HUDSON v. COMMISSIONER OF INTERNAL REVENUE.
No. 7495.
Circuit Court of Appeals, Sixth Circuit.
Nov. 12, 1938.
HAMILTON, Circuit Judge, dissenting.
Hillsman Taylor, of Memphis, Tenn. (Hillsman Taylor, of Memphis, Tenn., W. H. Holmes, of Little Rock, Ark., and F. E. Ilagler, of Memphis, Tenn., on the brief), for petitioner.
Morton K. Rothschild, of Washington, D. C. (James W. Morris, Sewall Key, and Morton K. Rothschild, all of Washington, D. C., on the brief), for respondent.
Before HICKS, ALLEN, and HAMILTON, Circuit Judges.
ALLEN, Circuit Judge.
Petition to review an order of the Board of Tax Appeals determining a deficiency in income tax of $5,127.99 for the year 1929. 34 B.T.A. 155.
The facts, as stipulated, and found by the Board, are as follows:
Charles Hudson, deceased, was the president and principal stockholder of the Hudson & Dugger Company, a Tennessee corporation, owning 6731J4 shares of the capital stock, the remaining shares, 768%, being owned by his son, Galvin Hudson. Petitioner is the widow of Charles Hudson, and also is trustee for Marie Hudson, their daughter. At the death of Charles Hudson, on December 24, 1924, Galvin, Kate and Marie Hudson shared equally in his estate.
Charles Hudson for a number of years prior to his death had withdrawn from the corporation various sums of money which were charged to his personal account. At the time of his death his account was in debt to the corporation in the amount of $43,910.19. Charles Hudson died intestate, and Galvin Hudson was appointed administrator.
As administrator, Galvin Hudson withdrew from the corporation sufficient funds to pay funeral expenses • and administration fees, and to wind up the estate. These amounts were charged on the books of the corporation to the account of Galvin Hudson, administrator, and after being reduced by certain credits which need not he itemized, the balance due the corporation was $58,768.81. In 1926, by order of the Probate Court of Shelby County, Tennessee, the administrator distributed the capital stock of the corporation belonging to the estate, one-third each to petitioner individually, and to her as trustee for Marie Hudson, and to himself individually.
During the period from January 1, 1925, to March 15, 1929, petitioner’s withdrawals from the corporation left a balance due of $16,271.96. During practically the same period Marie Hudson withdrew certain amounts which left her aggregate debit balance as of March 15, 1929, $2,089.64. Upon March 1, 1929, as shown by the corporate minutes, the directors took up the question of the debit balances of the stockholders, and adopted the following resolution:
“Be It Resolved that the overdrafts shown on the accounts of Charles Hudson, Galvin Hudson, Administrator, Mrs. Charles Hudson and Miss Marie Hudson be cleared out of the assets of the Hudson and Dugger Company by charging them and each of them to surplus, it being the sense of this resolution and so understood by all that the accounts above set out are not being forgiven and that Hudson and Dugger Company still owns its equity therein; that at such time as may be convenient and appropriate proper settlement will be made to the company by the parties of such account.”
The various overdrafts were charged on the books of the Hudson & Dugger Company to undivided profits, and the accounts of the debtors were credited with amounts equal to the debt balances shown in their respective accounts. Petitioner does not contend that the corporate surplus was not at that time sufficient for the payment of dividends in the amounts of the overdraft. Neither does it appear that any of the items represented in the overdrafts was returned for taxation by the individual drawers in the respective years when the withdrawals were made. None of the amounts was taken as a deduction for income tax purposes by either the corporation or by the estate. In 1931, at a meeting of the stockholders, the president of the corporation suggested, since there was controversy between the stockholders and the corporation, and also with the federal government with reference to these accounts, that stock in the company be surrendered by each of the debtors, and canceled. The corporation approved this suggestion, and in 1932, such a surrender was actually made by petitioner, both in her own right and as trustee for her daughter.
In determining deficiencies against petitioner and Galvin Hudson and Marie Hudson, the Commissioner decided that each had received a dividend of $34,226.33, or one-third of $102.679.04, the latter sum being the aggregate of the debts of Charles Hudson and Galvin Hudson, administrator, owing to the corporation. He further 'determined that the sum of $16,-271.96 credited to petitioner’s account constituted a dividend to her, and that $2,-089.64 credited to the account of Marie Hudson was a dividend to her. The Board of Tax Appeals sustained the Commissioner.
Petitioner contends:
1. That no dividend was declared by the corporation, and that the amount of the withdrawals does not constitute income.
2. That claims against the administrar tor and against Charles Hudson, when charged off, are not dividends to distributees of the estate; and
3. That the claim of the corporation against the estate had been outlawed at the time the account was charged off, and that therefore the amount of the debts, even if they were canceled, was not a dividend to the distributees. We do not consider this contention, because that question was not raised before the Board of Tax Appeals nor decided by it.
The main question presented is whether the action taken by the. corporation in its resolution of March 1, 1929; created a taxable dividend within .the definition in § 115(a) of the Revenue Act of 1928, 45 St at. 791, 26 U.S.C.A. § 115(a), which provides that “The term ‘dividend’ when used in this title [chapter] *■ * * means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.”
Petitioner urges that as the corporation’s resolution states that the debts are not to be forgiven, the charge-off did not constitute a dividend, especially as the debts are alleged to have been paid by transferring to the corporation some of the shares of capital stock which petitioner inherited. The fallacy of this argument is apparent from the nature of the acts done and the effects thereof..
This court has held in Cohen v. Commissioner, 6 Cir., 77 F.2d 184 that cash withdrawals from a corporation made by its stockholders constitute dividends in the taxable year during which corporate action was taken canceling or charging off such accounts against surplus. The resolution of March 1, 1929, authorized just such action as that taken in the Cohen Case. The accounts of the following persons were actually credited, in accordance with that action, with the following amounts:
Mrs. Charles Hudson..........$16,271.96
Marie Hudson ............... 2,089.64
Charles Hudson.............. 43,910.19
Galvin Hudson, administrator.. 58,768.81
But the resolution introduced an element of ambiguity by specifying that the debts were not being forgiven. So far as we know, accounting practice provides no way in which items charged against surplus may be carried on the books as “not being forgiven.” We are aware that certain decisions hold that book entries, while of evidential value, are not determinative of tax liability. Cf. Helvering v. Midland Mut. Life Ins. Co., 300 U.S. 216, 223, 57 S.Ct. 423, 81 L.Ed. 612, 108 A.L.R. 436. But in this case the book entries reflect the acts done by the corporation. The individuals were in fact given credit for payment of the debts, and they were charged off to surplus. The book entries clarify the vague and indefinite reservation of the resolution. The burden of proof was on the petitioner to show that the Commissioner erred in his determination. Cohen v. Commissioner, supra. This burden it did not sustain. While in the Cohen Case the debt was charged off by formal resolution, in the instant case the same thing was accomplished by resolution and by book entries made in conformity to the resolution. Cf. Wiese v. Commissioner, 8 Cir., 93 F.2d 921. We conclude that the principle announced in Cohen v. Commissioner, that there was a distribution of profits, and that income-accrued at that time, controls.
The release to the corporation by petitioner of sufficient shares of stock at $100 par value to pay for her one-third of the estate debts does not affect the conclusion. The record does not show that these shares when released had any substantial value. The transaction resulted in no loss to petitioner, and amounted to no more than a .minor re-allotment of shares among the shareholders. The corporation was a closed one, owned by three members of one family. The stock turned in was canceled and the book value of the outstanding shares was changed. In reality the so-called repayment of the withdrawals merely resulted in the fact that a fewer number of shares existed, but they were held in practically the same proportions as previously, and represented the same quantum of net worth.
The second principal question is whether the Commissioner was correct in his determination that one-third of the $102,679.04, constituting the aggregate sum of the deceased’s withdrawals, and the estate expenses, represents income to the petitioner. Up to March 3, 1929, the amount had been carried on the books of the corporation as an asset in the form of accounts receivable.
Under § 8336 of the Code of Tennessee 1932, petitioner was personally obligated for debts of the estate, in proportion to the value of her distributive share. American Surety Co. v. Grace, 151 Tenn. 575, 271 S.W. 739. The resolution of March 1, 1929, was the first corporate action taken with regard to the withdrawals. It provided for charging off the debts to undivided profits. When the accounts were credited with the amount of the debts and the charge-off was made in accordance with the resolution, the action was tantamount to cancellation. Wiese v. Commissioner, supra. As to petitioner, the charge-off constituted either an increase in her inherited estate or the relinquishment of a lien on her inherited property.
We conclude that petitioner received in 1929, as dividends, one-third of the sum of $102,679.04. The additional withdrawals of $16,271.96 credited to petitioner’s account must of course, in view of the above considerations and in view of our holding in Cohen v. Commissioner, supra, be regarded as income in 1929.
The order of the Board of Tax Appeals is affirmed.
Deficiencies for the same year were determined against Kate Hudson, trustee for Marie Hudson, and against Galvin Hudson, respectively. By agreement the decision in this case will bind the other two parties.