Erdle v. Dorgan, 9812

• Decision Date: 19 December 1980
• Docket Number: No. 9812,9812
• Parties: Zeno A. and Florence C. ERDLE, Roland D. Schultz, Ralph and Beatrice Messer, John and Adeline Erdle, and Wolfram and Betty Wald, Plaintiffs, Appellees, and Cross Appellants, v. Byron L. DORGAN, North Dakota State Tax Commissioner, Defendant, Appellant, and Cross Appellee. Civ.
• Court: North Dakota Supreme Court

Page 834

300 N.W.2d 834

Zeno A. and Florence C. ERDLE, Roland D. Schultz, Ralph and Beatrice Messer, John and Adeline Erdle, and Wolfram and Betty Wald, Plaintiffs Appellees, and Cross Appellants, v. Byron L. DORGAN, North Dakota State Tax Commissioner Defendant, Appellant, and Cross Appellee.

Civ. No. 9812.

Supreme Court of North Dakota.

Dec. 19, 1980.

Rehearing Denied Jan. 8, 1981.

Pearson & Christensen, Grand Forks, and Morris Tschider, Bismarck, for plaintiffs, appellees, and cross appellants; argued by Garry A. Pearson.

Albert R. Hausauer, Sp. Asst. Atty. Gen., State Tax Dept., Bismarck, for defendant, appellant, and cross appellee; argued by Albert R. Hausauer and Leo Wilking, Sp. Asst. Attys. Gen.

ERICKSTAD, Chief Justice.

This is a tax case in which the defendant, the North Dakota Tax Commissioner (hereinafter Commissioner), assessed additional taxes for the year 1976 against the plaintiffs (hereinafter taxpayers). The taxpayers appealed to the Burleigh County District Court from the Commissioner's decision which the district court affirmed in part and reversed in part. The Commissioner has filed an appeal from that part of the district court's judgment reversing the Commissioner's decision and the taxpayers have filed a cross-appeal from that part of the district court's judgment affirming the Commissioner's decision.

THE RMC, INC. ISSUE

During July, 1976, the taxpayers, shareholders of RMC, Inc., adopted a statement of intent to dissolve the corporation in accordance with the provisions of Section 337 of the Internal Revenue Code of 1954, as amended. The corporation distributed all of its assets in complete cancellation and redemption of all outstanding shares of stock of the corporation and the taxpayers reported the liquidation distribution on their 1976 federal income tax returns pursuant to Section 331 of the Internal Revenue Code. Thus, in reporting the distribution the taxpayers deducted their stock basis from the amount of distribution received and reported the balance as a capital gain or loss.

In filing state income tax returns for 1976, the taxpayers used federal taxable income as the starting point for computing their state income tax. Upon auditing the taxpayers' returns, the Commissioner determined that additional state income taxes were due because, in the Commissioner's view, the taxpayers should have reported, as ordinary income, the entire liquidation distribution received in excess of $15,000.00 by adjusting (increasing) federal taxable income on their state tax returns.

On February 10, 1978, the Commissioner issued Notices of Determination and Assessment of Individual Income Tax Due against the taxpayers for the year 1976. On March 6, 1978, the taxpayers filed protests and objections with the Commissioner and requested hearings in accordance with the Administrative Agencies Practice Act. On September 8, 1978, the taxpayers and the Commissioner entered a stipulation stating that an administrative hearing officer would issue findings of fact, conclusions of law, and a decision based upon stipulated facts and briefs. Consequently, no oral arguments were made or evidentiary material presented to the administrative hearing officer. On May 9, 1979, the Commissioner entered his decision holding that the amounts received by the taxpayers in liquidation of RMC, Inc., constituted dividends for state tax purposes and were not to be considered payments in exchange for shares of stock. The Commissioner determined that federal taxable income should be increased on the state tax return to reflect, as ordinary income, the entire liquidation distribution received by each taxpayer in excess of $15,000.00.

The taxpayers appealed to the Burleigh County District Court from the Commissioner's decision. On April 21, 1980, the district court entered a judgment reversing the Commissioner's determination. The Commissioner has now appealed to this Court from that part of the district court's judgment reversing the Commissioner's decision on this matter. The sole issue involved is whether or not the Commissioner's adjustment of the taxpayer's federal taxable income figure for state tax purposes and the resulting additional assessment of taxes was in accordance with North Dakota law.

The Commissioner asserts that his application of the law in this case is mandated by this Court's decision in Lanterman v. Dorgan, 255 N.W.2d 891 (N.D.1977). We conclude that the Commissioner has fundamentally misinterpreted and misapplied our decision in Lanterman, and we affirm the district court's judgment reversing the Commissioner's decision.

For a better understanding of this issue and of the relevance of the Lanterman decision, it is necessary to set forth the following pertinent statutory provisions:

"57-38-01. Definitions. As used in this chapter, unless the context or subject matter otherwise requires:

"20. 'Taxable income' in the case of individuals, estates, trusts and corporations shall mean the taxable income as computed for an individual, estate, trust or corporation for federal income tax purposes under the United States Internal Revenue Code of 1954, as amended, plus or minus such adjustments as may be provided by this act and chapter or other provisions of law." 57-38-01(20), N.D.C.C.

"57-38-01.1. Declaration of legislative intent. It is the intent of the legislative assembly to simplify the state income tax laws and to demonstrate that federal legislation is not necessary to deal with certain interstate tax problems, by adopting the federal definition of taxable income as the starting point for the computation of state income tax by all taxpayers and providing the necessary adjustments thereto to substantially preserve and maintain existing exemptions and deductions.

"It is the further intent of the legislative assembly to eliminate double taxation of the earnings of small corporations by recognizing a subchapter S election when made for federal income tax purposes." 57-38-01.1, N.D.C.C.

"57-38-01.2. Adjustments to taxable income for individuals and fiduciaries.

"1. The taxable income of an individual, estate, or trust as computed pursuant to the provisions of the United States Internal Revenue Code of 1954, as amended, shall be:

i. Reduced by any dividends or income, up to a maximum of fifteen thousand dollars, received from stock or interest in any corporation and included in the adjusted gross income as computed for federal income tax purposes where the income of such corporation has been assessed and tax paid by the corporation under this chapter and such dividends or income was received by the taxpayer as income during the income year if such corporation has reported the name and address of each North Dakota resident owning stock and the amount of dividends or income paid each such person during the year, provided, that when only part of the income of any corporation shall have been assessed and corporation income tax paid thereon under this chapter, only a corresponding part of the dividends or income received therefrom and included in federal adjusted gross income shall be subtracted. The commissioner is hereby authorized to prescribe rules and regulations to implement this subdivision to avoid injustice to taxpayers, to prevent duplication of deductions, and to eliminate taxation of income not fairly and properly taxable under this chapter." 57-38-01.2, N.D.C.C.

The factual situation in Lanterman, supra, is similar to that of the instant case. The taxpayers in Lanterman were shareholders of a domestic corporation which distributed all assets to its shareholders as a liquidation distribution in redemption and cancellation of all the shares of stock of the corporation. The Lanterman taxpayers, like the taxpayers in the instant case, reported the liquidation distribution on their federal income tax returns by deducting their stock basis from the amount received and treating the balance as a capital gain or loss, and they used federal taxable income as the starting point for computation of their state income tax. However, unlike the taxpayers in the instant case, the Lanterman taxpayers adjusted the taxable income on their state returns by deducting that portion of the liquidation distribution which was included as taxable income on their federal returns (i. e. the amount received in excess of their stock basis less the long-term capital gain deduction). The Lanterman taxpayers asserted that such adjustment was allowed by Section 57-38-01.2(1)(i), N.D.C.C., as a deduction of dividends or income received from stock or interest in a corporation. This Court upheld the Lanterman taxpayers' position that a liquidation distribution constituted dividends or income received from stock or interest in a corporation which, to the extent included in the adjusted gross income of the taxpayer as computed for federal income tax purposes, was deductible as an adjustment to taxable income for state purposes under Section 57-38-01.2(1)(i), N.D.C.C. ¹

The Commissioner asserts that because this Court, in Lanterman, supra, held that liquidation distributions qualify as "dividends or income ... received from stock or interest in any corporation" deductible, up to $15,000.00, as an adjustment to taxable income by virtue of Section 57-38.01.2(1)(i), N.D.C.C., the taxpayers in the instant case must increase the federal income tax figure on their state tax returns to include as ordinary income gross liquidation distributions received in excess of $15,000.00. The Commissioner's position is that because a liquidation distribution qualifies as a deduction adjustment to income under Section 57-38-01.2(1)(i), N.D.C.C., such distribution must be given the same dividend or income identity for determining the federal taxable income figure to be used on the state tax return. In accord with that position, the Commissioner asserts that on the taxpayers' state tax return, federal...