Roebling v. Comm'r of Internal Revenue
| Decision Date | 07 July 1981 |
| Docket Number | 7530-73.,Docket Nos. 644-72 |
| Citation | 77 T.C. 30 |
| Parties | MARY G. ROEBLING, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Trenton Trust Co., prior to 1958, had outstanding preferred stock A, preferred stock B, and common stock. The preferred stock A was issued to the Reconstruction Finance Corp. as security for loans made in 1934 and 1936. About 90 percent of the preferred stock B had been purchased by petitioner's deceased husband in connection with the loan and was owned by petitioner in 1958. Petitioner owned about 45 percent of the common stock, the rest of which was owned by the general public. In 1958, a plan of recapitalization was adopted by Trenton Trust, which involved retiring all the preferred stock A, capitalizing dividend arrearages on the preferred stock B and splitting it 2 for 1, and issuing additional common stock to improve its capital position. The certificate of incorporation was amended to provide a cumulative dividend of $2.80 per share for the preferred stock B, priority over the common stock with respect to earnings and assets upon liquidation, and voting rights. It also provided that $112,000 of the preferred stock B should be redeemed at par each year, and the bank should establish a sinking fund for that purpose. Some of petitioner's preferred stock B was redeemed at par during each of the years 1965-69, and she sold some shares in 1965 and 1966. Held, the redemption of petitioner's preferred stock B during the years involved was not essentially equivalent to a dividend within the meaning of sec. 302(b)(1), I.R.C. 1954, so the proceeds from the redemptions were taxable as capital gains. Held, further: That portion of the par value of the preferred stock B representing capitalized dividend arrearages was sec. 306 stock, and petitioner failed to prove that its distribution, disposition, or redemption was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax. Hence, sec. 306(b)(4) does not apply, and the aforementioned portion of the proceeds from the redemption or sale of the preferred stock B was taxable as ordinary income. A. Arthur Davis III and Ralph A. Straw, Jr., for the petitioners.
Stephen J. Sokolic, for the respondent.
In these consolidated cases,1 respondent determined deficiencies in petitioner's income tax for the taxable years as follows:
+--------------------+
¦Year ¦Deficiency ¦
+------+-------------¦
¦ ¦ ¦
+------+-------------¦
¦1965 ¦$18,447.43 ¦
+------+-------------¦
¦1966 ¦20,705.96 ¦
+------+-------------¦
¦1967 ¦54,475.31 ¦
+------+-------------¦
¦1968 ¦11,734.85 ¦
+------+-------------¦
¦1969 ¦20,595.73 ¦
+--------------------+
After concessions by the parties, the issues for decision are:
(1) Whether Trenton Trust Co.'s redemption of its preferred stock B from petitioner in each of the taxable years in issue was “not essentially equivalent to a dividend,” within the meaning of section 302(b)(1), I.R.C. 1954;2 and
(2) Whether, as part of a 1958 plan of recapitalization under section 368(a)(1)(E), Trenton Trust's capitalization of $6 of dividend arrearages on each share of its preferred stock B “was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax,” within the meaning of section 306(b)(4).
Some of the facts were stipulated and they are so found. The stipulation of facts together with the exhibits attached thereto are incorporated herein by this reference.
Petitioner Mary G. Roebling (hereinafter petitioner) resided in Trenton, N.J., when she filed her petition herein. She filed individual income tax returns for each of the taxable years in issue with the District Director for the District of New Jersey. Petitioner reported her income for these years on the cash receipts and disbursements method.
From July 22, 1958, through February 25, 1972, petitioner was chairman of the board of directors of Trenton Trust Co. (hereinafter Trenton Trust or bank). She was president of Trenton Trust from the early 1950's through approximately 1965. Although petitioner had overall responsibility for the operation of Trenton Trust, her primary activities involved public relations, marketing, and the development of new business.
Trenton Trust was a banking corporation organized in 1887 under the laws of the State of New Jersey. From that time through February 25, 1972, it carried on a banking business in the city of Trenton, N.J. Effective February 25, 1972, Trenton Trust merged into National State Bank of Elizabeth, N.J. (hereinafter National State), pursuant to Agreement to Merger between the two banks dated September 28, 1971.
The business and operations of Trenton Trust were subject to supervision, control, regulation, and examination by the Department of Banking and Insurance of the State of New Jersey (hereinafter Department of Banking) and the Federal Deposit Insurance Corp. (hereinafter FDIC).
Petitioner is the widow of Siegfried Roebling (hereinafter Roebling), who died on January 1, 1936. Roebling was a stockholder and director of Trenton Trust in the early 1930's. In 1931, Roebling owned approximately one-third of Trenton Trust's common stock, then its only class of stock.
During the early 1930's, Trenton Trust experienced financial difficulties. In order to improve its financial position, certain of the bank's directors, including Roebling, gave personal notes totaling approximately $500,000 to Trenton Trust in exchange for certain assets (outstanding loans which were only slowly being repaid) of an approximately equal amount. The assets were delivered to trustees for collection, and any proceeds received were paid to Trenton Trust and applied on the personal notes. Any amounts remaining due on the notes after application of the proceeds were then to be paid by the individual directors.
The preceding plan did not sufficiently improve Trenton Trust's financial position. As a result of an examination of Trenton Trust by the FDIC and in order for Trenton Trust to obtain membership in the FDIC, Trenton Trust entered into negotiations with the Reconstruction Finance Co. (hereinafter RFC) which resulted in RFC's agreeing to lend $2 million to Trenton Trust.
The agreement between Trenton Trust and RFC provided that RFC would loan the money to Trentrusco, a nonactive subsidiary corporation of Trenton Trust, and that Trentrusco would in turn use the $2 million to purchase from the bank shares of a to-be-issued new class of preferred stock, preferred stock A. These shares, together with the assets which the bank directors had previously received for their personal notes and which they were required to deliver to Trentrusco as part of the loan agreement, were then to be pledged to RFC as collateral for the $2 million loan.
As a condition for its loan, RFC required that Trenton Trust raise an additional $2 million of capital from its directors and other interested parties by the issuance of a second new class of preferred shares, preferred stock B.
The loan agreement between RFC and Trenton Trust, as described above, was effected. In order that Trenton Trust could issue the preferred stock A and B, its certificate of incorporation was amended in March 1934 to permit the issuance of 100,000 shares of preferred stock A ($20 par value) and the issuance of 20,000 shares of preferred stock B ($100 par value).
As amended, the certificate of incorporation also provided:
(1) Dividends.—-Cumulative dividends of 5 percent were payable on the preferred shares, and preferred stock A shares had priority over preferred stock B shares, which in turn had priority over the common stock. As long as any dividends on the preferred stock were unpaid, no other dividends or distributions were payable.
(2) Net profits application.—-If preferred stock A shares were outstanding, net profits were to be applied in the following order:
(a) 10 percent to a surplus fund;
(b) Preferred stock A dividends;
(c) Preferred stock A retirement fund;
(d) Preferred stock B dividends; and
(e) Common stock dividends and other lawful purposes.
If all preferred stock A shares were retired and preferred stock B shares were outstanding, net profits were to be applied:
(a) 10 percent to a surplus fund;
(b) Preferred stock B dividends;
(c) Preferred stock B retirement fund; and
(d) Common stock dividends and other lawful purposes.
(3) Retirement of preferred stock.—-Provided that (a) unimpaired capital surplus and undivided profits exceeded $5,400,000 by an amount necessary to effect a contemplated stock retirement, and (b) approval of the commissioner of the Department of Banking could be obtained, preferred stock would be retired by purchase or call whenever $40,000 had been accumulated in a preferred stock retirement fund.
(4) Voting rights.—-As a general rule, each share of preferred and common stock was entitled to one vote. In the event dividends were in arrears, a formula was provided which increased the voting rights of the preferred shares.
Roebling and certain other directors of Trenton Trust agreed to purchase the $2 million of preferred stock B, with Roebling purchasing 18,700 shares for $1,870,000. When Roebling died in 1936, petitioner acquired these shares from his estate.
Shortly after the infusion of the $4 million of capital into Trenton Trust, governmental agencies determined that such amount was insufficient and they required that an additional $2 million of capital be raised. This amount was obtained when RFC purchased directly from Trenton Trust an additional $2 million of preferred stock A.
This purchase of additional preferred stock A necessitated another amendment of the bank's certificate of incorporation. As amended, the certificate of incorporation provided in pertinent part:
(1) Capital stock.—-The authorized capital stock consisted of: 200,000...
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