Court Opinion

ID: 4483811
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:18.878369+00
Date Added: 2024-06-11T14:53:44.346126
License: Public Domain

Wilbur, J., dissenting: I agree with Judge Featherston that petitioner was “largely an operating company” within the meaning of section 1.1244(c)-l(g)(2), Income Tax Regs., and that language differences in sections 1371 and 1244 make it unnecessary to frustrate the basic purposes of section 1244 by applying precedents that interpret section 1371 in an extremely literal manner. Nevertheless, both sections 1371 and 1244 were enacted contemporaneously, both are designed to assist small business, and both employ identical language to disqualify corporations with excess receipts from sources other than “royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities.” Sec. 1244(c)(1)(E) and sec. 1371(e)(5). It is not wholly unreasonable, therefore, for the majority to attempt to harmonize the precedents interpreting the words “royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities” that are common to both sections. However, in implicitly adopting this objective the majority should have reexamined these precedents1 to determine whether they are directly applicable, consistent with each other, or adequately reflect the purposes of section 1244. I believe those precedents were erroneous to begin with, and if the majority believes they cannot be distinguished, they should be overruled. Marshall v. Commissioner, 60 T.C. 242 (1973), affd. 510 F.2d 259 (10th Cir. 1975), will suffice to illustrate the point. In Marshall, we held that “interest and rental income are part of ‘passive investment income’ even though the recipient of such interest or rental income may be actively engaged in a small loan or real estate business.” 60 T.C. at 252.2 We relied on the following quote (somewhat out of context) from Buhler Mortgage Co. v. Commissioner, 51 T.C. 971, 978 (1969), affd. per curiam 443 F.2d 1362 (9th Cir. 1971): We conclude that the test established is one which requires us to look only to the plain meaning of the words used to define the income, not to the activity required to produce it. * * * These statements in Marshall and Buhler are clearly in error. The regulations under both sections 1371 and 1244 make it clear that the nature and extent of the underlying activity producing the income — not just the income itself — must be examined in light of the legislative purpose. For example, payments for “the use or occupancy of rooms or other space where significant services are also rendered to the occupant” are excluded from the term rent by the regulations under both sections, which go on to explain: Generally, services are considered rendered to the occupant if they, are primarily for his convenience and are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only. The supplying of maid service, for example, constitutes such services; whereas the furnishing of heat and light, the cleaning of public entrances, exits, stairways, and lobbies, the collection of trash, etc., are not considered as services rendered to the occupant. Payments for the use or occupancy of entire private residences or living quarters in duplex or multiple housing units, of offices in an office building, etc., are generally “rents” under section 1244(c)(1)(E). * * * [Sec. 1.1244(c)-l(g)(l)(iii), Income Tax Regs.; see also sec. 1.1372-4(b)(5)(vi), Income Tax Regs. Emphasis added.] These regulations carefully examine the nature and extent of the underlying economic activity in the light of the related legislative purpose. Unless these regulations are invalid, our position in Marshall that “rent and interest” are passive income per se regardless of the nature and intent of the underlying activities is clearly wrong.3  While the regulations do not define interest, the statute lumps “royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities” together. These terms are united by the congressional purpose they were employed to implement. If one of the terms is a “per se” term, they all are, and vice versa. A common policy underlies all the words, and under the principle of noscitur a sociis, a common principle of construction should be applied. Additionally, the majority recognizes that the provisions of the regulations confining the benefits of section 1244 to operating companies cannot be found within the language of the statute. After a careful analysis of the purpose of the statute, the majority upholds the regulation on the ground that Congress, in using the words “royalties, rents, dividends, interest, annuities, and sales or exchange of stock or securities,” intended to provide the benefits of section 1244 to operating companies, and deny the benefits to nonoperating companies. That _is, these words were intended to permit operating companies (and only operating companies) to qualify for section . 1244 treatment. As noted, the regulations make it clear that rents can be produced by an operating company (renting personal property or an apartment with ancillary services) or by a nonoperating company (rental of space for occupancy only). Rental income can fall on either side of the line depending on whether the income is generated by an operating company or by passive investment activities. Similarly, the companion term interest can fall on either side of the line. Since “rent or interest” may be produced either by an operating company or a nonoperating company (one engaged in passive investment activities) these items are not, as Marshall wrongly held, always passive income (passive income per se).4  Marshall, already sinking from the weight of its own error, cannot resurface in the 1244 area, for the words “operating company” simply cannot be circumnavigated. They represent an obstacle that cannot be submerged. Thus, we are unanimous in our agreement that the statute was intended to benefit “operating companies.” But how can we determine which companies qualify as “operating companies” without looking at operations? Certainly we cannot do it by looking “only to the plain meaning of the words used to define the income, not to the activity required to produce it.” Buhler Mortgage Co. v. Commissioner, supra at 978; Marshall v. Commissioner, supra at 251. We cannot be mesmerized by the appellation routinely applied to the income, but by definition must look at operations to determine whether we have an “operating company.” Further examples abound, but one more from the regulations will suffice. The regulations, in discussing the operating company limitation, contain the following example: Thus, for example, assume that a person who is not a dealer in real estate forms a corporation which issues stock to him which meets all the formal requirements of section 1244 stock. The corporation then acquires a piece of unimproved real estate which it holds as an investment. The property declines in value and the stockholder sells his stock at a loss. The loss does not qualify for ordinary loss treatment under section 1244 but must be treated as a capital loss. [Sec. 1.1244(c)-l(g)(2), Income Tax Regs.] Obviously, the corporation in this example is not disqualified by “the plain meaning of the words used to define income,” for the corporation has none of the forbidden income. Rather it is disqualified by “the activity required to produce” the income, and the quote from Buhler Mortgage Co. v. Commissioner, swpra, that set all this mischief in motion is therefore once more squarely at odds with the language of the regulations. But Buhler and Marshall, relied on so heavily by the majority, pretty much ignored the anomaly of sustaining respondent on arguments at war with his own regulations. And of course these cases were so enamored with “plain meaning” (that weary substitute for hard thought) that very little attention was directed towards legislative intent and the purpose of the statute. In the final analysis, the regulation, in using the term operating company, was designed to limit the availability of section 1244 to small corporations operating an active business, and deny its availability to companies engaged essentially in passive investment activities. The regulations thus give a reading to the statute consistent with the remedial purpose Congress had in mind. Congress explained this purpose as follows: This provision is designed to encourage the flow of new funds into small business. The encouragement in this case takes the form of reducing the risk of a loss for these new funds. The ordinary loss treatment which the bill accords shareholders in small corporations in effect is already available to proprietors and partners. They report directly the earnings from these busimss ventures and thus ordinary losses realized by a proprietorship or partnership presently constitute ordinary losses to the proprietor or partner. As a result, from the standpoint of risk taking, this bill places shareholders in small corporations on a more nearly equal basis with proprietors and partners. [H. Rept. 2198, 85th Cong., 1st Sess. (1958), 1959-2 C.B. 709,711. Emphasis added.] Congress wanted to assist small businesses “from the standpoint of risk taking,” to encourage them to incur “the risk of loss” that a businessman always evaluates in beginning a new enterprise. The income-producing activities and the income produced by small businesses must be examined from the standpoint of business risk — do we have a coupon clipper or an entrepreneur? The regulations do this by referring to operating companies. They do it again by disqualifying real estate investment companies even though these companies realize none of the specific forms of forbidden income. And they do it again in defining “rent” by distinguishing between space passively leased for occupancy only (where the rent check is simply picked up at the mailbox), and active rental activities also involving the provisions of services (i.e., maid, security, recreation, and other ancillary services in a luxury apartment). Congress had no different objective in mind in using the term “interest” than in using the term “rent,” or the term “dividends,” or the term “annuities.” It simply sought to draw the line between “operating companies” and those engaged in passive investment activities on the basis of business risk.5 The regulations, in focusing on the term "operating company,” give a meaning to the specific words in issue that reflects the policy of the statute as clearly revealed in the legislative history. By any reasonable interpretation Greenbelt was an operating company. Petitioner incorporated business activities similar to those he had engaged in for years to earn his living. As Judge Featherston points out, from a careful reading of all the documents (including the income tax returns), we know or may infer that Greenbelt— received applications for loans, made credit investigations, made loans on automobiles, took liens to secure these loans, discounted its paper at four different banks to raise additional funds for loans, collected the loan installments, repossessed its security for delinquent accounts, sold foreclosed automobiles, and applied the proceeds of those sales to indebtedness owed the corporation!6! Petitioner had made his living by performing services in this business for years. He simply organized a small business to go out on his own, exercising precisely the kind of initiative section 1244 was specifically designed to encourage. It must come as a rude shock to the ordinary man to learn that, when this operation is run through the rigors of legal learning, it is no longer an operation. If Mr. Davenport had been apprised of this earlier, he would have been saved time and grief. He could simply have stayed home and clipped coupons; no doubt he would still have his money. Drennen and Goffe, JJ., agree with this dissenting opinion.   Marshall v. Commissioner, 60 T.C. 342 (1973), affd. 510 F.2d 259 (10th Cir. 1975); Zychinski v. Commissioner, 60 T.C. 950 (1973), affd. 506 F.2d 637 (8th Cir. 1974), cert, denied 421 U.S. 999 (1975); Bidder Mortgage Co. v. Commissioner, 51 T.C. 971 (1969), affd. per curiam 443 F.2d 1362 (9th Cir. 1971). Contra, Doehñng v. Commissioner, 527 F.2d 945 (8th Cir. 1975), revg. a Memorandum Opinion of this Court; Puckett v. Commissioner, 522 F.2d 1385 (5th Cir. 1975), affg. a Memorandum Opinion of this Court; House v. Commissioner, 453 F.2d 982 (5th Cir. 1972), revg. a Memorandum Opinion of this Court. See also contra, Valley Loan Ass’n. v. United States, 258 F. Supp. 673 (D. Colo. 1966). Some of these decisions hold against the taxpayer by suggesting that a conforming change in the heading of subpar. 1372(e)(5) from “Personal Holding Company Income” to “Passive Investment Income” was intended to completely alter the results in the ease before us. Aside from the difficulty of such a reading, Congress made it as clear as the English language permits that no such change was intended. In S. Rept. 89-1007, U.S. Code Cong. & Adm. News 2141, 2160 (1966), Congress stated “Subparagraph (C) defines the term ‘passive investment income’ to mean the same gross receipts as are taken into account under existing law.” (Emphasis added.) Respondent agrees with this interpretation. See Doehring v. Commissioner, 527 F.2d 945, 948 n. 8 (8th Cir. 1975). We may safely assume that this is the position of the Fifth Circuit, to which this case is appealable, see Home v. Commissioner, supra at 987 (“neither did the interest earned by a small loan company fit the words ‘passive investment income’ ”); and Puckett v. Commissioner, supra. If the cases cited in this footnote are, as the majority implies, the dispositive precedents, the spirit if not the letter of Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971), requires that we sustain the taxpayer.    In affirming our opinion the Court of Appeals made essentially the same statement — “the clear language of Section 1372(e)(5) * * * enumerates ‘interest’ as a per se form of ‘passive investment income.’ ” Marshall v. Commissioner, 510 F.2d at 264.    Indeed, the regulations make it clear that the term “rent” includes payments “for the use of, or right to use, property (whether real or personal)” (Emphasis added.) Sec. 1.1244(c) — l(g)(l)(iii), Income Tax Regs. If rent is passive income per se, presumably it includes rental income from leasing cars, medical equipment, tools, or furniture. Acme Car Rental and Abbey Rents, both competitive businesses incurring considerable business risks, would not qualify under either sec. 1371 or sec. 1244.    In Marshall, we specifically noted (60 T.C. at 251) that House v. Commissioner, 453 F.2d 982 (5th Cir. 1972), reversing a Memorandum Opinion of this Court, overlooked the following statement from our Buhler Mortgage opinion: “The standard used by the Code and the regulations does not permit us to look behind normal characterizations of a corporation’s receipts in order to classify them as active or passive. If this were not so, we can only guess at what criteria might be properly used to say, e.g., that a rent item was “active” because the tenant was such poor pay. * * * ” Simply reading the regulations would have obviated the necessity of guessing about the criteria to be applied to rent — it is spelled out there in considerable detail. Presumably the Fifth Circuit read the regulations and this may explain why, in the words of Marshall (60 T.C. at 252) our position “cannot be reconciled with the holding of the Fifth Circuit in House v. Commissioner, supra.”    Probably the principal reason why this limitation on passive investment income was adopted was to reduce the incentive to incorporate one’s investment activities merely to obtain tax deferral benefits accorded to pension, profit-sharing, and similar plans. * * * [S. Rept. 91-1535 (1970), 1971-1 C.B. 614. Emphasis added.]    It is worth noting that if petitioner’s business was “operated” as a sole proprietorship, he would pay the self-employment tax on the “interest” received (after business deductions). If he were 65, the “interest” (after business deductions) would reduce his social security benefits under the “earnings” limitation (unlike investment interest). And certainly the “interest” would not qualify for the retirement income tax credit. ("While the retirement income tax credit has been radically amended, sec. 37(d) retains the definition of retirement income (annuities, interest, rents, dividends) for certain purposes). How then can this same interest be “passive income per se”?