon the sale of all of these cattle, the proceeds from the sale of the donated cattle were paid to the donee. The Commissioner contended that these proceeds should be treated as income to the taxpayer-donor. Even though there was some doubt in that case as to whether there had been a bona fide gift,⁴ this Court held that the taxpayer had not received income. 209 F.2d at 336.

Two cases involving complete liquidations of corporations are also instructive of the law in this area. Jacobs v. United States⁵ and Winton v. Kelm⁶ each involved the donation of corporate stock to charity immediately prior to payment of a liquidating dividend. In both cases the gifts were held to be effective and thus the taxpayers were found to have received no income from the liquidating dividend paid on the donated shares. Apt v. Birmingham⁷ concerned a gift of shares to a taxpayer's wife just seven days prior to the distribution of a liquidating dividend. In that case, too, the Commissioner urged that "under the realities of the situation" there was no gift of stock, but only of the distribution in liquidation. 89 F.Supp. at 368 (emphasis added). In each of these cases the Commissioner's argument that the gift step of the transaction should be ignored failed to persuade the courts. Other courts have also rejected this argument of the Commissioner in similar cases. Sheppard v. United States, 361 F.2d 972, 176 Ct.Cl. 244 (1966) (donation of interests in racing horse); Humacid Co., 42 T.C. 894 (1964) (contribution of promissory notes); White v. Brodrick, 104 F.Supp. 213 (D.Kan.), appeal dismissed 198 F.2d 751 (10th Cir. 1952) (donation of grain); Elsie SoRelle, 22 T.C. 459, 475-479 (1954) (gifts of land on which crops had been planted); Mamie F. Farrier, 15 T.C. 277, 283-284 (1950) (gift of cattle).

The Commissioner suggests that United States v. General Geophysical Co.⁸ and Crenshaw v. United States⁹ in this Circuit should control our decision in this case.

General Geophysical concerned the propriety of a stepped-up basis for certain depreciable assets. Two of Geophysical's major stockholders redeemed their shares for depreciable assets with a tax basis of $169,290. Later the same day these assets were sold back to the corporation for their fair market value of $746,525. Judge Wisdom's opinion in that case pointed out that:

The facts of these transactions will not support a holding that the corporation had terminated its ownership * * *. It parted with bare legal title to the property for a few short hours. It made no physical delivery of any of the assets. Its control and use of the property were never interrupted. 296 F.2d at 89

The Court denied the corporation a stepped-up basis for its assets. This case is distinguishable from the instant case not only because the facts establish that there was no bona fide loss of dominion and control by the corporation, but...