Rickey v. C. I. R., 26-775
| Decision Date | 19 July 1974 |
| Docket Number | No. 26-775,26-775 |
| Citation | 502 F.2d 748 |
| Parties | 74-2 USTC P 9616 John H. RICKEY and Lorraine C. Rickey, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. |
| Court | U.S. Court of Appeals — Ninth Circuit |
Paul E. Anderson (argued), San Francisco, Cal., for appellants.
John A. Townsend (argued), Dept. of Justice, Washington, D.C., for appellee.
Before KOELSCH and HUFSTEDLER, Circuit Judges, and ANDERSON, * District Judge.
John H. Rickey (Taxpayer) and Lorraine C. Rickey 1 appeal from a decision of the Tax Court 2 determining a deficiency in income taxes for the tax year 1962. Our jurisdiction is founded on Section 7482 of the Internal Revenue Code of 1954, 26 U.S.C. 7482.
Two distinct issues are presented for review. The first is whether Taxpayer received over 30 per cent of the selling price of stock in two corporations in the year of sale, thereby precluding reporting of the gain under the installment method provided by Code Section 453, 26 U.S.C. 453. See 26 U.S.C. 453(b)(2)(ii). The second is whether a loss suffered by Taxpayer on the liquidation of a corporation qualifies under the provisions of 26 U.S.C. 1244 for treatment as an ordinary loss. The Tax Court held against Taxpayer on both issues. 3
In 1962 Taxpayer owned all of the stock of Rickey Enterprises (Enterprises), a California corporation. Enterprises owned and operated a restaurant in Palo Alto, California (Rickey's), a bar-restaurant in San Francisco, California, and 90 per cent of the stock of a corporation which operated a restaurant next to Rickey's in Palo Alto. Taxpayer also owned 50 percent of the stock of Rickey's Studio Inn Hotel (Studio Inn), another California corporation; the other half was owned by two brothers, Alfred and Lewis Marsten. Studio Inn owned a large motel in Palo Alto adjacent to Rickey's, and a restaurant in Marin County, California.
In early 1962 Hyatt Corporation of America (Hyatt) sought to purchase the motel owned by Studio Inn and the adjacent restaurant, Rickey's, owned by Enterprises. Hyatt did not want any of the other assets. But, apparently because of tax considerations on both sides, the sale was ultimately cast in the form of a sale of the stock of the two corporations. To accommodate Hyatt and as part of the transaction, Taxpayer, shortly before the sale was consummated, purchased and received from the two corporations all their unwanted assets. The purchase price was set up on their books as an account receivable from Taxpayer. The contract to sell and purchase the corporate stock was then executed on March 31, 1962. The basic sales price was set at $3,600,000, subject to an immediate audit. 4 Of the pre-audit sales price, $1,400,000 was allocated to mortgage indebtedness in that amount; $1,852,000 to the stock of Studio; and $348,000 to the stock of Enterprises. The contract further provided for a payment of $250,000 upon execution and $852,000 plus interest at 4 1/2 per cent, reflected by long-term notes. The difference between the sum of these two figures and the adjusted total sales price was to be determined and paid as follows: the difference between the down payment of $250,000 and 29 per cent of the adjusted total sales price (hereafter the Deferred Down Payment) within 30 days of the audit, the remainder (hereafter the Residual Payment) on January 2, 1963.
The contract also provided a mechanism for off-setting Taxpayer's indebtedness for the withdrawn assets against the amounts due him. Section 5-b of the contract provides:
'It is further expressly understood and agreed that in the audit as at the close of business on March 31, 1962, hereinafter provided for, all liabilities of said companies then owing to the selling stockholders and their related companies and all indebtedness of the selling stockholders and their related companies to said companies shall be offset and cancelled to the extent thereof; that each of the selling stockholders waives, releases and relinquishes all claims and demands against each of said companies which do not appear on or are reflected and accounted for in the respective audited balance sheets of said companies as of the close of business on March 31, 1962, and that after accomplishing such offsets any then remaining balance of indebtedness of a selling stockholder and/or his related companies to said companies shall be paid as follows: first, by the application of the balance of the 29% Installment of purchase price payable to such stockholder for his stock, provided for in paragraph 2 of this agreement; second, by the application of all installments of purchase price payable to such stockholder for his stock due on or after January 1, 1963; and third, by credit against amounts becoming due on such stockholder's promissory note.'
Thus, Taxpayer was only to receive the payments on the sales price (except for the fixed sum paid on execution of the contract) after cancellation of his indebtedness to the two corporations for the withdrawn assets.
The sale was consumated on April 2, 1962. As agreed in clause 2-b, Taxpayer received $125,000 in cash and $426,000 in notes for his half interest in Studio Inn, and $100,000 in cash and $148,000 in notes towards payment for the stock of Enterprises. Immediately on closing, Hyatt liquidated the two corporations; and Taxpayer's debt to the corporations thereupon became payable to Hyatt.
The audit, completed in June, 1962, resulted in a slight reduction of the sales price. It also reduced the portion of the total sales price allocable to Studio Inn, in which the Marstens owned a half-interest, and thus entitled Taxpayer to a larger proportion of the payments. As stated in the Tax Court's opinion (54 T.C. at 686):
'The audit . . . determined an adjusted sales price of $631,605.50 for petitioner's interest in Studio Inn and $449,437.98 for petitioner's interest in Enterprises, or a total adjusted sales price of $1,081,043.48 for petitioner's interest in both corporations. The amount of each payment due petitioner under the terms of the contract . . . for his stock of both corporations is as follows:
Rickey's
Studio Rickey
Inn Hotel Enterprises Total
----------- ----------- -------------
Due at closing $125,000.00 $100,000.00 $ 225,000.00
Due 30 days after audit 58,165.00 30,337.00 88,502.00
Due January 2, 1963 22,440.50 171,100.98 193,541.48
Payment due by note 426,000.00 148,000.00 574,000.00
----------- ----------- -------------
631,605.50 449,437.98 1,081,043.48
----------- ----------- -------------
The amount due petitioner under the terms of the contract in the year of sale, namely the amounts due at closing and 30 days after audit, for his respective interest in each corporation represented 29 percent of the selling price of petitioner's stock in each corporation. Also, the total amount due petitioner in the year of sale for his stock in both corporations represented 29 percent of the total selling price of his stock in both corporations.'
The audit also revealed that Taxpayer 'owed' the two corporations (and hence, after their liquidation, Hyatt) the net sum of $466,398.83 for the withdrawn assets. This sum was considerably larger than the parties had anticipated. As already noted, the contract provided for interest on Hyatt's long-term indebtedness to Taxpayer; however, it contained no such provision with respect to Taxpayer's debt, undoubtedly because the parties did not anticipate that the latter debt would exceed the sum of the Deferred Down Payment and the Residual Payment. Thus, because of the size of Taxpayer's debt, Hyatt was unexpectedly confronted with the prospect of paying interest on long-term notes, the principal of which, because of the offset provisions of the contract, Hyatt would never have to pay-- to follow the logic of the contract, Taxpayer 'owed' Hyatt money on which he was not obligated to pay interest at the same time that Hyatt 'owed' Taxpayer money on which interest was accruing.
When Hyatt threatened to rescind the contract, Taxpayer made some payments on his debt, but these were relatively small, and Hyatt remained dissatisfied. 5
However, on August 29, 1962, the parties succeeded in amicably resolving the problem. As evidenced by letter agreement of even date, they in effect offset the Residual (and Deferred Down) Payment pro tanto against Taxpayer's debt to Hyatt and provided that Taxpayer would pay interest from September 1, 1962, on the remainder. 6
In his tax return for 1962 Taxpayer reported his gain from the sale of his stock in Enterprises and Studio Inn as an installment sale in that year. The Commissioner rejected the installment method of reporting, concluding that Taxpayer had effectively received the 1963 Residual payment in 1962, thereby receiving more than the permissible 30 per cent of the sales price in the year of sale. The Commissioner computed the year of sale payments as follows:
Enterprises Studio Inn Total
----------- ----------- -------------
Sale price of
capital stock $449,437.98 $631,605.50 $1,081,043.48
Payments in year of sale 100,000.00 125,000.00 225,000.00
30,337.00 58,165.00 88,502.00
171,100.98 22,440.50 193,541.48
----------- ----------- -------------
301,437.98 205,605.50 507,043.48
Percent of sales price 67 32.55 46.93
The Tax Court sustained the Commissioner. It held that Taxpayer received the $193,541.48 payment as income in the year of sale because an equivalent amount of Taxpayer's indebtedness to Hyatt for the assets retained was effectively set off against Hyatt's indebtedness to Taxpayer in 1962. 7 The Tax Court rested decision on two separate bases: (1) that analysis of the substance of the transaction under familiar tax principles...
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