McKelvy v. United States
| Decision Date | 11 May 1973 |
| Docket Number | No. 357-71,358-71.,357-71 |
| Citation | 478 F.2d 1217 |
| Parties | Robert H. McKELVY and Maxine McKelvy v. The UNITED STATES. R. Hugh McKelvy and Tula E. McKelvy v. The UNITED STATES. |
| Court | U.S. Claims Court |
COPYRIGHT MATERIAL OMITTED
Edward R. Smith, Lubbock, Tex., attorney of record, for plaintiffs; Smith & Baker, Lubbock, Tex., of counsel.
Richard D. Silvester, Washington, D. C., with whom was Asst. Atty. Gen. Scott P. Crampton, for defendant; Joseph Kovner, Washington, D. C., of counsel.
Before COWEN, Chief Judge, and DAVIS, SKELTON, NICHOLS, KASHIWA, KUNZIG and BENNETT, Judges.
The above-entitled claims are consolidated suits for the refund of federal income taxes for calendar year 1969. An assessment was made by the Government on a "distribution and loan-back" transaction made on or about April 12, 1969, between McKelvy Furniture, Inc. and its shareholders, Robert H. and Maxine McKelvy and R. Hugh and Tula E. McKelvy, involving the amounts of $5,136.17 and $17,851.74, respectively. The total consolidated refund claimed is $6,192.02 ($1,570.51 claimed by Robert H. and Maxine McKelvy; $4,621.51 claimed by R. Hugh and Tula E. McKelvy) together with interest.
The sole question is whether the said April 12, 1969, transaction was a taxable dividend to the extent of earnings and profits of McKelvy Furniture, Inc. for its fiscal year ending January 31, 1970. We find for the defendant in both cases.
McKelvy Furniture, Inc. was incorporated under the laws of the State of Texas on February 1, 1959; its place of business was Lubbock, Texas. From its inception through its fiscal year ending January 31, 1969, the corporation elected to be taxed as a small business corporation under Subchapter S of the Internal Revenue Code of 1954, as amended, 26 U.S.C. §§ 1371-1378 (1970).1 The corporation properly terminated its election to be a small business corporation under Subchapter S beginning with its fiscal year ending January 31, 1970, that is, as of February 1, 1969. Plaintiffs Robert H. and Maxine McKelvy together owned, as their community property, 50 percent of the outstanding stock of the corporation, the remaining 50 percent being owned by plaintiffs R. Hugh and Tula E. McKelvy together as their community property. Such stock ownership was and has been the same for all periods material to this litigation. Taxpayers are on a calendar-year basis for the purpose of filing their personal income tax returns and were on such a calendar-year basis for the year 1969.
The corporation reported current earnings and profits of $21,058.33 for its fiscal year ending January 31, 1969, and $14,378.30 for its fiscal year ending January 31, 1970. These figures are taken from the income tax returns of McKelvy Furniture, Inc. for its fiscal years ending January 31, 1969, and January 31, 1970, which have been stipulated as accurately reflecting earnings and profits for the purposes of these cases. At the beginning of the fiscal year ending January 31, 1969, the corporation reported that it had previously taxed income (hereinafter referred to as PTI) totaling $36,017.97. By the end of that taxable year, the corporation reported on its books that this amount of PTI had been reduced by $35,941.672 to $76.30. No reduction was reported in the corporation's capital stock account at any time during the fiscal years ending January 31, 1969, or January 31, 1970. On January 31, 1969, McKelvy Furniture, Inc. had $3,465.86 in cash on hand.
On January 30, 1969, the directors of the corporation lawfully and effectively adopted the following resolution:
RESOLVED, That there be declared, and there is hereby declared, a dividend payable to the shareholders of record at the present time in the amount of $57,000, such dividend to be paid as follows: All accounts receivable from R. Hugh McKelvy and Robert H. McKelvy shall be forgiven and cancelled on January 31, 1969, and the balance of such dividend of $57,000 shall be paid in cash on or before April 15, 1969.
The dividend payable of $57,000, above mentioned, was paid by the corporation as shown below:
Robert H. R. Hugh
McKelvy McKelvy
By credit on the corporation's
books on January 31, 1969
to accounts receivable
From Robert H. McKelvy $23,363.83
From R. Hugh McKelvy ................................. $10,648.26
By the corporation's check
dated and given April 12
1969 ................................... 5,136.17 17,851.74
_________________________
Total ................................. $28,500.00 $28,500.00
At the time (and immediately prior thereto) the corporation's above-described checks, dated April 12, 1969, in the respective amounts of $5,136.17 and $17,851.74, were given to taxpayers, the corporation's checking account showed a balance of $21,695.22. On April 11, 1969, the matter of paying the balance of the $57,000 dividend was discussed by taxpayers and the certified public accountant who represented the corporation and them. It was then agreed that to finance such a balance taxpayers would make loans back to the corporation. Upon receipt by taxpayers of the corporation's checks, dated April 12, 1969, described above, the respective payees endorsed the checks and deposited them to the corporation's checking account to the extent of $5,000 and $17,750, respectively, taking and retaining the balances of $136.17 and $101.74, respectively, in cash. The amounts so deposited to the corporation were treated by all parties thereto as loans from the respective taxpayers to the corporation. No notes were given by the corporation to evidence those loans.
At the end of the fiscal year ending January 31, 1969, the corporation's balance sheet showed dividends payable of $22,987.91. This figure had been reduced to zero by the end of the fiscal year ending January 31, 1970, but nothing appears in any of the exhibits or stipulations to indicate exactly what happened to this figure. On their calendar year income tax returns for 1969, taxpayers each reported as income $10,529.16, their pro rata shares of the corporation's current earnings and profits for its fiscal year ending January 31, 1969. Taxpayers reported no additional amount on their 1969 returns as a dividend or other income from McKelvy Furniture, Inc. In the audit of taxpayers' 1969 income tax returns, the Internal Revenue Service determined that the loans from taxpayers to the corporation on the transaction heretofore described constituted dividends to taxpayers in calendar year 1969 out of earnings and profits of the corporation's fiscal year ending January 31, 1970, available in 1969. Based upon that determination, taxes and interest were assessed against taxpayers. The Government viewed the transactions as follows:
Fiscal 1969 earnings and profits (taxable
to taxpayers in calendar 1969 under
Subchapter S) .................................. $21,058.33
Fiscal 1970 earnings and profits available
in 1969 (taxable to taxpayers in
calendar 1969 as a result of April 12
1969, distribution of corporation
obligations) ................................... 14,378.30
Balance of dividend obligation (tax effects
not determined by Internal Revenue
Service and not in issue here) ................. 21,463.37
__________
Total ........................................ $57,000.00
Based upon this determination, taxes and interest were assessed against taxpayers. Taxpayers paid the assessments and filed timely claims for refund thereof, which claims were disallowed by the Commissioner of Internal Revenue on March 30, 1971.
The very narrow question presented to this court is whether the above-described "distribution and loan-back" transaction of April 12, 1969, was a taxable dividend to the extent of earnings and profits of McKelvy Furniture, Inc. for its fiscal year ending January 31, 1970 (in the amount of $14,378.30).3
Before reaching this question, however, it is necessary to distinguish the consequences of distributions with respect to regular Subchapter C corporations on the one hand and Subchapter S corporations on the other. In a regular corporation, for federal tax purposes, distributions of cash or other property to stockholders are deemed dividends to the extent of current and accumulated4 earnings and profits with current earnings and profits deemed to be the first source of payment. Section 316(a). Any such distributions after exhausting earnings and profits are deemed to be payment of capital and are not taxable income but reduce the basis of the shareholder's stock. Section 301(c)(2). Distributions can only reduce basis to zero, and any distribution in excess of basis is governed by the rules of section 301(c)(3),5 not here relevant.
A somewhat altered structure has been created in the Subchapter S context. If the electing corporation distributes dividends, they are includible in the shareholders' gross income in the same manner as dividends distributed by regular corporations. Treas.Reg. § 1.1372-1(c)(2) and (7); DeTreville v. United States, 445 F.2d 1306, 1309 (4th Cir. 1971). The Subchapter S provisions go on to deal with a new category of account, known as "undistributed taxable income" (hereinafter referred to as UTI), and defined by section 1373(c) to be:
* * * taxable income * * * minus * * * the amount of money distributed as dividends during the taxable year, to the extent that any such amount is a distribution out of earnings and profits of the taxable year as specified in section 316(a)(2). Emphasis supplied.
After the amount of UTI is calculated. section 1373(b), an operational section, prescribes the following addition to gross income not contemplated by regular corporations:
(b) Amount included in gross income.
Each person who is a shareholder of an electing small business corporation on the last day of a taxable year of such...
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