Aldrich v. Commissioner

Harriet Aldrich, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mary Whitehouse, Petitioner, v. Commissioner of Internal Revenue, Respondent. Janetta Whitridge, Petitioner, v. Commissioner of Internal Revenue, Respondent Aldrich v. Commissioner Docket Nos. 108776, 108777, 108778 United States Tax Court 1 T.C. 602; 1943 U.S. Tax Ct. LEXIS 232; February 18, 1943, Promulgated *232 Decision will be entered for the respondent. The three taxpayers inherited all the shares of an insolvent corporation and a claim against it. Dissolution was then considered. They authorized the corporation to transfer the assets to them as creditors. This was done and the corporation dissolved. Held, the amount received by the taxpayers is not a liquidating distribution, of which only a percentage would be taxable, but the gain is ordinary income, of which all is taxable. Clyde W. Sorrell, Esq., for the petitioners. F. S. Gettle, Esq., for the respondent. Sternhagen, Judge. STERNHAGEN *602 The Commissioner determined the following deficiencies in petitioners' income tax: [1938] Harriet Aldrich $ 14,939.75 $ 1,830.88 Mary Whitehouse 7,352.04 3,022.68 Janetta Whitridge 12,135.71 2,874.16 The petitioners contest the determination that an amount received by them from a corporation of which they owned all the shares was in payment of indebtedness and not in liquidation of shares. Most of the facts are stipulated and need not be specially found. *603 FINDINGS OF FACT. The petitioners filed their returns in the second district of New*233 York. They are the daughters of Harriet Crocker Alexander, who died July 16, 1935, and by her will left them each 100 shares of Alexander Estate, Inc., and an equal share in a claim against the corporation of $ 2,063,484.42 face amount. The assets of the corporation at that time and thereafter were less than its liabilities. In determining estate tax upon the mother's estate, the claim was valued at $ 1,200,070.67 and the 300 shares at zero. During the administration of the estate, the corporation paid the executors $ 383,000. In 1937, after full consideration, in November and December, the corporation and the shareholders decided to dissolve the corporation. On December 10, 1937, petitioners, as shareholders, gave written authorization to the officers and directors to pay over, transfer, and deliver, prior to January 1, 1939, "all or any part of the assets of said corporation to the creditors of said corporation in payment, in part or in full, of the indebtedness of said corporation to said creditors." On December 21, 1937, the corporation wrote each of the petitioners, reciting the authorization, asking their approval, as creditors, of a plan to transfer the corporation's *234 securities to the Chase National Bank as their agent "in reduction of the indebtedness of the corporation to you and your sisters." Each petitioner noted her approval at the foot of the letter. On December 22, 1937, the directors resolved to deliver the securities to the bank "as agent for the creditors" to be divided among them and applied "upon said indebtedness." On the same day, the bank received from the corporation securities having an aggregate fair market value of $ 883,908.29. In 1938 petitioners each received $ 4,706.58 or $ 4,706.59 cash from the corporation, and the assets were thus completely exhausted. Early in 1938 petitioners executed a certificate of dissolution which was filed with the Secretary of State of New York and the corporation was dissolved on or about June 27, 1938. OPINION. There is no dispute as to the basis to petitioners of the claim and stock and the amounts received by them or the times of receipt. They argue upon the proposition that the amounts were received by them as shareholders of the corporation in distribution of its assets in liquidation, and, as such, were, according to the Revenue Acts of 1936 and 1938, section 115 (c), to be treated*235 as in payment "in exchange for the stock." So treated, they are taxable as capital gains, which are limited to the percentages stated in sections 117 (a) of the 1936 Act and 117 (b) of the 1938 Act. The respondent stands upon the proposition stated in the deficiency notices that the amounts were received by petitioners, not as shareholders, but as creditors, and that *604 the gain is taxable as ordinary income to the extent that it exceeds the basis, i. e., the value of their interests in the claim against the corporation when they acquired them upon their mother's death. We think the correctness of the Commissioner's determination is free from doubt. The corporation, although it contemplated dissolution, recognized its indebtedness to the petitioners. On December 10, 1937, petitioners, as all the shareholders, authorized the officers to pay over the assets in payment of the debts. Reciting this authorization of the shareholders and the insufficiency of the assets to pay the claim, the corporation, on December 21, wrote the petitioners for "their approval as creditors" of a proposal to transfer assets in reduction of the indebtedness. This approval was given in writing. *236 Thereupon, in 1937, substantially all the assets were transferred to the Chase National Bank "as agent for the creditors." This was the correct procedure. The creditors had a prior claim on the corporation's assets and normally the claims should be paid before a distribution is made to the shareholders; especially since, as was known to the officers and directors, the assets were less than adequate for the discharge of the debt. This deliberate and normal conduct is not susceptible of characterization as a liquidation distribution to shareholders either by rationalization or reference to any evidence of a liquidation distribution. In both substance and form it was payment on account of debt. Clearly, the payment to creditors is no less so by reason of the fact that dissolution was in contemplation or actually occurred soon thereafter for the corporation had no net assets to distribute. The small amount of remaining cash which was paid to the petitioners as creditors in 1938, after the dissolution, and which exhausted the assets, was also a receipt by them on account of their claim and not a liquidation distribution. The decision in ,*237 relied upon by petitioners, appears to be but is not really at variance with what is now held. No question was considered in that case as to whether the amount received by the shareholder was in payment of the corporation's debt to him, on the one hand, or in liquidation of his shares, on the other. The Commissioner had held that the amount was received in liquidation of both the shares and the claim and this was contested on the ground that, because a merger had occurred, no gain was realized. No suggestion was made that, if the gain was taxable to the individual, it was to be taxed as a capital gain and not as ordinary income, and nothing in the opinion purports to consider that proposition. The Board decided, adequately for the purpose of the case, that the corporation's assets were received by Word, who held both the shares and the claims, in liquidation of the shares and claims and not by the *605 Supply Co. in a statutory reorganization. Since the issue was entirely different, the language of the opinion is not helpful here. In , also relied upon by petitioners, the issue also was entirely different*238 -- namely, whether a liquidation distribution received in 1937 was one in a series of liquidation distributions beginning in 1935, or was the first in a new plan. In holding the latter, the Board had no occasion to consider whether the distribution might have been other than a liquidation of shares, as in the case at bar; and nothing said in that opinion throws light on such a hypothetical question. The reorganization cases () can not be regarded as authority for the general proposition that, for present purposes involving no question of statutory reorganization, creditors of an insolvent corporation must be treated as if they were shareholders so that the payment of the debt is a distribution to shareholders. The Commissioner's determinations as to all the petitioners for both years are sustained. Decision will be entered for the respondent.