Case Name: Earle F. Johnson, Petitioner, v. Commissioner of Internal Revenue, Respondent
Court: United States Board of Tax Appeals
Jurisdiction: United States
Decision Date: 1941-03-14
Citations: 43 B.T.A. 960
Docket Number: Docket No. 97388
Parties: Earle F. Johnson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
Judges: 
Reporter: Reports of the United States Board of Tax Appeals
Volume: 43
Pages: 960–968

Head Matter:
Earle F. Johnson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
Docket No. 97388.
Promulgated March 14, 1941.
Ward Peck, Esq., for the petitioner.
Paul A. Sebastian, Esq., for the respondent.

Opinion:
OPINION.
Van Fossan:
The sole question before us is whether or not petitioner received a distribution in liquidation within the purview of section 115 (c) of the Revenue Act of 1934. If we should hold that petitioner received a liquidating dividend, petitioner's loss must be limited by the provisions of section 117 (d) of the Revenue Act of 1934. The parties agree that petitioner sustained a loss in the taxable year on his investment in the stock of the Great Miami Realty Corporation.
Petitioner contends that he sustained an ordinary loss due to the fact that his stock in the corporation became worthless in the taxable year. He maintains that he lost the total amount of his investment and received nothing in exchange. Respondent argues that petitioner constructively received a distribution in liquidation within the meaning of section 115 (c) by reason of the liquidator's release of the unpaid balance of petitioner's subscription or by application of the unpaid balance as an asset of the corporation against the debt which petitioner owed the corporation upon his subscription.
Respondent cites Philips v. Slocumb, 35 Del. 462; 167 Atl. 698; Cumberland Lumber Co. v. Clinton Hill Lumber Mfg. Co., 57 N. J. Eq. 627; 42 Atl. 585; and Fletcher v. Bank of Lonoke, 71 Ark. 1; 69 S. W. 580, as authorities that subscribers are legally liable to the corporation for unpaid subscriptions to capital stock. In each of these cases, however, it is indicated that where the corporation ceases to be a going concern or is in receivership liability on unpaid stock subscriptions is limited to amounts necessary for payment of creditors, equalization of shareholders, and payment of liquidation expenses. Such is the prevailing rule.
Respondent contends that, since petitioner was liable to the corporation upon his subscription contract and was released from that liability by the liquidator, petitioner thereby received a dividend in liquidation. In support of this contention respondent relies upon Bracken v. Stuart, 32 Ohio App. 399; 168 N. E. 149. The Bracken case is no authority here. In that case the receivers of a corporation brought an action for unpaid subscription against a subscriber to the capital stock of the corporation. The defendant demurred to the complaint on the ground that it did not allege that the corporation was insolvent or that the collection of the subscription was necessary for payment of creditors of the corporation. The court held that the complaint stated a cause of action and hence was not demurrable. From this decision respondent argues that the liquidator could have enforced petitioner's liability for payment of his subscription even though the funds would not be necessary for payment of debts or expenses of liquidation.
As indicated above, the question in the Bracken case arose on demurrer. It would be profitless to conjecture what the court would have held on the merits. In any event, that case did not involve the present question.
The problem here is somewhat analogous to that considered by the Circuit Court of Appeals for the Seventh Circuit in Hirsch v. Commissioner, 115 Fed. (2d) 656. There the taxpayer purchased real property for $29,000, paying $10,000 cash and assuming a mortgage of $19,000. In the taxable year the balance due on the mortgage was $15,000, while the value of the mortgaged property had depreciated to $8,000. The taxpayer offered to convey the property to the mort-Igagee in full payment of his debt. The mortgagee refused the offer land accepted $8,000 in full payment of the $15,000 due under the mortgage. The Commissioner taxed the reduction of $7,000 in the mortgage indebtedness as income to the taxpayer. The court held that no income was realized because "petitioner received nothing of exchangeable value." Although we are not considering a question of income here, the analogy is close. Petitioner received nothing in exchange for the additional payments on his stock subscription. The payments were made in order that debts could be cleared, fully paid shareholders placed on an equal basis and liquidation expenses met. The total amount paid by petitioner was the cost of his investment. The release from the remainder of his subscription liability by the liquidator was "nothing of exchangeable value." The fact that petitioner received nothing in liquidation distinguishes this case from cases such as White v. United States, 305 U. S. 281; Helvering v. Weaver Co., 305 U. S. 293, and similar cases.
We are of the opinion that no amount was distributed to petitioner in liquidation of the Great Miami Realty Corporation within the meaning of section 115 (c) of the Revenue Act of 1934. Accordingly, we hold that his loss due to worthlessness of stock of the corporation is deductible as an ordinary loss in the year 1935.
Reviewed by the Board.
Decision will be entered wnder Bule SO.
SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
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(e) Distributions in Liquidation. — Amounts distributed in complete liquidation oí a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117 (a), 100 per centum of the gain so recognized shall be taken into account in computing net income. In the case of amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits within the meaning of subsection (b) of this section for the purpose of determining the taxability of subsequent distributions by the corporation.
SEC. 117. CAPITAL GAINS AND LOSSES.
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(d) Limitation on Capital Losses.. — Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges.