Dohrmann v. Commissioner

ANDREW B. C. DOHRMANN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Dohrmann v. Commissioner Docket No. 20658. United States Board of Tax Appeals 19 B.T.A. 507; 1930 BTA LEXIS 2382; April 8, 1930, Promulgated *2382 1. During 1920 petitioner exchanged certain assets for 50 per cent of the capital stock of a new corporation. Held, upon the evidence, that the new stock received in exchange had no "fair market value" within the meaning of that term as used in section 202(b) of the Revenue Act of 1918. 2. Under the decision by the Supreme Court in the case of Lucas v. Earl,281 U.S. 111, held, that the salary in question was correctly returned by the wife, who earned it. Ralph W. Smith, Esq., and Homer Tooley, Esq., for the petitioner. Eugene Meacham, Esq., for the respondent. LOVE *507 This proceeding is for the redetermination of deficiencies in income tax for the years 1920 and 1921 in the amounts of $151,884.24 and $3,970.74, respectively. The errors assigned are: (1) The respondent erred in determining that petitioner made a profit in 1920 when he and his wife transferred certain assets to a new corporation (A.B.C. Dohrmann Co.) in exchange for all of the latter's stock, each spouse receiving 50 per cent; and, (2) The respondent erred in including in petitioner's taxable income for the years 1920 and 1921*2383 the amounts of $2,250 and $9,000, respectively, which amounts constituted salary earned and reported as income by petitioner's wife. Relative to the first issue a motion was granted confining the hearing on that issue to the single question whether the stock of the A.B.C. Dohrmann Co. at the time received by the petitioner had a fair market value within the purview of section 202(b) of the Revenue Act of 1918, and, that in case the decision should be that it did have such a value, "another hearing may be had to put in evidence other facts in the case." FINDINGS OF FACT. The petitioner is an individual with his office at 135 Stockton Street, San Francisco, Calif. He has been one of the leading merchants in that city for the past 45 years. *508 On or about October 1, 1920, the petitioner caused to be incorporated the A.B.C. Dohrmann Co., for the purpose of taking over and holding certain personal and real property then owned by the petitioner and his wife. The property transferred by the petitioner and his wife, Edith L. Dohrmann, to the A.B.C. Dohrmann Co. on October 1, 1920, in exchange for the entire 10,000 shares of capital stock of the new company, together with*2384 the fair market value on October 1, 1920, of the assets transferred as determined by the respondent, is as follows: 200 shares common stock Yosemite National Park Co $20,000.00 400 shares common stock Palace Hardware Co 40,000.00 9 shares common stock Anglo California Trust Co 900.00 4 shares common stock Western America Realty Co 400.00 283 shares common stock Parmelee-Dohrmann Syndicate 283.00 160 shares preferred stock The Emporium 16,000.00 180 shares preferred stock Dohrmann Commercial Co 18,000.00 125 shares preferred stock Bully Hills Mining Co 12,500.00 25 shares preferred stock B. L. M. Bates Corporation 2,500.00 10 shares common stock F. S. Wythe Picture Corporation 1,000.00 656 shares common stock Bully Hills Mining Co None 7 shares common stock B.L.M. Bates Corporation None 3,617 shares common stock Dohrmann Commercial Co 723,400.00 1,133 shares common stock The Emporium 148,592.95 Residence, 3673 Jackson Street, San Francisco, Residence, 3277 Pacific Avenue, San Francisco, and Pierce Arrow automobile 168,000.00 Total fair market value as determined by the respondent 1,151,575.95 The petitioner and his wife each*2385 received 5,000 shares, or 50 per cent of the stock of the A.B.C. Dohrmann Co. The Emporium conducts the largest department store in San Francisco. On October 1, 1920, it had 22,500 shares of common stock outstanding. The Dohrmann Commercial Co. was a family corporation. The business conducted by it was originally started by petitioner's father and one B. Nathan, who in 1868 organized the first crockery store in San Francisco. Petitioner became a partner in 1898 with a one-fourth interest. Petitioner's father had a one-half interest and Nathan a one-fourth. The partnership was incorporated in 1904. On October 1, 1920, the stock of the Dohrmann Commercial Co. was owned substantially in equal proportions by the petitioner, his brother and his sister. A statement of its assets and liabilities as at October 1, 1920, is as follows: *509 DOHRMANN COMMERCIAL COMPANY Balance sheet as at October 1, 1920 Assets Cash $118,506.94 Accounts receivable - subsidiaries 2,161,869.10 Accounts receivable - stockholders 121,978.42 Investments in subsidiaries 38,609.87 Investments - outside 1,649,800.00 Real estate (land and buildings) 230,850.55 Unexpired interest 14,306.25 Sundry assets 209.42 Total assets 4,344,192.65 Liabilities and capital Bills payable $1,515,044.30 Federal tax reserve 7,483.52 Welfare fund 208.47 General welfare fund 9,779.83 Warehouse site and building reserve 44,017.61 Bad-debt reserve 14,330.87 Marine-insurance reserve 66,250.11 Net earnings Jan. 1 to Oct. 1, 1920 128,945.20 Surplus 210,432.74 Capital stock, preferred 1,247,700.00 Capital stock, common 1,100,000.00 Total liabilities and capital 4,344,192.65 *2386 The earnings, dividends paid, and surplus balances appearing on the books of the Dohrmann Commercial Co. from January 1, 1909, to December 31, 1922, are as follows: Year Earnings Dividends Surplus as at Dec. 31 [1909] $83,532.42 $60,000.00 $111,716.20 [1910] 91,162.49 75,000.00 121,543.42 [1911] 124,750.85 160,000.00 86,294.27 [1912] 168,367.86 160,000.00 94,662.13 [1913] 162,372.84 160,000.00 97,034.97 [1914] 73,584.90 100,000.00 70,619.87 [1915] 157,374.24 140,000.00 87,994.11 [1916] 189,604.40 180,000.00 97,598.51 [1917] $182,567.06 $198,000.00 $100,727.38 [1918] 107,493.61 66,000.00 142,220.99 [1919] 210,129.43 220,000.00 132,350.42 [1920] 930,278.12 198,000.00 398,367.42 [1921] 695,382.51 210,000.00 433,749.93 [1922] 393,242.80 195,000.00 628,466.60 Total 3,569,843.53 2,122,000.00 In addition to the above statement the following adjustments were made to the surplus account as it appeared on the books of the Dohrmann Commercial Co.: Date Amount Explanation Dec. 31, 1910 $6,335.27 Debit adjustment. Jan. 31, 1917 18,651.81 Credit adjustment. Dec. 31, 1920 400,000.00 Stock dividend. Dec. 31, 1920 $66,261.12 Debit adjustment. Dec. 31, 1921 450,000.00 Stock dividend. Dec. 31, 1922 3,526.13 Debit adjustment. *2387 An analysis of the common and preferred capital stock accounts of the Dohrmann Commercial Co. from 1909 to 1922 taken from the latter's books, is as follows: COMMON CAPITAL STOCK Jan. 1, 1909, balance $1,000,000 Jan. 2, 1917, cash 100,000 Dec. 31, 1920, stock dividend 400,000 Dec. 31, 1921, stock dividend 450,000 Dec. 31, 1922, balance 1,950.000 *510 PREFERRED CAPITAL STOCK Jan. 1, 1909 None. Jan. 1, 1910, cash $250,000 Dec. 31, 1914, cash 350,000 During 1915, cash 122,000 Oct. 1, 1918, cash 28,000 Jan. 1, 1919, cash 250,000 During 1920, cash 500,000 During 1921, cash 150,500 During 1922, cash 230,700 Dec. 31, 1922, balance 1,881,200 On October 17, 1922, the petitioner, Minna D. Pischel and F. Dohrmann, Jr., as executors of the estate of Blanca D. Paulsen, purchased from the estate the following stock at the following prices: Stock Shares Price per share Dohrmann Commercial Co. (common) 1,418 $119.07 Parmelee-Dohrmann Syndicate [60] 10.15 The Emporium (common) [606] 108.65 The Emporium (preferred) [40] 100.00 Neither The Emporium nor the Dohrmann Commercial Co. stock*2388 was listed on any stock exchange. On October 1, 1920, there was no market for either one of these stocks. The petitioner and his wife each thought it would be more convenient to manage their several properties if such properties were all transferred to a single corporation and it was for this purpose that the A.B.C Dohrmann Co. was incorporated. After incorporation each spouse placed the new stock received in a revocable trust where it has always remained up to and including the day of the hearing before this Board. On October 1, 1920, the petitioner would not have been willing to have sold his stock in the A.B.C. Dohrmann Co. at its "intrinsic" value or at any other value except a "ridiculous price" which he knew no one would be willing to pay. On the other hand, he could not have sold his stock except at a great sacrifice. The stock of the A.B.C. Dohrmann Co. received by the petitioner on or about October 1, 1920, in exchange for the assets previously itemized herein did not at that time have any fair market value. The respondent determined that the cost or fair market price or value of the assets transferred by the petitioner to the A.B.C. Dohrmann Co. on or about*2389 October 1, 1920, was as follows: *511 200 shares common stock Yosemite National Park Co $20,000.00 400 shares common stock Palace Hardware Co 40,000.00 9 shares common stock Anglo California Trust Co 900.00 4 shares common stock Western America Realty Co 400.00 283 shares common stock Parmelee-Dohrmann Syndicate 283.00 160 shares preferred stock The Emporium 16,000.00 180 shares preferred stock Dohrmann Commercial Co 18,000.00 125 shares preferred stock Bully Hills Mining Co 12,500.00 25 shares preferred stock B. L. M. Bates Corporation 2,500.00 10 shares common stock F. S. Wythe Picture Corporation 1,000.00 656 shares common stock Bully Hills Mining Co 656.00 7 shares common stock B. L. M. Bates Corporation 700.00 2,367 shares common stock Dohrmann Commercial Co 248,719.58 33 shares common stock The Emporium 6,100.00 Total cost 367,758.58 Plus excess of Mar. 1, 1913, value over cost of stock acquired prior to that date 7,060.00 Total cost or Mar. 1, 1913, value of property exchanged as determined by the respondent 374,818.58 The respondent further determined that the fair market value of the 10,000 shares of stock*2390 of the A.B.C. Dohrmann Co. on or about October 1, 1920, was the same as the fair market value of the assets given in exchange therefor, and, that therefore, since he had determined the fair market value of the assets to be $1,151,575.95, the fair market value of the 5,000 shares received by the petitioner was the amount of $575,787.97, and that the difference between this amount and the cost or March 1, 1913, fair market price or value of $374,818.58, or $200,969.39, represented a taxable gain to the petitioner. During the years 1920 and 1921 the petitioner's wife received as salary from the A.B.C. Dohrmann Co. the amounts of $2,250 and $9,000, respectively. She reported these amounts as income in her separate income-tax returns for the years 1920 and 1921. The respondent determined that the amounts should have been reported by the petitioner, and therefore, included the $2,250 and $9,000 in the petitioner's taxable income for the years 1920 and 1921, respectively. OPINION. LOVE: The issues in this proceeding are (1) whether the petitioner realized a taxable profit in 1920 when he exchanged certain assets for 50 per cent of the stock of a newly organized corporation, and*2391 (2) whether salaries paid to the petitioner's wife are taxable to the petitioner. The applicable statute in connection with the first issue is section 202(b) of the 1918 Act, which, so far as is material, provides as follows: *512 When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any; * * * The petitioner contends that the 5,000 shares of stock of the A.B.C. Dohrmann Co. which he received in the exchange did not have any fair market value and that, therefore, he did not realize any taxable gain on the exchange. In his brief he also questions the constitutionality of section 202, supra, in so far as the section may be interpreted to provide for the possible determination of income from a transaction such as is involved in this proceeding, his contention being that such an interpretation would be contrary to the Sixteenth Amendment. The respondent contends that the stock of the A.B.C. Dohrmann Co. had a fair market value equal to the fair market value of the assets exchanged therefor and that the difference*2392 between the cost or March 1, 1913, fair market price or value of the assets exchanged and the fair market value of the new stock received in exchange constitutes taxable gain to the petitioner. Working on this contention or theoryn of the case, the respondent determined that the fair market value of all the assets given in exchange by both the petitioner and his wife was the amount $1,151,575.95; that the fair market value of all the stock of the new company received in exchange by both the petitioner and his wife was the same, to wit, $1,151,575.95; that since each spouse received 50 per cent of the stock of the new compoany, the fair market value of the stock received by the petitioner was $575,737.97; that the cost or March 1, 1913, fair market price or value of the assets given in exchange by the petitioner was $374,818.58; and that the petitioner realized a taxable gain on the exchange in the amount of $200,969.39 ($575,737.97 minus $374,818.58). The respondent in support of his contentions argues in his brief that: It is quibbing to say that a stock, or other security, has no fair market value merely because no sales have been made of the security or because it is the opinion*2393 of those qualified to pass on the question that a purchaser, if one should be found, would buy only at a price considerably less than the intrinsic or book value of the security. Evidence of the latter character goes rather to a determination of the value of the security, fair market value or whatnot, than to a determination of whether the particular kind of property under consideration has a value. To hold for the petitioner on the issue here under consideration would amount to a determination by the Board that the closely-held stock of any corporation could not have a fair market value, a position which the respondent respectfully submits is entirely untenable. No doubt Congress recognized that under certain circumstances it was possible for stock or any other property, at a given time, to have no fair market value, else it would not have added the words *513 "if any" in the statute. The "Advisory Tax Board" which was created by section 1300(d) of the Revenue Act of 1918 took cognizance of such a possibility in its well considered Recommendation No. 57, published as T.B.R. 57 (I.C.B. 40). Upon several occasions we have decided from the evidence that certain property*2394 had no fair market value at the time in question. See Joliet-Norfolk Farm Corporation,8 B.T.A. 824, as to second mortgage notes; George S. Parker,10 B.T.A. 854, as to capital stock; S. T. Swenson, Executor,14 B.T.A. 675, as to capital stock; Helen Pitts Parker et al.,14 B.T.A. 1185, as to capital stock; Will M. Ott,15 B.T.A. 867, as to capital stock; Woodmar Realty Co.,17 B.T.A. 88, as to contracts; and Ault & Wiborg Co.,17 B.T.A. 665, as to capital stock. To the same effect see Bourn v. McLaughlin, 19 Fed.(2d) 148, as to stock in family corporation; O'Meara v. Commissioner, 34 Fed.(2d) 390, as to capital stock; and Heafey v. Allen, 34 Fed.(2d) 941, as to capital stock. We think it is well settled that whether property at a given date has a fair market value or not is a question of fact to be determined from all of the evidence introduced and admitted in each individual case; that no set rule or formula can be employed; and that in weighing and sifting the evidence the fact to be found, if it*2395 exists, is the cash price at which a seller willing but not compelled to sell and a buyer willing but not compelled to buy, both having reasonable knowledge of all the material circumstances, will trade. Walter v. Duffy,287 Fed. 41; Phillips v. United States, 12 Fed.(2d) 598; Heiner v. Crosby, 24 Fed.(2d) 191; O'Meara v. Commissioner, supra;Adult & Wiborg Co., supra; and James Couzens,11 B.T.A. 1040. Cf. Ray Consolidated Copper Co. v. United States,268 U.S. 373. In Phillips v. United States, supra, the court at page 601 said: The law of the case seems perfectly plain. It is well settled that the fair market price or value of the property as of March 1, 1913, is a question of fact under all the circumstances of the case. No method of determining this value can be stated which will adequately meet all circumstances. The stock sales made from time to time are to be considered together with the nature and extent of the sales, and the circumstances under which they were made; hence forced sales, or sales of small lots, may*2396 often be no real indication of the value. The test is the fair market value. This may be defined to be the value of the property in money as between one who wishes to purchase and one who wishes to sell; the price at which a seller willing to sell at a fair price, and a buyer willing to buy at a fair price, both having reasonable knowledge of the facts. *514 Judge Davis in Heiner v. Crosby, supra, said at page 193 of his opinion: The fair market price or value of stock at a particular time is a question of fact, to be determined from all the circumstances. Market price implies the existence of a market, of supply and demand, of sellers and buyers. Sales are always evidence of a market price, but the statute requires that, in "ascertaining the gain derived from the sale," there must be not simply a "market price," but a "fair market price." After quoting section 202(b), supra, the court in O'Meara v. Commissioner, supra, in reversing the Board's decision reported in 11 B.T.A. 101, said: Under this section, where property is exchanged for other property, there is no taxable gain unless the property received*2397 in exchange has a value realizable in money's worth. If the property received in exchange does not have such a value, the exchange leaves the taxpayer where he was before the exchange. Such must be the construction of section 202(b), if it is to be brought within the definition of "income" as laid down in Eisner v. Macomber, supra, because, if the value of the property received in exchange cannot be realized in money, then the profit in the transaction is not susceptible of being severed from the capital. * * * A negative is always difficult to establish, but we think appellants sustained the burden of proof, and established that the stock in question could not have been sold at a price approximating what the Commissioner determined to be its intrinsic value. (Italics ours.) Earlier in the same opinion the court also said: It seems clear to us that stock for which there is no market - which could not be sold, or could not be sold for an amoount reasonably approximate to its real or intrinsic value - has no market value, within the meaning of section 202(b) of the Revenue Act of 1918. It seems equally clear to us that such stock, which would have to be sacrificed*2398 by the holder in order to convert it into cash, does not have an exchangeable value, within the meaning of the definition laid down in Eisner v. Macomber, supra. Before examining the evidence we deem it important to cite another well settled rule, namely, that the respondent's determination is prima facie correct and the burden of disproving it is upon the petitioner. Avery v. Commissioner, 22 Fed.(2d) 6; William Reibert,7 B.T.A. 1198. The evidence introduced on behalf of the petitioner consisted of his own testimony and that of three experienced bankers and the inheritance tax appraiser for the city and county of San Francisco. The respondent confined his evidence to certain financial statements of one of the companies whose stock was transferred to the new company and a few sales, all of which we have set out in our findings. The petitioner testified that he would not have been willing in 1920 to have sold his stock in the new company for its intrinsic value or at any other price except a ridiculous one which no one would have paid; that there was no market for the stocks of The *515 Emporium, the Dohrmann Commercial*2399 Co. or the A. B. C. Dohrmann Co. in 1920; that he did not think any one would buy in a family concern except at a great sacrifice to the seller; and that it was his opinion that no purchaser could have been found for the stock of the A.B.C. Dohrmann Co. at the time he received it in 1920. Mortimer Fleishhacker is a former president of the Anglo-California Trust Co. and the present vice president of the London Paris National Bank. He is an experienced banker, having been in that profession for about thirty years. He has constantly dealt with the marketability or salability of securities. It was his opinion that the stock of the A.B.C. Dohrmann Co. did not have a fair market value when received byn the petitioner in 1920, and, when asked to state his reasons therefor, he testified as follows: Various reasons, in the first place, due to its lack of salability and marketability, stock of this nature is not stock that can be readily sold, and could only be sold ordinarily at a great sacrifice. In fact in every case at a great sacrifice. There are many objections to stock of this kind; in the first place, it is a family affair, and people as a rule like to keep out of family matters. *2400 The stock was not listed upon any stock exchange, not even on the curb exchange. Stock of this kind could not be listed. It can't pass from hand to hand. It is not stock that could readily be used as collecteral in making a loan. It would not ordinarily be considered first class collateral, and it is a class of stock that would be almost impossible to get a quotation on. It is generally the last kind of a collateral that a bank desires to take, and for that reason it would decidedly not have a fair market value. He further testified that another disadvantage to stock of the kind in question was that the petitioner did not own or receive a majority interest in the compoany; that stock like this could not be sold except at a ridiculous sacrifice; and that one "can sell almost anything at some price, but the price would be so low and entirely at variance with the intrinsic value of the stock you might say it is unsalable." R. M. Sims occupies the position of vice president and trust officer of the American Trust Co., a ninety to a hundred million dollar institution. He has been connected with that company since the year 1909. He also testified that in his opinion the stock*2401 in question did not have a fair market value on October 1, 1920, and gave substantially the same reasons as did the previous witness Fleishhacker. Sims though that if the stock in question could be sold at all, it would have to be at a sacrifice of at least 60 per cent of its value. Frederick L. Lipman has been engaged in banking in the City of San Francisco for the past 46 years. For the past 9 years he has been president of the Wells Fargo Bank & Union Trust Co. He testified that in his opinion the A.B.C. Dohrmann Co. stock did not *516 have any fair market value on or about October 1, 1920. His principal reasons for such a conclusion were that the 5,000 shares in question constituted a minority interest in a family corporation; and that they could not be marketed except at a sacrifice. J. S. Lamson, an attorney at law, has occupied the position of inheritance tax appraiser for the City and County of San Francisco during the past 18 years. Some of the reasons he gave as to why in his opinion the 5,000 shares of stock received by the petitioner in October, 1920, had no fair market value were that "market value for a security presupposes the existence of a market"; *2402 that "market implies more than one buyer and more than one seller"; that "market for this type of security in this vicinity at that time never did exist"; that "people who form family corporations do not form them for the purpose of selling securities to the public"; that "in fact they usually form them for the purpose of keeping intact family holdings which are more or less private affairs"; and that his answer would be the same even if it were a fact that the assets which were transferred to the new company had a fair market value at the time they were so transferred. The only evidence which the respondent introduced was evidence tending to support the theory upon which his determination was based, namely, that the assets back of the stock in question had substantial intrinsic values. In Tsivoglou v. United States, 27 Fed.(2d) 564, the court in construing the words "fair market value" as used in section 202(b), supra, said at page 566: The Board of Tax Appeals, in cases cited, has evidently proceeded on the theory that, if the property received in exchange has no market value established by actual sales, it may proceed to determine the value of*2403 the stock by ascertaining the value of the property represented by the stock, and that such value for the purposes of section 202(b) may be deemed the fair market value. Appeal of W. Zeigler, Jr.,1 B.T.A. 186; Appeal of Charles T. Plunkett, et al.,3 B.T.A. 1265. The federal courts, however, have refused to sanction this method when it was applied for the purpose of establishing a gain resulting from a transfer of property to a corporation in exchange for the shares of its stock, there being no market for the shares. Bourn v. McLaughlin (D.C. 19 F.(2d) 148. The above case was affirmed by the Circuit Court. See Tsivoglou v. United States, 31 Fed.(2d) 706. See also O'Meara v. Commissioner, supra. It is our conclusion that the above holdings are but another way of saying that if, in fact the evidence in each case proves that the property in question has "no fair market value" on the date involved, neither the taxing authorities nor the courts have authority *517 to construct such a value by means of any set rule or formula. The evidence introduced and admitted in each*2404 case is the controlling factor. Applying what we have said to the evidence in the instant case, we believe that the petitioner has overcome the burden that was his, and has proved, as far as this proceeding is concerned, that the 5,000 shares of the A.B.C. Dohrmann Co. stock at the time received by him on or about October 1, 1920, had no "fair market value" within the meaning of that term as used in section 202(b) of the Revenue Act of 1918. It follows that the respondent was in error in including in the petitioner's taxable income for the year 1920 the amount of $200,969.39. In view of the foregoing it is not necessary to discuss the constitutional question or to grant the second hearing mentioned in our opreliminary statement. In connection with the second issue the petitioner contends that the salary received by his wife from the A.B.C. Dohrmann Co. during the years 1920 and 1921 was her separate property, and was correctly returned by her as such in the first instance. The respondent determined that the salary received by the petitioner's wife was, under the laws of the State of California, community property, and upon the authority of *2405 United States v. Robbins,269 U.S. 315, he included such salary in the petitioner's taxable income for the years 1920 and 1921, respectively. Since the hearing in the instant case, the Supreme Court has handed down its opinion and decision in the case of Lucas v. Earl,281 U.S. 111. In that case the court held that the question, turns on the import and reasonable construction of the taxing act. There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skilfully devised to prevent the salary when paid from vesting even for a second in the man who earned it. That seems to us the import of the statute before us and we think that no distinction can be taken according to the motives leading to the arrangement by which the fruits are attributed to a different tree from that on which they grew. Under the Earl case, we hold that the salary in question was correctly returned by the wife who earned it. Reviewed by the Board. Judgment will be entered under Rule 50. MURDOCK concurs on the first point and dissents*2406 on the second.