# Petition — Shimberg v. United States

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition
- **Published:** January 1, 1979
- **Citation:** 439 U.S. 1115

## Text

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| OCT 25 197¢
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In the Supreme Court of the Unde BRERA 8

ee
OCTOBER TERM, 1978

No. 78-698

MANDELL SHIMBERG, JR., and ELAINE F. SHIMBERG,
Petitioners,

V.

UNITED STATES OF AMERICA,
Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT

SHERWIN P. SIMMONS
Post Office Box 1102
Tampa, Florida 33601
Attorney for Petitioners
Haroutp W. MUuLLIs, JR.
WILLIAM KALISH
Davip A, PEARSON
TRENAM, SIMMONS, KEMKER, Gomans.
BARKIN, FRYE & O’NEILL,
PROFESSIONAL ASSOCIATION

Post Office Box 1102
Tampa, Florida 33601

Of Counsel

E. L. MENDENHALL, INc., 926 Cherry Street, Kansas City, Mo. 64106, (816) 421-3030

INDEX

II dis J saireencsieclccpncsivartisonckeagosvenasadas. + -iaSbenons 2
I ia a8 hoo ci cence eeieenitcesenmnnciconsorisumace laden 2
I er cs shondiniosenisoneantanshinbainbabagiacieeelo 2
Statutory Provisions Involved -.......0.22....2.--ccccecccesseeesesseees 3
ea NE MN eee PL 5
Reasons for Granting the Wit 0.0.2.2... .cecscssssseseeeseeees 8

1. The Decision of the Fifth Circuit in This Case

Is in Direct Conflict With Decisions of the Courts

of Appeals for the Second and Eighth Cir-its
BE ee 8

2. The Decision Below Sanctions a Bifurcation of

an Integrated Transaction Contrary to the Step

Transaction Doctrine, Section 356(a)(2) and the

Decision of the Eighth Circuit in Wright v.
NRE shea einen RE SCN DOES Zs 11
ERE et ch an Cee OTE aE EOI CP nO PE AE 13
a ES saphsiikcneintinciiarcarinsien ahs etaccandaponsiotehielabaiasaacuasaslaoansane Al
IE TEE. tn cerdanustacpetscanthiniashannsselgntoeunindiselusdamhaoanscancuoeiele All
I hn ical ila csc seintnaegreedalapneeasiidipienabmenessadsbentaaile Al2
SERIE EC ERENCES RD EE A27

Citations
CASES

Alabama Asphaltic Limestone Co., Helvering v., 315
5 Ry 2). SXetananaaeoranenannane oniabasiiek bast cuaia eyateaenseee 11

Bedford, Estate of, Commissioner v., 325 U.S. 283 (1945)
SE EL BOER DS BY RP SPR ALR EN See RAS EOD SNE TEES ETS. 9, 13, 15

II

Davis, United States v., 397 U.S. 301 (1970) ............ 2, 7, 8, 9,
10, 11, 14
Hawkinson v. Commissioner, 235 F.2d 747 (2d Cir. 1956)
Siac talaadelialioaicrataseasncsasslece alinidtssabeanccehaadhssheanddadianbheinioaunil 8, 11, 13, 14
Idaho Power Co. v. United States, 161 F. Supp. 807

(Ct.Cl. 1958) ....... EAETDD gente LN ROR MERPORD FON Rae RS OO 13
McDonald v. Commissioner, 52 T.C. 82 (1969) 0.00.00... 12
Ross v. United States, 173 F. Supp. 793 (Ct.Cl. 1959),

cert. denied, 361 U.S. 875 (1959) ~....00.00000..... Diaicsende 8, 11, 14

Wright v. United States, 482 F.2d 609 (8th Cir. 1973)
ie hdialadaletaiedinnetheesdeirea lrebaapeabigesi< 1saxeee\abbessainien 7, 8, 9, 10, 11, 12, 14

Zenz Vv. Quinlivan, 213 F.2d 914 (6th Cir. 1954) ............ 12
STATUTES

Internal Revenue Code of 1954 (26 U.S.C.):
BS) REUSE aE pn 2, 3, 8,9, 11, 14
I: Sa a 3, 13
Section 356(a) (2) ............ 2, 4, 7, 8, 9, 10, 11, 12, 13, 14, 15
BOCs BERR) C1) CA) nncnccrceccsnccnsscessesseses a iesiniibononabbeeaoe 6

Revenue Act of 1924, c. 234, 43 Stat. 253:
I on i ecrescaseenaiceenemnenneionneteess 12

REVENUE RULINGS

Revenue Ruling 74-515, 1974-2 C.B. 118 0.0... 9,11,14

Revenue Ruling 74-516, 1974-2 C.B. 121 00... 9,11,14

Revenue Ruling 75-83, 1975-1 C.B. 112 0000000... 9, 11,14
MISCELLANEOUS

B. Bittker & J. Eustice, Federal Income Taxation of
Corporations and Shareholders, § 14.34 at 14-92 (3d
I EN eceesviiccci terns cacehetesconeesavscpeaoniealis cana necetdhnnaiateeousTantsaia 9,14

III

H.R. Rep. No. 179, 68th Cong., Ist Sess. (1924), 1939-1
(Part 2) C.B. 241, 252 ....... ESP P88 ARE ORES POS ASL: OR 12
Levin, Adess and McGaffey, ‘‘Boot Distributions in
Corporate Reorganizations—Determination of Divi-
dend Equivalency,” 30 The Tax Lawyer 287 (1977) 8,14
S. Rep. No. 398, 68th Cong., 1st Sess. (1924), 1939-1
(Part 2) C.B. 266, 277 ......... poicspevasegrumbatightemimasoigeek Ne
Wittenstein, “Boot Distributions and Section 112(c)
(2): A Re-Examination,” 8 Tax. L. Rev. 63 (1952) 14

In the Supreme Court of the United States

OCTOBER TERM, 1978

No.

MANDELL SHIMBERG, JR., and ELAINE F. SHIMBERG,
Petitioners,

V.

UNITED STATES OF AMERICA,
Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT

Petitioners, MANDELL SHIMBERG, JR., and ELAINE
F. SHIMBERG, respectfully pray that a writ of certiorari
issue to review the judgment and opinion of the United
States Court of Appeals for the Fifth Circuit entered in
this proceeding on July 28, 1978.

OPINIONS BELOW

The order of the District Court for the Middle District
of Florida (Appendix A, infra, pp. Al-A10) granting judg-
ment for Petitioners is reported at 415 F. Supp. 832. The
opinion of the United States Court of Appeals for the
Fifth Circuit reversing the judgment of the district court
(Appendix C, infra, pp. Al2-A26) is reported at 577 F.2d
283.

JURISDICTION

The judgment of the Court of Appeals for the Fifth
Circuit (Appendix D, infra, p. A27) was entered on July
28, 1978. This petition for a writ of certiorari was filed
within ninety (90) days of that date. The jurisdiction
of this Court is invoked under 28 U.S.C. 1254(1).

QUESTIONS PRESENTED

1. Whether the meaningful reduction test for deter-
mining dividend equivalence in corporate redemptions un-
der Section 302(b)(1) of the Internal Revenue Code of
1954 (the “Code”), as enunciated by this Court in United
States v. Davis, 397 U.S. 301 (1970), is applicable under
Section 356(a) (2) of the Code to corporate reorganizations
where a stockholder of a merged corporation receives cash
in addition to stock and securities of the continuing cor-
poration.

2. Whether an integrated tax-free merger may be
fragmented into separate steps for the purpose of analyz-
ing under Section 356(a) (2) of the Code a boot distribution
incident to the merger.

STATUTORY PROVISIONS INVOLVED

Sections 302 and 356 of the Internal Revenue Code
of 1954, 26 U.S.C. 302 and 356, provide in pertinent part
as follows:

SEC. 302. DISTRIBUTIONS IN REDEMPTION OF
STOCK.

(a) General Rule—If a corporation redeems its
stock (within the meaning of section 317(b)),
and if paragraph (1), (2), (3), or (4) of sub-
section (b) applies, such redemption shall be
treated as a distribution in part or full pay-
ment in exchange for the stock.

(b) Redemptions Treated as Exchanges.—

(1) Redemptions Not Equivalent to Divi-
dends.—Subsection (a) shall apply if the
redemption is not essentially equivalent
to a dividend.

s * se

SEC. 356. RECEIPT OF ADDITIONAL CONSIDER-
ATION.

(a) Gain on Exchanges.—
(1) Recognition of Gain.—If—

(A) section 354 or 355 would apply to
an exchange but for the fact that

4

(B) the property received in the ex-
change consists not only of property
permitted by section 354 or 355 to
be received without the recognition
of gain but also of other property
or money,

then the gain, if any, to the recipient shall be recog-
nized, but in an amount not in excess of the sum
of such money and the fair market value of such
other property.

(2) Treatment as Dividend.—If an exchange
is described in paragraph (1) but has the effect of
the distribution of a dividend, then there shall be
treated as a dividend to each distributee such an
amount of the gain recognized under paragraph (1)
as is not in excess of his ratable share of the undis-
tributed earnings and profits of the corporation ac-
cumulated after February 28, 1913. The remainder,
if any, of the gain recognized under paragraph (1)
shall be treated as gain from the exchange of property.

STATEMENT OF THE CASE

The facts in this proceeding were fully stipulated and
may be summarized as follows.

Prior to December 9, 1970, LaMonte-Shimberg Corpo-
ration (“LSC”) was a local Florida corporation engaged
primarily in the business of building and selling single
family houses. Petitioner’ was its president, chief execu-
tive officer and majority stockholder, owning directly and
indirectly 68.43% of its 135,521 issued and outstanding
shares of LSC capital stock. The balance of its outstand-
ing LSC stock was owned by 19 unrelated stockholders.

MGIC Investment Corporation (“MGIC”), a “publicly
held” corporation, the stock of which was registered and
traded on the New York Stock Exchange, was a holding
company engaged through its various subsidiaries primar-
ily in the financial guaranty business, insuring lenders
and lessors against credit and rental losses in the real
estate financing business. Immediately prior to the events
of December 9, 1970, a total of 6,204,448 shares of MGIC
common stock were issued and outstanding, being held
by some 5,191 stockholders of record.

MGIC’s financial statement for December 31, 1970, re-
flected ownership of assets having a value of $250,527,729,
liabilities of $170,433,208 and stockholders’ equity of
$80,094,521. By comparison, LSC’s consolidated balance
sheet for October 31, 1970, showed assets of $6,047,122, lia-
bilities of $5,225,126 and stockholders’ equity of $821,996.

1. References to ‘Petitioner’ are to Mandell Shimberg, Jr.
Petitioner Elaine F. Shimberg is involved in this proceeding only
because she filed a joint Federal income tax return with Mandell
Shimberg, Jr. for the calendar year 1970.

The financial conditions of MiGIC and LSC were substan-
tially the same at the time of the merger as they were on
December 31, 1970 and October 31, 1970, respectively.

Pursuant to the terms of a merger agreement executed
on September 18, 1970 and consummated on December
9, 1970, LSC was merged into MGIC in a transaction
which qualified as a reorganization under the provisions
of Section 368(a)(1)(A) of the Internal Revenue Code
of 1954 (the “Code”).” ,

Incident to the merger, the LSC stockholders received
in the aggregate a pro rata distribution of cash in the
amount of $625,000 plus a total of 32,132 shares of MGIC
common stock outstanding and an additional 32,132 MGIC
common shares placed in escrow subject to an earnout.
Petitioner, in exchange for his LSC stock, received
$417,449 in cash plus 21,461 shares of MGIC common stock
and a like number of MGIC common shares in escrow.
After consummation of the merger, Petitioner owned less
than 1% of the issued and outstanding common stock of
MGIC.

On his federal income tax return for 1970, Petitioner
reported the cash received incident to the merger as long-
term gain from the sale of a capital asset. Upon audit,
the Internal Revenue Service determined that the cash
was taxable as a dividend. Petitioner paid the resulting
deficiency under protest, and following denial of his claim
for refund, initiated suit for refund in the district court.

The parties stipulated that the merger of LSC into
MGIC constituted a “reorganization” within the meaning
of Section 368(a)(1)(A) of the Code and that Petitioner
was entitled to capital gain treatment with respect to the

2. All references to section numbers, unless otherwise ex-
pressly indicated, are to the Internal Revenue Code of 1954.

7

cash received unless the payment of the cash had “the
effect of the distribution of a dividend” within the meaning
of Section 356(a) (2) of the Code.

The district court found (Appendix A, infra, pp. A7-
Al0) that the principles enunciated by the Eighth Circuit
in Wright v. United States, 482 F.2d 600 (8th Cir. 1973)
were controlling, and held that the cash received by Peti-
tioner pursuant to the reorganization did not have the
effect of a dividend because there had been a meaningful
reduction in the nature of Petitioner’s interest in the con-
tinuing enterprise. The district court noted (Appendix
A, infra, pp. A8-A9) that Petitioner had been president,
chief executive officer and owner of approximately 66%
of the stock in LSC prior to the merger, and subsequently
held less than 1% of the outstanding stock of MGIC. Be-
cause the district court determined (Appendix A, infra,
p. A9) that the loss in valuable corporate rights resulting
from the reorganization constituted a meaningful reduc-
tion, the district court held in favor of Petitioner.

On Respondent’s appeal to the Court of Appeals for
the Fifth Circuit, that court reversed, holding that the
meaningful reduction test enunciated by this Court in
United States v. Davis, 397 U.S. 301 (1970), and as utilized
in Wright, was not applicable to the facts of the present
case. Instead, the court (Appendix C, infra, p. A22)
deemed the cash received by Petitioner to be part of a
hypothetical pro rata distribution by LSC to its stockhold-
ers. The court found on this analysis that the distribution
had the “effect of the distribution of a dividend” within
the meaning of Section 356(a)(2) and reversed the judg-
ment in favor of Petitioner. ‘Appendix C, infra, pp. A22-
A23, A26).

REASONS FOR GRANTING THE WRIT

1. The Decision of the Fifth Circuit in This Case
Is in Direct Conflict With Decisions of the
Courts ot Appeals for the Second and Eighth
Circuits and the Court of Claims.

In 1970 the Court in United States v. Davis, 397 U.S.
301 (1979), prescribed the meaningful reduction test for
determining dividend equivalence under Section 302(b) (1)
in corporate redemption transactions. No comparable test
has been provided by this Court for determining the divi-
dend effect of boot distributions under Section 356(a) (2).
However, when faced with this precise question, the Eighth
Circuit in Wright v. United States, 482 F.2d 600 (8th Cir.
1973), following the rationale of the Second Circuit in
Hawkinson v. Commissioner, 235 F.2d 747 (2d Cir. 1956)
and the Court of Claims in Ross v. United States, 173
F. Supp. 793 (Ct.Cl. 1959), cert. denied, 361 U.S. 875
(1959), held that Section 302(b) (1) and Section 356(a) (2)
should be read in pari materia and concluded (428 F.2d
at 605) that the appropriate measure to be applied to
Section 356(a)(2) boot distributions was the meaningful
reduction test enunciated by the Court in Davis.*

In explaining its application of the Davis test in the
context of a reorganization, the Eighth Circuit in Wright
stated (482 F.2d at 605):

We read [the ‘meaningful reduction’] language and
Davis as holding that the proper inquiry is the per-
centage change of ownership in the corporation and
the attendant overall results due to that change. Stated

3. See generally Levin, Adess and McGaffey, “Boot Dis-
tributions in Corporate Reorganizations—-Determination of Divi-
dend Equivalency,” 30 The Tax Lawyer 287 (1977).

otherwise, the basic inquiry is whether the distribution
had the ‘net effect’ of a dividend. [Citations omitted. |

We think that if a distribution is not to have
the ‘net effect’ of a dividend, there must have occurred
a meaningful reduction of the redeeming shareholder’s
proportionate interest or in other words a meaningful
change in the relative economic interests or rights of
the shareholder after the redemption... .

... [V]iewing the transaction as a realistic whole,
the taxpayer has reduced his holding in [the preex-
isting corporation] from almost complete ownership
in [that corporation] to 61.7 per cent ownership in
[the surviving corporation]. . . . [Emphasis added. ]

As noted by the Eighth Circuit, the Government in
Wright agreed that Section 302(b)(1) and Section 356(a)
(2) should be read in pari materia.* Thereafter, the In-
ternal Revenue Service published its accord with this statu-
tory construction. Rev. Rul. 75-83, 1975-1 C.B. 112. See
also Rev. Rul. 74-515, 1974-2 C.B. 118; Rev. Rul. 74-516,
1974-2 C.B. 121.

It was the Davis meaningful reduction test and the
Wright analysis of viewing the transaction as a realistic
whole which the district court below applied to find that
the boot received by Petitioner incident to the merger
was taxable as capital gain.

In reversing, the Fifth Circuit refused to apply in
this case either the Wright analysis or the Davis teachings.
Thus, the Fifth Circuit held (Appendix C, infra, p. A19):

4. The Government’s agreement reflected a major shift in
policy from its ‘automatic dividend” position following the
Court’s decision in Commissioner v. Estate of Bedford, 325 U.S.
283 (1945). See B. Bittker & J. Eustice, Federal Income Tazxa-
tion of Corporations and Shareholders, { 14.34 at 14-92 (3d Ed.
1971).

10

The ‘meaningful reduction’ test cannot be indis-
criminately applied in the reorganization context. The
Davis case illustrates its proper application in a re-
demption under § 302, as does the recently decided
case of Morris v. United states, 441 F.Supp. 76 (N.D.
Tex.1977), while Wright indicates that it also is ap-
propriate when a reorganization can be realistically
treated as a redemption. Even assuming that Wright
is correctly decided—a point on which, we express
no opinion—the instant case presents radically differ-
ent facts and calls for correspondingly different anal-
ysis. We agree with the government that ‘the undif-
ferentiating invocation of stock redemption principles
in a reorganization case’ such as this one is erroneous,
and we decline to apply on a wholesale basis the
‘meaningful reduction’ test in cases arising under
§$ 356(a)(2). [Footnote omitted. ]

In explaining its refusal to follow Wright and Davis,
the Fifth Circuit said (Appendix C, infra, p. A20) that
the application of Section 302 principles “would render
§ 356(a)(2) virtually meaningless when a large corpora-
tion swallows a small one in a reorganization, for there
will always be a marked decrease in control by the small
corporation’s shareholders, unless the same shareholders
control both corporations.”

Indeed, according to the Fifth Circuit (Appendix C,
infra, p. A22):

... § 356(a)(2) requires a determination of whether
the distribution would have been taxed as a dividend if
made prior to the reorganization or if no reorganiza-
tion had occurred. This inquiry is essentially a com-
parison of the effect of actual distribution and the
effect of a hypothetical one. | Emphasis added. |

11

Certainly the courts must recognize the factual differ-
ences inherent in redemptions and corporate reorganiza-
tions. However, Petitioner submits that the legal guide-
lines for determining dividend effect under Section 356 (a)
(2) should be the same as those used in determining divi-
dend equivalence under Section 302(b)(1). Indeed, the
Internal Revenue Service and the courts which have con-
sidered the statutory construction issue, with the exception
of the Fifth Circuit in this case, are in agreement that
Section 302(b)(1) and Section 356(a)(2) are to be read
in pari materia®

The uncertainty in the law resulting from the Fifth
Circuit’s failure to follow the Wright analysis and the
Davis guideline concerning boot distributions in tax-free
corporate reorganizations will seriously undermine the
planning of such transactions in the future, and the ad-
ministration of the Internal Revenue Code with respect
thereto.

2. The Decision Below Sanctions a Bifurcation of
an Integrated Transaction Contrary to the Step
Transaction Doctrine, Section 356(a)(2) and
the Decision of the Eighth Circuit in Wright v.
United States.

The step transaction doctrine requires that all parts
of an integrated multi-step exchange or reorganization be
grouped together to determine the appropriate tax treat-
ment for the entire transaction. Helvering v. Alabama
Asphaltic Limestone Co., 315 U.S. 179 (1942). The Eighth

5. Wright v. United States, 482 F.2d 600 (8th Cir. 1973);
Hawkinson v. Commissioner, 235 F.2d 747, 751 (2d Cir. 1956);
Ross v. United States, 173 F. Supp. 793, 797 (Ct.Cl. 1959), cert.
denied, 361 U.S. 875 (1959); Rev. Rul. 74-515, 1974-2 C.B.
118; Rev. Rul. 74-516, 1974-2 C.B. 121; Rev. Rul. 75-83, 1975-1
C.B. 112.

12

Circuit’s analysis of the facis in Wright v. United States
was in accord with the step transaction doctrine.

Although the Fifth Circuit recognized the existence
and validity of the step transaction doctrine (Appendix
C, infra, p. A24), it reasoned that this doctrine was not
a bar to the fragmenting of the merger between LSC
and MGIC into parts and the consideration of a nypotheti-
cal pre-merger pro rata distribution. The Fifth Circuit
explained (Appendix C, infra, p. A24) that it was not
treating the hypothetical boot distribution as a separate
step in an overall transaction but rather “analyzing the
distribution in accordance with the requirements of § 356

(a) (2).”

Neither the language of Section 356 (a) (2), its legisla-
tive history, nor business reality supports the conclusion
that a statutory merger can be fragmented or a portion
of the operative facts disregarded. There is nothing on
the face of the statute which remotely suggests that, in
making the critical determination, less than all the facts
of the transaction are to be considered or that some of
the facts are to be taken out of context and viewed in
isolation. Moreover, the legislative history of Section 203
(D) (2), of the Revenue Act of 1924, the predecessor of
Section 356(a)(2), does not suggest that the appropriate
inquiry by a reviewing court is the fragmenting of the
transaction and the disregarding of a portion of the facts.
See Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954), and
McDonald v. Commissioner, 52 T.C. 82 (1969). Lastly,
the “fragment and disregard” approach of the Fifth Circuit
in making Section 356(a)(2) analyses creates uncertainty
as to the circumstances in which the step transaction

6. H.R. Rep. No. 179, 68th Cong., Ist Sess. (1924), 1939-1
(Part 2) C.B. 241, 252; S. Rep. No. 398, 68th Cong., Ist Sess.
(1924), 1939-1 (Part 2) C.B. 266, 277.

13

doctrine will be applied and is contrary to the economic
and business realities of most reorganizations.

The effect of the Fifth Circuit’s opinion in this case
is to disregard the step transaction doctrine. As a result,
the future application of that doctrine to integrated trans-
actions is unclear.

CONCLUSION

The tax consequences of common commercial transac-
tions can be fairly and predictably determined only where
there is a uniform administration of the tax laws. It
is important to taxpayers and the Government alike that
whenever possible there be certainty as to the meaning
of complicated tax provisions.

For many years, it was unclear whether all boot re-
ceived in a reorganization automatically had the effect
of a dividend to the extent of earnings and profits or
whether leeway existed for capital gain treatment. Fol-
lowing the decision in Commissioner v. Estate of Bedford,
325 U.S. 283 (1945), the Internal Revenue Service took
the position that, in situations where a taxpayer continued
as a stockholder after the exchange, Section 356(a) (2)
automatically converted gain recognized pursuant to Sec-
tion 356(a) (1) into dividend income to the extent of earn-
ings and profits.

However, this so-called “automatic dividend” position
was strongly and effectively criticized by commentators,
and the cases decided in later years retreated from that
view.”

7. Hawkinson vy. Commissioner, 235 F.2d 747 (2d Cir. 1956);
Idaho Power Co. v. United States, 161 F. Supp. 807 (Ct.Cl. 1958);

(Continued on following page)

14

Finally, in 1974, following its agreement in Wright
as to the applicability of Section 302 standards to Section
356 (a) (2) determinations, the Service abandoned its “auto-
matic dividend” position and accepted the reasoning that,
in determining whether boot has the effect of the distribu-
tion of a dividend for purposes of Section 356(a) (2), the
standards of ‘‘essential dividend equivalence” under Sec-
tion 302 should be applied.*

As the result of the decisions of the Second and Eighth
Circuits in Hawkinson and Wright, respectively, and the
Court of Claims in Ross, and the agreement of the Service
regarding the proper statutory construction, taxpayers had
every reason to believe that at long last some certainty
had come into the law as to the appropriate test to be
applied in determining dividend effect under Section 356
(a)(2). This belief was reinforced by the existence of
the Davis guideline for determining dividend equivalence
under Section 302(b) (1).

The refusal of the Fifth Circuit in this case to apply
Section 302 standards and the Davis test to boot distribu-
tions under Section 356(a)(2) and its disregard of the
step transaction doctrine reintroduces into the law a high
degree of uncertainty. Indeed, the Fifth Circuit’s decision
to adopt a “limited automatic dividend” rule is a throwback

Footnote continued—

Ross v. United States, 173 F. Supp. 793 (Ct.Cl. 1959), cert. denied,
361 U.S. 875 (1959); Wright v. United States, 482 F.2d 600 (8th
Cir. 1973). See B. Bittker & J. Eustice, Federal Income Taxation
of Corporations and Shareholders, { 14.34 at 14-92 (3d ed. 1971);
Wittenstein, “Boot Distributions and Section 112(c)(2): A Re-
Examination,” 8 Tax. L. Rev. 63 (1952). See also Levin, Adess
and McGaffey, “Boot Distributions in Corporate Reorganizations—
— of Dividend Equivalency,” 30 The Tax Lawyer 287

8. Rev. Rul. 74-515, 1974-2 C.B. 118; Rev. Rul. 74-516,
1974-2 C.B. 121; Rev. Rul. 75-83, 1975-1 C.B. 112.

15

to the Bedford case, the point of beginning more than
33 years ago.

Only a definitive pronouncement by this Court as
to the proper guidelines for determining dividend effect
under Section 356(a) (2) will reconcile the conflicts among
the courts and bring certainty to the law.

For the reasons set forth above, the petition for a writ
of certiorari should be granted.

Respectfully submitted,

SHERWIN P, SIMMONS

Post Office Box 1102
Tampa, Florida 33601

Attorney for Petitioners

Haroitp W, MUuLLIs, JR.
WILLIAM KALISH
Davin A, PEARSON
TRENAM, SUMMONS, KEMKER, SCHARF,
BaRKIN, Frye & O'NEILL,
PROFESSIONAL ASSOCIATION
Post Office Box 1102
Tampa, Florida 33601
(813) 223-7474

Of Counsel
October 24, 1978

APPENDIX .

Al

APPENDIX

APPENDIX A

UNITED STATES DISTRICT COURT
MIDDLE DISTRICT OF FLORIDA
TAMPA DIVISION

No, 74-440-Civ-T-H

MANDELL SHIMBERG, JR. and ELAINE F. SHIMBERG,
Plaintiffs,

VS.

UNITED STATES OF AMERICA,
Defendant.

ORDER
(Filed July 1, 1976)

The sole issue for determination in this proceeding
is whether cash in the amount of $417,449 received by
the Plaintiff, Mandell Shimberg, Jr.,{ on December 9, 1970
in connection with the merger of Lamonte-Shimberg Cor-
poration into MGIC Investment Corporation is taxable as
proceeds from ihe sale of a capital asset, entitled to long-
term capital gain treatment for federal income tax pur-
poses, as contended by the Plaintiffs; or, whether the cash
proceeds are taxable as a dividend or ordinary income
as contended by the Defendant.

1, The Plaintiff, Elaine F. Shimberg, is involved in this pro-
ceeding only because she filed a joint federal income tax return
with Mandell Shimberg, Jr. for the calendar year 1970, Unless
otherwise expressly indicated, all references herein to the “Plain-
tiff” shall refer solely to Mandell Shimberg, Jr.

A2

The issue has been submiited to the Court for determi-

nation upon stipulated facts contained in the parties’ pre-
trial stipulation. The following is a summary of the facts:

(a) LaMonte-Shimberg Corporation (“LSC”)
was incorporated under the laws of the State of Florida
on September 28, 1959. LSC was, at all material times,
engaged primarily in the business of building and
selling single family homes. The Plaintiff was its
president and chief executive officer. :

(b) The Plaintiff was the majority stockholder
of LSC, owning, directly or indirectly, approximately
90,517 shares or sixty-six per cent (66%) of its 135,521
issued and outstanding shares of common stock. The
remainder of the stock of LSC was owned by nineteen
unrelated stockholders.

(c) MGIC Investment Corporation (“MGIC”) is
a corporation organized and existing under the laws
of the State of Delaware, having been incorporated
in that state in 1968. MGIC was, at all material times,
a “publicly held’ corporation, the stock of which was
traded on the New York Stock Exchange, engaged
through its various subsidiaries primarily in the finan-
cial guaranty business, insuring lenders and lessors
against credit and rental losses in the business of real
estate financing.

(d) On November 9, 1970, 6,204,448 shares of
MGIC common stock were issued and outstanding,
being held at that time by 5,191 stockholders of record.
The stock ownership of MGIC did not materially
change during the period from November 9, 1970
through December 9, 1970.

(e) On September 18, 1970, MGIC and LSC exe-
cuted a Plan and Agreement of Merger (the “Agree-

A3

ment”), pursuant to which LSC was to be merged
into MGIC in a transaction meeting the requirements
of the applicable provisions of the Delaware General
Corporation Law and the Florida Corporation Law.
The Agreement contemplated that LSC would be
merged into MGIC in a transaction qualifying as a
“reorganization” under the provisions of Section
368(a)(1)(A) of the Internal Revenue Code of 1954,
as amended, 26 USC §368.

(f) On December 9, 1970, LSC was merged into
MGIC, the surviving corporation, and the separate
existence of LSC was terminated. The merger was
consummated in accordance with the applicable laws
of the states of Florida and Delaware.

(g) In connection with the merger, the stock-
holders of LSC received ratably, in exchange for all
of their LSC stock, 32,132 shares of MGIC common
stock outright, 32,132 shares of MGIC common stock
in escrow, and cash in the total amount of $625,000.
Specifically, the Plaintiff received in exchange for his
LSC stock, 21,461 shares of MGIC common stock out-
right, 21,461 shares of MGIC common stock in escrow,
and cash in the amount of $417,449. The undistributed
earnings and profits of both corporations, immediately
prior to December 9, 1970, was in excess of $625,000
each.

(h) On their joint federal income tax return for
1970, the Plaintiffs reported the cash received in con-
nection with the merger as long-term capital gain.
Upon audit and examination of the return, the Internal
Revenue Service determined that the cash received
by the Plaintiff in connection with the merger was
taxable as a dividend or ordinary income. The Com-
missioner of Internal Revenue assessed a federal

A4

income tax deficiency against the Plaintiffs in the
amount of $125,883. The amount of the deficiency,
and interest in the amount of $15,664.67, was timely
paid by the Plaintiffs on June 19, 1973. Additional
interest in the amount of $505.26 was paid by the
Plaintiffs on August 17, 1973.

(i) On January 4, 1974, the Plaintiffs timely filed
a claim for refund with respect to the amount of
the deficiency and interest paid. On May 8, 1974,
the Plaintiffs were notified by the Commissioner of
Internal Revenue that their claim for refund was disal-
lowed in full.

(j) This suit for recovery of the amount of the
deficiency, and all interest paid, was commenced on
August 8, 1974.

Section 354 of the Code, 26 USC §354, provides that
no gain or loss shall be recognized for tax purposes if,
pursuant to a plan of reorganization, stock and securities
in a corporation are exchanged solely for stock or securities
in another corporation which is a party to the reorganiza-
tion. Section 368(a)(1)(A) of the code, 26 USC §368(a)
(1)(A), defines the term “reorganization” to include a
“statutory merger,” that is, a merger effected pursuant
to the laws of one or more states. Accordingly, the In-
ternal Revenue Code permits a stockholder to dispose
of stock owned by him in a statutory merger free of
federal income tax consequences so long as he receives
as consideration only stock or securities of the other cor-
poration participating in the merger.

However, most state laws, including those of Florida
and Delaware,’ permit consideration other than stock or

2. Sections 608.20 and 608.21, Florida Statutes; Section 252,
Delaware General Corporation Law.

A5

securities to be utilized in effecting a statutory merger.
The additional consideration, commonly referred to as
“boot,” may consist of cash or any property other than
the stock or securities of the acquiring corporation.

The receipt of “boot” in connection with a statutory
merger does not make the transaction completely taxable;
rather, it has the effect of making the ordinarily tax-
free transaction partially taxable. Section 356(a) of the
Code, 26 USC §356 (a), provides:

$356. Receipt of Additional Consideration
(a) Gain on Exchanges.—
(1) Recognition of Gain.—If

(A) section 354... would apply to an ex-
change but for the fact that

(B) the property received in the exchange
consists not only of property permitted by Section
354... to be received without the recognition —
of gain but also of other property or money,

then the gain, if any, to the recipient shall be recog-
nized, but in an amount not in excess of the sum
of such money and the fair market value of such
other property.

(2) Treatment as Dividend—If an exchange is
described in paragraph (1) but has the effect
of the distribution of a dividend, then there
shall be treated as a dividend to each dis-
tributee such an amount of the gain recog-
nized under paragraph (1) as is not in excess
of his ratable share of the undistributed earn-
ings and profits of the corporation accumu-
lated after February 28, 1913. The remainder,

A6

if any of the gain recognized under paragraph
(1) shall be treated as gain from the exchange
of property.” [Emphasis added. ]

Accordingly, in statutory mergers involving the receipt
of “boot,” the recipients are required to recognize gain
to the extent of the value of the “boot.” The question
is whether it is taxable as proceeds from the sale of the
capital asset or is taxable as a dividend, and the answer
turns on whether the payment and receipt of the “boot”
“... has the effect of the distribution of a dividend .. .”

within the meaning of Section 356(a) (2). That, of course,

is the ultimate issue in this case.

Based upon the Supreme Court decision in Commis-
sioner v. Bedford’s Esicte, 65 S.Ct. 1157, 325 U.S. 283
(1945), the Internal Revenue Service took the position
for many years that, in situations where the taxpayer
continued as a stockholder after a reorganization exchange,
Section 356(a)(2) “automatically” treated “boot” recog-
nized pursuant to Section 356(a)(1) as dividend income
to the extent of the distributing corporation’s earnings
and profits. See, Rev. Rul. 56-220, 1956-1 C.B. 191. The
so-called “automatic dividend” rule was criticized by the
commentators, however, and the more recent cases*® tended
to abandon the rigidity of that approach in favor of a
more flexible analysis similar to that employed under Sec-
tion 302(b)(1) (relating to dividend equivalence incident -
to a stock redemption. )

Accordingly, following the decision in Wright v. United
States, 482 F.2d 600 (8th Cir. 1973), the Internal Revenue

3. King Enterprises, Inc. v. United States, 418 F.2d 511 (Ct.
Cl. 1969); Hawkinson v. Commissioner, 253 F.2d 747 (2d Cir.
1956); Ross v. United States, 173 F.Supp. 793 (Ct. Cl. 1959);
Idaho Power Co. v. United States, 161 F.Supp. 807 (Ct. Cl. 1958).

A7

Service has apparently abandoned the “automatic divi-
dend’ application of Bedford and has accepted the reason-
ing that, in determining whether “boot” has the effect
of a distribution of a dividend for purposes of Section
356 (a) (2), the standard of “essential dividend equivalency”
under Section 302(b)(1) should be applied. (See Rev.
Rul. 74-515, LR.B. No. 1974-43, p. 7; Rev. Rul. 74-516,
I.R.B. No. 1974-43, p. 9).*

In United States v. Duvis, 397 U.S. 301, 90 S.Ct. 1041
(1970), the leading authority interpreting and applying
Section 302(b) (1), the Supreme Court held that in decid-
ing whether a payment in redemption of stock “is not
essentially equivalent to a dividend,” within the meaning
of that section, the inquiry should be “whether the redemp-
tion could be characterized as a sale’ (397 U.S. at 311;
90 S.Ct. at_ 1047); and the answer to that question, in
turn, should not be sought by examining the business
motives underlying the transaction, but by ascertaining
whether the redemption resulted “in a meaningful reduc-
tion of the shareholder’s proportionate interest in the cor-
poration” (397 U.S. at 313; 90 S.Ct. at 1048).

Thus, in Wright v. United States, supra, the Eighth
Circuit applied the Davis “meaningful reduction” standard
in resolving the same issue of law presented by this case
under Section 356(a) (2), concentrating in particular upon
the taxpayer’s reduction in voting power in the surviving
corporation and concluding that the “boot” he received
in addition to a stock-for-stock exchange arising out of

4. “The question whether a distribution in redemption of
stock of a shareholder is not essentially equivalent to a dividend
under Section 302(b)(1) depends upon the facts and circum-
stances of each case.” Tres. Reg. §$1.302-2(b). [Emphasis sup-
plied]

A8

a corporate consolidation did not have “the effect of a
distribution of a dividend” under Section 356(a) (2).°

In the final analysis, therefore, the issue in this case
under Section 356(a) (2), as to whether the payment of
the “boot” had the “effect of the distribution of a dividend,”
must be treated as an ultimate issue of fact to be resolved
by an examination of the total transaction and its result-
ing effect upon the interests of the taxpayer as a stock-
holder. Stated more precisely the factual -question is
whether sale or dividend characteristics predominate in
the transaction, regardless of the underlying motives of
the parties; and the test to be applied in answering that
question is whether the transaction resulted “in a meaning-
ful reduction of the shareholder’s proportionate interest
in the corporation.”

Prior to the merger in this case, Plaintiff was
the president, chief executive officer and owner (directly
or indirectly) of approximately 66% of the stock of LSC.
As a result, under Florida law he could effectively control
the corporation. Subsequent to the merger the Plaintiff

5. In resolving the sale-or-dividend issue under Section
356(a)(2) the Court in Wright first devoted considerable space in
its opinion to an analysis of the reorganization under the so-called
“safe harbor” or “substantially disproportionate redemption” pro-
visions of Section 302(b)(2). In so doing the Court viewed the
transaction involved as one in which only stock was issued, fol-
lowed by a fictional redemption by the acquiring corporation of
a portion of its newly issued stock for the “boot.” The Court
concluded, nevertheless, that the “boot” would not qualify as the
proceeds of a “redemption” under the mathematical limitations of
Section 302(b)(2), and then turned its attention to the general,
dividend equivalence test of Section 302(b)(1) to resolve the
parallel issue presented under Section 356(a)(2). Thus, to the
extent the opinion might suggest application of Section 302(b) (2)
in a reorganization context governed by Section 356(a)(2), it is a
dubious dictum and need not be pursued here despite Plaintiff's
contention that his resulting stock position in MGIC would meet
the requirements of Section 302(b)(2) should that analysis be
made in this case.

AQ

owned (directly and indirectly) less than 1% of the out-
standing common stock of MGIC, a large publicy-held
corporation whose stock was traded on the New York
Stock Exchange and was held by approximately 5,200
shareholders. His former rights to direct the affairs of
LSC were extinguished. His interest in MGIC afforded
him no control whatsoever over the destiny of the large
national corporation. No longer was he the major “owner”
of a successful local company operating in several Florida
counties. He was then the holder of a miniscule percentage
of the outstanding stock of a huge, publicly-held corpora-
tion. It is clear that the merger resulted in a radical
change and meaningfui reduction in the nature of the
Plaintiff’s interest in the continuing business. The net
effect of the transaction was a sale by the Plaintiff and
the other LSC stockholders of their LSC stock to MGIC
for cash and marketable securities in a publicly owned
corporation.®

The Court concludes that the cash or “boot” received
by the Plaintiff on December 9, 1970, in connection with
the merger of LSC into MGIC did not have “the effect
of the distribution of a dividend” within the meaning of

6. The Defendant, in apparent reliance upon that portion of
the Wright opinion discussed in the preceding footnote, contends
that the scope of the inquiry should be a narrow one, i.e., that the
“meaningful reduction” test should not be applied on a before and
after basis, but should be restricted to a post merger comparison
between what the taxpaper’s interest in the resulting consolidated
corporation would have been with and without the boot payment.
Wright does not support such a myopic view of the consequences
of the transaction in determining Section 302(b)(1) “dividend
equivalence” in resolving the parallel issue presented under Sec-
tion 356(a)(2). The other authorities cited by the Defendant,
namely King Enterprises, Inc. vs. United States, 418 F.2d 511 (Ct.
Cl. 1969), and Ross vs. United States, 173 F.Supp. 793 (Ct. Cl.
1959), cert. denied, 361 U.S. 873 (1959), are inapposite on their
facts, involved minority shareholders, and did not have the bene-
fit of the teachings of Davis.

Al0

Section 356(a)(2) and is taxable as proceeds from the
sale of a capital asset. It follows that the Plaintiffs are
entitled to recover and the parties are directed, pursuant
to paragraph 6(t) of the pre-trial stipulation, to submit
an agreed form of judgment within forty days from the
date hereof.

The foregoing shall constitute the Court’s findings of
fact and conclusions of law pursuant to Rule 52, F.R.Civ.P.

DONE and ORDERED at Tampa, Florida, this Ist day
of July, 1976.
/s/ W. Terrell Hodges
United States District Judge

All

APPENDIX B

IN THE
UNITED STATES DISTRICT COURT FOR THE
MIDDLE DISTRICT OF FLORIDA
TAMPA DIVISION

CIVIL ACTION NO. 74-440-Civ-T-H

MANDEL SHIMBERG, JR. and ELAINE F, SHIMBERG,
Plaintiffs

Vv.

UNITED STATES OF AMERICA,
Defendant

JUDGMENT
(Filed August 2, 1976)

Pursuant to the findings of fact and conclusions of law
by the Court in its order, entered in this cause on July 1,
1976, it is hereby

ORDERED and ADJUDGED that plaintiffs recover
from the defendant income taxes and assessed interest paid
by them for the year 1970 in the amounts of $125,240.00
and $16,087.34, respectively, together with statutory inter-
est on the total amount of $141,327.34 pursuant to law, and
the plaintiffs are awarded their costs.

DONE and ORDERED this 2nd day of August, 1976,
at Tampa, Florida.

/s/ W. Terrell Hodges
United States District Judge
Approved as to form:
/s/ Harold W. Mullis, Jr.
Attorney for Plaintiffs

/s/ Rodger M. Moore
Attorney for Defendant

Al2

APPENDIX C

Mandell SHIMBERG, Jr. and Elaine F. Shimberg,
Plaintiffs-Appeilees,

Vv.

UNITED STATES of America,
Defendant-Appellant.

No. 76-3749.

United States Court of Appeals,
Fifth Circuit.

July 28, 1978.

* 2 >

Appeal from the United States District Court for the
Middle District of Florida.

Before BROWN, Chief Judge, and THORNBERRY
and CLARK, Circuit Judges.

THORNBERRY, Circuit Judge:

If Justice Holmes was correct that “[t]axes are what
we pay for civilized society,” then the question in this case
is how much civilization the taxpayer will be required to
purchase.

More precisely, we are asked to decide the proper tax
treatment of a pro rata distribution of cash to shareholders
in the course of a corporate reorganization. The taxpayer
contends that this “boot” should be taxed as a long-term
capital gain, while the government argues that it has “the

1. Compania General de Tabacos de Filipinas v. Collector of
Internal Revenue, 275 U.S. 87, 100, 48 S.Ct. 100, 105, 72 L.Ed. 177
(1927) (Holmes, J., dissenting).

Al3

effect of the distribution of a dividend” within the mean-
ing of 26 U.S.C, § 356(a)(2) and should thus be taxed as
ordinary income, The district court agreed with the tax-
payer and awarded him a substantial refund.” For the rea-
sons stated below, we reverse,

The facts are fully stipulated. LaMonte-Shimberg
Corp, (LSC), a Florida corporation engaged in home con-
struction and sales, was controlled by taxpayer Mandell
Shimberg, Jr., who owned 66.8 per cent of the stock, His
wife* owned an additional 1.6 per cent for the benefit of
their children, and nineteen other unrelated persons held
the remaining shares, MGIC Investment Corp, (MGIC) is
a holding company incorporated under the laws of Dela-
ware that is primarily engaged, through various subsidiar-
ies, in the financial guaranty business, In September 1970,
MGIC and LSC executed a merger agreement, pursuant to
which LSC was to be merged into MGIC in a transaction
qualifying for statutory merger treatment under 26 U.S.C,
§ 368(a)(1)(A), To so qualify, the merger must satisfy
applicable state laws regarding such reorganizations,‘
Thus, MGIC would be the surviving corporation, and the
separate corporate existence of LSC would cease, Under
the agreement, LSC shareholders were to receive, pro rata,
$625,000 in cash and 32,132 shares of MGIC common stock,
plus another 32,132 shares in escrow to be delivered in five
years if the conditions of the agreement were met,

2. Shimberg v. United States, 415 F.Supp. 832 (M.D.Fla.
1976),

3. Mrs, Shimberg is involved in this case only because she
filed a joint income tax return with her husband for 1970, the
year in question,

4. See Del.Code Ann,, tit, 8, § 252 (Supp.1977); Fla.Stat.Ann,
§ 607,234 (1977). Section 368(a)(1) (A) also applies to consolida-
tions, and transactions under this section are commonly known as
“A” reorganizations,

Al4

The merger was consummated on December 9, 1970,
and taxpayer in exchange for his LSC stock received $417,-
449, plus 21,461 shares of MGIC commori stock and a like
number in escrow, Immediately prior to the merger, the
undistributed earnings and profits of both corporations
were in excess of $625,000 each.°

On his federal income tax return for 1970, taxpayer
reported the cash received in connection with the merger
as a long-term capital gain, Upon audit and examination
of the return, the Internal Revenue Service determined
that the cash received was taxable as a dividend, that is,
as ordinary income, Accordingly, the IRS assessed a tax
deficiency against taxpayer in the amount of $125,883,
That amount, plus interest totalling $16,169.93, was paid,
and taxpayer then filed for a refund, The IRS disallowed
the refund claim in full, and taxpayer commenced this suit.

Under 26 U.S.C, § 368(a)(1), six types of corporate
transactions are defined as “reorganizations,” among them
a “statutory merger” pursuant to state law.’ If the cor-
porate transaction meets one or more of these definitions
and thus qualifies as a reorganization, favorable tax treat-
ment is available under § 354(a) (1), which provides that no
gain or loss shall be recognized if, pursuant to a reorgani-
zation plan, stock or securities of one corporation are ex-
changed solely for stock or securities of another corpora-
tion that is a party to the reorganization. Accordingly,
such transactions are generally characterized as “tax-free”
reorganizations,

5. As of October 31, 1970, LSC’s consolidated balance sheet
showed retained earnings of $724,559, while on December 31, 1970,
MGIC had retained earnings of $34,012,746.

6. Section 368(a)(1)‘A). See generally 1 Fox & Fox, Cor-
porate Acquisitions & Mergers, 13.03, 4.02 (1977); Comment, 60
Nw.L. Rev, 655 (1965).

Al5

However, § 354(a) (1) makes clear that not all reorga-
nizations will be entirely tax free, for it applies so long as
a shareholder of one corporation receives as consideration
only stock or securities of another corporation participat-
ing in the reorganization, Under some reorganizations—
including the statutory merger—the transaction is not a
stock-for-stock exchange but may involve additional con-
sideration such as cash or property other than stock, In
these circumstances, this additional consideration—com-
monly known as “boot’—does not qualify for tax-free
treatment, 26 U.S.C, § 356(a)(1).". Thus, the reorganiza-
tion is only partially tax-free,

Most state laws, including the Florida and Delaware
statutes applicable here,’ permit other consideration in ad-
dition to stock to be utilized in a statutory merger, In the
instant case the “boot” was a pro rata distribution of
$625,000 to the LSC shareholders, The question in this
case is not whether the “boot” is to be taxed—for § 356 (a)
(1) makes clear that it is—but whether it is to be taxed
as proceeds from the sale of a capital asset, i, e., as a capital
gain, or as a dividend, i, e., as ordinary income,

7, Section 356(a) (1) provides:
Gain on exchanges.—
(1) Recognition of gain,—-If——

(A) section 354 or 355 would apply to an exchange but
for the fact that

(B) the property received in the exchange consists not
only of property permitted by section 354 or 355 to be
received without the recognition of gain but also of other
property or money,

then the gain, if any, to the recipient shall be recognized, but
in an amount not in excess of the sum of such money and the
fair market value of such other property,

8, Del.Code Ann,, tit, 8, § 252 (Supp.1977); Fla.Stat.Ann,
§§ 607,214, 607,234 (1977).

Al6

The answer turns on whether the payment and receipt
of the “boot” has “the effect of the distribution of a divi-
dend” within the meaning of § 356(a) (2), which provides:

Treatment as dividend.—If an exchange is described
in paragraph (1) but has the effect of the distribution
of a dividend, then there shall be treated as a dividend
to each distributee such an amount of the gain recog-
nized under paragraph (1) as is not in excess of his
ratable share of the undistributed earnings and profits
of the corporation accumulated after February 28, 1913.
The remainder, if any, of the gain recognized under
paragraph (1) shall be treated as gain from the ex-
change of property.

The district court, 415 F.Supp. 832, held that the test
to be applied in determining whether the exchange had
“the effect of the distribution of a dividend” is whether
the transaction resulted in a “meaningful reduction” of
the taxpayer’s proportionate interest in the corporation,
relying on United States v. Davis, 397 U.S. 301, 90 S.Ct.
1041, 25 L.Ed.2d 323 (1970), and Wright v. United States,
482 F.2d 600 (8 Cir. 1973). The court then compared
the taxpayer's interest in the merged corporation (LSC)
with his interest in the surviving corporation (MGIC).
Because taxpayer held a controlling interest—68 per cent
of the stock—in LSC prior to the merger and owned less
than one per cent of MGIC’s stock after the merger, the
court concluded that the merger resulted in “a radical
change and meaningful reduction” in taxpayer’s interest
in the continuing business and thus did not have the effect
of the distribution of a dividend under § 356(a)(2). Ac-
cordingly, the court held that the “boot” was taxable as
a capital gain. Unfortunately, this approach is too sim-
plistic.

AlT7

In United States v. Davis, supra, the Supreme Court
was faced with interpreting 26 U.S.C. § 302,” under which
a stock redemption is treated as a distribution in payment
in exchange for the stock and ths qualifies for capi-
tal gain treatment under certain circumstances. Under
§ 302(b) (1), capital gain treatment is available if the re-
demption is “not essentially equivalent to a dividend.”
However, if the redemption has dividend equivalency, it
is taxed as ordinary income. Although the Court was
primarily faced with two other issues,’ it followed a
long line of prior decisions'' in holding that to qualify
under § 302(b) (1), a redemption must result in a “mean-
ingful reduction of the shareholder’s proportionate interest
in the corporation.” 397 U.S. at 313, 90 S.Ct. at 1048.
If the redemption does not result in such a reduction,
it is considered essentially equivalent to a dividend and
is taxed as ordinary income. The taxpayer in Davis was

9. Section 302 provides, in nertinent part:

(a) General Rule.—If a corporation redeems its stock (with-
in the meaning of section 317(b)), and if paragraph (1), (2),
(3), or (4) of subsection (b) applies, such redemption shall
be treated as a distribution in part or full payment in ex-
change for the stock.

(b) Redemptions treated as exchanges.—

(1) Redemptions not equivalent to dividends.—Subsec-
tion (a) shall apply if the redemption is not essentially
equivalent to a dividend.

10. In resolving these questions, the Court held that the rules
of attribution of stock ownership in § 318(a) apply to § 302(b) (1)
and that “business purpose” was irrelevant in determining whether
a redemption is equivalent to a dividend.

ll. E. g., Levin v. Commissioner of Internal Revenue, 385
F.2d 521 (2 Cir. 1967); Bradbury v. Commissioner of Internal
Revenue, 298 F.2d 111 (1 Cir. 1962); Keefe v. Cote, 213 F.2d 651
(1 Cir. 1954); Commissioner of Internal Revenue v. Roberts, 203
F.2d 304 (4 Cir. 1953); Flanagan v. Helvering, 73 App.D.C. 46, 116
F.2d 937 (1940). See also 1 J. MERTENS, LAW OF FEDERAL
INCOME TAXATION, § 90.100 (1974); B. BITTKER & J. EUS-
TICE, FEDERAL INCOME TAXATION OF CORPORATIONS &
SHAREHOLDERS, 9-24—9-27 (3d ed. 1971).

Als

the sole shareholder in a corporation both before and after
he redeemed a certain amount of his stock and thus did
not meet the meaningful reduction test. Obviously, his
relationship with other shareholders in the corporation
did not change and he suffered no loss of voting power
or control.

In Wright v. United States, supra, the Eighth Circuit
applied the ‘meaningful reduction” analysis to a corporate
reorganization. There three corporations were owned and
controlled by the same shareholders but in different pro-
portions. The principal shareholders wanted to consolidate
two of the corporations into a single entity in which their
ownership would be approximately the same proportion
as in the other corporation. This goal could not be ac-
complished through a simple merger because one corpora-
tion was worth about twice as much as the other. Ac-
cordingly, the reorganization required payment of a “boot”
to the taxpayer to reflect his greater entitlement and to
result in a new corporation with the desired ownership
percentages. Even though a formal redemption did not
occur, the court viewed the “‘boot” from the reorganization
as having been paid to the taxpayer by the newly formed
corporation when he redeemed his stock in that corporation
—stock which never had been issued and which the tax-
payer had never owned. The court thus treated the trans-
action as if there had been only one corporation all along
and as if one shareholder had redeemed his stock. Because
this hypothetical redemption resulted in a 23 per cent
reduction in the taxpayer’s ownership,’ the court con-
cluded that the “redemption” had caused a “meaningful
reduction” under Davis. Thus, the court concluded that

12. Before the reorganization, the taxpayer owned 85 per
cent of the two corporations. After the reorganization, he owned
62 per cent of the new corporation.

Alg

the “boot” was “not essentially equivalent to a dividend”
under § 302(b)(1) and therefore did not have “the effect
of the distribution of a dividend” under § 356 (a) (2).

Application of the “meaningful reduction” test in
Wright was not illogical, given the court’s recasting of
the transaction, since a single shareholder was treated
as having redeemed his stock in a single corporation. In
the instant case, however, the reorganization involves two
different corporations of different sizes and with different
shareholders. There is no commonality of ownership as
in Wright, and, accordingly, no opportunity for reshaping
the transaction as a redemption. Moreover, there was
not a single “boot” distribution to a single shareholder,
as in Wright, but a pro rata distribution to all LSC share-
holders.

The “meaningful reduction” test cannot be indis-
criminately applied in the reorganization context. The
Davis case illustrates its proper application in a redemp-
tion under § 302, as does the recently decided case of
Morris v. United States, 441 F.Supp. 76 (N.D.Tex.1977),
while Wright indicates that it also is appropriate when
a reorganization can be realistically treated as a redemp-
tion. Even assuming that Wright is correctly decided—
a point on which we express no opinion—the instant case
presents radically different facts and calls for correspond-
ingly different analysis. We agree with the government
that “the undifferentiating invocation of stock redemption
principles in a reorganization case” such as this one is
erroneous, and we decline to apply on a wholesale basis
the “meaningful reduction” test in cases arising under
§ 356(a)(2).%° Accordingly, we hold that the district

13. We are not unaware of several cases indicating that
Sections 356(a) (2) and 302(b)(1) are to be read in pari materia,

(Continued on following page)

A20

court erred in utilizing “meaningful reduction” analysis
in this case. A contrary holding would render § 356 (a) (2)
virtually meaningless when a large corporation swallows
a small one in a reorganization, for there will always
be a marked decrease in control by the small corporation’s
shareholders, unless the same shareholders control both
corporations. And, even in that situation, disproportionate
ownership—as in Wright—could result in a meaningful
reduction.

Section 356(a) (2) requires that a “boot” be taxed as
a dividend if it “has the effect of the distribution of a
dividend.” The focal point of our analysis, then, is the
effect of the “boot” in the instant case, and we must
examine all of the facts and circumstances surrounding
its distribution in light of basic tax principles pertaining
to dividends and reorganizations.

Under 26 U.S.C. § 316(a), “dividend” is defined as
“any distribution of property made by a corporation
to its shareholders ... out of its earnings and profits,”
either current or accumulated. Thus, a dividend is the
severance of profits from the corporation and the distribu-
tion of those profits to the shareholders. United States
v. Phellis, 257 U.S. 156, 170, 42 S.Ct. 63, 66 L.Ed. 180 (1921).

Footnote continued—

despite the absence of an express statutory relationship between
them. E. g., Hawkinson v. Commissioner of Internal Revenue, 235
F.2d 747, 751 (2 Cir. 1956); Ross v. United States, 173 F.Supp. 793,
797, 146 Ct.Cl. 223, cert. denied, 361 U.S. 875, 80 S.Ct. 138, 4
L.Ed.2d 113 (1959). This is correct in that both provisions are
usually triggered by pro rata distributions. - However, the facts of
th? instant case illustrate why principles developed in § 302(b)
(1) cases cannot be haphazardly applied in the context of a § 356
(a)(2) reorganization. The Internal Revenue Service has stated
that tests developed for § 302 may “in appropriate cases” serve as
“useful guidelines for purposes of applying § 356(a)(2).” Rev.
Rul. 74-516, 1974-2 Cum.Bull. 121. We agree with the govern-
ment that the instant case is not among those “appropriate cases,”

A21

Section 301(c) provides that a dividend is to be included
in the taxpayer’s gross income.

The theory behind tax-free corporate reorganizations
is that the transaction is merely “a continuance of the
proprietary interests in the continuing enterprise under
modified corporate form.” Lewis v. Commissioner of In-
ternal Revenue, 176 F.2d 646, 648 (1 Cir. 1949); Treas.Reg.
§ 1.368-1(b). See generally Cohen, Conglomerate Mergers
and Taxation, 55 A.B.A.J. 40 (1969). Indeed, if the trans-
action does not involve the exchange of sufficient stock
or securities, the judicially-created “continuity of proprie-
tary interest” test destroys the transaction’s treatment as
a reorganization."

If a pro rata distribution of profits from a continu-
ing corporation is a dividend, and a corporate reerganiza-
tion is a “continuance of the proprietary interests in the
continuing enterprise under modified corporate form,” it
follows that the pro rata distribution of “boot” to share-
holders of one of the participating corporations must cer-
tainly have the “effect of the distribution of a dividend”
within the meaning of § 356(a)(2). King Enterprises,
Inc. v. United States, 418 F.2d 511, 189 Ct.Cl. 466 (1969);
Hawkinson v. Commissioner of Internal Revenue, 235 F.2d
747 (2 Cir. 1956); Ross v. United States, 163 F.Supp. 793,
146 Ct.Cl. 223, cert. denied, 361 U.S. 875 (1959); Love v.

14. The purpose of the test is to ensure that the shareholders
of the corporations involved in a reorganization retain a signifi-
cant continuing equity interest in the reorganized business. See
Le Tulle v. Scofield, 308 U.S. 415, 60 S.Ct. 313, 84 L.Ed. 355
(1940); Helvering v. Minnesota Tea Co., 296 U.S. 378, 56 S.Ct. 269,
80 L.Ed. 284 (1935); Pinellas Ice & Cold Storage Co. v. Commis-
sioner of Internal Revenue, 287 U.S. 462, 53 S.Ct. 257, 77 L.Ed. 428
(1933); Southwest Natural Gas Co. v. Commissioner of Internal
Revenue, 189 F.2d 332 (5 Cir.), cert. denied, 342 U.S. 860, 72 S.Ct.
88, 96 L.Ed. 647 (1951). See generally Sapienza, Tax Considera-
tions in Corporate Reorganizations and Mergers, 60 Nw.L.Rev. 765
(1966); Fox & Fox, supra, n. 6, 1 4.02[5][a].

A22

Commissioner of Internal Revenue, 113 F.2d 236 (3 Cir.
1940); Rose v. Little Inv. Co., 86 F.2d 50 (5 Cir. 1936); Com-
missioner of Internal Revenue v. Owens, 69 F.2d 597 (5 Cir.
1934). Moreover, the legislative history of § 356(a) (2)’s
predecessor statute makes clear that a distribution that
would have been a dividend if made prior to the reorga-
nization is subject to the same treatment when made as
part of the transaction. H.Rep. No. 179, 68th Cong., Ist
Sess., 14-15 (1924) [1939-1 Cum.Bull. (Part 2), 241, 252];
S.Rep. No. 398, 68th Cong., 1st Sess., 15-16 (1924)
[1939-1 Cum.Bull. (Part 2), 266, 277].

Accordingly, § 356(a)(2) requires a determination
of whether the distribution would have been taxed
as a dividend if made prior to the reorganization or if
no reorganization had occurred. This inquiry is essentially
a comparison of the effect of actual distribution and the
effect of a hypothetical one. Prior to the mergef in the
instant case, LSC had retained earnings of approximately
$725,000. In the course of the merger, LSC shareholders
received a pro rata distribution of $625,000 as “boot”. If
no reorganization had taken place and LSC had made
such a pro rata distribution, or if LSC had taken such
action prior to the merger, there is no doubt that this
would have been a dividend taxable as ordinary income.
The same result should obtain where, as here, the LSC
shareholders received a pro rata “boot” of $625,000.

15. The “boot” is to be treated as having been distributed
by the acquired corporation—here LSC—rather than by the ac-
quiring corporation. See Commissioner of Internal Revenue v.
Owens, supra; Ross v. United States, supra; James Armour, Inc.,
43 T.C, 295 (1964). Our decision in Davant v. Commissioner of
internal Revenue, 366 F.2d 874 (5 Cir. 1966), cert. denied, 386
U.S. 1022, 87 S.Ct. 1370, 18 L.Ed.2d 460 (1967), is not to the con-
trary. There we recognized the general rule stated above, but
looked to the acquired and acquiring corporations since both had
the same shareholders. As we pointed out, the two corporations
ye but different pockets in the same pair of trousers.” 366

.2d at 889.

A23

Indeed, the legislative history of the predecessor to
$ 356(a) (2) offers virtually the same fact situation as an
example of a transaction having the effect of a dividend
distribution.’” The taxpayer should not be able to reap the
benefits of capital gain treatment simply because he re-
ceived his share of the distribution after the merger in the
form of a “boot” rather than before the merger in the form
of a dividend.

Taxpayer argues that we ignore economic reality by
hypothesizing that LSC could have declared a dividend
prior to the merger, since the corporation had only $147,000
in cash on hand when the merger took place. Taxpayer
thus asks us to erase approximately $725,000 in retained
earnings from the corporation’s pre-merger balance sheet
and pretend that these profits were never made. This
we refuse to do. It is apparent that taxpayer, who con-
trolled LSC made a considered decision to utilize the
corporation’s retained earnings for purposes other than

16. The House Report states:

The necessity for this provision may best be shown by an
example: Corporation A has capital stock of $100,000, and
earnings and profits accumulated since March 1, 1913, of
$50,000. If it distributes the $50,000 as a dividend to its
stockholders, the amount distributed will be taxed at the full
surtax rates. On the other hand, corporation A may organize
corporation B, to which it transfers all its assets, the consid-
eration for the transfer being the insurance by B of all its
stock and $50,000 in cash to the stockholders of corporation A
in exchange for their stock in corporation A. Under the
existing law, the $50,000 distributed with the stock of cor-
poration B would be taxed, not as a dividend, but as a capital
gain, subject only to the 12% per cent rate. The effect of
such a distribution is obviously the same as if the corporation
had declared out as a dividend its $50,000 earnings and profits.
If dividends are to be subject to the full surtax rates, then
such an amount so distributed should also be subject to the
surtax rates and not to the 12% per cent rate on capital gain.
Here again this provision prevents evasions.

House Report No. 179, supra at 14-15. Senate Report No. 398,
supra at 15-16, gives the same example.

£
+ eR OF ower —_—_

A24

payment of a dividend. It cannot be said that LSC was
unable to pay a dividend; rather, for reasons not revealed
in the record, it chose not to do so. Moreover, despite
taxpayer’s protestations to the contrary, it seems clear
that the merger operated as a device for “bailing out”
LSC’s retained earnings, which were evidently tied up
in certain aspects of the business’ operation.

Taxpayer also contends that our analysis in this case
constitutes abrogation of the “step transaction” doctrine.
We disagree. Under the doctrine, which has application
in a variety of tax situations, all parts of a multi-step
exchange or reorganization are grouped together to deter-
mine the appropriate tax treatment for the entire transac-
tion, if the several steps are an essential and integral
part of the overall plan. See Helvering v. Alabama As-
phaltic Limestone Co., 315 U.S. 179, 62 S.Ct. 540, 86 L.Ed.
775 (1942); Kanawha Gas & Utilities Co. v. Commissioner
of Internal Revenue, 214 F.2d 685 (5 Cir. 1954). However,
the doctrine is certainly no bar to our comparing the
“boot” distribution in the instant case with a hypothetical
situation in which the pro rata distribution of LSC’s re-
tained earnings would obviously have becn a dividend.
If the doctrine forbids such an examination of the “boot”
portion of the reorganization scheme, it would be impos-
sible to determine whether the “boot” distribution had
the effect of the distribution of a dividend. We are not
treating the “boot” distribution as a separate step in the
overall transaction but are rather analyzing the distribu-
tion in accordance with the requirements of § 356(a) (2).!7

17. The doctrine’s place in the reorganization context is
plain, for when cash is received in a series of transactions in
connection with a general reorganization plan, the taxable result
may vary considerably depending upon whether the transactions
are to be considered separately or as a whole and whether the

(Continued on following page)

A25

Moreover, taxpayer’s reliance on the step transaction
doctrine seems bottomed on his view that the meaningful
reduction test applies here and that the appropriate focus
is control of the corporation.'* We again reject this ap-
proach, for, as we have previously pointed out, a majority
shareholder in a small corporation will always become
a minority shareholder in a large corporation that acquires
the small one, so long as there is no commonality of owner-
ship. Further, although taxpayer and the other LSC share-
holders relinquished their control of LSC, they certainly
did not part with their interests in the continuing corporate
entity under the reorganization, i. e., MGIC. Taxpayer’s
approach also fails to address the effect of the “boot”
distribution itself, an inquiry mandated by the plain lan-
guage of § 356(a) (2).

Finally, we are compelled to note that our decision
today does not signal a return to the now-discredited “auto-
matic dividend” rule." We are concerned in this case

Footnote continued—

cash constitutes “boot” or the sole consideration in connection
with a single step in the transaction. See 3 J. MERTENS, LAW
OF FEDERAL INCOME TAXATION, §§ 20.161 et seq. (1972).
There is no doubt in the instant case that the “boot” was dis-
tributed pursuant to an overall plan of corporate reorganization.

18. Taxpayer cites and discusses various § 302 redemption
cases. E. g., Zenz v. Quinlivan, 213 F.2d 914 (6 Cir. 1954); Arthur
D. McDonald, 52 T.C. 82 (1969). As we have previously indi-
cated, we will not haphazardly apply § 302 principles in § 356
cases. Moreover, the cases relied on by taxpayer only peripherally
involve the step transaction doctrine and simply stand for the
proposition that either the complete termination of a taxpayer’s
interest in a corporation or the substantial reduction of that inter-
est does not result in dividend equivalency. The Supreme Court
reaffirmed this principle in Davis.

19. This rule stemmed from language in Commissioner of
internal Revenue v. Estate of Bedford, 325 U.S. 283, 65 S.Ct. 1157,
89 L.Ed. 1611 (1945). The opinion was widely criticized, how-
ever, because it appeared to encompass all distributions, regardless

(Continued on following page)

A26

with the effect of a pro rata “boot” distribution, not with
the effect of a distribution on a non-pro rata basis. Ob-
viously, the latter variety does not bear the earmarks
of a classic dividend. Further, we do not totally reject
the relevance of principles developed in § 302 redemption
cases in the context of a corporate reorganization implicat-
ing § 356. However, such a blind application of those
principles would be somewhat akin to hunting ducks with
a deer rifle, since there are fundamental differences be-
tween the redemption of stock in a single corporation
and the reorganization of two or more corporations that
results in a “boot”.

Accordingly, we hold that the district court erred in
concluding that the meaningful reduction test of Davis was
applicable here and that the “boot” received by the t-x-
payer was to be taxed as a capital gain. Because the
distribution of the “boot” had the cffect of the distribution
of a dividend, § 356(a)(2) requires that it be taxed as
ordinary income.”

REVERSED.

Footnote continued—

of whether they were made on a pro rata basis. Accordingly, a
string of lower court decisions have retreated from the rule and
have examined, as we have done here, the facts and circumstances
of each case in order to determine the effect of the distribution.
E. g., Hawkinson v. Commissioner of Internal Revenue, supra;
Ross v. United States, supra.

20. This case is obviously a complex one, and the court was
aided by the excellent briefs and argument of both parties. We
thus cannot say that this tax puzzle is one that “cometh not out
save by fasting and by prayer,” Houston Textile Co. v. Commis-
sioner of Internal Revenue, 173 F.2d 464 (5 Cir. 1949) (Hutcheson,
J.), although we certainly do not disparage either of those
activities.

ee

A27

APPENDIX D

UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT

No. 76-3749

D. C. Docket No. 74-440-Civ-T-H

MANDELL SHIMBERG, JR. and
ELAINE F. SHIMBERG,
Plaintiffs-Appellees,

versus

UNITED STATES OF AMERICA,
Defendant-Appellant.

Appeal from the United States District Court for the
Middle District of Florida

Before BROWN, Chief Judge, and
THORNBERRY and CLARK, Circuit Judges.
JUDGMENT

This cause came on to be heard on the transcript
of the record from the United States District Court for
the Middle District of Florida, and was argued by counsel;

ON CONSIDERATION WHEREOF, It is now here
ordered and adjudged by this Court that the judgment
of the said District Court in this cause be, and the same
is hereby, reversed;

It is further ordered that plaintiffs-appellees pay to
defendant-appellant, the costs on appeal to be taxed by
the Clerk of this Court.

July 28, 1978
Issued As Mandate:

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_1960%3A1. Public record. Not legal advice.