Court Opinion

ID: 4482557
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:33.497144+00
Date Added: 2024-06-11T14:53:34.218876
License: Public Domain

Hall, J. I respectfully dissent. If a cash method taxpayer transfers $1,000 of trade receivables to an outside party in exchange for the assumption and payment of $1,000 of the taxpayer’s trade payables, he has no taxable income. He realizes $1,000 of gross income on the receivables, for they have been sold for payment of the payables, but he realizes an offsetting deduction of $1,000 on the payables, for they have been paid for by the recipient of the receivables. See James M. Pierce Corp. v. Commissioner, 326 F. 2d 67 (C.A. 8, 1964), reversing 38 T.C. 643 (1962); Royal Oak Apartments, Inc., 43 T.C. 243 (1964); Andrew Jergens, 17 T.C. 806 (1951). Under the majority’s reasoning, the same taxpayer making the same exchange with his wholly owned corporation will have $1,000 of taxable income. Section 351, intended as a shield against recognition of gain on incorporation, thereby perversely becomes a sword to impose a tax where none would be due in an ordinary recognizing transaction. The difficulty with the majority’s reasoning does not lie in the application of section 357 (c), for the statutory mandate there is clear. In our illustration, the incorporating taxpayer has caused his corporation to assume $1,000 of liabilities, and the receivables transferred had a zero basis. Accordingly, $1,000 “shall be considered as a gain from the sale or exchange of * * * property [the receivables] which is not a capital asset.” Sec. 357(c)(1). In other words, the taxpayer has made a taxable sale of his receivables. But what for ? Clearly, assumption and payment of the payables. It is the assumption, under the statute, which generates the gain. But, as we have noted, when a cash method taxpayer sells his receivables for assumption and payment of his payables, he is just as much entitled to a deduction for payment of the payables as he is accountable for income on the sale of the receivables. Section 357 (c) takes so much of the transaction out of section 351 and treats it as an ordinary recognizing exchange. It should be so treated as to both payables and receivables. Nothing in section 351 or 357 requires treatment of only one side of the receivable-payable “sale” as a recognizing transaction. The statutory purpose is far better served if payables paid by the transferee in the taxable year of transfer are treated as deductible to the transferor to the extent the offsetting receivables are treated as received by him. Since payment of a deductible liability by a cash method taxpayer gives rise to a deduction, the same deduction should be allowed on payment when section 357 (c) treats the liability as assumed in exchange for receivables. Admittedly no such deduction is available where assets are transferred in a section 351 transaction to the extent not treated as a sale under section 357. Arthur L. Kniffen, 39 T.C. 553, 566-567 (1962);1 Doggett v. Commissioner, 275 F. 2d 823 (C.A. 4, 1960), affirming a Memorandum Opinion of this Court, certiorari denied 364 U.S. 824 (1960); Citizens Nat. Trust & Savings Bank v. Welch, 119 F. 2d 717 (C.A. 9, 1941). Likewise, a bankrupt gets no deduction on the mere transfer of assets to a trustee, where a new entity is created and there is no direct correspondence between transfer of assets and subsequent payment of the bankrupt’s liabilities. Henry C. Mueller, 60 T.C. 36, 43-44 (1973); B & L Farms Co. v. United States, 238 F. Supp. 407, 409-410 (S.D. Fla. 1964), affirmed per curiam 368 F. 2d 571 (C.A. 5, 1966), certiorari denied 389 U.S. 835 (1967). Neither of these situations is comparable to the present facts, where (in order to avoid a negative basis) section 357 treats a portion of what would otherwise be a section 351 transaction as a taxable sale. Our analysis is fully in accord with the purpose of section 357 (c). Under it, there is no need to strain, as does Bongiovanni v. Commissioner, 470 F. 2d 921 (C.A. 2,1972), to read the word “liabilities” in a difficult-to-define, artificial “tax” sense. Section 357(c) is given full, literal effect. As a matter of appropriate allocation, in the case of incorporation of a cash basis business, the trade accounts payable should, for this purpose, be netted against the trade accounts receivable, up to the lesser of the trade accounts payable or the amount of liabilities treated as paid under section 357(c). Such an allocation is simple, straightforward and best follows the statutory intent. Applying these principles to the present case, the liabilities assumed exceeded the adjusted basis of assets transferred by $102,367.73. Accordingly, there is $102,367.73 of section 357(c) gain. There were $164,065.54 of unrealized accounts payable, and $317,146.96 of unrealized receivables. The corporation paid all the payables in petitioner’s same taxable year. Accordingly, all $102,367.73 of the section 357 (c) gain would properly be allocated to sale of the receivables in exchange for assumption and payment of the payables, and the partnership should be treated as having paid $102,367.73 of the payables. Since the payables appear to have represented ordinary and necessary business expenses (they were all deducted by the corporation), the partnership was entitled.to deduct that amount, which exactly offsets the section 357 (c) ordinary gain on the receivables. There should be no net addition to taxable income on the transaction. It is not necessary for present purposes to consider the effect, if any, of application of the above analysis to the subsequent corporate payment of the pay-ables assumed and receipt of the receivables purchased thereby. FORRESTER and Featherston, /</., agree with this dissent.   In Arthur L. Kniffen, 39 T.C. 553 (1962), the cash method taxpayer conceded and the Court found $8,246.58 of income under sec. 357(c)(1) on the transfer to a corporation of a sole proprietorship, the liabilities of which exceeded the adjusted basis of its assets by that amount. Among the liabilities so transferred and paid by the transferee were $22,466.31 in unpaid business expenses. The taxpayer claimed the full amount thereof as a deduction and it was denied on the authority of Doggett v. Commissioner, 275 F. 2d 823 (C.A. 4, 1960), affirming a Memorandum Opinion of this Court, certiorari denied 364 U.S. 824 (1960), and Citizens Nat. Trust & Savings Bank v. Welch, 119 F. 2d 717 (C.A. 9, 1941). The findings of fact do nojt indicate whether the assumed payables were in fact paid during the same taxable year. The taxpayer did not, in any event, contend that he was entitled to a deduction limited to the extent of his sec. 357(c) (1) gain, and the Court did not consider the point. The authorities cited in Kniffen by the Court, while clearly barring the deduction of the full $22,466.31, do not involve the present question of whether amounts taken out of sec. 351 by application of see. 357 (e) should give rise to deductions on payment of the liabilities giving rise to the application of that section.