*3366 1. Where a corporation is engaged in liquidating its assets in part and operating in part, and makes distributions to the stockholders, the surplus earned since March 1, 1913, must be distributed as an ordinary dividend before liquidating payments are made.
2. Depreciation rates determined.
3. Parol agreement as to ownership of stock by a wife when such stock was in the name of the husband, supported by the action of the parties in reporting income, accepted as proof of ownership.
*1306 In these proceedings, which were consolidated for hearing and decision, the petitioners seek redetermination of their income and surtaxes for the years listed below, for which the Commissioner has determined deficiencies as indicated:
| Year | Deficiency | |
| 1918 | $152.53 | |
| 1919 | 88.91 | |
| Elizabeth Berthold | 1920 | 917.57 |
| 1922 | 39.79 | |
| 1919 | 206.88 | |
| Louise K. Solfisburg | 1920 | 836.07 |
| 1922 | 477.90 | |
| 1918 | $592.68 | |
| 1920 | 2,614.04 | |
| Estate of John Thorwarth | 1921 | 35.35 |
| 1922 | 561.55 | |
| 1918 | 500.98 | |
| 1919 | 916.31 | |
| John Knell | 1920 | 2,417.19 |
| 1922 | 538.80 |
*3367 The petitioners allege error on the part of the Commissioner in his determinations of the taxable dividends received for each of the years in question from the Aurora Brewing Co. Second, John Knell, Docket No. 7420, alleges error on the part of the Commissioner in failing to allow adequate depreciation on property for each of the years 1918, 1919, 1920, and 1922, and also in including in his taxable income certain dividends during each of the years 1918 to 1922, inclusive, which were properly income of his wife and reported as such by her.
*1307 FINDINGS OF FACT.
The petitioners in this case were stockholders of the Aurora Brewing Co., hereinafter sometimes referred to as the corporation, an Illinois corporation whose corporate name was, during the period, changed to Aurora Beverage Co. The stock ownership was as follows:
| Shares | |
| Estate of John F. Thorwarth | 1,500 |
| John Knell, Sr., Estate | 1,350 |
| Elizabeth Berthold | 1,200 |
| John Knell, Jr. | 150 |
| H. A. Berthold | 300 |
| Total | 4,500 |
The stock listed in the name of John Knell, Sr., Estate was actually owned equally by Louise K. Solfisburg and John Knell, Jr. Therefore, Louise K. Solfisburg owned 675*3368 shares and John Knell, Jr., owned 825 shares.
Prior to the years in question the Aurora Brewing Co. had established, and during the years involved it followed, a custom of from time to time paying dividends out of its profits to the stockholders in proportion to their stockholdings without record of the minutes of the directors' meetings authorizing these distributions. The distributions were returned as income by the stockholders in the years in which they were received. During the year 1917, $45,000 was thus distributed and reported as income by the recipients. On April 16, 1918, this dividend was formally authorized at a meeting of the board of directors. The Commissioner has held that the dividends were to be reported on the date of the formal declaration. During the year 1918, $27,000 was distributed to the stockholders, and on February 26, 1919, this dividend was formally confirmed at a meeting of the board of directors. The Commissioner has held that $27,000 was income to the stockholders in 1919 when it was formerly declared.
In December, 1917, the Aurora Brewing Co. commenced disposing of its capital assets. Certain of them were transferred to the several stockholders, *3369 who gave their notes to the corporation in amounts equal to the appraised values of the assets received. Subsequently, as opportunities offered, other assets were disposed of to outside parties. From time to time during the years 1918, 1919, 1920, and 1922, the stockholders withdrew from the corporation sums of money arising from these sales of corporate assets, and the amounts thus withdrawn were charged to the accounts of the different stockholders. On October 31, 1920, the total amount with which the various stockholders had been charged on account of the foregoing distributions *1308 and withdrawals prior to this time was $367,553, which amount was carried on the corporation's books as an indebtedness of the stockholders to the corporation. In 1922 a distribution was made to the stockholders by the corporation in the amount of $106,500. The parties have stipulated that $30,000 of the foregoing amount of $106,500 was a cash dividend in 1922, and that the remainder, $76,500, represented either a liquidating dividend or a distribution of profits in 1922, as the Board might determine.
In March, 1920, the corporation, acting in the manner prescribed by the State of Illinois, *3370 reduced its capital stock from $450,000 to $100,000, and adopted a resolution requesting and requiring the stockholders to surrender their old shares of stock and receive in lieu thereof new stock on the basis of one share of new stock for four and one-half shares of old stock. Each share of old and new stock had a par value of $100 and both the old and the new stock were of the same class, namely, common stock. Acting upon the advice of an accountant, a resolution was adopted on October 31, 1920, which adjusted the corporation's books on account of the reduction in capital stock and extinguished the liability of the stockholders to the corporation in the amount of $367,553. The resolution stated that an amount of $517,152.38 was to be distributed, which amount was the difference between the net book value of the corporation's assets (which assets included the amount due from the stockholders of $367,553) and the reduced capital stock of $100,000. Under the foregoing resolution the stockholders' accounts were credited with their proportionate share of $517,152.38, and these credits were used to offset the charges which represented the indebtedness of the stockholders. After these*3371 offsets had been made there remained credit balances in favor of the stockholders amounting to $149,599.38. The resolution then stated that since there was no cash available with which to pay the amount represented by these credit balances, the stockholders should waive claim to these amounts, which was done. Entries were then made charging the various stockholders' accounts with the amount of their respective credit balances and crediting the total of these balances to an account entitled "Paid-in Surplus." The parties have stipulated that the foregoing transaction represented withdrawals in 1920 of at least $367,553, which was to be treated as liquidating dividends or as withdrawals of profits, effective in 1920, as the Board might determine.
The Commissioner determined that the capital and surplus of the Aurora Brewing Co. on December 31, 1920, was $649,395.61 and that the balance sheet on December 31, 1912, showed capital and surplus of $561,887.59, from which he computed that the book value of 3,500 shares surrendered was $437,024 as of December 31, 1912. Accepting *1309 the statement appearing in the minutes that there was a distribution of $517,152.38, the Commissioner*3372 found a net dividend from earned surplus of $80,128.38, which was distributed among the various stockholders in proportion to their interests and taxed to them as a dividend. The parties have stipulated that for the purpose of these proceedings the March 1, 1913, value of the 4,500 shares of stock was $630,000, or $140 per share.
Some time prior to July 7, 1916, Helena Knell, the wife of John Knell, Sr., died and under the terms of her will her two children, John Knell, Jr., and Louise K. Solfisburg, inherited all her property in equal proportions. On July 7, 1916, John Knell, Jr., and his sister entered into an agreement wherein John Knell, Jr., was given complete control of the operation and administration or disposal of the property thus inherited, with a few exceptions which were noted. The earnings from the properties involved were reported by John Knell, Jr., as executor of the estate of H. Knell. In the original return of the estate of H. Knell, a deduction for depreciation for 3 per cent a year was made on the Terminal Building at Aurora, Ill., the South Main Street Building in Aurora, and a building in De Kalb, Ill. In reviewing the return the Commissioner reduced*3373 the depreciation rate to 2 per cent. The proper rate of depreciation to be allowed on these buildings is 3 per cent a year as originally claimed.
John Knell, Jr., was married in 1911 to Olga Goetz. At the time of her marriage and subsequently, Mrs. John Knell, Jr., received various money and property from her father, which money and property she turned over to John Knell, Jr., for investment. In 1915, John Knell, Jr., invested $3,000 of his own money and $4,000 of his wife's money, acquiring one-half of the stock of the All Steel Equipment Co. He subsequently invested an additional $5,000 of his own money and $1,000 of his wife's. In 1916, his company changed its stock to two classes and in the recapitalization John Knell, Jr., for himself and wife, received $12,500 par value of common stock and certificates of 7 per cent cumulative nonparticipating preferred stock callable at par plus a premium of 3 per cent. Certificates for the preferred stock were issued as follows:
| Shares | |
| October 1, 1916, in the petitioner's name | 46 |
| In that of his uncle, Mr. Heinzelman | 4 |
| November 7, 1916, in petitioner's name | 50 |
| January 2, 1918, in petitioner's name | 130 |
Ten*3374 shares in the name of Mrs. Knell were also issued in return for $1,000 of her money paid into the company.
John Knell, jr., at the time the corporation was recapitalized, made a verbal agreement with his wife that she should own all of the *1310 preferred stock and he would own the common stock. In her returns for 1919 and subsequent years, Mrs. Knell reported dividends received on stock of this company in the sum of $1,680 a year. John Knell, jr., in his returns, reported $400 in dividends received in 1920, and no dividends in the other years. In auditing the returns of John Knell, jr., the Commissioner added to his income the $1,680 received as dividends on the preferred stock.
The preferred stock of the petitioner properly belonged to Mrs. Knell, wife of John Knell, Jr., and the dividends, amounting to $1,680 per year, were properly included in her return and did not constitute income to John Knell, Jr.
OPINION.
LOVE: It has been agreed by stipulation between the parties that the dividends formally declared in 1918 were properly included as income by the petitioners in the year 1917, and that the dividends formally declared in 1919 were properly included as*3375 income in the year 1918 and did not constitute income in the year 1919. Therefore, the amount of dividends to be included in the year 1918 by the stockholders of the Aurora Brewing Co. amounted to $27,000 instead of $45,000 as determined by the Commissioner, and no dividends were received during the year 1919.
This leaves as the principal issue, which is common to all of the appeals, the effect to be given, for income-tax purposes in the cases of the petitioners who were stockholders of the Aurora Brewing Co., to a reduction of the capital stock of this corporation in 1920 and the cancellation of certain liabilities of the stockholders to the corporation. In other words, our question is as to the extent to which the stockholders, petitioners in these proceedings, are taxable in 1920 on account of this transaction. The parties have stipulated that what happened amounted to a withdrawal by the stockholders in 1920 of at least $367,553, and that this amount should be treated either as a liquidating dividend or as a withdrawal of profits, as the Board may determine. The respondent, however, contended that there was not only a distribution of $367,553, but also of an additional amount*3376 of $149,599.38, the credit balances to which claim was waived by the stockholders. With respect to the latter contention, we are of the opinion that, having due regard to the stipulation between the parties and the evidence furnished as to the reasons for adopting the resolution which authorized the purported distribution of $517,152.38, what happened in 1920 did not result in a distribution in excess of $367,553, the indebtedness of which the stockholders were relieved, *1311 and that the amount of $149,599.38 was neither actually nor constructively received by the petitioners, nor was it intended to be distributed to them. What the corporation did was to reduce its capital stock from $450,000 to $100,000 and then later take corporate action which resulted in the extinguishment of certain liabilities of the stockholders to the corporation, which liabilities had been created by the transfer of physical properties and funds received from the sale of assets to the petitioners. Whether these withdrawals were in fact made prior to October 31, 1920, it becomes unnecessary to determine, since the parties have stipulated that these were withdrawals in 1920 and the evidence is insufficient*3377 to make a determination otherwise, but we are unwilling to say that there was a distribution in excess of the indebtedness of which the petitioners were relieved.
Next, to what extent were the petitioners taxable on the withdrawals or distribution of $367,553? Since the stock had been reduced prior to October 31, 1920, when the withdrawals are stipulated to have been made, we are of the opinion that this was not in effect a dividend in liquidation, but was rather a distribution made out of capital or surplus then held by the corporation. Whether the entire $450,000 of capital stock represents capital paid in, the record does not show other than that the capital stock of $150,000 which was outstanding in 1911 was increased in that year to $450,000 and that the individual accounts of the petitioners would indicate that this increase was made up in part at least of stock dividends. But under any circumstances, the capital or surplus which the corporation had on March 1, 1913, would be exempt from tax when distributed to the petitioners in 1920, and it would only be the earnings or accretions accumulated since March 1, 1913, that would be subject to tax when distributed. Our problem*3378 then is to determine how much of the distribution of $367,553 represents capital or surplus existing on March 1, 1913, and how much represents profits accumulated since that time. No evidence was furnished as to the capital or surplus on March 1, 1913, other than the reports of the revenue agent, which show that in his determination he used balance sheets which reflected a capital and surplus at December 31, 1912, of $561,887.59, and the individual accounts of the petitioner, which show that dividends totaling $22,500 were credited to them on February 6, 1913. We also have the March 1, 1913, value of the stock of the corporation, but this would not aid in determining the profits which had accumulated from March 1, 1913, to October 31, 1920. From the same reports there is shown capital and surplus at December 31, 1920, of $649,395.61 before adjustment for the transaction which occurred on *1312 October 31, 1920. No information is available as to the result of operations from December 31, 1912, to March 1, 1913, or from October 31, 1920, to December 31, 1920. From the above facts, however, it would appear that there was an increase in surplus from December 31, 1912, to December 31, 1920, of*3379 $87,508.02, which, if it could be accepted as the profits which were accumulated from March 1, 1913, to October 31, 1920, would be the portion of the distribution of $367,553 made on October 31, 1920, which would be taxable as a distribution of profits on that date. The evidence, however, is insufficient to show that the foregoing amount represents a correct determination for the period in question. In the determination made by the respondent, the amount which was determined to be taxable was $80,128.38, and since we are satisfied from the evidence that it was not less than this amount, his determination as to the amount will be accepted, although arrived at in a manner contrary to the principles set forth above. The distribution, to this extent, is subject to tax as an ordinary dividend as distinguished from a liquidating dividend which appears to be the manner in which it was treated by the respondent, though erroneously referred to as a liquidating dividend.
With respect to 1922, when a distribution of $106,500 was made, the parties have stipulated that $30,000 represented a cash dividend in 1922 from profits and that the remaining amount of $76,500 was either a liquidating*3380 dividend or a distribution of profits, as the Board may determine. The petitioners stated in their briefs that "It is not particularly material * * * whether or not the 1922 distribution be treated as taxable to the extent claimed by the respondent." The respondent determined that the petitioners were taxable on dividends to the extent of $49,475.12, out of the total of $106,500, or $19,475.12, in addition to the $30,000 which the parties have stipulated represented a cash dividend. We are satisfied from the evidence that there was a distribution from profits of at least the amount so considered by the respondent and, accordingly, his action with respect to the dividend distribution in 1922 is affirmed.
The testimony of Mr. Knell to the effect that the preferred stock of the All Steel Equipment Co. was the personal property of his wife was further supported by the fact that Mrs. Knell reported the income from such stock during the years involved. The mere fact that the stock was held in the name of John Knell does not constitute sufficient grounds for rebutting this testimony.
Judgment will be entered under Rule 50.