Lynch v. Hornby

Supreme Court of the United States · Corporations

CorporationsIncome taxationDividendsdividendssurpluspre-1913 earningsMarch 1, 1913stockholder income

Facts

Hornby owned 434 of 10,000 shares of the Cloquet Lumber Company, which had accumulated substantial value before March 1, 1913 through appreciation of timber lands and business operations. In 1914, while continuing its regular lumber business, the company distributed dividends totaling $650,000, of which $410,000 came from conversion into money of property owned or held on March 1, 1913. Hornby's share of that latter amount was $17,794, which he did not include in his income tax return. The Commissioner assessed an additional tax of $171, and Hornby paid under protest and sued to recover it.

Issue

Whether, under the Income Tax Act of 1913, a stockholder must treat as taxable income a dividend declared and paid after March 1, 1913 in the ordinary course of business when the dividend was paid from corporate surplus or asset value that had accrued before March 1, 1913.

Rule

Under the 1913 Act, all dividends declared and paid in the ordinary course of business to stockholders after March 1, 1913 are taxable income to the stockholder for purposes of the additional tax, whether derived from current earnings or from accumulated surplus consisting of past earnings or increased value of corporate assets, even if that surplus accrued in whole or in part before March 1, 1913. This rule does not govern special situations involving liquidation or surrender of the stockholder's entire interest.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

In 1914, Red Mesa Milling Co., a Kansas corporation based in Wichita, continued its regular grain-processing business and declared a cash dividend to all shareholders. The directors stated that the money came entirely from surplus built up before March 1, 1913, and shareholder Elena Park kept all of her shares after receiving the payment.

Under the 1913 Income Tax Act, is Elena's dividend taxable to her for purposes of the additional tax?

Explanation. The majority held that under the 1913 Act, all dividends declared and paid in the ordinary course after March 1, 1913 are taxable income to the shareholder, whether drawn from current earnings or from accumulated surplus or appreciation that accrued before March 1, 1913. Because Red Mesa was continuing its regular business and Elena merely received an ordinary dividend without surrendering her shares, the payment is taxable. (Derived from Lynch v. Hornby (n.d.).)