Baker v. Commissioner (A)

R. E. BAKER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ARTHUR G. MCKEE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. T. W. RUTLEDGE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Baker v. Commissioner (A) Docket Nos. 58152, 61120, 61121. United States Board of Tax Appeals 37 B.T.A. 1135; 1938 BTA LEXIS 929; June 30, 1938, Promulgated *929 1. Corporation A was organized to acquire, as of January 1, 1915, certain assets and business of a partnership, in exchange for 270 shares of its stock. In 1920 corporation B was organized and acquired the assets and business of corporation A, ten shares of its preferred and five shares of its common being exchanged for each share of the common stock of A. This exchange was taxable but the stockholders, believing and being advised that it was nontaxable, reported no gain. Thereafter the petitioning stockholders, the former partners, bought and sold common stock of corporation B. In April 1928 corporation B was reorganized, new class A and class B stock being issued in exchange for the old common stock, the old preferred stock having theretofore been redeemed. This was a nontaxable reorganization. Thereafter and in 1928 petitioners sold some of their class A and class B stock, reporting some gain. The Commissioner determined that additional gain should have been reported and that petitioners had used wrong bases for the common stock of corporation B. Held, the basis for the common stock must be determined under section 113(a)(6) of the Revenue Act of 1928 and section 202(b) *930 of the Revenue Act of 1918. In determining such bases the value of the assets turned over by the partnership in 1915 to corporation A and the fair market value of the stock of corporation B in 1920 must be, and have been, determined under the evidence. 2. No evidence was adduced identifying or enabling the Board to identify the shares of corporation B stock sold between 1920 and 1928. Under the circumstances, it is held that the "first in, first out" rule must be applied. 3. The evidence failing to show any false representations or willful failure to report the true facts, it is held that the petitioners are not estopped to claim the true bases for the stock sold, even though they failed to report the gain realized in 1920 in the taxable exchange of the stock of corporation A for the stock of corporation B. 4. Notwithstanding certain restrictions upon the sale of class B stock, it is held that the cost basis of the old common stock of corporation B may be allocated between the class A and class B shares. Helvering v. Tex-Penn Oil Co.,300 U.S. 481, distinguished. Arthur C. Denison, Esq., and Oscar I. Koke, C.P.A., for*931 the petitioners. S. B. Pierson, Esq., for the respondent. MELLOTT *1136 These consolidated proceedings involve deficiencies in income tax for the year 1928 as follows: Name Docket No. Amount T. W. Rutledge 58152 $436.97 R. E. Baker 61120 14,086.77 Arthur G. McKee 61121 11,984.22 In Docket No. 58152 it is alleged that the respondent erred in determining that the petitioner realized a gain from the sale in 1928 of a portion of two classes of stock of Arthur G. McKee & Co., received in exchange for 59 shares of the common stock of the same company. The gist of petitioner's contention is that no apportionment of the cost of the common stock to petitioner could properly be made between the two classes of stock received in exchange. The several errors alleged in Docket Nos. 61120 and 61121 are the same, all pertaining to the determination by the respondent of the cost basis to be used in determining the gain realized in 1928 upon the sale of stock of Arthur G. McKee & Co. In these proceedings the respondent affirmatively pleads that the petitioners are now estopped from claiming a higher basis, to be used in computing profit*932 or loss from the sale of such stock, than that allowed by him in determining the deficiencies. FINDING OF FACT. Arthur G. McKee in 1905 established himself in business in Cleveland, Ohio, as a consulting engineer. In about April 1909 Robert E. Baker, having previously established a small consulting business of his own in Cleveland, joined McKee as a silent partner. In May of the same year Donald D. Herr joined them as a silent partner. The business conducted by the partnership was principally consulting, designing, and engineering in connection with blast furnaces for making pig iron, steel plants, rolling mills, coke ovens, and similar parts of the iron and steel industry, and, in addition making valuations of properties and utilities. On January 1, 1915, the partnership was incorporated under the laws of Pennsylvania as "Arthur G. McKee & Company", hereinafter *1137 referred to as the Pennsylvania Co., with an authorized capital of 500 shares of the par value of $100 a share, only 270 of which were then issued, McKee receiving 150 shares, Baker 60 shares, and Herr 60 shares. McKee was president, Herr, vice president, and Baker, secretary and treasurer of the company. *933 The assets and liabilities of the corporation, as shown by its books of account as of January 1, 1915, were as follows: Assets Furniture and fixtures $2,669.87 Library books 1,013.08 Patterns 1,138.35 Tools and equipment 1,224.60 Prints in vault 210.31 Tracings 2,943.79 51 shares of Blast Furnace Appliance Co. stock 510.00 Materials on hand 107.70 Accounts receivable: Customers invoiced 14,068.17 Customers not invoiced 3,392.99 Jones, J. T 16.16 Cash on deposit 13,307.50 Total 40,602.52 Liabilities Bills payable $2,040.48 Accounts payable 4,181.57 Deferred - profits on uncompleted contracts 7,380.47 Capital stock: Common $50,000 Unsubscribed 23,000 Issued 27,000.00 Total 40,602.52 Of the above Baker and Herr each contributed $6,000 in cash, McKee contributing the remaining assets in the amount of $28,602.52, subject to liabilities of $13,602.52, which the corporation assumed, or net assets of $15,000. The Blast Furnace Appliances Co., hereinafter referred to as the Appliance Co., was organized in February 1912, with an authorized capital stock of 100 shares of the par value of*934 $100 per share, for the purpose of holding and licensing patents used in connection with blast furnaces and the smelting of iron. Baker was instrumental in organizing this company and was its president. At the first meeting of its stockholders McKee and his associates offered to sell to the company two letters patent of the United States for the sum of $5,850 to be paid for by the company by the issuance of 58 1/2 shares of its stock. Two other letters patent of the United States and certain other design patents were offered to the company by others for the amount of $3,150, to be paid for in stock of the company. In addition $10 per share was paid in, so that the entire authorized capital of the company was issued for such letters patent and $1,000 in cash. In addition to the transfer of his interest in such letters patent, McKee paid $510 in cash to the company and received 51 shares of its stock, which were included in the assets he turned over to the Pennsylvania Co. on January 1, 1915. For the calendar year 1915 the Pennsylvania Co., which conducted all of the business of the Appliance Co., was paid sales commissions by the latter in the amount of $3,000, and for the year*935 1916, $9,500. In *1138 1914, 1915, and 1916 the Appliance Co. paid dividends and had undistributed profits remaining at the end of each year as follows: Year Dividends paid Undistributed profits [1914] $13,000 $3,366.38 [1915] 15,000 1,056.61 [1916] 22,500 160.68 The Appliance Co. derived its income solely from the exploitation of its patents. Certain of these patents covered some very effective devices in connection with blast furnace distribution. At the present time there are few blast furnaces not equipped under such patents. Under date of June 12, 1915, McKee, Baker, and Herr entered into a written agreement for the protection of their interests in the Pennsylvania Co., it being agreed in part that, if any one of them ceased to be an officer or employee of the corporation, the parties remaining with it should purchase the stock of the party severing his connections at a "purchase price equal to the book value of said stock as shown on the books" of the corporation on the date of sale, and that, in the event of the death of any one of them, the parties remaining should purchase one-half of the stock held by the decedent from his estate. *936 The agreement also gave an option to both Baker and Herr to purchase 50 additional shares of the stock, 10 shares to be purchased between the first and fifteenth days of January 1917, and 10 shares between the first and fifteenth days of January each 2 years thereafter until each had purchased 50 shares at a purchase price "equal to the book value of outstanding stock" of the corporation on the date of the exercise of the option, which book value was to be determined as follows: That the term "book value" * * * shall be understood as the values at which all property, securities, accounts or moneys are carried upon the books of the said corporation, plus all earned but undistributed profits on uncompleted work or contracts, on the date or dates on which such determination of book values shall be made. It is understood and agreed that the book values of furniture and fixtures, books, drawings, patterns and equipment shall have been entered on the books of the corporation at the allowance for same made to the seller at the time of purchase; and that additions as made to such items shall have been added to the various book values of such items from time to time; and that all of such*937 items as are subject to depreciation shall have been reduced by an amount equal and equivalent to such depreciation, such deduction having been made annually. It will also be understood and agreed that the stock of The Blast Furnace Appliances Company, held by the said corporation, shall have been carried on the books of the said corporation at an arbitrary valuation of Ten Dollars ($10.00) per share, but that in the determination of book values hereunder, the value of said stock shall be determined from the cash assets of The Blast Furnace Appliances Company on the date when such book value determination is made. * * * *1139 Between January 2, 1919, and January 2, 1920, Baker purchased 50 shares of the stock of the Pennsylvania Co. at $55,865, which increased his stock holdings in the corporation to 110 shares. 1 As of December 31, 1919, the assets and*938 liabilities of the Pennsylvania Co., as shown by its books of account, were as follows: Assets Cash $39,842.48 Government securities, plus accrued interest 62,019.36 Accounts receivable, less allowance for doubtful, at $1,400 177,369.54 Inventory, less allowance for possible shrinkage, $1,500 253,923.71 Other assets 82,199.60 Permanent assets (depreciated book value): Building 36,909.31 Tools and equipment 18,613.82 Blue print equipment 1,485.73 Furniture and fixtures 9,853.21 Patterns 2,521.89 Library 927.06 Tracings and vault prints 3,213.56 Deferred items 5,481.01 Total 694,360.28 Liabilities Accounts payable (including accrued real and personal taxes, but no Federal income taxes) $218,529.41 Deferred income 151,223.07 Capital stock: Authorized $50,000.00 Unissued 15,133.34 34,866.66 Surplus 289,741.14 Total 694,360.28 In the early part of 1920 it was decided to reorganize the Pennsylvania Co. Pursuant to a plan of reorganization, a corporation was organized under the laws of Delaware under the same name, "Arthur G. McKee & Company", which will hereinafter be referred*939 to as the Delaware Co. It had an authorized capital stock of $5,000 shares of nonvoting 7 percent cumulative preferred stock of the par value of $100 per share, redeemable at not in excess of $105 a share, and 4,000 shares of common stock of no par value. On April 1, 1920, 3,886 2/3 shares of the preferred stock and 1,943 1/3 shares of the common stock of the Delaware Co. were issued in exchange for the outstanding 388 2/3 shares of stock of the Pennsylvania Co., each share of stock of the latter company being exchanged for 10 shares of the preferred and 5 shares of the common stock of the former. The net worth of the Pennsylvania Co. as of March 31, 1920, as shown by its books of account, was as follows: 388 2/3 shares of stock outstanding $38,866.66 Surplus 349,800.00 Total $388,666.66 The above surplus contained undistributed earnings of the company upon which McKee, Baker, and Herr had paid Federal income taxes under the personal service status of the company, as follows: McKee, $78,261.79: Baker, $45,272.75. *1140 The above surplus of $349,800, together with the $38,866.66, was set up in the books of account of the Delaware Co. as representing*940 capital, on the basis of which 3,886 2/3 shares of preferred stock were issued. The preferred stock had no restrictions as to sale and could be sold to any one. However, the common stock was restricted similarly as was the stock of the Pennsylvania Co. in its ownership and sale to officers and employees exclusively, all transfers being subject to the approval of the secretary. After the organization of the Delaware Co., the Pennsylvania Co. was dissolved. In connection with the reorganization referred to above, McKee and Baker received stock as follows: McKee Baker Shares Par value Shares Par value Pennsylvania Co. stock [150] $15,000 [110] $11,000 Exchanged for: Delaware Co.: Preferred 1,500 150,000 1,100 110,000 Common [750] No par [550] No par Neither McKee nor Baker reported in his 1920 Federal income tax returns any gain realized from the above exchange of stock in the belief, and upon legal advice, that the issuance of the new common stock was an exchange of stock for stock and that the issuance of the preferred stock was a stock dividend, and, as such, nontaxable. McKee and Baker purchased and sold common stock of the*941 Delaware Co. as follows: McKee Purchases Sales Cost Selling price Year Shares Per share Total Shares Per share Total [81] $259.49 $21,018.69 35 2/3 $172.55 $6,154.27 [40] 266.23 10,649.20 [40] 266.23 10,649.20 [287] 123.33 35,395.71 [75] 123.33 9,249.75 [1925] 292 1/2 256.88 75,136.59 Total [408] 67,063.60 443 1/6 101,189.81 Baker [1920] 50 1/6 $379.08 $19,016.86 56 1/6 $172.55 $6,031.16 [30] 399.50 11,985.21 [287] 123.33 35,395.71 [74] 123.33 9,126.42 [129] 161.90 20,884.64 [1927] 89 3/6 293.12 26,234.20 Total 367 1/6 66,397.78 348 2/3 62,276.42 After the above purchases and sales McKee owned 714 5/6 shares and Baker owned 568 1/2 shares of the common stock of the Delaware*1141 Co. Neither McKee nor Baker reported in his Federal income tax returns any gain from the above sales, in the belief that they were entitled to recover first the cost basis. The statute of limitations has now run against the collection of any additional taxes for the years in which such sales were made. The 3,886 2/3 shares*942 of preferred stock issued by the Delaware Co. on April 1, 1920, were all repurchased by the company at the redemption price by the middle of 1921, the company thereafter having only common stock outstanding. The preferred stock was held as treasury stock and was not actually retired until the reorganization in 1928, which will be hereinafter referred to. The assets and liabilities of the Delaware Co. as of March 31, 1928, as shown by its books of account were as follows: Assets Current: Cash $247,081.86 Customers accounts receivable 142,059.35 Pulaski Engineering Works, Inc. - entire outstanding stock 130,500.00 Open account 21,910.72 Notes receivable 30,500.00 Stocks and bonds of other corporations 16,950.00 Personal and miscellaneous notes and accounts, receivable 7,810.97 Insurance deposits 558.50 Claims against common carriers 39.38 Permanent assets: (Depreciated book value.) Tools and equipment 22,398.77 Locomotive crane 13,632.29 Furniture and fixtures 5,276.65 Tracings and vault prints 3,213.56 Blue print equipment 1,311.01 Patterns 1,029.51 Library books 732.15 Deferred: Supplies inventory 6,263.00 Unexpired insurance premiums 612.71 Total 651,880.43 Liabilities Current: Accounts payable, including 1927 Federal income tax $40,411.19 Accrued, including Federal taxes 1928 to date, estimated 46,395.76 Deferred income: Invoices rendered to Mar. 31, 1928, less costs and unapplied expenses on uncompleted oil refining contracts 224,050.42 Capital stock: Preferred authorized $500,000 Unissued 111,333.33 In treasury 388,666.67 Common no par - Authorized shares 4,000 Unissued shares 2,056 2/3 Outstanding shares 1,943 1/3 Capital and surplus 3/31/28 341,023.06 Total 651,880.43 *943 Pursuant to a plan of reorganization, in the early part of 1928 the charter of the Delaware Co. was amended to provide for a reclassification of its authorized capital stock to permit the issuance of 32,500 class A stock of no par value and 55,000 shares of class B stock of no par value. In April 1928 such stock was issued by the company in exchange for the then outstanding 1,943 1/3 shares of common no par value stock. McKee and Baker received in exchange for their old stock new stock as follows: Shares of new stock received Shares of old stock exchanged Class A Class B McKee 714 5/6 11,955 20,231 Baker 568 1/2 9,508 16,090 *1142 Both classes of stock were entitled to "full voting power." Class A stock was entitled to cumulative dividends of $3 a share per year and was redeemable at $50 a share and accrued dividends. The articles of incorporation, as amended in connection with the reorganization, restricted the sale of the class B stock to officers and employees. The restrictions are shown in full in section 6 of article 4 2 of the certificate of incorporation. *944 The holders of class B stock, all of whom were officers and employees of the Delaware Co. in order to assure ownership thereof remaining in the officers and employees of the company, entered into a written agreement during the month of April 1928, in which they *1143 agreed to deposit with trustees all of the shares of class B stock, endorsed in blank, together with $1 per share, to be held as a so-called "Stockholders' Fund", and to assign and transfer to the trustees "all their respective preemptive rights as holders of class B stock to purcchase shares of class B stock from other holders or from the estates of deceased holders of said class B shares" as conferred by the terms of the amended charter. By the agreement they also empowered the trustees to purchase pro rata from the depositing stockholders, at the then existing purchase price as defined in the agreement, shares of stock to be resold to officers or employees of the company who should make written application to the trustees to buy the same, the trustees being empowered in their absolute discretion to transfer any shares so purchased to the officers and employees so making written application. The agreement*945 further provided as follows: 1. The funds deposited with the Trustees may be invested and re-invested from time to time in such securities as the Trustees shall elect and the proceeds thereof, at the discretion of the Trustees, shall be devoted by the Trustees to the purchase of Class B shares, either by exercise of the pre-emptive purchase provisions set forth in the Charter assigned to the Trustees hereunder or by voluntary sale by Class B Stockholders, at a purchase price not in excess of that defined in Section 6 of Article Fourth of the Charter. 2. All such Class B stock so purchased by the Trustees shall be held by the Trustees and all dividends thereon shall be payable to the Trustees for the purposes of the trust. All or any part of said shares so purchased by the Trustees may, at the discretion of the Trustees, be sold to such officers or employees of Arthur G. McKee & Company making application therefor as the Trustees, in their absolute discretion, shall determine subject to the limitations hereinafter set forth. Such shares shall be sold by the Trustees at the then existing purchase price of said shares as defined in Section 6 of Article Fourth of the Charter aforesaid. *946 3. Any officer or employee of Arthur G. McKee & Company, whether or not at such time a Stockholder, may make application in writing to the Trustees to purchase a specified number of Class B shares and, in the event that shares shall not be available, the Trustees are hereby empowered in their discretion to purchase for resale to such applications all or any part of the shares applied for from the remaining Stockholders pro rata at the then existing purchase price as hereinbefore defined. In April 1920 McKee was just past 50 years of age, Herr was 43, and Baker was 40. All contemplated remaining actively in the business, their health permitting, as the business represented their life work. From the time of the organization of the Pennsylvania Co. on January 1, 1915, to the death of Herr in the latter part of 1923, McKee, Baker, and Herr were the only stockholders. Thereafter McKee and Baker were the controlling stockholders, and in 1928 owned 1,283 1/3 shares of the 1,943 1/3 shares outstanding, the remainder of the stock being owned by employees. By 1915 the partnership had attained considerable reputation in its field and had furnished services to about two-thirds of*947 all concerns *1144 in the United States and Canada which were engaged in the manufacture of iron and steel. After 1915 the business continued along the same line. However, the volume of business transacted increased greatly. The force of designers, draftsmen, and experts was gradually increased and at times there were as many as 400 persons employed. The officers and directors of the corporation endeavored to develop new processes, of which some were patentable and some were simply formulae. Considerable money had been expended by April 1, 1920, in the preparation of inventions, patents, formulae, drawings, and designs. In addition, substantial amounts were expended by the stockholders and employees in the development of patents and formulae. In 1920 there were some eighty-odd patents. None of them were owned by the Pennsylvania Co. or the Delaware Co., but these companies had exclusive licenses to use them. In 1920 it was decided to recapitalize because circumstances prevailing indicated a possible increase of business through the use of additional capital. By 1928 services had been rendered to substantially all or a large majority of all concerns engaged in making*948 iron and steel throughout the United States, Canada, and other foreign countries. Neither the cost of the patents, licenses, designs, drawings, formulae nor good will was ever set up or capitalized on the books of either company except a small item representing the actual cost of blueprints and drawings. The income of the partnership and subsequent corporations, without any deduction for Federal income taxes, from 1911 to 1927 was as follows: Year Income before "Salaries" to Income after deduction for McKee, Baker, deduction for "Salaries" and Herr "Salaries" Partnership [1911] $16,646.51 $7,800.00 $8,846.51 Do [1912] 25,968.83 7,800.00 18,168.83 Do [1913] 35,121.56 11,850.00 23,271.56 Do [1914] 39,161.21 15,000.00 24,161.21 Pennsylvania Co [1915] 37,401.44 12,600.00 24,801.44 Do [1916] 62,886.58 12,600.00 50,286.58 Do [1917] 120,596.00 85,900.00 34,696.00 Do [1918] 179,894.00 85,818.00 94,076.00 Do [1919] 383,350.00 112,260.00 271,090.00 Pennsylvania Co. (Jan. 1-Mar. 31) [1920] 79,557.88 23,130.00 56,427.88 Delaware Co. (Apr. 1-Dec. 31) [1920] 229,199.76 111,299.82 117,899.94 Do [1921] 84,650.86 65,249.31 19,401.55 Do [1922] 194,250.97 54,000.00 140,250.97 Do [1923] 114,108.23 97,666.67 16,441.56 Do [1924] 128,433.51 70,311.12 58,122.39 Do [1925] 171,423.83 46,449.92 124,973.91 Do [1926] 237,772.48 46,399.92 191,372.56 Do [1927] 336,253.75 42,499.92 293,753.83 *949 During 1915 and 1916 the Pennsylvania Co. paid Federal income taxes at corporation rates. For 1917 the corporation paid taxes under section 209 of the Revenue Act of 1917 on the basis of "nominal" invested capital. The company made application to the Commissioner *1145 for taxation under personal service classification for the years 1918 and 1919 and the period from January 1 to April 1, 1920. This application was granted and during that period the corporation was taxed as a personal service corporation. From April 1 to December 31, 1920, Federal income taxes were paid under part personal service classification, and from 1921 to 1927, both inclusive, Federal income taxes were paid upon the regular corporation basis. The fair market value of the assets turned over by the partnership to the Pennsylvania Co. in connection with the organization of that company on January 1, 1915, including patent licenses, formulae, designs, drawings, Appliance Co. stock, good will, and the other assets set up on the books of the company, was $115,000. The fair market value of the 3,886 2/3 shares of preferred stock of the Delaware Corporation issued and outstanding, on April 1, 1920, was*950 $388,666.66 and the fair market value of its 1,943 1/3 shares of common stock issued and outstanding on that date was $443,978.54. In 1928 the petitioners disposed of the new shares of stock as follows: Sale price Shares sold Per share Total McKee 7,356 class A $34.00 $250,104.00 Do 4,981 class B 12.66 63,059.46 313,163.46 Baker 5,850 class A 34.00 198,900.00 In their returns for 1928 McKee reported a gain on the sale of his stock in the amount of $217,289.46 and Baker reported a gain on the sale of his stock in the amount of $86,234.62. The gains represented the difference between the sale price of the stock and their respective aliquot portions of what they claimed to be its "original cost", plus the total amount paid for common stock of the Delaware Co. purchased from 1920 to 1927, inclusive, and less the total amount received from the sale of stock sold during that period. The Commissioner determined that the entire amounts received constituted income. Accordingly he added to the net incomes shown by the returns the differences between the amounts received and those reported. The shares of the class A stock which were*951 disposed of by the petitioners and others in 1928 were sold to Hayden, Miller & Co., investment bankers of Cleveland, in the aggregate amount of 15,900 shares, which the bankers were to offer and sell to the public at $40 a share. In about 1930 all of the class A stock was retired with the privilege of conversion into class B stock. Thereafter the class B *1146 stock was listed on the Cleveland Stock Exchange. The class B stock was not available for sale to the general public in 1928. T. W. Rutledge purchased shares of stock of the Delaware Co. as follows: Cost Year Shares purchased Per share Total [42] $123.33 $5,179.86 [10] 216.17 2,161.70 [7] 209.03 2,163.20 Total [59] 9,504.76 Upon the recapitalization of the Delaware Co. in April 1928, Rutledge received, in exchange for his 59 shares of stock, 987 shares of class A stock and 1,670 shares of class B stock. In the same year he sold 607 shares of class A stock at $34 per share, or $20,638, and 470 shares of class B stock at $12.66 per share, or $5,950.20. In his income tax return for 1928 he reported a gain from the sale of such stock in the amount of $17,083.44, *952 the difference between the aggregate sale price of $26,588.20 received for both the class A and B stock sold and the entire cost of the 59 shares. The respondent determined a gain of $21,968.04 by allocating the cost of the 59 shares to each class of new stock in the proportion which the value (sale price) of each class issued bears to the value (aggregate sale price) of the total shares issued of both classes of stock. 3 OPINION. MELLOTT: The issues raised in the proceedings of McKee (No. 61121) and Baker (No. 61120) will be discussed first. The principal *1147 one may be stated generally in the form of a question as follows: "May the petitioners, *953 in computing their gains from the sales in 1928 of their stock in the reorganized Delaware Co., use other than a 'zero basis' for the stock sold?" In other words, what basis should be used for the purpose of computing petitioner's gain or loss upon the sales of such stock and are they now estopped to claim a larger basis than zero? The determination of the Commissioner that zero is the proper basis for the stock is predicated primarily upon section 113(a)(6) of the Revenue Act of 1928. 4 Under that section, which provides by its terms that the basis shall be the same as the property exchanged, "increased in the amount of gain * * * that was recognized upon such exchange under the law applicable to the year in which the exchange was made * * *", it is necessary to examine the law as it existed at that time (April 1, 1920). This is reflected in section 202(b) of the Revenue Act of 1918. 5 *954 The stock which was sold by these petitioners in 1928 was stock which had been received by them in a nontaxable exchange in April 1928. Accordingly, it had the same basis for the computation of gain or loss that the stock exchanged had in their hands on April 1, 1920, except in so far as such basis had been affected by the sales *1148 and purchases made subsequent to April 1, 1920, and prior to the date of the reorganization in 1928. Whatever effect such sales or purchases had upon the basis, and respondent's contention that the petitioners are estopped to use a basis other than zero, will be discussed later; but first the basis of the stock as of April 1, 1920, will later; but first the basis of the stock as of April 1, 1920, will be determined. Columns 1 and 3 of the following schedule reflect the method, as we interpret the respondent's notice of deficiency and his argument upon brief, by which the basis of the common stock of the Delaware Co. stock was determined to be zero. Columns 2 and 4 reflect the present contentions of the petitioners. McKee Column 1 Column 2 Cost of stock Penn. Co. 1-1-15, 270 sh. 1 (150 sh.) $15,000.00 $130,000 Capital contributions (earnings taxed to stockholders) 78,261.79 135,000 Purchase price 50 sh Total cost of Penn. Co. stock 4-1-20 93,261.79 265,000 Par value Del. Co. stock received 4-1-20 $150,000.00 $150,000 Par value of Penn. Co. stock exchanged for Del. Co. stock 15,000.00 15,000 11,000.00 Excess in par value 135,000.00 135,000 (The above excess must be "treated as a gain to the extent that the fair market value of the new stock * * * is greater than * * * the cost of the stock exchanged.") Fair market value of new stock 2 150,000.00 385,940 Cost of stock exchanged 93,261.79 265,000 To be treated as gain inasmuch as this amount is not greater than the excess in par value $56,738.21 $120,940 Statutory basis of Del. Co. stock (cost plus recognizable gain) 150,000.00 385,940 Deduct par value of Del. Co. preferred stock received 150,000.00 150,000 Basis of Del. Co. common stock received Zero 235,940 *955 Baker Column 3 Column 4 Cost of stock Penn. Co. 1-1-15, 270 sh. 1 (60 sh.) $6,000.00 $52,000 Capital contributions (earnings taxed to stockholders) 45,272.75 99,000 Purchase price 50 sh 55,865.00 55,865 Total cost of Penn. Co. stock 4-1-20 107,137.75 206,865 Par value Del. Co. stock received 4-1-20 110,000.00 $110,000 Par value of Penn. Co. stock exchanged for Del. Co. stock 11,000 Excess in par value 99,000.00 99,000 (The above excess must be "treated as a gain to the extent that the fair market value of the new stock * * * is greater than * * * the cost of the stock exchanged.") Fair market value of new stock 2 110,000.00 283,020 Cost of stock exchanged 107,137.75 206,865 To be treated as gain inasmuch as this amount is not greater than the excess in par value $2,862.25 $76,155 Statutory basis of Del. Co. stock (cost plus recognizable gain) 110,000.00 283,020 Deduct par value of Del. Co. preferred stock received 110,000.00 110,000 Basis of Del. Co. common stock received Zero 173,020 *956 Petitioners, stating that they have consistently followed the "recovery of cost" theory in respect to proceeds realized from sales, now insist that they have overpaid their tax. McKee contends that he should have reported a gain of $111,349.07 instead of the $217,289.67 which he reported. Baker contends that he should have reported a gain of $25,419.04 instead of the $86,234.62 which he reported. The *1149 details of their present contentions are reflected in the following schedule: McKee Baker Basis of common stock acquired on April 1, 1920, exchange. (750 shares) $235,940.00 (550 shares) $173,020.00 Deduct proceeds realized from shares sold (443 1/6 shares) 101,189.81 (348 2/3 shares) 65,936.82 Residual basis 4-1-1928 (306 5/6 shares) 134,750.19 (201 1/3 shares) 107,083.18 Add cost of shares purchased 4-1-1920 to 4-1-1928 67,063.60 66,397.78 Basis for class A and B shares 201,813.79 173,480.96 Proceeds realized: Class A $250,104.00 $198,900.00 Class B 63,059.46 Total 313,163.46 198,900.00 Taxable gain (difference between basis and amounts realized) $111,349.67 $25,419.04 *957 The first difference between the parties is in connection with the cost of the Pennsylvania Co. stock. The respondent used the amounts shown by the books of the corporation as contributed by the partners, viz., $15,000, $6,000, and $6,000, or a total of $27,000. This did not include any value for what the petitioners refer to as "intangibles", i.e., good will, uncompleted contracts, patterns, patent licenses and rights, designs, drawings, formulae, etc., turned over by the partnership to the corporation but not shown on the books. Petitioners place a value upon all of the assets of $234,000 on January 1, 1915, determined as hereinafter shown. We have determined that the assets had a value of $115,000 rather than that ascribed to them by either of the parties. In making such determination we have considered all of the evidence and the contentions made by the respective parties. It will not be amiss, however, to point out some of the reasons why we have not accepted the value fixed by either. We do not agree with respondent's contention that no value can be attributed to the so-called intangible assets because none was set up on the books of the company. This is a mere evidentiary*958 fact and not controlling. Doyle v. Mitchell Brothers Co.,247 U.S. 179; Helvering v. Midland Mutual Life Insurance Co.,300 U.S. 216; D.N. & E. Walter & Co.,4 B.T.A. 142. Nor do we agree that it is improper to ascribe any value to the good will and similar factors merely because of the fact that the corporation afterwards claimed and was allowed the classification of a "personal service" corporation. If the partnership, through the character, skill, industry, integrity, and ability of the partners had built up good will, which was transferred to and utilized by the successor corporation, it was an asset of value and could have been set up on the books of the corporation. Though this was not done, it is nevertheless our duty to determine its value. No uniform rule can be stated for the determination of such value. It is a question of fact to be determined in the light of all the facts and circumstances. *1150 Cf. Watab Paper Co.,27 B.T.A. 488; *959 House & Herrmann,13 B.T.A. 621; affd., 36 Fed.(2d) 51; Mossman, Yarnelle & Co.,9 B.T.A. 45; Schulz Baking Co.,3 B.T.A. 470. Some of the facts and circumstances which have been considered are the following: The partners had carried on their highly specialized and technical trade or business for several years. They were experts in their line and had attained enviable reputations, both individually and as members of the Firm of Arthur G. McKee & Co. The firm name was well known, especially to the iron and steel companies in the United States and Canada, many of whom had employed it to supervise the construction and installation of new blast furnaces and ovens. Considerable sums of money had been expended by the partnership and its members in the development of patents, new processes, formulae, drawings, designs, blueprints, and methods of construction, all of which were available to the corporation. In addition the corporation had the exclusive right to the use of some eighty patents owned by the Appliance Co. many of which were basic. The record of the earnings of the partnership for the four years immediately preceding*960 the organization of the corporation shows a progressive increase in earnings each year after the deduction of substantial salaries paid to the partners. These factors, we think, show a substantial value for the good will of the partnership, though we do not deem it necessary to set out such value in dollars and cents. Cf. Henry F. McCreery,4 B.T.A. 967; Theo Planz, Inc.,10 B.T.A. 1158. Another factor which has been considered in fixing the cost or value of the total assets turned over by the partnership to the corporation is the Appliance Co. stock. Fifty-one shares of the 100 shares issued were carried on the books at $510. During 1914 this company paid dividends of $13,000 and had undistributed profits of $3,366.38. This, we think, indicates that the stock had a value greatly in excess of that set up on the books of the corporation. Whether such value should be classified as part of the good will or added to the value of the tangible assets need not be decided. It is, however, a factor to be, and which has been, considered in determining the value of all the assets to be $115,000, when turned over by the partnership to the corporation. *961 The value urged by the petitioners of $234,000 is not justified by the evidence. It was determined, as shown in the margin, 6 through the *1151 use of a formula. Apparently an effort was made to apply the formula suggested by the Commissioner in A.R.M. 34, 2 C.B. 31; but instead of using the average earnings over a period of years prior to the basic date, petitioners have used an average of the earnings for two years prior and two years subsequent to that date. In addition, the stipulated earnings for three of the years were less than those used by the petitioners. If, therefore, a formula should be used for the purpose of determining the value of the assets, the one set out in the margin as "Formula under A.R.M. 34" 6 would probably give a fairer and more nearly accurate approximation than the one used by petitioners. *962 The fair market value of the stock of the Delaware Co. received by petitioners in exchange for their stock in the Pennsylvania Co. must next be determined. It will be noted that the respondent treated the par value of 10 shares of the preferred stock of the Delaware Co. ($1,000) as the combined fair market value of 10 shares of the preferred and 5 shares of the common, received by petitioners for each share of the common stock of the Pennsylvania Co. He then attributed all of such value to the preferred stock of the Delaware Co., leaving a "zero basis" for the common, "for the reason [as stated in his notice of deficiency] that the preferred stock was issued in an amount equal to the book value or net worth of the old corporation and since no intangible value is recognized, no value is assigned to the common stock." Petitioners, as shown in their contentions, supra, assign an aggregate fair market value to the 1,943 1/3 shares of common and 3,886 2/3 shares of preferred of $1,000,000. Deducting the par value of the preferred, which they owned, from their aliquot portions of the $1,000,000, they determine their basis for the common stock to be *1152 as shown in the*963 tabulation, i.e., for McKee's 750 shares, $235,940, and for Baker's 550 shares, $173,020. The evidence shows that the income of the Pennsylvania Co. from 1915 to 1920, after deducting the salaries paid to McKee, Baker, and Herr, increased from $24,801.44 to $174,327.82; that the net worth, as shown by its books, increased from $27,000 to at least $388,666.66 during the same period; that the secretary determined a value of $172.55 for the common stock of the Delaware Co. as of April 1, 1920, for the purpose of establishing a selling price and that both he (Baker) and McKee made sales during that year at that price; that during the years 1920 and 1921 McKee and Baker purchased such stock at $259.49, $379.08, and $399.50 per share. Baker, testifying at the hearing before us, stated that in his opinion the stock of the Delaware Co. on April 1, 1920, was worth 8 times the earnings for the preceding 12 months. One investment banker expressed the opinion it was worth 6 2/3 times the average earnings during the period from January 1, 1918, to April 1, 1920, while another (both called by petitioners) stated that he would value it on the basis of from 5 to 7 times its net earnings available*964 for the payment of dividends. We have carefully considered all of the evidence and have concluded, as shown in our findings, that the fair market value of the 3,886 2/3 shares of the preferred stock of the Delaware Co. on April 1, 1920, was $388,666.66 and the fair market value of the 1,943 1/3 shares of common was $443,978.54, a total of $832,645.20. Respondent's affirmative plea of estoppel will be considered next. He contends that even if it be held that the common stock had a fair market value on April 1, 1920, petitioners should not be allowed to use it because they elected to treat the transaction in 1920 as nontaxable, elected to report no profit on subsequent sales, escaped taxation on the profit derived from the sales made prior to 1928, and, since the statute of limitations has now run against the collection of taxes for those years, that they are estopped to claim a stepped-up cost basis. In United States v. Scott & Sons, Inc., 69 Fed.(2d) 728, the court stated: * * * To constitute estoppel (1) there must be false representation or wrongful misleading silence. (2) The error must originate in a statement of fact and not in an opinion or a statement*965 of law. (3) The person claiming the benefits of estoppel must be ignorant of the true facts, and (4) be adversely affected by the acts or statements of the person against whom an estoppel is claimed. * * * The evidence shows that no gain was reported by the petitioners in 1920 because they believed, and were so advised, that the transaction constituted a distribution of a nontaxable stock dividend, since merely the surplus, consisting entirely of earnings upon which the *1153 stockholders had paid income taxes, had been capitalized. Baker testified - and notwithstanding the fact that he was an interested party we are of the opinion that he was an entirely credible witness - that no profits were reported on the sales between 1920 and 1928 because petitioners believed they were "merely recovering cost." Inasmuch as investigations were made by revenue agents and no questions were raised, he was of the opinion that they had acted properly. The report made by the revenue agent indicates that he was justified in this belief; for therein it is stated that the capital of $38,866.66 outstanding at the date of reorganization in 1920 was "increased to $388,666.66 by a stock dividend. *966 " We do not understand that the respondent is making any claim that the petitioners acted fraudulently or that they were guilty of willful misrepresentation or wrongful misleading silence. There is no showing that the respondent was ignorant of the true facts or that he was misled by any act of commission or omission on the part of these petitioners. As stated in Brooklyn City Railroad Co.,27 B.T.A. 77, 83; affd., 72 Fed.(2d) 274, "certainly misconstruction of the law, and action based upon a legal theory rather than upon a factual theory, would not constitute a false representation concerning a material fact." Nor can estoppel "originate in a mere statement of law or in silence due to an error of law." Commissioner v. Union Pacific R.R. Co., 86 Fed.(2d) 637, affirming 32 B.T.A. 383. Estoppel can not be "predicated on a mistake of law in the absence of some misrepresentation of fact," Estate of William Steele,34 B.T.A. 173, 175; nor does an innocent mistake made in a tax return afford a basis for its invocation. *967 Wobber Brothers,35 B.T.A. 890, 892. Estoppel must be proven by the one asserting it, and the proof "should be clear and not depend upon inference or argument." Tide Water Oil Co.,29 B.T.A. 1208, 1221; Helvering v. Brooklyn City Railroad Co., 72 Fed.(2d) 274, affirming 27 B.T.A. 77. Cf. Lansing McVickar,37 B.T.A. 758. The petitioners computed and reported the gain on the sales made in 1928 according to their theories. The respondent finally determined that the transaction in 1920 was taxable and that to compute the gain in 1920 in order to ascertain the basis under section 113(a)(6), 1928 Act, "it is necessary to determine the original cost to the shareholders of the corporation stock received in 1915 and the fair market value of the new stock received in 1920" and that for this purpose "the fact that such gain was not reported by or taxed to the respective individuals is immaterial." Whether his present plea of estoppel is inconsistent with these statements need not be determined. If the determination of the respondent of the factors required by law for the ascertainment of the basis to be used*968 for the computation of gain or loss in 1928 is erroneous, estoppel can not be availed of *1154 to justify or perpetuate such errors. Furthermore, the Board stated in Sugar Creek Coal Mining Co.,31 B.T.A. 344, 348, as follows: * * * As a general proposition, estoppel does not support a belated assessment merely because the taxpayer has omitted the income from his earlier returns and the statute of limitations has barred the correct assessment. We are of the opinion, and hold, that no estoppel has been shown and that petitioners are entitled to use the bases which we have determined in computing gain or loss upon the sale or disposition of their common stock. The basis of the 750 shares of common stock owned by McKee, computed in accordance with the statute and the views herein expressed, is $127,150.67, while the basis of the 550 shares owned by Baker is $115,693.29. We show the computation of such bases in the margin. 7 It is necessary, however, to pass upon one more question before actual computation of the gain or loss sustained by the petitioners upon the disposition of the stock can be made. *969 *1155 It has been found that after the organization of the Delaware Co. in 1920 and before the reorganization in 1928 McKee sold 443 1/6 shares and purchased 408 shares of the common stock while Baker sold 348 2/3 shares and purchased 367 1/6 shares. There is no evidence to enable us to identify the shares sold; hence the "first in, first out" rule must be applied. Cf. Jacob Epstein,36 B.T.A. 109; Miller v. Commissioner, 80 Fed.(2d) 219. Applying the rule to the sales made by McKee (subject to the right of either party to call our attention to any mathematical errors) we conclude that the gain which should have been reported by him was $257,073.42 instead of the $217,289.67 reported. A similar computation with reference to the sales made by Baker discloses that he should have reported a gain of $157,827.15 instead of the $86,234.62 which he reported. The petitioners in the three proceedings - and this is the sole issue in Docket No. 58152 - contend that, because of the restriction of ownership in officers and employees of the company and in particular because of the trust agreement, the class B stock was not marketable; that therefore*970 the apportionment of the basis of the old stock between the two classes of new stock is impracticable; and that they are entitled to recover the entire cost. While the trust agreement was entered into to limit the ownership of the class B stock to officers and employees of the company, the sale of such stock was not made impossible. Under the trust agreement the trustees were authorized to purchase class B stock and to sell such stock to any officer or employee making application therefor. The trust agreement has 41 signatures, presumably all holders of class B stock. We do not know how many employees the company had at this time, but the number may have been considerably more than 41. Class B stock was sold during 1928, McKee having sold 4,981 shares and Rutledge 470 shares. Additional purchases and sales may have been made by others. The sale price was fixed at $12.66 a share. The situation herein is not comparable to the situation existing in Helvering v. Tex-Penn Oil Co.,300 U.S. 481; Propper v. Commissioner, 89 Fed.(2d) 617; and *971 Morris D. Kopple,35 B.T.A. 1056. In those cases the sale of stock was absolutely restricted for a certain period of time, sale during the period of restriction being impossible. In H. A. Green,33 B.T.A. 824, 830; dismissed, 84 Fed.(2d) 1003, 1004, the Board stated: * * * the principle of allocation is based on market value. Where there is no market value, no allocation can be made, and the taxpayer is entitled to recover his entire original basis before gain or loss will be recognized on the disposition of the new securities. Edwin D. Axton, supra. [32 B.T.A. 613.] The fact that the class B stock was not available for sale to the public does not prove that it had no market value. The situation *1156 is somewhat analogous to that pertaining to closely held stock. As to the latter the courts and this Board have held that the absence of actual trading or sales in closely held stock or the fact that no sale was made in the open market does not prove that such stock had no market value. *972 Insurance & Title Guarantee Co.,12 B.T.A. 452; affd., 36 Fed.(2d) 842; and George M. Wright,19 B.T.A. 541; affd., 50 Fed.(2d) 727. There was a market here, though limited to officers and employees as evidenced by the sales. Such sales show a demand on the part of the officers and employees for the stock and a supply to meet the demand. In fact the trustees were authorized to meet any demand by a purchase pro rata of the deposited stock. The petitioners do not claim that the class B stock had no fair market value, but merely that it was impracticable to apportion the aggregate value between the two classes of stock. In H. A. Green, supra, it was held that the following provision of article 1567 of Regulations 62 under the Revenue Act of 1921: * * * the proportion of the original cost, or other basis, to be allocated to each class of new securities is that proportion which the market value of the particular class bears to the market value of all securities received on the date of the exchange. lays down a principle equally applicable in determining gain or loss under subsequent acts. This principle*973 of allocation was applied by the respondent in determining the gain realized by Rutledge and, in our opinion, it should have been applied. It is equally applicable in apportioning the basis of the common stock held by McKee and Baker in April 1928, between the class A and B stock owned by them. Decision will be entered for the respondent in Docket No. 58152. Decision will be entered under Rule 50 in Docket Nos. 61120 and 61121. Footnotes 1. Exhibit 19 discloses that Baker and Herr each subscribed for 10 shares of stock at $632.07 per share on January 1, 1917. This subscription was apparently made under the options given to them in the agreement of June 12, 1915, the 10 shares subscribed being a part of the 50 shares purchased by Baker in 1919. ↩ 2. 6. In case any holder of Class B shares of the corporation who now is, or shall be or shall at any time become, actively connected with the corporation, either as officer or employee, shall cease for any cause, other than death, to be actively connected with the corporation, then the remaining holders of Class B shares shall have the right to purchase, pro rata, at any time within thirty (30) days after the termination in any manner of such holder's active connection with the corporation, the Class B shares held by each holder, and, in case of the death of any holder of Class B shares, then the remaining holders of Class B shares shall have the right to purchase, pro rata, the Class B shares so held by such deceased holder, at any time within sixty (60) days after notification to the secretary of the corporation of the appointment and qualification of an administrator or executor for the estate of such deceased holder; and in case any holder of Class B shares shall at any time desire to sell any of the Class B shares so held by him, or any part thereof, he shall notify the secretary of the corporation, in writing, of such desire, and the remaining holders of Class B shares shall have the right to purchase, pro rata, said shares, at any time within thirty (30) days after receipt by the secretary of such notice. When any such officer or employee shall cease, otherwise than by death, to be actively connected with the corporation, or when the secretary of the corporation shall receive notice of the appointment of an administrator or executor of the estate of any deceased holder of Class B shares, or when any holder of Class B shares shall notify said secretary of such holder's desire to sell Class B shares, then the secretary shall at once, by registered mail, notify all holders of Class B shares of such fact, and of the number of said shares which they are entitled pro rata to purchase and of the purchase price thereof, and said shareholders shall, by registered mail, notify said secretary, within five (5) days after receipt by them of such notice, of their intention so to purchase. In the event any of said shareholders fail so to do, then the rights of said shareholders, so failing to notify said secretary of intention to purchase said shares, shall be at an end, and such rights, shall accrue, pro rata, to the remainder of the holders of Class B shares, who may exercise said rights within the thirty (30) or sixty (60) days' period, as the case may be, hereinbefore provided. In the event of election by any holder or holders of Class B share to purchase any of the Class B shares of the corporation under any of the foregoing provisions, the purchase price of each of such shares shall be determined as follows: From the average annual net earnings of the corporation, after all charges, including federal taxes payable, for the four calendar years of the corporation, next preceding the accrual of such right to purchase, there shall be deducted a sum equal to the amount of the dividend for the current calendar year, upon the Class A shares then outstanding, at the rate of Three Dollars ( $3) per share, and the remainder shall be multiplied by eight (8) and divided by the number of then outstanding Class B shares; and the quotient so obtained shall be the purchase price per share of such Class B shares. The term "pro rata", wherever used in this section 6, means "in proportion to the numbers of said Class B shares, held respectively by the shareholders having the right to purchase." Said rights of Class B shareholders to purchase said Class B shares shall be assignable to other officers and employees of the corporation. All of the Class B shares of the corporation shall be issued and held subject to the provisions of this section 6, a copy whereof shall appear upon each certificate for said shares. None of said shares shall be transferred without the consent of the secretary of the corporation endorsed upon the certificate representing the shares so to be transferred and naming the person or persons to whom such shares may be transferred. ↩ 3. Class of Stock Total No. of Shares Issued Value Total Value Percentage A 32,500 $34.00 $1,105,000 61.35 B 55,000 12.66 696,300 38.65 1,801,300 100.00 Cost of 59 Shares 61.35% of $9,504.76 equals $5,831.05 Cost of 987 shares of Class A, $5.908 sh. 38.65% of $9,504.76 equals $3,673.51 Cost of 1,670 shares of Class B, $2.20 sh. ↩ Shares Sold Cost Per Share Total Cost 607 Class A $5.908 $3,586.16 470 Class B 2.20 1,034.00 4,620.16 4. 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— * * * (6) Tax-free Exchanges Generally↩.—If the property was acquired upon an exchange described in section 112(b) to (e), inclusive, the basis shall be the same as in the case of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such exchange under the law applicable to the year in which the exchange was made. If the prpoperty so acquired consisted in part of the type of property permitted by section 112(b) to be received without the recognition of gain or loss, and in part of other property, the basis provided in this paragraph shall be allocated between the properties (other than money) received, and for the purpose of the allocation there shall be assigned to such other property an amount equivalent to its fair market value at the date of the exchange. This paragraph shall not apply to property acquired by a corporation by the issuance of its stock or securities as the consideration in whole or in part for the transfer of the property to it. 5. SEC. 202. (b) 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; but when in connection with the reorganization, merger, or consolidation of a corporation a person receives in place of stock or securities owned by him new stock or securities of no greater aggregate par or face value, no gain or loss shall be deemed to occur from the exchange, and the new stock or securities received shall be treated as taking the place of the stock, securities, or property exchanged. When in the case of any such reorganization, merger or consolidation the aggregate par or face value of the new stock or securities received is in excess of the aggregate par or face value of the stock or securities exchanged, a like amount in par or face value of the new stock or securities received shall be treated as taking the place of the stock or securities exchanged, and the amount of the excess in par or face value shall be treated as a gain to the extent that the fair market value of the new stock or securities is greater than the cost (or if acquired prior to March 1, 1913, the fair market value as of that date) of the stock or securities exchanged ↩ 1. Respondent determined the value of all assets to be $27,000, there being 270 shares of par value of $100 Petitioners claim that the assets had a value of $234,000.↩ 2. Respondent determined that the fair market value of the new stock was no more and no less than the total net worth as shown by its books prior to the exchange, viz., $388,666.66. Petitioners claim that such stock had a fair market value of at least $1,000,000. ↩ 6. ↩ Formula used by petitioner Formula under A.R.M. 34 Earnings of business: [1911] $8,846.61 [1912] 18,168.83 [1913] $36,121.56 23,271.56 [1914] 40,161.21 24,161.21 [1915] 37,401.44 [1916] $67,001.56 180,685.77 $74,448.11 Average earnings $45,000 18,612.03 Less earnings on tangible assets at 8% (on $15,000) 1,200 (On $27,000) 2,160.00 Earnings on intangible assets 43,800 16,452.03 Capitalization on average annual earnings attributable to intangible assets at 20% $43,800 $16,452.03 [5] 219,000 82,260.15 Value of partnership business: Intangible assets 219,000 82,260.15 Tangible assets 15,000 27,000.00 Total 234,000 109,260.15 7. Computation of Cost Basis Under Statute McKee Baker Cost of stock Penn. Co. 1-1-15(270 sh.) (150 sh.) 1 $63,888.88 (60 sh.) Capital contributions (earnings taxed to stockholders) 78,261.79 Purchase price 50 shs Total cost of Penn. Co. stock 4-1-20 142,150.67 Par value Del. Co. stock received 4-1-20 $150,000.00 $110,000.00 Par value of Penn. Co. stock exchanged for Del Co. stock 15,000.00 11,000.00 Excess in par value 135,000.00 (The above excess must be "treated as a gain to the extent that the fair market value of the new stock * * * is greater than * * * the cost of the stock exchanged.") Fair market value of new stock 2 $321,346.72 2 $235,654.26 Cost of stock exchanged 142,150.67 126,693.29 To be treated as gain only to the extent of the excess in par value 179,196.05 108,960.97 Statutory basis of Del. Co. stock (cost plus recognizable gain) 277,150.67 Deduct par value of Del. Co. preferred stock received 150,000.00 Basis of Del. Co. common stock received 3 127,150.67 Computation of Cost Basis Under Statute Computation of Cost Basis Under Statute↩ Baker Cost of stock Penn. Co. 1-1-15(270 sh.) 1 $25,555.54 Capital contributions (earnings taxed to stockholders) 45,272.75 Purchase price 50 shs 55,865.00 Total cost of Penn. Co. stock 4-1-20 126,693.29 Par value Del. Co. stock received 4-1-20 Par value of Penn. Co. stock exchanged for Del Co. stock Excess in par value 99,000.00 (The above excess must be "treated as a gain to the extent that the fair market value of the new stock * * * is greater than * * * the cost of the stock exchanged.") Fair market value of new stock Cost of stock exchanged To be treated as gain only to the extent of the excess in par value Statutory basis of Del. Co. stock (cost plus recognizable gain) 225,693.29 Deduct par value of Del. Co. preferred stock received 110,000.00 Basis of Del. Co. common stock received 3 115,693.29 Footnotes [_FN2] Value 1-1-15 - $115,000 / 270 = $425.9259 per share. [_FN3] McKee Value April Number of 1, 1920 shares Value each Shares Value Common stock $443,978.54/ 1,943 1/3 = $228.4623 [750] $171,346.725 Preferred stock 388,666.66 / 3,886 2/3 = [100] 1,500 150,000.000 Total 832,645.20 321,346.725 Baker Shares Value Common stock [550] $125,654.265 Preferred stock 1,100 110,000.000 Total 235,654.265 [_FN4] $127,150.67 / 750 = $169.5342. $115,693.29 / 550 = $210.3514.