Sanders v. Fox

• Decision Date: 03 April 1957
• Docket Number: C90-56,No. C89-56,C91-56.,C89-56
• Parties: Robert V. SANDERS and Nancy Ritter Sanders, Plaintiffs, v. Charles I. FOX, Director of Internal Revenue, Defendant. Kimball J. CRANNEY and Janice J. Cranney, Plaintiffs, v. Charles I. FOX, Director of Internal Revenue, Defendant. N. V. SANDERS and Clover J. Sanders, Plaintiffs, v. Charles I. FOX, Director of Internal Revenue, Defendant.
• Court: U.S. District Court — District of Utah

149 F. Supp. 942

Robert V. SANDERS and Nancy Ritter Sanders, Plaintiffs, v. Charles I. FOX, Director of Internal Revenue, Defendant.

Kimball J. CRANNEY and Janice J. Cranney, Plaintiffs, v. Charles I. FOX, Director of Internal Revenue, Defendant.

N. V. SANDERS and Clover J. Sanders, Plaintiffs, v. Charles I. FOX, Director of Internal Revenue, Defendant.

Nos. C89-56, C90-56, C91-56.

United States District Court D. Utah, Central Division.

April 3, 1957.

Thornley K. Swan and C. Preston Allen, of Ray, Quinney & Nebeker, Salt Lake City, Utah, for plaintiffs.

A. Pratt Kesler, U. S. Atty., Salt Lake City, Utah, and James P. Garland and David R. Frazer, Attys., Dept. of Justice, Washington, D. C., for defendant.

KERR, District Judge.

The above cases were consolidated for trial for the reason that the issues of fact and law are common in each case.

Through these actions plaintiffs seek to recover income taxes paid for the years 1949, 1950 and 1951 in the combined amount of $8,750.20, together with interest thereon.

For convenience I will refer to the plaintiffs as "taxpayers", the defendant as "Director" and the Clover Club Foods Company, a Utah corporation, as "Corporation".

The sole question for determination is whether premiums paid by Corporation on insurance taken out on the lives of its four stockholders are equivalent to distributions of corporate dividends and taxable to the individual stockholders within the meaning of Section 115, Internal Revenue Code of 1939. It is appropriate at the outset to quote the applicable provisions of the Revenue Code (26 U.S.C., 1952 Ed., Section 115):

"§ 115. Distributions by corporations — (a) Definition of dividend.

"The term `dividend' when used in this chapter (except in section 201(c) (5), section 204(c) (11) and section 207(a) (2) and (b) (3) (where the reference is to dividends of insurance companies paid to policy holders)) means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made. * * *

"(b) Source of distributions.

"For the purposes of this chapter every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Any earnings or profits accumulated, or increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after the earnings and profits accumulated after February 28, 1913, have been distributed, but any such tax-free distribution shall be applied against and reduce the adjusted basis of the stock provided in section 113." * * *

The facts are stipulated and are not in dispute. They may be summarized as follows:

During the taxable years in question the taxpayers were the sole stockholders in the Corporation; N. V. Sanders was President of the Corporation and his wife, Clover J. Sanders, was Vice President, Secretary and Treasurer; Kimball J. Cranney was Salesmanager of the Corporation and Robert V. Sanders was employed part time as a general worker. In 1949 N. V. Sanders and his wife, Clover J. Sanders, each owned 43% of the stock of the corporation; Kimball J. Cranney and Robert V. Sanders each owned 7%; in 1950 N. V. Sanders and Clover J. Sanders each owned 40% of the stock and Kimball J. Cranney and Robert V. Sanders each owned 10%; in 1951 N. V. Sanders and Clover J. Sanders each owned 37% of the stock and Kimball J. Cranney and Robert V. Sanders each owned 13%.

On March 23, 1949, the Taxpayers entered into a Stock Purchasing Agreement with the Corporation. This agreement provided that insurance was to be taken out on the lives of the stockholders according to a schedule attached to the agreement. The agreement provided the Corporation would pay the premiums and be designated the owner of the policies during the lifetime of the insured. The insured stockholder was to designate the beneficiary. I quote two paragraphs of the Agreement:

"8. For the purposes of this Agreement, the `value' of all of the outstanding stock of the Corporation shall be fixed from time to time by resolutions passed at duly called meetings of the Stockholders by the unanimous vote of the Stockholders voting at each such meeting, which valuations shall not include the cash surrender value of or any other value for the insurance policies then subject hereto. At the death of a stockholder, the value of his stock shall be the value shown in the last resolution voted by the stockholders. If the Stockholders voting at any such meeting shall be unable to unanimously agree on the value of said stock, they shall by a resolution passed by a majority vote of the Stockholders voting at such meeting, appoint three (3) disinterested arbitrators in such manner as shall be provided for in said majority vote, and the value agreed upon by any two (2) of the arbitrators thus appointed shall be binding upon all the parties to this Agreement.

"Until the next meeting of the Stockholders the value of all the outstanding stock of the Corporation shall be $225,000.00, and each share shall have a value proportionate thereto.

"The Resolution to be adopted at said meetings shall be in the following form:

"`Resolved, That the value (for the purposes of Section 8 of Stock Purchase Agreement dated Mar. 23-1949) of all the outstanding stock of the Clover Club Foods Company Corporation shall be $225,000.00, and that each outstanding share of stock shall have a value proportionate thereto, said valuation to be effective from Mar. 23-1949, and to continue until changed by the Stockholders in accordance with the terms of said Stock Purchase Agreement.'

"At the death of a Stockholder, the Adjusted Price to be paid for his stock shall be the greater of the following: (1) the value thereof, hereinabove stated, plus a percentage of the cash surrender value, as of the day prior to his death, of all the insurance policies (including those on his life) equal to the percentage of all the shares of stock of the Corporation which were then owned by him, or (2) the amount of the said insurance proceeds payable under the terms of the said policy or policies on decedent's life."

"11. It is agreed that all premiums on the insurance policies subject hereto shall be paid out of current corporate earnings or surplus which, but for the payment of such premiums would be available for distribution as dividends; so that rights of corporation creditors will not be prejudiced by use of corporate funds for payment of such premiums. It is further agreed that so long as this agreement continues, the said insurance policies and all values therein, shall constitute a special reserve for the purpose of enabling the corporation to acquire, under the terms of Section 5 hereof, stock of any stockholder who dies. If, at the time any premium on such insurance policies becomes payable, the corporation has no current earnings, or surplus, available for payment of such premiums this agreement shall terminate, and the beneficiary of the said insurance policies shall be changed to the corporation so that the corporation may hold said policies as ordinary assets to be retained or disposed of as the corporation may decide.

"It is further agreed that any purchase by the corporation of its own Stock, with funds other than said insurance proceeds, as provided in Sections 6 or 9 hereof, shall be made only out of earnings or surplus of the corporation, the use of which will not prejudice corporation creditors. If the corporation is unable to make such purchase, then the stockholders (other than the one whose stock is involved in the sale) may jointly, as individuals, exercise all rights of the corporation in respect to purchase of such stock; and if they exercise said right, they shall assume responsibility for the purchase price and acquire said stock in the same respective proportions as the number of shares of stock in the corporation which each of them had prior to such sale bears to the number of shares which all of them had prior to said sale."

I construe the provisions of the agreement to mean that the beneficiary not only gets the fair market value of the stock as determined by the stockholders, but he also gets a pro rata percentage of the cash surrender value of all the insurance policies as of the day prior to decedent's death. It will be noted that if the stock should become of little value, the beneficiary would still receive the full proceeds taken out on the life of the decedent.

The Agreement provided that upon the death of the insured stockholder the beneficiary would receive the insurance proceeds on the condition that the beneficiary would sell the stock of the decedent to the Corporation at an adjusted price determined by the stockholders. The Agreement also provided that upon the death of a stockholder the adjusted price to be paid for his stock would be the greater of the following: (1) the value of the stock (as set out in the Agreement) plus a percentage of the cash surrender value, as of the day prior to his death, of all insurance policies (including those on his life) equal to the percentage of the shares of stock which were then owned by him; or (2) the amount of the proceeds payable under the terms of the policies on decedent's life.

The Agreement provided for the purchase by the Corporation out of the earnings and surplus any additional shares held by a decedent over and above the amount that could be purchased from the insurance proceeds. In the event the Corporation is unable to make such purchase out of the earnings and surplus, then the other stockholders may exercise all of the rights of the Corporation and purchase...