Gouldman v. Commissioner of Internal Revenue

• Decision Date: 05 January 1948
• Docket Number: No. 5673.,5673.
• Citation: 165 F.2d 686
• Parties: GOULDMAN v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Fourth Circuit

165 F.2d 686 (1948)

GOULDMAN v. COMMISSIONER OF INTERNAL REVENUE.

No. 5673.

Circuit Court of Appeals, Fourth Circuit.

January 5, 1948.

R. Carter Scott, Jr., of Richmond, Va., for petitioner.

S. Dee Hanson, Sp. Asst. to the Atty. Gen. (Theron Lamar Caudle, Asst. Atty. Gen., and Helen R. Carloss and A. F. Prescott, Sp. Asst's to the Atty. Gen., on the brief), for respondent.

Before SOPER and DOBIE, Circuit Judges, and CHESNUT, District Judge.

SOPER, Circuit Judge.

This is an appeal from a decision of the Tax Court which upheld an income tax deficiency and penalty in the aggregate sum of $3,111.08 assessed by the Commissioner of Internal Revenue for the year 1941. The principal issue is whether the Tax Court erred in holding that a dividend on stock originally issued to the taxpayer but later transferred by him to his son was taxable to the taxpayer. There is also involved the question whether the Commissioner properly assessed a 5 per cent. negligence penalty as to this item, and also on two other items of income which, it is now admitted, should have been reported.

The Tax Court's findings of fact are not challenged. They show that during 1941 the taxpayer was the president of the Bank of Lancaster at Kilmarnock, Virginia, and a substantial stockholder therein. In May or June of 1941 he and one W. C. Chilton organized the Indian Creek Company, Inc., and each of them purchased 50 shares of the company's stock of the par value of $100 each. For this purpose the taxpayer borrowed $5,000 from the Bank of Lancaster and gave his note therefor secured by his stock.

The Indian Creek Company was organized to engage in the fish business. Its predecessor had been owned by the bank and Chilton, and was indebted to the bank on a note which was considered practically worthless. It was hoped that the new company would be financially successful and would enable the old company to pay its note. On August 13, 1941, 40 shares of the Indian Creek stock were transferred on the books of the company from the taxpayer to his son, and the son paid to his father the sum of $4,000 which he borrowed from the bank on his note secured by the stock which had been issued in his name. The taxpayer paid the bank $4,000 on his note and gave a new note for $1,000 secured by the remaining 10 shares of stock originally issued to him and his note for $5,000 was marked paid.

The fish business during the period, which had already passed when this transfer of stock took place, had been very profitable, and there was reason to believe that it would continue to be profitable during the balance of the season. So it turned out, and on December 9, 1941, the Indian Creek Company declared a 100 per cent. dividend and issued a check for $4,000 to the son who deposited it in his account at the Farmers & Merchants State Bank. On the same day he made a loan of $3,500 to thet taxpayer, which was secured by 200 shares of stock in the Bank of Lancaster. The $4,000 dividend was reported by the son in his income tax return for 1941. It is this item which is directly involved in the pending case, since the Commissioner determined that the dividend was income to the taxpayer rather than to his son.

On January 17, 1942, the company declared a 50 per cent. dividend and a check for $2,000 was delivered to the son. On the same day the son advanced the taxpayer $1,750 which was secured by 100 shares of stock of the Bank of Lancaster.

The taxpayer's indebtedness to his son on these transactions, amounting to $5,250, was discharged by him on February 16, 1946. However, he had borrowed additional money from his son and, at the time of the hearing before the Tax Court, was indebted to him in the sum of $5,100.

The Tax Court, in view of these facts and of others hereinafter noted, concluded that, while the formalities of a sale had been observed, a bona fide sale did not take place, and that the taxpayer and his son engaged in the transactions described so that the taxpayer might evade the payment of the tax on the income derived from the transferred shares. The taxpayer contends that this conclusion was erroneous as a matter of law and, alternatively, that it was not supported by the evidence. He argues in the first place that the transfer of the stock was valid and binding on the parties under the law of Virginia, since they complied with the local statutory provisions, and that the Tax Court was not free to reach a contrary conclusion for tax purposes. The argument is by no means convincing since it is not clear that the Virginia courts would be governed in all situations by the formalities rather than by the substance of the transaction. But even if this were not so, the taxpayer's contention could not be sustained for it must now be regarded as the established law that the validity of a transaction under state law is not conclusive of its bona fides for the purpose of federal taxation. In the recent decision of the Supreme Court in Commissioner v. Tower, 327 U.S. 280, 287, 288, 66 S.Ct. 532, 536, 90 L.Ed. 670, 164 A.L.R. 1135, it was said: "Respondent contends that the partnership arrangement here in question would have been valid under Michigan law and argues that the Tax Court should consequently have held it valid for tax purposes also. But the Tax Court in making a final authoritative finding on the question whether this was a real partnership is not governed by how Michigan law might treat the same circumstances for purposes of state law. Thus, Michigan could and might decide that the stock-transfer here was sufficient under state law to pass title to the wife, so that in the event of her death it would pass to whatever members of her family would be entitled to receive it under Michigan's law of descent and distribution. But Michigan cannot, by its decisions and laws governing questions over which it has final say, also decide issues of federal tax law and thus hamper the effective enforcement of a valid federal tax levied against earned income. The contention was rejected in Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731. There husband and wife made an agreement for joint ownership of the husband's future income. Assuming that the husband's future earnings were under California law considered as partly owned by the wife, this Court refused to accept the State's concept of the effect of the agreement which would have reduced the federal tax on income actually earned by the husband. And in Helvering v. Clifford, 309 U.S. 331, 334, 335, 60 S.Ct. 554, 556, 557, 84 L.Ed. 788, we held that the purpose of 26 U.S.C. § 22(a), 26 U.S.C.A. Int.Rev.Code, § 22(a), to tax all income against the person who controlled its distribution could not be frustrated by family group arrangements, even though the distribution arrangements were valid for state law purposes. The statutes of Congress designed to tax income actually earned because of the capital and efforts of each individual member of a joint enterprise are not to be frustrated by state laws which for state purposes prescribe the relations of the members to each other and to outsiders. Cf. Burk-Waggoner Oil Ass'n v. Hopkins, 269 U.S. 110, 114, 46 S.Ct. 48, 49, 70 L.Ed. 183."

And in Doll v. Commissioner, 8 Cir., 149 F.2d 239, certiorari denied 326 U.S. 725, 66 S.Ct. 30, 90 L.Ed. 430, where a decree from a state court defining the rights of the parties in a family partnership had actually been obtained, the federal court had no hesitation in holding that questions involving the application of federal laws and the interests of the federal government, must be decided on the merits by the appropriate authorities within the federal government, and that final effect cannot be given to the state court's interpretation of the relationship of the parties.

In accordance with these rules the federal courts have not infrequently found it necessary to look beneath the surface of the formal transactions of a taxpayer in order to determine whether a transfer of property, ostensibly made by him, has been made with the intention on his part actually to divest himself of beneficial ownership or, on the other hand, with the intention to create the appearance of a genuine transfer so as to avoid or reduce the payment of income taxes while really maintaining control of the property for his own profit.

It is of course axiomatic that genuine transactions will be given full effect even though they were undertaken for the purpose and have the result of avoiding taxes; Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596, 97 A.L.R. 1355; but it is equally true that the purpose and effect of a transfer may be considered in determining whether it was bona fide. It has been...