David Metzger Trust v. C.I.R., 81-4324
| Decision Date | 13 December 1982 |
| Docket Number | No. 81-4324,81-4324 |
| Parties | 82-2 USTC P 9718 DAVID METZGER TRUST, et al., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Fifth Circuit |
Herbert S. Kendrick, Don C. Stephenson, Donald L. Stuart, Dallas, Tex., for petitioners-appellants.
Whitfield J. Collins, William D. Ratliff, III, Fort Worth, Tex., amicus curiae for Mid-Continent Supply Co.
Glenn L. Archer, Jr., Asst. Atty. Gen., Michael L. Paup, Ch. App. Sec., Jonathan S. Cohen, Farley P. Katz, Tax Div., U.S. Dept. of Justice, Washington, D.C., for respondent-appellee.
Appeal from the Decision of the United States Tax Court.
Before THORNBERRY, JOHNSON and HIGGINBOTHAM, Circuit Judges.
We decide today a story driven by tensions as old as Genesis but told in the modern lexicon of the tax law. It is the story of David who built a business and left it in the charge of his eldest son Jacob to be shared with Jacob's two sisters Catherine and Cecelia, of their alienation and resulting quarrel with the tax collectors. In reviewing this decision of the Tax Court we are asked to determine the tax consequences of a reallocation of ownership of this family-owned business operated as a closely held corporation. In doing so we face three questions: (1) whether the attribution rules of I.R.C. Sec. 318(a) must be applied despite family discord in determining whether a redemption meets the "not essentially equivalent to a dividend test" of Sec. 302(b)(1); (2) whether a trust may waive the attribution rules of Sec. 318(a) by filing a waiver agreement pursuant to Sec. 302(c)(2)(A)(iii); (3) whether the attribution rules of Sec. 267(c) must be applied to interest payments between family members in discord. Governed by the plain language of the Code, a goal of a coherent tax policy, and the relevant Supreme Court precedents, 76 T.C. 42. We affirm the decision of the Tax Court.
The relevant facts are not in dispute and have been agreed to in a stipulation of record. Appellant David Metzger Trust was created by David Metzger in 1942 to benefit his wife as life income beneficiary and his three children, Jacob, Catherine, and Cecelia, as one-third remaindermen each. Jacob, the eldest son, was named trustee of the Trust. Four years later, David incorporated the family business as Metzger Dairies, Inc., the other appellant. The Trust became a shareholder of Metzger Dairies.
On David's death in 1953 Jacob Metzger assumed control of Metzger Dairies. Catherine and Cecelia were directors. In the years following the father's death the sibling quarrel grew in intensity. By the 1960's, open animosity developed among Jacob, Catherine, and Cecelia. Whatever the source of their alienation, a downturn in the success of the dairy only exacerbated the problem. Catherine and Cecelia became angry when the corporation stopped paying dividends. Catherine resented what she considered to be Jacob's interference in the management of Metzger Dairy of San Antonio, a corporation of which her son was president but whose stock was owned for the most part by the same parties who owned the stock of Metzger Dairies. Cecelia was annoyed at both Jacob and Catherine because both corporations failed to pay dividends. The argument among Jacob, Catherine, and Cecelia over these and other issues unrelated to the business of the corporations continued until 1972, when the acrimony reached the point that Jacob After lengthy negotiations all agreed that Jacob and his family would own Metzger Dairies, Catherine and her family would own Metzger Dairy of San Antonio, and Cecelia and her family would be cashed out. The plan was for Metzger Dairies to redeem all shares owned by Catherine, Cecelia, the trusts for Catherine and Cecelia, and the David Metzger Trust. It was necessary to include the David Metzger Trust in the redemption because Catherine and Cecelia were due to receive one-third of the Trust corpus on the death of David Metzger's widow.
Catherine, and Cecelia concluded it was necessary to terminate their joint ownership of the corporations.
Immediately before the redemption, the stock of Metzger Dairies was held as follows:
Stockholder Shares
----------- ------
David Metzger Trust 420
Nora Metzger (David Metzger's
widow) 420
Jacob Metzger 600
Trust for Jacob Metzger 120
Catherine 600
Trust for Catherine 120
Cecelia 600
Trust for Cecelia 120
The redemption occurred on January 22, 1973, leaving Metzger Dairies' stock as follows:
Stockholder Shares
----------- ------
Jacob Metzger 600
Trust for Jacob Metzger 120
Trust for David Metzger, II 294
(son of Jacob)
Trusts for Nan Metzger 207
(daughter of Jacob)
The Commissioner concedes that the principal motivation for the redemption was not to receive undistributed earnings, 1 but to end a business relationship that was characterized by hatred and discord among Jacob, Catherine, and Cecelia. On February 10, 1976, Jacob, as trustee of the David Metzger Trust, delivered to the IRS a waiver agreement, executed pursuant to 26 C.F.R. Sec. 1.302-4 and purporting to waive any future interest the trust might have in the corporation.
The deferred obligation of Metzger Dairies to pay for Cecelia's 600 shares was evidenced by a promissory note executed by the corporation and payable to Cecelia in three annual installments of principal, plus interest, beginning January 22, 1974. Interest payments were actually made on January 21, 1974, January 7, 1975, and January 5, 1976. As a cash basis taxpayer, Cecelia reported interest income in 1974, 1975 and 1976, the respective years of receipt. Metzger Dairies was an accrual basis taxpayer and claimed deductions in the fiscal years ending September 30, 1973, September 30, 1974, and September 30, 1975, for the liability for interest as it accrued.
In May 1977 the Commissioner of Internal Revenue assessed deficiencies against the David Metzger Trust for the calendar year 1973 and against Metzger Dairies for the fiscal years ending September 30, 1973, and September 30, 1974. 2 On August 17, 1977, Metzger Dairies and the Trust petitioned the Tax Court for a redetermination of these deficiencies. Later the Commissioner assessed deficiencies against Metzger Dairies for fiscal year 1975 as well. 3 Metzger Dairies filed a second petition for redetermination with the Tax Court. All of the cases were consolidated for trial. The Tax Court upheld the deficiencies. After an
agreed computation had been filed, it entered the judgment 4 here appealed from.
While ordinary income treatment for dividends and capital gains treatment for sales of stock are primer categories of the Internal Revenue Code, their line of separation with stock redemptions is less than bright. Stock redemptions may resemble both sales of stock and dividends, since they involve corporate payment to a shareholder for stock but may also distribute corporate earnings. The desire for tax advantage insures recurring disputes over when a stock redemption is a dividend and when it is a purchase of stock. Given the inherent economic incentives of stock redemptions in myriad form mirroring the variety of their commercial objectives and often constructed by lawyers trained in an adversarial tradition, a workable decision mechanism must be capable of looking through innovative form to the economic reality beneath. It is not surprising then that the categorization process is heavily indexed by actual changes in corporate ownership. That is, when a redemption significantly reduces a stockholder's voting interest in a corporation, it resembles a sale of stock more than a dividend and is to be accorded capital gains treatment. On the other hand, if the redemption is basically a pro rata distribution, it is treated as a dividend. 5 This principle, whose application may also be termed a wary search for reality, is overlaid by the circumstance that here the tax code presents in an acute fashion the constant judicial tension of the competing demands of predictability and case specific equity. Despite their generality these principles form the regression line for case reconciliation, and as we will see they provide an aid to the identification of the judicial outliers.
Our specific analysis is channelled by the Code's structure: payments to shareholders from accumulated earnings will be treated as dividends unless the payment can be brought under an exception. That is, the controlling premise is that distributions by corporations to stockholders out of the taxable year's earnings or out of accumulated earnings are to be treated as dividends. I.R.C. Sec. 316(a). Section 302 provides the exceptions. If the redemption is "not essentially equivalent to a dividend," Sec. 302(b)(1), a "substantially disproportionate redemption of stock," Sec. 302(b)(2), or a "termination of [the] shareholder's interest," Sec. 302(b)(3), it will be treated as a distribution in exchange for the stock. At first glance, all three of these provisions are applicable to the Metzger transaction since the corporation purchased all the stock of Catherine, Cecelia, their trusts, and the David Metzger Trust, while at the same time made no payments to the other stockholders, namely Jacob Metzger and his trust. Yet the attribution rules of the Code pose immediate problems.
If a father sells some of his shares back to a corporation, yet after the transaction he and his ten year old son end up owning the same combined percentage of voting shares, the transaction cast as a stock purchase might be an extraction of corporate earnings in nondividend form. The Code responds to this risk,...
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