Sullivan v. United States

• Decision Date: 29 June 1965
• Docket Number: Civ. A. No. 14661-4.
• Citation: 244 F. Supp. 605
• Parties: William J. SULLIVAN and Georgia K. Sullivan, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Western District of Missouri

244 F. Supp. 605

William J. SULLIVAN and Georgia K. Sullivan, Plaintiffs, v. UNITED STATES of America, Defendant.

Civ. A. No. 14661-4.

United States District Court W. D. Missouri, W. D.

June 29, 1965.

COPYRIGHT MATERIAL OMITTED

Harry A. Morris, Claude R. Sanders, of Morris, Sanders, King & Stamper, Kansas City, Mo., for plaintiffs.

F. Russell Millin, U. S. Atty., John L. Kapnistos, Asst. U. S. Atty., Kansas City, Mo., Louis F. Oberdorfer, Asst. Atty. Gen., John B. Jones, Jr., Acting Asst. Atty. Gen., Jerome Fink, Chief, Refund Trial Sec. 3, John M. Bray, Attorney, Tax Division, Department of Justice, Washington, D. C., for defendant.

BECKER, District Judge.

This is an action by plaintiffs William J. Sullivan and Georgia K. Sullivan, his wife, to recover federal income taxes and interest thereon, alleged to have been erroneously assessed and collected by the defendant. There has been compliance with all statutory conditions precedent to filing of this action. Jurisdiction to determine this controversy exists under Section 1346(a) (1), Title 28, U.S.C.A.

The plaintiffs filed a timely joint federal income tax return for the calendar year 1956. Thereafter, the District Director of Internal Revenue determined that the plaintiff William J. Sullivan received during the year 1956 additional income equivalent to a dividend, in the amount of $198,334.58 from the Sullivan-Nelson Chevrolet Company, a corporation (hereinafter designated the "corporation" regardless of changes in name), as a result of the purchase or redemption by the corporation of the stock in the corporation owned by Frank W. Nelson. On the basis of this determination, additional income tax for the year 1956 in the sum of $150,166.55, plus accrued interest in the sum of $53,150.70, was assessed against the plaintiffs. Payment of the additional tax and interest was made by plaintiffs on or about March 8, 1963, in the sum of $203,317.25. Thereafter, on March 26, 1963, plaintiffs received a refund in the amount of $98.81 on the ground that the original assessment was incorrect to that extent. The amount now in controversy is the net payment of $203,218.44, plus interest.

Question for Determination

The sole question for determination in this action is whether the plaintiff William J. Sullivan received income equivalent to a dividend (a constructive dividend) in the amount of $198,334.58 during the taxable year 1956 when the corporation purchased or redeemed the shares of stock therein owned by Frank W. Nelson.

Applicable Statutory Provisions

The statutory provisions applicable in the determination of this action are the following portions of Sections 302 and 316 of the Internal Revenue Code of 1954 (Sections 302 and 316 of Title 26, U.S.C.A.):

"§ 302. Distributions in redemption of stock

"(a) General rule. — If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.

"(b) Redemptions treated as exchanges. —

"(1) Redemptions not equivalent to dividends. — Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.

"(2) Substantially disproportionate redemption of stock. —

"(A) In general. — Subsection (a) shall apply if the distribution is substantially disproportionate with respect to the shareholder.

"(B) Limitation. — This paragraph shall not apply unless immediately after the redemption the shareholder owns less than 50 percent of the total combined voting power of all classes of stock entitled to vote.

"(C) Definitions. — For purposes of this paragraph, the distribution is substantially disproportionate if —

"(i) the ratio which the voting stock of the corporation owned by the shareholder immediately after the redemption bears to all of the voting stock of the corporation at such time,

is less than 80 percent of —

"(ii) the ratio, which the voting stock of the corporation owned by the shareholder immediately before the redemption bears to all of the voting stock of the corporation at such time.

For purposes of this paragraph, no distribution shall be treated as substantially disproportionate unless the shareholder's ownership of the common stock of the corporation (whether voting or nonvoting) after and before redemption also meets the 80 percent requirement of the preceding sentence. For purposes of the preceding sentence, if there is more than one class of common stock, the determinations shall be made by reference to fair market value.

"(D) Series of redemptions. — This paragraph shall not apply to any redemption made pursuant to a plan the purpose or effect of which is a series of redemptions resulting in a distribution which (in the aggregate) is not substantially disproportionate with respect to the shareholder.

"(3) Termination of shareholder's interest. — Subsection (a) shall apply if the redemption is in complete redemption of all of the stock of the corporation owned by the shareholder."

"§ 316. Dividend defined

"(a) General rule. — For purposes of this subtitle, the term `dividend' means any distribution of property made by a corporation to its shareholders —

"(1) out of its earnings and profits accumulated after February 28, 1913, or

"(2) out of its earnings and 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."

Regulations and Revenue Rulings Relied on by Plaintiffs

In support of their claim for relief, plaintiffs rely upon the following Income Tax Regulations under the 1954 Internal Revenue Code: Sections 1.302-1, 1.316-1, and 1.317-1. Since this case is decided upon the statutes involved and the judicial decisions construing the statutes, and since there is no disagreement concerning the interpretation of the regulations, the regulations will not be set out in detail.

The Revenue Rulings relied upon by the plaintiffs are as follows: Revenue Ruling 614, 1958-2 Cum.Bull. 920 and Revenue Ruling 286, 1959-2 Cum.Bull. 103.

FINDINGS OF FACT

In February 1941, the plaintiff William J. Sullivan (hereinafter designated "Sullivan"), a resident of Kansas City, Missouri, acquired a Chevrolet franchise in Blytheville, Arkansas. In the same month, to exploit the franchise, Sullivan formed the Loy Eich Chevrolet Company, an Arkansas corporation, with its principal place of business in Blytheville, Arkansas. Its authorized capital stock consisted of 1,000 shares of common stock, having a par value of $100 each. The corporation commenced business upon the issuance of 300 shares of its capital stock, which was issued at par value. Its initial shareholders were plaintiffs Sullivan and Georgia K. Sullivan (hereinafter designated "Mrs. Sullivan"), holding 290 shares, and Loy B. Eich and Ruth Eich, holding 10 shares. The name of the corporation, Loy Eich Chevrolet Company, was changed on February 21, 1948, to the Sullivan-Nelson Chevrolet Company, and thereafter again changed on May 8, 1956, to the Kaw Finance Company.

In 1941, Loy B. Eich (hereinafter designated "Eich") was employed as resident manager of the corporation, and continued to manage the corporate business until February of 1948. Between 1941 and 1948, Eich acquired by purchase an additional 110 shares of stock in the corporation so that his total holdings in February of 1948 were 120 shares, which were 40 percent of the outstanding 300 shares. On March 17, 1946, Eich (then owning 30 percent of the stock of the corporation) and Sullivan (then owning or controlling through his and his wife's ownership 70 percent of the stock of the corporation) entered into a written agreement whereby Eich acknowledged that the Chevrolet franchise for Blytheville, Arkansas, and contiguous territory was the individual property of the plaintiff Sullivan, though nominally owned by Sullivan and Eich. In the written agreement, Eich further agreed to surrender the stock in the corporation owned by him, upon demand by Sullivan at any time in the future, and further agreed to sell his stock to Sullivan at its net worth and book value determined from the company's books and financial statement.

In February 1948, Sullivan purchased all the shares in the corporation owned by Eich and his wife. Following this purchase Sullivan and Mrs. Sullivan owned all the issued and outstanding capital stock of the corporation, a total of 400 shares. Sullivan then entered into negotiations with Frank W. Nelson (hereinafter designated "Nelson") to secure Nelson's services as resident manager of the corporation. Nelson had been employed since 1944 by Sullivan as general manager of a Chevrolet dealership in Kansas City, Missouri.

After negotiations, Sullivan and Nelson entered into a written contract dated September 10, 1948, signed by Nelson on September 10, 1948, and by Sullivan on September 14, 1948 (Plaintiffs' Ex. 4). The material provisions of this contract (hereinafter designated "memorandum agreement") are as follows:

"MEMORANDUM AGREEMENT

"This agreement made and entered into this 10th day of September, 1948, by and between William J. Sullivan of Kansas City, Missouri hereinafter called `Sullivan' and Frank Nelson of Blytheville, Arkansas, hereinafter called `Nelson', witnesseth:

* * * * * *

"WHEREAS, Loy B. Eich has since retired from the business and severed his connection with the corporation and sold and transferred his stock in the Loy B. Eich Chevrolet Company to said William J. Sullivan and the corporate name has been changed to Sullivan-Nelson Chevrolet Co.; all of the stock of the corporation is owned by William J. Sullivan and Georgia Sullivan except one qualifying share owned by the undersigned, Frank Nelson, and

* * * * * *

"WHEREAS, said Nelson desires to purchase shares of stock in the

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