Memorandum Findings of Fact and Opinion
In the two consolidated cases, respondent determined deficiencies in income taxes for the year ended December 31, 1936 as follows:
| Joseph E. Sorg | $22,129.80 |
| Walter Lipford | 19,499.40 |
In docket No. 102928, the petitioner, Joseph E. Sorg, died after the filing of the petition, and his personal representatives were substituted as petitioners.
The sole question presented is whether Joseph E. Sorg and Walter F. Lipford realized taxable income in 1936 by virtue of receiving dividends of preferred stock on their common stockholdings in the Strong Bag Co., Inc., the stock dividend having been declared on April 3, 1936, and issued on May 9, 1936.
Findings of Fact
Prior to the year 1923, Joseph E. Sorg, Walter F. Lipford and Philip C. Schloss were partners engaged in the manufacture and sale of paper bags. In 1923 Schloss died and his widow retained his interest in the partnership. In 1929 Sorg and Lipford bought the widow's interest and in 1929 became equal co-owners of*367 the business.
In 1931 the business became incorporated under the name of Strong Bag Co., Inc. The original charter provided for an authorized issue of 20 shares of common stock of the par value of $100 per share and 980 shares of preferred stock of the same par value per share. Sorg and Lipford each subscribed and paid for 10 shares of common and 200 shares of preferred stock; and the remainder of the authorized preferred stock was not issued. Both Sorg and Lipford retained these holdings until July 1, 1936.
The business of Strong Bag Co., Inc., prospered between 1931 and 1936. The corporation's surplus account as of January 1, 1936 showed a balance of $96,197.04.
On March 11, 1936 Strong Bag Co.'s board of directors met and passed a resolution amending that paragraph of its Certificate of Incorporation providing for capital stock so that the maximum authorized capital stock might be increased. It was provided that the preferred stock should carry no voting power unless four quarterly dividends thereon should have become due and remained unpaid. At a stockholders' meeting held on March 23, Sorg and Lipford, as the corporation's sole common stockholders, unanimously ratified the*368 directors' resolution; and on April 3, 1936, adopted the following further resolution:
WHEREAS, the corporate balance sheet as of January 1, 1936 shows capital stock issued and outstanding of $42,000.00 and a surplus of $96,197.04; and,
WHEREAS, since that date the surplus account of the corporation has not been substantially changed; and,
WHEREAS, on April 2nd, 1936, the State Corporation Commission of Virginia issued an amendment to the Certificate of Incorporation of the corporation increasing the capital stock of the corporation, such increase to be represented by TWO THOUSAND (2,000) shares of 8% Preferred Stock, of the par value of ONE HUNDRED ($100.00) DOLLARS per share, making the total maximum authorized capital stock of the Corporation TWO HUNDRED NINETY-EIGHT THOUSAND ($298,000) DOLLARS of Preferred Stock and TWO THOUSAND ($2,000.00) DOLLARS of Common Stock; and
WHEREAS, the corporation requires all of its present available assets and funds for working capital and the prosecution and enlargement of its business.
RESOLVED, that the stockholders do hereby authorize the present issue of EIGHT HUNDRED (800) shares of Preferred Stock of the corporation.
RESOLVED, FURTHER, *369 that a stock dividend of EIGHTY THOUSAND ($80,000.00) DOLLARS, represented by EIGHT HUNDRED (800) shares of the Preferred Stock of the corporation of a par value of ONE HUNDRED ($100.00) DOLLARS per share be, and the same hereby is declared, the said preferred stock to be issued to the holders of record of the common stock issued and outstanding as of this date, pro-rata and in proportion to the present holdings of common stock of the respective holders of each class thereof.
RESOLVED, FURTHER, that the Treasurer of the Corporation be, and he hereby is directed to transfer upon the books of the Corporation the sum of EIGHTY THOUSAND ($80,000.00) DOLLARS from surplus account to capital account.
RESOLVED, FURTHER, that no issue of stock hereunder shall be made until the report thereof required by law shall have been made to the State Corporation Commission and notification of the filing thereof shall have been received.
Sorg and Lipford had made reasonable efforts to ascertain whether the distribution of stock dividends would be non-taxable in the hands of the recipients and thus be a satisfactory and desirable method to "freeze" surplus. Both an attorney and a Certified Public Accountant*370 informed them that according to the appropriate Revenue Acts then in existence stock dividends were held non-taxable. Lipford investigated the statutes and confirmed this information to his own satisfaction.
On April 10, 1936, the corporation's surplus account was debited in the sum of $80,000.00 and the preferred stock account was credited in a like amount.
On May 9, 1936, two certificates, each of which represented 400 shares of preferred stock, were issued by the corporation to Sorg and Lipford. Whereas they had each previously held 10 shares of common and 200 shares of preferred stock, they now each held 10 shares of common and 600 shares of preferred stock. At no time prior to July 1, 1936, was any other stock issued or was any of the shares mentioned above held by an individual other than Joseph E. Sorg or Walter Lipford.
Sorg and Lipford filed their individual income tax returns for 1936 at the office of the collector of internal revenue at Richmond, Virginia. Neither individual included in their taxable income for 1936 any amount as representing the value of the preferred stock received in 1936.
Opinion
KERN, Judge: The issue presented is whether the preferred stock, *371 issued as a nonpreferential dividend on the common stock of the Strong Bag Co., Inc., held in equal amounts by Joseph E. Sorg and Walter F. Lipford, constituted a taxable dividend in the hands of those two individuals. On the authority of , we decide this issue in favor of petitioners.
Decision will be entered for the petitioners.