Divine v. Comm'r of Internal Revenue
| Decision Date | 25 October 1972 |
| Docket Number | Docket Nos. 5339-65,6667-66. |
| Citation | 59 T.C. 152 |
| Parties | HAROLD S. DIVINE AND RITA K. DIVINE, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
George V. Delson and Arnold Broser, for the petitioners.
Daniel J. Boyer, Robert D. Grossman, Jr., and Donald W. Geerhart, for the respondent.
The factual and legal issues in this case are virtually identical to those in Luckman v. Commissioner, 418 F.2d 381 (C.A. 7, 1969)reversing50 T.C. 619 (1968). Petitioner received distributions of property in 1961 and 1962 from Rapid in his capacity as a stockholder. The petitioner in Luckman received comparable distributions in 1961. Prior to and during the years in issue Rapid's employees purchased 186,558 shares of its stock by exercising restricted stock options. The aggregate market values of these shares at the date the options were exercised was $5,671,120. The prices set by the stock options were such that Rapid received a total of $2,044,748 in exchange for these shares. Held, the very tenuous and strictly fortuitous relationship between shareholders in a large public corporation does not warrant giving Luckman collateral estoppel effect herein. Held, further, Rapid's earnings and profits were not reduced by the aggregate difference between the option price and the market value of the stock at the time the options were exercised, and therefore Rapid had sufficient earnings and profits to cause the distributions received by petitioner during 1961 and 1962 to be taxed as dividends.
Respondent determined deficiencies in petitioners' income tax for the taxable years 1961 and 1962 in the amounts of $15,134.77 and $21,334.40, respectively, and also determined with respect to 1962 an addition to tax under section 6653 (a)1 in the amount of $1,066.72. Due to a number of concessions 2 the only two issues remaining for our decision are the following: (1) Whether the case of Luckman v. Commissioner, 418 F.2d 381 (C.A. 7, 1969), reversing 50 T.C. 619 (1968), as collateral estoppel effect on this case; and, if not, (2) whether, with respect to a statutory stock option plan of Rapid American Corp. (Rapid), the difference between the option price and the fair market value of the stock at the time of the exercise of the option reduces Rapid's earnings and profits, so that certain distributions of property which Rapid made thereafter to petitioners were distributions of capital rather than dividends. All of the facts have been stipulated.
Petitioners Harold S. and Rita K. Divine resided in Great Neck, N.Y., at the time the petitions herein were filed. Using the cash receipts and disbursements method of accounting, petitioners filed joint Federal income tax returns for the calender years 1961 and 1962 with the district director of internal revenue in New York, N.Y. Rita K. Divine is a petitioner in this case solely because she filed joint Federal income tax returns with her husband for the years in issue, and we will hereinafter refer to Harold S. Divine as petitioner.
During the years 1961 and 1962 petitioner owned, respectively, 37,000 and 40,000 shares of the common stock of Rapid. His total adjusted cost basis of these shares exceeded $18,501.40 in 1961 and $20,572.04 in 1962.
Rapid was incorporated under the laws of Ohio in 1902. Its common stock is listed on the New York Stock Exchange and is widely held. Throughout the years 1957 to 1963 it had more than 2,000 shareholders; as of January 31, 1963, there were 2,035,854 shares outstanding.
For the years prior to 1960 Rapid kept its books of account and filed its Federal corporate income tax returns on a calendar year basis. However, effective with the month ended January 31, 1960, Rapid secured the permission of the Internal Revenue Service to change its annual accounting period to a fiscal year ending January 31.
Rapid made cash distributions to its stockholders during its fiscal years ended January 31, 1962, and January 31, 1963, as follows:
+------------------------------------------------------+
¦Mar. 30, 1961 ¦$175,324.70¦Mar. 30, 1962 ¦$256,638.80 ¦
+--------------+-----------+--------------+------------¦
¦June 30, 1961 ¦205,178.56 ¦June 29, 1962 ¦256,638.00 ¦
+--------------+-----------+--------------+------------¦
¦Sept. 29, 1961¦206,765.28 ¦Sept. 28, 1962¦256,638.00 ¦
+--------------+-----------+--------------+------------¦
¦Dec. 20, 1961 ¦253,571.99 ¦Dec. 28, 1962 ¦254,922.93 ¦
+--------------+-----------+--------------+------------¦
¦Total ¦840,840.53 ¦Total ¦1,024,836.93¦
+------------------------------------------------------+
Of these amounts petitioner received cash distributions totaling $18,501.40 during the calendar year 1961, dispense at the rate of 50 cents per share per annum (12 1/2 cents per quarter), as follows:
+--------------------------------------------+
¦Date distributed ¦Date received ¦Amount ¦
+------------------+---------------+---------¦
¦ ¦ ¦ ¦
+------------------+---------------+---------¦
¦Mar. 30, 1961 ¦Mar. 31, 1961 ¦$4,242.38¦
+------------------+---------------+---------¦
¦June 30, 1961 ¦July 1, 1961 ¦4,242.38 ¦
+------------------+---------------+---------¦
¦Sept. 29, 1961 ¦Sept. 30, 1961 ¦4,242.38 ¦
+------------------+---------------+---------¦
¦Dec. 29, 1961 ¦Dec. 30, 1961 ¦5,774.26 ¦
+--------------------------------------------+
During 1962 petitioner received from Rapid cash distributions totaling $20,572.04, dispensed at the same rate as in 1961 as follows:
+--------------------------------------------+
¦Date distributed ¦Date received ¦Amount ¦
+------------------+---------------+---------¦
¦ ¦ ¦ ¦
+------------------+---------------+---------¦
¦Mar. 30, 1962 ¦Mar. 31, 1962 ¦$4,723.13¦
+------------------+---------------+---------¦
¦June 29, 1962 ¦June 30, 1962 ¦5,080.38 ¦
+------------------+---------------+---------¦
¦Sept. 28, 1962 ¦Sept. 29, 1962 ¦5,080.85 ¦
+------------------+---------------+---------¦
¦Dec. 28, 1962 ¦Dec. 29, 1962 ¦5,688.31 ¦
+--------------------------------------------+
Petitioner followed Rapid's advice and did not report any of the above distributions as taxable dividend income on his Federal income tax return for either 1961 or 1962. Respondent concluded, contrary to Rapid's advice, that Rapid's earnings and profits were sufficient to render the distributions taxable dividends, and determined deficiencies accordingly.
Prior to the years here in question Rapid had issued to certain of its officers and key employees restricted stock options which came within the provisions of section 421 of the Internal Revenue Code of 1954. During the period from January 1, 1957, through January 31, 1963, these officers and employees purchased a total of 186,558 shares of Rapid stock by exercising their restricted stock options. Based upon quoted market prices at the dates of purchase, the total value of these shares was $5,671,120. However, the exercise price of the options was such that Rapid received only a total of $2,044,748 in cash consideration for the stock. More detail with respect to the exercise of these restricted stock options is provided by the following table:
+-------------------------------------------------------+
¦ ¦Number of¦Amount ¦Market ¦ ¦
+----------+---------+---------+-------------+----------¦
¦Year ended¦shares ¦received ¦value at date¦Difference¦
+----------+---------+---------+-------------+----------¦
¦ ¦issued ¦by Rapid ¦of issue ¦ ¦
+----------+---------+---------+-------------+----------¦
¦12/31/57 ¦40,000 ¦$300,000 ¦$630,000 ¦$330,000 ¦
+----------+---------+---------+-------------+----------¦
¦12/31/58 ¦214 ¦2,358 ¦4,753 ¦2,395 ¦
+----------+---------+---------+-------------+----------¦
¦12/31/59 ¦27,065 ¦266,165 ¦985,211 ¦719,046 ¦
+----------+---------+---------+-------------+----------¦
¦1/30/60 ¦1,122 ¦10,332 ¦45,770 ¦35,438 ¦
+----------+---------+---------+-------------+----------¦
¦1/30/61 ¦56,224 ¦648,841 ¦2,107,869 ¦1,459,028 ¦
+----------+---------+---------+-------------+----------¦
¦Subtotals ¦124,625 ¦1,227,696¦3,773,603 ¦2,545,907 ¦
+----------+---------+---------+-------------+----------¦
¦1/31/62 ¦49,770 ¦661,664 ¦1,533,603 ¦871,939 ¦
+----------+---------+---------+-------------+----------¦
¦Subtotals ¦174,395 ¦1,889,360¦5,307,206 ¦3,417,846 ¦
+----------+---------+---------+-------------+----------¦
¦1/31/63 ¦12,163 ¦155,388 ¦363,914 ¦208,526 ¦
+----------+---------+---------+-------------+----------¦
¦Totals ¦186, 558 ¦2,044,748¦5,671,120 ¦3,626,372 ¦
+-------------------------------------------------------+
Rapid did not claim the difference between the market value of the stock and the amounts which it received therefor as a deduction on its Federal income tax returns. Also, it did not reduce by such difference either its earnings and profits or its accounting surplus on its books of account and annual financial statements.
If we view Rapid's restricted stock option plan as having no effect on earnings and profits, then Rapid's accumulated earnings and profits as of January 1, 1961, totaled at least $967,877.80, its current earnings and profits for the year ended January 31, 1962, totaled at least $1,169,889.30, its accumulated earnings and profits as of January 31, 1962, totaled at least $1,296,926.57, and its current deficit in earnings and profits for the year ended January 31, 1963, totaled up to $981,234.48. However, if we find that Rapid's restricted stock option plan does warrant reductions in earnings and profits, then Rapid's accumulated earnings and profits as of January 31, 1961, should be reduced by $2,545,907, its current earnings and profits for the year ended January 31, 1962,...
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