Genecov v. United States

• Decision Date: 11 June 1969
• Docket Number: No. 26139.,26139.
• Citation: 412 F.2d 556
• Parties: A. S. GENECOV and wife, Hilda Genecov, Appellants, v. UNITED STATES of America, Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

412 F.2d 556 (1969)

A. S. GENECOV and wife, Hilda Genecov, Appellants, v. UNITED STATES of America, Appellee.

No. 26139.

United States Court of Appeals Fifth Circuit.

June 11, 1969.

COPYRIGHT MATERIAL OMITTED

Henry Schwartz, II, Charles F. Potter, Spruiell, Lowry, Potter, Lasater & Guinn, Tyler, Tex., for appellant.

Richard B. Hardee, U. S. Atty., William Wayne Justice, U. S. Atty., Tyler, Tex., Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson, Elmer J. Kelsey, Harry Marselli, Michael B. Arkin, Attys., Tax Div., U. S. Dept. of Justice, Washington, D. C., for appellee.

Before COLEMAN and GODBOLD, Circuit Judges, and SCOTT, District Judge.

COLEMAN, Circuit Judge:

The Internal Revenue Service determined a deficiency in the income tax of the taxpayers, Mr. and Mrs. A. S. Genecov, of Tyler, Texas, in the amount of $4,499.80 for the calendar year 1963. The deficiency was paid and suit was filed to recover it. The primary issue was whether certain stock became worthless in 1963, entitling the taxpayers to a deduction for a capital loss. The case was tried to the District Court, without a jury. The Court held that the stock became worthless in earlier years and the taxpayers were thus not entitled to recover. We affirm.

The dispute centers upon the worth, or worthlessness, of certain Carlton Hotel Company securities owned by the taxpayers.

The Carlton Hotel Company was organized by a group of Tyler businessmen in the 1950's. The Company had authorized capital stock of $800,000, represented by 8,000 shares of common stock with a par value of $100 each. One of those participating in the organization was the taxpayer, Mr. Genecov. In a period from 1953 to 1956, he purchased 156 shares of the Carlton stock for $15,550. He paid as much as $100 for some shares and as little as $50 for others.

From initiation, the hotel was never a financial success. In 1957, the Carlton Hotel Company began negotiating for the sale of the hotel to two Longview, Texas, businessmen, Earl Hollandsworth and Lee Travis.

The parties, Carlton Hotel Company (Carlton No. 1, old company) and Hotel Carlton, Inc. (Carlton No. 2, the new corporation formed by Hollandsworth and Travis), reached an agreement on February 28, 1957, pursuant to which Carlton No. 2 agreed to purchase the hotel building, the land on which the hotel stood, and all personal property in the building.

Payment was to be made in the following manner: (1) Carlton No. 2 was to pay $297,000 in cash within ten years, for the benefit of Carlton No. 1's cumulative debenture holders (the debentures were issued in 1956 in an attempt to meet losses which had been incurred). (2) Carlton No. 2 was to pay Carlton No. 1 one-half of its net annual profits (as shown on Federal Income Tax Returns) until $435,550 was paid. The greatest portion of this, or $391,600 was for the benefit of Carlton No. 1's stockholders, and the remainder was for the benefit of one of its creditors. (3) Carlton No. 2 was to pay $60,914.25 to cancel delinquent taxes on the hotel property, and $48,614.52 to two banks, who were creditors of Carlton No. 1. (4) Carlton No. 2 was to assume payment of the balance of Carlton No. 1's $800,000 promissory note. If Carlton No. 2 failed to pay within ten days after the installment became due or failed to pay any installment or principal within thirty days from due date, or if the holder should mature the note, Carlton No. 2 was to return the property to Carlton No. 1, free of all encumbrances, except the balance due on the note.

The agreement further provided that if Carlton No. 2 wished to sell the property before paying the Carlton No. 1 debenture holders' and stockholders' obligations, Carlton No. 1 would first be given an opportunity to repurchase the property. In the event that Carlton No. 2 sold the property to another person, the proceeds received were to apply first to the debenture holders' obligation and one-half of the remainder to the stockholders' obligation.

Subsequent to this agreement and sale, Carlton No. 1 discovered that no provision had been made for the payment of the Texas Corporation Franchise Tax, and it had no funds with which to make the payment. Its stockholders met on July 17, 1958, to consider dissolving the corporation and transferring its assets to a trustee in order to avoid payment of the franchise taxes. That same day, Carlton No. 1 entered into a trust agreement with Peoples National Bank of Tyler, thereby transferring all property, accounts receivable, and other assets to the bank. In addition, it transferred all rights which it had under the agreement with Carlton No. 2 and all rights to collect the debenture holders' obligation.

The debenture holders and stockholders were the beneficiaries of the trust, and the trust was to continue until the trust estate was paid to the beneficiaries. The agreement gave no operating or managerial powers to the trustee. A written list of the stockholders of Carlton No. 1 was attached to the trust agreement, representing the beneficial ownership of the assets of the trust.

Following the sale to Carlton No. 2 in 1957, Carlton No. 1 carried on no business except to wind up its affairs. In June, 1958, it surrendered its charter and a certificate of dissolution was issued. It filed its final tax return in July, 1958, reporting no corporate activity and no corporate assets. Attached to the return was a form which was to be filed within thirty days of dissolution or liquidation including the certificate of dissolution.

During the ten years following the purchase of the hotel, Carlton No. 2 did not make a profit (in the federal tax return sense), and had not paid any money pursuant to the stockholders' obligation. Its net operating losses have averaged $65,000 per annum.

In 1961, Genecov purchased 250 shares of Carlton No. 1 for $12.50, or a nickel per share. Then, in 1963, he sold his entire interest in Carlton No. 1 for $100, or twenty-five cents per share.

Genecov brought this suit to recover a refund on income taxes paid in 1963. He alleged that the stock in Carlton No. 1 became worthless in that year, and consequently, he was entitled to deduct the difference between the amount he paid for the stock ($15,862.50) and its sale price ($100) as a loss in 1963.

The Court found that four identifiable events occurred in 1957 and 1958 which made the Carlton No. 1 stock worthless in those years:

(1) Carlton No. 1 sold all of its operating assets in 1957;

(2) Carlton No. 1 conveyed its remaining assets in trust in 1958;

(3) Carlton No. 1 was dissolved in 1958; and

(4) Carlton No. 1 filed its last income tax return and notification of intent to dissolve or liquidate in 1958.

The Court concluded (1) that Carlton No. 1's dissolution in 1957 and 1958 constituted a liquidation under § 331 of the Internal Revenue Code, and, following sale of the hotel, that Carlton No. 1 took no further steps inconsistent with liquidation; (2) that the assignment of the stockholders' obligation to the trustee constituted a distribution to the beneficial owners of the obligation; (3) that the taxpayers failed to establish that the stockholders' obligation had a fair market value at the time the hotel was sold or when the obligation was transferred to the trustee, and therefore it had only a nominal fair market value; in any event it could not have exceeded 50% of the stockholders' original investment, since the obligation was for only $391,500 while the authorized capital was $800,000; (4) that the taxpayers' loss was complete in 1958; (5) that irrespective of Carlton No. 1's liquidation, the taxpayers' investment therein was worthless by 1958; and (6) that the taxpayers did not suffer a loss in 1963. Therefore, the Court held that the Genecovs were not entitled to a refund in 1963. The taxpayers appeal.

The finding that there were four identifiable events in 1957 and 1958 which evidenced the worthlessness of the stock in those years is attacked as clearly erroneous. The holding that there was a corporate liquidation in 1958 under § 331 of the Internal Revenue Code is challenged as erroneous. We do not agree with either contention.

I

The statute in question provides:

"Section 165, I.R.C. (1954)

"(a) General Rule — There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.

* * * * * *

"(g) (1) Worthless Securities — If any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom shall, for purposes of this subtitle, be treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset.

"(2) Security Defined — For purposes of this subsection, the term `security\' means —

(A) A share of stock in a corporation."

To be allowable as a deduction, the loss must be evidenced by closed and complete transactions, which are fixed by "identifiable events", Treasury Regulation 1.1651-1(b). The question of whether a stock becomes worthless during a particular year is strictly a question of fact, and the fact finder is entitled to draw reasonable inferences and conclusions. This Court, in review, is limited to a consideration of whether the finding was in accordance with law, Boehm v. Commissioner of Internal Revenue, 326 U.S. 287, 293, 66 S.Ct. 120, 90 L.Ed. 78 (1945). See, also, Rule 52(a), F.R.Civ.P., findings of fact are not to be set aside unless "clearly erroneous".

The Court in Boehm, supra, made clear that a subjective test, limited to the taxpayer's own idea of "worthlessness", is not adequate:

"And a determination of whether a loss was in fact sustained in a particular year cannot fairly be made by confining the trier of facts to an examination of the taxpayer\'s beliefs and actions. Such an issue of necessity requires a practical approach, all pertinent facts and circumstances being open to inspection and consideration regardless of their objective or subjective

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