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corporation

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Related Cases

Chertkof v. Commissioner of Internal Revenue, 72 T.C. 1113

Facts

Jack O. Chertkof and his father, David Chertkof, along with Wallace Smith, organized E & T Realty Co. in 1941. After Smith's death, conflicts arose between Jack and David regarding the management of E & T and its major asset, the Essex Shopping Center. In 1965, they agreed that E & T would redeem all of Jack's stock, and he would receive a one-third undivided interest in E & T's real estate. The redemption agreement was executed on July 12, 1965, and the distribution was valued at $167,027.56 on Jack's 1966 tax return, while the IRS later contended it was worth $330,000.

In 1941, petitioner, his father, David Chertkof, and Wallace Smith organized E & T Realty Co., which constructed, owned, and operated the Essex Shopping Center—a complex of retail stores and parking areas located in the Essex area of Baltimore County, Md. After Smith's death, conflicts arose between petitioner and his father over the management of E & T and its major asset, the Essex Shopping Center. In 1965, after continuing disagreements the other out, they agreed E & T would redeem all of petitioner's stock.

Issue

The main issues were the fair market value of the corporate distribution to Jack Chertkof and whether the redemption constituted a complete termination of his interest in the corporation under section 302(b)(3) and the 10-year rule of section 302(c)(2)(A).

The issues for decision are the fair market value of a corporate distribution to petitioner Jack Chertkof of an undivided one-third interest in real property in redemption of his stock in E & T Realty Co., and whether the redemption constituted a complete termination of his interest in the corporation within the meaning of section 302(b)(3) and the 10-year rule of section 302(c)(2)(A).

Rule

Under section 302(a), a distribution of property to a shareholder in redemption of stock is treated as a sale or exchange if it meets certain criteria. Section 302(b)(3) allows for capital gains treatment if all stock owned by the shareholder is redeemed, provided the shareholder has no interest in the corporation other than as a creditor immediately after the distribution.

Section 302(a) provides that a distribution of property to a shareholder by a corporation in redemption of stock will be treated as a sale or exchange of the stock if the redemption falls into one of four categories enumerated in section 302(b). Under section 302(d), all redemptions which do not meet a specific statutory exception are treated as dividend distributions under section 301(c)(1), to the extent the corporation has earnings and profits.

Analysis

The court analyzed the management agreement that Chertkof entered into after the redemption, determining that it gave him significant control over E & T's operations. Unlike the case of Estate of Lennard, where the taxpayer's services were limited, Chertkof's management powers allowed him to make major policy decisions and affect the profitability of the corporation. This led the court to conclude that he retained a prohibited interest in E & T, thus disqualifying him from capital gains treatment.

By virtue of the management agreement, petitioner not only became an integral part of E & T in operating its business. Prior to the redemption, petitioner's father established the policy by which the corporation was operated and petitioner executed that policy. After having become party to the management agreement on behalf of his corporation, however, the power and authority petitioner acquired permitted him to formulate major policy decisions in managing E & T's property.

Conclusion

The court concluded that the distribution was taxable as an ordinary dividend, affirming the IRS's valuation of $330,000 for the distribution. The court held that Chertkof's management agreement constituted a prohibited interest under the relevant tax code sections.

Accordingly, we hold that the distribution is taxable as an ordinary dividend.

Who won?

The prevailing party was the Commissioner of Internal Revenue, as the court upheld the IRS's determination that the distribution was taxable as an ordinary dividend due to Chertkof's retained interest in the corporation.

Decision will be entered for the respondent.

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