Luckman v. Commissioner

United States Tax Court · 1969 · Corporations

CorporationsDividendsEarnings and profitsCorporate distributionsSection 332 liquidationssection 301section 316section 332

Facts

Rapid made cash distributions to shareholders in 1961, and Sid Luckman received $37,245.75 but did not report any of it as dividend income because Rapid advised that the distributions were returns of capital. As of January 31, 1961, Rapid's accumulated earnings and profits became a deficit of $1,578,029.20 after giving effect to the stock-option reduction recognized by the Seventh Circuit. On July 31, 1961, Rapid acquired under section 332 the assets of the Cellu-Craft companies, which had aggregate earnings and profits of $1,634,046.30 and aggregate deficits of $224,152.19. Rapid also had reported installment-sale income from the sale of its Paper division in fiscal 1961 and 1962, but later recognized a large installment loss in fiscal 1965, and the Commissioner later disallowed certain pre-1961 deductions, increasing Rapid's prior taxable income.

Issue

Whether Rapid's 1961 distributions to shareholders were taxable dividends to the extent of earnings and profits when Rapid had a preacquisition deficit, later acquired earnings and profits in a section 332 liquidation, had recognized installment-sale income in 1961 and 1962 that was followed by a later loss in 1965, and had prior-year taxable income increased by disallowed deductions. More specifically, could Rapid's preacquisition deficit offset acquired earnings and profits, could the earlier installment-sale income be ignored in computing earnings and profits, and must the later tax adjustments retroactively increase earnings and profits as of January 31, 1961?

Rule

A corporation's distribution is a dividend under sections 301 and 316 to the extent made out of current or accumulated earnings and profits. Under section 381(c)(2)(B), in a section 332 acquisition the acquiring corporation's preacquisition deficit may be used only to offset earnings and profits accumulated after the transfer date and may not reduce earnings and profits acquired from the transferor. Under section 312(f)(1), gain or loss from a sale or disposition affects earnings and profits only to the extent recognized in computing taxable income under the law applicable to the year of recognition, so installment-sale income recognized in earlier years increases earnings and profits in those years and a later recognized loss reduces earnings and profits only in the later year. Where prior deductions are later disallowed and the taxpayer fails to show otherwise, earnings and profits must be retroactively increased accordingly.

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Maple Ridge Components, Inc., a Wisconsin corporation, had an accumulated earnings-and-profits deficit of $900,000 on June 30. On that date, it liquidated its wholly owned subsidiary, Lakefront Plastics, Inc., into itself in a transaction qualifying under section 332. Lakefront had accumulated earnings and profits of $1.4 million, and Maple Ridge made a cash distribution to shareholders in August.

For purposes of determining whether the August distribution is a dividend, how should Maple Ridge treat its preacquisition deficit and Lakefront's acquired earnings and profits?

Explanation. Under the majority opinion's reading of section 381(c)(2)(B), in a section 332 acquisition the acquiring corporation's preacquisition deficit cannot reduce earnings and profits acquired from the transferor. The acquired earnings and profits are taken into account as of the close of the transfer date, and the acquiring corporation's prior deficit is usable only against earnings and profits accumulated after that date.