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Keywords

contractliabilitypartnershipcorporation

contractattorneyliabilitypartnershipcorporation

Related Cases

Nye v. Commissioner of Internal Revenue, 50 T.C. 203

Facts

Dale Thornton and George Nye, partners in a sheet-metal contracting business, organized Delta Sheet Metal & Air Conditioning, Inc. to take over their partnership business. On October 31, 1961, they transferred cash and partnership assets to the corporation in exchange for stock and a promissory note. The transaction was structured to limit personal liability and involved a covenant not to compete, which was later deemed to lack economic substance.

On or about September 1, 1954, Thornton and Nye, as equal partners, formed a partnership, Delta Sheet Metal Co. to engage in the business of operating a sheet-metal shop and doing sheet-metal contracting. In 1961, Thornton and Nye decided to expand their business. They consulted their attorney and, for various reasons including limiting their personal liability, decided to form a corporation through which their business would be conducted.

Issue

Whether the transfer of partnership assets to the corporation qualifies under section 351 of the Internal Revenue Code, and whether the corporation can amortize the covenant not to compete.

Whether the transaction whereby the partnership assets were transferred to the corporation falls within the provisions of Code section 351.

Rule

Section 351 of the Internal Revenue Code states that no gain or loss shall be recognized if property is transferred to a corporation solely in exchange for stock or securities, provided the transferors are in control of the corporation immediately after the exchange.

Section 351 provides that no ‘gain or loss shall be recognized if property is transferred to a corporation * * * by one or more persons solely in exchange for stock or securities in such corporation’ and immediately after the exchange such person or persons are in ‘control’ of the corporation.

Analysis

The court found that the transfers of cash and assets were part of a single transaction that fell under section 351. The promissory note was deemed a security, and the partners maintained control of the corporation after the transfer. The court also determined that the covenant not to compete did not have economic substance, thus disallowing its amortization.

The transaction whereby the partnership assets were transferred to the corporation was not a bona fide sale of assets to the corporation by Thornton and Nye or by the partnership. Rather it was part of a larger transaction whereby the individual partners transferred cash and assets to the corporation in exchange for stock and a promissory note in the amount of $73,889.30.

Conclusion

The court concluded that the transaction was a tax-free exchange under section 351, and the corporation could not amortize the covenant not to compete due to its lack of economic substance.

Who won?

The Commissioner prevailed because the court upheld the determination that the transaction fell under section 351 and that the covenant not to compete lacked economic substance.

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Keywords

Related Cases

Aqualane Shores, Inc. v. C.I.R., 269 F.2d 116, 4 A.F.T.R.2d 5346, 59-2 USTC P 9632

Tyler v. Tomlinson, 414 F.2d 844, 24 A.F.T.R.2d 69-5426, 69-2 USTC P 9559

Sola Basic Industries, Inc. v. U. S. Fidelity & Guaranty Co., 90 Wis.2d 641, 280 N.W.2d 211

Drybrough v. C.I.R., 238 F.2d 735, 57-1 USTC P 9212, 50 A.F.T.R. 781

Berger Machine Products, Inc. v. Commissioner of Internal Revenue, 68 T.C. 358