Zenz v. Quinlivan

United States Court of Appeals for the Sixth Circuit · 1954 · Corporations

CorporationsTaxationStock redemptionDividendsLiquidationSection 115(g)Section 115(c)redemption of stock

Facts

The taxpayer became the owner of all shares of a closely held corporation after her husband's death and later sought to dispose of the company to a competitor. Because the buyer did not want to assume tax liabilities believed to be inherent in the corporation's accumulated earnings and profits, the buyer first purchased part of the taxpayer's stock for cash. Three weeks later, after corporate reorganization and corporate action, the corporation redeemed the balance of the taxpayer's stock as treasury stock, using substantially all of the accumulated earnings and surplus. The taxpayer treated the redemption as a cancellation or redemption of all the stock of a particular shareholder under § 115(c) and the Treasury Regulation, while the Commissioner treated the amount received from earnings and profits as an ordinary dividend under § 115(g).

Issue

Whether a distribution of substantially all of a corporation's accumulated earnings and surplus, made in redemption of all outstanding shares owned by one person, is essentially equivalent to the distribution of a taxable dividend under § 115(g). More specifically, the question was whether a redemption that completely terminated the taxpayer's ownership interest could be taxed as a dividend.

Rule

Whether a distribution in connection with a cancellation or redemption of stock is essentially equivalent to a taxable dividend depends on the facts and circumstances of each case. But where a taxpayer effects a redemption that completely extinguishes the taxpayer's interest in the corporation and the taxpayer retains no beneficial interest whatever, the transaction is not essentially equivalent to the distribution of a taxable dividend as to that taxpayer.

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

In Columbus, Ohio, Nora Patel owns 30% of Riverbend Components, Inc., a closely held manufacturer, and two other investors own the rest. After a dispute, the corporation redeems all of Nora's shares for cash drawn largely from accumulated earnings, and Nora resigns from all positions and keeps no contractual right to profits, control, or future ownership.

How should the redemption most likely be characterized as to Nora?

Explanation. The governing rule is that dividend equivalence depends on the facts and circumstances, but where a redemption completely extinguishes the shareholder's interest and the shareholder retains no beneficial interest whatever, the transaction is not essentially equivalent to a taxable dividend as to that shareholder. The use of accumulated earnings to fund the redemption is relevant but not controlling.