Fuhlage v. Commissioner

ALFRED E. FUHLAGE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Fuhlage v. Commissioner Docket No. 61754. United States Board of Tax Appeals 32 B.T.A. 222; 1935 BTA LEXIS 980; March 12, 1935, Promulgated *980 1. In 1920 a corporation capitalized earned surplus and issued additional common stock. This was necessary in order to care for increased business and in order to provide for the contemplated entry into another phase of the same business. Thereafter, the business did not improve to the extent anticipated and the matter of business expansion was definitely abandoned in 1929. It was then determined that the company did not need all its capital for successful operation. The capitalization was reduced by the redemption of a portion of the capital stock. From 1923 to 1929 the corporation declared substantial cash dividends. Held that the cancellation or redemption of the stock of the corporation was not "at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend" within the meaning of section 115(g) of the Revenue Act of 1928; held, further, that the petitioner sustained a deductible loss upon the redemption or cancellation of his stock. 2. During the year 1929 the petitioner, a single man, was the sole support of his unmarried sister, age 55, whom he*981 maintained in his household, and who had no trade, occupation, or income. Held that the petitioner was the head of a family and entitled to a personal exemption as head of a family under the provision of section 25(c) of the Revenue Act of 1928. Stanley S. Waite, Esq., for the petitioner. T. M. Mather, Esq., for the respondent. MCMAHON *222 This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1929 in the amount of $22,989.99. It is alleged that the respondent erred (1) in determining that the amount received by the petitioner in May 1929 from the Beacon Paper Co. upon the surrender by him of 1213 1/3 shares of stock of that corporation represented a taxable dividend instead of determining that the transaction resulted in a loss to the petitioner of $1,929.20, and (2) in failing to allow petitioner the statutory exemption as head of a family. In his answer the respondent makes claim for any increase in deficiencies which may result from the Board's redetermination. FINDINGS OF FACT. The petitioner is an individual, with residence at University City, Missouri. The parties entered into*982 the following stipulation of facts: 1. Petitioner was one of the organizers of the Beacon Paper Company, hereinafter called the "company." He is a director and president of the company. *223 2. The company deals in fine paper such as is used by printers. It does not manufacture any paper. Its business requires fairly large warehouse facilities. On December 31, 1919, the company had an authorized capital stock of 1,000 shares, all common stock, of the par value of $100 each, a surplus of $283,386.07 and merchandise inventory of $135,507.27. Gross sales for the year 1919 were $1,137,566.78. During the year 1920 the sales of the company increased very materially and the stockholders of the company during said year conceived the idea of capitalizing some of the surplus to take care of increased business and of going into the wrapping paper business, thus adding wrapping paper to its line of fine papers. In order to care for its increased business and to enter the wrapping paper business additional capital would be required for the purpose of carrying larger inventories and for the purpose of purchasing an additional warehouse. The warehouse then owned by the company*983 was entirely inadequate for such expansion. 3. On September 22, 1920, the surplus and undivided profits of the company, accumulated subsequent to March 1, 1913, exceeded the sum of $300,000. 4. On September 22, 1920, the authorized and outstanding capital stock of the company consisted of 1,000 shares of common stock of the par value of $100 each or a total par value of $100,000. At a meeting of the stockholders of the company held on September 22, 1920, at which all of the stockholders of the company were present, a resolution was adopted increasing the authorized capital stock from $100,000 to $500,000 by capitalizing $400,000 of the earned surplus of said company and issuing additional common stock of $400,000. At the time of said meeting the stockholders, and the number of shares owned by each, were as follows: Louis Alt 333 1/3 Alfred E. Fuhlage 333 1/3 R. L. Tillman 333 1/3 5. Subsequently the proper certificates were duly filed with the Secretary of State of Missouri, setting forth the increase of capital from $100,000 to $500,000. Additional stock was issued representing the $400,000 additional capital and immediately thereafter the stockholders, *984 and the number of shares held by each, were as follows: Louis Alt 1,666 2/3 shares A. E. Fuhlage 1,666 2/3 shares R. L. Tillman 1,666 2/3 shares 6. During the year 1921 each of said stockholders sold 150 shares of said stock after which the stockholders and the number of shares held by each were as follows: Louis Alt 1,516 2/3 shares A. E. Fuhlage 1,516 2/3 shares R. L. Tillman 1,516 2/3 shares E. A. Hartman 150 shares George F. Schall 150 shares J. W. Beckman 150 shares 7. After the stock dividend, the officers of the company then endeavored to find a suitable warehouse for purchase and took the matter up with several real estate firms and dealers in the City of St. Louis, some of which are as follows: Hemmelmann-Spackler Real Estate Company, Mullin-Walter Realty Company, E. A. Bokern Real Estate Company and Isaac Hedges, who had *224 charge of the real estate transactions for Washington University, St. Louis, Missouri. They also negotiated with the Simmons Hardware Company of St. Louis, Missouri, having at one time in mind the purchase of the hardware company's warehouse No. 8. They also negotiated with the Cupples Estate, *985 which had a building for sale at the time which was considered suitable for a warehouse. The real estate concerns named offered many buildings for sale and the officials of the company examined the buildings. However, prior to the consummation of any deal, the depression of 1921 set in and in that year the company sustained a loss of $154,975.60, which impaired its capital in the amount of $68,668.36. The balance sheets of the company on December 31, 1919, 1920 and 1921, the gross sales, the net profit earned and the dividends paid during said years are as follows: Dec. 31, 1919 Dec. 31, 1920 Dec. 31, 1921 ASSETS Merchandise as per Inv $135,507.27 $367,524.92 $126,821.21 Furniture & Fixtures Tools and Machinery 3,299.63 3,071.37 2,880.89 Accounts Receivable 196,917.92 213,264.09 121,263.56 Notes Receivable 7,821.28 6,827.09 6,631.80 U.S. Liberty Bonds 85,000.00 76,503.99 76,503.99 U.S. Certificate of Indebt 131,000.00 U.S. War Saving Stamps 834.00 834.00 834.00 Cash 22,410.51 24,181.20 17,841.73 451,790.61 692,206.66 483,777.18 LIABILITIES Accounts Payable 68,404.54 105,899.42 52,445.54 Capital 100,000.00 500,000.00 500,000.00 Surplus 283,386.07 86,307.24 (Red) 68,668.36 451,790.61 692,206.66 483,777.18 Sales 1,137,566.78 1,853,715.72 817,893.43 Profit 70,343.99 202,921.17 (Red) 154,975.60 Dividend Paid Cash 25,000.00 None None *986 8. The outlook for business being uncertain and this being the first loss suffered by the company since its incorporation, the matter of going into the wrapping paper business and the purchase of the new warehouse was deferred. The company made a profit in 1922 but at the end of that year its capital was still impaired. In 1923 the company made a net profit of $80,503.37, resumed the payment of dividends and again considered the matter of expanding its business and purchasing the warehouse, but no definite action was taken to enter the wrapping paper business or to purchase the warehouse. The company's business did not improve after 1921 to the extent anticipated and the amount invested in merchandise during each year subsequent to 1921 was approximately $200,000 less than the amount invested in merchandise as of December 31, 1920. The matter of expansion came up and was frequently considered thereafter. In 1929 it was definitely determined not to go into the wrapping paper business or to purchase a warehouse. It was at the same time determined that the Company did not need all of its capital for successful operations, and it could be successfully operated and conducted with*987 a capital of $300,000. 9. On January 18, 1927, petitioner purchased from Louis Alt his entire stock in said corporation consisting of 1,516 2/ 3 shares at $101.59 a share, the aggregate purchase price being $154,078.16. Louis Alt died in 1927. *225 10. At a meeting of the stockholders held on May 7, 1929 at the company's office in St. Louis, Missouri, a resolution was adopted reducing the capital from $500,000 to $300,000. Said resolution is as follows: RESOLVED, that the capital stock of the Beacon Paper Company be reduced from $500,000, divided into five thousand shares of the par value of $100.00 per share, to $300,000.00, divided into three thousand shares of the par value of $100.00 per share; and resolved that the officers of the company and of this meeting be authorized and directed to execute such statements, certificates and affidavits and to take such action and do such things as may be necessary to carry this resolution into effect and to procure the approval of the Secretary of State to such reduction in the capital stock of the Company; and RESOLVED FURTHER, that in order to accomplish such reduction in the capital stock of the company and for the*988 purpose of carrying into effect such reduction of capital, the officers of the Company be and they are hereby authorized and directed, for and in behalf of the Company, to purchase, with the funds of the Company, two thousand shares of the capital stock of the Company at par, viz., at the price of $100.00 per share, from the holders of said shares, who in writing have agreed to sell said shares at said price, to-wit: From Alfred E. Fuhlage 1,213 1/3 shares. From Robert L. Tillman 606 2/3 shares. From E. A. Hartman 60 shares. From George F. Schall 60 shares. From J. W. Beckman 60 shares. All of the stockholders of the Company, in writing, having consented to said purchase; and RESOLVED FURTHER, that said two thousand shares, so purchased, shall be retired and cancelled. 11. On May 7, 1929, the company pursuant to said resolution, purchased from petitioner, 1,213 1/3 shares of the company's stock acquired by petitioner from Louis Alt on January 18, 1927, at a cost of $101.59 a share. The company paid him in said year $121,333.33 for said stock. 12. In his income tax return for the calendar year 1929 petitioner treated the transaction as payment to*989 him for said 1,213 1/3 shares and reported a loss on the transaction of $1,929.20. 13. It is petitioner's contention that said loss is deductible which contention is denied by respondent. Respondent's contention is that the amount paid by the company for said 1,213 1/3 shares ($121,333.33) is taxable as a dividend under the provisions of Section 115(g) of the Revenue Act of 1928. 14. During the year 1929, petitioner was a single person. Throught said year he maintained a home, in a ten room house, at 311 Westgate Avenue, University City, Missouri, and exercised authority thereover. Throughout said year, petitioner was, and he still is the sole support of his unmarried sister whom he maintained during said year and still maintains in the household at said address at petitioner's expense. Petitioner's said sister is 55 years old, and during 1929 had no trade or occupation, had no income and acted as petitioner's housekeeper. It is, and was during 1929, necessary for petitioner to employ a servant. Petitioner has another sister who teaches [sic] school part of said year and who lives in the same household. *226 The parties entered into the following stipulation*990 of additional facts: 1. At the time he purchased from Louis Alt 1516 2/3 shares of the stock of Beacon Paper Company, a corporation, on January 18, 1927, petitioner, Alfred E. Fuhlage, was the owner of 1516 2/3 of the stock of said company, so that just after said purchase petitioner was the owner of 3027 1/3 shares of the stock of said company, and petitioner was the owner of said 3027 1/3 shares on May 7, 1929, immediately prior to the purchase by said company from petitioner of 1213 1/3 shares of its stock held by him and purchased from Louis Alt, as stated in said original stipulation. 2. On May 7, 1929, just prior to the purchase by the Beacon Paper Company of $200,000 in par value of its capital stock (which included said 1213 1/3 shares purchased from petitioner), said Beacon Paper Company had in its capital account earnings and profits which were accumulated subsequent to February 28, 1913, and which were capitalized on September 22, 1920, and against which the stock dividend of September 22, 1920 was issued, an amount equal to $400,000. 3. The Beacon Paper Company paid cash dividends to its stockholders in the years and in the amounts as follows: — 1909 — $ 20,000 — 1910 — 20,000 — 1911 — 20,000 — 1912 — 20,000 — 1915 — 20,000 — 1916 — $ 40,000 — 1917 — 75,000 — 1919 — 25,000 — 1923 — 50,000 — 1924 — 50,000 — 1925 — $ 50,000 — 1926 — 50,000 — 1927 — 40,000 — 1928 — 50,000 — 1929 — 30,000 *991 4. The balance sheets of the Beacon Paper Company on December 31, 1928, and December 31, 1929, are as follows: 12-31-1928 12-31-29 ASSETS Merchandise as per Inventory 129,033.03 140,127.87 Furniture & Fixtures Tools & Machinery 427.70 427.70 Accounts Receivable 127,833.96 115,522.13 Notes Receivable 15,212.68 11,803.90 U.S. Liberty Bonds 69,031.50 69,031.50 U.S. Certificates of Indebt 125,156.25 50,062.50 U.S. War Savings Stamps Bank Certificates of Deposit 50,000.00 Real Estate Mortgage Bonds 95,000.00 Cash 7,842.40 2,375.90 619,537.52 389,351.50 LIABILITIES Accounts Payable 61,616.46 46,235.05 Capital 500,000.00 300,000.00 Surplus 57,921.06 43,116.45 619,537.52 389,351.50 OPINION. MCMAHON: The Beacon Paper Co. in 1929 redeemed and canceled $200,000 par value of its capital stock, paying cash therefor. The petitioner surrendered to the company 1,213 1/3 shares of stock, receiving from the company in payment therefor $121,333.33. This was stock which the petitioner had purchased from Louis Alt in *227 1927 at a cost of $101.59 per share or $123,252.53. The respondent held that the payment of the amount*992 of $121,333.33 to the petitioner in 1929 was the equivalent of a taxable dividend under section 115(g) of the Revenue Act of 1928. The petitioner contends that the amount received by him in redemption of such stock was not the equivalent of a taxable dividend, but was a payment in partial liquidation of the company, and that the distribution is controlled by section 115(c) of the Revenue Act of 1928. There are set forth in the margin applicable provisions of the Revenue Act of 1928. 1 *993 We agree with the contention of the petitioner. On September 22, 1920, the company increased its authorized capital stock from $100,000 to $500,000 by capitalizing $400,000 of the earned surplus and issuing additional common stock of $400,000. The balance sheets of the company at the end of the years 1919 and 1920 indicate that during the year 1920 the company did not have cash or its equivalent sufficient to pay a cash dividend even approximating $400,000. The declaration of the stock dividend was pursuant to a plan to capitalize some of the surplus to make it available to take care of increased business and for the purpose of going into the wrapping paper business. The company was already in the business of dealing in fine paper, such as is used by printers. The stipulated facts show that in order to care for its increased business and in order to enter the wrapping paper business, additional capital would be required for the purpose of carrying larger inventories and for the purpose of purchasing an additional warehouse. Due to the depression of *228 1921, in which year the company sustained a loss of $154,975.60, thereby impairing its capital to the extent of $68,668.83, *994 the matter of going into the wrapping paper business and the purchase of a new warehouse was deferred. In 1922 the company made a profit, but its capital still remained impaired. However, in 1923 the company made a substantial profit and resumed the payment of dividends and again considered the matter of expanding its business and purchasing a warehouse, but no definite action was taken. The business did not improve after 1921 to the extent anticipated and the amount invested in merchandising during each year subsequent to 1921 was approximately $200,000 less than the amount invested in merchandise as of December 31, 1920. Thereafter the matter of expansion was frequently considered, but in 1929 the company definitely determined not to go into the wrapping paper business or to purchase a warehouse. In 1929 it was determined that the company did not need all of its capital for successful operations and that it could be successfully operated and conducted with a capital of $300,000. Thereupon, in that year, the capitalization was reduced from $500,000 to $300,000 by the redemption of stock as heretofore pointed out. In our opinion, the evidence of the reasons for the declaration*995 of the stock dividend in 1920 and the subsequent redemption and cancellation of a part thereof nine years later, in 1929, is sufficient to show that there was no continuing plan to distribute corporate earnings by means of a distribution made in connection with cancellation or redemption of stock rather than by the declaration of ordinary dividends. It should be noted that from 1923 to 1929 the company did declare substantial cash dividends. If there had been such a continuing plan it is reasonable to suppose that the petitioner, being one of the principal stockholders, would have known thereof. The fact that in 1927 he purchased 1,516 2/3 shares of stock in excess of its par value tends to show that there was no such plan; otherwise his purchase of the stock would have been an unreasonable act. From a consideration of all the stipulated facts it is clear to us that the cancellation or redemption of the stock was not "at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend" within the meaning of section 115(g) of the Revenue Act of 1928. *996 This proceeding is governed in principle by the authorities cited by the petitioner. ; affd., ; certiorari denied, ; ; and ; affd., ; certiorari *229 denied, . To the same effect is . See . We hold that the amount of $121,333.33 paid to the petitioner upon the surrender of his stock constituted an amount distributed in partial liquidation of the company, within the meaning of section 115(c) and (h) of the Revenue Act of 1928. It has been stipulated by the parties that the 1,213 1/3 shares of stock surrendered by the petitioner in 1929 was a part of that which petitioner had purchased in 1927 for $101.59 per share. The cost of such stock to the petitioner was $123,252.63. The total cost of the stock to the petitioner is the basis for the determination of gain or*997 loss. Sec. 113(a), Revenue Act of 1928. 2 Thus the petitioner sustained a deductible loss upon the surrender of the stock in the amount of the excess of the basis over the amount realized, or $1,929.20. Sec. 111(a), Revenue Act of 1928. 3 The petitioner, who is a single man, contends that the respondent erred in denying him a personal exemption of $3,500 as the head of a family under the provisions of section 25(c) of the Revenue Act of 1928. 4 *998 Article 292 of Regulations 74, promulgated under the Revenue Act of 1928, is set forth in the margin. 5 This portion of the regulations is not in conflict with the statute, but is a fair interpretation thereof. It, therefore, has the force and effect of law. . This provision of the regulations is the same as corresponding provisions of prior and subsequent regulations, 6 and the fact that Congress has continued to reenact, in the successive revenue acts, the provisions regarding the personal exemption of the head of a family, without *230 change, 7 is persuasive evidence of legislative approval of the regulation. ; . *999 In the instant proceeding the evidence shows that during the year in question the petitioner actually supported and maintained in his household his unmarried sister, age 55 years. In our opinion, the petitioner's right to exercise family control and provide for his dependent sister was based upon a moral obligation. He was her sole support. She had no trade or occupation and had no income. It is our conclusion that the petitioner is entitled to a personal exemption of $3,500 as the head of a family. . , affirmed in , is distinguishable. There we held the taxpayer was not entitled to an exemption as the head of a family where his sister, 43 years of age, lived with him and supervised the running of the household. The taxpayer there paid the expenses of the home and also his sister's expenses. Upon the evidence there we held, in effect, that the taxpayer's sister had the status of an employee, rather than a dependent. See *1000 This is not true in the instant proceeding. It is true that it is stipulated that the petitioner's sister "acted as petitioner's housekeeper." However, the meaning of the word "housekeeper" is not limited to one who is employed (see Webster's New International Dictionary, 1929); and the other stipulated facts show that she was not employed by the petitioner. Among other things it is stipulated that during the year in question he was her sole support and maintained her, and that she had no trade or occupation and had no income. Furthermore, the petitioner did employ a servant during the year in question. Under the circumstances we consider it only natural that a feeling of gratitude or an interest in the household would prompt the sister to act as housekeeper. The only inference to be drawn in view of all of the stipulation, covering this point, is that what she did in this respect was done gratuitously. There are numerous facts appearing in the instant proceeding which were not present in *1001 , some of which appear from the stipulation herein in part as follows: * * * Throughout said year, petitioner was, and he still is, the sole support of his unmarried sister whom he maintained during said year and still maintains in the household at said address at petitioner's expense. Petitioner's said sister is 55 years old, and during 1929 had no trade or occupation, had no income and acted as petitioner's housekeeper. It is, and was during 1929 necessary for petitioner to employ a servant. * * * In *231 our opinion the stipulated facts are sufficient to overcome the presumption in favor of the respondent's determination that the petitioner was not, in 1929, the head of a family. See . Reviewed by the Board. Decision will be entered under Rule 50. SEAWELL concurs in the result. Footnotes 1. SEC. 115. DISTRIBUTION BY CORPORATIONS. * * * (c) Distributions in liquidation. - Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. In the case of amounts distributed in partial liquidation (other than a distribution within the provisions of section 112(h) of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits within the meaning of subsection (b) of this section for the purpose of determining the taxability of subsequent distributions by the corporation. * * * (g) Redemption of stock. - If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. In the case of the cancellation or redemption of stock not issued as a stock dividend this subsection shall apply only if the cancellation or redemption is made after January 1, 1926. (h) Definition of partial liquidation.↩ - As used in this section the term "amounts distributed in partial liquidation" means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock. 2. SEC. 113. BASIS FOR DETERMINING GAIN OR LOSS. (a) Property acquired after February 28, 1913.↩ - The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that - [exceptions not material here]. 3. SEC. 111. DETERMINATION OF AMOUNT OF GAIN OR LOSS. (a) Computation of gain or loss.↩ - Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in section 113, and the loss shall be the excess of such basis over the amount realized. 4. SEC. 25. CREDITS OF INDIVIDUAL AGAINST NET INCOME. There shall be allowed for the purpose of the normal tax, but not for the surtax, the following credits against the net income; * * * (c) Personal exemption.↩ - In the case of a single person, a personal exemption of $1,500; or in the case of the head of a family or a married person living with husband or wife, a personal exemption of $3,500. * * * 5. ART. 292 [Regulations 74]. Personal exemption of head of family.↩ - A head of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. * * * 6. Article 302 of Regulations 69 (1926), 65 (1924), Regulations 62 (1921), and 45 (1918); and article 292 of Regulations 77 (1932). ↩ 7. Section 216(c) of the Revenue Acts of 1918, 1921, 1924 and 1926; section 25(c) of the Revenue Acts of 1928 and 1932; and section 25(b)(1) of the Revenue Act of 1934. ↩