Source: http://openjurist.org/527/f2d/1014/kraut-v-commissioner-of-internal-revenue
Timestamp: 2017-06-28 02:08:17
Document Index: 193264735

Matched Legal Cases: ['§ 1222', '§ 501', '§ 1222', '§ 7453', '§ 55', '§ 511']

527 F2d 1014 Kraut v. Commissioner of Internal Revenue | OpenJurist
527 F. 2d 1014 - Kraut v. Commissioner of Internal Revenue HomeFederal Reporter, Second Series 527 F.2d.
527 F2d 1014 Kraut v. Commissioner of Internal Revenue 527 F.2d 1014
76-1 USTC P 9161
Aaron KRAUT et al., Petitioners-Appellants,v.COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
Nos. 359--360, Dockets 75--4124, 75--4125.
These appeals by taxpayers raise once again the question of the tax consequences under § 1222(3)1 of the Internal Revenue Code of 1954 of a sale of stock by an ordinary seller to a tax-exempt purchaser, when the sale is financed by the profits of the sold business. See CIR v. Brown, 380 U.S. 563, 85 S.Ct. 1162, 14 L.Ed.2d 75 (1965) (Clay Brown). The transactions involved here preceded the Tax Reform Act of 19692 and the decision below was rendered before the opinion of this court in Berenson v. CIR, 507 F.2d 262 (2 Cir. 1974). The question posed is to what extent, if any, are the proceeds of such sale to be considered ordinary income to the seller.
In 1966, an investment counseling firm brought a proposal to Rev. Rex T. Humbard, pastor of the Cathedral of Tomorrow (Cathedral), a tax-exempt religious corporation in Akron, Ohio, that it purchase Nassau. Before any deal was consummated, however, the Krauts entered into a contract of sale on May 31, 1966 with Wilson Mold & Die Corporation (Wilson) which purported to sell all the stock of Nassau to Wilson. Shortly thereafter, on June 15, 1966 the Krauts entered into a three-cornered deal with Wilson and Cathedral whereby Wilson was relieved of its obligation to buy the Nassau stock and Wilson assigned all of its rights and obligations to Cathedral. The significant terms of the agreement are set forth in the margin.3 We note that the sales price was dependent upon Nassau's future profits and was to range from a minimum of $500,000 to a maximum of $3,500,000, entirely paid from the sold business's income, for the following ten years. The Krauts, husbands of the Nassau stockholders, were retained as employees of Cathedral at $5,200 each per annum and so remained in effective day-to-day control of the business. Cathedral qualified under § 501(c)(3) of the Internal Revenue Code as a tax-exempt religious organization and so was exempt from paying either normal income tax or taxes on unrelated business income.4 Cathedral paid off its debt to the Krauts with tax-free income from Nassau.
In Clay Brown the Supreme Court held that the somewhat similar transaction there involved constituted a sale within the meaning of § 1222(3) (and thus was taxable as long-term capital gain) even though the exempt organization incurred no downside risk. The absence of a shift in risk did not preclude the 'sale' of the stock and underlying assets under applicable law. The Court further noted the Tax Court's finding that the purchase price was 'within a reasonable range in light of the earnings history of the corporation and the adjusted net worth of the corporate assets.' 380 U.S. at 572, 85 S.Ct. at 1167. In Clay Brown the appraised net worth of the assets of the business was.$1,064,877 and the sales price was approximately $1,300,000.
The sole issue before us is whether or not the Tax Court's refusal to disturb the Commissioner's determination that the true value of Nassau's stock was $168,445.60 was erroneous. We commence with the proposition that the deficiency asserted by Commissioner is presumptively correct and the burden of disproving it rests upon the taxpayer. Rule 142(a), Rules of Practice and Procedure of the United States Tax Court (see 26 U.S.C.A. § 7453 (1975 Supp.)); Holvering v. Taylor, 293 U.S. 507, 515, 55 S.Ct. 287, 291, 79 L.Ed. 623 (1935) ('Unquestionably the burden of proof is on the taxpayer to show that the Commissioner's determination is invalid.' (citations omitted)); Rockwell v. CIR, 512 F.2d 882, 885 (9th Cir. 1975); Valetti v. CIR, 260 F.2d 185, 187 (3d Cir. 1958) ('It is the burden of a taxpayer who institutes such a suit as this to overcome the presumption that the Commissioner's deficiency finding was correct by showing by a preponderance of evidence that the Commissioner erred.'); 10 J. Mertens, Federal Income Taxation § 55.18, at 113--14 and cases cited (1970).
The only evidence presented by the petitioners below as to Nassau's fair market value was the testimony of Aaron Kraut, who testified that, on the basis of consumer acceptance of Nassau's new wire and unfilled orders for the first half of 1966, he anticipated gross profits of more than $10,000,000 during the next ten years. No documentary evidence of any sort was submitted in support of this estimate. Moreover, Judge Raum held 'we . . . simply do not believe this evidence.' He characterized Kraut's memory of the transaction as 'narrowly selective and seemingly self-serving . . . we are hardly inclined to credit Aaron Kraut with the necessary knowledge or ability to lend the slightest probative value to his testimony.' 62 T.C. at 430--31.7 In view of Judge Raum's opportunity to observe the demeanor of the witness we obviously cannot characterize this finding of fact as clearly erroneous. CIR v. Duberstein, 363 U.S. 278, 291, 80 S.Ct. 1190, 4 L.Ed.2d 1218 (1960); Adler v. CIR, 422 F.2d 63, 68 (6th Cir. 1970) (credibility of witnesses is particularly for the Tax Court); Casey v. CIR, 267 F.2d 26, 31 (2d Cir. 1959) (same) (dictum). Finally, the fact that a taxexempt organization was willing to pay a maximum price of $3,500,000 for the stock was obviously not probative of its value to a non-tax-exempt entity.
That act, Pub.L. 91--172, 83 Stat. 536, repealed the preferred status of churches with respect to unrelated business income by deleting the former exception for churches in Int.Rev.Code § 511(a)(2)(A)
We note that, in general, a trial court's evaluation of stock or other property is subject to reversal only if it is clearly erroneous. E.g., Bormes v. CIR, 512 F.2d 442 (8th Cir. 1975) (per curiam) (affirming valuation of real estate donated to charity, where Tax Court sustained the Commissioner's valuation); Rubber Research, Inc. v. CIR, 422 F.2d 1402, 1405 (8th Cir. 1970) (per Blackmun, J.) (valuation of stock for tax purposes is a question of fact, and hence is subject to the 'clearly erroneous' standard of review); Seas Shipping Co. v. CIR, 371 F.2d 528, 532 (2d Cir.), cert. denied, 387 U.S. 943, 87 S.Ct. 2076, 18 L.Ed.2d 1330 (1967) (same)