Two wholly owned corporations were each availed of with a view to distributions of the excess proceeds of FHA-insured mortgages prior to corporate realization of a substantial part of the net income to be derived from the properties so mortgaged, and the fact that said distributions to sole common stockholder were unaccompanied by surrenders of any stock does not operate to take them out of the operation of
34 T.C. 1085">*1085 The respondent determined deficiencies in income tax for the calendar years 1950 and 1951 in the respective amounts of $ 40,150.77 and $ 28,288.62. The sole issue for our determination is whether certain cash distributions made by Second Fair 34 T.C. 1085">*1086 Lawn Corporation and Third Fair Lawn Corporation are taxable to petitioners as ordinary income or as long-term capital gains.
FINDINGS OF FACT.
Some of the facts have been stipulated, are so found, and are incorporated herein by this reference.
Petitioners are husband and wife and reside in New York, New York. They 1960 U.S. Tax Ct. LEXIS 70">*71 filed joint income tax returns for the calendar years 1950 and 1951 with the collector of internal revenue for the third district of New York. Jesse Hartman will hereinafter be referred to as Hartman.
Hartman had considerable experience in the real estate construction business. On January 27, 1949, and July 11, 1949, respectively, he organized Second Fair Lawn Corporation (hereinafter referred to as Second Fair Lawn) and Third Fair Lawn Corporation (hereinafter referred to as Third Fair Lawn) under the laws of the State of Connecticut. The corporations were formed to construct and operate housing projects. At all times here material, Hartman held all the outstanding common stock of both corporations and was president and a director of each. The Federal Housing Administration (hereinafter referred to as FHA) was the owner of all the preferred stock.
By warranty deeds dated March 11, 1949, and August 4, 1949, respectively, Second Fair Lawn and Third Fair Lawn acquired separate parcels of land in Stamford, Connecticut, as sites for their proposed buildings.
Hartman financed the construction on both sites, pursuant to the provisions of section 608 of the National Housing Act, by first 1960 U.S. Tax Ct. LEXIS 70">*72 applying for a mortgage from private lending institutions and then having the proposed mortgagee (with Hartman as sponsor) apply to the FHA for mortgage insurance. Thus, Hartman secured Fidelity Title & Trust Company as mortgagee on both projects. 1 Then, an application having been filed with the FHA under the prescribed procedure, the FHA agreed to insure the mortgages on the two projects. The commitments were issued on November 26, 1948, and May 25, 1949, respectively.
The schedule below (with the amounts rounded to the nearest dollar) compares the estimated and actual costs of construction and sets forth the insurance commitment of the FHA on each project (in both cases the mortgagee agreed to and did advance the sum for which the FHA had issued a commitment): 34 T.C. 1085">*1087
Second Fair | Third Fair | |
Lawn | Lawn | |
Estimated total cost 1 | $ 1,235,000 | $ 1,425,000 |
Equity of corporation | 110,000 | 125,000 |
Amount of loan for which insurance requested | 1,125,000 | 1,300,000 |
FHA commitment | 1,080,000 | 1,181,000 |
Actual costs expended | 956,235 | 921,093 |
Unused mortgage proceeds | 123,765 | 259,907 |
Per cent of excess of actual costs | 12.9 | 28.2 |
The above estimates included the following amounts for architects' and contractors' fees:
Second Fair | Third Fair | |
Lawn | Lawn | |
Contractors | $ 53,200 | $ 61,451 |
Architects | 55,860 | 64,524 |
Total | 109,060 | 125,975 |
Second Fair Lawn contracted to pay the architect only $ 8,500 and actually paid him only $ 8,300 for his services. Third Fair Lawn contracted to pay the same architect $ 6,801 and actually paid him that amount. Both contracts were signed by Hartman as president of the respective corporations.
Each corporation was its own contractor and no contractor's fees were ever intended to be paid, or in fact paid, with respect to either project. Hartman was the overseer in charge of construction on both projects.
The schedule below indicates the dates on which various steps in the construction occurred:
Second | Third | |
Fair Lawn | Fair Lawn | |
Final certificate of occupancy issued | Sept. 9, 1949 | May 26, 1950 |
Construction superintendent left project | Oct. 1949 | June 1950 |
Final endorsement of mortgagee 1 | May 4, 1950 | Oct. 13, 1950 |
At a meeting of Second Fair Lawn's three-man 1960 U.S. Tax Ct. LEXIS 70">*74 board of directors held on December 1, 1950, the land and improvements comprising the corporation's project were appraised at $ 1,250,000 and the board thus decided to write up the value of these assets by increasing capital surplus in the amount of $ 256,961.90. On December 8, 1950, the 34 T.C. 1085">*1088 board then voted a distribution out of capital surplus to Hartman in the amount of $ 100,000. This amount was paid on December 18, 1950.
Similarly, on June 11, 1951, Third Fair Lawn's board of directors (consisting of the same three parties who were on Second Fair Lawn's board) appraised its land and improvements at $ 1,250,000 and thus wrote up their value by increasing capital surplus in the amount of $ 263,789.90. Then, on June 25, 1951, the board voted a distribution out of capital surplus to Hartman in the amount of $ 75,000. Such amount was paid on June 30, 1951.
Petitioners reported these amounts on their 1950 and 1951 returns, respectively, as long-term capital gains, labeling them as "[Distributions] not out of earnings or profits."
The net income and the earned surplus and undivided profits of the corporations for the periods in question were as follows:
Second Fair Lawn | ||
1949 | 1950 | |
Net income (loss) | $ 3,152.88 | $ 14,170.38 |
Earned surplus and undivided profits | 2,489.70 | 3,141.70 |
Third Fair Lawn | ||
Fiscal year ended June 30 -- | ||
1950 | 1951 | |
Net income (loss) | ($ 3,170.48) | 11960 U.S. Tax Ct. LEXIS 70">*75 $ 33,524.50 |
Earned surplus and undivided profits | 0 | 1,180.21 |
At every phase of construction of each of these projects, Hartman was aware of the amount of money actually expended, and prior to completion of construction on each project, he was aware that the mortgage proceeds would be in excess of the funds actually needed for construction.
Both corporations were availed of principally for the construction of properties with a view to the realization by their sole common shareholder of gain attributable to such properties through distributions to that shareholder before the realization by the respective corporations of a substantial part of the net income to be derived from such respective properties.
OPINION.
1.
This case presents a familiar factual pattern involving a statutory provision which has produced frequent litigation resulting in a harmony of decision quite singular in a field so beset with uncertain distinctions and obscure definitions as is the Federal tax law.
34 T.C. 1085">*1089
While the primary use made of collapsible corporations in the past has usually involved their liquidation in the manner indicated above, it is apparent that the shareholders forming or availing themselves of such a corporation could raise the same tax questions as would be raised by a liquidation by selling their stock to outside interests at the time and under the circumstances when the corporation might otherwise be liquidated. In like manner, the corporation might distribute the property in question without liquidating and, under section 115(d), the value of the property distributed, to the extent that it was not a dividend, would first be applied 1960 U.S. Tax Ct. LEXIS 70">*77 against the adjusted basis of the stock to the shareholders and the excess, if any, would be taxable in the same manner as a gain from the sale or exchange of property.
Against this legislative background, taking into account the several alternative patterns of abuse of the corporate device, we consider as quite feeble petitioners' contention that while
Furthermore, it is well to bear in mind the often-cited note of caution sounded by the late Chief Judge Parker, speaking for the Fourth Circuit, in affirming our decision in the
Because the basic type of transaction which gave rise to the legislation involved the use of temporary corporations which were dissolved and their proceeds distributed after tax avoidance had been accomplished, the term "collapsible corporation" was employed to describe the corporations used for this form of tax avoidance; but the statute was drawn in broad general terms to reach the abuse which had arisen, whatever form it might take.
The Treasury regulations likewise take the same position, 41960 U.S. Tax Ct. LEXIS 70">*81 but petitioners urge us to follow a prior, and apparently contrary unpublished ruling issued by a Deputy Commissioner to
Assuming, without deciding, that such ruling was made upon facts comparable to those in the instant case, we must still decline to follow it. A similar ruling was urged upon the Fourth Circuit in the
it is well settled that it is not to be accorded the weight of a regulation. As said by the Supreme Court in
The Supreme Court has also held that even published rulings "have none of the force or effect of Treasury Decisions."
Petitioners next contend that the congressional enactment of section 312(j) of the 1954 Code 51960 U.S. Tax Ct. LEXIS 70">*83 shows that Congress did not intend to reach these distributions until 1954. We have answered this identical argument adversely to petitioners' contention in
Accordingly, we hold that
2.
These distributions are each thus taxable as ordinary income if made by a corporation which is "collapsible" as that term is defined in
34 T.C. 1085">*1092 Petitioner neither argues nor attempts to prove that these distributions were not made prior to the realization by the respective corporations of a substantial part of the net income to be derived from these 1960 U.S. Tax Ct. LEXIS 70">*84 housing projects, but argues, based upon his own testimony, that he never had any intent (view) to make the distributions until each respective construction was fully completed and the idea and advice to do so was given to him by his accountants. But, of course, we must weigh this manifestly self-serving testimony against the background of the actual events which have occurred.
Furthermore, it is well settled that the requisite view exists if the intention to distribute funds (or liquidate or sell the stock) is formed at any time prior to completion of construction.
if the sale, exchange, or distribution is attributable to circumstances present at the time of the * * * construction * * * the corporation shall, in the absence of compelling facts 1960 U.S. Tax Ct. LEXIS 70">*85 to the contrary, be considered to have been so formed or availed of.
This latter portion of the regulations was specifically approved by the Fourth Circuit in the
The portion of the regulations here quoted seems to state but a logical and necessary inference which a reasonable mind must draw from a record like the one before us. Thus, ignoring for the moment such compelling evidence as the great disparity between estimated architects' and contractors' fees and those actually paid (a disparity of over $ 100,000 as to each project) and assuming
Indeed, the spirit of the entire "collapsible corporation" section would be seriously evaded if we were to attach the significance urged 34 T.C. 1085">*1093 by petitioner to the very nice distinction that here the
1. Subsequent to obtaining the FHA commitments on each project, at times not otherwise material herein, the Greenwich Savings Bank replaced Fidelity Title & Trust Company as mortgagee on each project.↩
1. Exclusive of land owned by corporations.↩
1. At this time the final advance of funds was made to the respective corporations in the amounts of $ 129,248 and $ 140,878.↩
1. Before net operating loss deduction on account of net operating loss carryover from preceding year.
2.
(m) Collapsible Corporations. -- (1) Treatment of gain to shareholders. -- Gain from the sale or exchange (whether in liquidation or otherwise) of stock of a collapsible corporation, to the extent that it would be considered (but for the provisions of this subsection) as gain from the sale or exchange of a capital asset held for more than 6 months, shall, except as provided in paragraph (3), be considered as gain from the sale or exchange of property which is not a capital asset. (2) Definitions. -- (A) For the purposes of this subsection, the term "collapsible corporation" means a corporation formed or availed of principally for the manufacture, construction, or production of property, or for the holding of stock in a corporation so formed or availed of, with a view to -- (i) the sale or exchange of stock by its shareholders (whether in liquidation or otherwise), or a distribution to its shareholders, prior to the realization by the corporation manufacturing, constructing, or producing the property of a substantial part of the net income to be derived from such property, and (ii) the realization by such shareholders of gain attributable to such property.↩
3. Petitioners argue that such distributions should fall under section 115(d) of the 1939 Code, which provides:
(d) Other Distributions from Capital. -- If any distribution made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not a dividend, then the amount of such distribution shall be applied against and reduce the adjusted basis of the stock provided in section 113, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale or exchange of property. This subsection shall not apply to a distribution in partial or complete liquidation * * *↩
4. Section 39.117(m)-1(a) of Regulations 118 provides:
Sec. 39.117(m)-1
5. SEC. 312. EFFECT ON EARNINGS AND PROFITS.
(j) Distribution of Proceeds of Loan Insured by the United States. -- (1) In general. -- If a corporation distributes property with respect to its stock, and if, at the time of the distribution -- (A) there is outstanding a loan to such corporation which was made, guaranteed, or insured by the United States (or by any agency or instrumentality thereof), and (B) the amount of such loan so outstanding exceeds the adjusted basis of the property constituting security for such loan, then the earnings and profits of the corporation shall be increased by the amount of such excess, and (immediately after the distribution) shall be decreased by the amount of such excess. * * * (2) Effective date. -- Paragraph (1) shall apply only with respect to distributions made on or after June 22, 1954.↩
6. See footnote 2,
7. Regs. 111, sec. 29.117-11(b).↩