Appendix — Gooding v. United States

. - APPENDIX A

IN THE UNITED STATES COURT OF CLAIMS

(Decided January 24, 1964)

No. 165-59

F. E. Goopine

v.

Tae Unrrep States

- No. 166-59

EvizaBETH Goopinc

v. }

Tue Unrrep States |

Roger K. Powell and Ernestine B. Powell for the plain-

tiffs. :

Conrad T. Hubner, Jr., with whom was Assistant Attor-

* ney General Louis F. Oberdorfer, for the defendant.

Edward S. Smith, Lyle M. Turner and Philip R. Miller

were on the brief.

Before Jones, Chief Judge, WuitaKer, Laramore, Dur- ©

rEE and Davis, Judges. : )

Opinion

Davis, Judge, delivered the opinion of the court:

- Mr. and Mrs. Gooding have brought these refund suits to

regain admitted overpayments of income taxes for 1946.

Under the stipulated facts, recovery is time-barred unless

the mitigation portion of the Internal Revenue Code of

1954, §§ 1311-1315, or the doctrine of equitable recoupment

is applicable.

2a

On August 24, 1946, the Goodings and their minor daugh-

ter, who had operated an amusement-park equipment busi-

ness as partners, transferred their respective interests in

the assets formerly used: by the partnership! to the Gooding

Amusement Company, Inc. (a corporation organized on the

same day). In return, the plaintiffs and their daughter

_received all of the corporate common stock, certain notes

of the corporation, and an as+umption by the corporation

of their liability for the partnership debts. The assets, at

that time, had a fair market value of $294,970.34, and a

depreciated book value or adjusted basis of $180,237.29.

The assets’ fair market value of $294,970.34 was the total

consideration paid by the new company.

As a result of this transaction, Mr. Gooding received as

his portion of the consideration $168,554.51, consisting of _

140 shares of no-par common stock having a stated value of

$28,000, 5 notes due in successive years (beginning in 1947)

totalling $132,527.08, and an assumption of liability of

$7,982.43 (which was his share of the partnership debt).

Mrs. Gooding received as her part $84,277.25, in the form of

70 shares of stock ($14,000), 5 notes ($66,286.04), and an

assumption of her liability ($3,991.21).

For the year 1946, the Goodings filed separate returns

treating this transaction as taxable to the extent of the

notes received, as ‘‘other property’’ or ‘‘boot’’ under Sec-

tion 112(c) of the 1939 Code. ae they recognized

spectively (t.e., the consideration receiv ed by each, “hte the

adjusted basis of the assets attributable to each). A

capital gains tax was paid on these sums and the Internal

Revenue Service, upon audit of the returns, accepted the

taxpayers’ treatment of the transaction as requiring the

recognition of gain.

1 Land, buildings, cables, mechanical rides, accounts and notes

receivable, unexpired insurance, advance payments to employees,

and advance payments on equipment.

3a

’ In 1947, the corporation paid the first of the notes. held

by Mr. Gooding ($26,514.42) and part of one of the notes

held by Mrs. Gooding ($5,000) ; in 1948, another of the notes:

held by Mr. Gooding was paid_ ($26,514.42). The taxpayers

treated the proceeds of these payments as a return of

capital and therefore not taxable. ‘The Internal Revenue

Service disagreed. After limitations had run for 1946, the

Service determined that the 1946 transaction was a tax-

free exchange under Section 112(b)(5) of the 1939 Code

and that the payments on the three notes. in 1947 and 1948

were distributions of earnings and profits, fully taxable at

ordinary income rates as a taxable dividend.’ The view of -

the Service was sustained in a decision of the Tax Court

(Gooding Amusement Co., Inc. ¥. Commissioner, 23 T.C.

po (1! Not), aff’d, 236 F.2d 159 (C.A. 6, 1956), cert. denied,

2 U.S. 1031 (1957)) which became final on March 11,

past. W ithin a few months, taxpayers ‘filed claims for

refund of the capital gains taxes paid for 1946. These

claims were rejected on June 16, 1958. In 1959, plaintiffs

filed petitions in this court,seeking recovery of all the 1946

taxes paid on the erroneous supposition that the reorgani-

zation ‘was a taxable transaction.

To pass over the limitations hurdle, the Goodings rely

primarily on the mitigation provisions of the 1954 Code?

(sections 1311-1315) which grant extra-limitations relief to

the taxpayer and the Government if and when they suffer

from inconsistent treatment.of tax matters by the other

side. This relief is limited to defined circumstances 3 the

statute ‘‘does not purport to permit the correction of all

errors and aaa Brennen v. Commissioner, 20 T.C.

495, HOO (1953 ,

The defendant admits that the position it stk (andy

which the Tax Court adopted) with respect fo the paymentk

on the notes in 1947 and 1948 was inconsistent with ifs

2 The 1954 provisions, rather ane those of the 1939 Code, govern

here. See 1954 Code, § 1315.

da : -

acceptance of the capital gains tax in 1946. Defendant also

concedes that the treatment given the 1946 transaction was

erroneous; it should have been considered non-taxable. —

Thus far, the case falls under section 1311 which declares

. that whrre ‘*the correction of the effect of an error is pre-

vented by operation of any law or rule of law [here, the

statute of limitations] * * * then the effect of the error

shall be corrected by an adjustment * ° °,’’ if the Service

has maintained, and a court has accepted, an inconsistent

position with respect to an erroneous ‘‘inclusion’’ of in-

come or ‘‘recognition’”’ of gain.2 The dispute arises be-

cause the adjustment permitted by the mitigation provi-

sions is confined. to the specific groups of: cases listed in

section 1312. The defendant maintains that taxpayers’ sit-

uation ‘fits none of these classes; the taxpayers assert that

they can rely on either of two named categories: ‘‘ Double

Inclusion of an. Item of Gross Income”’ (§ 1312(1)), or

‘‘Basis of Property After Erroneous Treatment of a Prior

Trausaction’’ (§ 1312(7)). We agree that section 1312(7)

applies, and therefore do not assess the other alternative,

Section 1312(7) provides:

(7) Basis of property after erroneous treatment of

a prior transaction.—- , ,

(A) General rule.—The determination deter-

mines the basis of property, and in respect, of any

transaction on which such basis depends, or in re-

spect of any transaction which was erroneously

treated as affecting such basis, there uvceurred with

respect to a taxpayer described in subparagraph (B)

of this paragraph any of the errors described in

subparagraph (C) of this paragraph.

(B) * * * Taxpayers with respéct to whom the

erroneous ‘treatment occurred must be—

2 If the mitigation provisions apply, the taxpayer has one year

after the date of the fina] determination within which to take the

appropriate steps to recover. Section 1314(b).

e

~

0a

(i) the taxpay er with respect to whom the

‘ree ismade*** — .

(C) Prior erroneous treatment —wWith respect to |

a taxpayer om in subparagraph (B) of this |

paragraph—

(i) there was an erroneous inclusion in, or

omission from, gross income,

(ii) there was an erroneous recognition, or non-

ini or of or loss * * *

* ° e e e eo

It is agreed that the Tax Court ruling on the 1947 and 1948

payments was a ‘‘determination’’ under the statute. ‘The

only disagreement is whether that decision ‘‘determine[d]

the basis of property,’’ within subparagraph A.‘

The Tax Court found that for tax purposes the notes re-

ceived by the taxpayers in 1946 were not bona fide evidences

of indebtedness; but were more nearly in the nature of

stock or equity instruments.’ , The necessary result of that

holding is that the notes could not have constituted ‘‘other

‘property’’ which subjected the 1946 transaction to recog-

* We point out in footnote 12, infra, that the other conditions of

section 1312(7) are clearly fulfilled.

5 The Tax Court did not hold, and defendant does not contend,

that the notes were mere pieces of paper (without any iegal validity

for any purpose) or wholly unconnected with the payments made

in 1947 and 1948. Rather, the court viewed the notes as if they

were shares of stock or comparable obligations. The court said

(23 T.C. at 419) that the taxpayers’ position with respect to the

notes ‘‘was akin to that of the ordinary shareholder, who under-

stands that his investment is subject to the risk of the venture and

the prior claims of creditors.’ The opinion also said (id. at 423)

that ‘‘the notes which were received by petitioners [taxpayers]

* * © were in fact representative of risk capital invested in the

nature of stock * * *.”’ ee

- 6a &

_ hition of gain to the extent of the ‘‘other property’’ or

‘*boot’’ (see Section 112(c) of the 1939 Code); there was

thus an erroneous recognition of gain at the time of that

tran¥action. 1939 Code, § 112(b) (5).

How id this affect basis? Under the taxpayers’ original

position that the 1946 transaction entailed recognizable

gain, the notes plus the stock would have had a basis equal

to the fair market value of the assets transferred by the *

Goodings to the new company (see United States v. Davis,

370 U.S. 65, 72 (1962)); the basis of each of the notes

would have been equivalent to its face amount (the notes

plus the stated value of the no-par stock equaled the fair

market value of the transferred assets). Under the view

Of the Tax Court that the 1946 transaction was a tax-free

exchange, the notes and the stock shared a common basis

equivalent to the adjusted basis of the assets. 1939 Code,

§ 113(a)(6). Since this adjusted basis was lower than the

fair market value, the immediate effect of the Tax Court

decision was to reduce the total basis of the notes and stock

from what it was under the position taken by the taxpayers

and the Internal Revenue Service in 1946. With respect

. to the particular notes which were satisfied in 1947 and

1948, the effect on basis was even more drastic. For the

Tax Court to uphold a tax on all of the proceeds of those

notes, they must have been treated as having no basis—-

neither a proportion of the lower adjusted basis nor a

proportion of the higher fair market value. If they were

‘deemed to have a basis, the taxpayers would have to be

permitted to recover it before being taxed on the gain or

some other arrangement would have to be made for the

basis. The levy sustained by the Tax Court was on the’

entire proceeds of the notes, not merely the excess over

basis.- What happened is that, by operation of law, any

basis the redeemed notes initially had was reallocated to

the remaining notes and the stock. See Stolz v. Commis-

, stoner, 30 T.C. 530, 538-39 (1958), aff’s per curiam, 267 F.

2d 482 (C.A. 5,°:1959); Treas. Reg. § 1.302-2 (1954 Code).

; a

See also Curlee v. Commissioner, 28 B.T.A. 773, 782 (1933),

aff’d, 76 F. 2d 472 (C.A. 8, — cert, denied, 296 U.S.

599, 600 (1936).

We think that a court decision with such a dinsit innate

ate, and drastic impact on the basis-of the notes is a deter-

mination of the basis of that property under section 1312

(7)(A). It is unimportant that the Tax Court did not

spell out the change in basis which would follow upon its

décision or that it failed to advert specifically to the prob-

lem-of basis. A major. shift in the basis of the notes was a

necessary result of the decision, implicit in its rationale. °

More than thai—as we have just pointed out—the court

could not have approved the tax on the full proceeds of the

- notes without deciding that the notes had no basis to be ©

recovered or that the basis would have to be reallocated.

Neither the involvement of basis nor the effect on basis

was tangential, conjectural, oblique, or incidental; both

were direct, immediate, and massive. Unless the compli-

cated words of-the mitigation provisions are to be. given

some special, restricted application, we would seem to

have here (in the Tax Court’s ruling) a ‘‘determination of

basis’? in thé normal sense. Cf. Rosenberger v. United

States, 138 F. ‘Supp. 117, 119 (E.D. Mo., 1955), aff’d, 235

F. 2d 69, 73-74 (C.A. 8, 1956).

The Government says, in effect, that the courts have al-’

ready given such a singular reading to section 1312(7) and

its predecessors. We are referred to Tax Court and Second

_Cireuit rulings denying mitigation, but those decisions,

whether right or wrong,’ do not touch our case. In the

precursor, American Foundation Co. v. Commissioner, 2

T.C. 502 (1943), the taxpayer sold its mining company (in

1931) to a corporation for a consideration which included

15,000 shares of the corporation’s stock having a fair mar-

*See Note, Sections 1311-15 of the Internal Revenue Code;

Some Problems in Administration, 72 Harv. L. Rev. 1536, 1543-

~ 1549 (1959).

8a

ket value of $20 per share (adjusted basis was lower). The

taxpayer did not recognize any gain with respect to the

stock, but the Internal Revenue Service felt otherwise and .—

assessed a deficiency; on the latter viéw, the basis of the

stock would be its fair market value. The deficiency was

paid and the taxpayer brought, suit for a refund, claiming

' that no gain should have been recognized for 1931. While

this was pending, the taxpayer sold some of the shares in

1934, 1936, and 1937, returning a gain which was computed

_ by using the fair market value of the shares as basis rather

than the lower adjusted basis. Thereafter, when a reopen-

ing of the transactions in 1934, 1936 and 1937 was time-

barred, the'district court, in a final determination, sustained

the taxpayer’s position that no ga‘. should have been

recognized with respect to the stock received in the 1931

transaction. The Service, then, pursuant tothe basis pro-

vision of the mitigation sections, assessed a deficiency for .

the later years when the stock sales took place, on the

ground that adjusted ‘asis rather than fair market value

’ should have been employed.. The Tax Court held against

the Commissioner. It said, first, that the district court’s

ruling on the 193] transaction did not determine basis, but

only whether there was a recognizable gain on the receipt

of the shares in 1931. That. ground of the Tax Court's

decision does*not govern here. Since the prior district

court ruling in American Foundation had held the trans-

action non-taxable, and therefore that gain should not be -

recognized and taxed, the district court can be said to

have had no occasion to consider, pass upon, or take ac-

count of basis—which is normally involved. (in. direct

fashion) where gain is assessed and taxed, but not where

gain, whatever amount it may be, is still to be recognized.

In the Goodings’ case, on the other hand, the Tax Court

upheld the levy and therefore, as we have said, must neces-

sarily have taken account of basis..

The second ground of the American Foundation Co.

opinion also distinguishes that case. The court, held that

9a

the Government failed to come under the mitigation pro-

visions because the taxpayer’s ‘‘omission’’ from gross in-

come in 1934, 1936, and 1937, was with respect to the sale

of the shares in those years and not with respect tothe

transaction upon which the basis depended, t.e., the 1931

transaction. In our case that-condition is met; taxpayers

seek to recover for 1946. |

The other decisions cited by defendant’ can also be put ©

apart. They were concerned with the question of whether

prior rulings that certain amounts should be deducted

rather than capitalized constituted ‘‘determinations of

basis’’; it was-held that they were not. In none’of these

cases was the tax consequences of a transaction involving a

disposition of property before the prior courts. Their

- decisions merely had an incidental or tangential effect on

basis and did not have to take account of the basis of any

particular property. — -

“The Government’s next line of defense is that, since the .

basis of the notes which were paid in 1947 and.1948 is allo-

‘ cated to the corporate stock and the unredeemed notes, the

taxpayers cannot yet claim to have been hurt by the defend- °

ant’ discordant positions since no final determination, of

basis has yet been made; unless and until the reallocated

basis is used to compute gain, defendant. says, .the “tax- .

payers can suffer no injury arising from their payment

both of the capital gains tax in 1946 and of ordinary in-

come taxes in 1947 and 1948. It may be that, in the long

run, there will be no oceasion for the Internal Revenue

Service to assert that the basis of the remaining assets

(stock and notes) is less than the fair market value (in

1946) which would have been the basis if the view taken by

both the taxpayers and the Government in 1946 had been

7 Sherover v. United States, 137 F. Supp. 778 (S.D.N.Y.), aff'd

per curiam, 239 F. 2d 766 (C.A. 2, 1956) ; Landau v. Commissioner,

21 T.C. 414 (1953) ; Schulman vy. Commissioner, 21 T.C. 403 (1953) ;

Brennen v. Commissioner, 20 T.C. 495 (1953).

s°

10a

correct.” If that is so, plaintiifs will not, in the long run,

be subjected to an inconsistent treatment of basis; on the

other hand, if at some later time the Commissioner does

have occasion to insist on a lower basis the mitigation

provisions can then be invoked.

Though this argument has some theoretical appeal, we

believe that it should be rejected. To postpone indefinitely,

perhaps to the Greek calends, the caleuius of injury-plus-

inconsistency would clash with the basic aims of the miti-

gation provisions, as well as with the structure of our

income tax system. Sections 1311-1315 create a mechanism

_ of relief, designed in general to operate when a forma] de-

termination validates an inconsistent position so as to cause

an apparent injustice. See Gooch Milling & Elevator Co.

'y. United States, 111 Ct. Cl. 576, 581, 78 F. Supp. 94, 97

(1948).* The Tax Court's holding against taxpayers was

a definitive rulng plainly adopting a position opposed to

that taken by- the Governnient when the 1946 transaction

was under scrutiny. The immediate result of the decision

_ sanctioning that inconsistency was that, taking the years.

1946, 1947, and 1948 together, the taxapvers had to ‘pay

more taxes than they reaily owed. Even in the long run,

the probable consequence of the decision—though not the

inevitable ivsult—is that taxpayers would ultimately pay

(leaving aside the mitigation provisions) more taxes than

they would have paid if the 1946.transaction had been

deemed non-taxable. Certainly, there is no :eason to say

- that in the end taxpayers will receive a windfall if m'tiga-

* Or the Service may not otherwise ivapose a tax without taking

account of the premature recognition of gain in 1946.

® In Gooch and later cases, this court has indicated that the miti-

gation provisions should be given a liberal and remedial’ inter-

pretation. The Tax Court and the Second Circuit have seemed to

_ adopt a more restrictive view of the statute. See Note, 72 Harv.

‘L. Rev. 1536, 1543-1549, cited in footnote 6, supra. For the prob-

lems of the present case,“we dv not consider this difference in

general approach to be decisive.

lla

tion is now allow ed. These considerations suggest that it

fulfills the general purposes underlying sections’ 1311-1315

to cure at this time what seems today to be an injustice

stemming from the Giovernment’s inconsistency. Added to

this factor is the broad principle, infused into our income

tax structure through the wnnual accounting system and in

other ways, that, unless some good reason is advanced for

an exception, there should not be indefinite prolongation

of the tax effects of events or transactions. The summing

up of accounts between the Treasury and the taxpayer is |

not usually allowed to drag along for an uncertain pro-

tracted period. Cf. Burnet v. Sanford & Brooks Co., 282

U.S. 359 (1931). The Tax Court’s ruling is a sharp, spe-

cific, event which can easily be the occasion for striking a

balance between citizen and Government. If the choice is

between clearing the slate sooner rather than later, we

think that the Congress which authorized the mitigation

provisions would incline toward having it done in the pres-

ent rather than the indeterminate future. In this light, the

Tax Court’s decision ean properly be viewed as the basis

determination of which section 1312(7} speaks, even though

it is'conceivable that in the long run the taxpayers will not

be pecuniarily hurt by the Government’s change of position.

- The defendant also urges that, in any event, the Goodings

should be barred from recovery because they would have

had to pay the same capital gains tax for 1946 even if the

particular notes paid in 1947 and 1948 had not been treated

as ‘‘boot.’’?'® .This would be so only-if we continued the.

error of regarding the 1946 transaction as involving ‘‘ boot”

” As then viewed, Mr. Gooding realized gain on the 1946 trans: ~

action of $65,561.76 ($168,554.51 (total consideration received) less

$102,992.75 (adjusted basis of his assets)). The defendant says

that he would have received the same taxable gain if the trans-

action had involved only the three notes still outstanding after

1948 (totaling $79,542.24 in face amount), rather than the five

riotes actually issued, since his total consideration would necessarily.

have remained the same. A comparable calculation is made for

Mrs. Gooding.

12a

(i.e., the notes) and therefore as taxable. But the mitiga-

tion provisions demand that, after the Tax Court’s deter-

_ mination, we must look at the 1946 transaction correctly—

as a tax-free exchange. In its references to the prior

**transaction,’’ section 1312(7)(A) requires that, although

the total effects of the error may not be wiped out at once,

the proper view of the transaction itself must be adopted.

What the Giovernment would have us do is to make the

proper adjustment for the satisfied notes and then com-

pensate for it by regarding the remaming items (stock and

outstanding notes) as still within the frame of the wrong

picture of the 1946 transaction."

Nevertheless, we cannot allow the { payers to recover

the whole capita) gains tax paid for 1946, but only that

portion of the tax allocable to the three notes paid in 1947

and 1948 which were the subject, of the Tax Court’s deci-

sion. The mitigation provisions do not authorize the re-

covery of all the tax erroneously paid, without more. Sec-

tion 1314(a) specifies that the adjustment in the erroneous

impost must be confined to that ‘‘which results solely from

the correct treatment of the item which was the subject

of the error * * *.’’ The legislative history also admonishes

that the mitigation provisions are ‘‘ predicated on the prin-

ciple that correction is made only with respect to the item

involved in the determination. The operation of the bar

of the statute of limitations is not affected with respect to

any other item, even though such other item also had been

erroneousiy treated in the same year.. As to these items

there has been no chang of position, no double tax or double

deduction, to call for the relief provided by this section.”’

S. Rep. No. 1567, 75th Cong., 3d’ Sess. 52 (1938). The-

opinions which advert to this issue have taken the same

™ Section 1314(c) provides that ‘‘the amount to be * * * re- *

funded or credited * * * shall not be diminished by any eredit or

set-off based upon any item other than the one which was the

subject of the adjustment.’’ {Emphasis added.)

Ia

stand. Central Hanover Bank & Trust Co. v. United States,

163 F. 2d 60, 64 (CLA. 2, 1947); Gili v. Commissioner, 306

F. 2d 902, 906 (CLA. 5, 1962); First Nat. Bank of Phila. v.

Commissioner, 205 F. 2d 82, 86 (C.A. 3, 1953). For the

present taxpayers this rule measures recovery by the three

satisfied notes which were paid or partially paid and as

to which the taxpayers have already been hurt by the

defendant’s inconsistency. They have not similarly suffered

on account of the remaining notes; those may never be

paid or the corporation’s profit position may be so poor

that future payments on the notes will not be deemed a

distribution of dividends. Mitigation must abide the actual

event. In so limiting recovery, we are not continuing to

regard the 1946 transaction erroneously; we are recogniz-

ing that, as to the outstanding notes, the taxpayers have

not vet undergone the detriment with which the mitigation

sections are concerned.”

Finally, we hold that plaintiffs cannot have their claim

for the remainder of the 1946 tax considered under the

doctrine of equitable recoupment. . When Congress estab-

lished the detailed provisions of the mitigation sections. it

intended, we think, that they supersede any common-law

recoupment remedies with respect to the categories desig-

nated in section 1312. Since plaintiffs are covered by

2 With respect to the three notes paid in 1947 and 1948, tax-

payers clearly meet the other requirements of Section 1312(7).

Under Section 1312(7)(A), the error disclosed in the **determina-

tion of basis’’ must be ‘‘in respect of any transaction on which such

basis depends, or in respect of any transaction which was errone-

ously treated as affecting such basis."" The Tax Court's deter-

mination was grounded on the fact that, for tax purposes, the notes

were not bona fide evidences of indebtedness when they were, re-

ceived in 1946. Taxpayers also meet the condition “(in Section

1312(7)(B)) that they are the taxpayers with respect to. whom

the Tax Court made its basis determination end validated the

later tax; as well as the condition (in Section 1312(7)((€)) that

they erroneously recognized gain in 1946 as a consequence of

receiving the uotes. ,

l4a

Section 1312(7), they must also accept the bounds of the

relief Congress has granted. .

Plaintiffs are entitled to recover and judgment is entered

to that effect. Tie amount of recovery will be determined

under Rule 38(c) in accordance with this opinion.

WHITakeR, Judge; concurs in the result:

FINDINGS OF FACT

The court, having considered the evidence, the stipnlation

of the parties, the report of Trial Commissioner Robert K.

McConnaughey, and the‘briefs and argument of counsel,

makes findings of fact as follew:

1. F. E. Gooding and Elizabeth Gooding (hereinafter

referred to as plaintiffs) are husband and wife.

2. Plaintiffs filed individual income tax returns with the

Collector of Internal Revenue, Columbus, Ohio, for the

calendar year 1946 on March 15, 1947, and made their last

payment of 1946 income tax on or before such date. The

statute of limitations for refund of 1946 income tax paid,

prescribed by section 322(b)(1), Internal Revenue Code of

1939, expired March 15, 1950.

3..On August 24, 1946, Gooding Amusement Company,

‘Ine. (hereinafter referred to as the corporation) was or-

gavized with F. E.°Goeding, Elizabeth Gooding, and

Kathleen Holleran, its president and treasurer, vice presi-

dent, and secretary, respectively.

4. On August 24, 1946, F. E. Gooding, Elizabeth Gooding,

and Joyce Ann Gooding, their minor daughter, offered to

sell their interests in certain assets to the corporation at

a value of $294,970.34. These assets had been received by

F. E., Elizabeth, and Joyce Ann Gooding from a partner-

ship in which they were partners, and such assets consisted

of advances to employees, accounts and notes receivable,

land, buildings, cables, mechanical rides, unexpired insur-

ance, and advance payments on equipment.

.

15a

5. The depreciated book value of these assets distributed

by the partnership to the partners and offered to the cor- .

poration, as determined upon audit by the Commissioner

of Internal Revenue in 1948, was $180,237.29.' Upon the

basis of the same audit, F. E. Gooding’s share of the depre-

-ciated book value of these distributed assets was $102,992.75

and Elizabeth Giooding’s share of - depreciated book

value was $51,496.38. :

6. The difference, $114,733.10, between the depreciated |

book value of the distributed assets in the amount of

$180,237.29, and the offering price of *$294,970.39 to the

corporation, was the difference between the book value-and

the fair maret value of the assets.

7. The corporation accepted the partners’ offer and in

payment for such assets issued the partners 245 shares of

its common stock, having a stated value of $200 per share

or a total of $49,000, and ordinary negotiable judgment

notes having fixed maturity dates, in the amount of

$232,001.14, together with the assumption of liabilities of

the partners in the amount of $13,969.25, or the total con-

sideration, of $294,970.39. In return for their share of the

assets, based upon their respective interests in the partner-

ship, plaintiffs F.. E. Gooding and Elizabeth Gooding

received the foliowing: | . '

l6a

F. E. Gooding....... *140 shares of no-par common $28,000.00

stock having stated value of.

5 notes due in 5 succeeding 132,572.08

years beginning in 1947 at

$26,514.42. (or $26,514.41)

each.

\ Individual’s share of partner- 7,982.43

ship debt assumed.

Total consideration re 168,554.51

ceived.

Elizabeth Gooding.... *70 shares of no-par common 14,000.00

stock having stated value of. "i

5 notes due in 5 succeeding 66,286.04.

years beginning in 1947 at

$13,257.20 (or $13,257.21)

each.

Individual’s share of partner- 3,991.21

ship debt assumed.

Total consideration re- 84,277.25

ceived.

* (The only stockholder, other than F. E. Gooding and Elizabeth

Gooding, was their minor daughter. }

8. Plaintiffs, in their 1946 ieee tax returns, treated the

sale as a taxable transaction, to the extent of the notes

received as being ‘‘other property’’ under section 112(c) of

the Internal Revenue Code of 1939 and reported, the trans-

action as resulting in a recognized long-term capital gain,

determined upon audit by the Commissioner of Internal

Revenue in 1948 to be $98,342.64. By virtue of reporting

such gain, plaintiffs paid capital gains taxes for 1946. The

Commissioner of Internal Revenue upon his subsequent

audit determined that the.transaction was a reorganiza-

tion upon which gain was recognized and did not eliminate

the capital gains reported in connection therewith.

9. On January 10, 1947, the eorporation paid $26,514.42,

being the face amount of the note due F. E. Gooding one

‘

l7a

vear from date and dated August 24, 1946, to plaintiff

F. E. Gooding, and paid $5,000, on November 12, 1947,

being the face amount of the note due Mrs. F. BK. Gooding

(Elizabeth Gooding) dated August 24, 1946, and due one

year after date, to plaintiff Elizabeth Gooding. On August

31, 1948, the cofporation paid $26,514.42, being the face

amount of a note due F. E. Gooding dated August 24, 1946,

and due two years after date, to plaintiff F. E. Gooding.

There were also ‘‘interest’’? payments which are not in

dispute in this case.

10. In 1946 and in subsequent years, the corporation com-

puted depreciation expense and capital gains and losses

. attributable to the former partnership assets on the basis

of the increased valuation given to the assets at the time

of transfer to the corporation.

11. By reports of examination dated August 15, 1951,-

October 1, 1951, and January 21, 1952, the Commissioner

of Internal Revenue determined that the payments made to

plaintiffs in 1947 and 1948 on account of .these notes were

taxable income, and that such notes were the equivalent of

stock received in a nontaxable transaction.

12. The Commissioner also disputed the deductions taken

by the corporation for interest paid on the notes held by

plaintiffs and the use of the increased valuation on August

24, 1946, as a basis in computing the corporation's depre-

ciation expense and capital gains and losses.

13. Four cases in the Tax Court of the United States,

Gooding Amusement Company, Inc. v. Commissioner, F. E.

Gooding v. Commissioner, Elizabeth Gooding’ y. Commix

sioner, and fF’. E. Gooding and Elizabeth Gooding vy. Com-

missioner, were consolidated for trial, and under the title,

Govding v. Commissioner, 23 1.C. 40S, aff'd. (6th Cir. 1956),

236 F. (2d) 159, cert. dented, 252 U.S. 1031 (1957), it was

held in that part of the decision relating to plaintiffs that:

no indebtedness arose between the plaintiffs and the cor-

sd

18a

poration and that the amounts paid on the notes held by

- plaintiffs in 1947 and 194S8qwere dividends under the broad

language of section 115(a), being ‘‘distributions of cor-

' porate eh to-the stockholders as stockholders and not

as creditors.”’

14. On June 19, 1957, plaintiffs filed dean for refund

with respect to the tax imposed on account of the inclusion

of these notes from the corporation in their income for 1946.

Such claims were officially rejected by the Commissioner of

Internal Revenue on June 16,1958.

15. The parties have, by agreement, limited this proceed-

ing to issues relating to the plaintiffs’ right to recover and

have stipulated that, should the court find that the plain-

tiffs have a right to recover, the amount thereof may be

determined in further proceedings under Rule 38(c).

CONCLUSION OF LAW

Upon the foregoing findings. of fact, which are made a

part of the judgment herein, the court concludes as a matter

of law that plaintiffs are entitled to recover and judgment

is entered to that effect. The amvuunt of recovery will be

determined pursuant to Rule 38(c) in accordance with this

opinion.

Order

This case comes before the court on defendant’s motion

for reconsideration of the decision of the eourt of January

24, 1964. It appears to the court that plaintiffs have failed

to file a response thereto or a motion for an extension of

time therefor and that the time for so doing pursuant to

the Rules of the court has expired. Upon consideration

thereof,

Ir Is Ornvexep that the decision of the court entered here-

in on January 24, 1964, be and the same is hereby amended

in that the following is added thereto as the frst paragraph

of footnote 12 appearing at page 1] of the slip opinion :

Flas

19a z

We de not consider Example 5 of Treas. Reg.

§ 1.1312-7(c)—as ‘uming that it means what it appears

to Say and that it is valid—to be contrary to our hold-

ing on the extent of the recovery to be allowed the

present taxpayers. The Example, we think, poses a

situation in which a final determination definitively

decides, in connecticn with the taxability of the later

transaction, the propriety of recognition or non-recog-

nition of:gain or loss in the prior transaction; since

the sole ground given in the Example’ for the Tax

Court’s upholding the Commissioner (as to the gain

in the 1952 saie) is the prior erroneous nonrecogni- ~

tion of loss, the Tax Court must have treated directly ,

and squarely with that issue. On that view, the whole

of the prior transaction can be perhaps considered the

‘‘item’’ which was the subject of the érror. ‘In this

case, On the other hand, the Tax Court did not decide

whether or not the Goodings were or were not réquired

to have recognized some gain in 1946 when they ex-

changed their business assets for stock and notes. and

the court was certainly not passing upon the issue of

whether any gain ut all should have been recognized.

Although the implication of the decision is that gain

should not have beea recognized as to the later satis-

fied (or partially satisfied) notes, the Tax Court was

not treating with the 1946 transaction but only with

the payments on those notes in the later years; there

was no holding as to the whole of the transaction in

the prior year. This analysis suffices to distinguish

the Example, and we leave for future cases the issue

of its validity under the statute.

Ir Is Fueruer Orpverep that defendant’s motion for

" reconsideration be and the same is denied:

By Tue Covrr

April 3, 1964 . °

Marvin Jones ~ e

Chivf Judges

20a

_ APPENDIX B

IN THE UNITED STATES COURT OF CLAIMS

No. 165-59

F. E. Goopine, Plaintiff

v. 4s

Unrrep States or America, Defendant

J No. 166-59.

Exvizaseta Goopine, Plaintiff

v.

Unitep States or America, Defendant

Defendant's Motion for Reconsideration

Pursuant to Rule 53 of the Rules of the United States

Court of Claims, defendant moves the Court for recon-

sideration of its decision.

As the Court will recall, plaintiffs asserted that they

were entitled to recovér all of the taxes which they had

paid with respect to the transaction of August 24, 1946,

wherein they transferred their interests in assets to the

Gooding Amusement Company, Inc., in ¢xchange for stock

and ‘‘notes’’. Since the ‘statute of limitations otherwise

barred a’recovery, they based their claims on the mitiga-

tion provisions of the. 1954 Code. More specifically, their

claim was-in.the alternative and relied on Section .1312(1)

which applies to’ situations involving a double inclusion

of an item of gross income or Section 1312(7) which

applies to situations involving the basis of property after

an erroneous treatment of a prior transaction.

The Government denied that either subsection was avail-

able to the plaintiffs. This motion raises no point with

respect to Section 1212(1). Instead, it is limited to the

2la -

decision of the Court which brings the cases within the.

scope of Section 1312(7) but limits the recovery, at this-

time, to: the part of. the earlier tax which resulted from

treating as taxable the three ‘‘notes’’ on which payments

were made in 1947 and 1948.

As the Court will futther recall, among the arguments

advanced by the Government in its brief (pp. 13-21) was

one to the effect that under the Regulations the determina-

tion of the Tax Court holding that the plaintiffs received

a. distribution of earnings and profits substantially equiva-.

lent to a dividend was not a determination of a question

of basis such as was contemplated by Section 1312(7).

This position was thought to be sound for the reason that

the result in the case of the Goodings (as distinguished

from the case of the cerporation) would have been the

same regardless of what basis might be attributed to the

(ioodings’ interest-in the s.ocks and ‘‘notes’’, It was

thought that the illustrations under the Regulations gave

- support to that view in that, in each case, the hypothetical

' situations used clearly involved, in themselves, the ques-

tion of what was fhe proper basis of the assets in question.

Among the illustrations cited (Br. 18) were the examples

under Section 1-1312-7(¢c), Treasury Regulations on In-

~ come Tax under the Internal Revenue Code of 1954.

At that time Example 5, together with other examples,

was merely cited and not quoted. It was not quoted be-

cause it was the Government's position that Section 1312

(7) did not apply to the plaintiffs’ case and no contention

was being made that, if it’ did apply, less than the full

amount of the 1946 taxes wax refundable.

3

As it turned out, the Court concluded that the mitigation

provisions of Section 1312(7) were available to the plain-

tiffs but because there was not as yet any double taxation

of more than a part of the reported taxable income of

1946—and there might never be any double taxation on the

f}

22a

“balance—the bar of the statute of limitations was’ pres-

ently lifted only to a partial degree and only a part of the

1946 taxes could be. recovered.

The Court, having reached its conclusion that Section

1312(7) is applicable to the case, Example 5 now takes on

a different significance than that for which it was cited.

The example reads as follows:

Example (5). In 1946 a taxpayer received 100

shares of stock of the X Corporation having a fair

market value of $5,000, in exchange for shares of stock

in the Y Corporation which he had acquired at a cost

of $12,000. In his return for-1946 the taxpayer treated

the exchange as one in which gain or loss was not

recognizable. The taxpayer sold 50 shares of the X

Corporation stock in 1947 and in his return for that

vear treated such shares as having a $6,000 basis. In

1952, the taxpayer sold the remaining 50 shares of

stock of the X Corporation for $7,500 and reported

$1,500 gain in his return for 1952, After the expira-

tion of the period of limitations on deficiency assess- °

ments and on refund claims for 1946 and 1947, the

Commissioner asserted a deficiency for 1952 on the

ground that the loss realized on the exchange in 1946

was, erroneously treated as nonrecognizable, and the_

basis for computing gain upon the sale in 1952 was

$2,500, resulting in a gain of $5,000. The deficiency is

sustained by the ‘Fax Court in 1955. An adjustment is

authorized with respect to the vear 1946 as to the

entire $7,000 loss realized on the exchange, as the

Court’s decision determines the basis of property, and

in a prior transaction upon which such basis depends

there was an erroneous nonreeognition of loss to the

taxpayer with respect to whom.the determination was

made. - No adjustment is authorized with respect to

the vear 1947 as the basis for computing gain upon the

sale of the 50 shares in 1952 does not depend upon the

transaction in 1947 but upon the transaction in 1946.

7

3a

F rom the above it seems clear that, so far as the ‘Sie:

tions are concerned under their terms all of the earlier

taxes wonld be refunded. ‘To the extent that the example

does not limit the recovery as does the Court’s opinion

the two do not appear susceptible of reconciliation.

Since the Court made no reference to this example in

its deeision, it is unknown to the Government whether or

not this inconsistency was Inadvertent or, whether the

Court felt the example was an improper interpretation of

the mitigation provisions in view of the Court’s reading

of the Congressional purpose as poor in the legislative

history of the statute, and Section 1314.

The Government, how ever, does not feel that the matter

may be left in doubt. Infhe interests of certainty, it is.

bringing this part of the Regulations to the Court’s atten-

tion in order that fv'l consideration may be given to all

matters which may have a bearing on the question if,

‘through the failure of the parties to more clearly eall the

example to the Court’s attention, less than full considera-

tion has been given.

Respectfully subniitted,

Lovis F, Opernporrer

Louis F. Oberdorfer

‘Assistant Attorney General

Coxrap Tuomas Hupner, Jr.

Conrad T. Hupner, Jee” :

Attorney

“24a

APPENDIX C

Interna] Revenue Code of 1939:

Sec. 112 [as amended by See. 213(c) of the Revenue

Act of 1939, ¢. 247, 53 Stat. $62, and Sec. 121(d)(1),

Revenue Act of 1943, ¢. 63. 58 Stat. 21]. Recogyition

oF GaN or Loss.

(b) Exchanges Solely in Kind. —

(5) Transfer to corporation controlled by trans-

feror.—No gain or loss shall be recognized if prop-

-erty is transferred to a corporation by one or more

persons solely in exchange for stock or securities

in such corporation, and innmediately after the ex-

change such person or persons are in control of the

corporation ; ***. Where the transferee assumes a

liability of a transferor, or where the property of

a transferor is transferred subject to a liability,

then for the purpose only of determining whether

the amount of. stock or securities received by each

of the transferors is in the proportion required by

this paragraph, the amount of such liability (if

under subsection {k) it is not to be considered as

‘‘other property or money"’) shall be considered as

stock or securities received by such transferor.

* * ° .

(c) Gain from exchanges not solely inkind.—

(1) If an exchange would be wjthin the provisions

of subsection (b) (1), (2), (3), or (5), or within the

‘provisions of subsect.on .(1),°of this section if it

were not for the fact that the property received in

exchange consists not only of property permitted

by such paragraph or by subsection (¢) to be. re-

ceived without the recognition of gain, but also of

other property or money , then the gain, if any, to

the recipient sball be ree ognized, but in an amount

= a

not in excess of the sum of-such money and tbe fair

market value of such other property.

(26 U.S.C. 1952 ed., See. 112)»

Internal Revenue Code of 1954:

Sec. 358 [as amended by See, 21 (a) of the Technical

Amendments Act of 1958, P. L. 85-866, 72 Stat. 1606].

Basis ‘ro DistripuTEEs.

(a) General Rule.—In the case of an exchange to

which section 351, 354, 355, 356, 361, or 371(b) ap-

plies— .

(1) Nonrecognition property.--The basis of the

property permitted to be received under such see-

tion without the recognition of gain or less shall be

the same as that of the property exchanged—

(A) decreased by-——

(i) the fair market value of any other prop-

erty (except money) received by the taxpayer,

(ii) the amount of any money received by the

taxpayer, and

(iii) the amount of loss to the taxpayer which

was recognized on such exchange, and

(B) increased by-—

(i) the amount which was treated as a divi-

dend, and |

(ii) the amount of gain to the taxpayer which

was recognized on such exchange (not includ-

ing any portion of such gain which was treated

as a dividend).

(2) Other property.—The basis of uny other

property (except money) received by the taxpayer

shall be its fair market value,

26a -

(b) Allocation of Basis.—

(1) In General—Under regulations prescribed

by the Secretary or his delegate, the basis’ deter-

- mined under subsection (a) (1) shall be allocated

among the properties permitted to be received with-

out the recognition of gain or loss.

> ” se o

(d) Assumption of liability —Where, as part of the

consideration to the taxpayer, another party to the

exchange assumed a liability of the taxpayer or .ac-

quired from the taxpayer property subject to a liabil-

ity, such assumption or acquisition (in the amount of

of the liability) shall, for purposes of this section, be

treated as money received by the taxpayer on the

exchange.

* * a ad -

(26 U.S.C. 1958 ed., See. 358) -

Sec. 1311. Correction or Hrror.

(a) General Rule-—If a determination (as defined

in section 1513) is described in one, or more of the

paragraphs of section 1312 and, on the date of the

determination, correction of the effect of the error

referred to in the applicable paragraph of section 1312

is prevented by the operation of any law or rule of ©

law, other than this part and other than section 7122

(relating to compromises), then the effect of the error

shall be corrected by an adjustment made in the

amount and in the manner specrfied in section 1314.

(b) Conditions Necessary for Adjustment.—

(1) Maintenance of an inconsistent position. —

Except in cases described in paragraph (3) (B) and

(4) of section 1312, an adjustment shall be made

under this part only if—

(A) in case the amount of the adjustment woula

be credited or refunded in the same manner as an

274

overpayment, under section 1314, there is adopted

in the determination a position maintained by the

Secretary or his delegate, or

me e o *

and tne position maintained by the Secretary or his

delegate in the case described in svrparagraph (A)

* * * is inconsistent with the erroneous inclusion, ex-

clusion, omission, allowance, disallowance, recognition,

or nourecognition, as the case may be.

(26 U.S.C. 1958 ed., See. 1311)

Sec. 1312 [as amended by See, 2Y(a), Technical

Amendments Act of 1958, supra}. CircUMSTANCES OF

ADJUSTMENT.

The circumstances under which the adjustment pro-

vided in section 1311 is: authorized are as follows:

(1) Double inclusion of an item of gross income.—

The determination requires the inclusion in gross

income of an item. which was erroneously included

‘in the gross income of the taxpayer for another tax-

able year or in the gross income of a related tax-

payer.

* . * a

(7) Basis of property after erroneous treatment

of a prior transaction.—

(A) General rule—The determination deter-

mines the basis of. property, and, in respect of any

transaction on which such basis depends, or in re-

spect of any transaction which was erroneously

treated as affecting such basis, there occurred,

with ‘respect to a taxpayer described in subpara-

graph (B) of this paragraph, any of the errors

déseribed in subparagraph (() of this paragraph.

(B) Taxpayers with respect to whom the erron-

cous treatment occurred,—The taxpayer with re-

‘

» &

28a

spect to whom the erroneous treatment occurred

must be— ~

(i) the taxpayer with respect-to whom the

determination is made,

(C) Prior erroneous treatment.—With respect

to a taxpayer described in’ subparagraph (B) of ©

this paragraph—

(i) there was an erroneous inclusion in, or

omission from, gross income,

(ii) there was an erroneous recognition, or

non-recognition, of gain or loss or * * *. ~

* * * -

(26 U.S.C. 1958 ed., See. 1312) '

Sec. 1313. Derinrrions. ‘ |

(a) Determination.—For purposes of this part, the |

term ‘‘determination’’ means— .

(1) a decision by the Tax Court or a judgment

decree, or other order by. any court of competent

jurisdiction, which has become final.

(26 U.S.C. 1958 ed., See. 1313)

Sec. 1314 [as amended by See. 59/b) of the Technical

Amendment Act of 1958, supra). AMount axnp Metuop

OF ADJUSTMENT. Are.

(a) Ascertuinment of Amount of Adjustment.—In

computing the amount of an adjustment under. this

part there shall first be ascertained the tax previously

determined for the taxabie year with respect to which -

_tbe error was made. The amount of the tax previously

determined shall be the excess of — .

29a

(1) the sum of—

(A) the amount shown as the tax by the tax-

payer on his return (determined as provided in

section 6211(b)(1) and (3), relating to the defini-

tion of deficiency), if a return was made by the

taxpayer and an amount was shown as the tax by

the taxpayer thereon; plus ~

(B) the aniounts previously assessed (or col-

’ lected without assessment) as a deficiency, over—

(2) the amount of rebates, as defined in section

6§211(b) (2), made. ' ¥i4

There shall then be ascertained the increase or de-

crease in tax previously determined which results:

solely from the correct treatment of the item which

was the subject of the error (with due regard given

to the effect of the item in the computation of gross

income, taxable income, and other matters under this

subtitle). uw» %! |

(c) Adjustment Unaffected by Other Items.—The

amount to be assessed and collected in the same man-

ner as a deficiency, or td be refunded or credited in the

same manner as an overpayment, under this part, shall

not be dimiritshed by any credit or set-off based upon

any item other than the one which was the subject of

the adjustment. The amount of the adjustment under

this part, if paid, shall not be recovered by a claim or’

suit for refund or suit. for erroneous refund based

upon any item other than the one which was the sub-

ject of the adjustment.

(26 U.S.C. 1958 ed., See. 1314)

30a

APPENDIX D

‘Treasury Regulations on Income Tax (1954 Code):

See. 1.1312-7 Basis or Property AFTER Erroneous

TREATMENT OF A Prion TRANSACTION.

(a) Paragraph (7) of section 1312 applies if the deter-

mination establishes the basis of property, and there occur-

red one of the following types of errors in respect of a

prior transaction upon which such basis depends, or in

respect. of a prior transaction which was erroneously

treated as affecting such basis:

(2) An erroneous recognition or nonrecognition of gain

or Joss, or ,

. @ Sd oe > e | e e *

No adjustment is authorized with respect to the transferor

of the property in a transaction upon which the basis of

the property depends, when the determination is with

respect to the original transferee or a subsequent trans-

feree of such original transferee. — .

(c) The application of this section may be illustrated

by the following examples:

Example (5). In 1946,.4 taxpayer received 100 shares

of stock of the X Corporation having a fair market value

of $5,000, in exchange for shares of stock in the Y Corpo-

ration which he had acquired at a cost of $12,000. In lis

return for 1946 the taxpayer treated the exchange as one

in which gain or loss was not recognizable. The taxpayer

sold 50 shares of the X Corporation stock in 1947 aud in

his return for that year treated such shares as having a

$6,000 basis. In 1952, the taxpaver sold the remaining 50

shares of stock of the X Corporation for $7,500 and re-

ported $1,500 gein in his return for 1952. After the expira-

tion of the period of limitations on deficiency assessments

and on refund claims for 1946 and 1947, the Commis-

3la

sioner asserted a deficiency for 1952 on the ground that

the loss realized on the exchange in 1946 was erroneously

treated as nonrecognizable, and the basis for computing

gain upon the sale in 1952 was $2,500, resulting in a gain

of $5,000. The deficiency is sustained by the -Tax Court

in 1955. An adjustment is authorized with respect to the

year 1946 as to the entire $7,000 loss realized on the ex-

changé, as the Court's decision determines the basis of

property, and in a prior transaction upon which such basis

depends there was an erroneous nonrecognition of loss to

‘the taxpayer with respect to whom the determination was

made. No adjustment is authorized with respect to the

vear 1947 as the basis for computing gain upon the sale

of the 50 shares in 1952 does not depend upon the trans-

action in 1947 but upon the transaction in 1946. (Reg.

Sée. 1.1312-7.)

(T. D. 6162, 2-8-56. Amended by T. D. 6617, 11-6-62.)