dissenting: I respectfully disagree with the majority herein. The fact that two Circuit Courts of Appeals and now this Court have had to evolve three different theories, producing differing consequences, in order to qualify the word "liabilities” in section 357(c) provides the clearest basis for concluding that we should accord that word its ordinary meaning. Even the broad-brush approach which the Supreme Court adopted in Nash v. United States, 398 U.S. 1 (1970), cannot be applied here. At least in that case, the Court was able to accord section 351 a pervasive effect in a situation where the transfer of the item involved was not specifically covered by another provision. By way of contrast, section 357(c) speaks directly to the applicability of section 351 to the transfer of "liabilities.” To me, whatever remedial steps may be appropriate should be taken by the Congress and not by the courts. See Braunstein v. Commissioner, 305 F.2d 949, 959 (2d Cir. 1962), affd. 374 U.S. 65 (1963). See also Brewster v. Commissioner, 67 T.C. 352, 367 (1976). This Court’s opinion in Thatcher v. Commissioner, 61 T.C. 28 (1973), revd. on the issue 533 F.2d 1114 (9th Cir. 1976), aptly expresses my views and I would continue to follow it.
Hall, J.,dissenting: Viewed in relation to our opinions in Raich, Bongiovanni, and Thatcher, the majority today is far closer to being on target. But unfortunately it has not quite scored a bull’s-eye. I adhere to the views expressed in my dissenting opinion, and by the Court of Appeals for the Ninth Circuit, in Thatcher.
The majority "construes” the term "liabilities” in section 357 as excluding an obligation "to the extent that its payment would have been deductible if made by the transferor.” There are numerous problems with this analysis.
In the first place, it is inconsistent with the plain wording of the statute. The statute provides no such limitation on the word "liabilities.” While words undoubtedly take on considerable coloration from their context and purpose, they are not infinitely elastic. The majority would seemingly have a dentist’s bill be a "liability” or not according to whether the cash basis taxpayer in question itemized his deductions or claimed the standard deduction, according to whether he had other medical expenses which in total equaled 3 percent of his adjusted gross income, according to the appropriate "stacking” rules used to determine whether the dental bill was part of the 3 percent, part of the excess, or part of each, and according to whether he had any gross income at all that year, or perhaps had a net operating loss carryback to that year from a later year. The word "liability” ought not to be stretched so far by judges. We tinker with too complex a statutory framework. Cf. Hempt Bros., Inc. v. United States, 490 F.2d 1172 (3d Cir. 1974) (refusing to exclude accounts receivable from "property” for purposes of section 351).
Second, the "legislative history” advanced for the majority’s theory fails to provide much, if any, support for it. The majority notes correctly that sections 357(a) and 357(c) have no clear legislative history on this point. The majority points to a footnote in Crane v. Commissioner in which the Supreme Court noted in passing the Commissioner’s position in that case. There the Commissioner had contended, successfully, that the transfer to a third party of property subject to the lien of a nonrecourse debt in excess of the transferor’s basis gave rise to gain to the transferor. However, conceded the Commissioner, such gain did not include deductible accrued interest. This footnote, however, provides insufficient reason for us to conclude that Congress in enacting section 357 had anything in mind beyond the normal meaning of the word "liability.” It may or may not be that had Congress thought about it, it would have so limited section 357 á la Crane. But since we do not sit as a legislature, it is not for us to rewrite the statute.
It has been said, with more than a grain of truth, that judges in tax cases these days tend to consult the statute only when the legislative history is ambiguous. Today, bona fide legislative history being absent, we go one step further by constructing a purely hypothetical legislative history out of a random footnote in a Supreme Court decision. Following a law review article, we unrealistically presume on faith that Congress must have focused on the footnote when it wrote section 357(c). What is wrong with reading the statute?
Third, the majority approach, while well-intentioned, will lead to doubt in every other place in the Code where the word "liability” or "liabilities” appears, whether the strange new meaning with which we now invest that word applies there too. By computer search the word currently appears 400 times. For example, in the rather closely analogous section 752, a partner includes in the basis of his partnership interest his share of partnership "liabilities.” When he is relieved of such "liabilities” he is treated as having received a distribution of money. Does this language include liabilities such as trade accounts payable, deductible to a cash method taxpayer only upon payment? The longstanding Internal Revenue Service interpretation, now thrown into doubt by the majority opinion, is yes. Rev. Rui. 60-345, 1960-2 C.B. 211.
Fourth, the majority approach is conceptually unsound. For one thing, the majority approach runs afoul of the basic principle that a cash basis taxpayer gets no deduction for an expense until it is paid. The effect of the majority’s approach is to provide the deduction, for all practical purposes, when it is assumed, whether or not paid. Return to the dental bill, for example, and assume favorable resolution of all the ambiguities over whether it is sufficiently "deductible” to meet the majority’s test. Assume that the cash method debtor transfers $100 of trade receivables to his corporation in exchange for its stock and the assumption of a $100 dentist’s bill. Suppose that the corporation never pays the bill but obtains the dentist’s release in consideration of recommending the dentist to corporate employees. Under the majority analysis, the taxpayer, who has gotten $100 of money’s worth out of his trade receivables and never paid the dentist, will evidently go untaxed. This points up an important distinction between the majority’s analysis and that of the Ninth Circuit in Thatcher. In the latter analysis, there is no deduction to the transferor until payment occurs. The exchange triggers immediate recognition of gain on the transferred assets to the extent of the excess of liabilities assumed over basis of assets transferred; the offsetting deduction to the transferor arises only if and when payment of a deductible liability is made by the transferee on the transferor’s behalf. Furthermore, the majority analysis produces materially different results from only formalistically different procedures. While the tax law regrettably contains other such anomalies, we should draw back and reconsider the theoretical soundness of our position before creating new ones. The majority’s analysis produces ultimate tax consequences which differ according to whether the taxable exchange of appreciated property for the assumption of unbooked liabilities in excess of basis occurs separately from, or as an incident of, an incorporation. To illustrate the point, assume the following posture of a cash basis taxpayer:
Value Adjusted basis Assets
Long-term securities. $1,000 $600
Liabilities
Trade accounts payable. 900 0
If, not in connection with an incorporation, he sold the securities and paid the payables with $900 of the proceeds, he would have $400 of long-term capital gain and a $900 deduction.
Under the majority’s analysis, the taxpayer can incorporate, have his corporation assume the payables, and avoid all tax on the incorporation exchange. But by having the corporation pay his bills for him, he has effectively realized $300 of the $400 appreciation on his securities. He has gotten $900 of money’s worth out of his appreciated securities. This is just as true whether the bills his corporation will pay for him would be deductible to him or not. The majority errs in stating that this is "something that was not in fact economic gain to a cash basis” taxpayer. There is economic gain, very clearly, when one uses appreciated property to get someone else to pay his bills. True, to the extent of the $600 adjusted basis of the transferred assets, section 357(a) and regulations section 1.358-3(b) decree that there is deemed to be a return of basis rather than taxablé income on the relief of debt. But after the $600 basis of the transferred assets has been exhausted, and the transferor’s basis in his stock in the new corporation has thereby been reduced to zero, under regulations section 1.358-3(b), example (2), gain should be recognized to the extent of the $300 remainder of the liabilities assumed. That being so, there is no good reason why the tax consequences should be any different as to the taxable portion of such exchange than the consequences of a similar taxable exchange of $300 of assets for relief of $300 of liabilities outside the context of the incorporation. If the liabilities assumed are deductible and are paid by the transferee, there should be a deduction to the transferor, who has in effect paid them by proxy. Any deduction should await payment, but the $300 deduction should be available to the transferor, not the transferee. The transferee corporation should be treated as having purchased $300 worth of the securities with the $300 of liabilities it assumed in the taxable transaction. Because of the incorporation and the operation of section 357(a), $600 of the $900 deduction will not flow to the transferor, but under section 357(c), the $300 excess should flow to the transferor.
A further serious difficulty with the majority’s approach is that its effect reaches far beyond the rather infrequent occasions where liabilities assumed exceed adjusted basis and section 357(c) is involved. By reading "liabilities” as "nondeductible liabilities,” the majority also is making a fundamental change in the meaning of sections 357(a) and. 357(b). Henceforth, if the majority’s position becomes accepted, the assumption of trade accounts payable or other "deductible” debts in a section 351 exchange will no longer be treated as an offset to basis in the transferor’s stock. This will give rise to no end of confusion over basis both of corporate stock and corporate assets. And taxpayers will now be free to use assumption of deductible debts for tax-avoidance purposes despite section 357(b). (For example, a taxpayer seeking to avoid the minimum tax on excess itemized deductions under section 57(b) can transfer zero basis receivables to his new corporation in exchange for the corporation’s assumption and ultimate payment of, say, his charitable pledge.) While the majority is seeking to achieve a reasonable solution to the conundrum, its wrenching of the word "liabilities” to force the right answer has collateral consequences out of all proportion to the very problem it addresses. Reading section 357(c) as written, but allowing the transferor the deduction (to the extent section 357(c) makes the exchange taxable) on the same terms as he would get it in any other taxable exchange of assets for debt relief avoids these difficulties, leaves the rest of section 357 where the legislature left it, and ends up with the correct and fair result.
Fifth, the majority’s straining to reinterpret the word "liabilities” in an unnatural manner is unnecessary to cure the problem it perceives with the statute. The majority saws against the grain in struggling to avoid the application of section 357(c). It would be far easier to read the word "liabilities” in its normal sense. Reading it in that sense does no violence either to the statute or to equity if we simply recognize that a corollary of recognition of gain under section 357(c) is an offsetting deduction, if and to the extent that assumption and payment of deductible liabilities is the price for which there was a taxable sale of appreciated assets. The very example chosen in the majority opinion to attack the theory nicely illustrates the point. P transfers to X $35 in cash and X assumes $40 of deductible trade accounts payable. The majority opinion would shield P from gain although he is clearly $5 ahead economically. He paid $35 but he got $40 of his bills paid for him. What matter whether the bill is deductible? The Ninth Circuit approach would be first to require inclusion of the $5 gain, and then to allow the transferor up to a $5 deduction as and when the payables are paid if they are of a deductible nature to him. If indeed the payables are paid in the same taxable year, the net result of either approach to the transferor is the same. But if they are not so. paid, the Ninth Circuit approach reaches a correct result; the majority, in effect, erroneously accelerates the cash basis taxpayer’s $5 deduction merely because the taxable exchange in question happened to be with a corporation rather than some other entity.
The Ninth Circuit approach, moreover, provides a straightforward answer to the question the majority leaves open — the tax consequences to the transferee. There is, and should be, no deduction to the transferee on payment of that portion of the payables, assumption of which was part of the taxable section 357(c) exchange. Payment of that portion of the payables was simply the cost of the assets purchased by the assumption of the payables. Holdcroft Transportation Co. v. Commissioner, 153 F.2d 323 (8th Cir. 1946). The face amount of that portion of the payables adds to the transferee’s basis in such assets. As a matter of appropriate allocation, the taxable part of the payables (here $53,512) should be netted first against receivables (here $42,237.10) and then any balance against other assets (except cash) in proportion to their respective fair market values under the principles of section 1.357-2, Income Tax Regs. The result in this case is that $11,274.90 of gain has been realized on inventory and fixed assets. To that extent, gain has been recognized on those assets, its character being dependent upon their tax nature. Some portion may be capital gain. This case, accordingly, provides a good illustration of a further fallacy in the majority’s theory. By not applying section 357(c) as written, the taxpayer is to a limited extent deprived of the tax benefit inherent in obtaining an ordinary deduction on payment of the payables, with an offsetting gain which may in part be a capital gain. Such situations may be unusual because in most incorporations trade receivables will exceed payables. But they do exist, as here, and where they do, the Ninth Circuit analysis, unlike the majority’s, reaches the correct result.
Since the findings of fact in this case do not disclose whether the liabilities were in fact paid, or in what year such payment took place, I would condition allowance of the offsetting deduction upon production of appropriate proof of payment. Because this Court’s prior opinions failed to put the taxpayer on notice that such proof would be required, I would reopen the case for evidence on this point.