Court Opinion

ID: 4482556
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:33.491645+00
Date Added: 2024-06-11T14:53:33.921293
License: Public Domain

Qtjealt, /., dissenting and concurring: I must disagree with the opinion of the majority with respect to the application of section 357 (c) to the facts in this case. With respect to this issue, the opinion of the majority follows the line of prior decisions of this Court in N. F. Testor, 40 T.C. 273 (1963), affd. 327 F. 2d 788 (C.A. 7, 1964), and Peter Raich, 46 T.C. 604 (1966). That view was rejected by the U.'S. Court of Appeals for the Second Circuit in Bongiovanni v. Commissioner, 470 F. 2d 921 (C.A. 2, 1972), reversing T.C. Memo. 1971-262. While it was my decision that was reversed, I am in full accord with the decision of the appellate court in« the Bongiovarmi case. There are inherent problems in applying section 357 (c) in the case of a taxpayer whose books and records are kept on the cash basis of accounting where there has been a transfer of the business in “midstream.” Since neither all of the income actually earned nor all of the expenses actually incurred may be reflected on the books of such taxpayer, the transferor will not have fully accounted for its income and deductions. Where the transfer qualifies for nonrecognition under section 351, the transferee is required to pick up any unreported income and receives the benefit of any deductions attributable thereto which have not been paid by the transferor. Under the opinion of the majority, however, the allowance of the deduction to the transferee is offset by the inclusion of a corresponding amount in the gain taxable to the transferor under section 357(c). This has troubled the courts. Bongiovanni v. Commissioner, supra; Peter Raich, supra.1  As was aptly pointed out by the appellate court in Bongiovanni v. Commissioner, supra, section 351 was originally enacted to provide for the simple incorporation of a sole proprietorship or partnership for purposes of continuing the business in that form without the realization of any taxable gain or loss. Where the liabilities assumed in that type of transaction are reflected in the transferor’s method of accounting, it is only logical to take suck, liabilities into account in determining tke consideration received.2  On tke otker kand, wkere neitker tke liabilities in question nor the corresponding receivables have been taken into account under the taxpayer’s method of accounting, tke treatment of suck liabilities as “other property” received by tke transferor produces an absurd result. Accordingly, in the Bongiovanni case, tke appellate court said: Section 357(c) — if read literally — requires that “liabilities” assumed by the transferee corporation which exceed the aggregate adjusted basis of the properties transferred are to be considered as gain from the sale or exchange of that property. However, we believe that the word “liability” is used in Section 357(c) in the same sense as the word “liability” referred to in the legislative history of Section 357(c). It was not meant to be synonymous with the strictly accounting liabilities involved in the case at bar. Section 357(c) was meant to apply to what might be called “tax” liabilities, i. e., liens in excess of tax costs, particularly mortgages encumbering property transferred in a Section 351 transaction. See 3 U.S. Code Cong. & Admin. News pp. 4064, 4266-67, 4908 (1954). Any other construction results in an absurdity in the case of a cash basis taxpayer whose trade accounts payable are not recognized as a deduction ('because he is on the cash basis) but whose “liabilities” (although unpaid) we recognized for purposes of 'Section 357(c). The-payables of a cash basis taxpayer are “liabilities” for aceowvtinf/ purposes but should not be considered “liabilities” for taat purposes under Section 357(c) until they are paid. See Note, Section 357(c), And The Cash Basis Taxpayer, 115 U. Pa. L. Rev. 1154 (1967). [470 F. 2d 921, 923-924 (C.A. 2, 1972).] In resolving tkis issue, wkerever possible it is our duty to arrive at a decision wkick will be compatible witk the statute as a whole. As Judge Rives said in Davant v. Commissioner, 366 F. 2d 874, 879 (C.A. 5, 1966), “rules prescribed by Congress in tke Code are often wholly reasonable and appropriate when taken in isolation, but that fact alone should not and must not prevent a court from harmonizing these apparently divergent elements of specific policy so that they may continue to cohabit tke same body of general law wkick Congress has directed shall be viewed as a single plan.” The decision of tke appellate court in tke Bongiovanni case achieves that result. In fact, it more nearly carries out tke intent of the Congress in that a distinction is made not on the basis of “secured liabilities,” but on tke basis whether tke liability in question was reflected in determining tke income and expense of tke taxpayer on a cash basis. Wkere a taxpayer buys a depreciable asset with borrowed funds, tke deduction for depreciation enters into tke computation of tke taxpayer’s income on a cask basis of accounting regardless whether tke borrowings constitute a lien on tke asset or represent a general obligation of the taxpayer. The indebtedness is reflected in the taxpayer’s accounting. On the other hand, where the liability represents am inven-toriable or deductible expense, it cannot be reflected in the computation of income on a cash basis until paid. The distinction makes sense, and I would adopt it. With respect to the second issue, the facts are that for some 1 years Mr. Thatcher and Mr. Teeples had been partners in the contracting business in Portland, Oreg., and in the operation of a farm some 350 miles distant. They divided their duties, Mr. Thatcher being in charge of -the contracting business and Mr. Teeples being in charge of the farm. As of January 1,1963, a corporation was organized to take over the contracting business. Mr. Teeples owned or controlled 300 shares of a total of 500 shares of stock outstanding. In March 1963, the corporation entered into a contract to pay Mr. Teeples a total of $100,000 in monthly installments of $1,250 for such services as he might perform for the corporation. It was understood at that time that Mr. Teeples would continue to reside at the farm but would be available from time to time as needed. In May of 1963, the corporation redeemed or repurchased the 300 shares of stock owned by Mr. Teeples for the sum of $42,500. Thereafter, in accordance with the custom of his church (Church of Jesus Christ of Latter Day Saints), Mr. Teeples was called upon to undertake a mission for the church in Formosa. He accepted the call. Thereupon the board of directors of the corporation voted to continue his salary during his absence. The respondent has determined that at least to the extent of $1,000 per month, the amounts paid to Mr. Teeples were not an allowable deduction under section 162 (a) (1). It is clear from the record that Mr. Teeples was withdrawing from the contracting business, whether in anticipation of the call from his church or otherwise. He so testified. Furthermore, in determining the price at which his stock, representing three-fifths of the outstanding stock of the corporation, was redeemed, Mr. Teeples said: I did not have access to the boohs, but I have an accountant that was handling the boohs all of the time. And when this split came we, of course, figured what we had, less the liabilities and the obligations that I had, to complete the jobs that we would have to complete, and that was the amount of money that was left over. Such testimony is only compatible with the facts if it is assumed that the contractual liability to pay Mr. Teeples $1,250 per month until October 30, 1969, was also taken into account. In other words, either the employment contract was a part of the consideration for the sale by Mr. Teeples of his stock or the financial condition of the corporation was grossly understated to him. Since he was the controlling stockholder at that time, I am not inclined to accept the latter. We must assume, therefore, that the additional amounts which Mr. Teeples was to receive, whether he worked or not, were in part consideration to be paid for his stock. Gorm, /., agrees with this opinion.   A similar harsh result may follow where a cash basis taxpayer becomes bankrupt. Henry C. Mueller, 60 T.C. 36 (1973).    For example, where the transferor has purchased machinery and equipment with borrowed funds, irrespective of the method of accounting, the transferor’s basis for depreciation reflected the full cost of the machinery and equipment.