Clark v. Comm'r of Internal Revenue

Decision Date06 February 1986
Docket NumberDocket No. 9428-83.
Citation86 T.C. No. 10,86 T.C. 138
CourtU.S. Tax Court


BASIN was merged into NL, a publicly held company, under a plan of reorganization which satisfied the requirements of sections 368(a)(1)(A) and (a)(2)(D), I.R.C. 1954. Petitioner husband as sole shareholder of BASIN received stock and cash in exchange for his stock in BASIN. The cash constituted ‘boot‘ under section 356(a)(1), I.R.C. 1954. HELD the distribution of the ‘boot‘ did not have the effect of a dividend under section 356(a)(2), I.R.C. 1954. The test of Wright v. United States, 482 F.2d 600 (8th Cir. 1973), rather than the test of Shimberg v. United States, 577 F.2d 283 (5th Cir. 1978) applied. Walter B. Slocombe, Daniel B. Rosenbaum and Daniel M. Davidson, for the petitioners.

Kathleen E. Whatley, for the respondent.


Respondent determined a deficiency in petitioners' Federal income taxes for the taxable year 1979 of $972,504.74. The sole issue for decision is whether the receipt by petitioners of cash (‘boot‘) as partial consideration under a plan of reorganization pursuant to section 368(a)(1)(A) and (a)(2)(D), 1 should be treated as a dividend pursuant to section 356(a)(2), instead of long-term capital gain under section 356(a)(1).


Some of the facts have been stipulated and are so found. This reference incorporates the stipulation of facts and attached exhibits.

Petitioners, husband and wife, resided in Buckhannon, West Virginia, at the time they filed their petition in this case. They timely filed a joint Federal income tax return for the calendar year 1979 with the Internal Revenue Service Center in Memphis, Tennessee.

For some time prior to April 18, 1979, petitioner husband Donald E. Clark (hereinafter referred to as petitioner) owned all the outstanding stock (58 shares) of Basin Surveys, Inc. (‘BASIN‘), a West Virginia corporation. BASIN's principal business was furnishing radiation, nuclear, and electronic open-hole logging services to the petroleum industry. Petitioner was the president of BASIN from 1964 until April 18, 1979.

N.L. Industries, Inc. (‘NL‘) is a New Jersey corporation engaged in the manufacturing and supplying of petroleum equipment and services, chemicals and metals. NL is a publicly held corporation whose stock is traded on the New York Stock Exchange and the Pacific Stock Exchange. As of the end of March 1979, NL had outstanding approximately 32,533,000 shares of its single class of common stock (par value $2.50 per share) and 500,000 shares of preferred stock. N.L. Acquisition Corp. (‘NLAC‘) was a wholly owned subsidiary of NL.

In 1978, NL initiated discussions with petitioner regarding the possible acquisition of BASIN by NL. After several months of negotiations, on March 6, 1979, NL offered petitioner a choice between two alternatives: in exchange for petitioner's BASIN stock, NL was willing to give petitioner either (1) 425,000 shares of NL common stock and no cash, or (2) a combination of 300,000 shares of common stock and $3,250,000 cash. Petitioner accepted NL's combined stock and cash offer. By accepting this offer, the total number of NL common shares outstanding increased to approximately 32,833,000 shares, and petitioner's stockholdings represented approximately .92 percent of that total. If petitioner had accepted the all stock deal of 425,000 shares, the total number of NL common shares outstanding would have increased to approximately 32,958,000 shares, and petitioner's stockholdings would have represented approximately 1.3 percent of that total.

On April 3, 1979, an Agreement and Plan of Merger (the ‘Plan‘) was executed by BASIN, NLAC, petitioner and NL. The Plan provided that on April 18, 1979, BASIN would merge with and into NLAC and that each outstanding share of NLAC would remain outstanding, each outstanding share of BASIN common stock would be exchanged for $56,034.482 cash and 5,172.4137 shares of NL common stock, and each share of BASIN common stock held in the treasury of BASIN would be cancelled. The Plan further provided that the articles of incorporation of NLAC would be amended to change its name to Basin Surveys, Inc. Moreover, pursuant to the plan, petitioner signed a covenant not to compete for five years and an employment agreement to remain with Basin Survey, Inc. for three years.

For the purposes of this case, the parties agree that the merger of BASIN into NLAC (the ‘Merger‘) was effected pursuant to, and qualified as a reorganization under, section 368(a)(1)(A) and (a)(2)(D). The closing price of NL common stock on the New York Stock Exchange on April 18, 1979 was $23- 1/8 per share. Based on that closing price, the NL stock received by petitioner had a value of $6,937,500 which constituted 68.1 percent of the total value of the consideration which petitioner received for his BASIN stock. Prior to the Merger, petitioners did not own any stock in NL or NLAC.

Petitioner's basis for his BASIN stock immediately prior to the Merger, was $84,515. He incurred expenses of $25,013 in connection with the Merger. In their joint Federal income tax return for 1979, petitioners reported recognition of $3,195,294 of long-term capital gain as a result of the Merger. As of April 18, 1979, BASIN had accumulated undistributed earnings and profits of $2,319,611, and total assets of $2,758,069 and liabilities of $808,132. Among its assets were $138,490 in cash, $1,231,552 in trade notes and accounts receivable (after allowance for bad debts) and buildings and other fixed depreciable assets with a book value net of accumulated depreciation of $929,306.


The issue for decision is whether the cash (‘boot‘) received by petitioner had the effect of a dividend under section 356(a)(2), and should therefore be taxed as ordinary income. Resolution of this issue requires us to choose between two judicially-articulated tests (the so-called Wright test, Wright v. United States, 482 F.2d 600 (8th Cir. 1973), and the so-called Shimberg test, Shimberg v. United States, 577 F.2d 283 (5th Cir. 1978)), in interpreting what is, at best, an ambiguous statute. Respondent argues that we should choose the Shimberg test and treat the $3,250,000 cash payment as if it constituted a distribution in redemption of stock by the ACQUIRED corporation (BASIN) prior to, and separate from, the Merger. If this is our choice, then, according to respondent, since the redemption fails to satisfy the requirements of either section 302(b)(1) or (b)(2), the cash payment should be treated as a dividend from BASIN under section 356(a)(2) to the extent of its earnings and profits ($2,319,611), and as capital gain in respect of the excess. 2 Petitioner, on the other hand, urges us to choose the Wright test and treat the cash payment as a distribution by the ACQUIRING corporation (NL) in a hypothetical redemption of the shares of NL stock that would have been received if petitioner had accepted stock in lieu of the cash consideration under the all stock alternative available to him. Petitioner then argues that such a redemption would have resulted in a meaningful or substantially disproportionate reduction in petitioner's stock interest in NL and that consequently, the entire $3,250,000 cash payment should be treated as a payment in exchange for NL stock, under section 302(a), 3 taxable as capital gain under section 356(a)(1). For the reasons hereinafter set forth, in the context of this case, we agree with petitioners.

The issue of choice is not a novel one, although as will subsequently appear, the number of judicial precedents is limited. It has spawned a large number of articles and commentaries of both an historical and analytical nature 4 dealing with the proper test to be used in applying section 356 to acquisitive reorganizations. 5 While we deem it unnecessary to lay out a detailed, evolutionary history, a brief review of the statutory provisions and their historical genesis appears to be in order as a prerequisite to understanding the parameters of the choice we are called upon to make.

Sections 354 and 356 provide the tax treatment to be afforded shareholders of corporations which are parties to reorganizations qualifying as such under section 368(a)(1). Specifically, under section 354(a)(1)

No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, EXCHANGED SOLELY FOR THE STOCK OR SECURITIES IN SUCH CORPORATION OR IN ANOTHER CORPORATION A PARTY TO THE REORGANIZATION. (Emphasis added)

In situations in which the reorganization is not a straight stock for stock deal, but instead includes some additional consideration, the Internal Revenue Code (the ‘Code‘) does not simply recategorize the entire transaction as a taxable exchange. Rather, it provides for a limited recognition of gain under section 356(a)(1)

(1) Recognition of gain.—If—

(A) section 354 or 355 would apply to an exchange but for the fact that

(B) the property received in the exchange consists not only of property permitted by section 354 or 355 to be received without the recognition of gain but also of other property or money,

then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

This gain is to be treated as a capital gain unless the exchange qualifies for dividend treatment under section 356(a)(2), which provides— If an exchange is described in paragraph (1) but HAS THE EFFECT OF THE DISTRIBUTION OF A DIVIDEND *** then there shall be treated as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The...

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4 cases
  • Durkin v. Comm'r of Internal Revenue (In re Estate of Durkin)
    • United States
    • U.S. Tax Court
    • November 18, 1992
    ...of his case. We held that, as in Zenz, the transaction may be taxed in the form chosen by the taxpayer. See also Clark v. Commissioner, 86 T.C. 138, 151–152 (1986), affd. 828 F.2d 221 (4th Cir.1987), affd. 489 U.S. 726 (1989). Section 302(b)(3) provides that a redemption is not treated like......
  • Commissioner of Internal Revenue v. Clark, 87-1168
    • United States
    • U.S. Supreme Court
    • March 22, 1989
    ...a deficiency of $972,504.74. Respondents petitioned for review in the Tax Court, which, in a reviewed decision, held in their favor. 86 T.C. 138 (1986). The court started from the premise that the question whether the boot payment had "the effect of the distribution of a dividend" turns on ......
  • Tribune Pub. Co. v. U.S.
    • United States
    • U.S. Court of Appeals — Ninth Circuit
    • January 6, 1988
    ...if I.R.C. Sec. 356 does apply, we need not address the difficult question of when boot should be treated as dividend. See Clark v. Commissioner, 86 T.C. 138, 140 (1986), aff'd, 828 F.2d 221 (4th Cir.1987) (comparing Shimberg v. United States, 577 F.2d 283 (5th Cir.1978), cert. denied, 439 U......
  • Clark v. C.I.R.
    • United States
    • U.S. Court of Appeals — Fourth Circuit
    • September 4, 1987
    ...Tax Court. In a unanimous reviewed opinion, the Tax Court held that the corporate boot should be treated as a capital gain. Clark v. Commissioner, 86 T.C. 138 (1986). The Commissioner According to Sec. 356(a)(2), cash received during a reorganization is considered ordinary income if it has ......
1 books & journal articles
  • The correct E&P for measuring Sec. 356(a) (2) dividend income.
    • United States
    • The Tax Adviser Vol. 24 No. 7, July 1993
    • July 1, 1993
    ...AFTR2d 89-860, 89-1 USTC [paragraph] 9230), aff'g 828 F2d 221 (4th Cir. 1987) (60 AFTR2d 87-5592, 87-2 USTC [paragraph] 9504), aff'g 86 TC 138 (1986). (4) Regs. Sec. 1.381(c)(2)-1(c). (5) Rev. Ruls. 71-364, 1971-2 CB 182; 72-327, 1972-2 CB 197; and 72-498, 1972-2 CB 516. (6) Rev. Rul. 70-24......

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