Johnson v. C.I.R.

• Decision Date: 30 March 1993
• Docket Number: No. 92-1938,92-1938
• Citation: 989 F.2d 484
• Parties: NOTICE: First Circuit Local Rule 36.2(b)6 states unpublished opinions may be cited only in related cases. Peter A. JOHNSON and Claire P. Lyon, Petitioners, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee.
• Court: U.S. Court of Appeals — First Circuit

Page 484

989 F.2d 484

NOTICE: First Circuit Local Rule 36.2(b)6 states unpublished opinions may be cited only in related cases.

Peter A. JOHNSON and Claire P. Lyon, Petitioners, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee.

No. 92-1938.

United States Court of Appeals First Circuit.

March 30, 1993

Appeal from the United States Tax Court

Peter A. Johnson and Claire P. Lyon on brief pro se.

James A. Bruton, Acting Assistant Attorney General, Gary R. Allen, Jonathan S. Cohen and Regina S. Moriarty, Attorneys, Tax Division, on brief for appellee.

U.S.T.C.

AFFIRMED.

Before Selya, Cyr and Boudin, Circuit Judges.

Per Curiam.

The appellants, Peter A. Johnson and Claire P. Lyon, appeal a decision of the Tax Court that sustained a deficiency determined by the Internal Revenue Service on the appellants' joint income tax return for 1986. We affirm the Tax Court's decision.

I

Mr. Johnson and Ms. Lyon are married and reside in New Hampshire. Mr. Johnson is a certified public accountant and for a number of years made his living as a consultant, primarily to law firms practicing in the field of energy regulation. In 1980, Mr. Johnson and Ms. Lyon incorporated Peter A. Johnson Associates, Inc. (PAJA), through which Mr. Johnson then carried on his consulting business. The corporation initially issued 100 shares of stock: 51 shares to Mr. Johnson and 49 shares to Ms. Lyon. The corporation later sold 8 more shares to an entity known as PAJA Pension Trust.

Mr. Johnson worked full-time for PAJA until 1985, when he accepted a salaried position at a hospital and his consulting work tapered off. Late in 1986, with PAJA relatively dormant, Mr. Johnson and Ms. Lyon decided to liquidate the company and distribute its assets to the shareholders.

At the time, the tax laws offered a choice to shareholders of liquidating corporations. Under 26 U.S.C. § 331, they could recognize all of the distributed assets on their income tax returns for the year in which the liquidation occurred, but pay taxes on the distribution at the capital gains rate, which was lower than the rate applied to "ordinary income" such as wages or dividends. Or, they could elect to treat the distribution under 26 U.S.C. § 333. Section 333 required the shareholders to allocate the distributed assets to two categories: (1) earnings and profits, and (2) all other assets. The shareholders had to declare the portion of the distribution that came from earnings and profits as ordinary income on their returns for the year in which the liquidation occurred, and pay taxes on it at the higher income tax rate. However, with respect to the portion of the distribution that took the form of the corporation's other assets, the shareholders could postpone recognizing any gain until they themselves sold the assets. Roughly speaking, then, Section 333 was a good deal only for shareholders of "a corporation holding appreciated property but having little or no earnings and profits...." B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders at p 11.62 (5th ed. 1987). If the corporation had significant earnings and profits, the shareholders were better off electing Section 331, recognizing a gain immediately on the entire distribution, but avoiding taxation of the earnings and profits at the higher income tax rates.

This case concerns the appellants' election to treat PAJA's distributed assets under Section 333 when they dissolved the corporation at the end of 1986. Mr. Johnson knew that Congress had repealed Section 333, effective January 1, 1987. See Pub.L. 99-514, Title VI, § 631(e)(3), Oct. 22, 1986, 100 Stat. 2273. He thus felt some urgency to liquidate PAJA by year's end. But, because personal business intervened, he did not sit down to the task until December 28, 1986.

Mr. Johnson and Ms. Lyon executed a number of documents on December 28. The first was a Form 1120-A, a "Short-Form Corporation Income Tax Return" for PAJA. This document showed that PAJA had assets of $132,249, of which "retained earnings" constituted $96,311. With such a significant amount of earnings-which the shareholders would have to declare as ordinary income under Section 333, but could treat as a capital gain under Section 331-liquidation under Section 333 was an unwise choice.

However, the appellants made it. For reasons never fully explained, Mr. Johnson figured PAJA's "earnings and profits" at zero when deciding whether to elect Section 331 or Section 333. Consequently, he and Ms. Lyon made a written shareholder Lyon made a written shareholder resolution to liquidate the corporation under Section 333. Each of them executed and filed with the IRS a Form 964, which bears the caption "Election of Shareholder under Section 333 Liquidation." Mr. Johnson also executed and filed, on behalf of the corporation, a Form 966, captioned "Corporate Dissolution or Liquidation," which identified Section 333 as the "Section of the Code under which the corporation is to be dissolved or liquidated." Mr. Johnson then wrote checks on PAJA's corporate account that distributed more than $137,000 in assets: $64,607 to himself, $63,632 to Ms. Lyon, and $9,622 to PAJA Pension Trust.

Four months later, when Mr. Johnson and Ms. Lyon filed their joint income tax return for 1986, they should have attached copies of the already-filed Forms 964, to alert the IRS to their election, see 26 C.F.R. §§ 1.333-3 and 1.333-6(a)(5), and treated their share of the distributed assets pursuant to Section 333-that is, by declaring the portion attributable to earnings and profits as ordinary income, but postponing recognition of any gain on the remainder.

The appellants did not do what their election required them to do. They did not attach Form 964; in fact, their income tax return contained no mention of the liquidation. It characterized all of the money they had received from the liquidation as proceeds of a "sale" of PAJA stock, and treated the entire distribution as a capital gain. This calculation would have been consistent with a liquidation under Section 331, or with a simple sale of stock unaccompanied by a liquidation, but it did not jibe with the Section 333 election the appellants had made the previous December.

The IRS accepted the appellants' return and took no further action until an audit in 1988 revealed the inconsistency between the election under Section 333 and the tax treatment given the distribution in the appellants' return. The IRS then rejected the appellants' efforts to revoke their Section 333 election, recalculated their tax liability to take the election into account, determined a deficiency of $24,790, and added penalties for negligence and for making a substantial understatement of taxes owed. The appellants sought review in the Tax Court, which held a one-day trial and sustained the IRS' actions. This appeal followed.

II

Mr. Johnson and Ms. Lyon say that they are not liable for taxes calculated according to Section 333 for two reasons: first, because they never made a valid election; and second, because their election, even if formally valid, was based on a mistake and was therefore revocable.

A

The appellants point to a number of errors they say they made while attempting to elect Section 333 and liquidate PAJA, and assert that strict compliance with all of Section 333's requirements is necessary in order to enjoy the benefits (or in this case, suffer the detriments) of the statute. This is not completely true. The level of compliance needed to make a valid tax election varies according to the nature of the requirement. The IRS " 'may insist upon full compliance with [its] regulations' when the regulatory requirements relate to the substance or essence of a statute, but [the Tax Court has] held that substantial compliance with regulatory requirements may suffice when such requirements are procedural and when the essential statutory purposes have been fulfilled." American Air Filter Co. v. Commissioner, 81 T.C. 709, 719 (1983) (citations omitted). See also Dunavant v. Commissioner, 63 T.C. 316 (1974) (same, construing Section 333).

Two of the regulations which the appellants say they violated-26 C.F.R. § 1.333-6, which required them to provide supplemental information about the liquidation, and 26 C.F.R. § 1.333-3, which required them to file a copy of Form 964 along with the original at the time of election-plainly do not go to the "essence" of the statute and are therefore "procedural" in the sense discussed above. Their breach will not defeat the election.

The other asserted defects require some discussion. First, the appellants say that the distribution was not "in complete cancellation or redemption of all the stock," 26 U.S.C. § 333(a)(1), because their Forms 964 inaccurately listed the number of shares each held. Mr. Johnson owned 51 shares at the time of the election, but listed only 47 in his Form 964; Ms. Lyon owned 49 shares, but listed only 46.

The premise does not support the conclusion. Nothing in the record causes us to believe that, in return for the company's assets, Mr. Johnson and Ms. Lyon (and PAJA Pension

Trust) actually gave up anything less than all of their shares in PAJA. And if that is so, then the distribution was "in complete cancellation or redemption of all the stock." Putting the wrong count on the forms did not affect the substance of the liquidation and therefore did not go to the essence of the statute.

Second, the appellants claim that they failed to make a timely election. Section 333(d) says: "The filing [of the written election form] must be within 30 days after the date of the adoption of the plan of liquidation." The cases indicate that this is an "essential" requirement. Shull v. Commissioner, 291 F.2d 680, 682-85 (4th Cir. 1961); Kelley v. Commissioner, 10 T.C.M. 143, 146 (1951). However, whether and when a plan of liquidation was adopted "is a question of fact ordinarily for the Tax Court," Shull, 291...