Court Opinion

ID: 4483810
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:18.87113+00
Date Added: 2024-06-11T07:58:23.097917
License: Public Domain

Featherston, J., dissenting: I respectfully dissent. Section 1244(c)(1) defines the term “section 1244 stock” to mean common stock in a domestic corporation which meets certain requirements. There is no dispute that petitioner meets all these requirements except one. .The disputed requirement, contained in subparagraph (E), is that the corporation, during its 5 most recent taxable years ending before the date the loss is sustained (or such lesser period as the corporation is in existence), “derived more than 50 percent of its aggregate gross receipts from sources other than * * * interest,” etc. (hereinafter the gross receipts test). Section 1244(c)(1)(E) provides the exception, however, that “this subparagraph shall not apply with respect to any corporation if, for the period referred to, the amount of the deductions allowed by this chapter (other than * * * [those allowed by specified sections]) exceed the amount of gross income” (hereinafter the except clause). In the instant case, the income of Greenbelt, petitioner’s corporation, was derived from interest on loans, but its deductions exceeded its gross income during the relevant period. Therefore, in my opinion, the interest limitation in section 1244(c)(1)(E) does not apply, and petitioner’s stock qualifies as section 1244 stock. His loss should be given ordinary treatment. The majority has denied ordinary treatment of petitioner’s loss by relying upon the following sentences of section 1.1244(c)-1(g)(2), Income Tax Regs.: Notwithstanding the provisions of this subparagraph [i.e., the except clause] and of subparagraph (1) [the gross receipts test] of this paragraph, pursuant to the specific delegation of authority granted in section 1244(e) to prescribe such regulations as may be necessary to carry out the purpose of section 1244, ordinary loss treatment will not be available with respect to stock of a corporation which is not largely an operating company within the five most recent taxable years (or such lesser period as the corporation is in existence) ending before the date of the loss. The majority concludes that petitioner’s automobile finance company was not “largely an operating company” and, therefore, its stock was not section 1244 stock. I disagree. While the trial record leaves much to be desired, it contains evidence which shows, or from which it may be inferred, that the corporation received applications for loans, made credit investigations, .made loans on automobiles, took liens to secure those 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. In my opinion, such activities show that Greenbelt was “largely an operating company.”1  The purpose of section 1244 is to encourage the flow of funds into small business by allowing losses incurred by shareholders on the failure of small corporations to be treated in the same manner as losses incurred by partnerships and sole proprietor-ships.2 The disputed regulation can be sustained as a measure to achieve that end. The regulation so interpreted would deny ordinary loss treatment of a shareholder’s losses in respect of a corporation’s stock if the corporation’s losses were attributable largely to investment rather than business transactions. Indeed, the sentences in the regulation which follow the ones quoted above illustrate the “largely an operating company” requirement in those terms. In no circumstances, however, does the regulation reach the losses of an automobile finance company like Greenbelt. To disqualify petitioner’s stock in Greenbelt as section 1244 stock, the majority introduces a “passive income” concept which is foreign to both the language and legislative history of section 1244. Under that concept, as I understand it, all interest income is classified as passive income, and the stock of any corporation engaged in producing interest income is, as a matter of law, deprived of qualification as section 1244 stock. This interpretation of the regulation, in my opinion, places it at odds with the statute and if that is what the regulation means, it is invalid. In laying down the gross receipts test of section 1244(c)(1)(E), Congress spoke specifically to the effect of the receipt of interest income, i.e., for the corporation to have section 1244 stock, more than 50 percent of its gross receipts must be derived from sources other than interest, etc. Further, Congress specifically provided that the gross receipts test does not apply if the corporation’s deductions exceed its gross income during the corporation’s most recent 5 years or such lesser period as the corporation is in existence. Where Congress has focused on a subject, such as the effect interest income has on section 1244 stock qualification, and prescribed a statutory rule, the Treasury Department’s authority, notwithstanding the specifically granted section 1244(e) power to prescribe regulations, does not permit it to add a requirement which abrogates the statutory rule. That is what the regulation, as interpreted by the majority, does. The majority quotes from H. Rept. 2198, 85th Cong., 1st Sess. (1958), 1959-2 C.B. 709, 711, to sustain its conclusion. But the House version of section 1244 which that committee report undertakes to explain was not enacted. The House version did not contain the “except clause” which is part of section 1244(c)(1)(E) as enacted. The House Report, therefore, is not a reliable guide to the meaning of the statute. There was no Senate committee report on section 1244. Senator Kerr introduced what became section 1244 as an amendment to a bill under consideration on the Senate floor. He inserted in the Congressional Record, vol. 4, p. 17,090 (daily ed. Aug. 12,1958), a “summary of the amendment” which explained the “largely an operating company” requirement in terms of the gross receipts test and the “except clause” as follows: Also, a restriction has been imposed which is designed to limit this tax benefit to shareholders in companies which are largely operating companies. Thus, the corporation, in the 5 years before the taxpayer incurs the loss on the stock'(or for the period of its existence if less than 5 years) must have derived more than half of its gross receipts from sources other than royalties, rents, dividends, interest, annuities, and the sale of stock or securities. This restriction is to a/pply, however, only if the gross income equals or exceeds deductions (ignoring the net operating loss carryforward or hack and the deductions for partially tax exempt interest and dividends received). [Emphasis added.] This explanation of the test to be applied in respect of interest and similar items, in my opinion, forbids the imposition of a further test based on a passive income concept. I am aware of this Court’s opinions, cited by the majority, which apply section 1872(e)(5), headed “Passive Investment Income.” Those opinions read section 1372(e)(5) literally and hold that, if more than 20 percent of a corporation’s income consists of interest, it is not eligible to make the subchapter S election regardless of what operations were required to earn the interest. See Buhler Mortgage Co. v. Commissioner, 51 T.C. 971, 977-979 (1969), affd. per curiam 443 F.2d 1362 (9th Cir. 1971); Marshall v. Commissioner, 60 T.C. 242, 251 (1973), affd. 510 F.2d 259, 264 (10th Cir. 1975), which emphasize the “plain meaning” or the “clear language” of section 1372(e)(5). That section, however, does not contain an “except clause” similar to the one appearing in section 1244(c)(1)(E), and if section 1244(c)(1)(E), including the “except clause,” is given the same literal reading as the above-cited cases give section 1372(e)(5), petitioner’s Greenbelt stock clearly is section 1244 stock. I think section 1244(c)(1)(E) means what it says, and the interpretation which the majority gives the regulation to make it symmetrical with the section 1372(e)(5) cases does violence to the language of section 1244(c)(1)(E) and has no foundation in that section’s legislative history or purpose. I would allow ordinary treatment of petitioner’s loss. Drennen, Fay, Sterrett, Goffe, and Hall, JJ., agree with this dissenting opinion.   While most of petitioner’s brief is devoted to arguing the language of sec. 1244(c)(1)(E), his brief contains the following argument: “Greenbelt Finance, Inc., was an operating company from its inception in 1959 until its failure in 1971.” I do not think we can properly ignore this argument.    The general purpose of Code sec. 1244 is explained in H. Rept. 2198, 85th Cong., 1st Sess. (1958), 1959-2 C.B. 709, 711, and the “summary of the amendment” in almost identical language. The “summary of the amendment” states: “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 business 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 amendment places shareholders in small corporations on a more nearly equal basis with proprietors and partners.”