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tax lawcorporation
plaintiffregulationbail

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Fireoved v. U.S., 318 F.Supp. 133, 27 A.F.T.R.2d 71-717, 71-1 USTC P 9182

Facts

Eugene W. Fireoved and his wife filed a joint federal income tax return for 1959, which included proceeds from the redemption of preferred stock. The IRS assessed additional taxes, treating the proceeds as ordinary income, leading to a deficiency of $15,337.13. Fireoved had received preferred stock as a stock dividend in 1954, and the corporation had sufficient earnings and profits at the time of both the distribution and redemption of the stock.

Plaintiffs seek the recovery of Internal Revenue taxes assessed against their income tax return for the calendar year 1959. The parties have stipulated to facts and exhibits and we make the following FINDINGS OF FACT.

Issue

The main legal issue was whether the proceeds from the redemption of preferred stock received by Fireoved were taxable as ordinary income or capital gains.

The government maintains that the preferred stock issued to Fireoved in 1954 was section 306 stock and that its redemption in 1959 therefore gave rise to ordinary income.

Rule

The court applied the principles of tax law regarding stock dividends and the treatment of section 306 stock, which dictates that certain stock transactions are treated as ordinary income rather than capital gains.

Section 306 was enacted in the 1954 Code to plug the loophole commonly known as the ‘preferred stock bailout’ which received attention following the decision in Chamberlin v. Commissioner of Internal Revenue, 207 F.2d 462 (C.A.6, 1953).

Analysis

The court analyzed the nature of the stock distribution and determined that the preferred stock issued to Fireoved was effectively a stock dividend, which meant that the proceeds from its redemption were subject to ordinary income tax treatment. However, because Fireoved had reduced his common stockholdings, the court concluded that the proceeds from the redemption of the preferred stock were subject to capital gains rates.

Fireoved therefore argues that, at the very least, 65 of the 451 shares of preferred redeemed in 1959 should be subject to the application of the Commissioner's regulations pertaining to the disposition of stock acquired at different times, 26 C.F.R. § 1.1012-1(c) (essentially tax treatment on a ‘first-in, first-out’ basis).

Conclusion

The court ruled that the proceeds from the redemption of the preferred stock were subject to taxation at ordinary income rates, but the portion related to the reduction of common stockholdings was subject to capital gains rates.

Order accordingly.

Who won?

The United States prevailed in the case, as the court upheld the IRS's treatment of the proceeds from the redemption of the preferred stock as ordinary income.

The government maintains that the preferred shares issued to Fireoved in 1954 were section 306 stock and that its redemption in 1959 therefore gave rise to ordinary income.

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