Peterson v. Commissioner

OTTO PETERSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

EDWARD M. MAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

LYNN L. HOSIER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Peterson v. Commissioner

Docket Nos. 95168, 95171, 95172.

United States Board of Tax Appeals

42 B.T.A. 102 ; 1940 BTA LEXIS 1045 ;

June 18, 1940 , Promulgated

*1045 Petitioners were officers, directors, and the only stockholders of a manufacturing corporation. In order to reduce taxes on both the corporation and themselves as stockholders, they adopted, as directors, a resolution to sell treasury stock to members of their families at $10 per share, which was substantially less than the market or intrinsic value of the stock. All legal formalities necessary to transfer the new stock to the new stockholders were complied with. They have since remained the record owners, returning and paying income tax on all the dividends paid thereon. Three days after the issuance of the stock, the corporation declared and, within the taxable year, paid dividends of $50 per share, which were received by all stockholders. Held:

(1) Petitioners are not taxable in respect of the dividends declared and paid on the stock issued to members of their families, since the latter actually owned this stock.

(2) The fraud penalties fall with the deficiencies.

Edward A. Smith, Esq., and Ralph W. Barbier, Esq., for the petitioners.

Philip M. Clark, Esq., for the respondent.

LEECH

*102 These consolidated proceedings are *1046 brought to redetermine deficiencies in income tax and penalties for the calendar year 1936 as follows: Petitioner Docket No. Tax deficiency 50% penalty

Otto Peterson 95168 $6,186.06 $3,093.03

Edward M. May 95171 26,256.69 12,618.63

Lynn L. Hosier 95172 4,261.08 2,130.54

*103 The common issues are (1) whether petitioners are taxable in respect of the dividends declared and paid during the taxable year on certain stock issued to their respective wives and daughters and (2) whether the returns filed by petitioners were false and fraudulent with intent to evade tax.

FINDINGS OF FACT.

Petitioners are officers and stockholders of the Mayson Manufacturing Co. (hereinafter referred to as the company), which was incorporated in 1929 under the laws of Michigan and engaged in the manufacture and sale of iceless refrigeration parts. The original stockholders of the company and the number of shares held by each were as follows: Frank L. Wurl 400 shares

Edward M. May 300 shares

Lynn L. Hosier 100 shares

The petitioner, Peterson, became a shareholder in 1931 by the purchase of 150 shares from Wurl. The company was authorized *1047 to issue 5,000 shares of $10 par value common stock, but prior to 1936 only the 800 shares above mentioned were issued and outstanding.

Wurl and petitioners had been connected with various iceless refrigeration concerns prior to the organization of the company. They decided to combine their talents, and in the company as ultimately constituted, May acted as designer and engineer, Hosier acted as sales manager, and Peterson acted as shop superintendent and production manager. The combination worked out successfully, and each individual felt that the earnings of the company would suffer should the services of any one of them be lost.

To guard against the possibility of the company going into the hands of an outsider and to keep the stock from getting into the hands of strangers in the event that one of the existing management should die, the stockholders entered into an agreement on July 17, 1934, respecting the method of liquidating the interest of any one of their number who should either die or sever his connection with the company. The parties to this agreement were the four stockholders (i.e., petitioners and Wurl), the company, and the Equitable Trust Co. (hereinafter *1048 referred to as the trustee). By the agreement, each stockholder deposited his stock with the trustee, reserving the rights to dividends and to vote the stock. The company took out policies of insurance on the life of each stockholder and deposited them with the trustee, continuing, however, to pay the premiums. The trustee agreed, upon being advised of the death of a stockholder, *104 to collect the proceeds of the policy and pay it over to the decedent's estate. After making this payment, the trustee was then to deliver to the company as many of the decedent's shares as could be paid for with the proceeds of the policy, at the agreed per share value of $200 plus a proportionate amount of the company's surplus. Any excess proceeds would belong to the company, and, if the proceeds of the policy were insufficient to buy all of the decedent's stock, the company had the option of advancing sufficient funds to buy the remaining stock within 60 days. The company had a similar option in case one of the stockholders elected to sell his shares.

Wurl died in April 1936, and the company purchased his shares at approximately $282 per share, pursuant to the above agreement. On *1049 July 15, 1936, the agreement was amended to cover the changed situation, but the general scheme remained the same. Wurl's death left the division of stock ownership as follows: Edward M. May 300 shares

Lynn L. Hosier 100 shares

Otto Peterson 150 shares

From 1929 to 1934 the company retained its profits to be used as additional working capital. In 1935 a dividend of $40,000 was declared and paid.

As 1936 progressed, it became apparent that the company was making substantial earnings. Petitioners found themselves faced with a dilemma: If the company retained its surplus, it became liable to the provisions of section 102 of the Revenue Act of 1936; if it distributed its surplus in the form of dividends, petitioners became liable for additional surtaxes. Accordingly, they decided to expand and diversify the stock ownership of the company in order that dividends might be spread more widely and surtaxes avoided. The method for accomplishing this, undertaken upon advice of competent counsel, was to sell additional shares of stock to members of petitioners' families. Counsel advised that these sales must be bona fide and that the new stockholders must actually *1050 buy the stock.

On November 28, 1936, petitioners met as directors of the company and resolved to increase its outstanding capital stock for the stated purpose of securing additional needed working capital. Up to 4,200 shares of $10 par value common stock were to be sold to persons selected by the directors, with rights in the existing stockholders to purchase all or part of the additional issue. On December 11, 1936, the Michigan Corporation and Securities Commission authorized the issuance of 4,200 shares of the company's unissued common stock at a price of $10 per share.

*105 The additional stock was subscribed for by and issued to the following persons, who paid for the stock at the rate of $10 per share: Shares

Ella C. Peterson, daughter of Otto Peterson 225

Inez G. Peterson, daughter of Otto Peterson 225

Olive M. Hosier, wife of Lynn L. Hosier 200

V. June Hosier, daughter of Lynn L. Hosier 50

M. Jeanne Hosier, daughter of Lynn L. Hosier 50

Christine G. May, wife of Edward M. May 900

The stock was issued on December 12, 1936. On the same day each of the new stockholders executed an agreement with the company, somewhat similar to the *1051 agreement entered into by petitioners with the company and the trustee. By these new agreements, each subscriber agreed that she would not sell or dispose of the stock during the existence of petitioners' agreement without the consent of petitioners, that in the event of the death of her relative (husband or father, as the case might be) or of his election to sell his stock, her stock would be subject to purchase by the company at the same price as that to be given for her relative's stock, that she would be bound by the terms of petitioner's agreement, and that she would deposit her stock certificates with the secretary of the company. The lives of the new subscribers were not insured. Thereafter, each of the new stockholders. endorsed her certificates in blank and deposited them with Hosier, the secretary.

Petitioners, the company, and the trustee amended their agreement on December 12, 1936, conformably to the execution of the agreements with the new stockholders. On the same day they formally waived their rights to purchase the shares issued to the new stockholders.

On December 15, 1936, petitioners as directors of the company declared a cash dividend of $50 per share *1052 to all stockholders of record, payable on December 26, 1936. The new stockholders received checks from the company covering their dividends; and petitioners' personal accounts with the company were credited with petitioners' dividends.

The details of the acquisition of stock in the company by the new stockholders were these. Hosier told his wife and two daughters that the company was thinking of selling some additional shares and asked them if they would like to buy some. They said they would. Hosier and his wife maintained a joint bank account, upon which she had unlimited authority to draw, and upon which she drew a check for $2,000 to cover the purchase price of her stock. When she subsequently received the dividend check, which was in the amount of $10,000, she deposited it in the joint account. The *106 two daughters bought their stock on credit, although Hosier was financially able to loan them the purchase price. That is, on December 29, 1936, they opened joint accounts with their mother and deposited the dividend checks received from the company therein. Then they drew upon the accounts for the purchase price of their stock. Hosier never exercised any control *1053 over their joint accounts with their mother.

Mrs. May had long been wanting to buy stock in the company, her husband having criticized her other investments. When May told her that stock was available, she at once decided to buy some. She did not know what the stock was worth or what dividends it would carry, and she was surprised at the dividend she received. She maintained a savings account, a safe deposit box to which she alone had access, and a joint account with her husband. During the year 1934 May had given her $35,000, which he had duly reported for gift tax purposes. She had placed part of this in her savings account and part in her safe deposit box. At the time of purchasing stock in the company, she withdrew $10,000 cash from her safe deposit box and opened an individual commercial account. Upon this latter account she drew a check for $9,000 to the company to pay for the stock. On December 29, 1936, she received a dividend check in the amount of $45,000. Of this she placed $10,000 in her individual commercial account, $10,000 in her safe deposit box and $25,000 in her savings account.

Peterson told his daughters around Thanksgiving of 1936 that he was going *1054 to make them a Christmas present of $2,500 each. In December, he told them that there was stock in the company for sale and asked them if they would like to buy some. They said they would, and he told them they would have to execute agreements with the company similar to the one to which the existing stockholders were parties. He also told them that they could buy the stock out of the money he was giving them for Christmas. Each daughter thereafter opened a joint account with her father, deposited her Christmas check therein, and later drew upon the account in the amount of $2,250 to pay for her stock. Likewise each daughter deposited her dividend check, which was in the amount of $11,250, in her joint account. Peterson had two other joint accounts with his daughters, as well as an individual account, and made withdrawals from them occasionally for his own use. He never made a withdrawal from either of the two new joint accounts opened in December 1936 to take care of the purchase of the company's stock, except to buy other securities for the account of the daughters.

None of the petitioners ever had any agreement with the members of their respective families as to the ownership *1055 of the stock of *107 the company, nor did they exercise any dominion or control over the stock, nor receive any of the dividends upon the stock owned by members of their families actually or constructively. Each of the new stockholders executed proxies to vote the stock purchased by them at the stockholders' meetings, the holder of the proxy in each case being the husband or father of the new stockholder.

The company deposited in its account all the checks received by it in payment for the new stock. In 1937 it paid dividends of $35 per share and checks covering the dividends were sent to the new stockholders and deposited by them in the same manner as the dividends received in 1936.

All of the new stockholders filed income tax returns for 1936 and 1937, reported therein the dividends received from the company, and paid the income tax thereon.

The petitioners, during the taxable year, owned none of this Mayson stock issued to the members of their families.

None of the returns filed by petitioners for 1936 were false and fraudulent with intent to evade tax.

OPINION.

LEECH: Respondent taxed to the respective petitioners the dividend of $50 per share, paid during *1056 the taxable year on the treasury stock issued to the members of their respective families. He did this upon the premise that these shares of stock thus issued were then actually owned by the respective petitioners. He cites , and , as authority for his determination of the existence of this premise here.

We do not think either case is in point except as they support the fundamental concept, recognized here, that substance and reality shall prevail in tax matters over form and unreality.

Our sole inquiry is whether, in fact, this stock was owned by petitioners after its issue to the members of their families. If it actually belonged to the members of the petitioners' families to whom it was issued - regardless of whether they acquired it by gift or purchase - then it did not belong to petitioners and the dividends thereon, basing the deficiencies, are not taxable as income of petitioners.

It is true the alleged purchases of some of this stock were necessarily financed by the petitioners, individually, or by the corporation which they controlled. *1057 See ; ; affd., . It may be that an obligation to "purchase" such stock arose upon receipt of these finances. See ; . But those *108 facts establish only that the transactions were gifts of the stock and not sales. They do not contradict the ownership of this stock by the persons to whom it was issued.

Nor does the absurdly low price at which the stock was issued do so. That fact, in view of the close family relationship, may have indicated an intention to make a gift at least of the excess value. See ; affd., ; see also sec. 503, Revenue Act of 1932. But the existence of the option to buy this newly issued stock, under specified conditions, not at that low figure but at approximately book value, is evidence of the acquisition of real ownership of the stock by the record holders and not contradictory of that fact. *1058 ; affd., ; ; affd., ; . Similar options were outstanding against petitioners' stock and there is no dispute as to its ownership.

That some of the recipients of this stock and the dividends in dispute deposited these dividends in accounts to which the respective petitioner to whom they were related were parties, is of little significance. Those moneys were never used except as the funds of the recipient.

This stock, after appropriate legal procedure, was issued to the several members of petitioners' families and has remained there. None of the petitioners have exercised nor attempted to exercise any control over the stock except by proxies voluntarily executed - a circumstance certainly not unusual in view of the family relationship. See . These record stockholders received not only the contested dividends but other dividends in later years - all of which they returned *1059 as their own income and paid the income tax thereon. See .

Though this record may disclose that, as a bona fide sale and purchase, this stock issue to the members of petitioners' families is heavily tainted with sham and unreality, the same evidence convinces us that the transfer of title to that stock to those record owners was actual and absolute. That conclusion disposes of our only inquiry in these proceedings. It follows that there are no deficiencies and therefore no fraud penalties.

It would appear from this record that the petitioners or the corporation are taxable on the transfer of this stock as gifts (see Revenue Act of 1932, sec. 503), but that question is not before us.

Reviewed by the Board.

Decisions will be entered for the petitioners.