Cox v. Comm'r of Internal Revenue
| Decision Date | 15 June 1982 |
| Docket Number | Docket No. 10115-78. |
| Citation | 78 T.C. 1021 |
| Parties | RUFUS K. COX, JR., and ETHEL M. COX, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioners owned 100 percent of the stock of RCI and New Roanoke. On Jan. 2, 1974, petitioners sold all of their New Roanoke stock to RCI in exchange for five notes, in the amount of $20,000 each, payable beginning in 1975. RCI had no earnings and profits at the time. Petitioners realized $98,000 long-term capital gain from the transaction. Held, sec. 304(a)(1), I.R.C. 1954, recast the stock sale as a contribution to capital followed by a redemption distribution to which sec. 301 applies and thus no “sale” took place under sec. 453. Held, further, sec. 301(c)(3)(A) only characterizes the income from a distribution in excess of earnings and profits and a shareholder's stock basis, it does not provide a sale. Because all distributions are to be accounted for identically, petitioners must report their entire gain in 1974. Charles H. Burton and Robert J. Tyrrell, for the petitioners.
Richard F. Stein, for the respondent.
By letter dated June 5, 1978, respondent has determined a deficiency of $12,428 in petitioners' 1974 Federal income taxes. After concessions, the sole issue for decision is whether petitioners are entitled to elect to report their gain from a sale1 of stock under section 453.2
This case was submitted without trial pursuant to Rule 122, Tax Court Rules of Practice and Procedure. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Petitioners Rufus K. Cox, Jr., and Ethel M. Cox, husband and wife, resided in Roanoke, Va., when they filed their petition herein. Petitioners' 1974 joint Federal income tax return was filed with the Internal Revenue Service Center, Memphis, Tenn., and used the cash method of tax accounting.
On December 28, 1968, Rudy Cox, Inc., Realtors (hereinafter RCI) was incorporated. RCI is engaged in the real estate business. Petitioner Rufus K. Cox, Jr., has owned 100 percent of RCI's stock since the date of incorporation.
Until January 2, 1974, petitioners owned, as tenants by the entirety, 100 percent of the stock of New Roanoke Investment Corp. (hereinafter New Roanoke).
Petitioner Rufus K. Cox, Jr., had a drawing account with RCI. As of December 31 of 1972, 1973, 1974, and 1975, the balances of this account were as follows:
+--------------------------+
¦Date ¦Amount ¦
+--------------+-----------¦
¦ ¦ ¦
+--------------+-----------¦
¦Dec. 31, 1972 ¦$123,041.04¦
+--------------+-----------¦
¦Dec. 31, 1973 ¦56,260.43 ¦
+--------------+-----------¦
¦Dec. 31, 1974 ¦36,623.53 ¦
+--------------+-----------¦
¦Dec. 31, 1975 ¦18,403.37 ¦
+--------------------------+
On September 7, 1973, petitioner Rufus K. Cox, Jr., assumed $110,000 of an indebtedness of RCI, which reduced his drawing account balance with RCI by that amount. On December 28, 1973, petitioners executed ten $11,000 promissory notes to RCI, one note being payable in each of the succeeding 10 years. Interest on each note was 8 percent annually. These notes were given in exchange for 4.86 acres of land previously transferred to petitioners by RCI.
On January 2, 1974, petitioners transferred their stock in New Roanoke to RCI in exchange for five promissory notes, in the amount of $20,000 each, from RCI. These notes were payable over a 5-year period. One note was due each year on January 2, the first note being due on January 2, 1975, and the last note on January 2, 1979. Each note provided an annual interest rate of 5 percent. On April 30, 1975, New Roanoke merged into RCI.
On January 2, 1974, petitioners' basis in their New Roanoke stock was $1,000. At that time, petitioner Rufus K. Cox, Jr.'s basis in his RCI stock was $1,000. As of January 2, 1974, RCI had no earnings and profits.
On their 1974 return, petitioners elected to report the gain3 from the sale of the New Roanoke stock on the installment method. Petitioners reported no payments received in 1974 and thus no gross income in that year from the sale of the New Roanoke stock. Petitioners have reported gains from this sale on their 1975, 1976, and 1977 Federal income tax returns.
In the notice of deficiency issued to petitioners, respondent stated:
It has been determined that on January 2, 1974, you realized a long-term capital gain of $99,000 from the receipt of five promissory notes of $20,000 each, issued by Rudy Cox, Inc. Realtors, and that such long-term capital gain is includible in your income for the taxable year ended December 31, 1974.
Respondent maintains that petitioners are not entitled to report this gain under section 453 because the transfer of the New Roanoke stock to RCI, by reason of the application of sections 304 and 302, was not a “casual sale” as required by section 453(b)(1)(B), prior to its amendment by the Installment Sales Revision Act of 1980, Pub. L. 96-471, 94 Stat. 2247, which provided that income from a casual sale of personal property for a price exceeding $1,000 may be returned on the installment method. Petitioners argue that they are entitled to report the gain on the installment basis for two reasons: (1) The transaction was in form a sale and because sections 302 and 304 apply only to determine the amount and character of the resultant income, they do not change that form, and (2) because section 301(c)(3)(A) treats their gain as “gain from the sale or exchange of property,” section 453(b)(1)(B) is satisfied.4
In order to provide a clearer understanding of the parties' arguments, it is necessary to travel through the statutory framework provided in sections 301, 302, 304, 316, and 318.
Section 304(a)(1) provides:
SEC. 304. REDEMPTION THROUGH USE OF RELATED CORPORATIONS.
then * * * such property shall be treated as a distribution in redemption of the stock of the corporation acquiring such stock. In any such case, the stock so acquired shall be treated as having been transferred by the person from whom acquired, and as having been received by the corporation acquiring it, as a contribution to the capital of such corporation.
Section 304(c)(1) defines “control” as the ownership of stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote, or at least 50 percent of the total value of shares of all classes of stock. The constructive ownership rules of section 318 apply in determining control. Sec. 304(c)(2).
Prior to the sale, petitioners were in control of both New Roanoke and RCI. Indeed, each petitioner, under the rules of sections 304 and 318, is deemed to have owned 100 percent of each corporation.5 Section 304(a)(1) thus applies to the sale, and the RCI notes are treated as a distribution in redemption of RCI stock. Therefore, section 302(b) must be addressed to determine whether this distribution is to be treated as a distribution under section 301, pursuant to section 302(d), or payment in exchange for the stock, pursuant to section 302(a). Section 304(b)(1) states that in testing the transaction under section 302(b), the determination must be made with reference to the stock of the “issuing corporation,” i.e., the New Roanoke stock.
After the sale to RCI, both petitioners still owned 100 percent of New Roanoke; petitioner Rufus K. Cox, Jr., by reason of his 100-percent ownership of RCI (sec. 318(a)(2)(C)), and petitioner Ethel M. Cox, by reason of the stock ownership of her husband (sec. 318(a)(1)(A)(i)).6 Therefore, the redemption failed to satisfy any of the tests of section 302(b) and is a distribution to be treated under section 301. See United States v. Davis, 397 U.S. 301 (1970).
Section 301(a) states that a distribution of property made by a corporation to its shareholder with respect to its stock shall be treated as provided in section 301(c). Section 301(c) provides the rules for the amount taxable to the shareholder: 7
SEC. 301(c). AMOUNT TAXABLE .—-In the case of a distribution to which subsection (a) applies—-
(1) AMOUNT CONSTITUTING DIVIDEND .—-That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income.
(2) AMOUNT APPLIED AGAINST BASIS .—-That portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock.
(3) AMOUNT IN EXCESS OF BASIS .—-
(A) IN GENERAL .—-Except as provided in subparagraph (B), that portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or exchange of property.
Section 316 defines a dividend as follows:
SEC. 316(a). GENERAL RULE. —-For purposes of this subtitle, the term “dividend” means any distribution of property made by a corporation to its shareholders—-
(1) out of its earnings and profits accumulated after February 28, 1913, or
(2) out of its earnings and profits of the taxable year (computed as of the close of the taxable year without dimunition by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.
Section 304(b)(2)(A) guides us to the earnings and profits of RCI, the acquiring corporation. Because RCI had no earnings and profits, no amount of the distribution is a dividend.8 Section 301(c)(2) requires the petitioners' basis in their RCI stock, as increased by the “capital contribution” created in section 304(a)(1), to be decreased by the distribution. Thus, the $2,000...
To continue reading
Request your trial
-
Read v. Comm'r of Internal Revenue
...sec. 453(a) and (b)(1), and a “distribution of property” under sec. 302(d) does not meet that requirement, see Cox v. Commissioner, 78 T.C. 1021, 1982 WL 11110 (1982); see generally Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, “Distributions of Corporation's ......
-
Ruf v. Commissioner, Docket No. 3471-91.
...Brams v. Commissioner [84-1 USTC ¶ 9495], 734 F.2d 290 (6th Cir. 1984), affg. [Dec. 39,828(M)] T.C. Memo. 1983-25; Cox v. Commissioner [Dec. 39,103], 78 T.C. 1021 (1982). Thus, respondent's new theory would result in an increased deficiency to the Rufs in 1986, the year in which the Neiman-......
- Earl v. Comm'r of Internal Revenue
-
Brams v. Commissioner
...where section 304 applied so as to treat the purported sale as a distribution to which section 301 applied. Cox v. Commissioner Dec. 39,103, 78 T.C. 1021 (1982).16 We held that there was no "casual sale or other casual disposition of personal property," as required by section 453(b)(1)(B). ......
-
Stock basis recovery in outbound sec. 304 transfers.
...to Sec. 304, courts looked to the transferor's basis in the shares deemed issued and the shares of the acquiring corporation (see Cox, 78 T.C. 1021 Basis Recovery Prior to the 2009 Regs. The following example illustrates how the reasoning underpinning the 2006 regulations falls short when t......