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corporation
willcorporationrespondent

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C.I.R. v. Godley’s Estate, 213 F.2d 529, 54-1 USTC P 9423, 45 A.F.T.R. 1614, 1955-1 C.B. 253

Facts

In 1947, shareholders of Southern Natural Gas Company received a distribution that included both cash and property, specifically shares of stock from Southern Production Company, Inc. The gas company had acquired the production company stock for $3,199,950, but at the time of distribution, its fair market value was $8,983,407.75. The total cash distribution was $2,113,722.03, resulting in total receipts of $11,097,129.78 for the shareholders. The gas company had earnings and profits available for dividends totaling $5,674,586.32. The decedent treated half of her receipts as ordinary income, while the Commissioner assessed the entire amount as taxable ordinary income.

The facts were stipulated and were found accordingly. Respondents' decedent held stock of the Southern Natural Gas Company. In 1947 she and the other shareholders of the gas company received a distribution partly in cash and partly in property. The property consisted of shares of stock of the Southern Production Company, Inc., which had been held by the gas company.

Issue

The main legal issue was whether the distribution of appreciated property reduced the distributing corporation's earnings or profits by the fair market value of the property or only by the cost of the property.

The problem acquires its setting from the following provisions of the Internal Revenue Code.

Rule

The court applied the principle that a corporate distribution of appreciated property should reduce earnings or profits only by the cost of the property, not by its fair market value.

We hold that upon a corporate distribution of property that has appreciated over cost but whose cost is exceeded by earnings or profits, considered without addition of the property's appreciation in value, the proper reduction of earnings or profits is to the extent of cost.

Analysis

The court reasoned that the Tax Court's approach, which matched earnings or profits against the fair market value of the property, was incorrect. Instead, the court held that the proper method was to reduce earnings or profits by the cost of the property distributed, as the appreciation in value was not realized income for the corporation. This interpretation aligned with the statutory definitions of dividends and the treatment of unrealized gains under the Internal Revenue Code.

The Tax Court's insistence that there must always be an exact correlation between the amount of dollars by which a dividend in kind affects the earnings or profits of a corporation and the amount of dollars that are taxable in the hands of the stockholder receiving the dividend renders Section 115(j) meaningless and makes of 115(a) and (b) the sections which not only determine the character and the source of the distribution but which value the distribution in the hands of the stockholder.

Conclusion

The appellate court reversed the Tax Court's decision, holding that the entire distribution was a dividend and that the distributees were taxable on the full fair market value of the property received.

The judgment of the Tax Court will be reversed and the cause remanded for proceedings in accordance with this opinion.

Who won?

The Commissioner of Internal Revenue prevailed in the case, as the appellate court found that the Tax Court's reasoning was flawed and that the distribution should be treated as a dividend taxable at its full fair market value.

The Commissioner's contention was that earnings covered the cost of the property distributed and, therefore, the distribution was ‘out of earnings or profits' under 115(a) and was backed by earnings or profits ‘to the extent’ of cost under 115(b).

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