McDaniel v. Comm'r of Internal Revenue
| Decision Date | 22 November 1955 |
| Docket Number | Docket No. 41415. |
| Citation | 25 T.C. 276 |
| Parties | J. PAUL McDANIEL AND MARY C. McDANIEL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Held, certain payments in redemption of stock were distributions in partial liquidation within section 115(c) of the 1939 Code and not essentially equivalent to a taxable dividend within section 115(g) of the 1939 Code. John W. Oast, Jr., Esq., for the petitioners.
A. Russell Beazley, Jr., Esq., for the respondent.
Respondent determined a deficiency in petitioners' income tax for the year 1948 in the amount of $3,353.08. The sole issue is whether the proceeds, $13,500, received in a redemption of stock are taxable as a dividend under section 115(g) of the Internal Revenue Code of 1939 or treated as a distribution in partial liquidation under section 115(c).
J. Paul McDaniel (hereinafter referred to as petitioner) and Mary C. McDaniel are husband and wife residing in Norfolk, Virginia. They filed a joint income tax return for the year 1948 with the collector of internal revenue of the Richmond district in Virginia.
Nichols Bros., Incorporated, was incorporated in 1909 under the laws of Virginia with its principal office located in Norfolk, Virginia. The corporation was engaged in the manufacture and sale of lumber products generally.
Capital stock in the amount of $50,000 was authorized, with stock at a par value of $100. Only common stock was authorized. There was paid-in capital of $5,000.
By amendment to the charter of incorporation in 1922, the authorized capital stock was raised to $150,000. On this date, there were 500 shares of common stock issued and outstanding.
Nichols Bros., Incorporated, was organized by John F. McDaniel, father of the petitioner, Charles K. Nichols, and Anthony D. Nichols. Charles K. Nichols and Anthony D. Nichols were president and vice president, respectively, while John F. McDaniel was secretary-treasurer.
John F. McDaniel was the active manager of the business from its inception in 1909 to the year 1943, when he retired, at which time petitioner became manager of the corporation.
Nichols Bros., Incorporated, was beneficiary of and paid the premiums on a life insurance policy on the life of John F. McDaniel, and upon his death in May 1947, the corporation received the proceeds of $50,161.30.
John F. McDaniel, at the time of his retirement, owned 300 shares of common stock. These were redeemed by the corporation in that same year (1943), reducing to 500 the shares of common stock outstanding.
Petitioner, at the beginning of 1948, owned 200 shares of common stock in the corporation. These were acquired in the following manner:
+-------------------------------------------------------+
¦Date ¦ ¦Number¦Par ¦ ¦
+-------------+------------------+------+-------+-------¦
¦acquired ¦Acquired from— ¦shares¦value ¦Cost ¦
+-------------+------------------+------+-------+-------¦
¦Sept. 9, 1942¦J. F. McDaniel ¦100 ¦$10,000¦$10,000¦
+-------------+------------------+------+-------+-------¦
¦Dec. 21, 1943¦Annie O. Nichols ¦65 ¦6,500 ¦6,500 ¦
+-------------+------------------+------+-------+-------¦
¦May 26, 1947 ¦Charles O. Nichols¦35 ¦3,500 ¦7,000 ¦
+-------------------------------------------------------+
On July 22, 1948, the corporation redeemed the entire block of 300 shares of common stock then owned by Charles O. Nichols, terminating his ownership in the corporation. The shares were redeemed for $62,676, of which $32,676 represented the premium over and above the par value of the stock and which was charged to the surplus account. Subsequent to this date, petitioner was the sole stockholder of Nichols Bros., Incorporated.
On September 24, 1948, the board of directors of Nichols Bros., Incorporated, consisted of petitioner, his wife, Mary C. McDaniel, and Frederick G. Swink, who is in no way related to petitioner. At a board of directors' meeting held on that date, it was agreed to have the corporation redeem 100 shares of common stock from petitioner: 35 shares at $200 per share, or $7,000, and 65 shares at par, or $6,500. The distribution in redemption, $13,500, received by petitioner was equal to his cost basis for the 100 shares redeemed. Book value of the stock at the date of redemption was $273 per share. It was agreed at the directors' meeting to cancel the petitioner's indebtedness of $6,500 to the corporation in exchange for the 65 shares of stock. This indebtedness arose in connection with petitioner's purchase of 65 shares of stock from Annie O. Nichols in 1943. Petitioner had borrowed the necessary funds from his father to make the purchase. Subsequently, petitioner had obtained a loan of $6,500 from the corporation to reimburse his father. The corporation had retained the 65 shares of common stock as collateral for the loan to petitioner.
Nichol Bros., Incorporated, had accumulated and undistributed earnings and profits on December 31, 1947, of $69,075.90, which figure included the insurance proceeds of $50,161.30 paid to the corporation during 1947. Accumulated earnings and profits were $25,789.79 on December 31, 1948.
No resolution has ever been passed by the board of directors of Nichols Bros., Incorporated, authorizing a partial or complete liquidation of the corporation. However, the management policy of Nichols Bros., Incorporated, from 1941 to 1948 had been to contract the operations of the corporation and to dispose of its operating assets with the end in mind of gradually liquidating the corporation.
From 1920 to 1948 the operating income of Nichols Bros., Incorporated, totaled $266,102.49, and, over this same period, cash dividends were paid amounting to $204,950.
Through the year ending December 31, 1953, the operating income, cash dividends paid, and the surplus account were as follows:
+--------------------------------------------------------------+
¦ ¦Operating ¦Cash dividends¦ ¦
+------------------+------------+--------------+---------------¦
¦Year ended Dec. 31¦income ¦paid ¦Surplus Dec. 31¦
+------------------+------------+--------------+---------------¦
¦1949 ¦($12,804.20)¦ ¦$36,757.70 ¦
+------------------+------------+--------------+---------------¦
¦1950 ¦(2,977.41) ¦ ¦34,641.08 ¦
+------------------+------------+--------------+---------------¦
¦1951 ¦(6,310.77) ¦ ¦35,971.23 ¦
+------------------+------------+--------------+---------------¦
¦1952 ¦(11,493.74) ¦ ¦33,250.49 ¦
+------------------+------------+--------------+---------------¦
¦1953 ¦(5,983.18) ¦ ¦37,249.26 ¦
+--------------------------------------------------------------+
During the years 1931 to 1941, Nichols Bros., Incorporated, made additions to its plant and equipment in the amount of $155,000.
In the year 1940 the operating assets of Nichols Bros., Incorporated, had a book value of $135,000. In 1941 the corporation sold plant and equipment, with a cost basis of $80,000, at a profit of $20,914.05. At the end of 1948 the operating assets of the corporation had a book value of $7,294.19. No such assets were sold by the corporation between September 24, 1948, when the stock redemption occurred, and the end of the year. The book value of the operating assets in subsequent years was as follows:
+---------------------------+
¦December 31 ¦Book value ¦
+--------------+------------¦
¦1949 ¦$3,031.41 ¦
+--------------+------------¦
¦1950 ¦6,816.38 ¦
+--------------+------------¦
¦1951 ¦5,211.40 ¦
+--------------+------------¦
¦1952 ¦4,770.38 ¦
+--------------+------------¦
¦1953 ¦1,879.88 ¦
+---------------------------+
During 1948 Nichols Bros., Incorporated, conducted, on a reduced scale, its general operations of buying and selling piling. There were no manufacturing activities during that year. The corporation in 1948 owned an open yard where pilings were processed, some cutting machinery of the hand tool variety, and some cranes for handling the pilings. At the date of this hearing, April 1954, Nichols Bros., Incorporated, though not dissolved, was not engaged in active operation; the corporation still owned the yard, together with one crane.
Nichols Bros., Incorporated, has been in the process of complete liquidation since 1941.
Avoidance of tax was not one of the reasons for the distribution.
The distribution of September 24, 1948, was a distribution in partial liquidation of the corporation, and the redemption of stock was not at such a time nor in such a manner as to make the distribution and redemption essentially equivalent to the distribution of a taxable dividend.
Under section 115(c) of the Internal Revenue Code of 1939, amounts distributed in partial liquidation of a corporation are treated as in part or full payment in exchange for stock. A partial liquidation, as defined in section 115(i), may be either a distribution by a corporation in complete cancellation or redemption of a part of its stock or one of a series of distributions in a complete cancellation or redemption of all or a portion of its stock.
It fairly appears from the taxpayer's petition that he alleges: (1) the $13,500 received in redemption of the stock was not taxable as a dividend because the nontaxable character of the income received by the corporation (proceeds of a life insurance policy) retained its nontaxable character when distributed to stockholders, and (2) the redemption payment was made in partial liquidation of the corporation. Petitioner, in his brief filed here, abandons the first contention.
Respondent's argument is in the main that the redemption payment was essentially a distribution of a taxable dividend because paid out of the...
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