Lewis v. Comm'r of Internal Revenue, Docket No. 530-64.

• Decision Date: 18 November 1966
• Docket Number: Docket No. 530-64.
• Citation: 47 T.C. 129
• Parties: PERRY S. LEWIS AND ESTHER LEWIS, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

47 T.C. 129

PERRY S. LEWIS AND ESTHER LEWIS, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 530-64.

Tax Court of the United States.

Filed November 18, 1966.

Lester M. Ponder, for the petitioners.

W. Dean Short, for the respondent.

In 1956, petitioner, who owned 49.5 percent of the stock of a corporation and whose sons owned the remaining stock, entered into an agreement with the corporation for the redemption of his stock over a period of years. After the agreement, he remained an officer and director of the corporation, but he received no compensation from the corporation, performed no services for it, and exercised no influence over its affairs. He reported the profit from the redemption of his stock as capital gain in his income tax returns for 1956-61. Held, the payments in exchange for petitioner's stock were not essentially equivalent to a dividend.

TANNENWALD, Judge:

The respondent determined deficiencies in petitioner's income tax in the amounts of $1,596.87 for 1959, $1,701.45 for 1960, and $1,703.52 for 1961. The only question remaining is whether the proceeds of a redemption of stock shall be treated as capital gain or as a dividend. All other adjustments have been settled by stipulation and will be reflected in a Rule 50 computation.

FINDINGS OF FACT

Some of the facts are stipulated and are found accordingly.

Perry S. Lewis and Esther Lewis are husband and wife residing in Crawfordsville, Ind. They filed joint income tax returns on a cash basis with the district director of internal revenue at Indianapolis, Ind., for the taxable years 1959, 1960, and 1961. Any reference herein to ‘petitioner’ shall be deemed to mean Perry S. Lewis.

Petitioner entered the retail automobile business in 1910 and purchased the Ford agency at Crawfordsville, Ind., in 1926. He operated it as a sole proprietorship until 1950, when it was incorporated as Perry Lewis Co., Inc. (hereinafter referred to as the corporation).

Petitioner at all pertinent times understood that Ford Motor Co., because the retail automotive business was highly competitive, was very much interested in having its dealers acquire and keep young blood and young people in the active management of their businesses.

Petitioner likewise planned that his sons would come into the business and one day acquire it from him. John and Perry, petitioner's sons, began working full time in the business about 1946. They were joined by Gene, their youngest brother, after he graduated from college in 1952.

After World War II, the petitioner constantly reduced his role in the active conduct of the business. From 1950 to 1956, petitioner was president and a director, but his services to the corporation were on a diminished scale, consisting for the most part of consulting with his sons and giving them advice regarding the business.

In 1950 when the corporation was organized, the petitioner owned all of the stock. It was his intent to dispose of his stock to his sons at such times as they were able to purchase it. By July 1956, petitioner owned 495 shares, Gene owned 1 share, and John owned the remaining 504 shares.¹

The petitioner acquired and began to operate a farm in 1941. In 1956, he decided to dispose of all of his interest in the corporation and devote himself to farming. At that time, petitioner was 69 years old.

In June 1956, petitioner offered to sell his 495 shares to the corporation at $100 per share, which was their approximate book value. At special meetings of the board of directors and of the shareholders, held on June 28, 1956, petitioner's offer was accepted. The directors also granted to Gene the right to purchase from the corporation from time to time a maximum of 250 of the shares to be acquired from petitioner at book value at the time of each purchase.²

On July 1, 1956, petitioner entered into an agreement with the corporation which provided that the latter would purchase all of his stock for $49,500. The corporation was to pay petitioner $500 per month with interest at 5 percent per annum on the unpaid balance, with a right in the corporation to pay more than the required monthly amounts. At the end of each year, the total payments to principal were to be calculated and petitioner was required to deliver the number of shares paid for at the rate of $100 per share. The petitioner retained the right to vote any of the shares not paid for and delivered to the purchaser. The agreement provided that the certificates representing petitioner's shares were to be endorsed with a legend referring to the sale of the shares. Following this transaction, there was no basic change in the day-to-day business operations of the corporation.

Commencing July 1, 1956, petitioner's salary of $1,000 per month was discontinued. He resigned as president and was elected vice president of the corporation on June 11, 1956. He retained this position and his position on the board of directors through all of the taxable years in question.³ After July 1, 1956, petitioner neither performed any services for the corporation nor actively exercised any powers as vice president or director. ⁴ Petitioner attended informal meetings of the board of directors but did not participate in any of the deliberations. The business was operated solely by John and Gene, although petitioner from time to time inquired generally how business was progressing.

On May 6, 1958, a major medical plan covering the officers of the corporation was considered at a special meeting of the board of directors, and the officers of the corporation were authorized to acquire an appropriate insurance policy.

The corporation has never paid a dividend and had accumulated earnings and profits at the end of 1956 in the amounts of $42,163.41; in 1959, $62,263.82; in 1960, $77,648.15; and in 1961, $86,711.60.

After the respondent had begun an audit of petitioner's income tax returns, petitioner mailed a document dated June 5, 1963, purporting to be an agreement under section 302(c)(2)(A)(iii) of the Internal Revenue Code of 1954. ⁵ Petitioner requested that such document be attached to his 1961 income tax return, but respondent rejected it on the grounds that it was not filed in duplicate and should have contained an agreement to notify the district director of any reacquisition within 10 years from December 31, 1961, instead of July 1, 1956, the date used by petitioner in the document.

In each of the taxable years in issue, 1959, 1960, and 1961, petitioner received principal payments of $10,000 and in exchange delivered 100 shares of stock at the close of each year. In addition to the payments of principal, petitioner received interest payments of $1,394.16 in 1959, $882.00 in 1960, and $351.21 in 1961, which he separately reported on his tax returns for those years. Petitioner's final delivery of 100 shares in 1961 completely terminated his actual stock ownership in the corporation. Petitioner's basis for his shares in 1956 was $61.20 per share, and, as of January 1, 1959, he had an unrecovered cost basis of $18,360 for 300 shares.

The payments received by petitioner in payment for his shares during the taxable years in question were not essentially equivalent to a dividend.

OPINION

Once again we are faced with the troublesome question whether a distribution by a corporation to a shareholder is ‘essentially equivalent to a dividend’ within the meaning of section 302(b)(1). A finding of nondividend equivalency would dispose of the case and make unnecessary a determination as to whether there was a complete redemption within the meaning of section 302(b)(3) and the subsidiary question whether petitioner complied with the requirements of section 302(c). The pertinent statutory provisions are set forth in the margin.⁶

At the outset, we emphasize that this case involves a situation where the taxpayer was both a minority shareholder and an active participant in the business and that, leaving aside the attribution rules, the transaction herein resulted in the complete termination of such active participation and shareholder interest. We believe that the numerous cases, involving only a partial redemption and where the taxpayer was a majority shareholder and it was apparent that he continued in a position of control, are clearly distinguishable.

The fact that petitioner did not immediately surrender all of his stock, but rather did so over a period of 5 years, is not an impediment to the application of section 302(b)(1) if the partial redemptions were but steps in a single transaction. In Re Lukens' Estate, 246 F.2d 403 (C.A. 3, 1957), reversing 26 T.C. 900 (1956); Jackson Howell, 26 T.C. 846 (1956), affd. 247 F.2d 156 (C.A. 9, 1957); Carter Tiffany, 16 T.C. 1443 (1951), acq. 1957-1 C.B. 5. An examination of the record convinces us that this was in fact the case. Without contradiction, petitioner testified that it was his long-held intention to retire from the business and allow his sons to purchase it. His conduct for the past 26 years confirms and supports this testimony. Both the provisions of the agreement with the corporation and the conduct of the parties in adhering to its terms convince us that this transaction must be considered in its entirety.

It is clear that, even if there was not a complete redemption under section 302(b)(3) because of petitioner's alleged failure to comply with the provisions of section 302(c), petitioner is not precluded from claiming the benefits of section 302(b)(1). See sec. 302(b)(5). As the report of the Senate Committee on Finance at the time of the enactment of the Internal Revenue Code of 1954 states . . .

In general under * * * (sec. 302(b)) your committee intends to incorporate into the bill existing law as to whether or not a reduction is essentially equivalent to a dividend under section 115(g)(1) of the 1939 Code, and in addition to provide three definite standards in order to provide certainty in specific instances. (Emphasis added. S....