Kraus Trust v. Commissioner

Edward L. Kraus, Jr., Trust, Lehigh Valley Trust Company, Trustee, Petitioner, et al., 1 v. Commissioner of Internal Revenue, Respondent Kraus Trust v. Commissioner Docket Nos. 4481, 4500, 4501, 4502, 4503, 4541 United States Tax Court 6 T.C. 105; 1946 U.S. Tax Ct. LEXIS 310; January 24, 1946, Promulgated *310 Decisions will be entered under Rule 50 in Docket Nos. 4481 and 4541. Decisions will be entered for the respondent in Docket Nos. 4500, 4501, 4502, and 4503. A corporation in which petitioners owned 50 percent of the 3,000 shares of outstanding stock made distributions in 1940 of $ 50 per share on stock having $ 50 par value. The business of the corporation was making school slates. For several years surplus funds not needed in the business were invested in securities. In 1940 the securities were sold and the proceeds distributed to the stockholders. The distribution did not serve any business need of the corporation but was made for the benefit of trusts owning stock. No plan of liquidation of the corporation had been adopted. The corporation was not engaged in any investment business. No stock was canceled. Later, in 1942, 1,500 shares of stock were canceled. Upon the facts, held, that the 1940 distributions were not in partial liquidation of the corporation under code sections 115 (c) and (i). *311 Leon Meltzer, Esq., and E. C. Fish, Esq., for the petitioners. W. J. McFarland, Esq., for the respondent. Harron, Judge. HARRON *106 Respondent determined deficiencies in income tax for the year 1940, as follows: Docket No. 4500, $ 1,209.78; Docket No. 4501, $ 1,281.42; Docket No. 4502, $ 15,055.01; Docket No. 4503, $ 29,972.31; Docket No. 4481, $ 9,659.18; Docket No. 4541, $ 10,286.95. The total amount of the deficiencies is $ 67,464.65. These proceedings have been consolidated for hearing and opinion. Grenville and Charlotte Parsons, husband and wife, filed a return with the collector for the twenty-first district of New York. The returns of all of the other petitioners*312 were filed with the collector for the first district of Pennsylvania. The petitioner trusts, Docket Nos. 4500, 4501, 4502, 4503, are the owners of all of the stock of National School Slate Co., which made two distributions to stockholders in 1940, in the amount of $ 75,000 each, a total of $ 150,000. The question is whether these distributions were made in partial liquidation of the company under sections 115 (c) and (i) of the Internal Revenue Code, as petitioner contends. Charlotte Kraus, Docket No. 4481, and Edward G. Kraus, Docket No. 4541, are beneficiaries of the Arthur H. Kraus trust, created under the will of Arthur H. Kraus, deceased, Docket No. 4503. In the event that it is held that the distributions which were made by the corporation in 1940, part of which were received by the trustees of the Arthur H. Kraus trust, were dividends, taxable as such, then such income is taxable either to the trust, or to the beneficiaries, Charlotte and Edward Kraus. The parties have not submitted in these proceedings any question under sections 161, 162, and 163 of the Internal Revenue Code. The parties have indicated that, under Rule 50, an agreed recomputation will be submitted to *313 eliminate a double tax on the same items of income in Docket Nos. 4503, 4481, and 4541. Some of the facts have been stipulated. Evidence was adduced at the trial through oral testimony and exhibits. FINDINGS OF FACT. The facts which have been stipulated are adopted as part of our findings of fact. The stipulations are incorporated herein by reference. The National School Slate Co., a Pennsylvania corporation, was incorporated in 1899. Its business is the manufacture and sale of slate products. In 1908 the charter was amended to increase the capital stock from $ 5,000, consisting of 100 shares, to $ 50,000, consisting of 1,000 shares of the par value of $ 50 a share. A stock dividend of $ 100,000, consisting of 2,000 shares, was declared in 1922, which increased the capital to $ 150,000, represented by 3,000 shares. The stock was owned equally by Edward L. Kraus and Arthur H. Kraus, *107 brothers and residents of Slatington, Pennsylvania. Each brother deposited two shares of stock in escrow in 1920 under an agreement which provided that upon the death of one of the brothers the survivor should purchase two shares of stock, at par value, from the representatives of the deceased*314 brother. The purpose of the agreement was to place in the surviving brother the control of the Slate Co. The agreement provided, further, that upon the death of the surviving brother, two shares of stock should revert to the estate of the first deceased brother to reestablish equal holdings in the company. Edward L. Kraus died on August 10, 1926, and thereafter Arthur H. Kraus owned the majority of the Slate Co. stock. Arthur H. Kraus died on January 19, 1940. Edward L. Kraus was survived by a daughter, Helen Kraus, and Edward L. Kraus, Jr., a natural nephew and adopted son. Arthur H. Kraus was survived by two children, Charlotte Kraus Parsons and Edward L. George Kraus -- hereinafter referred to as George Kraus. George Kraus was named the executor and trustee under the will of Arthur H. Kraus. Edward L. Kraus created a trust for the benefit of Augusta Brady during his lifetime, and he directed that two trusts should be created under his will for the benefit of his daughter and adopted son. Arthur H. Kraus, in his will, directed that a trust should be created for the benefit of his widow and his two children. Lehigh Valley Trust Co. is the trustee of the three trusts created*315 under a deed and under the will of Edward L. Kraus. After the death of Arthur H. Kraus, on January 19, 1940, the stock of the Slate Co. was held as follows: Shares Edward L. George Kraus, executor and trustee under will of Arthur H. Kraus 1,500 Lehigh Valley Trust Co., trustee under will of Edward L. Kraus (Helen Kraus, beneficiary) 1,000 Lehigh Valley Trust Company, trustee under will of Edward L. Kraus (Edward L. Kraus, Jr., beneficiary) [250] Lehigh Valley Trust Co., trustee under deed of trust created by Edward L. Kraus (Augusta Brady and Mary Antoinette Kraus, beneficiaries) [248] Helen Kraus [2] Total 3,000 Edward L. Kraus, prior to his death, was active in the management of the Slate Co.'s business, giving particular attention to technical problems, designing machinery, and production. Edward L. Kraus, Jr., assisted him in the management of the business, and upon his death took over the duties of Edward L. Kraus. Arthur H. Kraus, subsequent to the death of Edward L. Kraus, devoted himself almost *108 exclusively to the investment of the accumulated surplus of the Slate Co. and gave almost no attention to the company's business. He invested a*316 large part of the accumulated surplus in stocks, bonds, and mortgages. The total investments amounted to $ 146,258.75 in 1927. Arthur H. Kraus continued to operate an investment account, using the accumulated surplus of the Slate Co., from 1927 until he died. The investments were carried on the books of the Slate Co. as an asset, and any profit or loss from the sales of securities was charged appropriately to surplus. The total amount invested in securities increased to $ 292,308.16 in 1933. At the end of 1939 the investments amounted to $ 191,948.75. At the end of 1939, according to the balance sheet of the Slate Co. the assets and liabilities were as follows: ASSETS Cash $ 74,257.48 Accounts receivable 27,495.47 Inventory 32,839.78 Life insurance 15,909.10 Investments 191,948.75 Plant and equipment, depreciated value 27,209.96 Total 369,660.54 LIABILITIES Current liabilities: Accounts payable $ 13,454.04 Reserve for 1939 Federal income tax 2,050.78 Dividends declared and unpaid 18,000.00 33,504.82 Capital: Common stock, 3,000 shares, $ 50 par value 150,000.00 Surplus net 186,155.72 Net worth 336,155.72 Total 369,660.54 *317 During the period 1927 to 1938, inclusive, Edward L. Kraus, Jr., was the general manager of the business of the Slate Co., exclusive of the operation of the investment account. He resigned from the company in December 1938, after a series of disputes with George Kraus, son of Arthur. Thereafter, George Kraus was the manager of the business. Harvey H. Steckel, an attorney, had represented the Slate Co. since 1916, and he was well acquainted with members of the Kraus families. He was also counsel for the Lehigh Valley Trust Co. In 1932 Edgar Mortimer, an officer of the Lehigh Valley Trust Co., became a member of the board of directors of the Slate Co., to represent the three *109 trusts which had received 1,498 shares of stock from Edward L. Kraus. Steckel has been a member of the board of directors for a long period, and he has been a director during the period from 1938 to the present. In 1940 the board of directors consisted of Mortimer, Steckel, and George Kraus. Helen Kraus, who was dependent upon the income of the trusts created for her benefit, believed that the operation of the investment account by Arthur H. Kraus should be terminated and that distribution should*318 be made to the trusts so that the trustees could invest funds in legal securities and thus safeguard the equities of the trusts' beneficiaries. After 1932 Mortimer and Steckel attempted to persuade Arthur H. Kraus to liquidate the investments held by the Slate Co., since practically one-half of the stock of the company was held by the Lehigh Valley Trust Co. in trust for beneficiaries. However, Arthur H. Kraus was reluctant to liquidate the investment account and make the proposed distributions to the trusts. His view prevailed. After the death of Arthur H. Kraus, the board of directors gave serious consideration to the matter of liquidating the holdings of the Slate Co. in stocks, bonds, and mortgages. The Lehigh Valley Trust Co. was mindful of a clause in the will of Edward L. Kraus which provided, inter alia, as follows: My share of the Capitol Stock of the National School Slate Company I authorize, empower and direct my Trustee to retain without liability for any loss for so doing or being surcharged with the same for and during the life of my brother, Arthur H. Kraus, and for so long a time thereafter as may be required to dispose of the same advantageously. The trust*319 company believed that it was unwise to attempt to sell the Slate Co. stock which was held by the three trusts under which it was trustee. There was no market for the stock. The trust company believed that as an alternative to selling the Slate Co. stock held by the trusts, the complete liquidation of the investment account of the Slate Co. and the distribution of the proceeds to the trusts would preclude it from being surcharged for not disposing of the stock under the direction contained in the above quoted provision of the will of Edward L. Kraus. The trust company had in mind the possibility that the future of the Slate Co.'s business might be uncertain, and it desired to protect the estates held under the trusts. After the death of Arthur H. Kraus, a problem confronted the directors of the Slate Co. Edward L. Kraus, Jr., expressed a desire to be taken back into the business under an arrangement whereby the business would be conducted by him and George Kraus. The two men had been incompatible in the past. Steckel decided that it would be impossible for the two men to conduct the business successfully, and *110 he was instrumental in bringing about a decision of the directors*320 to reject the request of Edward L. Kraus, Jr., to participate in the management. The decision displeased Edward L. Kraus, Jr., and Helen Kraus, and they addressed a letter to all the Slate Co.'s customers announcing that they would not be associated with the company in the future. Edward L. Kraus, Jr., did various things which, at the time, constituted a threat to undermine the business of the Slate Co. It appeared that he was making an effort to persuade the chief sales representative of the Slate Co., Julius Levenson, to discontinue his valuable services to the company. It was feared that Edward L. Kraus, Jr., might succeed in inducing customers of the Slate Co. to transfer their patronage to some competitor. A situation existed in the early part of 1940 which caused the Lehigh Valley Trust Co. and Steckel to become alarmed over the future of the Slate Co.'s business. However, the business of the company was not affected by Kraus' activities in 1940, or thereafter. At a meeting held on February 13, 1940, a resolution was adopted by the directors authorizing the officers of the Slate Co. to convert into cash all the securities held by the company, with the exception of the stock*321 of Blue Ridge Quarries, Inc., which stock was not an investment stock. Blue Ridge Quarries, Inc., is a company which produces the special kind of slate which was used in the Slate Co.'s business, and the Slate Co. owned the Blue Ridge stock for the purpose of obtaining raw material. The Slate Co. owned 79.7 percent of the stock of Blue Ridge. It was also resolved at this meeting that a special meeting should be held later to determine the manner and form in which the distribution should be made of the proceeds realized from the sale of the securities in the investment account. All of the securities were sold during the month of February 1940, with the exception of one mortgage which was disposed of during the following month. The liquidation of the investment account yielded cash in the amount of $ 151,703.65. At some time prior to March 15, 1940, Steckel, Mortimer, and an attorney for Helen and Edward L. Kraus, Jr., met and discussed the problems of distributions by the Slate Co. with a tax adviser named Shecter. The representatives of the trusts and the trust beneficiaries realized that a problem would arise upon the making of a large distribution by the Slate Co. to the trusts*322 created by Edward L. Kraus. At this time the estate of Arthur H. Kraus was still in administration and the trust created under his will had not yet been established. Considerations were being given to the tax effect of distributions to the trusts of which Lehigh Valley Trust Co. was the trustee. The *111 problem was whether a large distribution by the Slate Co. would be considered as falling into the principal of the trusts for the remaindermen, in whole or in part. If all or part of a distribution would be classified properly as belonging to the life tenants under the trusts, the income beneficiaries, they would have income tax liability as a result of any distribution accruing to their benefit. It was understood that when a distribution was made by the Slate Co. a ruling would have to be made by the Lehigh County Orphans' Court on the respective rights of the remaindermen and the life beneficiaries under the trusts in the distribution. Pending a ruling by the Orphans' Court, Shecter advised that it would be prudent to have the Slate Co. make distributions to the stockholders over a period of years to reduce the income tax liability, if any, of the beneficiaries of the*323 trusts. At the meeting with the tax adviser the representatives of the Slate Co. and the trust company discussed matters relating to the complete liquidation or the partial liquidation of the Slate Co., among other things. As a result of the above conference with the tax adviser, the directors of the Slate Co., at a meeting held on March 15, 1940, adopted a resolution to make distributions in two or more separate years. The following appears in the minutes of the meeting: The meeting was held to determine the manner and form in which distribution of the assets was to be made pursuant to the resolution of the Board adopted at a meeting held on the 13th day of February, 1940. Between the meetings of February 13, 1940 and March 15, 1940, Mr. Shecter, an income tax expert, was consulted with respect to the manner and form of distribution and the probable tax to be paid by those beneficially interested in the stock of the Corporation. Mr. Gehringer reported that it would be to the interest of his clients to have distribution made by way of dividends in two or more separate years. Accordingly, on motion, a dividend of $ 25.00 a share, or 50%, was declared, payable on the 15th day of*324 March, 1940 to the stockholders of record as of that date. Pursuant to the resolution adopted at the meeting held on March 15, 1940, the Slate Co. distributed $ 75,000 to its stockholders shortly after the meeting. Subsequent to the meeting of March 15, 1940, the Lehigh Valley Trust Co. filed its accounts in the Orphans' Court. During the following months it became evident that the trust company and the representatives of the beneficiaries would agree that the distributions by the Slate Co. of the proceeds realized from the liquidation of the investment account could be treated as belonging to the remaindermen of the trusts so that little, if any, would be distributed to the income beneficiaries of the trusts. Ultimately, after hearings in the Orphans' Court, an agreement of counsel was filed in the Orphans' Court on the basis of which the court entered a decree on January 9, 1941, *112 allocating the distributions made in 1940 out of the proceeds from the sales of the securities to the principal of the trusts. By November of 1940 it was agreed a further distribution could be made by the Slate Co. to the stockholders to complete the distribution of the proceeds from the sales*325 of the securities. A meeting of the directors of the Slate Co. was held on November 25, 1940. The minutes of this meeting state, in part, as follows: * * * Mr. Gehringer, counsel for Helen and Edward L. Kraus, Jr., also attended the meeting. The meeting was called to reconsider the action of the Board taken at its meeting held on the 15th day of March, 1940, whereat the Board declared a dividend of $ 25.00 a share on the assumption that by so doing the action of the Board would result favorably to the interests of Mr. Gehringer's clients. After a discussion, Mr. Gehringer concluded that by reason of changed circumstances his clients' interests might best be served by declaring a dividend of $ 25.00 a share presently, whereupon It was, on motion, unanimously Resolved, that a dividend of $ 25.00 a share or 50% be declared payable on the 26th day of November, 1940, to the stockholders of record as of that date. Accordingly, a distribution of $ 75,000 was made to the stockholders of the Slate Co. in November of 1940. The distributions in March and November totaled $ 150,000 and represented distributions of $ 50 per share. These distributions were made from the proceeds received from*326 the sale of securities. No resolution was adopted to retire and cancel any stock in 1940. In March of 1942, one-half of the outstanding stock, 1,500 shares, was retired and canceled. At that time all of the certificates of stock were delivered to the Slate Co. New certificates were issued at the rate of 1 share for 2 shares surrendered. There were 2 meetings of the directors held to consider the retirement of one-half of the outstanding stock. The meetings were held on December 29, 1941, and March 12, 1942. The Slate Co. had been advised by a deputy commissioner of internal revenue on March 19, 1941, that the distributions in 1940 of $ 150,000 were held to be taxable as dividends to the stockholders. The deputy commissioner's letter stated, in part, as follows: An examination of the data furnished by you discloses that your corporation is not in liquidation in view of the fact that there has been no change in your outstanding capital stock during 1940. The distributions of $ 150,000.00 (which were reported on 1099Ls submitted) and of $ 36,000.00 (which were reported on forms 1099) have been tentatively determined to be taxable in their entirety as dividends to the individual*327 shareholders. Forms 1099 submitted have been accepted as filed. Forms 1099L (which are required to be filed only to report distributions in liquidation) will be changed in this office to forms 1099 to show that the distributions are 100% taxable as dividends. *113 The minutes of the meeting of December 29, 1941, state, in part, as follows: The directors present discussed at length the advisability of a further liquidation of the corporation, commenced in 1940, and finally concluded that no further liquidation would be made, and accordingly the officers were directed to carry out the wishes of the shareholders in having the corporation demand and receive from the shareholders one-half of their shareholding for cancellation. Following the cancellation of 1,500 shares, the number of shares outstanding as of January 1, 1942, would be 1,500 shares. It was decided that the authorized capital stock of the corporation should be reduced from $ 150,000 to $ 75,000, and Harvey H. Steckel was to be notified to do whatever was necessary to carry this resolution into effect. The minutes of the meeting of March 12, 1942, state, in part, as follows: This meeting was called for the purpose *328 of formally completing the partial liquidation of the corporation decided upon by the Directors at their meeting held on December 29, 1941, the partial liquidation as of January 1, 1942, to be effected through the reduction of the outstanding capital stock from 3,000 shares to 1,500 shares by calling in all the capital stock and issuing one share of stock for every two shares surrendered. After further discussion, it was unanimously Resolved, that Paragraph 7 of the Articles of Incorporation of the corporation be and the same is hereby amended so as to read as follows: "The amount of capital stock of said corporation is $ 75,000 divided into 1,500 shares of the par value of $ 50.00 each." The officers of the corporation were directed to do all things required to be done to make their desires effective. At the close of the year 1913 the Slate Co. had accumulated earnings and profits in the amount of $ 5,578.67. From 1913 to 1922, both years inclusive, a period of 10 years, dividends were paid in 4 years in the total amount of $ 32,500. Profits increased from $ 5,578.67 in 1913 to $ 25,125.96 in 1919, and in 1922 the profits reached the highest point of $ 65,384.38. At the end*329 of 1922 accumulated earnings and profits amounted to $ 161,354.16. In no years during this period did the company operate at a loss. The above indicates, briefly, the situation as it existed in 1922 when $ 100,000 of earnings was capitalized by the declaration of a stock dividend of 2,000 shares of stock of a par value of $ 50 a share. During the four-year period 1923 to 1926, both years inclusive, no dividends were paid except in 1926, when $ 15,000 in dividends was paid. During these years the company earned profits of $ 43,143 in 1923; $ 40,122 in 1924; $ 38,190 in 1925; and $ 33,076 in 1926. At the end of 1926 accumulated earnings amounted to $ 300,887.59. During the fourteen years from 1927 to 1940, both years inclusive, the earnings, dividends paid, and accumulated profits at the end of *114 each year were as set forth in the following schedule. Beginning in 1934 and continuing through 1939, the sources of dividends were designated in resolutions declaring dividends, and according to those resolutions the sources of dividends in certain years are shown in the following schedule: Source Year Earnings Distributions Current profits [1927] $ 57,263.14 $ 7,500 [1928] 53,490.27 22,500 [1929] 53,961.15 26,250 [1930] 32,888.30 30,000 [1931] 7,106.20 7,500 [1932] 5,304.38 15,750 [1933] 1 (9,679.72) 4,500 [1934] 9,850.14 13,500 $ 9,000 [1935] 14,610.90 22,500 [1936] 14,226.87 36,000 21,000 [1937] 12,865.11 15,000 [1938] 2,224.25 9,000 9,000 [1939] 15,825.52 9,000 [1940] 1 (6,380.73) 2 36,000 18,000 *330 Source Year Accumulated profits Accumulated profits end of year [1927] $ 350,650.73 [1928] 381,641.00 [1929] 409,352.15 [1930] 412,240.45 [1931] 411,846.65 [1932] 401,401.03 [1933] 387,221.31 [1934] $ 4,500 (from profits since Aug. 1926) 383,571.45 [1935] $ 22,500 (from surplus) 375,682.35 [1936] $ 15,000 (from surplus) 353,909.22 [1937] $ 15,000 (from surplus) 351,774.33 [1938] 344,998.58 [1939] $ 9,000 (from profits of 3 yrs. 1935-1937) 351,824.10 [1940] $ 9,000 (from profits past 7 yrs.) 2 159,443.37 $ 9,000 (from surplus accumulated prior to 8/1/36). The following schedule shows, for the period 1927 to 1942, inclusive, the net sales, net business income, interest and dividends, profit and loss from sale of investments, and total net*331 income: Year Net sales Net business Interest and P. & L. from income dividends sale of Total net investments income [1927] $ 374,173.68 $ 61,112.76 $ 5,819.11 $ 7.81 $ 66,939.68 [1928] 379,936.38 50,344.05 9,207.20 1,910.48 61,461.73 [1929] 371,589.21 41,979.07 11,440.25 3,928.48) 57,347.80 [1930] 298,926.98 22,920.22 12,537.80 (1,381.37) 34,076.65 [1931] 193,023.50 4,807.54 12,644.83 (4,609.32) 12,843.05 [1932] 86,467.46 (2,242.99) 10,611.80 (1,124.83) 7,243.98 [1933] 106,174.05 (1,386.09) 10,839.37 (6,531.21) 2,922.07 [1934] 148,759.82 11,286.23 10,263.40 (2,000.00) 19,549.63 [1935] 146,409.23 7,314.18 10,944.80 (611.51) 17,647.47 [1936] 148,338.73 3,358.34 11,277.81 5,294.44 19,930.59 [1937] 181,377.58 5,736.47 11,850.90 2,228.72 19,816.09 [1938] 163,197.52 1,244.16 9,221.58 (2,000.00) 8,465.74 [1939] 183,087.59 13,100.26 7,781.98 2,100.87 22,983.11 [1940] 217,942.46 21,873.88 2,489.16 None 24,363.04 [1941] 269,983.79 28,055.18 304.43 None 28,359.61 [1942] 308,723.81 39,355.74 29.38 None 39,385.12 *115 The following tables show the total assets, liabilities, and net worth *332 of the Slate Co. as of the end of each year for the years 1927 to 1943, inclusive, and the current assets during the same period: Assets Liabilities and net worth As of Dec. 31 -- Current Plant and Current Capital and assets equipment Total assets liabilities surplus [1927] $ 407,240.88 $ 42,418.80 $ 449,659.68 $ 32,258.38 $ 417,401.30 [1928] 433,669.87 40,249.55 473,919.42 25,527.85 448,391.57 [1929] 462,116.23 33,935.83 496,052.06 23,892.42 472,159.64 [1930] 459,834.82 28,704.31 488,539.13 17,431.58 471,107.55 [1931] 456,858.67 18,222.96 475,081.63 12,327.77 462,753.86 [1932] 440,630.90 17,185.34 457,816.24 6,045.33 451,770.91 [1933] 439,154.72 16,102.55 455,257.27 6,496.61 448,760.66 [1934] 372,790.30 16,253.13 389,043.43 37,774.44 351,268.99 [1935] 373,170.48 16,668.76 389,839.24 44,564.94 345,274.30 [1936] 350,818.31 15,847.81 366,666.12 29,432.56 337,233.56 [1937] 332,647.07 27,844.60 360,844.60 18,255.50 342,236.17 [1938] 329,930.34 27,772.35 357,702.69 15,740.23 341,962.46 [1939] 342,450.58 27,209.96 369,660.54 33,504.82 336,155.72 [1940] 149,853.57 29,600.10 179,453.67 13,156.95 166,296.72 [1941] 149,190.58 34,617.08 183,807.66 16,736.64 167,071.02 [1942] 162,730.56 36,530.15 199,260.71 32,999.58 166,261.13 [1943] 155,515.03 34,554.63 190,069.66 28,498.78 161,570.88 *333 CURRENT ASSETS Notes and As of Dec. 31 -- Cash accounts Inventory receivable [1927] $ 147,296.20 $ 60,423.39 $ 44,946.44 [1928] 124,016.49 45,503.56 40,356.28 [1929] 91,415.05 68,975.75 36,475.18 [1930] 89,849.84 51,701.30 42,345.42 [1931] 94,689.53 37,330.88 40,624.95 [1932] 91,277.59 31,098.14 30,959.89 [1933] 69,627.83 32,134.78 32,496.45 [1934] 79,295.62 27,264.97 23,752.29 [1935] 99,131.21 28,361.57 26,769.08 [1936] 50,229.10 25,948.81 26,039.17 [1937] 55,599.55 23,156.46 34,577.31 [1938] 65,518.59 29,754.00 30,730.68 [1939] 74,257.48 27,495.47 32,839.78 [1940] 65,497.54 34,041.34 42,439.33 [1941] 45,721.54 42,031.73 43,343.25 [1942] 46,516.82 48,054.70 45,933.78 [1943] 20,808.91 51,236.48 56,054.48 CURRENT ASSETS As of Dec. 31 -- Life Investments Total current insurance assets [1927] $ 8,316.10 $ 146,258.75 $ 407,240.88 [1928] 8,425.20 215,368.34 433,669.87 [1929] 8,425.20 256,825.05 462,116.23 [1930] 8,425.20 267,513.06 459,834.82 [1931] 11,615.60 272,597.71 456,858.67 [1932] 12,032.30 275,262.98 440,630.90 [1933] 12,587.50 292,308.16 439,154.72 [1934] 13,140.90 229,336.52 372,790.30 [1935] 13,699.80 205,208.82 373,170.48 [1936] 14,258.00 234,343.23 350,818.31 [1937] 14,814.10 204,499.65 332,647.07 [1938] 15,364.50 188,562.57 329,930.34 [1939] 15,909.10 191,948.75 342,450.58 [1940] None 7,875.36 149,853.57 [1941] 218.70 17,875.36 149,190.58 [1942] 437.40 21,787.86 162,730.56 [1943] 627.30 26,787.86 155,515.03 *334 The stocks and bonds and other investments held by the Slate Co. did not constitute property of a kind which would be included properly in the inventory of the Slate Co., and they were not held by the company primarily for sale to customers in the ordinary course of its business. The Slate Co. was not registered or licensed under state or Federal law as a dealer in securities. In 1940 there was no indication that Edward L. George Kraus was not managing the business of the Slate Co. satisfactorily. Net sales increased as follows: $ 163,197.52 in 1938; $ 183,087.59 in 1939; $ 217,942.46 in 1940; $ 269,983.79 in 1941; $ 308,723.81 in 1942. Net business income increased as follows: $ 1,244.16 in 1938; $ 13,100.26 in 1939; $ 21,873.88 in 1940; $ 28,055.18 in 1941; $ 39,355.74 in 1942. *116 From 1927 through 1939 the capital of the Slate Co. was ample to meet all of the needs of the business without in any way employing or drawing upon the funds invested in securities in the so-called securities account. The funds invested in securities were not needed in the conduct of the business of petitioner in 1940, or in earlier years. The securities in the so-called investment account *335 had not been used and were not being used in any way in the conduct of the company's business, as collateral to secure loans, or in any other way. No plan for liquidation of the Slate Co. was drawn up or considered in 1940. The company continued to operate its business profitably after 1940, and it is still in business. Net earnings for 1941 and 1942 were $ 15,337.74 and $ 15,948.05, and dividends were paid in the sum of $ 15,000 in both years. After 1940 the company took steps to acquire another source of slate in addition to the sources previously used. The Slate Co. was engaged solely in the business of manufacturing slate blackboards and other products from slate. It was not engaged in a business of buying and selling securities. The securities account represented merely the investment of surplus funds which were not needed in the conduct of the company's business. The sales by the Slate Co. of the securities in the securities account in 1940, and the distributions in 1940 of the proceeds, in the amount of $ 150,000, were made to satisfy the desires of the trustee of the trusts created by Edward L. Kraus during his life and under his will and of the beneficiaries of those *336 trusts. Beginning in 1934, the attorney for the Lehigh Valley Trust Co., Steckel, had requested that a policy be adopted of making distributions to stockholders from the accumulated earnings of the business. Steckel, as attorney for the trust company, was anxious to have the Slate Co. sell the securities in the securities account and to get the proceeds from the sales into the hands of the trustee, which, in turn, would invest the proceeds in securities legal for trust funds. It was the desire of the trustee to preserve the fund in the trusts for the remaindermen as well as to provide the life beneficiaries with income from the fund when invested in legal securities for trust funds. The basis of the 248 shares of stock of the Slate Co. in the trust for Augusta Brady created in 1923 was $ 16,666. In March of 1942 1,500 shares of the outstanding stock of the Slate Co. were retired. All of the stock certificates were delivered to the company and new certificates were issued on the basis of 1 new share for 2 old shares. During 1940 the Slate Co. distributed $ 36,000 to stockholders, of which a dividend of $ 18,000 was declared on December 28, 1939, and was paid in January of 1940. *337 These distributions were dividends *117 without any question. In its income tax return for 1940, filed in March of 1941, the company reported in schedule M, as the total distributions to stockholders charged to earned surplus during the taxable year, $ 168,000, which sum includes the distributions totaling $ 150,000. In the balance sheet of the Slate Co. as of January 1, 1940, before the investment account was liquidated, surplus was stated to be $ 186,155.72. In the balance sheet as of January 1, 1941, after the sales of the securities and the distributions of $ 150,000, the surplus was stated to be $ 16,296.72 after payment of "dividends" in 1940 of $ 168,000. In both of these balance sheets capital was stated to be 3,000 shares of stock of a value of $ 150,000. The cost of the securities which were sold in 1940 was $ 191,355.39; the proceeds from the sales were $ 151,703.65; and the net loss from the sales was $ 39,651.74. The capital and surplus account of the Slate Co. is shown to be as follows in the balance sheet of January 1, 1941: Capital: 3,000 shs. common stock, $ 50 par val. (authorized and outstanding) $ 150,000.00 Surplus: Credit bal. 1/1/40 $ 237,319.27 Debit to P. & L. (charge-off on investments as of 4/24/34, 12/30/39 and 1/19/40 40,772.20 196,547.07 Loss disallowed, acct. 1933 B. & O. R. R. Co $ 3,098.43 Loss on sale of securities during Feb. 1940 45,215.54 48,313.67 Profit -- sales securities during Feb. 1940 5,563.50 42,750.17 153,796.90 Life insurance -- net collected, A. H. Kraus 15,555.32 169,352.22 Credit to P. & L. -- 12 mos. ended 12/31/40 14,944.50 184,296.72 Dividends declared and paid during 1940: Paid 2/15/40 $ 6,000.00 " 3/15/40 75,000.00 " 12/26/40 75,000.00 " 12/5/40 9,000.00 " 12/31/40 3,000.00 168,000.00 16,296.72 Net worth Jan. 1, 1941 166,296.72 *338 *118 In the balance sheet of the company as of January 1, 1942, the capital was stated to be 1,500 shares of a value of $ 75,000 and surplus was stated to be $ 92,071.02, as follows: Capital (common stock): (1,500 shares, $ 50 par) $ 75,000.00 Surplus: Credit bal. Jan. 1, 1941 $ 16,296.72 Credit to P. & L. for 12 mos. ended 12/31/41 15,774.30 32,071.02 Less dividends paid 12/30/41 15,000.00 17,071.02 Credit to surplus account of partial liquidation of corporation as of Jan. 1, 1942 -- capital stock reduced from $ 150,000 to $ 75,000 75,000.00 92,071.02 Net worth Jan. 1, 1942 167,071.02 During 1940 and years prior, the Slate Co. did not conduct an investment business. The decision to sell securities in 1940 did not involve or represent any curtailment of the business of the company. The decision was made primarily to meet the request of the trustee of trusts owning one-half of the company's stock, which request was motivated by reasons pertaining to the trusts and not to the needs and conditions of the business of the Slate Co. The directors and stockholders of the Slate Co. did not have any plan or intent in 1940 to cancel*339 or redeem any stock of the company, or to conclude part of its business. There is no evidence that the stockholders intended to liquidate the company in 1940 or prior. The $ 150,000 distributed by the Slate Co. in 1940 to its stockholders did not constitute amounts distributed in complete cancellation or redemption of a part of its stock or distributions in partial or complete liquidation. At the time the distributions aggregating $ 150,000 were made the company had earnings accumulated after February 28, 1913, in excess of that amount. The distributions aggregating $ 150,000 were ordinary taxable dividend distributions within the meaning of section 115 (a) of the Internal Revenue Code. OPINION. The question presented by the pleadings is whether the Slate Co.'s distributions of $ 150,000 in 1940 were distributions in partial liquidation within section 115 (c) of the Internal Revenue Code, as petitioners contend. Petitioners' argument that the distributions in question were made in partial liquidation of the company, as defined in section 115 (i), is founded upon their contention that *119 the cancellation of 1,500 shares of stock in 1942 was related to the distributions of*340 $ 75,000 each in 1940; or, in another manner of statement, that those two distributions were made in 1940 in redemption of 1,500 shares of stock, despite the lapse of time between the distributions and the retirement of the stock, and despite the absence of any expression in the resolutions which declared the distributions to be "dividends" to state that stock was to be redeemed and canceled. Respondent denies the correctness of petitioners' contentions. He contends that the distributions in question were ordinary dividends as defined in section 115 (a). In the event that it is held that the distributions were made in cancellation and redemption of 1,500 shares of stock, respondent then contends that section 115 (g) must be considered to determine whether the company canceled its stock at such time and in such manner as to make the distributions and cancellation of stock in whole or in part essentially equivalent to the distribution of a taxable dividend. Petitioners contend that in 1940 there was an intention to partially liquidate the Slate Co. because it was decided to sell the securities in which funds of the company had been invested, and because there was concern over the *341 possible effects on the slate goods business of actions of Edward L. Kraus, Jr., following a decision not to take him back into the business. Petitioners allege that the company had been conducting two businesses, a slate goods business and an investment business, and that upon the decision to sell the securities it followed that part of the company's business was being terminated, and, hence there was a partial liquidation. Upon a careful review of all the evidence, we must conclude that the concern in 1940 over the activities of Edward L. Kraus, Jr., was not the controlling reason for selling the securities and distributing the proceeds, and that the facts do not show an intention to partially liquidate the company because of those activities. There was no evidence in 1940 of a decline in business or profits or even the prospect of losing business because of the attitude and actions of Edward. The business continued after the sales of the securities with increased profit, and it was conducted in the same way as before. On this point, the argument of petitioners is rejected as without merit. We must also reject petitioners' argument that the Slate Co. conducted two businesses, *342 one of which was an investment business. We have set forth in the findings of fact substantially all of the evidence of record relating to the investment account of the Slate Co. The Slate Co. was organized to conduct a business of fabricating school slates and products using slate materials made of a particular kind of slate, and it has always conducted that business. The business was conducted profitably and profits were accumulated. The need for capital *120 in the business is best shown by the size of inventory carried and the cost of fixed assets such as plant and equipment. Taking a year close to 1940, we find that the balance sheet of January 1, 1937, shows plant and equipment having a cost of $ 160,546. In 1936 the depreciated value was $ 27,772. Balance sheets for subsequent years show small annual additions to machinery and equipment so that as of January 1, 1942, the cost of plant and equipment was $ 171,147 and the depreciated value was $ 34,617.08. Over the period from 1927 to 1939, the inventory of the company ranged from $ 23,752 to $ 44,946 annually. There is evidence that the company requires working capital of about $ 146,000. That estimate appears*343 to be liberal. The paid-in capital was $ 50,000, plus $ 100,000 capitalized in 1922 out of earnings. The record does not show when the company began investing its surplus funds in securities, or why. But there is testimony that the securities were not used in any way for the purpose of the manufacturing business, or for securing loans and credit. Thus it appears to be a fact that the funds set aside in securities were not needed in the conduct of the business during the time securities were owned. In 1927 and 1928 large sums of cash were on hand, $ 147,296 and $ 124,016. In the same years the company owned securities which presumably cost $ 146,258 and $ 215,016. Total net earnings from 1913 to 1927 aggregated $ 348,387.59, from which only $ 49,500 had been distributed in dividends, leaving a net amount of $ 298,887.59 of accumulated profits. The purpose of capitalizing $ 100,000 of earnings in 1922 has not been shown, but, assuming arguendo that none of that sum was invested in securities, there remained about $ 198,000 of surplus earnings. The logical inference is that the surplus was invested in securities. Testimony supports the inference. It is a customary business*344 practice to invest surplus funds, for money is not left idle. The securities yielded income to the company in interest and dividends, about $ 10,000 a year. There were sales of securities, sometimes at a loss. The only basis for the contention that the Slate Co. engaged in an investment business is that it owned securities. But the ownership of such assets, even though productive of income, does not lead to the conclusion that an investment business was conducted. The argument is made that an investment business was conducted of course to support the contention that there was a partial liquidation of the company when the securities were sold. But the liquidation of assets of the character we have here does not necessarily result in a liquidation of a "business," nor does the fact that the $ 150,000 which was distributed was most of the proceeds from the sale of securities stamp them as liquidating distributions. See W. E. Guild, 19 B. T. A. 1186, 1206. If the securities represented the investment of accumulated *121 profits, as we are compelled to conclude, the sales of the securities in 1940 operated to return to the company a fund of accumulated*345 profits. The distribution of that fund to stockholders is the matter under consideration. Whether or not the distribution was a distribution of dividends under section 115 (a) is to be determined by particular tests under the statute. We think the question at issue must be decided with due consideration of the fact that the Slate Co. conducted a profitable manufacturing business throughout the years in the same way and with adequate working capital apart from the existence of the investment account, both before and after the securities were sold for cash. Therefore, we reject the argument that the company's business included an "investment business" and that the decision to sell the securities was evidence of a partial liquidation of the company. It is concluded that the business of the Slate Co. was the business of manufacturing slate products. There is no evidence that the business of the company was in process of liquidation in 1940. The question of whether a corporation is in liquidation is one of fact. T. T. Word Supply Co., 41 B. T. A. 965, 981. Furthermore, there is an abundance of evidence to show that the decision to sell investments *346 which had been held for many years was impelled by the strong desires of the trustee of trusts in existence in 1940, owning one-half of the stock of the Slate Co., to put the trusts in a more secure position. The trustee desired distribution of the fund which was tied up in the securities. Cf. Isaac W. Frank Trust of 1927, 44 B. T. A. 934, 937. For several years the trustee had suggested that the Slate Co. should distribute its accumulated surplus, and some dividends had been paid out of surplus instead of out of current earnings. The surplus funds of the company were not invested in securities legal for trust funds. The evidence strongly suggests that the trustee of the trusts owning 50 percent of the stock of the company was fearful that the surplus funds, if left in the securities owned by the company, might be lost or decreased. In fact, a loss was sustained upon the sales of the securities. Thus the sales of the securities in 1940 were not made for any business need of the Slate Co., but for the benefit, if not the protection, of the trusts owning stock in the company. At the date of the death of Edward L. Kraus in 1926, a substantial part*347 of the value of the stock which passed to the trusts he created lay in the accumulated surplus of the company which was invested in securities. The trustees desired to preserve that value as far as possible and, at least, to take the surplus fund away from the chances of dissipation or diminution. The word "liquidate" has a restricted meaning in section 115 (c). The popular sense of the word does not aid petitioners. Partial liquidation *122 in the statute is restricted in its application to "distributions by a corporation in complete cancellation or redemption of a part of its stock." Cf. Beattie Investment Co. v. United States, 101 Fed. (2d) 850, 852. The question is whether there was a partial liquidation as defined in the statute. W. C. Robinson, 42 B. T. A. 725, 735. "It is clear that the statute contemplates partial liquidations of corporations, accompanied by a partial retirement of outstanding stock." Commissioner v. Cordingly, 78 Fed. (2d) 118. There was no cancellation of capital stock at the time the distributions were made in 1940, and there is no evidence that*348 the stockholders and directors intended that any capital stock would be retired. Resolutions were adopted declaring dividends. They were neither called liquidating dividends nor declared to be in payment of any stock to be retired. There was no plan to liquidate the business conducted by the company, as shown by facts existing before, during, or after 1940. See A. J. Long, Jr., 5 T. C. 327, 331, 335. It is true that later, in December of 1941, after some correspondence with deputies of the Commissioner who had determined that the distributions were dividends, a resolution was adopted to retire and cancel 1,500 shares of stock. We said in W. E. Guild, supra, that: Liquidation is not a technical status which can be assumed or discarded at will by a corporation by the adoption of a resolution by its stockholders, but an affirmative condition brought about by affirmative action, the normal and necessary result of which is the winding up of the corporate business. See, also, Holmby Corporation, 28 B. T. A. 1092, 1103; affd., 83 Fed. (2d) 548. The situation existing*349 in 1940, when dividends of $ 150,000 were declared, was not one of a corporation in process of liquidation, as we have discussed at length above. Upon the facts as we understand them, the later resolution to cancel half of the outstanding stock could not operate retroactively to the 1940 distribution so as to fit the provisions of section 115 (i), because there was no plan in 1940 to liquidate the business and no affirmative action to that end had been or was being taken. To recognize the subsequent cancellation of stock as part of the 1940 distribution would be to allow the company to assume a technical status of liquidation by the mere adoption of the 1941 and 1942 resolutions. The company was a going concern in 1940 and thereafter. We must regard the sales of the securities, sales of assets which were not being used in the business and which had not been used in the business, as only a return to cash of invested surplus, not as a liquidation of the company, in part. The situation here is like that in Tate v. Commissioner, 97 Fed. (2d) 658; certiorari denied, 305 U.S. 639, where a corporation sold securities and distributed*350 the proceeds, $ 731,250, to stockholders. There *123 no stock of the corporation was retired at the time of the distribution, or afterward, the chief difference from this case. Otherwise the facts in the Tate case closely resemble the facts here, particularly in the unusually large size of the distribution. It was held that the distribution was not in partial liquidation, but was a dividend. We recognize the force of Hellmich v. Hellman, 276 U.S. 233, and find it a guide here. It points to the distinction between distributions to stockholders by a going concern, and distributions to stockholders in the liquidation of a corporation. Judged by the recognized meaning of the term liquidation, see Mabel I. Wilcox, 43 B. T. A. 931, 939; affd., 137 Fed. (2d) 136, there was no liquidation of the Slate Co. to which the distributions in question were an accompaniment. As in the Wilcox case, all that was done here was to distribute a portion of the accumulated profits which were not needed in the normal course of the company's business. See also John K. Beretta, 1 T. C. 86, 94;*351 affd., 141 Fed. (2d) 452; certiorari denied, 323 U.S. 720. There an interest in property was sold by a corporation and the proceeds of the sale were distributed to stockholders, just as here securities were sold and the proceeds were distributed. It was held that there was not a partial liquidation. We can not accept as evidence that there was an intent in 1940 to cancel stock, a letter of Steckel dated May 20, 1941, written on the letterhead of his law firm and addressed to a deputy of the respondent, saying that the distributions in 1940 were "liquidating dividends" and that "in line with the policy of liquidation commenced in 1940," the capital stock would be reduced 50 percent in 1941. That letter was sent in reply to letters from the Commissioner advising the company that the distributions were held to be dividends. We can not pass lightly over the fact that no resolution to cancel or redeem part of the company's stock was adopted until after advice was received in 1941 from a deputy of the Commissioner that the distributions of $ 150,000 would be treated as ordinary dividends. The decision in December of 1941 to cancel*352 1,500 shares of stock must be recognized to be an afterthought in view of the lack of evidence that there was an intent in 1940 to cancel stock at or about the time the distributions were authorized. While the question now under consideration arises under section 115 (c), and we do not now refer to section 115 (g), the matter of intent of the corporation in considering the question under section 115 (c) is just as important as it is when section 115 (g) is being considered. Here the intent of the corporation in 1940 was bound up with the demands of the trustee of certain trusts, and the distributions were made primarily for the benefit of the trusts which were stockholders. They were not made "primarily from the standpoint *124 and concern of the corporate business." Rheinstrom v. Conner, 125 Fed. (2d) 790. Cancellation of stock was not a matter under consideration in 1940 by the stockholders and directors. Under these circumstances and upon the evidence, we must conclude that the distributions in 1940 were not made in cancellation of part of the corporation's stock. The 1940 distributions must be treated in the light of what was done in*353 1940. The subsequent cancellation of 1,500 shares of stock in 1942 must be regarded as separate and apart from the 1940 distributions, because no plan of liquidation had been adopted. See Alice H. Bazley, 4 T. C. 897; affd., 155 Fed. (2d) 237. The effect of the cancellation of 1,500 shares of stock in 1942 was simply to reduce capital and increase surplus by $ 75,000, as the balance sheet of January 1, 1942, shows. It is held that the distributions of $ 150,000 in 1940 were not liquidating dividends under section 115 (c) and 115 (i). In view of our conclusion above, it is unnecessary to consider any alternative question under section 115 (g). However, if contrary to our view, there was a cancellation or redemption of stock, it was, we think, at such time and in such manner as to make the two distributions of $ 75,000 each and cancellation or redemption essentially equivalent to the distribution of taxable dividends; and, since the entire amount of $ 150,000 so distributed represented a distribution of earnings or profits accumulated after February 28, 1913, it was properly treated as a taxable dividend. See sec. 115 (g). *354 Wilcox v. Commissioner, 137 Fed. (2d) 136; McGuire v. Commissioner, 84 Fed. (2d) 431; certiorari denied, 299 U.S. 591; Flanagan v. Helvering, 116 Fed. (2d) 937; Rheinstrom v. Conner, supra;J. Natwick, 36 B. T. A. 866; Robinson v. Commissioner, 69 Fed. (2d) 972; Brown v. Commissioner, 79 Fed. (2d) 73; W. & K. Holding Corporation, 38 B. T. A. 830; Bass v. Commissioner, 129 Fed. (2d) 300; Smith v. United States, 121 Fed. (2d) 692; Alice H. Bazley, supra. Mary Dupont Faulkner, 3 T. C. 1082, and George E. Mason, 3 T. C. 1087, cited by petitioners, are not in point. Neither are Ward M. Canaday, Inc., 29 B. T. A. 355; affd., 76 Fed. (2d) 278; certiorari denied, 296 U.S. 612;*355 Holmby Corporation, supra; and Milton Tootle, Jr., 20 B. T. A. 892; affd., 58 Fed. (2d) 576. Harold F. Hadley, 1 T. C. 496, and John K. Beretta, supra, cited by respondent are not squarely in point, but they lend support to the conclusion reached. It is immaterial that the decree of the Orphans' Court of Pennsylvania, which was entered to adopt an agreement of the counsel before that court, allocated the $ 150,000 distributed to the trusts owning stock of the Slate Co. to the corpus of the trusts. Ella P. Burdick, 29 B. T. A. 731; affd., 76 Fed. (2d) 672. The question presented, *125 whether the distributions were liquidating distributions, is not determined by the way they were held in the trusts, subsequently. In Docket Nos. 4481 and 4541 there should be recomputations of the deficiencies, for there is no contention made that the petitioners in those cases are taxable upon dividends distributed to the trusts created for their benefit by Arthur H. Kraus. It is our understanding*356 that only the trusts are taxable on the dividends, Docket Nos. 4500, 4501, 4502, and 4503. Accordingly, Decisions will be entered under Rule 50 in Docket Nos. 4481 and 4541. Decisions will be entered for the respondent in Docket Nos. 4500, 4501, 4502, and 4503. Footnotes 1. The following cases have been consolidated with this proceeding: Augusta Brady, et al., Trust; Helen Kraus Trust; Estate and Trust of Arthur H. Kraus, Deceased; T. Grenville Parsons and Charlotte Kraus Parsons, and Edward G. Kraus.↩ 1. Loss.↩ 2. There were distributions, also, of $ 150,000 during 1940, the distributions which are involved in the issue presented in this proceeding. This amount of distribution is omitted from the above table because it is in issue. Of the $ 36,000 dividends paid in 1940, $ 18,000 was declared by resolution adopted 12/28/39 which directed that payment should be made on or before 1/15/40. Payment was made in 1940.↩