Williams v. C. I. R.

• Citation: 627 F.2d 1032
• Decision Date: 31 July 1980
• Docket Number: No. 78-1985,78-1985
• Parties: 80-2 USTC P 9550 C. F. WILLIAMS and Jeanne V. Williams, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (10th Circuit)

Page 1032

627 F.2d 1032

80-2 USTC P 9550

C. F. WILLIAMS and Jeanne V. Williams, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 78-1985.

United States Court of Appeals, Tenth Circuit.

Argued May 9, 1980.

Decided July 11, 1980.

Rehearing Denied July 31, 1980.

Donald E. Herrold, Tulsa, Okl. (Paul R. Hodgson, Tulsa, Okl., on briefs), for appellants.

John D. Dudeck, Jr., Washington, D. C. (M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews, and Richard W. Perkins, Attys., Tax Div., Dept. of Justice, Washington, D. C., on the brief), for appellee.

Before McKAY and BREITENSTEIN, Circuit Judges and MARKEY, Chief Judge, United States Court of Customs and Patent Appeals. ^*

BREITENSTEIN, Circuit Judge.

Taxpayers appeal from a Tax Court decision, PH Memo P 78,306, which upheld the Commissioner's determination of deficiencies totaling about $285,000 for the tax years 1964 through 1969. The issue is whether cash withdrawals from closely held corporations are taxable dividends or bona fide loans. We affirm.

The petitioners-taxpayers are Clint Williams and his wife Jeanne Williams. Three Oklahoma corporations are involved, Oil Tool Sales Co. (Sales), Oil Tool Manufacturing Co. (Manufacturing), and Williams Machine Co. (Machine). Clint and Jeanne each owned about 48% of the stock in Sales and Manufacturing and 45% of the stock of Machine. They were respectively president, vice president, and member of the board of directors of each company. The other directors were either employees of the companies or daughters of Clint.

Before the period in question, taxpayers advanced money to the three corporations for which no notes or security were given. In 1964 taxpayers began to withdraw funds from the corporations in addition to their salaries. The withdrawals were treated as receivables on the books and balance sheets of the corporations, on state and federal income tax returns, and on state franchise tax returns. Taxpayers' withdrawals were treated as assets on the corporations' general ledgers.

The combined salaries of taxpayers ranged from $32,400 in 1964 to $43,500 in 1969. The earned surplus of Sales was $42,441 in 1965 and $548,630 on December 31, 1969. At the same times that of Manufacturing was $149,589 and $351,614, and of Machine $250,370 and $352,588. No formal dividends were ever declared or paid by any of the three corporations. Clint testified that the surplus was intended for use in expansion but admitted on cross-examination that there were no definite plans for expansion.

The Commissioner's notice of deficiency determined that for the pertinent period Clint and Jeanne received constructive dividends by reason of the following net withdrawals:

                Sales .......... $ 320,152
                Manufacturing .... 210,155
                Machine ........... 45,999
                                 ---------
                   Total         $ 576,306
                

None of the companies required that the board of directors authorize loans to officers, employees, or customers. Customers whose accounts were more than a year old were required to furnish interest-bearing notes for the balance due. One of the companies made loans to customers without requiring notes or security. The companies regularly loaned small sums to employees which were repaid.

During the period the taxpayers had substantial personal assets with a combined net worth which, excluding constructive dividends and company stock, increased from $755,615 on December 31, 1963, to $1,375,876 on December 31, 1969. The taxpayers used the withdrawn funds for various personal purposes, including living expenses, investments, legal fees, and personal loan repayments.

Witness Bottenfield, the accountant for the taxpayers and the corporations, prepared the federal and state income tax returns and the state franchise tax returns. In his opinion the withdrawals were properly treated as loans.

From 1960 to 1969 the taxpayers were regularly investigated by the Internal Revenue Service. In August, 1969, the taxpayers knew that their income tax returns for the taxable years 1964 through 1968 had been assigned to a revenue agent for audit.

During 1964-1967 Bottenfield advised taxpayers that they should make notes to the companies for the various withdrawals. Before May 1, 1967, no note or other written agreement of indebtedness was executed with respect to any of the disputed withdrawals, and no security or collateral was pledged to secure payment. In May, 1967, Clint instructed an employee, Birdie Taylor, to determine the amount "owed" and prepare "notes." Clint executed demand notes, one to each company. The amounts varied from $120,067 to $25,243. The face amount of the notes was less than the balance shown in accounts receivable because of the omission of various withdrawals. They did not contain any payment schedule and were unsecured. No interest was paid on the notes.

On April 16, 1969, Clint sold Canadian property to B & L Land & Livestock, Ltd., Charles Laird, and Harold Beckwith for $20,000 cash and a 7% note for $655,000 (Canadian funds). The B & L note was secured by a second mortgage and seven sales contracts. It called for eleven equal annual payments of $54,885.

On the advice of counsel the taxpayers, on August 29, 1969, each executed notes to each company for the entire amount of withdrawals carried in their names as of July 31, 1969. The new notes included no interest accrued on the withdrawals or previously executed notes. The notes bore 6% interest and had a payment schedule coinciding with that of the B & L note. Clint's notes were secured by 2,292 shares of Sun Oil Company preferred stock and the B & L obligation. The notes executed by Jeanne were unsecured but were signed by Clint as guarantor. The board of directors of each company accepted the notes and cancelled all prior accounts and notes of Clint and Jeanne.

In October, 1969, negotiations began for the acquisition of Sales, Manufacturing, Machine, and two other companies by Smith International, Inc. The withdrawals by Clint and Jeanne were treated as accounts receivable and so represented to the New York Stock Exchange in connection with the listing of the Smith shares. Smith issued 90,000 shares of its stock in exchange for all of the stock of the companies controlled by the taxpayers.

In February, 1970, Clint assigned the B & L note to Sales, Manufacturing, and Machine and the accounts of Clint and Jeanne with those companies were credited with full payment except for a later satisfied obligation to Sales. In August, 1971, the B & L note was returned to taxpayers in exchange for shares of Smith.

The question of whether payments to stockholders of a closely held company are loans or constructive dividends is normally a fact issue but, when there is no dispute in the evidence, "it is a question of law whether the facts add up to debt or dividend." Dolese v. United States, 10 Cir., 605 F.2d 1146, 1153, application for certiorari pending. "A constructive dividend is paid when a corporation confers an economic benefit on a stockholder without expectation of repayment." Wortham Machinery Company v. United States,...