Estate of Durkin v. Commissioner

Beghe, J., dissenting: Even if what I think is the majority’s overly severe approach to this case 1 is confined to its peculiar facts, the majority opinion can only add more confusion and uncertainty to the already tangled tax jurisprudence of bootstrap acquisitions.

I respectfully dissent from the majority opinion, and submit that the majority have jumped, by way of assumption and assertion, without adequate analysis, to their conclusion that the $3.08 million distribution was a dividend to petitioners, rather than partial payment in exchange for petitioners’ GACC stock. 2 Nor does Judge Chabot’s concurrence provide a satisfactory path to the majority’s conclusion. Although his concurrence embarks on a more coherent justification for the majority’s conclusion, it also begs the question, and falls short of its goal.

For the purpose of this exercise, I accept Judge Colvin’s findings of fact as set forth at length in Estate of Durkin v. Commissioner, T.C. Memo. 1992-325 , particularly part 7 thereof, “The June 26, 1975 Transactions: Petitioners’ Purchase of Culm Banks from GACC and Sale of GACC Stock to Green”, and as restated and augmented in the preface to the majority opinion. Although I have some reservations about Judge Colvin’s finding that the culm bank transaction was mispriced, 3 the dispositive evaluation of that finding is best left to the U.S. Court of Appeals for the Third Circuit, to which this case will be appealable.

The majority hold that, inasmuch as petitioners paid substantially less than a fair market value for the culm banks that they acquired from GACC, they received a constructive dividend to the extent the true value of the culm banks exceeded the amount they paid GACC, determined in Estate of Durkin v. Commissioner, supra, to be $3.08 million. This holding is erroneous. The $3.08 million excess value of the culm banks received by petitioners in their transactions with Green and GACC was a payment in exchange for their GACC stock, received either on the sale of their GACC stock to Green or on a constructive redemption of the bulk of their GACC stock. Because the tax result to petitioners is the same under either of these alternatives, $3.08 million of long-term capital gain, the Court need not choose between them. Smith v. Commissioner, 82 T.C. 705, 717-718 (1984), discussed infra pp. 595-597, 598-599, 602, 604. 4

Part I of this dissent attempts to clear away the underbrush in two areas: To draw attention to the points in the majority opinion with which I agree, and to point out the various ways in which the cases relied upon by the majority have little or nothing to do with the case. Part II deals with this case by showing why the excess value of the culm banks received by petitioners was additional payment in exchange for their GACC stock, rather than a constructive dividend to them.

I.

I agree with the following points at the beginning and end, respectively, of the majority opinion: The presence or absence of animosity between petitioners and Green has no bearing on how this case should be decided; it is clear that petitioners and Green jointly controlled the form, structure, and end results of the transaction. Following Mr. Kingson’s approach, the question is what was the “negotiation substance” of the transaction, 5 insofar as it bears on how the Court should characterize the distribution exposed by respondent. Also, the question of whether petitioners actually owned 40 percent or 50 percent of the GACC stock does not bear on the outcome. The only issue for decision is whether the value of the distribution by GACC should be considered part of the consideration received by petitioners on their disposition of GACC stock, 6 or whether it should be treated as a constructive dividend to them.

The majority opinion characterizes the issue in this case as whether petitioners will be allowed to disavow the form of their transaction, citing National Alfalfa Dehydrating & Milling Co. v. Commissioner, 417 U.S. 134, 149 (1974). Majority op. pp. 570-571. That is not the issue. Rather, because respondent and the Court have exposed the undervaluation that the parties to the agreements had not disclosed, the further task of the Court is to determine its character for tax purposes, insofar as petitioners are concerned.

The majority have not fairly characterized what petitioners represented the form of the transaction to be. Petitioners did not at any time assert that there was a distribution. What they asserted, in response to respondent’s determination, is that there was no distribution, an issue no longer before the Court at this stage of the proceedings. What the majority is doing is putting words in petitioners’ mouths and then binding them to those words.

In any event, National Alfalfa does no more than stand for an “actual transaction” principle, 7 that the taxpayer is not entitled to recast a transaction into steps that were not actually taken. Petitioners have not asked this Court to speculate on the treatment of steps they did not take. Rather they ask us to characterize a newly identified distribution on the basis of the steps they actually took. Thus, National Alfalfa does not prevent the Court from performing its task, to determine the character in petitioners’ hands of the additional value they received in the culm bank leg of the overall transaction.

Moreover, petitioners are not asking the Court to violate the actual transaction principle of National Alfalfa, as applied in Glacier State Electric Supply Co. v. Commissioner, 80 T.C. 1047 (1983), and impute additional steps that were not actually taken. The majority and concurring opinions fail to recognize that the Court can hold petitioners to the form of their transaction, without imputing any additional steps, and still properly conclude that the newly discovered element, i.e., the $3.08 million excess value of the culm banks, was an amount received by petitioners as payment in exchange for their stock, not a dividend.

The majority also rely on the Third Circuit’s decision and opinion in Commissioner v. Danielson, 378 F.2d 771, 775 (3d Cir. 1967), vacating and remanding 44 T.C. 549 (1965), for the proposition that petitioners “may not disavow the form of their culm bank purchase and GACC stock sale.” Majority op. pp. 573-575. The Danielson rule does not prevent the Court from determining the character of the undervaluation. Petitioners disclosed on Rider D-6 to their 1975 return the interdependence of the culm bank transaction and the disposition of their GACC stock. The May 28, 1975, letter agreement between petitioners and GACC demonstrates that the culm bank agreement and the GACC stock purchase agreement were each incomplete without the other; the culm bank agreement was not legally binding and could not have gone forward without the consummation of the stock purchase agreement. Because each of the agreements, standing alone, is incomplete, the Pennsylvania parol evidence rule does not apply. See Mellon Bank Corp. v. First Union Real Estate, 951 F.2d 1399, 1405 (3d Cir. 1991); Mellon Bank, N.A. v. Aetna Business Credit, Inc., 619 F.2d 1001, 1011 (3d Cir. 1980); Murray v. Univ. Pa. Hosp., 490 A.2d 839, 844 (Pa. Super. 1985); see also 3 Corbin on Contracts, secs. 581-582, at 440-464 (1960 & Supp. 1989); 2 Farnsworth, Contracts, sec. 7.3, at 470 (1990). The Third Circuit’s Danielson rule is therefore inapplicable because the Pennsylvania parol evidence rule does not preclude the Court from looking to extrinsic evidence in construing the two agreements and reading them together. The Court should also consider all relevant testimony and evidence regarding the negotiations leading up to the two agreements and the relationship between the agreements in order to determine the true character of the excess value received by petitioners.

Another school of red herring that swim through the majority opinion and the Chief Judge’s concurrence are the repeated references to Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954), and the characterization of petitioners’ position as an attempt to take advantage of Zenz by having the Court in this case treat the transaction as a redemption. The Court need not rely on or extend Zenz in order to reach the correct result. Zenz cannot be relied upon to impute a redemption; in Zenz there was an actual redemption.

Reitz v. Commissioner, 61 T.C. 443 (1974), affd. without published opinion 507 F.2d 1279 (5th Cir. 1975), is also inap-posite. Our decision in Reitz does not preclude us from holding that the transaction here in issue resulted in a constructive redemption of part of petitioners’ stock. The taxpayers in Reitz were the sole shareholders of a corporation, and caused it to declare a dividend to them equal to all its liquid assets before donating all their stock in the corporation to a local government agency. Although the distribution was a declared dividend, and labeled and referred to as such in all contemporaneous documentation, the taxpayers tried to have it treated for tax purposes as payment by the local government agency for their stock. There was no binding contract of sale between the taxpayers and the government agency when the dividend was declared or paid. Thus, the Court concluded that the distribution was a dividend in both form and substance. By contrast, in the case before us, there was a binding contract between petitioners and Green, a preexisting shareholder, for the sale of their stock, the two transactions happened on the same day, and no dividend was declared.

Judge Wisdom’s rule in Estate of Weinert v. Commissioner, 294 F.2d 750, 755 (5th Cir. 1961), revg. and remanding 31 T.C. 918 (1959), that a taxpayer cannot disavow the form of his transaction and assert that substance should control if he did not report the substance of the transaction in a manner consistent with the position taken before the Court, does not apply here. Petitioners’ primary position at trial was that there was no excess value. Inasmuch as the Court has rejected petitioners’ position in that respect, petitioners should be free to argue the substance of the distribution that the Court has found.

The majority take the view that Estate of Weinert requires that petitioners be left with the worst case characterization and separation of the stock sale and culm bank transaction for the five reasons set forth at pages 574-575 of the majority opinion. 8 These reasons are not compelling.

First, as to petitioners’ supposed disavowal of their tax return treatment of the transaction. The Court need not allow petitioners to disavow the form of their transaction, nor have petitioners attempted to do so here. Petitioners having disclosed on their 1975 return the interdependence of the two legs of the transaction, and the Court having so found, the Court should mush on and determine the character of the excess consideration that it has also found, which the agreements did not expressly provide for, much less allocate either to Green or to petitioners. In so doing, the Court would not be allowing petitioners to disavow their form, but assuming its proper responsibility to characterize the excess value of the culm banks received by petitioners.

The same is true of the second proposition, that petitioners did not show an honest and consistent respect for the substance of the transaction. The Court’s duty, in these circumstances, is to make the characterization and allocation that the parties to the transaction failed to do, so that the tax result is consistent with tax reality.

Third, the majority state that petitioners are now trying to treat the transaction as a redemption. That is not what petitioners are doing; they are trying to have the $3.08 million in excess value of the culm banks treated as part payment in exchange for their stock. As shown above, there are two alternative characterizations of the distribution, only one of which is a redemption, but either would result in capital gain treatment to petitioners.

Fourth, the majority state that petitioners would be unjustly enriched to permit them to change the deal after well-informed negotiations with Green. However, it is respondent and the Court who have changed the deal. There is a characterization of the transaction that would not have had any adverse effect on Green: a direct redemption of the bulk of petitioners’ stock by GACC. Green, under this approach, would not be charged with a dividend and he would still end up, as he actually did, as the sole shareholder of GACC.

In any event, this whole issue is speculative and academic. Green is dead, the period of limitations has in all likelihood expired against him and his estate for the tax year 1975, and we have no way, on the record before us, of knowing what tax treatment he actually received.

It beggars description to say that petitioners would be unjustly enriched by permitting them to belatedly change the deal after well-informed negotiations with Green. On the contrary, it is petitioners who will be even more greatly impoverished than Green’s estate by the Court’s endorsement of respondent’s determination that petitioners received a substantial distribution, and by the majority’s treatment of this distribution as a dividend to petitioners. 9 The deal as structured resulted in Green’s, for a payment of only $205,000, increasing from 50 percent to 100 percent his stake in GACC, a corporation that had a net worth in excess of $3 million as a result of what petitioners paid it for the culm banks (not to speak of any other assets that remained in GACC after the culm banks and related assets had been distributed).

The majority’s fifth reason for leaving petitioners with the more costly alternative is that the Commissioner will be whipsawed. 10 There is often a potential for whipsaw when there is a transaction between parties who have opposing tax interests, but the correct decision in this case does not require a whipsaw result either in favor of or against the Commissioner: “Every schoolboy knows” that a properly planned and executed bootstrap transaction does not result in dividend treatment of either the terminating or remaining shareholder. See State Pipe & Nipple Corp. v. Commissioner, T.C. Memo. 1983-338 .

Where, as here, the Court finds an element in the transaction that the parties have denied, the Court should determine the character of the element and make the allocation, without regard to whether the parties tried to maximize their mutual tax advantage. Instead, the majority completely disregard the objection, by the party before the Court, to the Commissioner’s characterization of the transaction. Consistent with Judge Tannenwald’s approach in Coleman v. Commissioner, 87 T.C. 178, 203 (1986), affd. without published opinion 833 F.2d 303 (3d Cir. 1987), we could treat the transaction as if both Green or his estate and petitioners were before the Court, and determine the recipient of the distribution in the light of respondent’s argument that petitioners, rather than Green, should be considered the recipient. If that is the result, then the distribution should be considered to have been received by petitioners in partial redemption of their stock. As Judge Fay concluded in Roth v. Commissioner, T.C. Memo. 1983-651 , discussed infra pp. 597-599, where the terminating shareholder received a corporate distribution as an incident of the transaction, the distribution was received in redemption of his stock, even though the parties had labeled it a dividend.

Contrary to the assertions of the majority, majority op. pp. 576-577, all the requirements for a step transaction were satisfied. Penrod v. Commissioner, 88 T.C. 1415, 1429-1430 (1987). On June 26, 1975, petitioners’ stock interests in GACC were terminated, and they have received a substantial corporate distribution (the amount by which the fair market value of the culm banks exceeded the consideration paid GACC) in simultaneous mutually binding interdependent transactions. The end result of these transactions is that, in one day, petitioners’ stock interests in GACC were completely terminated, as were all their other interests, as directors, officers, employees, and creditors, in GACC and its subsidiaries. In these circumstances, all amounts that petitioners received in these transactions, irrespective of whether their source was Green or GACC, look to me more like a payment in exchange for petitioners’ stock than a dividend to them. But that is the question the Court should address, and to that question I now turn.

II

Respondent, by finding that the culm banks were undervalued, uncovered the distribution. However, that distribution is, at best, ambiguous in character. Thus, the Court should not just agree with respondent’s determination that the distribution was a constructive dividend to petitioners. Rather, the Court should pay closer attention than the majority to the negotiations that led up to the June 26, 1975, transactions. Those negotiations reflected petitioners’ desire to acquire the culm banks as well as Green’s desire to acquire a 100-percent interest in GACC. Back in February 1975, Green had offered $1,205 million for petitioners’ stock. The negotiations eventuated in the letter agreement of May 28, 1975, in which petitioners and GACC agreed that the culm bank purchase would be conditioned on petitioners’ not owning any stock in GACC and their same-day agreement on the price petitioners would pay for the culm banks. Majority op. pp. 564-565. In the month that followed, the parties’ further negotiations culminated in the June 26, 1975, culm bank agreement, with a price for the culm banks and related assets paid by petitioners that exceeded the previously agreed-upon price by $1.2 million, while the price Green ostensibly paid for petitioners’ GACC stock was $1 million less than his initial offer 4 months previously.

The GACC distribution cannot be a dividend to petitioners because the culm bank agreement and stock purchase agreement, as supplemented by the May 28, 1975, letter agreement and other evidence in the record, clearly provided that the culm bank agreement would not close unless petitioners had given up all their GACC stock and all other interests in GACC. Therefore, the $3.08 million corporate distribution was either a constructive dividend to Green, the sole remaining shareholder, which he indirectly used as additional consideration to pay petitioners for giving up their stock, or it was a direct distribution to petitioners. If it was a direct distribution to petitioners, it cannot be a dividend to them because it was part of the consideration for their termination of all their legal and beneficial interests in GACC. Therefore, such direct distribution to petitioners from GACC must have been received by them in constructive redemption of the bulk of their GACC stock.

This Court has not hesitated to determine the reality of a transaction and find that payments labeled “compensation” or “dividend” were actually redemption distributions to shareholders whose interests in the corporation were being terminated. In Smith v. Commissioner, 82 T.C. 705, 717-718 (1984), the agreement in question provided for amounts to be paid to the taxpayer, who was disposing of all his stock in the corporation, that were allocated between stock “purchase price” paid by the remaining shareholders and “commissions due” that were paid by the corporation. In suggesting that a part sale and part redemption had occurred, the Court showed no concern for whether any stock certificates or shares had been transferred to the redeeming company:

If the corporation paid more than it was obligated to, it would appear that Progress was partially redeeming petitioner’s shares. Under this scenario, the transaction would not be a straight purchase by Schmitt and Benton as indicated by the terms of the original agreement. 11 Thus farther ambiguity surrounds who is the buyer of petitioner’s stock in Progress.

The Smith case is instructive on another account. Because the taxpayer was a Pennsylvania resident, the case was appealable to the Third Circuit, and the Danielson rule would have applied, but the Court found the Danielson rule inapplicable because the agreement was ambiguous. The Court therefore felt free, by resort to extrinsic evidence, to resolve the ambiguity of whether the corporate payment to the selling shareholder was commissions (as it had been labeled), taxable as ordinary income, or a payment in exchange for his stock, taxable as long-term capital gain.

Relying on expert testimony in the record, the Court found that the $8,500 purchase price recited in the stock purchase agreement was incredibly low, that the value of the taxpayer’s stock was approximately $25,000, and that the taxpayer had no preexisting right to commissions as such. Even though the corporation and its shareholders had been improperly treating yearend corporate payments to them as deductible commissions, thereby zeroing out the corporate tax, the Court did not treat the so-labeled final corporate payments to the terminating shareholders as commission payments, but rather as payments in exchange for their stock.

The Court’s peroration is instructive and right on point. It concludes, as I suggest, that it is not necessary to choose between the alternative characterizations of total stock sale versus part stock sale/part redemption:

Based upon the entire record in this case, we think the $24,974 amount the parties agree that petitioner received was for the purchase and sale of his stock interest in Progress. The terms of the agreement thus reveal that the buyers intended to use the corporation’s income as a means to finance a portion of the purchase price of petitioner’s stock. Essentially, the agreement was used as a financing tool. In this manner, the transaction took the form of a part sale and part redemption (see secs. 302(b)(3), 317(b)), or else a total sale to Schmitt and Benton using Progress as their agent (see Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954)). In either event, petitioner is entitled to capital gains treatment for the $14,974 amount (the excess of his amount realized over his basis in the stock). Sec. 1001. [Id. at 717-718; fn. refs, omitted.]

The analysis of then Chief Judge Dawson in Smith makes clear that the Court can find a redemption for tax purposes without finding that shares or share certificates were transferred to the corporation. This approach is consistent with the Court’s holding in Fowler Hosiery Co. v. Commissioner, 36 T.C. 201 (1961), affd. 301 F.2d 394 (7th Cir. 1962), that no actual surrender of stock by the shareholder is required in order to have a redemption, if the actual surrender of stock would be a mere formality. 11

Another case taking a similar approach to Smith v. Commissioner, supra, is Roth v. Commissioner, T.C. Memo. 1983-651 . Here, Judge Fay held that although a cash distribution from a corporation to one of its two individual shareholders was structured as a dividend, and labeled as such, the recipient was entitled to capital gain treatment. This was because application of the step transaction doctrine established that the distribution was in substance a redemption that, with other transactions, divested the recipient of his entire interest in the corporation. Judge Fay stated:

Clearly, the “step transaction” doctrine is applicable in the instant case. Petitioner’s sale of his Roth Boneless Beef stock to Roth Investment Company, the redemption of his remaining stock in that corporation by Roth Boneless Beef, the redemption by Roth Investment Company, and the cash distribution from Roth Boneless Beef, were contractually interdependent transactions which took place simultaneously. Moreover, the clear purpose of the transactions — to divest petitioner of his entire interest in the corporations and effectively give William sole ownership — could not have been accomplished in the absence of any one of these steps. Accordingly, we conclude that these integrated transactions must be viewed together for purposes of determining whether the cash distribution was, in substance, a dividend.

Viewing the cash distribution in the context of these interrelated transactions, we fail to see how it can be characterized as a dividend. To constitute a dividend, a payment must be made to a shareholder in his capacity as a shareholder. Sec. 1.301-l(c), Income Tax Regs. The integrated transactions in the instant case left no room for such a payment. Simultaneous with the cash distribution, petitioner’s interest in the corporations was in all respects completely terminated. Under such circumstances, we do not think it is logical to view the cash distribution as having been paid to petitioner in his capacity as a shareholder since, upon receiving the payment, he was from that point on no longer a shareholder. See United States v. Carey 289 F.2d 531, 538 (8th Cir. 1961). Accordingly, we conclude that the cash distribution represented nothing more than a payment in connection with the termination of petitioner’s stock interest rather than a dividend. That Roth Boneless Beef made no similar distribution to William, who was also a 50 percent stockholder in the corporation, certainly lends support to this conclusion. [Roth v. Commissioner, supra; fn. ref. and citation omitted.]

Judge Fay went on to deal with the Commissioner’s additional argument that addressed a problem similar to one in the case before us, the disparity per share of the payments received from two different sources by the selling shareholder:

Respondent argues in the alternative that if the cash distribution is treated as part of the redemption price for petitioner’s stock, then Roth Boneless Beef redeemed 844 shares for $206,089.50, or $244.18 per share, far in excess of the $53.33 per share paid by Roth Investment Company for the 14,156 shares it acquired. On that basis, respondent contends petitioner must still be treated as having received a “constructive” dividend to the extent Roth Boneless Beef paid him more than the fair market value for the 844 shares. We, however, reject this argument because we do not view these transactions in the same manner as respondent.

As discussed, the redemption of 844 shares by Roth Boneless Beef and the sale of 14,156 shares to Roth Investment Company must be viewed together, not as independent transactions. In that light, it is obvious that the cash distribution was received not only in consideration for the 844 shares redeemed by Roth Boneless Beef but also as additional consideration for the 14,156 shares simultaneously acquired by Roth Investment Company. Petitioner disposed of his entire interest in Roth Boneless Beef pursuant to a series of interrelated transactions and, when the “dust settled,” he had $961,089.50 to show for it. Significantly, this amount is consistent with the price at which petitioner originally agreed to sell these same shares to William pursuant to the July 7, 1976, “Offer and Acceptance” agreement. That Roth Boneless Beef paid him $206,089.50 and redeemed only 844 shares ($244.18 per share), and a related corporation paid him $755,000.00 and acquired 14,156 shares (53.33 per share), was of no economic consequence to petitioner. Viewing the transactions together, petitioner received $961,089.50 for his 15,000 shares of stock in Roth Boneless Beef, or $64.07 per share. Under the circumstances of this case, we conclude that he should be taxed on that basis. [Roth v. Commissioner, supra, fn. refs, omitted.]

This aspect of the case before us reinforces the applicabililty here of the approaches of Judges Dawson and Fay in the Smith and Roth cases — the obvious disproportion between the ostensible purchase price of the stock— $205,000 — and the net amount of the distribution — $3.08 million — that the majority and concurring opinions treat as a dividend. It does not make sense to conclude that petitioners sold their 50-percent stock interest to Green for $205,000, in the light of Green’s prior offer to purchase it for $1,205 million, while they were simultaneously receiving a gross distribution in excess of $7 million, even as they were also transferring back cash and other assets to GACC that left it with net worth of at least $3.17 million, 12 plus the net value of any other assets remaining in GACC and its subsidiaries.

Finally, there is another aspect of the transaction that makes redemption treatment, including the application of Fowler Hosiery Co. v. Commissioner, supra, especially appropriate. The sale-distribution in question consisted of the assets of a going business, not only the culm banks, but also the related assets that would be needed to exploit them. As a result, partial liquidation treatment under section 302(b)(4) would be appropriate. Although petitioners have not made this argument, its obvious applicability reinforces the conclusion that ordinary dividend treatment to petitioners is improper.

Judge Chabot, applying the presumption of correctness to respondent’s determination that the excess value portion of the culm banks was a dividend distribution to petitioners, concludes that petitioners did not carry their burden of persuading the Court that the excess value of the property distributed to them was an additional payment in exchange for their stock.

In an attempt to show that the $3.08 million in excess value of the culm banks could have been a dividend distribution to petitioners, even if they had no beneficial interest in GACC on June 26, 1975, Judge Chabot points out, supra p. 580, that “legal ownership of stock at the time of the distribution is not necessarily a requirement for dividend income.” As support, Judge Chabot cites section 1.61-9(c), Income Tax Regs., and 10 Mertens, Law of Federal Income Taxation, secs. 38B.18 and 38B.19, at 75-76 (1991), providing that a selling shareholder will be considered the recipient of a dividend even if the dividend is paid to him when he is no longer a shareholder, so long as the dividend was declared before the sale and the selling shareholder was entitled to receive the dividend as of the record date. However, these authorities deal with the income tax accounting question of who must include a declared dividend when stock is sold ex dividend: 13 the selling shareholder or the buying shareholder. In the case before us, no dividend was ever declared, and the prior question is not to whom the dividend is taxable, but whether there was a dividend at all. Even if GACC did pay a dividend, there is no per se requirement that petitioners, as the selling shareholders, be treated as the recipients of that dividend. The regulation cited by Judge Chabot begins by saying that “When stock is sold, and a dividend is both declared and paid after the sale, such dividend is not gross income to the seller.” Sec. 1.61-9(c), Income Tax Regs. Inasmuch as no dividend was ever declared by the closely held corporation in this case, it is impossible to know whether the stock traded ex dividend or with the dividend on.

Of course, a dividend need not be declared in order to be a constructive dividend, and it need not be pro rata. Lengsfield v. Commissioner, 241 F.2d 508, 511 (5th Cir. 1957), affg. T.C. Memo. 1955-257 . 14 Nevertheless, even assuming that a dividend was paid to someone, treating the payment as a dividend to petitioners does not provide a better fit than treating it as a dividend to Green. It is well established that a corporate payment for a shareholder’s benefit may be a constructive dividend to that shareholder. 15

To determine whether the excess value of the culm banks was transferred from GACC to petitioners on Green’s behalf, the negotiations and the agreements must be considered. The negotiations that led to the two agreements executed on June 26, 1975, as supplemented by the letter agreement of May 28, 1975, reflect that petitioners would only acquire the culm banks after they had terminated their stock interests in gacc. The negotiations and Judge Colvin’s findings of fact also reflect that petitioners’ stock was worth much more than $205,000. In my view, if here was a dividend, it should be attributed to Green rather than petitioners. Petitioners were able to acquire the culm banks from gacc at a bargain because Green, the sole remaining shareholder of gacc and its chairman, used gacc to pay petitioners additional consideration for their stock.

Observing that “there is no evidence that Green ever had even momentary legal or equitable ownership of the culm banks”, Judge Chabot concludes, supra p. 581, that the $3.08 million in excess value of the culm banks cannot properly be considered a dividend to him. Whether Green had legal or equitable ownership of the culm banks is not relevant to the inquiry. Under the tax law of constructive dividends in bootstrap acquisitions, the purchasing or remaining shareholder will be treated as having received a dividend distribution if the corporation pays an obligation on his behalf. 16 The dividend is “constructive” because the shareholder has not directly received it, but has enjoyed the indirect benefit of having the corporation pay his obligation. 17 Therefore, it is not necessary that Green ever had legal or equitable ownership of the culm banks for him to have received a constructive dividend equal to the excess value of the culm banks.

Judge Chabot also concludes, inasmuch as petitioners did not turn in any share certificates to GACC, that the facts before us are a “poor fit for a redemption” in light of Estate of Schneider v. Commissioner, 88 T.C. 906, 939-941 (1987), affd. 855 F.2d 435 (7th Cir. 1988). There the Court held, by application of the step transaction doctrine, that there was a “deemed redemption” of stock for purposes of section 317(b), even though the shares of stock were actually sold to a third party and the amounts received by the shareholder were essentially equivalent to dividends because there had not been a meaningful reduction of his stock interest in the corporation. Judge Chabot states that because Green negotiated to purchase petitioner’s stock, and did not acquire stock different from the stock disposed of by petitioners, the stock transaction is better characterized as a sale between petitioners and Green. This would be true if the only thing that happened was that petitioners disposed of their stock. However, they also received the excess value of the culm banks from GACC in a related simultaneous transaction. Looking at the stock transaction between petitioners and Green by itself, without regard to the culm bank transaction, is just as shortsighted as the majority’s approach of looking at the culm bank agreement by itself to determine whether petitioners received a dividend.

In Smith v. Commissioner, 82 T.C. 705 (1984), a case factually more similar to the case before us than Estate of Schneider v. Commissioner, supra, the Court had no difficulty finding that the transaction could be treated as a redemption under section 302, even though the corporation had not actually acquired the selling shareholder’s stock.

Judge Chabot states that petitioners, by arguing that the step transaction doctrine should apply, seek to have the Court impute a step that was never taken, Green’s ownership of the culm banks. However, as shown above, there is no need for Green to have acquired ownership of the culm banks in order for him to be treated as the recipient of a constructive dividend.

Of course, it is possible for a selling shareholder to receive a dividend distribution in a bootstrap transaction. As Bittker and Eustice observe, one of the three ways to structure a bootstrap transaction is a seller-dividend and sale. 18 Examples are where the corporation declares and pays a dividend to the selling shareholder before he is obligated to sell his stock, cf. Reitz v. Commissioner, supra, or where, under the formal terms of the stock sale agreement, he is still the owner of the stock when he receives the distribution, see Wilson v. Commissioner, 27 T.C. 976 (1957), affd. per curiam 255 F.2d 702 (5th Cir. 1958); Gilmore v. Commissioner, 25 T.C. 1321 (1956); Coffey v. Commissioner, 14 T.C. 1410 (1950); see also Steel Improvement & Forge Co. v. Commissioner, 36 T.C. 265 (1961), revd. 314 F.2d 96 (6th Cir. 1963), or was the beneficial owner of the stock when the dividend was declared, Steel Improvement & Forge Co. v. Commissioner, supra; Casner v. Commissioner, T.C. Memo. 1969-98 ; see also Hoffman v. Commissioner, 47 T.C. 218 , 233 (1966), affd. per curiam 391 F.2d 930 (5th Cir. 1968).

There are also situations, such as a purchase of the stock of a wholly owned subsidiary, in which the parties will try to structure the transaction as a dividend distribution to the corporate seller, coupled with or followed by a sale of all the seller’s shares to the buyer. The reason for this choice of form is to give the corporate seller the benefit of the dividends received deduction, or, if consolidated returns have been filed, exclusion of the dividend distribution in its entirety from the income of the selling parent. However, when the dividend and sale transactions have been so interdependent that the distribution received by the seller was obviously part of the consideration for the seller’s giving up its stock ownership, as they were here, the corporate seller has not been successful in sustaining dividend treatment, Waterman Steamship Corp. v. Commissioner, 430 F.2d 1185 (5th Cir. 1970), revg. 50 T.C. 650 (1968), and the Commissioner’s attempt to characterize a presale distribution to an individual seller as a dividend has been rejected in favor of its taxation as a dividend to the purchasing shareholder and inclusion in the sales proceeds received by the seller. Casner v. Commissioner, 450 F.2d 379 (5th Cir. 1971), affg. in part and revg. in part T.C. Memo. 1969-98 .

Even if we assumed that petitioners were still the beneficial owners of GACC stock immediately before they received the $3.08 million distribution, it nevertheless cannot properly be characterized as a dividend to them. Petitioners obviously received the distribution in consideration of the termination of their stock interest. See Smith v. Commissioner, supra; Roth v. Commissioner, supra. The regulation and case law cited by the majority, see majority op. p. 575-576, all pertain to continuing shareholders who benefit from a bargain purchase from their corporation. In this case, petitioner’s stock and other interests in GACC were fully terminated no later than when they received the $3.08 million excess value of the culm banks.

It may well be that petitioners have not carried the burden of showing whether the distribution was a dividend to Green that he used to pay additional purchase price for their stock, or a direct distribution to them in constructive redemption of the bulk of their stock. However, the teaching of Smith v. Commissioner, supra, is that the Court need not make this choice in order to arrive at the correct bottom line result. The facts of this case show that , the sum of the probabilities is more likely than not that petitioners received the excess value of the culm banks as a payment in exchange for their stock rather than as a dividend. The proper application of the Smith case to these facts compels this result.

Whalen and Halpern, JJ., agree with this dissent.

In light of the substantial consideration paid by petitioners for the culm bank assets ($4.17 million plus $1 per ton royalty, increased by $1.2 million from the agreement signed the month before), and the $1 million reduction in the ostensible purchase price for their GACC stock, as compared with the buyer’s original offer, I agree with Judge Chabot that we should not just disregard petitioners’ arguments. The majority’s objurgations on petitioners’ misconduct in structuring the transaction and failing to report the distribution that the Court has found should not prevent us from analyzing the facts in the record and properly applying the law in order to arrive at the correct characterization of that distribution.

The commentators cited by the majority would either agree that the result reached by the majority is mistaken, or that more analysis is required. See majority op. note 1.

Bittker and Eustice, without reaching any normative conclusions, describe the three formats into which a bootstrap transaction can be cast by the parties, and observe that “Not surprisingly, the Service seeks to fit ambiguous transactions into whatever pattern will produce the most revenue, while taxpayers seek to fit them into the least costly form.” Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 9.07, at 9-35 (5th ed. 1987).

Jassy concludes that even if a distribution labeled “dividend” is paid to a selling shareholder and is not treated as a constructive dividend to the purchaser or continuing shareholder, then it should have capital gain consequences to the seller, provided one of the requirements of sec. 302(b), such as the complete termination of the stock interest of the selling shareholder, is met. Jassy, “The Tax Treatment of Bootstrap Stock Acquisitions: The Redemption Route vs. the Dividend Route”, 87 Harv. L. Rev. 1459 , 1479-1483 (1974).

Kingson observes that corporate distributions in bootstrap acquisitions have no independent economic substance outside of tax consequences and therefore should be characterized by reference to what he calls “negotiation substance”. “If the negotiations are consistent with the form of the distribution and sale carried out by the parties, that form should determine the tax consequences [of the distribution].” Kingson, “The Deep Structure of Taxation: Dividend Distributions”, 85 Yale L. J. 861, 866-867, 883-884 (1976).

Lang, building on the review of the cases and rulings by Jassy and Kingson, does not attempt to reconcile or justify the diverse results of the cases and rulings, but instead analyzes and evaluates the current state of the law. Lang concludes that “Institutional considerations and fundamental tax considerations suggest that all acquisitions should be treated for tax purposes as if carried out by redemption of a portion of the seller’s stock in combination with a sale of the seller’s remaining stock to the purchaser.” Lang, “Dividends Essentially Equivalent to Redemp-tions: The Taxation of Bootstrap Stock Acquisitions”, 41 Tax L. Rev. 309 , 381 (1986).

Without expressing disagreement with the Court’s findings in Estate of Durkin v. Commissioner, T.C. Memo. 1992-325 , on the value of the culm banks as of June 26, 1975, I do point out that petitioners and their coventurers and licensees appear to have encountered heavy losses in their attempts to exploit the culm banks in subsequent years.

Indeed, in refusing to follow and apply the Division opinion in Smith v. Commissioner, 82 T.C. 705 (1984), the Court is sub silentio overruling it. I suggest that the preferable course, if Smith is not to be followed, would be for the Court expressly to overrule it.

See Kingson, supra at 883-884.

There seems to be no dispute about petitioners’ basis for their GACC stock, irrespective of whether it represented a 40- or 50-percent interest in GACC.

See Smith, “Substance and Form: A Taxpayer’s Right to Assert the Priority of Substance”, 44 Tax Law. 137 ,-141 (1990).

Gleaned from the somewhat longer list in Smith, supra at 144-147 .

The result of the majority’s holding is that petitioners will have a tax liability on this transaction, computed at the top marginal rate for 1975, on the order of $2.17 million which, with interest, will currently amount to more than $12 million. The tax liability on the capital gain would be on the order of $1.08 million, which, with interest, would currently exceed $6 million. The Schedule D to petitioners’ 1975 income tax return shows a net long-term capital loss of $1,032,050, chiefly attributable to the claimed worthlessness of securities of “Pocono Downs”. If this claimed loss is allowable, petitioners’ net long-term capital gains tax and interest liability resulting from sale or exchange treatment would be reduced, but there would still be a substantial liability for tax and interest. Since enactment of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, the distinction between long-term capital gain and ordinary income has been of less moment, with a rate differential for individuals currently amounting to only 3 percent. Sec. 1(h), I.R.C. 1992. See Faber, “Capital Gains v. Dividends in Corporate Transactions: Is the Battle Still Worth Fighting?”, 64 Taxes 865 (1986). In this case we are talking about a 35-percent rate differential and a substantive difference in dollars.

See Gilbert & Mather, “Whipsaw Revisited”, 43 Tax Law. 343 (1990), defining whipsaw as arising in a tax transaction when two taxpayers have a claim to the same tax benefit.

The issue of whether Schmitt and Benton are actual purchasers of petitioner’s stock or whether the corporation is redeeming petitioner’s shares was not presented to us by the parties for decision.

[Smith v. Commissioner, supra at 715.]

See Jassy, supra at 1480-1481. The Commissioner has agreed with the approach taken in Fowler Hosiery Co. v. Commissioner, 36 T.C. 201 (1961), affd. 301 F.2d 394 (7th Cir. 1962), and extended it in three revenue rulings. Rev. Rul. 90-13, 1990- 1 C.B. 65 ; Rev. Rul. 81-3, 1981- 1 C.B. 125 ; Rev. Rul. 79-257, 1979- 2 C.B. 136 . In these rulings, the Commissioner concluded that where there is only one shareholder, or where the distribution of corporate assets is pro rata, a surrender of stock is a meaningless gesture; after the transaction, the shareholder’s interest in the corporation remains unchanged, regardless of whether he actually surrenders his stock to the corporation. In such circumstances, the shareholder is “deemed to have constructively surrendered that number of shares the total fair market value of which equals the amount of the distribution. The requirement of a redemption may be deemed satisfied by these constructive exchanges.” Rev. Rul. 81-3, 1981-1 C.B. at 125-126.

This computation takes account of the $1 million payment by Blue Coal to IIT to induce it to release its lien on the Blue Coal culm banks. Conceivably, the $1 million release fee paid by Blue Coal to IIT to induce IIT to release its lien on the Blue Coal culm banks should be considered as distributed to Green and paid by him to IIT.

1.e., stock sold ex dividend is stock that is sold after a dividend has been declared but before it has been paid. In such a situation the selling shareholder will receive a reduced purchase price from the buyer. The seller may attempt to treat the dividend as a dividend to the buyer which the buyer used to pay for the stock. However, if the seller was the owner of the stock on the record date, the dividend is payable to the seller, not the buyer.

In that case, constructive dividends were found to have been paid to parties who remained shareholders of the corporation.

Bittker & Eustice, supra par. 7.05, at 7-34 to 7-36.

Id.

See 10 Mertens, Law of Federal Income Taxation, sec. 38B.37, at 105-113 (1991).

See Bittker & Eustice, supra par. 9.07, at 9-34.