52 T.C. 619">*619 The respondent determined deficiencies in the income tax of the corporate petitioner, O.B.M., Inc., as follows:

The respondent further determined that each of the individual petitioners is liable, as a transferee of O.B.M., Inc., for the total amount of the deficiencies asserted against O.B.M., Inc., $ 63,594.73, plus interest. The principal issue presented is whether all the assets of O.B.M., Inc., except for assets 1969 U.S. Tax Ct. LEXIS 95">*96 retained to meet claims, were distributed within 12 months of its adoption of a plan of complete liquidation, so that, under section 337 of the Internal Revenue Code of 1954, ² it is not taxable on the gain from the redemption of certain stock owned by it. The answer depends upon the interpretation of the phrase in that section, "less assets retained to meet claims," and the application of that phrase to the facts of this case.

FINDINGS OF FACT

Some of the facts have been stipulated, and those facts are so found. O.B.M., Inc. (O.B.M.), was organized under the laws of the State 52 T.C. 619">*620 of New York in 1906. Although the company was known by different names during its existence, we shall refer to it consistently as O.B.M. Its corporate income tax returns for the taxable years 1961, 1962, 1963, and 1964 were filed with the district director of internal revenue, Manhattan, New York. Its principal office was in New York City, N.Y., at the time its petition was filed in this case.

Each of the individual petitioners had his legal residence within the State of New York at the time his petition was filed 1969 U.S. Tax Ct. LEXIS 95">*97 in this case. At all times relevant to the issues herein, the individual petitioners owned stock in O.B.M. as follows:

Prior to 1958, O.B.M.'s principal business was contract dredging of boat slips in New York Harbor and towing of scows and equipment. On or about June 19, 1958, O.B.M. ceased all dredging operations and sold all of its operating equipment and properties, except for the tug DuBois II, to Tidewater Dredging Corp. (Tidewater). In return, O.B.M. received 50 percent, or 4,180 shares, of Tidewater's preferred stock and 50 percent, or 1,420 shares, of its common stock. The Tidewater stock constituted O.B.M.'s principal asset after June 19, 1958.

O.B.M. chartered the tug, DuBois II, to Tidewater from June 19, 1958, to March 31, 1960. From April 1, 1960, to approximately June 10, 1960, the tug was chartered to McAllister Bros., Inc.McAllister Bros., Inc., paid O.B.M. commissions in the amounts of $ 6,926.97 between June 1, 1960, and December 31, 1960, 1969 U.S. Tax Ct. LEXIS 95">*98 and $ 5,250 between January 1, 1961, and June 30, 1961. The U.S. Coast Guard certificate of inspection of DuBois II expired on June 12, 1960. The Coast Guard made a biennial inspection of the tug and on June 20, 1960, sent O.B.M. a letter detailing needed repairs. O.B.M. estimated that the repairs would cost $ 25,000 and decided not to make them. The DuBois II was not operated after June 1960.

On June 23, 1961, at a special joint meeting of stockholders and directors, a plan of complete liquidation of O.B.M. was adopted. Under the plan, O.B.M. was to sell all of its salable assets and distribute to its stockholders, within a 12-month period from the date of the plan, the sale proceeds and its other assets, "less such assets, if any, as may be necessary to meet * * * [O.B.M.'s] claims." On June 26, 1961, O.B.M.'s board of directors met and resolved that the 52 T.C. 619">*621 corporation be dissolved under section 337 and appointed Gerard M. McAllister, a stockholder, director, and officer (and one of the petitioners herein), as the trustee in liquidation. Louis J. Riso, the treasurer of O.B.M., handled the details of the liquidation under Mr. McAllister's general supervision.

On June 23, 1961, the 1969 U.S. Tax Ct. LEXIS 95">*99 balance sheet of O.B.M. reflected the following assets and liabilities:

Between June 23, 1961, and June 22, 1962, O.B.M. made cash distributions to its stockholders totaling $ 1,127,000. ³ In addition, on June 19, 1962, O.B.M. caused its 16,236 shares of stock in Mersick Industries, Inc., valued at $ 2.50 per share for Federal tax stamp purposes, to be transferred to its stockholders in proportion to their O.B.M. stockholdings.

On June 23, 1962, O.B.M. had assets, ascertained in existence and value, totaling $ 5,099, consisting 1969 U.S. Tax Ct. LEXIS 95">*100 of $ 3,913 in cash and $ 1,186 in insurance claims. It had liabilities ascertained as to existence and amount totaling $ 2,250, consisting of accounts payable of $ 1,000 and provision for damage claims in excess of insurance coverage of $ 1,250. In addition, as a result of its participation in a joint venture, described more fully later, O.B.M. was liable for a judgment which New York City had obtained against the joint venture for unpaid general business tax. This judgment was for $ 4,416.61 plus interest from the date of 52 T.C. 619">*622 the judgment, which amounted to approximately $ 1,300 on June 23, 1962.

Also on that date, O.B.M. owned the tugboat DuBois II with a book value of $ 14,553, an investment in the joint venture whose book value was $ 39,938, and its stock in Tidewater. On that date, certain of O.B.M.'s Federal, State, and local tax returns remained unaudited. These items are discussed later.

Tug DuBois II. -- The tug DuBois II was not operated after June 12, 1960. From that time until August 31, 1967, O.B.M. and Mr. McAllister as trustee in liquidation for O.B.M. maintained and paid for insurance on the tug and continued to offer it for sale for commercial purposes or for scrap. 1969 U.S. Tax Ct. LEXIS 95">*101 The tug had a scrap value, as of June 23, 1962, of between $ 3,000 and $ 5,000. In 1966, William B. McConnell made an offer of $ 12,000 for the tug, intending to use it as a shrimp boat. Mr. McConnell placed a $ 2,000 deposit on the boat, but after a thorough inspection, he decided not to purchase it and forfeited his deposit. In 1967, the tug was sold for scrap for $ 4,000.

Joint Venture. -- Prior to 1953, O.B.M. was engaged in a joint venture with Quist Construction Co., Inc., to perform a contract with New York City for the demolition of a pier. In 1953, the joint venture instituted a suit against New York City seeking damages in the amount of $ 250,000 on account of an alleged misrepresentation by the City in the demolition contract. On June 23, 1962, this lawsuit was still pending and was the joint venture's sole remaining asset. In 1958, O.B.M. acquired the right to any proceeds of this lawsuit, with limitations not here relevant. In 1954, two law firms declined to handle the suit and advised O.B.M. that it was worthless, but Albert Foreman, an attorney, agreed to represent the joint venture in the suit for a contingent fee of 33 1/3 percent, later reduced to 25 percent. 1969 U.S. Tax Ct. LEXIS 95">*102 Mr. Foreman engaged in various conferences with representatives of the City and, between the time he took the case and October 1962, stood ready to settle the case for no less than $ 70,000. In 1958, the City's legal representative proposed to recommend to the City comptroller that the case be compromised for $ 15,000; this proposal amounted to an offer of settlement. This offer was rejected at that time by Mr. Foreman but was never withdrawn prior to October 1962.

In October 1962, at a pretrial conference, Mr. Foreman offered to settle the case for $ 40,000, and the City refused. The judge thereupon strongly urged the attorneys for O.B.M. and the City to obtain authorization from their respective principals to settle the case for $ 25,000. Thereafter sometime prior to December 1963, the parties finally agreed to settle the case for $ 25,000. On account of this settlement, O.B.M., on May 20, 1964, received the net amount of $ 12,859.83. This amount 52 T.C. 619">*623 took into consideration a compromise of the City's judgment for business taxes and interest against O.B.M. This amount was computed as follows:

The 1969 U.S. Tax Ct. LEXIS 95">*103 Tidewater Stock. -- On or about June 19, 1961, Tidewater's stockholders voted to sell all of its physical assets to the Great Lakes Dredge & Dock Co. (Great Lakes) for $ 2,150,000. Great Lakes is a publicly owned company, with its principal office at Chicago, Ill., whose business is marine contracting and dredging. None of the stockholders of O.B.M. are or were stockholders of Great Lakes. On June 23, 1961, the stockholders voted that, following consummation of the sale, Tidewater should pay all of its debts and obligations and distribute to its stockholders, within 12 months of the adoption of the plan of liquidation, "all of the remaining assets of Tidewater less such assets, if any, as may be necessary to meet Tidewater's claims," and thereby observe the requirements of section 337. Mr. McAllister, who was a stockholder and officer of Tidewater, was designated trustee in liquidation, but Mr. Riso, who was Tidewater's financial vice president, handled the details of the liquidation. At the June 23, 1961, stockholders' meeting, Tidewater's name was changed to United Maritime Associates, Inc. ^{41969 U.S. Tax Ct. LEXIS 95">*104}

On June 30, 1961, Tidewater received from Great Lakes $ 2,136,000 on account of the sale of its assets. ⁵ Thereafter, O.B.M. received from Tidewater, prior to June 23, 1962, distributions totaling $ 834,060 on account of Tidewater's liquidation, the last distribution in that period being received on February 28, 1962. ⁶ None of the Tidewater shares 52 T.C. 619">*624 held by O.B.M. or any other of Tidewater's stockholders were ever surrendered as a result of the Tidewater liquidation.

As of February 28, 1962, after the liquidating distributions of that date, Tidewater's books reflected the following assets, liabilities, and stockholders' equity:

1969 U.S. Tax Ct. LEXIS 95">*105 Tidewater's annual report for the fiscal year ending February 28, 1962, stated that this balance sheet, which shows stockholders' equity in the amount of $ 115,816, did not reflect certain contingent liabilities, viz, additional retroactive workman's compensation premiums of approximately $ 51,000; liability to the owner of the vessel Judi Bob for damages estimated at $ 20,000 over and above the amount shown 52 T.C. 619">*625 on the books; and liability for additional Federal, State, and local taxes which might be asserted with respect to unaudited tax returns.

Subsequent to February 28, 1962, the Federal taxing authorities denied certain deductions claimed on Tidewater's 1962 income tax return and asserted a deficiency of approximately $ 30,000 plus interest. The Federal tax claims against Tidewater were settled sometime during 1963. Also in 1963, the workmen's compensation liability was settled for an amount less than the anticipated $ 51,000. On February 28, 1963, Tidewater made a distribution to its stockholders of which O.B.M. received $ 28,400. In 1964, Tidewater satisfied its liability arising out of the damage to the Judi Bob for $ 4,900. On December 9, 1964, Tidewater made a distribution 1969 U.S. Tax Ct. LEXIS 95">*106 to its stockholders, of which Mr. McAllister, as trustee in liquidation for O.B.M., received $ 7,500. On September 6, 1966, Tidewater completely wound up its affairs and made a final liquidating distribution to its stockholders of $ 1,107.32, of which Mr. McAllister, as trustee in liquidation for O.B.M., received $ 553.66.

Contingent Federal, State, and Local Tax Liabilities. -- As of June 23, 1962, certain of O.B.M.'s State and City tax returns were still subject to audit. Federal tax returns for the taxable years after 1957 were subject to audit; however, the 3-year statute of limitations had run with respect to the taxable year 1958. As of June 23, 1962, Mr. Riso and Gerard McAllister did not anticipate any specific tax liability for any particular year and set no assets aside specifically to meet anticipated tax liabilities.

On March 1, 1963, O.B.M., following the receipt of the $ 28,400 distribution from Tidewater, distributed $ 28,000 to its stockholders. On July 10, 1964, O.B.M. filed a certificate of dissolution with the secretary of state of New York, distributed its remaining assets to Mr. McAllister as trustee in liquidation for O.B.M., and went out of existence.

Between 1969 U.S. Tax Ct. LEXIS 95">*107 July 16, 1964, and September 7, 1966, the following deposits were made in a checking account in the name of Gerard M. McAllister, as trustee in liquidation for O.B.M.:

52 T.C. 619">*626 On July 20, 1964, Mr. McAllister, as trustee in liquidation for O.B.M., distributed $ 15,000 to O.B.M.'s stockholders, which amount consists, in part, of the proceeds of the settlement of the joint venture claim against New York City. On September 14, 1965, he distributed, as trustee, $ 4,000 to O.B.M.'s stockholders, so that they could pay attorneys' fees arising out of the present proceeding. As of the date of the trial in this case, the checking account in the name of Mr. McAllister, as trustee in liquidation for O.B.M., showed a balance of $ 8,339, which amount was retained in that account to pay the costs of the present proceeding, including possible appeals.

The 1969 U.S. Tax Ct. LEXIS 95">*108 following table summarizes the distributions received by O.B.M. from Tidewater and the cash distributions it made to its stockholders:

From 1961 through 1965, the individual petitioners received the following cash amounts in liquidation of their stockholdings in O.B.M.:

OPINION

While 1969 U.S. Tax Ct. LEXIS 95">*109 O.B.M. was in the process of liquidation, it received liquidating distributions from Tidewater in excess of its basis in the Tidewater52 T.C. 619">*627 stock. The question presented is whether O.B.M. has met the requirements of section 337(a) so that it is not required to recognize the gain it realized on the Tidewater liquidation. Section 337(a) provides:

SEC. 337. GAIN OR LOSS ON SALES OR EXCHANGES IN CONNECTION WITH CERTAIN LIQUIDATIONS.

(a) General Rule. -- If --

(1) a corporation adopts a plan of complete liquidation on or after June 22, 1954, and

(2) within the 12-month period beginning on the date of the adoption of such plan, all of the assets of the corporation are distributed in complete liquidation, less assets retained to meet claims,