Court Opinion

ID: 4473158
Source: CourtListenerOpinion
Date Created: 2020-01-14 19:35:08.886464+00
Date Added: 2024-06-11T14:53:48.330144
License: Public Domain

Halpern, J., dissenting: I. Introduction On February 5, 1986, Ms. Read disposed of all of her shares of stock in Mulberry Motor Parts, Inc. (the shares and MMP, respectively), by transferring the shares to MMP (the transfer). In consideration thereof, MMP paid Ms. Read $200,000 and agreed to pay her an additional $638,724 in installments (with interest). Ms. Read’s adjusted basis in the shares was zero, and she realized a gain on the transfer. See sec. 1001(a). That gain must be recognized to her unless some nonrecognition provision applies. See sec. 1001(c). Ms. Read relies on section 1041(a) to avoid the recognition of gain. Section 1041(a) provides: SEC. 1041(a). General Rule. — No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)— (1) a spouse, or (2) a former spouse, but only if the transfer is incident to the divorce.[1] Ms. Read is an individual, and she claims that no gain is recognized to her since she transferred the shares (property) to her former spouse (Mr. Read) incident to their divorce. Mr. Read disagrees that the transfer was to him. Ms. Read and Mr. Read agree that the question of whether the transfer was to him should be answered by determining whether he had a primary and unconditional obligation to purchase the shares. The majority holds that such an inquiry is inappropriate. I disagree. I further disagree with what seems to me to be the majority’s evocation of the principles of Commissioner v. Court Holding Co., 324 U.S. 331 (1945), to determine whether Ms. Read sold the shares to Mr. Read. II. Bootstrap Acquisitions Mr. Read acquired virtually complete ownership of MMP without expending any of his own funds. He did so by arranging for MMP to redeem the shards. Such an acquisition, where the acquirer uses funds of the corporation to aid in his acquisition of control, is sometimes referred to as a “bootstrap acquisition”. A part owner of a corporation can use the corporation’s funds to acquire complete ownership of the corporation in one of two ways. One, he can arrange for the corporation to purchase the seller’s shares. Two, he can purchase the seller’s shares and cause the corporation to redeem those shares from him. There is no practical difference between those alternatives. In both cases, the seller receives the same amount, and the remaining owner (sometimes, the buyer) becomes the sole owner of the corporation, whose assets are reduced by the same amount. It is well settled, however, that the difference in form between those alternatives may result in different income tax consequences (at least for the buyer). As Professors Bittker and Lokken put it: If the buyer purchased all of the seller’s stock and later recouped some of the cash outlay by causing the corporation to redeem part of the newly acquired stock, the redemption distribution would be a dividend to the extent of earnings and profits because, as a pro rata distribution, it could not meet the standards of §§302(b)(l), (2), or (3). The buyer, however, avoids dividend consequences where the redemption is from the seller unless the buyer makes the mistake of undertaking a personal obligation to purchase the shares before the corporation agrees to redeem them. [3 Bittker & Lokken, Federal Taxation of Income, Estates, & Gifts, par. 93.1.5, at 93-17 (2d ed. 1991).] Although the form of the acquisition may be tailored to suit the buyer’s tax status (a corporate buyer may prefer the dividend treatment that, given sufficient earnings and profits, generally would accompany the redemption of shares purchased from the seller), once it is tailored, the buyer is stuck with the chosen form. In an early leading case, Wall v. United States, 164 F.2d 462 (4th Cir. 1947), the taxpayer contracted to purchase stock from a co-shareholder, agreeing to make a cash downpayment and to deliver his notes for the remainder of the purchase price. The taxpayer made the downpayment and received the stock, which he transferred to two trustees, to be held by them as security for the notes. After paying the first note, he transferred his equity in the stock to the corporation and caused it to pay the remaining notes as they became due. The Court of Appeals for the Fourth Circuit had no difficulty in finding that the taxpayer’s transfer of his equity to the corporation in consideration of the corporation’s assumption of his liability was a redemption of the underlying stock and that the redemption and the payment of the remaining owner’s note that became due in the year in question were essentially equivalent to the distribution of a taxable dividend. See id. In a variation on Wall, in Sullivan v. United States, 363 F.2d 724 (8th Cir. 1966), the Court of Appeals for the Eighth Circuit held that, if a buyer is subject to an executory, primary, and unconditional obligation to purchase the shares of the seller but instead causes the corporation to purchase those shares, the purchase results in a constructive distribution to the buyer, because it discharges his obligation. In Sullivan, the Court of Appeals found that, after the transaction was complete, (1) the taxpayer’s personal obligation to purchase the stock had been discharged, (2) the taxpayer owned all of the outstanding shares of stock of the corporation, (3) the corporation’s assets were decreased by the amount paid to the seller for his stock, and (4) that stock was held by the corporation as treasury stock. See id. at 729. Although the Court of Appeals is not explicit on the point, it appears that it considered the taxpayer as having constructively received the stock from the seller, which stock the taxpayer then transferred to the corporation in consideration of the corporation’s constructive distribution to him in redemption of that stock. The Court of Appeals rejected the taxpayer’s argument that he had received a distribution in redemption of shares that was a distribution in full payment in exchange for the stock and not a redemption essentially equivalent to a dividend. See id. at 729-730. Thus, if a buyer wishes to accomplish a bootstrap acquisition, the buyer, once having put the Wall type format into legally enforceable form, cannot avoid the tax consequences of a redemption from him of the seller’s stock by having the corporation pay the seller directly. Nevertheless, if the corporation simply agrees to redeem the seller’s stock and pays for the stock in installments, over time, and the payments do not discharge any obligation of the remaining owner, the payments do not constitute constructive distributions to the remaining owner. See Edenfield v. ommissioner, 19 T.C. 13 (1952). That is true even if the remaining owner guarantees performance by the corporation, pledges his shares as security for the deferred payments, or agrees to buy the shares if the corporation defaults. See id.; Buchholz Mortuaries, Inc. v. Commissioner, T.C. Memo. 1990-269; Rev. Rul. 69-608, 1969-2 C.B. 43, 44 (Situation 5). The logic of the bootstrap acquisition cases leads to the conclusion that, where the buyer has already purchased the seller’s stock, as in Wall v. United States, supra, or has a primary and unconditional obligation to do so, as in Sullivan v. United States, supra, the transfer of that stock to the corporation is in satisfaction of the buyer’s obligation to surrender for redemption stock that, actually, in Wall, or constructively, in Sullivan, he had purchased from the seller. Any transfer by the seller directly to the corporation would, under that logic, be on behalf of the buyer. Contrariwise, if the remaining shareholder has not purchased the seller’s stock, and has no obligation to do so, as in Edenfield v. Commissioner, supra, the transfer to the corporation should not be viewed as on the remaining shareholder’s behalf. Since there is no practical difference between the Wall and Edenfield type formats, the choice of form by the parties to the transaction plays a dominant role in determining the income tax consequences that will follow, and the crucial distinction is whether the corporation satisfies a legal obligation of the remaining shareholder to purchase the redeemed stock. No matter how close a taxpayer comes to undertaking a legal obligation to purchase the redeemed stock, the Wall principle should not apply unless that obligation was in fact undertaken. Thus, in S.K. Ames, Inc. v. Commissioner, 46 B.T.A. 1020 (1942), we construed a contract to purchase stock that provided that the taxpayer would “purchase or cause to be purchased” the stock. We held that the promise to “purchase or cause to be purchased” provided several methods for satisfying the obligation created under the contract, and, therefore, the taxpayer incurred no absolute obligation to purchase the stock. See also Buchholz Mortuaries, Inc., v. Commissioner, supra (contract accorded taxpayers, “or their assigns” right to purchase stock; purchase by corporation (assignee) did not discharge personal and primary obligation of taxpayers); Bunney v. Commissioner, T.C. Memo. 1988-112 (similar). In Kobacker v. Commissioner, 37 T.C. 882 (1962), the taxpayer negotiated to buy all of the capital stock of a corporation. The purchase agreement contained the following paragraph: Buyer * * * is to have the right to assign this Agreement to a corporation, thereby releasing Buyer therefrom, and substituting such Corporation in the place of Buyer under this Agreement, with the same force and effect as if this Agreement were originally made with such Corporation, provided that such Corporation shall, by writing, agree to be bound by all of the terms, covenants and conditions of this Agreement. [Id. at 885.] In Kobacker, we held that the taxpayer had assumed no personal obligation to purchase the stock under that contract. See id. at 896. The fact that a bootstrap acquisition is incident to a divorce has no bearing on whether the buyer (for convenience, husband) and seller (wife) are held to the form upon which they have agreed. If the husband’s obligation to purchase the wife’s shares is primary and unconditional, then he is in constructive receipt of those shares notwithstanding that, on his behalf, the wife has transferred them to the corporation. If the husband does not have a primary and unconditional obligation to purchase the wife’s shares, then he is not in constructive receipt of those shares, and the wife’s transfer of those shares to the corporation is not on his behalf. If, pursuant to section 1041(a), the wife gains a tax advantage from the form settled upon by the parties (or loses a tax advantage if she realizes a loss on the disposition of the shares), then so be it. The bootstrap acquisition rules are fairly well settled and give the parties the flexibility to negotiate a mutually acceptable format for the wife to dispose of her shares. Those rules are consistent with the construction of section 1041(a) set forth in section 1.1041-1T(c), Temporary Income Tax Regs., 49 Fed. Reg. 34453 (Aug. 31, 1984). I see no reason why the primary and unconditional analysis is inappropriate to an analysis of the tax consequences in this and similar cases. III. Facts at Hand By agreement incorporated into the divorce judgment, Ms. Read was obligated to sell the shares to Mr. Read or, at his election, MMP or the ESOP plan of mmp (the ESOP). Mr. Read, MMP or the ESOP, as the case would be, was obligated to purchase the shares. Payment for the shares was to be made in installments, with Ms. Read retaining a security interest in the shares. Mr. Read was to guarantee payment of the installments if he elected to have MMP or the ESOP make the payments. Subsequent to the divorce, Mr. Read elected to have MMP purchase the shares. Mr. Read, Ms. Read, and one other individual constituted the board of directors of MMP (the board). By unanimous written consent, the board consented to MMP’s purchase of the shares. Subsequently, Ms. Read and MMP entered into a stock purchase agreement, and, pursuant thereto, MMP acquired the shares from her. Since Mr. Read had the right to assign his obligation to purchase the shares, I do not believe that his obligation to purchase the shares was primary and unconditional. The facts here are similar to the facts in S.K. Ames, Inc. v. Commissioner, supra, Buchholz Mortuaries, Inc. v. Commissioner, supra, and Bunney v. Commissioner, supra. Therefore, I would find that the transfer was to MMP, and not to (or on behalf of) Mr. Read. The majority finds that the transfer did not satisfy any liability or obligation of Mr. Read’s. Nevertheless, the majority finds that Ms. Read was, in effect, acting as Mr. Read’s agent in transferring the shares to MMP. Majority op. pp. 36-37. Without citing any authority, the majority appears to be relying on the principles of Commissioner v. Court Holding Co., 324 U.S. 331 (1945), where a corporation was taxed on gain on a sale by shareholders of property distributed by the corporation because the corporation went so far toward the sale before the distribution that the sale was in substance made by the corporation. In Court Holding Co., the Supreme Court said: The incidence of taxation depends upon the substance of a transaction. The tax consequences which arise from gains from a sale of property are not finally to be determined solely by the means employed to transfer legal title. Rather, the transaction must be viewed as a whole, and each step, from the commencement of negotiations to the consummation of the sale, is relevant. A sale by one person cannot be transformed for tax purposes into a sale by another by using the latter as a conduit through which to pass title. To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress. [Id. at 334; fn. ref. omitted.] The majority appears to be applying Court Holding Co. principles to determine that, in substance, Ms. Read sold the shares to Mr. Read although, on his behalf, she transferred them to MMP. That is an inappropriate analysis in the bootstrap acquisition area, where there is no practical difference between the two ways of accomplishing the bootstrap acquisition and the only relevant distinction is form, which is manifest by legal rights and duties. See the discussion by professors Bittker and Lokken at 3 Bittker & Lokken, Federal Taxation of Income, Estates, & Gifts, par. 93.1.5, at 93-19 (2d ed. 1991). IV. Conclusion Since I believe that Ms. Read has failed to prove that the transfer was to Mr. Read, I would hold section 1041(a) inapplicable and hold that she recognized gain on the transfer. Mr. Read, of course, had no item of gross income on account of the transfer. Wells and Beghe, JJ., agree with this dissent.   The term “incident to the divorce” is defined in sec. 1041(c), and that definition is not in issue here.