Court Opinion

ID: 4482104
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:18.97999+00
Date Added: 2024-06-11T14:53:27.299792
License: Public Domain

Goffe, Judge: Respondent determined a deficiency in petitioner’s Federal income tax for tbe taxable year ending June 30, 1967, in tbe amount of $56,985.10. Tbe sole issue for decision is whether tbe election of Parker Oil Co. to be taxed as a small business corporation under the provisions of section 1372(e) (3)1 terminated in 1966 for failure to comply with the requirement of section 1371(a) (4) that the corporation have only one class of stock. This will require us to decide whether 5 shares of stock of the petitioner covered by an agreement among the stockholders and the corporation which provided for an irrevocable proxy, for disproportionate voting for the election of directors, and for disproportionate voting by the directors, constitutes a second class of stock thereby terminating petitioner’s election to be taxed under the provisions of subchapter S. RINDING OR RACTS All of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein and adopted as our findings. Parker Oil Co., Inc. (sometimes hereinafter referred to as Parker Oil), is a corporation organized under the laws of Alabama. For all times material herein the joint venture of Fuel Services, Inc., and Parker Oil engaged in the business of refueling aircraft under a contract with the U.S. Government. At the time of filing its petition herein, the principal place of business of Parker Oil was Ozark, Ala. In reporting its income Parker Oil utilized a fiscal year which ended on June 30 and for the taxable year ended June 30,1967, it filed a U.S. small business corporation return with the district director of internal revenue, Birmingham, Ala. A valid election to be taxed as a small business corporation pursuant to section 1372 had been filed by Parker Oil on June 1,1959. At the time of incorporation 100 shares of stock were issued as follows: Shares Wilmer Parker_40 Annie Laura Parker (wife of Wilmer Parker)_10 Don W. Parker_50 The total number of shares issued represented a single class of voting common stock. On May 24,1961, Don W. Parker signed an instrument which purported to “sell, assign and transfer” to Annie Laura Parker 5 shares of the 50 shares owned by him. The instrument appointed Wihner Parker, president of Parker Oil, as agent to transfer the 5 shares of stock on the books of the corporation to Annie Laura Parker. The transfer of the 5 shares adjusted the stock ownership of the outstanding shares as follows: Sharea Wilmer Parker_40 Annie Laura Parker_15 Don W. Parker_45 On October 4, 1966, Don W. Parker sued Wilmer Parker, Annie Laura Parker, Henry B. Steagall II (an officer of the corporation but not a shareholder), and Parker Oil in the Circuit Court of Coffee County, Ala., Enterprise Division in Equity, seeking, among other relief, to have the 5 shares of stock previously transferred to Annie Laura Parker transferred back to him. Such litigation was settled by the parties and embodied in a written agreement dated December 30, 1966, which, provided (insofar as material herein) as follows: 1. Conveyance of 5 shares of the stock of Parker Oil from Annie Laura Parker to Don W. Parker; 2. Execution by Don W. Parker of an irrevocable proxy covering 5 shares of stock naming M. 1ST. Brown and Ben B. Henderson, jointly or the survivor of them, as the holders of the proxy. It granted to Brown and Henderson the power to vote the 5 shares at any meeting of the stockholders of Parker Oil from the date of the settlement agreement until final dissolution of Parker Oil. The right to vote granted by the proxy was as complete as the power would be in Don W. Parker if present to vote but could be exercised only upon the joint concurrence of Brown and Henderson. By a later agreement of the parties, Henderson was dropped from the proxy and M. 1ST. Brown became the sole holder of the proxy. The stock certificate, for the 5 shares transferred from Annie Laura Parker to Don W. Parker was to bear a legend that such shares were subject to the irrevocable proxy to Henderson and Brown. This legend was for the purpose of making the proxy apply to anyone who might own the 5 shares after Don W. Parker. 3. The directors elected were Wilmer Parker, Annie Laura Parker, Don W. Parker, Ben B. Henderson, and M. N. Brown. Henderson and Brown were given collectively one vote as a director if concurred in by both, and the remaining three votes or directors were given one each to directors selected by Wilmer Parker, Annie Laura Parker, and Don W. Parker, four votes being the maximum permitted so long as Parker Oil remained in corporate existence. Three votes were to constitute a quorum and a majority of those voting was required for corporate action. The voting power of Wilmer Parker, Annie Laura Parker, and Don W. Parker in the selection of directors was binding upon their successors in interest. 4. No officers’ salaries were to be paid by Parker Oil after the date of the settlement agreement and only routine daily activities of the business of the corporation were to be conducted thereafter; matters such as execution of contracts and loans were to require approval of the board of directors. All parties agreed to use their best efforts to continue in effect the contract of the U.S. Government with petitioner and Fuel Services, Inc., as joint venturers. Upon termination of the contract, Parker Oil was to be dissolved and liquidated unless the board of directors unanimously voted to extend the corporate existence for 1 year following termination of the contract. The settlement agreement was carried out by the parties, i.e., Annie Laura Parker conveyed 5 shares to Don W. Parker; Don W. Parker executed the irrevocable proxy covering the 5 shares in favor of M. 1ST. Brown and Ben B. Henderson and the stock certificate for the 5 shares covered by the proxy bore the legend that the shares were subject to the settlement agreement. The settlement agreement did not provide for amendment to the articles of incorporation to reflect any portions of the settlement agreement. The articles of incorporation provide that there shall be only one class of stock. After giving effect to the agreement the outstanding shares of Parker Oil were owned as they were at the time of incorporation, i.e.— Shares Wilmer Parker_ 40 Annie Laura Parker- 10 Don W. Parker_ 50 The voting power as stockholders of the corporation, after giving effect to the agreement (as amended to delete Ben. B. Henderson as a party), was as follows: Totes Wilma Parker_ 40 Annie Laura Parker_ 10 Don W. Parker_ 45 M. N. Brown_ 5 The voting power of the directors, giving effect to their method of selection as provided in the agreement, was as follows: Votes Wilmer Parker’s and Annie Laura Parker’s directors- 2 Don W. Parker’s director_ 1 M. N. Brown’s director_ 1 The respondent, in his statutory notice of deficiency, determined that petitioner ceased to be a small business corporation as defined in section 1371(a) during the taxable year ended June 30, 1967, because it had more than one class of stock and its election to be taxed under the provisions of section 1372(a) was terminated by reason of the operation of section 1372(e) (3) (B). OPINION The sole issue to be decided is whether petitioner ceased to be taxable under the provisions of subchapter S of the Internal Revenue Code by reason of creation of a second class of stock. Section 1371 of the Code defines a corporation which may elect to have its income taxed to its shareholders under the provisions of subchapter S as a “small business corporation.” One requirement under the definition is that the corporation have only one class of stock (sec. 1371 (a) (4)). If the corporation ceases to come within the definition of section 1371, its election to be taxed under the provisions of subchapter S terminates for the taxable year during which the corporation ceased to fall within the requirements of the definition of “small business corporation” (sec. 1372(e)(3)). Respondent contends that Parker Oil ceased to be a “small business corporation” for the taxable year ended June 30,1967, because during that taxable year it had more than one class of stock. No such second class of stock was created by the articles of incorporation such as was the case in Pollack v. Commissioner, 392 F. 2d 409 (C.A.5, 1968), affirming 47 T.C. 92 (1966). Nor does this issue turn on whether debt of the corporation is in substance equity such as was involved in W. C. Gamman, 46 T.C. 1 (1966). The instant case instead is one of substance versus form, the respondent contending that the settlement agreement and irrevocable proxy granted by Don W. Parker in substance created a second class of stock. In form there can be no second class of stock because it is expressly forbidden by the terms of the articles of incorporation. Respondent relies upon section 1.1371-1 (g), Income Tax Regs., upon Rev. Rul. 63-226, 1963-2 C.B. 341, and upon the Pollack case. Section 1.1371-1 (g), Income Tax Regs., provides in part: (g) Glasses of stoelc. A corporation having more than one class of stock does not qualify as a small business corporation. * * * If the outstanding shares of stock of the corporation are not identical with respect to the rights and interest which they convey in the control, profits, and assets of the corporation, then the corporation is considered to have more than one class of stock. Thus, a difference as to voting rights, dividend rights, or liquidation preferences of outstanding stock will disqualify a corporation. However, if two or more groups of shares are identical in every respect except that each group has the right to elect members of the board of 'directors in a number proportionate to the number of shares in each group, they are considered one class of stock. Obligations which purport to represent debt but which actually represent equity capital will generally constitute a second class of stock. Rev. Rul. 63-226,1963-2 C.B. 341, holds in part: Furthermore, in the event that the outstanding stock of a corporation is subject to any other type of voting control device or arrangement, such as a pooling or voting agreement or a charter provision granting certain shares a veto power or the like, which has the effect of modifying the voting rights of part of the stock so that particular shares possess disproportionate voting power as compared to the dividend rights or liquidation rights of those shares and as compared to the voting, dividend and liquidation rights of the other shares of stock of the corporation outstanding, the corporation will be deemed to have more than one class of stock. Accordingly, the corporation does not qualify as a small business corporation. The portions of the regulations and revenue ruling quoted above are apparently based upon the legislative history reflecting congressional intent in the enactment of subchapter S. We have had occasion to express our views on such congressional intent in other opinions. See W. C. Gamman, supra at 7-8, 13, and James L. Stinnett, Jr., 54 T.C. 221, 230-232, 235-236 (1970), on appeal (C.A. 9, Sept. 23, 1970). No useful purpose could be served by repeating such analysis here. Our views on the congressional intent as to the second class of stock requirement in the definition of a subchapter S corporation is shared by other courts. See A. & N. Furniture & Appliance Co. v. United States, 271 F. Supp. 40 (S.D. Ohio 1967), and Portage Plastics Co. v. United States, 301 F. Supp. 684 (W.D. Wis. 1969), reversed on other grounds 470 F. 2d 308 (C.A. 1972). Suffice it to say, we feel there is no congressional intent to deprive the taxpayer of subchapter S benefits under the facts of the instant case. We conclude that the overriding purpose of the requirement that only one class of stock exist in a corporation qualifying under subchapter S is to avoid complexities in taxing income to shareholders with different preferences as to the distribution of profits. The all-inclusive language of the regulations and revenue ruling quoted above is too broad in light of the congressional intent. When such language is applied to the facts in this case, we believe the intent of Congress is being thwarted. The alteration of voting power brought about by the settlement agreement among Parker Oil and its stockholders and the irrevocable proxy could not conceivably alter the reporting of the relative shares of the profits of the corporation by its stockholders. It created no complication as to the reporting of income by the stockholders. The shifting of voting power for 5 shares from Don W. Parker to M. N. Brown could not affect the distribution of earnings in any manner. The provisions of subchapter S were devised for small businesses. Many such corporations are family owned and differences of opinion as to management policies sometimes develop. Settlement of such differences can often be resolved by agreement of the shareholders. We conclude that is what happened here. Surely such a practical solution to discord within the corporation should not result in termination of subchapter S status by reason of a technical interpretation of the one class of stock provision where there is no reason for imposing a prohibition on the bare shift of voting power. We, therefore, hold that under such circumstances section 1.1371-1 (g), Income Tax Pegs., and Pev. Pul. 63-226, supra, are invalid to the extent that they hold a second class of stock is created unless all of the shares outstanding are identical as to all voting rights. A proxy is a widely used corporate tool. It has a very practical purpose even in a small, closely held corporation. Under the law of Alabama (the State of incorporation and principal place of business of petitioner) voting is permitted by proxy. See Ala. Code tit. 10, sec. 21 (53) (Supp. 1969). Petitioner argues that the Alabama law does not permit a proxy to be irrevocable. We find it unnecessary in deciding this case to interpret the Alabama law because we conclude that no second class of stock was created regardless of the irrevoca-bility of the proxy. Respondent relies upon the Pollack case. Pollack is distinguishable. It is an extreme case where an amendment to the articles of incorporation prior to the issuance of any stock established four classes of stock which set up voting power not proportionate to the number of shares in each class. The purpose of creating such classes was found to be occasioned by equal investment of capital by the organizers of the corporation but unequal ownership of shares. In that case there was in form more than one class of stock. The opinion was based upon the fact that the stockholders created more than one class of stock in the amended articles of incorporation thus coming within the specific terms of the statute and petitioners therein apparently did not argue that the treasury regulations failed to reflect congressional intent. We conclude, therefore, that no second class of stock was created during petitioner’s taxable year ended June 30,1967. Reviewed by the Court. Decision will be entered for the 'petitioner.   All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.