McKelvy v. United States

SkeltoN, Judge,

dissenting :

I respectfully disagree with the opinion of the court in this case. The court has restricted itself to what it describes as the “sole question” and the “narrow question” of whether the April 12, 1969, transaction was a taxable dividend 'to the extent of earnings and profits of McKelvy Furniture, Inc., in the sum of $14,378.80 for its fiscal year ending January 31, 1970. In so limiting its opinion, the court has erred. Such question is “narrow,” indeed, but it is not the “sole” question in the case. This restriction of the court’s decision to this isolated transaction leaves many questions unanswered and many issues undisposed of. In fact, the April 12, 1969, transaction, instead of being the controlling factor in this case, is, for all practical purposes, irrelevant and immaterial, because it did not materially alter the position of the taxpayers, nor change the situation that already existed as of January 31, 1969, as will be shown below. Actually, the April 12, 1969, transaction related back to the actions of the directors on January 30 and 31,1969.

In Union Pacific R.R. v. United States, 185 Ct. Cl. 393 , 401 F. 2d 778 (1968), cert. denied, 395 U.S. 944 (1969), we held that where a series of events have occurred in a case, it is not proper to decide the case on the basis of the most recent event, but it is necessary to consider all of the events and view the case from its four corners. In that case, the plaintiff was seeking to recover a refund of excess profits taxes for the year 1942 by increasing its equity invested capital. It had issued bonds in 1901 and 1907 that were convertible into common stock on a fixed par value basis for both. Many years later the bonds were converted into stock. The plaintiff contended that the court should look only to the situation existing at the time of conversion and by so doing it would be allowed to include the increased fair market value of the stock in its equity invested capital. We held that the case should not be decided by considering only the *577 most recent transaction (the bond-stock conversion), but that we had to go back to the beginning and consider all of the events that had occurred. There we said:

* * * It is necessary, to go back to the beginning of the transaction and consider all of the facts from that time up to and including the conversion of the bonds for the stock and look at the case from its four corners. The plaintiff would have us consider only what happened at the time of the conversion as if the exchange of the bonds for the stock was a new and independent act with no connection with what had transpired before. This we cannot do, as “the tail must go with the hide.” [ 185 Ct. Cl. at 400 ,401F. 2d at 781.]

In like manner in the case before us, the defendant would have us consider only what happened at the time of the transaction on April 12, 1969, as if that transaction was a new and independent act with no connection with what had transpired before. The court has agreed to this line of reasoning and in so doing has fallen into error, as will be fully shown below.

This case, like all tax cases involving Subehapter S corporations, appears at first glance to be difficult of solution because of the complicated nature of the statutes and regulations governing such corporations. However, by starting at the beginning and considering all of the events and transactions that have transpired up to and including the most recent event of April 12, 1969, and applying the applicable law to them in sequence, we find that the various elements and segments of the case fall logically into place and as a consequence, the solution of the case is not nearly as difficult as it first appeared.

Therefore, starting at the beginning and going forward we find the following events and transactions occurred, some of which are mentioned by the court, but most of which were ignored by it in deciding the case.

The McKelvy Furniture, Inc., is a Texas corporation chartered under the laws of that State on February 1,1959. From the beginning it was a small business corporation under Subchapter S of the Internal Revenue Code of 1954, as amended, 26 U.S.C. §§ 1371-1378 . The plaintiffs are the sole stockholders of the corporation and have been such since *578 the corporation was chartered. The taxpayers were on a calendar year basis, but the corporation was on a fiscal year basis ending on January 81 of each year during the years involved in this case. The corporation terminated its election to be a small business corporation under Subchapter S for its fiscal year ending January 31, 1970.

On January 31, 1969, the balance sheet of the corporation showed the following:

Asseis

Cash_ $3, 465. 86

Trade Notes and Accounts Receivable- 261,197. 48

Inventories_ 172, 811. 55

Buildings and other Fixed Depreciable

- 14, 452. 44

Finance Reserves_ 15, 125. 74

Utility Deposits_ 385. 37

Total Assets_$467, 438. 44

Liabilities and Shareholders’ Equity

Accounts Payable_$100, 595. 34

Mortgages, Notes, Bonds payable in less than one

year_ 252, 798. 45

Dividends Payable_ 22, 987. 91

Payroll Taxes Payable_ 1, 795. 28

State Sales Tax Payable_ 4, 466. 49

Capital Stock_ 84, 000. 00

Paid-in or Capital Surplus_ 718. 67

Shareholders’ Undistributed Taxable Income_ 76. 30

Total Liabilities and Shareholders’ Equity.- $467, 438. 44

This balance sheet shows that the corporation was highly solvent with assets far exceeding its liabilities. It further shows that the basis of taxpayers in their stock was $84,000. Of particular significance is the showing on the balance sheet that as of January 31, 1969, the corporation owed dividends payable to the stockholders in the sum of $22,987.91.

The stipulation further shows the following facts that are important in this case. The earnings and profits (undistributed taxable income) for years prior to the beginning of the fiscal year ending on January 31, 1969, was $36,017.97. This sum had become what is known under Section 1376 of the Internal Revenue Code of 1954, 1 and Treasury Regula *579 tions on Income Tax (1954 Code) Section 1.1376-1, as previously taxed income (PTI), since the taxpayers had paid income tax on these earnings and profits during previous years (prior to 1969) in accordance with Section 1373(b) of the 1954 Code, even though such earnings and profits had not been distributed to them in such prior years.

The earnings and profits of the corporation for its fiscal year ending January 31, 1969, was $21,058.33. This sum is known as undistributed taxable income (UTI), within the meaning of Section 1373(c), during the fiscal year in which the income is earned, and the stockholders (plaintiffs) were required to pay (and did pay) income taxes on it in accordance with Section 1373(b) whether it was distributed to them or not.

The facts further show that prior to January 30,1969, the plaintiffs 'as stockholders had borrowed $34,012.09 in cash withdrawals from the corporation, which was reflected on the books of the corporation. On said date, the corporation had $3,465:86 in cash on hand.

This was the situation that existed on January 30, 1969, when a directors meeting was held and the following resolution was adopted:

RESOLVED, That there be declared, and there is hereby declared, a dividend payable to the shareholders of record at the present time in the amount of $57,000, such dividend to be paid as follows: All accounts receivable from R. Hugh McKelvy and Robert PI. Mc-Kelvy shall be forgiven and cancelled on January 31, 1969 and the balance of such dividend of $57,000 shall be paid in cash on or before April 15,1969.

On January 31, 1969, the last day of the corporation’s fiscal year, the corporation canceled on its books the debts the taxpayers owed the corporation in the total sum of $34,012.09 ($23,363.83 owed by Robert H. McKelvy and $10,648.26 owed by R. Hugh McKelvy), and entered an item on its books showing additional dividends payable to taxpayers in the sum of $22,987.91. (See balance sheet entries above.)

Before determining the legal effect of all of the foregoing facts, events, and transactions on the income tax position of the taxpayers as stockholders in this Subchapter S corporation, the following facts as they existed on January 31,1969, *580 should be re-emphasized, because they are controlling in the solution of the issues in this case:

1. Taxpayers had a basis of $84,000 in their stock.

2. The corporation had on hand $36,017.97 previously •taxed income (PTI).

3. The corporation had earnings and profits for fiscal year ending January 31, 1969, the sum of $21,058.33, which was undistributed taxable income.

4. The corporation was highly solvent with assets that far exceeded its liabilities. (See balance sheet.)

5. The corporation cancelled the debts of the stockholder-taxpayers in the sum of 34,012.09 on January 31,1969.

6. The corporation became indebted to the stockholder-taxpayers in the sum of $22,987.91, by the action of the directors on January 30 and 31,1969.

By the application of the complex statutes governing Sub-chapter S corporations (Sections 1371-1378) and Regulations 1.1371-1.1378, together with statutes governing Chapter C Corporations (Sections 301-318) which are applicable when not in conflict with Subchapter S sections, it is clear that the actions of the directors and of the corporation on January 30, 1969, in declaring the dividend and on January 31, 1969, in cancelling the debts of the taxpayers on its books in the sum of $34,012.09 and in making entries on its records of an indebtedness owing by the corporation to its stockholders (the taxpayers) in the sum of $22,987.91, resulted in two significant events that affect the rights of the taxpayers. These were (1) the cancellation of the debts of the stockholders was a distribution to them in money of the amount of their debts in the total sum of $34,012.09; and (2) the creation of the dividend indebtedness in the sum of $22,987.91 owing by the corporation to the stockholders by the resolution and entries on its books was a distribution of property (a corporate obligation) by the corporation in January 1969, to its stockholders.

I will discuss these events and their legal effect on the issues in this case in the order named. The decided cases support the principle that the cancellation by a corporation of a debt owed to it by a stockholder is a distribution in money *581 to the stockholder at the time of the cancellation. Probably the leading case on this subject is Cohen v. Commissioner, 77 F. 2d 184 (6th Cir. 1985), cert. denied, 296 U.S. 610 . In that case, the stockholders had made cash withdrawals from the corporation from 1913 to 1927, which were charged as a debit on the corporation’s books. In 1928 the corporation’s directors by resolution cancelled these debts. The question before the court in that case was the determination of when was the distribution of the money made to the stockholders. They contended that since no cash or any other property had been received by them in 1928, the cancelled amounts could not be income to them in that year. The court decided otherwise, saying:

* * * [Tjhere was no evidence of any distribution by the corporation prior to the adoption of the resolution of 1928. * * *

❖ * * * *

* * * It was this action in October, 1928, which gave to the petitioners an indisputable right to the amounts previously advanced to them and effected a distribution of the accumulated earnings of the company. The Commissioner properly included them in the petitioners’ income for the year 1928. [Id. at 185-86.]

The same situation existed in Hudson v. Commissioner, 99 F. 2d 630 (6th Cir. 1938), cert. denied, 306 U.S. 644 , where the directors of a corporation cancelled by resolution the cash withdrawals theretofore made by stockholders. The court there held that the distribution occurred in the year the debts were cancelled, saying:

This court has held in Cohen v. Commissioner, 6 Cir., 77 F. 2d 184 that cash withdrawals from a corporation made by its stockholders constitute dividends in the taxable year during which corporate action was taken canceling or charging off such accounts against surplus.

* * *

* * * We conclude that the principle announced in Cohen v. Commissioner, that there was a distribution of profits, and that income accrued at that time, controls. [Id. at 632.]

See also Fitch v. Helvering, 70 F. 2d 583 (8th Cir. 1934); and Wiese v. Commissioner, 93 F. 2d 921 (8th Cir. 1938).

*582 The cancellation of the debts of the stockholders, being a distribution of money, is a non-taxable distribution and is allocated to the earnings and profits of the taxable year ending January 31,1969 (on which the stockholders have already paid taxes), in accordance with 26 U.S.'C. § 1375(b) 2 and Income Tax Eegulation § 1.1373-1 (d) . 3 Since the earnings and profits for that year were $21,058.33, the distribution of the $34,012.09 in money to the stockholders by the cancellation of their debts is allocated to the $21,058.33 of earnings and profits. This results in the elimination of all of such earnings and profits for that year. However, since the $34,012.09 distribution exceeds the earnings and profits of $21,058.33 by the sum of $12,953.76, such amount is a distribution in money that cannot be allocated to earnings and profits (UTI) since they have been eliminated. The question then arises as to how this excess money distribution in the sum of $12,953.76 can be disposed of. The answer is found in Section 1375 (d) (1) which provides as follows:

§ 1375. Special rules applicable to distributions of electing small business corporations.

(d) Distributions of undistributed taxable income previously taxed to shareholders.

(1) Distributions not considered as dividends.

An electing small business corporation may distribute, in accordance with regulations prescribed by the Secretary or his delegate, to any shareholder ail or any portion of the shareholder’s net share of *583 the corporation’s undistributed taxable income for taxable years prior to the taxable year in which such distribution is made. Any such distribution shall, for purposes of this chapter, be considered a distribution which is not a dividend., but the earnings and profits of the corporation shall not be reduced by reason of any such distribution.

Regulation 1.1375-4(a) is also applicable. It provides in pertinent part as follows:

§1.1375-4 Distributions of previously taxed income

(a) In general. Under section 1375(d) (1), a distribution by an electing small business corporation to a shareholder of all or any portion of his net share of previously taxed income is considered a distribution which is not a dividend. Such a distribution reduces the basis of the Shareholder’s stock in the corporation in accordance with section 301(c)(2), and, if it exceeds such basis, is subject to the provisions of section 301 (e) (3). The earnings and profits of the corporation are not reduced 'by reason of such a distribution. * * *

Also, Regulation 1.1375-4 (b) provides in pertinent part as follows:

(b) Source of distribution. * * * [A] distribution of previously taxed income may occur only if during its taxable year the corporation makes such money distributions in excess of its earnings and profits for such taxable year. * * * [Emphasis supplied.]

It is clear that this statute and these regulations authorize the distribution of previously taxed income (PTI) by a corporation to its stockholders in money as a non-taxable distribution that is not a dividend. In this case, there was $36,017.91 PTI from prior years. Accordingly, the $12,953.76 excess money distribution became a non-taxable distribution to that extent out of the previously taxed income of $36,017.91, thereby reducing the PTI to $23,064.15.

At this point, we have eliminated the earnings and profits (undistributed taxable income) of $21,058.33 for fiscal year 1969 and ¡have reduced the previously taxed income of $36,017.91 to the sum of $23,064.15.

We now reach the question of the effect of the second part of the dividend declared on January 30, 1969, namely, the creation of a debt owing by the corporation to its stockholders *584 in the sum of $22,987.91 by tlie resolution and by entering the indebtedness on its books and records on January 31, 1969.

The authorities are unanimous in holding that the declaration of a dividend creates a debt against the corporation in favor of the stockholders. One of the leading oases on this question is Bulger Block Coal Co. v. United States, 71 Ct. Cl. 636 , 48 F. 2d 675 (1931), wherein this court reviewed many cases on this subject, in pertinent part as follows:

The leading authorities on the relation of a stockholder to a corporation after a dividend has been declared are reviewed in the case of W. E. Caldwell Co., Inc., 6 B.T.A. 47, 51-52 , in which it is said.:

“The reasoning advanced in the Stange case [ 1 B.T.A. 810 ] was to the effect that upon the declaration of a dividend the corporation immediately becomes the debtor of the stockholder for his proportionate part of the dividend, regardless of the fact that actual payment is not to be made until later. There is abundant authority for this proposition and we have seen no authority to the contrary.”

Reference is further made to the case of Wheeler v. Northwestern Sleigh Co., 39 Fed. 347 , wherein the court declared:

“By the declaration of a dividend, however, the earnings, to the extent declared, are separated from the general mass of property, and appropriated to the then stockholders, who become creditors of the corporation for the amount of the dividend. The relationship of the stockholder to the corporation, as to the amount of the dividend, is thus changed from one of partnership ownership to that of creditor. He thereafter stands * * * with respect to the dividend, as creditor upon a par with other creditors of the corporation. * * * That the dividend is payable at a future date can work no distinction in the right. The debt exists from the time of the declaration of dividends, although payment is postponed for the convenience of the company.” (Italics ours.)

That the same rule has been laid down by all of the leading text writers on corporations is shown in Stoats v. Biograph Co., 236 Fed. 454 , in which, after quoting from Taylor on Corporations, 5th ed., sec. 568; Machen on Modern Law of Corporations, vol. 2, sec. 1358; Morawetz on Corporations, vol. 1, sec. 445, the opinion recites.

*585 “But if a board of directors should declare a cash dividend and make a public announcement of the fact, the courts have held that thereafter the board has no right to reconsider and rescind its action. The reason seems to be that the declaration of the dividend sets apart from the profits of the corporation a sum which is to be paid to the stockholders in proportion to their shares, and that it creates a debt due from the corporation to each shareholder, resulting in the relation of debtor and creditor. A dividend divides the property which belongs to the corporation into that which the corporation retains and that which the corporation agrees to pay to the stockholders, and which it is thereby bound to pay. That which one person is bound to pay to another is a debt. Lockhart v. Van Alstyne, 31 Mich. 76, 78 ; 18 Am. Rep. 156 (1875).” (Italics ours.)

*****

In McLaran, Administrator v. Crescent Planing Mill Co., 117 Mo. App. 40, 49 , after reviewing the authorities on this point and quoting at length from leading text writers on the subject, the court reached the conclusion that—

“The doctrine is that by the mere declaration, the dividend becomes immediately thereby separated and segregated from the stock and exists independently of it; that the right thereto becomes at once immediately fixed and absolute in the stockholder, and from thenceforth the right of each individual stockholder is changed by the act of declaration from that of partner and part owner of the corporate property to a status absolutely adverse to every other stockholder and to the corporation itself, in so far as his pro rata proportion to the dividend is concerned.” (Italics ours.) [Id. at 642-43, 48 F. 2d at 678 .]

We find the following statement in 18 C.J.S. Corporations § 467:

The declaration of a dividend creates a debt against the corporation in favor of each stockholder to the amount due him as his pro rata share, and this is true although the dividend is made payable at a future date, or “at the pleasure of the company,” or at “such time as may be directed by the board.” * * * [Footnotes omitted.] [Id. at 1114-15.]

See Chesapeake & Del. Canal Co. v. United States, 250 U.S. 123 (1919); Bryan v. Welch, 74 F. 2d 964 (10th Cir. *586 1935), cert. denied, 295 U.S. 748 ; Commissioner v. T. R. Miller Mill Co., 102 F. 2d 599 (5th. Cir. 1939); Lamberth v. Commissioner, 120 F. 2d 101 (9th Cir. 1941); Kraft Foods Co. v. Commissioner, 282 F. 2d 118 (2d Cir. 1956) ; and Roe v. Commissioner, 192 F. 2d 398, 403 (5th Cir. 1951), rev’g 15 T.C. 503 .

In Kraft Foods Co. v. Commissioner, supra, the court said:

Further, the doctrine that a dividend creates a debt in favor of the stockholder has always been accorded full legal recognition in tax cases. * * * [Footnote omitted.] [Emphasis supplied.] [Id. at 126.]

The instant case being a Texas case, the decision in (Commissioner v. Cohen, 121 F. 2d 348 (5th Cir. 1941), is particularly in point. In that case the court said:

* * * Under the law of Texas, a declaration of dividends creates a debt owed by the corporation in'favor of each stockholder which cannot be rescinded. Although the declaration of this dividend 'provided that the sums thereunder were payable to the stockholders of record at such times and in such installments during the year as the directors saw fit, the liability of the company accrued as of the date of the declaration, which was prior to the taxpayer’s death. * * *

* * * The stockholder receives the value of a dividend when it is declared, for if it is immediately paid he has his stock and his dividend, and if payment is deferred he has the value of his stock increased by the amount of the dividend upon it. * * * [Footnote omitted.] [Id. at 349.]

It appears from these authorities that there can he no dispute of the proposition that in the instant case the directors created a corporate debt on January '30,1969, in favor of the stockholders in the sum of $22,987.91. This debt was an obligation of the corporation. It was distributed to the stockholders not only by the written resolution of January 30, 1969, but also by the entries on its books and records on January 31, 1969. This was accomplished as effectively by the method used as would have been the case if it had executed notes for the debt and issued them to the stockholders. No citation of authority is necessary to show that a debt or *587 obligation of a corporation owed to its stockholders or anyone else is property. It can be assigned, pledged or sued on if not discharged when due. Therefore, it logically follows that the corporation distributed property of the value of $22,987.91 to its stockholders on January 30 and 31, 1969, by the dividend declaration and book entries.

Although the court in its opinion in this case does not discuss the fact that a Subchapter S corporation can distribute property, as distinguished from money, it is clearly permissible and is in fact authorized and contemplated by the statutes and regulations. See Sections 301(a) and (c), 312(a) and 316 (a) of the Code and Sections 1.1373-1 (d) and 1.1375-4(b) of the Income Tax Regulations. Regulation 1.1373-1 (d) provides in pertinent part:

* * * Therefore, such distributions of money are dividends from earnings and profits of the taxable year to the extent of such earnings and profits even though there may he distributions of property other than money during sueh taxable year * * *. [Emphasis supplied.]

Regulation 1.1375-4 (b), although recognizing that property may be distributed, places a restriction on how it may be allocated, provides in pertinent part:

* * * Thus, a distribution of property other than money * * * is never a distribution of previously taxed income [PTI]. * * * [Emphasis supplied.]

Thus, it is clear that although property, as distinguished from money, may be distributed, it cannot be allocated to previously taxed income. To put it another way, previously taxed income cannot be distributed as a non-taxable distribution in the form of property. 4 It can only be distributed in money. This means that although there is still $23,064.15 of previously taxed income available, it cannot be allocated to the debt distribution of property to the stockholders in the sum of $22,987.91. What then do we do with this distribution of property? The answer is found in Sections 301(a) and (c) and 316, as well as in decided cases to be discussed later, which provide that if a dividend is not paid out of earnings and profits of the taxable year, it “shall be applied *588 against and reduce tire adjusted basis of the sto'ck.” See Pitcher & Vance, “Loehed-in-Earnwigs” — How Serious a Problem Under Subchapter S, 49 Va. L. Rev. 1516 , 15B0 (1963). Also, see George A. Roesel, 56 T.C. 14, 27 (1971), where the court said:

* * * To the extent that the notes and debentures received by petitioners [a distribution of property other than money] are not deemed to be out of Milling’s earnings and profits, the basis of petitioners’ respective stock in Milling will be reduced pursuant to the provisions of section 801 of the Code.

Accordingly, the distribution of property to the stockholders in the form of the corporate debt in the sum of $22,987.91, must be applied to a reduction of the basis of the stockholders in their stock which was $84,000, thus leaving their basis in the stock in the sum of $61,012.09.

The foregoing was the situation of the taxpayers and the condition of the corporation at the end of its fiscal year ending January 31,1969. At that time it elected to terminate its status as a Subchapter S corporation. Then came the transaction of April 12, 1969, which, for all practical purposes, was the only part of the case considered by the court. On that date the corporation issued its checks to the taxpayers in the sum of $22,987.92. The taxpayers endorsed the checks and deposited $22,750.01 to the credit of the corporation, retaining $237.91 in cash.

Before considering what effect this transaction had on the rights of the taxpayers, I would like to point out that much of the court’s opinion was devoted to a discussion of two questions that are no longer in the case, namely, (1) whether the taxpayers had constructive receipt of the corporate debt dividend to them on January 30 — 31, 1969, and (2) whether the issuance of the checks on April 12,1969, within two and one-half months of the close of the corporation’s fiscal year on January 31,1969, was a distribution of money to the taxpayers in the corporation’s fiscal year ending January 31, 1969, within the meaning of Section 1375(f) (1) and Regulation 1.1375-6 (a) (1). Counsel for the taxpayers announced at oral argument that the taxpayers were not relying on either of these propositions. Consequently, I shall not dwell *589 on these questions, as I do not consider that they are material to a decision of the controlling issues in the case.

The effect o'f the check transaction on April 12,1969, was twofold. In the first place, it was a distribution of money in the sum of $237.91 by the corporation to the stockholders within two and one-half months of the close of its fiscal year ending January 31, 1969. However, it does not comply with the requirements of Section 1375(f) and Regulation 1.1375-6 (a) (1) which provide that any such distribution shall be “a distribution of the corporation’s undistributed taxable income for such year” (i.e., in this case the fiscal year ending January 31, 1969), and shall “be considered a distribution which is not a dividend,” because the undistributed taxable income (earnings and profits) for such year was eliminated by the debt cancellation distribution discussed above. Consequently, there was no undistributed taxable income for the fiscal year ending January 31, 1969, to which the cash distribution of $237.91 could be applied. See Bcmddll N. Clark, 58 T.C. 94 (1972). This cash distribution could not be allocated to the remaining previously taxed income in the sum of $23,064.15 because the “carry-back” provisions only authorized money distributions made within two and one-half months of the end of the fiscal year to be allocated to the “undistributed taxable income” of the preceding fiscal year. Therefore, since the distribution of the $237.91 was made in the fiscal year ending January 31, 1970, during which year the corporation was no longer a Subchapter S corporation, such amount must be allocated to the earnings and profits of such year, which were $14,378.30, as a taxable dividend to the stockholders in that year.

However, the second effect of the April 12, 1969, check transaction was entirely different. It will be remembered that after deducting the $237.91 from the checks, the balance in the sum of $22,750.01 was deposited to the credit of the corporation. This was nothing more than a confirmation and evidence of the existence of the corporate debt to the stockholders that was distributed to them on January 30 and 31, 1969, described above. The check transaction of April 12, 1969, except for the retained $237.91, related back to the declaration of the dividend on January 30, 1969, and the *590 entries on the books and records of the corporation on January 81,1969. Proof of this fact is shown by the fact that on January 31,1969, the stockholders had everything by way of corporate indebtedness to them that they had after the check transaction of April 12, 1969. The check transaction added nothing to the corporate debt that had been distributed to the stockholders the preceding January. The stockholders had the same debt and obligation of the corporation, except for the $237.91 retained in cash. The old debt had not been extinguished, and, as far as the record shows, has not been paid as of this date. In all fairness, what did the stockholders get on April 12, 1969, except for the $237.91 in cash, that they did not already have as of January 31,1969?

Clearly, the April 12, 1969, transaction to the extent of the sum of $22,750.01 related back to the events of January 30-31, 1969, and must be regarded as being effective as of January 31,1969. There is compelling and cogent support for such holding in the cases of Commissioner v. Goldwyn, 175 F. 2d 641 (9th Cir. 1949), aff'g 9 T.C. 510 ; George A. Roesel, 56 T.C. 14 (1971) ; DeTreville v. United States, 445 F. 2d 1306 (4th Cir. 1971) ; Zimco Elec. Supply, 40 Tax Court Mem. p. 71-918, para. 71,215 (1971); and Roe v. Commissioner, 192 F. 2d 398 (5th Cir. 1951), rev’g 15 T.C. 503 .

In the Goldwyn case, a dividend was declared in 1930, but it was not paid until 1933. The court held that the declaration of the dividend in 1930 created a debtor-creditor relationship and reduced the accumulated earnings in 1930 and not in 1933 when it was paid as claimed by the Commissioner of Internal Revenue.

In the Roe case, the corporation declared a dividend in 1926 to be paid “as funds were available.” There was not enough on hand in 1926 to pay the dividend. 5 The dividend was paid *591 in 1943 and 1945. The Commissioner contended there were distributions and taxable dividends in 1943 and 1945, which were “made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings or profits.” This is the same argument the government is making in the instant case. The court held in that case that the declaration of the dividend in 1926 created a debtor-creditor relationship and the situation was the same as if the corporation had paid the dividend in 1926 and the stockholders had loaned it back to the corporation. The court further held that the payments of the dividend in 1943 and 1945 were in satisfaction of a debt created in 1926 and were not taxable distributions or dividends in those years.

In the Zimco case, the corporation was a Subchapter S corporation, as in the instant case. There the corporation reported income to a stockholder of $9,023.54 during the fiscal year ending October 31,1963. In the following year, on January 4,1964, the corporation issued its note in that amount to the stockholder. The IRS contended that the stockholder received a taxable dividend when he received the note in 1964, and that it was a distribution out of the earnings and profits in 1964. The court held that the stockholder did not receive a dividend in 1964 in the sum of $9,023.54 and that the stockholder made a loan to the corporation in that amount when the dividend was declared in 1963 and that “the note dated January 4, 1964, was merely evidence of that indebtedness.” [Emphasis supplied.]

The Roesel case squarely supports the relation-back theory of the plaintiffs in this case. The corporation in that case was a Subchapter S corporation whose fiscal years ended February 28,1963, and February 28,1964, respectively. On those dates it declared dividends and issued checks for $345,000 and *592 $165,745, respectively. On March. 1,1963, and March 1,1964, the stockholders issued their checks back to the corporation in the amounts of $117,500 and $69,505, respectively, and received notes therefor from the corporation. The court held that the checks constituted money distributions in fiscal years 1963 >and 1964, respectively, in amounts equal to the differences in the amounts of the checks, namely, $227,500 in 1963 and $96,240 in 1964, and the balance for each year was a property distribution (i.e., a loan back to the corporation and a resulting corporate debt). However, the significant part of the decision was the holding of the court that the transactions occurred on the dates the dividends were declared, namely, February 28, 1963, and February 28, 1964, and not on the dates the stockholders issued their checks back to the corporation on March 1,1963, and March 1, 1964, and received notes therefor, which dates were in the following fiscal years. In that case the court said:

We agree with the respondent that the economic substance of a transaction must govern for tax purposes rather than the time sequence or form in which such transaction is cast. Gregory v. Helvering, 293 U.S. 465 . And it is well established that where a series of closely related steps are taken pursuant to a plan to achieve an intended result the transaction must be viewed as an integrated whole for tax purposes. Redwing Carriers, Inc. v. Tomlinson (C.A. 5), 399 F. 2d 652 , and cases cited therein.

* * * [T]he close proximity in time of the purported loans and the issuance of cheeks by Milling, and the correlation between the amounts purportedly loaned by each shareholder and his interest in Milling, all serve to establish that the purported distributions and loans were but parts of interrelated transactions which must be viewed as such for tax purposes.

* * * Under the circumstances, in substance, the notes and debentures were issued on February 28, 1963, and February 29, 1964. Once an integrated transaction is to be viewed as such for tax purposes, its component parts do not admit of separation. Redwing Carriers v. Tomlinson, supra, and cases cited therein. [ 56 T.C. at 25-26 .]

As will be seen from the foregoing holding of the court in Roesel, “economic substance of a transaction must govern *593 for tax purposes rather than time sequence or form in which such tramaction is cast” [Emphasis supplied.] Furthermore, the court held that where there are a series of closely related steps, the transaction must be viewed as an integrated whole for tax purposes. In this regard, the court held that “once an integrated transaction is to be viewed as such for tax purposes, its component parts do not admit of separation.” [Emphasis supplied.] This holding fits our case like a glove. Here there were a series of closely related steps taken pursuant to a plan to achieve an intended result and they must be viewed “as an integrated whole for tax purposes.” Once this is done, its component parts cannot be separated. Consequently, the April 12, 1969, check transaction, except for the retained cash of $237.91, must be viewed as the last of a series of closely related steps which cannot for tax purposes be separated from the prior closely related steps. Therefore, as in Boesel, the April checks were merely evidence of the dividend declared the previous January and related back to that time. As a matter of fact, as pointed out 'by the court’s opinion in this case, the checks were never regarded by the stockholders and the corporation as payments, except for the $237.91 retained cash, and under those circumstances, as was the situation in the recent case of C. D. and 'Sarah Fountain, 59 T.C. 693 , No. 69, decided February 22, (1973), the checks were not payments of money to the stockholders.

The case of DeTreville v. United States, 445 F. 2d 1306 (4th Cir. 1971) strongly supports the “relation-back” theory of the plaintiffs here. In that case, which involved a Sub-chapter S corporation, a dividend in the sum of $212,868.64 was declared by the corporation on December 31,1960, which was in its fiscal year 1960 and issued checks to its stockholders in that amount the same day. On January 6, 1961, which was in its fiscal year 1961, the stockholders issued their cheeks back to the corporation in the same amount in purchasing shares of insurance stock owned by the corporation equal in value to the previous distribution in 1960. The I960 checks of the corporation and the 1961 checks of the stockholders were deposited the same day, thus counterbalancing each other. The court considered these related steps as one integrated whole and held that the corporate checks issued to *594 the stockholders in 1960 were not distributions of money, but that, considered together, the transactions amounted to a distribution of property. In deciding the tax question the court had to decide when the property distribution took place. The government argued that -it occurred in fiscal year 1960, which was a position exactly opposite to the position it takes m the instmt case. On the other hand, the taxpayers contended that the distribution was made in fiscal year 19 61 when the stock was issued and when they issued their checks to the corporation. The court ruled in favor of the government and held that the distribution was made in fiscal year 1960. In this regard, the court said:

III. The Tear of Distribution

ijs $$$»!<

In this case a 1960 distribution was intended and checks, which represented little more than claim checks on the stock certificates, were issued to the stockholders in that year. Although not controlling, of persuasive significance is the further fact that the certificates were actually dated December 30, I960, the day before the pretensive checks were issued. We think the District Court was entirely correct in holding that the distribution took place in the very year that the company intended it to take place, even if the company and its shareholders were mistaken as to the nature of that distribution. [ 445 F. 2d at 1312 .]

Thus the court related the events that took place in 1961 back to 1960 to conform to the intention of the parties. In like manner, this court should relate the check transaction of April 12, 1969, back to the time of the declaration of the corporate dividend on January 30,1969, and the distribution of the corporate debt to the stockholders on that date by the declaration, as well as by the entries on its books and records on January 31,1969.

The court cites the case of Attebury v. United States, 430 F. 2d 1162 (5th Cir. 1970), as authority against the “constructive receipt” doctrine, which is no longer involved in our case, and also as authority against the “relation-back” theory. To support both arguments, the court says in its opinion that in Attebury “the corporation declared a dividend during fiscal year one.” The court is in error in making this statement, *595 because no dividend was actually declared. There was merely an informal agreement between the stockholders, who were the directors, that during the fiscal year they could make drawings on all of the corporation’s taxable income for the year as if they were dividends. This could not meet the requirements Of a dividend, 'because, among other obvious reasons, the taxable income of the corporation was not even known at the end of its taxable year. In this regard, the court in Attebwry said:

* * * It is clear from the record, and the district court specifically found, that Elevators’ [the corporation] taxable income was unknown on the last day of the corporation’s taxable year. In the light of these findings, it is clear that the alleged dividend distribution was neither credited to the shareholders nor unqualifiedly subject to their demand as of the last day of the corporate taxable year. [Emphasis supplied.] [ 430 F. 2d at 1171 n. 25.]

It is true that the taxpayers in Attebwry contended that there had been a dividend and that they were in constructive receipt of it, and that when the drawings were made by them in the following fiscal year they related back to the previous year as payments of corporate debts. But these contentions were contrary to the facts. It is obvious that there could not be a constructive receipt of a dividend that had never been declared on any date nor for any amount. For the same reason, there could be no relation back. What could the drawings relate back to either as to time, amount or corporate action? Furthermore, no dividend amount was credited on the books or records of the corporation to the stockholders in the previous fiscal year, unlike the crediting of the dividend in our case. The case is clearly distinguishable from the case before us.

One last item should be mentioned. When the corporation ceased to be a 'Subchapter S corporation in 1970, the remaining previously taxed income in the sum of $23,064.15 was required to be added to the basis of the stockholders in their stock, Which basis had been reduced to $61,012.09, as discussed above. Therefore, the stockholders entered fiscal year 1970 with basis in their stock in the sum of $84,076.24. See Sections 1376(a), 1372(b) (2) and Kegulation 1.1376-1.

*596

Qomcbusion

This is not a case of tax avoidance by the taxpayers. They have paid all taxes owing by them on all undistributed taxable income for the fiscal year ending January 31,1969, and on all previously taxed income accumulated prior to 1969. They will pay additional taxes in the future when they sell their stock or liquidate the corporation by reason of the reduced basis of their stock. The government has received and will receive from the taxpayers all of the taxes to which it is entitled. However, the decision of the court in this case imposes double taxation on the taxpayers contrary to the will and intent of Congress when it enacted the Snbchapter S statutes. The purpose of these statutes was to relieve small business corporations of double taxation. See Byrne v. Commissioner, 361 F. 2d 939 (7th Cir. 1966). Thus the decision is contrary to the spirit and purpose of these statutes.

The analysis I have made of this case in the foregoing paragraphs disposes of every question and issue in the case. However, by contrast, the decision of the court leaves the following questions unanswered and undisposed of:

1. The previously taxed income in the sum of $36,017.91.

2. The undistributed taxable income of fiscal year ending January 31,1969, in the sum of $21,058.33.

3. The cancellation of the debts owed by the stockholders to the corporation in the sum of $34,012.09.

4. An illusory amount of $21,463.37 as to which the government says “tax effects not determined by I.R.S.” It is surprising that the court would go along with this “hide and seek” position of the government on this item, and leave it as an “open-end” element of this case. If the government has not been able to make up its mind on this matter after four years, how can anyone have faith in its conclusions as to the rest of the case ?

5. The corporate debt in favor of the stockholders created in January 1969, in the sum of $22,987.91.

These are all important questions and issues in this case. They are closely related and integrated steps in the transactions involved here. Yet, the court leaves them hanging in limbo, with the IRS free to assert other and additional claims *597 according to its whims against the taxpayers with reference to one or more of them in the future if it desires to do so. I do not think this is proper. In my opinion, the income tax problems of the taxpayers for 1969 and 1970 were submitted to the court in this case and they should all be decided. Our responsibility is not discharged by merely considering the last isolated step in a series of closely integrated transactions.

'I would enter judgment for the plaintiffs for the amount prayed for, except for the sum of $237.91 which was received by them in cash on April 12, 1969, which amount should be taxed to them as a dividend out of the earnings and profits of the fiscal year ending January 31,1970.

CONCLUSION OP LAW

Upon the foregoing opinion, which contains the essential findings of fact as stipulated by the parties, the court concludes as a matter of law that the plaintiffs are not entitled to recover, and the petitions are therefore dismissed.

A11 references to statutory tax provisions are to the Internal Revenue Code of 1954, as amended.

§ 1375. Special rules applicable to distributions of electing small business corporations.

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(b) Dividends received credit not allowed.

The amount includible In tbe gross Income of a shareholder as dividends from an electing small business corporation during any taxable year of the corporation (including any amount treated as a dividend under section 1373(b)) shall not be considered a dividend for purposes of section 37 or section 116 to the extent that such amount is a distribution of property out of earnings and profits of the taxable year as specified In section 316(a) (2). For purposes of this subsection, the earnings and profits of the taxable year shall be deemed not to exceed the corporation’s taxable income (computed as provided in section 1373 (d) for the taxable year.

§ 1.1373-1 Corporation undistributed taxable Income taxed to shareholders.

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(d) Determination of dividends In money out of earnings and profits of the taxable year. In applying section 316(a) to distributions by an electing small business corporation, earnings and profits of the taxable year are first allocated to actual distributions of money made during such taxable year * * *.

Pitcher & Vance, “Loclced-In-Barnlngs" — How Serious a ProVlem Under SuUhapter S, 49 Va. L. Rev. 1516 ,1530 (1963).

The court in the instant ease emphasizes the fact that the corporation only had on hand the sum of $3,456.85 in cash when it declared the dividend on January 30, 1969. This is immaterial in view of the sound position of the corporation. The same situation existed in the case of A.D. Saenger, Inc. v. Commissioner, 84 F. 2d 23, 25 (5th Cir. 1936), cert. denied, 299 U.S. 577 , where the court said :

“* * * That A. & J., Inc., did not carry cash on hand sufficient to pay what it had unreservedly put to the credit of A, D. Saenger, Inc., [the dividend *591 to tlie stockholder]; is unimportant. It could on demand have borrowed it or raised it by sale of some of its investments. * * *”

This holding was approved and quoted by the court in Roe v. Commissioner, supra, at 403. This principle is particularly applicable to the instant ease where the balance sheet of the corporation showed it had, in addition to the cash, trade notes in the sum of $261,197.48, inventories of $172,811.55, financial reserves of $15,125.74, plus its building valued at $40,630.13. It could no doubt have borrowed the entire amount of the dividend by making a telephone call to a bank. It could certainly have done so by pledging some of the above assets.