*942 The executor of an estate, which owned all the outstanding shares of a corporation engaged in a hazardous business, delayed distribution of the shares because of the objection of the legatee trustee to accepting them as a trust investment. After the corporation had accumulated substantial earned surplus. it capitalized this surplus and issued a 200 percent stock dividend, most of which was, under Pennsylvania law, distributable by the trustee to income beneficiaries. The executor then made distribution, and immediately thereafter the trustee sold to the corporation for cash the minority shares held by it as corpus. Held:
(1) The payment by the corporation for the shares was not made at such time and in such manner as to be essentially equivalent to the distribution of a taxable dividend within the meaning of section 115(g), Revenue Act of 1932.
(2) The failure of the executor to make distribution earlier was not capricious and unreasonable and the basis for computing gain on the sale is not the fair market value of the shares on a date prior to actual distribution.
*1086 The Commissioner determined the following deficiencies in petitioners' income taxes for 1933.
| Petitioner | Docket No. | Deficiency |
| Clara Louise Flinn | 84483 | $147,791.43 |
| Louise Flinn Wainwright | 84484 | 85,438.05 |
| George H. Flinn, Jr | 84485 | 92,528.85 |
| Lawrence Flinn | 84486 | 85,977.32 |
| Colonial Trust Co. and George H. Flinn, Jr., Executors of Estate of George H. Flinn, deceased | 84487 | 6,516.77 |
| Colonial Trust Co., Trustee for Clara Louise Flinn Trust | 84488 | 129,774.21 |
| Colonial Trust Co., Trustee for Louise Flinn Wainwright Trust | 84489 | 76,713.95 |
| Colonial Trust Co., Trustee for George H. Flinn, Jr., Trust | 84490 | 76,695.20 |
| Colonial Trust Co., Trustee for Lawrence Flinn Trust | 84491 | 76,688.95 |
The trustee under the four trusts, Docket Nos. 84488-84491, assails the Commissioner's determination that an amount received from a corporation for shares immediately after a stock dividend is to be treated as a taxable dividend under section 115(g), Revenue Act of 1932. In the alternative the Commissioner*944 pleads affirmatively that the trusts are taxable on profits from the sale of such shares computed on the basis of value prior to their receipt from the executors, on the theory of constructive receipt because of unwarranted delay in settlement of the estate.
The beneficiaries of the trusts, Docket Nos. 84483-84486, assail the Commissioner's inclusion in their incomes of the corporate distribution to the trusts. They contend that no income of the trusts was currently distributable to them within the meaning of section 162(b), Revenue Act of 1932.
Two issues raised by the executors of the estate, Docket No. 84487, were settled by stipulation.
FINDINGS OF FACT.
George H. Flinn of Pittsburgh, Pennsylvania, died testate on March 29, 1929, leaving surviving a widow, Clara Louise Flinn, and three children, Louise Flinn Wainwright, George H. Flinn, Jr., and Lawrence Flinn, petitioners in Docket Nos. 84483-84486, respectively. *1087 All are residents of Pittsburgh except Louise Flinn Wainwright, who resides in New York City. The decedent's last will and codicil were duly probated before the Register of Wills for Allegheny County, Pennsylvania, and letters testamentary were*945 granted on April 4, 1929, to George H. Flinn, Jr., and the Colonial Trust Co. who, as executors, are petitioners in Docket No. 84487. The Colonial Trust Co. is also the trustee of four trusts created by the will for the benefit of the surviving widow and three children, respectively, and as such is petitioner in Docket Nos. 84488-84491. Its principal office is in Pittsburgh, Pennsylvania.
By the terms of his will decedent made minor bequests and then bequeathed to the Colonial Trust Co., as trustee, the residue of his estate, to hold one-third in trust for his wife's benefit during her life and two-thirds, divided into equal parts, for the benefit of his children. Other provisions directed a division of the wife's share upon her death among the children and covered contingencies in the case of a child's death. The trustee was given ample powers of management and directed to pay the income of the wife's share to the wife for life at convenient times, "depending upon the condition of the investment", and to use the net income of each child's share for the child's maintenance and education until he should reach the age of twenty-one, and to pay it thereafter to the wife, if surviving, *946 until the child should reach the age of thirty, to be used by her for the child's welfare. Upon reaching the age of thirty, the child was to receive the income for life and his descendants thereafter until each should reach the age of twenty-one. Trust corpus was then to be distributed per stirpes. The surviving children, Louise, George, and Lawrence, were born in 1901, 1905, and 1910, respectively.
Decedent left an estate originally appraised at $7,500,000. The executors entered promptly upon their duties, and in the course of the administration, which is not yet closed, have submitted four accounts to the Orphans' Court, all of which were approved. Under the first, filed December 5, 1930, and approved in January 1931, they distributed assets of $2,136,242.65 to the trustee; under the second, filed January 22, 1934, $1,391,387.95 was so distributed by a first decree and $946,254.62 by a second. Under the third account, filed January 3, 1936, $138,557.16 was distributed, and under the fourth, filed April 1, 1937, $764,999.33, $50,000 being then awarded back to the executors for further administration, and some additional estate assets have since been received. The executors*947 have filed income tax returns for the estate regularly. The first account reported the payment of all specific bequests, claims of creditors filed against the estate, and state and Federal inheritance taxes of $673,822.43 and $168,455.61, respectively. The second showed that all creditors of whom the executors had knowledge had received notice *1088 to file and no claims had been filed. Minor claims or bills were promptly paid.
The executors were confronted with several problems, however, which delayed final settlement. Shortly after decedent's death they sold shares of stock in the American Reduction Co. and the Detroit Reduction Co. for a consideration payable in installments from the companies' profits. The vendee defaulted, committed certain irregularities, and the estate's claim against him was not finally settled until 1936, by a compromise under which the estate received assets and paid out some cash. Decedent was a coguarantor on two mortgages. The mortgages were defaulted and the mortgagee made demand on the executors. This demand was met in 1935 by the estate's payment of the claim and receipt of the mortgages. In the latter part of 1936 a claim was made*948 against the estate for payment of a debt of $195,000 secured by mortgages. This claim was not adjusted until late in 1936. About the same time the executors also received the right to a seat on the New York Stock Exchange transferred in settlement of decedent's interest in a note on which $177,000 remained unpaid. The executors were further deterred by the depressed condition of the stock market.
The most difficult problem in the administration of the estate was the disposition of shares of stock in the George H. Flinn Corporation, herein called the corporation. At the time of death decedent owned its entire authorized and outstanding stock, consisting of 1,000 shares of a par value of $100 each. The Commissioner valued these shares at $941,733.13 for estate tax purposes, and the executors paid a tax computed to reflect that determination. This corporation conducted a long established business by which the Flinn family fortune had been accumulated. Decedent's father had been a member of Booth & Flinn, Ltd., formed in 1876 as a limited Pennsylvania partnership. The partnership engaged successfully in the contracting business in Pennsylvania, New York, and West Virginia, and*949 constructed among other things the Catskill Aqueduct and the Holland Tunnel. When the elder Flinn died in 1924, the partnership was liquidated, and decedent, his eldest son, bought the physical assets and formed the George H. Flinn Corporation in New York and a Pennsylvania corporation to carry on the business. The New York corporation, here involved, was organized in January 1926, with a capital of $100,000, and took over the New York business, assets, and personnel. The partnership at the time of liquidation was engaged in the construction of section 102-2 of the Independent Subway System in New York City under a contract involving $5,100,000. Performance had been guaranteed personally by the elder Flinn, and to meet the demands of the New York Board of Transportation and a surety company, decedent also guaranteed performance personally and agreed *1089 to furnish any necessary funds for completion. At the time of his death this project was nearly finished.
The corporation thereafter bid on numerous projects, putting up with the bid its certified check for from $25,000 to $200,000, as required. Its operations were largely confined to the building of public works, *950 principally subways in and about New York City. In June 1928 it was the successful bidder for the construction of section 106-1 of the Independent Subway System, and entered into a contract therefor involving $8,000,000. It was required either to put up a surety bond for $1,000,000 or to deposit $500,000 as a guaranty of performance; decedent advanced the cash for the deposit. It thereafter spent $400,000 for equipment and $200,000 for labor and materials before receiving any payment for the work. It was engaged in the performance of this contract when decedent died on March 29, 1929, and completed it in 1932. After decedent's death the New York Board of Transportation insisted that the corporation's capital stock be increased to improve its financial condition, and to satisfy the board $300,000 of the corporation's earned surplus was capitalized and a 300 percent dividend in common stock was issued on August 26, 1929.
In January 1930 the corporation entered into a contract for the construction of section 108-5 of the Independent Subway System in the Borough of Queens, completing it in 1932. The contract involved $4,300,000, and a bond of $550,000 was required, on which the*951 premium was $40,000. While work on this project was in progress, a contract was made to construct the adjoining section 108-6, the amount of the contract being $3,900,000 and the bond required, $500,000. The corporation had no cash for the alternative optional deposit. In February 1932 it began investigations on which to base a bid on the construction of twin tubes under the Hudson River for the New York Port Authority. The Port Authority's original purpose was to spend about twenty-five million dollars on the project and to require that the successful bidder have liquid assets of 10 percent of that amount. Being unable to dispose of its bonds, however, the Port Authority changed its plans, and on February 21, 1934, invited bids for the construction of a single tube, now known as the Lincoln Tunnel. A bond of $3,000,000 was to be required. The corporation submitted a bid of $7,393,214.75, accompanied by its certified check for $350,000, but this bid was second lowest and was not accepted. Between the time of decedent's death and the end of 1933 the corporation had no other contracts than the four mentioned, all of which had been completed or nearly completed at substantial*952 profits on the latter date. It is still actively engaged in the construction of subways.
The corporation's business has substantial hazards which its officers must take into consideration in bidding for a contract. Although the New York Board of Transportation and the contractor explore the *1090 subsurface of a proposed route with core-drillings, these are sometimes not deep enough and the contractor may unexpectedly encounter soft ground, soft rock or quicksand, requiring a change of route or the expense of steel and concrete supports. Prior to decedent's death, soft ground in constructing section 106-1, which ran under the Harlem River, required that operations be transferred to another point. Soft streaks were again encountered. On the same project, operations were suspended because of quicksand. All three of these difficulties fell in 1929. Other hazards of the business are labor troubles and advances in the cost of materials. During 1915 and 1916 the predecessor partnership lost about two million dollars because of them. Liability for damage to person and property is a constant risk against which the corporation acted as its own insurer. At the end of 1932*953 liability claims against it, arising from execution of the four contracts, aggregated $974,996.72, a substantial part of which were filed in 929 or earlier.
The officers of the Colonial Trust Co., coexecutor, were apprehensive of these hazards, and particularly of the risks involved in performance of the corporation's $8,000,000 contract for construction of subway section 106-1, running under the Harlem River. They declared that the Trust Co., as trustee of the testamentary trusts, would not accept the stock from the estate because it was not sufficiently safe for a trust investment. Efforts to dispose of it proved unsuccessful; liquidation of the corporation was considered but found impossible until completion of the contract, for which the corporation had made bond and pledged securities. Furthermore, George H. Flinn, Jr., the coexecutor, opposed liquidation for sentimental reasons. Nothing was done.
After 1929 the corporation entered into the two other contracts and considered bidding on the very large Hudson tube project. Meanwhile the executors considered various plans to dispose of the shares. In 1933 they decided to have the corporation declare a stock dividend and*954 to make an apportionment of the increased total number of shares, among the trusts and the trust beneficiaries in accordance with Pennsylvania law. This required the trustee to hold as corpus the equivalent of the fair market value (termed "intact value") of the shares held by decedent at the time of death. By such apportionment, the trustee would become a minority shareholder and hence relieved to some extent of responsibility for the investment and the corporation's management.
An accounting firm, employed to determine the intact value, fixed it at $951,560.45. The firm also determined the net worth of the corporation as of November 30, 1933. On December 27, 1933, a meeting was attended by all parties in interest or their representatives, and it was decided to have the corporation declare a stock dividend of *1091 8,000 shares and to have an apportionment made of the resulting 12,000 shares to the trusts and trust beneficiaries. On the basis of the accounting firm's appraisal of the corporation's net worth, all parties agreed on $228.721 as the value of each of the 12,000 shares, and accordingly determined mathematically that 4,160.3537 of them would represent the*955 intact value of the asset to be held by the trustee and that 7,839.6463 shares could properly be distributed to the trust beneficiaries. On the same date the corporation increased its authorized and issued capital stock from $400,000 to $1,200,000 by capitalizing $800,000 of its earned surplus and issuing a 200 percent dividend in common shares. The number of shares then held by the executors was 12,000.
By letter dated December 27, 1933, the executors transmitted endorsed certificates for the 12,000 shares to the corporation, explaining that under the laws of Pennsylvania:
* * * when a stock dividend is issued on securities held by an estate during the course of administration or during a trust, the fiduciary is obliged to make an apportionment of such stock among those entitled to income and those entitled to the principal of the estate.
They then requested that new certificates be issued as follows:
| Shares | |
| The Colonial Trust Company Trustee u/w of George H. Flinn for Clara Louise Flinn | 1,386.7844 |
| The Colonial Trust Company, Trustee u/w of George H. Flinn for Louise Flinn Wainwright | 924.5231 |
| The Colonial Trust Company, Trustee u/w of George H. Flinn for George H. Flinn, Jr | 924.5231 |
| The Colonial Trust Company, Trustee u/w of George H. Flinn for Lawrence Flinn | 924.5231 |
| Total | 4,160.3537 |
| Clara Louise Flinn | 2,613.2155 |
| Louise Flinn Wainwright | 1,742.1436 |
| George H. Flinn, Jr | 1,742.1436 |
| Lawrence Flinn | 1,742.1436 |
| Total | 7,839.6463 |
*956 The certificates were issued and so distributed by the executors, who included the 4,160.3537 shares, passing to the trustee, at a value of $951,560.45 among the distributed assets reported in their accounting to the Orphans' Court, filed January 2, 1934.
The trustee, however, was not satisfied to hold as a trust investment, the shares issued to it, and immediately negotiated with the corporation for their transfer for a consideration of $951,560.45. The trustee advised the corporation's president by letter, dated December 27, 1933, that it was unwilling to retain the shares because of the hazards of the contracting business; expressed a willingness to sell at $228.721 a share, and added that if it was unable to do so, it would object to the *1092 corporation's taking any more contracts and insist on a liquidation. On December 28, 1933, the corporation accepted the shares for the price asked, and the trustee thereafter invested the proceeds in municipal securities, which it still holds.
Since the interests of minors and of unborn children were involved in the distribution, a guardian ad litem was appointed to review what had been done. He submitted a report to*957 the Orphans' Court in which he attacked the determined amount of the intact value, contending that the profits from the contract being performed at the time of decedent's death should be added. The beneficiaries to whom the 7,839.6463 shares had been distributed were then called upon to return their shares, and under date of December 27, 1933, they executed an agreement, placing all of them in escrow with the Colonial Trust Co. for disposition in accordance with the judicial determination of the parties entitled thereto. The contention of the guardian ad litem was sustained after appeal to the Supreme Court of Pennsylvania, which rendered its decision on November 25, 1935. ; . In accordance therewith, 2,341.1356 of the shares originally transferred to the beneficiaries were awarded to the trustee, and are still held by it.
The Colonial Trust Co., as trustee of the four trusts, made only two distributions in 1933. On January 4 it distributed to Clara Louise Flinn $22,500 from accumulated trust income of prior years. On December 14 it distributed $32,400 to her.
In determining the income taxes of*958 the four trusts for 1933 (Docket Nos. 84483-84491) the Commissioner treated the purchase of the 4,160.3537 shares by the corporation for $951,560.45 as equivalent to the distribution of a cash dividend, and added three-ninths thereof, or $317,186.78 to the income of the trust for the benefit of Clara Louise Flinn, and two-ninths, or $211,457.89, to the income of each of the trusts for the benefit of the children. He similarly added as "Dividends from Estate of George H. Flinn" $317,487.95 to the individual income of Clara Louise Flinn for 1933 (Docket No. 84483) and $211,658.67 to the respective 1933 incomes of Louise Flinn Wainwright, George H. Flinn, Jr., and Lawrence Flinn (Docket Nos. 84484-84486).
The payment by the corporation of $951,560.45 to the trustee was not made at such time or in such manner as to be essentially equivalent to the distribution of earnings and profits.
The failure of the executor of decedent's estate to distribute the corporation's shares to the residuary legatee prior to December 1933 was not artibrary or unreasonable.
There was no plan or purpose of the executor, the trustee, or the individual beneficiaries to defeat the proper receipt or accrual*959 of income or of income tax.
*1093 OPINION.
STERNHAGEN: 1. The estate of George H. Flinn, deceased, in Docket No. 84487, contested the Commissioner's determination that its gross income for 1933 should include profit of $16,357.38 and its deductions should exclude one of $47,635.46. The parties have agreed that the $16,357.38 should be excluded from income and the $47,635.46 should be excluded from deductions; and the computation of deficiency will be made on that basis.
2. Docket Nos. 84488-84491 are proceedings instituted by the trustee of the four trusts created under the will for the widow and three children, respectively. They are four separate taxpayers, but each proceeding involves the same two issues, one assailing the Commissioner's determination and the other raised by the respondent's affirmative amended answer. The considerations are common to all four cases.
By the will, the residuary estate was left to the trusts. For the reasons set forth in the findings, the executors withheld distribution, and there has been long delay in the settlement of the estate. In 1933 a plan for handling the corporation's shares was worked out which would meet the fiduciary*960 demands of the trustee, the practical demands of the business, and the sentimental demands of the Flinn family. The surplus was capitalized, the shares increased, and a stock dividend declared, which facilitated a proportionate distribution among the trust beneficiaries without impairing the intact value of corpus to be retained by the fiduciary, and at the same time relieved the fiduciary of undue responsibility for the risks of the contracting business. Thereupon, to free the fiduciary completely from the business, the shares retained by it were bought by the corporation for $951,560.45, which is no more than their fair market value when received.
The Commissioner's determination rests upon the view that the corporation's purchase from the trustee was a cancellation or redemption of its shares essentially equivalent to a dividend and taxable as such under Revenue Act of 1932, section 115, subdivision (g). 2 This view is defended by respondent here on the ground, as stated in his brief, that:
* * * The facts clearly establish that there was a premeditated plan or artifice on the part of the petitioners in connection with the entire transaction and that the element of tax avoidance*961 motivated them * * *. The *1094 circumstances surrounding the redemption and reduction of the stock in time and manner clearly indicate and evidence a continuing plan to effect by that means a distribution of corporate earnings freed from the usual incident of tax upon ordinary dividends. The whole scheme was in fact an anticipatory arrangement to circumvent the tax.
The evidence clearly refutes this and establishes affirmatively the contrary. While it shows that the capitalization of earnings and the stock dividend were actuated primarily by a demand other than that of the corporation's own business, it shows equally clearly that the motive*962 was to provide a means of avoiding a forced complete liquidation of a successful business and yet to conform to the fiduciary's demand for safety and the requirements of the Pennsylvania law of apportionment. Indeed an inclination to reduce or avoid income tax while distributing earnings can be found nowhere in the evidence.
If the motive be left aside as not necessarily controlling, there is still an absence of such manner of distribution as to be essentially equivalent to a dividend. The statutory concept of dividend is a distribution out of earnings and profits, and normally it is propertionate to shares and leaves the shareholder holding his shares as his capital investment. Complete and partial liquidations are treated, for the purpose of the statute, as sales with a consequent measure of gain or loss, even though the proceeds may to some extent be derived from earnings. . Here there was a complete liquidation of the holdings of but one shareholder owning a minority of the shares. The purpose was not to distribute earnings, but to bring about a separation of this one shareholder from the corporation. The remaining*963 shareholders remained substantially unchanged in their relation to the corporation and its earnings. The shares purchased from the trustee by the corporation were not only those distributed to it as a stock dividend, but also those which this shareholder held as its intact investment. The only fact to give the purchase the semblance of a statutory dividend is that money went to a shareholder which to some extent could be traced to earnings. This is, in our opinion, less than enough to establish the essential equivalent of a dividend when considered in all the circumstances.
The Commission was in error in his determination that section 115, subdivision (g), was applicable.
3. The respondent, by an amended answer, affirmatively pleads that of the $951,560.45 received by the trustee from the corporation, $625,064.85 is properly to be treated as gain. Although there is no substantial room for doubt that the 4,160.3537 shares which were in effect received by the trustee on December 27, 1933, by way of distribution from the executors of the decedent's estate, were worth $951,560.45 when received, thus indicating no gain when they were *1095 sold, the respondent pleads affirmatively*964 that the basis to be used in computing gain is not the value of the shares when actually received by the trustee, but the value on January 30, 1931, when they are said to have been constructively received because they should have been actually received. The argument runs that the executors were in position to close and distribute the estate on the earlier date, and that their failure to do so was so capricious and unreasonable that it should not be recognized for present purposes.
The evidence, however, fails to substantiate this affirmative contention. As appears at length in the findings, there was sound and respectable reason for the trustee to resist distribution in specie of the corporation's stock. The corporation's business was hazardous and the trustee might reasonably contemplate the necessity for a long period of protecting the interests of minors and unborn children. There were other difficulties in the way of ready and prompt liquidation and of the administration of the assets, but the well founded reluctance of the fiduciary in regard to the corporate shares is enough. There is nothing to support a suspicion that the executors and the trustee or beneficiaries were*965 conspiring to raise the value of the corporate shares in order to reduce the gain and the resulting tax. The respondent has therefore failed to support the constructive receipt by the trustee in 1930 upon which his reduction in basis and increase in gain is built.
4. As to the four individuals who are beneficiaries of the trusts established by the will (Docket Nos. 84483-84486), the Commissioner, following his view that the $951,000 paid by the corporation for the 4,160 shares was properly to be regarded as a taxable dividend under section 115(g), held further that such amount constituted distributable income of the trusts and is, therefore, properly taxable to the individual beneficiaries of the trusts under section 162, Revenue Act of 1932. Actually the amount thus received by the trustee was retained as the intact value which it was not at liberty to distribute. It has been invested and continues to be held by it. No part has been distributed to the beneficiary petitioners. The decision that section 115(g) is inapplicable carries with it the decision that no part of the $951,000 may be regarded as distributable income of the trusts and no part thereof may be taxed to the*966 individual beneficiaries.
5. Petitioner Clara Louise Flinn, the widow, in fact received $22,500 on January 4, 1933, and $32,400 on December 14, 1933. These amounts can not from the record be clearly identified except that they were received by her from the trustee. Whether they were received as income from the trust separately set up for her or to any extent as income from any of the trusts for the children, to be used as provided in the will for their maintenance and benefit, has not *1096 been and can not be found. The distribution of $22,500 appears to have been made out of trust income of earlier years and is not properly taxable at the time of actual distribution in 1933. With regard to the later distribution of $32,400, nothing appears which would require the exclusion of any part from her individual 1933 income. The Commissioner's determination must, therefore, be sustained in whatever treatment he gave to the $32,400, and must be reversed as to the earlier distribution of $22,500, which was taxable in an earlier year.
Reviewed by the Board.
Judgment will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Louise Flinn Wainwright; George H. Flinn, Jr.; Lawrence Flinn; The Colonial Trust Company and George H. Flinn, Jr., Executors, Estate of George H. Flinn, Deceased; The Colonial Trust Company, Trustee, Trust under the will of George H. Flinn for Clara Louise Flinn; The Colonial Trust Company, Trustee, Trust under the will of George H. Flinn for Louise Flinn Wainwright; The Colonial Trust Company, Trustee, Trust under the will of George H. Flinn for George H. Flinn, Jr.; and The Colonial Trust Company, Trustee, Trust under the will of George H. Flinn for Lawrence Flinn. ↩
2. (g) REDEMPTION OF STOCK. - If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. ↩