Caruth v. US, Civ. A. No. 3-84-0877-R.

CourtUnited States District Courts. 5th Circuit. United States District Courts. 5th Circuit. Northern District of Texas
Writing for the CourtLouise P. Hytken, Dept. of Justice, Dallas, Tex., for defendant
Citation688 F. Supp. 1129
PartiesW.W. and Mabel P. CARUTH, and Caruth Corporation, Plaintiffs, v. UNITED STATES of America, Defendant.
Docket NumberCiv. A. No. 3-84-0877-R.
Decision Date20 October 1987

688 F. Supp. 1129

W.W. and Mabel P. CARUTH, and Caruth Corporation, Plaintiffs,
v.
UNITED STATES of America, Defendant.

Civ. A. No. 3-84-0877-R.

United States District Court, N.D. Texas, Dallas Division.

October 20, 1987.


688 F. Supp. 1130

Vester T. Hughes, Jr., David Sinak, David Kent, Cynthia Ohlenforst, Dallas, Tex., for plaintiffs.

Louise P. Hytken, Dept. of Justice, Dallas, Tex., for defendant.

MEMORANDUM OPINION

BUCHMEYER, District Judge.

This is an income tax case. It involves such exotic tax concepts as the "assignment of income" doctrine, the "economic realities" test, the "step-transaction" analysis, the business purpose requirement, and even an overworked horticultural metaphor.1

The plaintiffs are W.W. and Mabel Caruth. In 1978, they were majority stockholders in a closely held corporation, North Park Inn, and they were the sole stockholders of a separate company, the Caruth Corporation. On May 8, 1978, North Park declared a dividend of $1,500 per share — which was payable on May 17, 1978, to those who were shareholders of record on May 15, 1978. This opinion holds:

(i) That the Caruths are not required to pay income tax on the dividends for 1,000 shares of North Park stock which they donated to the Community Chest on May 9, 1978;
(ii) That the Caruths are not required to pay income tax on the dividends for 337.5 shares of North Park stock which they transferred to the Caruth Corporation, their wholly-owned company, on May 5, 1978.

The case was tried without a jury. This opinion constitutes the findings of fact and conclusions of law required by Rule 52, Fed.R.Civ.P.

I. THE FACTS

In April of 1978, W.W. and Mabel Caruth ("Caruth") owned the following shares of stock of North Park Inn, Inc. ("North Park"), a Texas corporation:

 Percentage of
                 Number of Ownership To
                Class of Stock Shares Owned Total Shares
                Common Stock 37.5 75%
                Class A Voting
                Common Stock 337.5 75%
                Class B Non-Voting
                Preferred Stock 1,000 100%
                Non-Voting
                (Callable at $100)
                

The remaining shares of Class A and Class B common stock of North Park were owned by Caruth's nephews, Harold Byrd and Caruth Byrd.2

In 1978, Caruth also owned 100% of the shares of the Caruth Corporation — which he had started almost 40 years before (his "first corporation") and which was an active business, with assets that included the Inwood Village Shopping Center in Dallas, a lumber company, a steel company, and two Florida hotels (Plantation Inn and Happy Dolphin Inn).3

For some time before April of 1978, Caruth had been thinking about having North Park declare dividends "in order to get money out of" this company. He planned to "wind down" the activities of North Park because the manager of the North Park Inn hotel was "about to die."4 Caruth

688 F. Supp. 1131
also wanted to buy the North Park shares held by his two nephews, but they had refused — and he hoped he might reach agreement with the nephews after they received a substantial dividend.5 And, on April 14, 1978, Caruth advised the Dallas Community Chest Trust Fund ("Community Chest") that he was "contemplating the gift of a substantial amount" of North Park stock.6

At the same time (April of 1978), Caruth was considering a "capital contribution" to the Caruth Corporation, which was having "more and more operations in Florida." Since the North Park operations were being "wound down," that company did not need cash reserves so Caruth knew he could make this "capital contribution" by giving North Park stock to the Caruth Corporation and having North Park declare a dividend.

Caruth did not get any legal advice from a tax specialist about these contemplated transactions. However, Caruth was knowledgeable about their tax consequences — he had an undergraduate degree in accounting and a masters degree from Harvard — and he was also aware of the possible, unfavorable impact of the "accumulated earnings tax" upon the capital reserves of North Park.

This, then, was the basic factual background in which the following events took place:

(i) On May 5, 1978, Caruth transferred his 337.5 shares of North Park Class B common stock (non-voting) to the Caruth Corporation.
(ii) On May 8, 1978, North Park declared a dividend of $1,500 per share, payable on May 17, 1978 to those who were shareholders of record on May 15, 1978.
(iii) On May 9, 1978, Caruth donated his 1000 shares of North Park preferred (non-voting) to the Community Chest.
(iv) On the dividend record date, May 15, 1978, the Community Chest was the shareholder of record of the 1000 shares of preferred stock of North Park; the Caruth Corporation was the shareholder of record of the 337.5 shares of Class B common stock; and Caruth remained the shareholder of record of the 37.5 shares of Class A common stock (voting) of North Park.

On May 17, 1978, the dividend payment date, North Park paid the dividends — which had been declared on May 8, 1978 — to the shareholders of record on May 15, 1978. Consequently, the Community Chest received a total dividend of $1,500,000 ($1500 per share for its 1000 shares of North Park stock) ... the Caruth Corporation received a total dividend of $506,250 ($1500 per share for its 337.5 shares) ... and W.W. Caruth received $56,250 ($1500 per share for his 37.5 shares).

Some two months later, on July 26, 1978, the Community Chest sent a letter to Caruth asking if he knew of someone who might buy the 1000 shares of non-voting preferred of North Park stock for the call price, $100 per share. Caruth had not made any agreement to repurchase this stock when it was donated to the Community Chest. However, on April 11, 1979, almost nine months after the Community Chest inquiry, Caruth wrote the Community Chest that, since he "didn't know of anyone else who is in the market for this stock and since the company is under my management," Caruth would repurchase the stock himself for $100,000.7 The 1000 shares of North Park were transferred back to Caruth for this amount.

688 F. Supp. 1132

In the Caruth tax return for 1978, the 1000 shares of North Park stock donated to the Community Chest were valued at $1,600,000 ($1,600 per share).8 The Internal Revenue Service objected, claiming that the dividend income on this stock should be attributed to Caruth because of the "assignment of income" doctrine. The IRS also took the position that the dividend income on the 337.5 shares of stock transferred to the Caruth Corporation should be attributed to Caruth, not to the corporation.9

On August 19, 1981, Caruth paid the deficiencies assessed by the IRS for the 1977 and 1978 tax years — $723,790.00 in taxes and $177,392.45 in interest.10 On December 19, 1981, Caruth timely filed claims for refund of these amounts.11 These were denied, and on May 31, 1984, Caruth filed this suit for refund of the taxes paid under protest.

II. THE DONATION OF STOCK TO THE COMMUNITY CHEST

The IRS contends that "assignment of income principles require that Caruth be taxed on $1,500,000 of dividend income paid to Community Chest with respect to the shares of North Park stock that Caruth transferred to Community Chest" on May 9, 1979, one day after the North Park dividend was declared. It also claims that the "economic realities test" dictates the same result because, after pruning away the corporate formalities, what remains is this: Caruth, as majority stockholder and director of North Park, manipulated the shareholder record date and the date of payment of the dividend, thereby substantially increasing the amount of his charitable contribution for the stock donated to the Community Chest.12

The Assignment of Income Doctrine

The "assignment of income doctrine" took root in Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731 (1930); it grew under Blair v. Commissioner, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465 (1937) and Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75 (1940); and it now covers a wide range of transactions.13 Under this doctrine, the assignment of the right to receive future income — without an accompanying transfer of the underlying asset — will not shift taxability of the income to the transferee.14

688 F. Supp. 1133

In this case, Caruth donated the 1,000 shares of North Park preferred to the Community Chest one day after North Park had declared the dividend (May 8, 1978), but before the dividend record date (May 15, 1978) or the dividend payment date (May 17, 1978). The IRS argues that, under the assignment of income doctrine, Caruth acquired an irrevocable right to the dividends when they were declared because he owned the North Park preferred; and because it was Caruth — acting as North Park director and majority stockholder — who caused the dividends to be declared and paid.

In response, Caruth argues that the transfer of the North Park preferred stock to the Community Chest took place before May 15, 1978, the shareholder record date set by the North Park directors; and that, therefore, when he donated this stock on May 9, 1978, Caruth had no legal right to the dividends, which were not to be paid until May 17, 1978.15 Accordingly, Caruth maintains that since he had no vested right to the dividends, there was no "assignment of income" when he transferred the North Park preferred stock to the Community Chest — despite the fact that, as controlling shareholder and director, he did determine that the dividends declared on May 8 were to be paid on May 17 to those who were shareholders of record on May 15, 1978.16

The leading case concerning a gratuitous assignment of dividend income is Estate of Putnam v. Commissioner, 324 U.S. 393, 65 S.Ct. 811, 89 L.Ed. 1023 (1945). There, the decedent owned stock in several corporations — which had declared dividends before his death, but which had set the shareholder record date for determining the recipient of the dividends for a date after his death. The issue was whether the dividends had "accrued" to the decedent/taxpayer prior to his death, within the meaning of...

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3 practice notes
  • Estate of Kluener v. C.I.R., No. 97-1201
    • United States
    • United States Courts of Appeals. United States Court of Appeals (6th Circuit)
    • November 10, 1998
    ...On the other hand, the same factors have led courts to find that a valid, non-tax business purpose exists. See Caruth v. United States, 688 F.Supp. 1129 (N.D.Tex.1987), aff'd on another issue, 865 F.2d 644 (5th Page 636 Cir.1989); Smalley v. Commissioner, 32 T.C.M. (CCH) 373 (1973). In Caru......
  • Caruth Corp. v. U.S., No. 88-1015
    • United States
    • United States Courts of Appeals. United States Court of Appeals (5th Circuit)
    • January 27, 1989
    ...with the taxpayer, reasoning that the taxpayer gave away an appreciated asset without ever himself realizing the appreciation upon it. 688 F.Supp. 1129 (N.D.Tex.1987). We affirm on the same This case is complicated, but its basic contours are easily described. The case involves the interact......
  • Estate of Kluener v. Commissioner, Docket No. 3867-95.
    • United States
    • United States Tax Court
    • November 25, 1996
    ...for the transfer is shown. Smalley v. Commissioner [Dec. 31,929(M)], T.C. Memo. 1973-85; Caruth v. United States [88-2 USTC ¶ 9514], 688 F. Supp. 1129, 1138-1142 (N.D. Tex. 1987), affd. on another issue [89-1 USTC ¶ 9172] 865 F.2d 644 (5th Cir. 1989).4 As we have noted, "The distinction bet......
3 cases
  • Estate of Kluener v. C.I.R., No. 97-1201
    • United States
    • United States Courts of Appeals. United States Court of Appeals (6th Circuit)
    • November 10, 1998
    ...On the other hand, the same factors have led courts to find that a valid, non-tax business purpose exists. See Caruth v. United States, 688 F.Supp. 1129 (N.D.Tex.1987), aff'd on another issue, 865 F.2d 644 (5th Page 636 Cir.1989); Smalley v. Commissioner, 32 T.C.M. (CCH) 373 (1973). In Caru......
  • Caruth Corp. v. U.S., No. 88-1015
    • United States
    • United States Courts of Appeals. United States Court of Appeals (5th Circuit)
    • January 27, 1989
    ...with the taxpayer, reasoning that the taxpayer gave away an appreciated asset without ever himself realizing the appreciation upon it. 688 F.Supp. 1129 (N.D.Tex.1987). We affirm on the same This case is complicated, but its basic contours are easily described. The case involves the interact......
  • Estate of Kluener v. Commissioner, Docket No. 3867-95.
    • United States
    • United States Tax Court
    • November 25, 1996
    ...for the transfer is shown. Smalley v. Commissioner [Dec. 31,929(M)], T.C. Memo. 1973-85; Caruth v. United States [88-2 USTC ¶ 9514], 688 F. Supp. 1129, 1138-1142 (N.D. Tex. 1987), affd. on another issue [89-1 USTC ¶ 9172] 865 F.2d 644 (5th Cir. 1989).4 As we have noted, "The distinction bet......

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