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Bongiovanni v. C. I. R., 470 F.2d 921, 31 A.F.T.R.2d 73-409, 73-1 USTC P 9133

Facts

John P. and Alice Bongiovanni filed a joint federal income tax return for 1965, during which John operated a masonry contracting business as a sole proprietorship. In April 1965, he transferred all assets and liabilities of his business to the newly formed Keystone Masonry Corporation in exchange for stock and a promissory note. The Commissioner later determined that this transfer resulted in a taxable gain due to the liabilities assumed by the corporation exceeding the adjusted basis of the assets transferred, leading to a tax deficiency assessment.

From 1963 to 1965 taxpayer-appellant ran a masonry contracting business known as the Keystone Masonry Company. It was a sole proprietorship and operated on the cash receipts and disbursements method of accounting. On or about April 1, 1965, the taxpayer transferred all of the assets and liabilities of his sole proprietorship to the Keystone Masonry Corporation which had been duly organized under the laws of the State of Connecticut.

Issue

Whether Section 357(c) of the Internal Revenue Code applies to a cash basis taxpayer's liabilities consisting of trade accounts payable in a tax-free Section 351 transfer.

The Tax Court affirmed the Commissioner's determination in an opinion primarily devoted to an explanation of why the taxpayer's attempt to change his accounting method from the cash to the accrual basis had been futile.

Rule

Section 357(c) requires that if the sum of the liabilities assumed exceeds the total adjusted basis of the property transferred in a Section 351 exchange, the excess shall be considered as gain from the sale or exchange of property.

Section 357(c) -if read literally-requires that 'liabilities' assumed by the transferee corporation which exceed the aggregate adjusted basis of the properties transferred are to be considered as gain from the sale or exchange of that property.

Analysis

The court analyzed the application of Section 357(c) to the facts of the case, noting that the Tax Court's interpretation incorrectly treated the unpaid trade accounts payable of a cash basis taxpayer as taxable liabilities. The court emphasized that the term 'liabilities' in Section 357(c) should not include trade accounts payable that have not been paid, as this leads to an inequitable result for cash basis taxpayers who cannot deduct these liabilities.

However, we believe that the word 'liability' is used in Section 357(c) in the same sense as the word 'liability' referred to in the legislative history of Section 357(c). It was not meant to be synonymous with the strictly accounting liabilities involved in the case at bar.

Conclusion

The Court of Appeals reversed the Tax Court's decision, ruling that the transfer was not taxable under Section 357(c) because the liabilities assumed did not exceed the adjusted basis of the assets transferred.

We reverse the decision of the Tax Court insofar as the Section 357(c) adjustment is concerned.

Who won?

John P. Bongiovanni prevailed in the case because the court found that the Tax Court erred in its interpretation of Section 357(c) as applied to cash basis taxpayers, leading to an unjust tax liability.

The views of the Commissioner and the Tax Court on the interpretation of Section 357(c) as applied to a cash basis taxpayer fly in the face of the sound judicial principles noted above.

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