Johnson v. United States
| Decision Date | 12 August 1969 |
| Docket Number | Civ. A. No. 6835. |
| Parties | W. Taylor JOHNSON, and Foye K. Johnson, Plaintiffs, v. UNITED STATES of America, Defendant. |
| Court | U.S. District Court — Eastern District of Virginia |
Francis N. Crenshaw, Robert C. Nusbaum, Norfolk, Va., for plaintiffs.
Charles Pekor, Tax Division, U. S. Dept. of Justice, Washington, D. C., Brian P. Gettings, U. S. Atty., Norfolk, Va., for defendant.
This action for refund of income taxes paid by the plaintiffs calls for a construction of Internal Revenue Code, section 301 (26 U.S.C., section 301), the facts being largely undisputed and contained in the stipulations filed at the pretrial conference and at trial.
The Mayflower Corporation owned a highrise apartment building at Virginia Beach, Virginia, constructed under the provisions of section 608 of the National Housing Act, 56 Stat. 303, 12 U.S.C., section 1743. The taxpayers acquired fifty-two percent of the corporation's stock in 1949 at a cost of $1,040. The remaining forty-eight percent of the stock was purchased in 1954 from F. A. VanPatten and Martha VanPatten by the taxpayers at a cost of $144,500.
From 1949 until 1963 no distributions were made to stockholders. There was, however, a substantial accumulation which counsel stated at the time of trial was a "depreciation reserve" for equipment in the corporate account entitled "Appreciation of Land and Building." On June 19, 1963, the taxpayers' attorney wrote Johnson recommending a distribution which, in his opinion, could be affected as a tax-free return of capital under section 301 of the Internal Revenue Code. Subsequently, on June 21, 1963, a Board of Directors meeting was held and a resolution was adopted calling for the distribution of $169,000 to be paid June 26, 1963.
In preparing the minutes of the stockholders' meeting, taxpayers' attorney did not specify whether the distribution was to be made on a "pro rata" or "non-pro rata" basis. It is contended by plaintiff, however, that since the clear and admitted intention of the taxpayers was to avail themselves of the benefits of section 301, and since this could not be done if the distribution was pro rata, the distribution must be deemed to have been on a non-pro rata basis.
When the distribution was made, the taxpayers, in the Federal Income Tax return for 1963, treated $13,564.70 as ordinary income because it came from earnings and profits of the corporation. The sum of $145,540 was reported as nontaxable return of capital and $9,895.30 was reported as a capital gain. The Commissioner of Internal Revenue assessed an additional tax in the amount of $17,472.76, plus interest of $3,318.82 on the grounds that the distribution was pro rata. On June 3, 1967, the taxpayers paid the additional assessment of taxes and interest in the aggregate sum of $20,791.58.
A separate claim for refund was properly filed with the District Director and, receiving no notice of disallowance within six months, the plaintiffs filed this action.
The Internal Revenue Code of 1954, section 301, provides:
Treasury Regulation, section 1.316-2 deals with "Sources of distribution in general" and further amplifies the effect of the above-quoted section as follows:
Taken at face value, it would appear that the statute allows a return of capital to a shareholder out of the corporate reserves to the extent that they are not earnings and profits. Without more, the Government concedes that this is so, but contends that where the distribution is to be made with respect to separate blocks of stock acquired at different times and at different bases, the distribution must be pro rata. It is further argued that an aggregation of bases; i. e., a non-pro rata distribution with respect to separately acquired blocks of stock, may not be effected without a legitimate business purpose other than a tax benefit.
The result of the Government's approach is that although the amount of a distribution might be sufficient to return the investment in all stock, the proportionate pro rata distribution would result in a return of basis and additional gain1 on some block or blocks of stock, and an incomplete return of basis on others.2 In the instant case, the Government would treat the $155,435.30 in excess of dividend in the following manner: fifty-two percent of that amount would be allocated to the stock acquired in 1949 for $1,040 resulting in a capital gain realized of $79,786; the amount received with respect to the 48 shares acquired in 1954 would be applied to reduce their basis from $144,500 to $69,891.06. In order to effect a complete recovery of basis the corporation would have to distribute approximately $301,041.62.
We do not read the statute as requiring this result. It is clear that the taxpayers, as directors and sole stockholders of the corporation, intended to, and effectively did make a non-pro rata distribution.
The major portion of the actual trial was taken up with argument over the question of whether the distribution was non-pro rata. We have no difficulty in finding that it was. The letters of counsel and the corporate resolution clearly show that the intent was to return the entire capital investment; to pay out $1,040 attributable to the stock acquired for that amount, and similarly $144,500 to the stock acquired for that amount; the remainder to be treated as capital gain. Although an aggregation of basis is not the ordinary procedure in corporate distributions, business and tax consequences do not rest upon labels. There is nothing magic about the words "non-pro rata" when the transaction was intended to be and was effected in the manner which the missing label would fit.
The taxpayer as well as the Government is entitled to...
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