*3317 Under the evidence, held that the returns of the petitioners are false and fraudulent and were made with intent to evade taxes.
*69 These proceedings, which were consolidated for the purpose of trial and decision, are for the redetermination of deficiencies in income tax and penalties for 1919 as follows:
| Petitioner | Docket No. | Tax | Penalty |
| Thomas L. Ross | 21746 | $3,620.19 | $1,846.10 |
| J. B. Jemison | 21747 | 7,220.66 | 3,610.33 |
The deficiencies in tax result from the petitioners' failure to report in their returns the following indicated amounts representing their *70 gain on the capital stock of J. B. Jemison & Co. resulting from a distribution in liquidation of the corporation:
| Thomas L. Ross | $19,637.60 |
| J. B. Jemison | 29,456.41 |
The respondent determined that the petitioners are subject to the 50 per cent penalty provided in section 250(b) of the Revenue Act of 1918 for making false or fraudulent returns with intent to evade tax.
FINDINGS OF FACT.
During 1919, the petitioners were residents*3318 of Thomasville, Ga., where they were engaged in the wholesale lumber business. From January 1, 1919, to May 24, 1919, the lumber business was conducted as a corporation under the name of J. B. Jemison & Co. Jemison was president of the corporation and owned 90 shares, or 60 per cent of the corporation's capital stock of $15,000. Ross was vice president and owned 60 shares or the remaining 40 per cent of the company's stock. On May 24, 1919, the company was dissolved and its charter was surrendered. The corporation's business, including its assets and liabilities, was transferred to a partnership which had the same name as the corporation. The partnership was composed of Jemison and Ross, who owned 60 per cent and 40 per cent interests, respectively, or the same interests as owned in the corporation.
All of the assets of the corporation were transferred to the partnership at their book value. No new books were opened for the partnership, but the books of the corporation were continued in use without change, except that the capital stock account was closed into the surplus and undivided profits account. At the date of dissolution the corporation's surplus amounted to $49,094.01. *3319 There was no distribution to the petitioners of this or any other amount other than indicated above.
On March 12, 1920, there was filed with the Collector of Internal Revenue for the District of Georgia a return for the corporation covering the period from January 1, 1919, to May 24, 1919. To this return were attached balance sheets of the corporation, showing, among other things, the amount of its surplus at the beginning and end of the period. On the same day a return return was filed for the partnership for the period from May 24, 1919, to December 31, 1919, to which were attached balance sheets showing, among other items, a surplus of $63,094.01 at the beginning of the period. The individual returns of the petitioners for 1919 were also filed on March 12, 1920. All of the foregoing returns were prepared by J. C. Murphy, an attorney, and acknowledged before him as a notary public on February 20, 1920. Murphy had previously been employed *71 for about five years as a deputy collector in the office of the collector of internal revenue at Atlanta, Ga., and while there his duties, among other things, had consisted of assisting taxpayers in the preparation of their income-tax*3320 returns. The returns were prepared in the office of the partnership at Thomasville, where Murphy had access to the books and records of the corporation and the partnership. The petitioners gave Murphy no instructions or directions as to how the returns were to be prepared, nor did they assist him in the preparation of such returns, except to give him the information he desired as to their personal matters, such as contributions, personal tax paid, and other items not appearing in the books and records of the business. J. W. Turner, the bookkeeper for the partnership and the bookkeeper and secretary of the corporation in 1919, gave Murphy such assistance as he could in answering questions and preparing figures.
Jemison and Ross reported in their individual returns for 1919 their respective salaries as officers of the corporation and their distributive shares of the profits of the partnership, but made no reference to any liquidating dividends or to their proportional interests in the surplus of the dissolved corporation whose business and assets were taken over by the partnership of which they were members.
In an audit of the corporation's return for the period ending May 24, 1919, the*3321 respondent in a letter dated February 2, 1921, requested, among other things, information as to whether the corporation was dissolved on May 24, 1919, and what disposition was made of its assets. Under date of March 4, 1921, a reply containing the following statement was forwarded to the respondent:
Our corporation was dissolved May 24th, 1919, and the charter surrendered. The assets, as shown on the balance sheet, were transferred to the partnership composed of J. B. Jemison and T. L. Ross, and the business continued by them as a partnership. All assets were transferred at book value, and therefore no loss or profit shown. Reference to the returns filed on this partnership for the fiscal period closing December 31st, 1919, will confirm this.
In connection with an audit of the return of the partnership covering the period of its existence in 1919, the respondent in a letter dated September 24, 1921, requested information as to what part of the amount of $5,584 taken in the return as a deduction for compensation of members was paid or credited to each partner. The information was furnished by the partnership in a letter dated September 28, 1921.
In March, 1922, an additional*3322 tax of $72 was assessed against Ross as a result of an office audit of his return. This amount, however, is not involved in the proceeding under consideration.
About February, 1926, a revenue agent made an investigation of the partnership returns for 1920 and 1921 and for a period ended *72 July 31, 1922. During the investigation he found that neither of the partners had reported his proportional part of the distribution made in liquidation of the corporation and so stated in his report. About April 17, 1926, the respondent advised the petitioners that he had come into possession of information that at the time the corporation of J. B. Jemison & Co. was dissolved on May 24, 1919, the books showed a surplus of $49,094.01 which was credited to the accounts of the stockholders. The respondent advised the petitioners that this amount of surplus to which they were entitled represented a liquidating dividend which should have been reported in their 1919 returns. The petitioners were also requested to advise the respondent as to their reasons for failure to report in their 1919 returns the amounts of surplus to which they were entitled.
Upon receipt of the respondent's letter, *3323 Jemison immediately took up the matter with Murphy, who on April 21, 1926, advised Jemison in part as follows:
It has been some time now since those returns were filed, but as I remember it, we did discuss the question of taxability of the corporation surplus account, but we all decided that in as much as there was doubt as to its taxability that it should not be reported. As I remember it, I told you at that time that the Commissioner of Internal Revenue might rule that this was taxable income and assess you accordingly. You know at that time the regulations were not clear, and there has been doubt as to many points all along, which is evidenced by the many changed rulings made by the Commissioner himself.
There has been nothing at all hid from the Commissioner. He has been in possession of the corporation returns now for more than six years, which showed on the face of it that the corporation was dissolved and that you were one of the stockholders, and whatever tax was properly assessible against you on this account should have been listed long ago.
Upon receipt of Murphy's letter, Jemison forwarded it to the respondent, informing him that Murphy had prepared the 1919*3324 returns. Jemison also informed the respondent that if any other information was desired on the subject he would be glad to furnish it.
On November 12, 1926, the respondent notified Ross and Jemison of his determination of the deficiencies in tax and penalty for 1919 as set out above and informed them that their net incomes as reported in their returns had been increased by $19,637.10 and $29,456.41, respectively, representing gain on the capital stock of J. B. Jemison & Co. resulting from a distribution in liquidation.
OPINION.
TRAMMELL: The only question involved in these proceedings is that relating to the imposition of the penalties. It is conceded that if it be found that the returns were false and fraudulent and made with the intent to evade taxes the proposed deficiencies are correct, *73 otherwise, the assessment and collection of the deficiencies in tax are barred by the expiration of the period of limitations as prescribed by statute.
The petitioners do not dispute the fact that the corporation at the time of its dissolution had a surplus of $49,094.01, which belonged to them. They contend, however, that they did not willfully make fraudulent returns*3325 in order to evade tax, but that they overlooked reporting their respective shares of the surplus as income because the assets and liabilities of the corporation were taken over in toto by the partnership and for the reason that the distributive interests in the capital and surplus of the stockholders of the corporation were identical with the distributive interests of the members of the partnership, and also for the reason that there was no segregation of the surplus to the accounts of the partners.
The petitioners testified that on account of their unfamiliarity with the income tax law and rulings thereunder, they left the matter of preparing the returns to Murphy, turning over to him the books and records of the partnership and furnishing him such other information as he required about their individual affairs as was not contained in the books and records of the business. The evidence indicates that when the returns were prepared the petitioner signed and swore to them without questioning Murphy as to their truthfulness or correctness. The petitioners also testified that at the time the returns were prepared they did not know what constituted a liquidating dividend and did not*3326 learn what such a dividend is until several years later.
Article 1566 of Regulations 45, relating to the income, war-profits and excess-profits taxes under the Revenue Act of 1918 as originally promulgated on April 17, 1919, provided:
(c) Where a corporation dissolves and distributes its assets in kind and not in cash no taxable income is received from the transaction by its stockholders, because they merely exchange an indirect interest for a direct interest in the same property. As to cash distributions, see Article 1548. * * *
By Treasury Decision 2924, approved September 26, 1919, article 1566 was modified and the above quoted provision was eliminated. Article 1548, Regulations 45 as originally promulgated and in force at the time the returns of the petitioners were filed, provided:
Distribution in liquidation. - So-called liquidation or dissolution dividends are not dividends within the meaning of the statute, and amounts so distributed, whether or not including any surplus earned since February 28, 1913, are to be regarded as payments for the stock of the dissolved corporation. Any excess so received over the cost of his stock to the stockholder, or over its*3327 fair market value as of March 1, 1913, if acquired prior thereto, is a taxable profit. A distribution in liquidation of the assets and business of a corporation, which is a return to the stockholder of the value of his stock upon a surrender of his *74 interest in the corporation, is distinguishable from a dividend paid by a going corporation out of current earnings or accumulated surplus when declared by the directors in their discretion which is in the nature of a recurrent return upon the stock.
Murphy had held the position of deputy collector from 1913 to September, 1918, and undertook to familiarize himself with the Regulations of the Treasury Department. He testified that, while the article of the regulations on the question of liquidating dividends was clear, he "never thought that particular regulation was supported by the law. As a matter of fact I always thought that liquidating dividends if taxed at all should be taxed as dividends subject only to surtax rates, but not subject to normal tax as it is under Art. 1548."
The article of the regulations which provided that there would be no taxable gain where a corporation dissolved and distributed its assets in*3328 kind was modified several months before the returns in question were filed. Article 1548, dealing with the question as it was originally promulgated, was clear and unambiguous as conceded by Murphy.
We believe from the testimony that this matter of reporting the liquidation dividends was discussed by the petitioners with Murphy before the returns were filed. Murphy, in his letter to Jemison, stated that "as I remember it I told you at that time that the Commissioner of Internal Revenue might rule that this was taxable income and assess you accordingly." The petitioners knew the facts and were advised by Murphy with respect to the probable action of the Commissioner. It is no extenuating circumstance that Murphy did not believe the regulation correctly interpreted the statute with respect to whether the surplus would be taxable at the normal rates. Even if he were correct in his interpretation of the law, still the return was false when it did not report the transaction. We believe that Murphy knew that the transaction gave rise to taxable gain even though it be true that he thought the gain was not taxable at the normal rate. The matter was discussed with the petitioners and*3329 they did not report it in their returns, although they were advised that the Commissioner would probably assess a tax based thereon. The failure to make a disclosure of the facts of the transaction in their returns under such circumstances is inconsistent with good faith and honest dealings with the Government.
From all the evidence we think that the returns filed by the petitioners were false and fraudulent and were made with the intent to evade the payment of taxes. The penalties as determined by the respondent are accordingly approved.
Judgment will be entered for the respondent.