Hines v. United States

• Decision Date: 02 May 1973
• Docket Number: No. 72-2731.,72-2731.
• Citation: 477 F.2d 1063
• Parties: Harry H. HINES, Jr., Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

477 F.2d 1063 (1973)

Harry H. HINES, Jr., Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 72-2731.

United States Court of Appeals, Fifth Circuit.

May 2, 1973.

James P. Knight, Jr., Thomas A. Bell, Jackson, Miss., for plaintiff-appellant.

Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, Atty., Jane Edmisten, App. Div. Tax Div., Dept. of Justice, Washington, D. C., H. M. Ray, U. S. Atty., Oxford, Miss., Jack D. Warren, Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellee.

Before RIVES, GOLDBERG and MORGAN, Circuit Judges.

GOLDBERG, Circuit Judge:

This is an appeal from the denial of a claim by taxpayer, Harry H. Hines, Jr., for a recovery of income taxes and interest assessed and paid for the years 1966 and 1967. Although this appeal involves only taxpayer's personal income tax liability, the controlling question is one of corporate taxation: Whether the proceeds from the sale of property that had been distributed to taxpayer by a family-owned corporation were properly imputed to the distributing corporation when that corporation (1) did not negotiate the sale prior to the distribution and (2) did not participate in the sale after the distribution. We hold that the Commissioner and the District Court improperly imputed the proceeds to the corporation and we reverse the District Court's denial of taxpayer's claim.

I. THE FACTUAL SETTING

The District Court's Memorandum Decision, reported at 344 F.Supp. 1259, lucidly summarizes both the factual context and the legal issue involved in this case. Accordingly, we set forth only those facts essential to an understanding of our disposition of this appeal.

Taxpayer was a director and secretary of Peeler Realty Company, Inc., a Mississippi corporation having its principal place of business in Kosciusko, Attala County, Mississippi. Hereinafter "Peeler Realty". Peeler Realty is a family-owned corporation, incorporated in 1950 by taxpayer, taxpayer's grandmother, Mrs. Ethel Peeler, and taxpayer's grandfather, S. J. Peeler, a successful businessman who for many years operated a large lumber business in Kosciusko. In the course of conducting that business, S. J. Peeler acquired a large amount of cutover timberland located in Attala and adjoining counties in Mississippi, most of which he obtained at tax sales in the late 1930's for amounts ranging from fifty to seventy-five cents per acre.

At the first meeting of the incorporators and subscribers of Peeler Realty, on November 6, 1950, S. J. Peeler transferred some 27,500 acres of timberland and numerous low-cost rental houses situated in Kosciusko to Peeler Realty for 3,998 shares of the corporation's 4000 shares of authorized capital stock. Immediately thereafter, he began transferring his shares to his wife, children, and grandchildren by way of gifts. By August 25, 1965, shortly before the period here in issue, he had divested himself of all of his stock interest in the corporation.¹

The business operations of Peeler Realty consisted almost entirely of holding the timberland conveyed to it by S. J. Peeler and renting out the low-cost houses. Although the corporation would occasionally sell small tracts of land or easements over the land and would sometimes market small quantities of timber, the corporate income was derived primarily from rents collected on the low-cost houses. Between 1954 and 1967, the corporation showed a profit in only four years; the losses during the other years were attributed primarily to the fact that the rental income was insufficient to pay the annual operating expenses and the ad valorem taxes on the timberland. The corporation's surplus account showed a deficit balance of $45,950.97 on October 31, 1966, the end of its fiscal year, and the deficit increased to $46,334.21 on October 31, 1967.

In the mid 1960's, the pulpwood industry in Attala County began to grow. The Georgia-Pacific Corporation had already purchased timberlands in the area and was eager to purchase other timberland to support its Mississippi mill operations. Moreover, during this period, the International Paper Company and the St. Regis Paper Company each built a pulpwood mill in Mississippi.

In November, 1964, following a "timber cruise,"² the Georgia-Pacific Corporation made a written offer to pay a cash price of $57 per acre for Peeler Realty's timberland. As an alternative inducement—designed to accommodate Peeler Realty's desire to reduce the tax incidence of a sale of its timberland— Georgia-Pacific Corporation offered to pay a purchase price of $50 per acre in Georgia-Pacific stock, in the hopes of effecting a tax-free exchange. When these offers were rejected, Georgia-Pacific Corporation agreed to pay from $60 to $63 per acre for the timberland.

Some of the shareholders of the company were eager to sell the land to obtain cash, which they needed for various personal reasons. A minority of the shareholders, representing 930 shares, did not wish to sell. Taxpayer was willing to sell for the right price, but he did not think the Georgia-Pacific offer was sufficient.

Other large paper mills and lumber dealers were also interested in acquiring Peeler Realty's timberland. In the latter part of 1965, taxpayer discussed a possible sale with International Paper Company, Weyerhaeuser Company, St. Regis Paper Company, and Attala Lumber Company. International Paper Company and St. Regis Paper Company made "cruises" of the timberlands after the corporation indicated it was interested in selling the land. Peeler Realty did not, however, enter into any solid negotiations with either of these firms.

Eventually, it was decided that the one firm offer from Georgia-Pacific was not acceptable because it was not high enough. On December 27, 1965, the shareholders and directors of Peeler Realty conducted a meeting to discuss the corporation's financial condition. At this meeting, Robert W. Hartford (a lawyer and certified public accountant who had served S. J. Peeler for years and who had been elected chairman of the board of Peeler Realty on August 27, 1965) outlined the financial condition of the corporation and set forth the alternative courses of action available. Mr. Hartford advised the meeting that if things continued as they were going, the corporation would soon be bankrupt. He discussed the pros and cons of liquidation and of separating the heavily-taxed land from the corporation.

The majority of the shareholders wanted to sell the timberlands, and taxpayer, who was the informal spokesman for most of the shareholders, was fully aware of the tax consequences that would follow if the sale were made by the corporation. The tax basis of the property was quite low, not exceeding $40,000, and the selling price clearly would be in excess of the 1.5 million dollars which had already been offered by Georgia-Pacific and rejected as insufficient. Furthermore, taxpayer and Hartford were aware that a corporate sale would result in the payment of a capital gains tax by the corporation followed by the imposition of an additional tax on the individual shareholders after distribution. Liquidation and dissolution, a method provided by the Internal Revenue Code to avoid double taxation,³ was not thought feasible because the corporation could not be terminated because S. J. Peeler's will left certain real property to the corporation and he had become mentally incompetent to change his will.

On January 18, 1966, the directors held a special meeting and decided to recommend to the shareholders that the corporation's timberland be distributed to the shareholders as tenants in common, with the interest of each to be determined by his or her pro rata interest in the corporate stock. The shareholders authorized the withdrawal and a law firm was engaged to prepare the conveyance, prior to which it was necessary to do substantial searching of the land records of the counties in which the land was located. The deed was executed by the directors on March 30, 1966, divesting Peeler Realty of title to the timberlands and leaving as its only asset the low-cost houses producing rental income. Once the deed was executed and recorded, the attorneys were authorized to make a title search of each tract and perform any work determined to be necessary in order to cure defects in the title and make the lands marketable.

The shareholders also executed a power of attorney giving taxpayer, Hartford, and Mrs. Ethel Peeler authority to handle the land and to sell it if they decided that a sale should be made. The power invested in the attorneys-in-fact by the document was very extensive, granting them an almost unlimited power to dispose of the property.

In October of 1966, as soon as the attorneys had completed their title search and the attorneys-in-fact had received assurances of the availability of title insurance, the attorneys-in-fact sent "Sales Guidelines" to International Paper Company, Georgia-Pacific Corporation, St. Regis Paper Company, and Attala Lumber Company, inviting them to submit sealed bids for the purchase of the land. The "Sales Guidelines" contained the conditions and terms of the sale and the method and manner of bidding on the land. The bids were opened in the office of Peeler Realty on November 14, 1966, and on December 15, 1966, International Paper Company's bid was accepted and the land was sold and conveyed to it on December 15, 1966 for $2,533,580.50.

The money received from the sale of the timberlands,⁴ less expenses of the sale amounting to $99,831.27, was paid to the tenants in common, the shareholders of Peeler Realty. Taxpayer reported his pro rata portion of the proceeds from the sale of his interest in the timberland and claimed long-term capital gains status. Peeler Realty did not report the proceeds of the sale by its shareholders on its corporate income tax, nor did it treat them as additions to its earned surplus on the corporation's books.

II. ACTION BY THE...