Schleppy v. C. I. R., s. 76-4247
| Decision Date | 23 August 1979 |
| Docket Number | Nos. 76-4247,76-4248,s. 76-4247 |
| Citation | 601 F.2d 196 |
| Parties | 79-2 USTC P 9551 Ronald E. SCHLEPPY and Leonette R. Schleppy, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. David N. SMITH and Judith A. Smith, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. |
| Court | U.S. Court of Appeals — Fifth Circuit |
M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews, Act. Chief, App. Section, U. S. Dept. of Justice, Stuart E. Seigel, Chief Counsel, Internal Revenue Service, Washington, D. C., Ernest J. Brown, Stanley S. Shaw, Jr., Attys., Tax Div., Dept. of Justice, Washington, D. C., for respondent-appellant in both cases.
Richard G. Holloway, Atlanta, Ga., for petitioners-appellees.
Meade Whitaker, Chief Counsel, Internal Revenue Service, Washington, D. C., for respondent-appellant in No. 76-4248.
Appeals from the Decision of the United States Tax Court.
Before TUTTLE, GODBOLD and RUBIN, Circuit Judges.
The government appeals from a decision of the Tax Court holding that the transfer by two taxpayers to a corporation of which they were the major but not sole shareholders, without consideration, to improve the financial condition of the corporation resulted in an ordinary loss to each of the taxpayers of the amount of his basis in the stock transferred.
The wives of the named taxpayers are named in the litigation solely because of the fact that their husbands and they filed joint returns for the years in question. The term "taxpayers" refers to the husbands only. Taxpayers were officers, directors and owners, before the transaction dealt with in this case, of 810,500 out of 1,155,833 shares of stock in the Communication and Studies, Inc. (C & S). As a result of a dispute between the corporation and a creditor holding convertible notes of the corporation in the face amount of $1,000,000, the directors of the corporation ratified an agreement to change the rate at which the creditor could convert its notes of C & S into shares of the corporation stock from $7 to $5 per share. In connection with this agreement, and, as the Tax Court found, in order to preserve the business of the corporation and to facilitate the agreement, 1 the taxpayers surrendered 57,142 of their 810,500 shares in C & S to the corporation. No other stockholders surrendered any stock.
On their tax returns for the appropriate years, the taxpayers sought to characterize their action as giving rise both to a long term capital gain measured by the difference between the taxpayers' cost in the shares and their fair market value at the time of the surrender and to a deductible ordinary loss in the amount of the fair market value of the shares. The Commissioner disagreed. He eliminated the capital gain and contended in the Tax Court that there was no loss upon the surrender of the shares to the corporation, claiming that such action was a contribution to the capital of the corporation, and not a taxable event. 2
The Tax Court rejected both contentions. It held that the surrender of the shares by the taxpayers produced an ordinary loss measured by the amount of the taxpayers' cost basis in the shares surrendered. The Commissioner appeals from this decision. We reverse.
In order to prevail, the taxpayers must come within the provisions of 26 U.S.C. § 165 which provides that there shall be allowed a deduction if it is a loss, "incurred in the trade or business" or a loss "incurred in any transaction entered into for profit, though not connected with the trade or business." In the two cases, Deputy v. DuPont, 308 U.S. 488, 60 S.Ct. 363, 84 L.Ed. 416 (1940) and Interstate Transit Lines v. Commissioner, 319 U.S. 590, 63 S.Ct. 1279, 87 L.Ed. 1607 (1943), the Supreme Court has made it clear that a payment by a stockholder for the benefit of his corporation does not entitle him to a loss deduction as "ordinary and necessary expenses . . . in carrying on" the "trade or business" of the taxpayer. This leaves the question whether the taxpayers' surrender of stock here resulted in a loss "incurred in any transaction entered into for profit."
The taxpayers do not dispute the general proposition that voluntary payments by a stockholder to his corporation in order to bolster its financial position cannot be claimed as a loss. In such a situation, the amounts paid are added to the basis of the stock in the stockholder's hands. See Eskimo Pie Corp., 4 T.C. 669 (1945). It is difficult to perceive why any distinction should arise if, instead of paying cash to the corporation, the shareholder surrenders part of his shares to bolster the corporation's financial health. Nevertheless, the Tax Court here, by relying on Estate of William H. Foster, 9 T.C. 930 (1947), and comparing the facts here with J. K. Downer, 48 T.C. 86 (1967) drew such a distinction. In Foster, the court said:
Generally, a payment by a stockholder to the corporation, made to protect and enhance his existing investment and prevent its loss, is a capital contribution, rather than a deductible loss, and should be added to the basis of his stock. He increases his capital investment and the determination of gain or loss is held in abeyance until disposition of some or all of his stock. First National Bank in Wichita v. Commissioner, 46 Fed. (2d) 283, affirming W. R. Ranney, 16 B.T.A. 1399; B. Estes Vaughan, 17 B.T.A. 620. On the other hand, when a stockholder surrenders a part of his stock to improve the financial condition of the corporation he sustains a deductible loss, measured by the basis of the stock surrendered, less the resulting improvement in value of the stock retained. Commissioner v. Burdick, 59 Fed. (2d) 395, affirming 20 B.T.A. 742; Julius C. Miller, 45 B.T.A. 292; Peabody Coal Co. v. United States, 8 Fed.Supp. 845.
In the Downer case, which was similar to Foster except that there a major stockholder transferred stock to a third party in consideration for the third party's performing service for the corporation, the court undertook to present a basis for its distinguishing the surrender of stock by a stockholder and the payment of cash to, or on behalf of, his corporation. The court said:
Certainly, a unitary view of a shareholder's total investment in a corporation would confirm such an approach (equating the...
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