Meyer v. CIR

• Decision Date: 06 October 1967
• Docket Number: 18531.,No. 18480,18480
• Citation: 383 F.2d 883
• Parties: Lucile H. MEYER, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Leon R. MEYER, Respondent.
• Court: U.S. Court of Appeals — Eighth Circuit

383 F.2d 883 (1967)

Lucile H. MEYER, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Leon R. MEYER, Respondent.

Nos. 18480, 18531.

United States Court of Appeals Eighth Circuit.

October 6, 1967.

Joseph A. Hoskins, Kansas City, Mo. for Lucile and Leon Meyer; Philip J. Erbacher, Kansas City, Mo., was with him on both briefs.

Robert Waxman, Atty., Dept. of Justice, for Commissioner of Internal Revenue in both cases. Mitchell Rogovin, Asst. Atty. Gen., and Lee A. Jackson and David O. Walter, Attys., Dept. of Justice, were with Robert Waxman, Washington, D. C., on the brief in case No. 18480.

Richard C. Pugh, Acting Asst. Atty. Gen., and Lee A. Jackson and David O. Walter, Attys., Dept. of Justice, were with Robert Waxman, Washington, D. C., on the brief in case No. 18531.

Before VAN OOSTERHOUT, BLACKMUN and MEHAFFY, Circuit Judges.

BLACKMUN, Circuit Judge.

Section 395 of the Bankruptcy Act, as amended, 11 U.S.C. § 795, is part of Chapter 11 relating to Arrangements. It provides (with exceptions not applicable here) that no taxable income shall be deemed to have been realized by a debtor by reason of a modification or cancellation of indebtedness in a Chapter 11 proceeding.¹ This rule, of course, is repeated in the income tax regulations. Treas.Regs. § 1.61-12(b) (1) (ii). For the corporation-debtor-taxpayer which has had an Arrangement confirmed under Chapter 11, this is all probably clear enough.

What, however, is the effect of that adjustment of indebtedness upon the debtor corporation's earnings and profits? The answer to this question becomes important when, subsequent to court confirmation of the Arrangement, the corporation makes a distribution. The nature of that distribution (as income or as capital) in the hands of the receiving shareholder obviously has a direct income tax consequence for that shareholder. This is the primary issue before us here. Despite the fact that § 395, and the corresponding §§ 268, 520, and 679 of the Bankruptcy Act, 11 U.S. C. §§ 668, 920, and 1079, have been on the statute books for almost thirty years, this may be an issue of first impression.

The taxpayers are Leon R. Meyer and Lucile H. Meyer. They are husband and wife. The taxable year involved is the calendar year 1959. The Meyers filed separate income tax returns for that year on the cash basis.

The controversy centers on Lucile's tax. The Commissioner, by his 90-day letters, proposed deficiencies of $17,402.09 and $40,101.55 in Lucile's and Leon's respective 1959 taxes. The Tax Court, in a decision not reviewed by the full court, determined deficiencies of $16,149.16 and $1,918.02, respectively. Lucile petitions for review. Leon does not. The Commissioner, however, has filed a petition in Leon's case as a protective step against the possibility that the decision in Lucile's appeal is adverse to the Commissioner on a theory of constructive receipt on behalf of Leon.

The two cases are thus interdependent. They were consolidated for trial in the Tax Court. We consider them together here.

The Tax Court's findings and opinion are reported as Leon H. Meyer, 46 T.C. 65 (1966).

The facts are complicated. They are set forth in great detail at pp. 68-81 of 46 T.C., to which we make general reference. They need not all be repeated here. We outline those particularly pertinent for our review.

1. For a time prior to July 31, 1946, Leon and Lucile were equal partners in a jewelry business known as Meyer Jewelry Co., in Kansas City, Missouri.²

2. In 1946 the Meyers incorporated this business, with the same name, under Missouri law. All the partnership assets, except a small amount of cash, were transferred to the corporation in exchange for its assumption of the partnership liabilities and its issuance to Leon and Lucile, equally, of its $100 per Class A voting capital stock and its $50,000, face value, 10-year promissory notes. The assets so transferred had aggregate carrying values of $315,899.22. The liabilities so assumed amounted to $206,399.22. The corporation kept its books on the basis of the fiscal year ended June 30.

3. In 1947 these promissory notes of the corporation were exchanged by the Meyers at face value without accrued interest for $100 par Class B voting shares of the corporation. The Class B shares possessed annual dividend priority and were subject to redemption at par. This exchange capitalized the corporation's theretofore existing liabilities to Leon and Lucile and improved its statement for credit purposes.

4. No dividends were paid by the corporation on any of its outstanding shares during its fiscal years 1946-1958 inclusive.

5. By 1956 the corporation was in financial difficulty. An involuntary bankruptcy petition was filed against it on May 31 of that year. The corporation, as debtor, then proposed a Chapter 11 Arrangement with its unsecured creditors. This Arrangement called for (a) the contribution by Leon of $25,000 to the corporation as additional working capital; (b) a loan of $100,000 to the corporation from a Kansas City bank, the loan to be guaranteed individually by Leon and partially by others, and to require principal payments of $10,000 in six months and $5,000 per quarter thereafter; (c) the issuance by the corporation to Leon of 250 additional shares of its Class B stock; and (d) the payment of expenses and specified debts in full and all other debts only to the extent of 30%.

6. The agreement with the Kansas City bank for its loan to the corporation provided that, in order to secure Leon's guaranty, Leon and Lucile were to pledge with the bank most of the corporation's issued and outstanding shares which they then held. Leon, in order to raise his $25,000 contribution, cashed in a life insurance policy on his life, on which Lucile was the beneficiary, and borrowed $15,000 from the same bank. This loan was secured by 798 shares of Thiokol Corp., which had a then fair market value of about $30,000.

7. The adjustment in the corporation's debts, as proposed by the Arrangement, amounted to $189,785.42. Of this amount, $74,886.84 served to reduce the corporation's income tax bases in its retained assets, as required by § 396 of the Act, 11 U.S.C. § 796.

8. In anticipation of the Arrangement, the corporation's accountant set up an account, designated "Contributed Capital", on the corporation's books and credited that account in the amount of $178,211.16. This was the amount of the debts so discharged, less certain items. Also, the corporation's assets were appraised and their carrying values were brought into line with their then lower fair market values.

9. The proposed Arrangement was accepted by creditors to the extent required by the Act and on July 3, 1956, it was confirmed by the district court. Payment of claims was effected shortly thereafter.

10. In September 1958, by appropriate corporate action, the respective rights of the Class A and Class B shares were made identical.

11. In December 1958 and February 1959 Lucile effected gifts of certain shares of the corporation to the Meyers' son, Louis S. Meyer, to their son-in-law, Richard C. Burstein, and to Jack Becker, an officer but not related. Thereafter Lucile owned only 40 Class A shares and 250 Class B shares.

12. Meanwhile, the 798 shares of Thiokol stock which Leon had pledged to the bank as collateral for his $15,000 note had grown to 1,848 shares through stock dividends, splits and exercises of rights. In addition, the Thiokol stock had greatly increased in value.

13. By April 1959 a plan was evolved aimed at the elimination both of the corporation's indebtedness (by then reduced to $50,000) to the bank and of Lucile's investment in the corporation. This was made feasible by the substantial increase in the value of Leon's Thiokol stock. The plan was effectuated in April and May by (a) Leon's making a capital contribution to the corporation of 700 of his collateralized 1,848 shares of Thiokol; (b) the corporation's authorizing the sale of the shares so contributed; (c) the bank's releasing to a broker certificates for 700 shares with appropriately executed stock powers; (d) the issuance of new certificates in the broker's name for those shares; (e) the sale of 638 of the shares by the broker on the New York Stock Exchange for the account of the corporation; (f) the corporation's receipt of $81,328.17 for the 638 shares; (g) the corporation's use of $50,000 thereof to pay the balance of its note to the bank; (h) the corporation's payment of the $31,328.17 remainder in two checks to Lucile; and (i) the corporation's placing this $31,328.17 on its books as a debit in an account receivable from Lucile, it being the intent of the parties that these payments to Lucile were to be in ultimate redemption of Lucile's stock in the corporation. These steps were followed by (j) Lucile's delivery of her stock for redemption late in the summer of 1959; (k) an agreement by the parties (reached after June 30, 1959) that Lucile's stock was redeemed at par ($29,000) rather than at its greater book value ($37,337.50) as of June 30, 1959; and (1) the corporation's crediting the account receivable from Lucile to the extent of $29,000 and debiting its capital stock accounts in the same amount as of December 31, 1959.

14. The $2,328.17 difference, between the $31,328.17 and the $29,000 figures, was continued, with other very minor items, in the corporation's account receivable from Lucile. The record does not show that this balance was ever paid.

15. This left 62 shares of the 700 which had been transferred from Leon. Of these, 32 were reissued in Leon's name. The other 30 were transferred, at Leon's direction, half to Louis S. Meyer and his wife as joint tenants, and half to Richard C. Burstein and his wife as joint tenants. The corporation's books reflect no account receivable from Leon with respect to these 62 shares and he made no payment to the corporation on...