In re Weisser
| Decision Date | 10 September 1979 |
| Docket Number | 70-249-Bk-J.,Bankruptcy No. 70-248-Bk-J |
| Citation | 1 BR 206 |
| Parties | In re Henry J. WEISSER, Debtor. In re Herman M. WEISSER, Debtor. |
| Court | U.S. District Court — Middle District of Florida |
Joseph M. Persinger, Dept. of Justice, Washington, D.C., Curtis Fallgatter, Asst. U.S. Atty., Jacksonville, Fla., for Government.
McCarthy Crenshaw, James L. Nipper, A.B. Blackburn, Jr., Jacksonville, Fla., for debtors.
This is an appeal from the order of the bankruptcy judge, the Honorable George L. Proctor, filed February 28, 1977, overruling the debtors' objections to the claims of the United States for additional taxes, penalties, and interest for the calendar years 1970, 1971, and 1972. Although this appeal involves two separate cases, since the cases are closely aligned, raise the same issues, and were treated as consolidated in the trial before, and the order of, the bankruptcy judge, the Court will consider the cases consolidated for the purposes of this review.
The facts, to which a stipulation has been entered, are not in dispute; only the legal conclusions to be drawn from the facts are at issue here.
On July 10, 1970, appellants-debtors, (hereinafter `petitioners'), Henry J. Weisser, Case No. 70-248-Bk-J, and Herman M. Weisser, Case No. 70-249-Bk-J, filed petitions for arrangement under Chapter XI of the Bankruptcy Act. 11 U.S.C. § 701 et seq. Included in their schedules of assets as required by 11 U.S.C. § 724, Rule 11-11, Chapter XI, Rules of Bankruptcy, was the stock held by each in the Daytona Motel Corporation. For the several years prior to the filing, and during the pendency, of the petitions, Daytona Motel Corporation was operated as a small business corporation (a Subchapter S corporation) under 26 U.S.C. § 1371 et seq. (hereinafter the `Code'); all six stockholders having made a valid election under § 1372(a) of the Code for it to be so treated.
Beginning on March 23, 1974, and upon various dates thereafter, the United States filed claims for taxes, penalties, and interest in each of the cases. All but two of the claims have been disposed of. Claim No. 14 against Henry Weisser and claim No. 16 against Herman Weisser were contested below and are the subject of this appeal. These claims arise out of an audit conducted by the Internal Revenue Service (hereinafter the `IRS') during 1970 which resulted in the assessment of additional income tax against each petitioner. The reason for the additional assessments was the disallowance of certain operating loss deductions of Daytona Motel Corporation for the year 1970 which were passed through to the individual tax returns filed by each petitioner. The disallowance of the operating loss deductions was based on the determination by the IRS that the Subchapter S status of the corporation was terminated in the calendar year 1970 when petitioners filed their petitions under Chapter XI of the Bankruptcy Act. This was the contention of the IRS despite its having issued a "no change report" in 1974 accepting the corporation's return (1120-S) "as filed".
In their objections, petitioners raised both substantive and procedural deficiencies in the manner in which the IRS made the assessments and claims. On November 9, 1976, the case came on to be heard before the bankruptcy judge who overruled the objections and held that the claims were valid.
Petitioners appeal the order of the bankruptcy judge, raising essentially the same issues as were argued below. They contend first that the bankruptcy judge erred in holding that the filing of a Chapter XI proceeding creates an estate in bankruptcy which terminates a Subchapter S election. Secondly, petitioners assert that the determination of the bankruptcy judge that the claims of the United States were timely filed was incorrect. Because the Court's resolution of the first issue is in favor of the petitioners, the second issue need not be addressed.
A Subchapter S corporation is a creation of tax law. The principal advantage of the Subchapter S classification is that the profits and losses of the corporation are passed through to the shareholders. Code § 1373. By eliminating the income tax at the corporate level, not only are the shareholders free of the double taxation usually incident to the corporate structure, but also are granted tax benefits with regard to the corporation's operating losses and certain other deductions. Code § 1374.
To qualify for Subchapter S status, the corporation and its shareholders must satisfy a number of strict statutory requirements. The corporation must be a domestic corporation which is not a member of an affiliated group and which does not
(1) have more than ten shareholders (now 15, Public Law 94-455, October 4, 1976);
(2) have as a shareholder a person (other than an estate) who is not an individual;
(3) have a non-resident alien as a shareholder; and
(4) have more than one class of stock. Code § 1374(a).
To have the corporation treated as a Subchapter S corporation for tax purposes, all persons who are shareholders must make an election. Code § 1372(a). This election may be terminated by a consent of the shareholders, Code § 1371(e)(2); by the introduction of a shareholder who does not consent to the election, Code § 1372(e)(1); or by the failure of the corporation at any time during the taxable year to satisfy the requirements of § 1371(a), Code § 1372(e)(3). Generally, a termination of the Subchapter S election at any time during the taxable year is effective for the entire taxable year. Code § 1372.
The intent of Congress in carving out the Subchapter S exception to the corporate tax system was to allow the shareholders of small, closely held corporations, which are economically aligned with proprietorships and partnerships, to operate their businesses as corporate entities and still be taxed similarly to partnerships. H.R. 775, S.R. 1983, Conference R. 2632, P.L. 85-866, 85th Cong., 2d Sess., 3 U.S.Code Cong. and Admin.News. pp. 4791, 4876-4878 (1958). To limit the law's application to only those corporations intended to be covered, and at the same time prevent undue administrative burdens from being placed on the government, the strict requirements of § 1371 were attached.
Of importance to this case is the application of § 1371(a)(2) which limits the type of shareholder a Subchapter S corporation may have. The regulations promulgated by the Secretary of the Treasury (hereinafter the `Secretary') expound somewhat on this requirement. 26 C.F.R. § 1.1371-1(e) (1978) states:
A corporation in which any shareholder is a corporation, trust, or partnership does not qualify as a small business corporation. The word "trust" as used in this paragraph includes all trusts subject to the provisions of subchapter D, F, H or J (including subpart E thereof), chapter 1 of the Code and voting trusts.
26 C.F.R. § 1.1371-1(d) (1978) addresses the necessity that the Subchapter S corporation have no more than ten shareholders. There it is stated:
Ordinarily, the persons who would have to include in gross income dividends distributed with respect to the stock of the corporation are considered to be the shareholders of the corporation. . . . Persons for whom a stock (sic) in a corporation is held by a nominee, agent, guardian, or custodian will generally be considered shareholders of the corporation.
In determining who actually holds the stock and whether the holder of the stock is in reality the shareholder under § 1371(a), the courts have taken various tacks. In Fulk & Needham, Inc. v. United States, 411 F.2d 1403 (4th Cir. 1969), the taxpayer contended that, although a trust actually held the stock, because the economic realities placed the tax burden on him, he should be considered the true shareholder under § 1371(a). The court, however, rejected the argument and held that, by a literal reading of § 1371(a), a trust which holds legal title to the stock is the real shareholder.
In Lafayette Distributors, Inc. v. United States, 397 F.Supp. 719 (W.D.La.1975) the court looked past the existence of a voting trust and, applying a beneficial ownership test, held that since the income of the corporation would be taxed to the shareholder rather than the trustee of the voting trust, the voting trust was not a shareholder of the corporation, despite its owning legal title to the stock. See also, A & N Furniture & Appliance Co. v. United States, 271 F.Supp. 40, 42 (S.D.Ohio 1967).
The beneficial ownership test was rejected by the court in W & W Fertilizer Corp. v. United States, 527 F.2d 621 (Ct.Cl.1975). There the court found that whether the entity holding the stock was recognized as a taxpayer by the code was significant to the determination of who the shareholder was. In rejecting the taxpayer's theory that he, as an individual, was the one who paid the tax on the corporation's dividends and, thus, was the real party in interest, the court reasoned that, although the code may eliminate a trust's obligation to pay taxes, since the trust remained a taxable entity, it, rather than the individual, was the shareholder under § 1371(a). The court stated "we believe section 1371(a) addresses only entities recognized as taxpayers by the Code." 527 F.2d at 627.
This "taxable entity" test reconciles the apparent conflict between the Lafayette and Fulk decisions. Only in those cases where the entity holding the stock is not required by the code to file tax returns, is that entity not considered a taxpayer for § 1371(a) purposes. If the entity holding the stock is required to file a tax return, then that entity would be a shareholder for purposes of determining the corporation's Subchapter S eligibility. Thus, the question in the present case would seem to be whether petitioners as debtors in possession are treated by the code as taxable entities apart and distinct from the petitioners as...
To continue reading
Request your trial