*67 Decision will be entered for the respondent.
Petitioner, the owner of 1034 3/8 shares of the common stock of the Jennison-Wright Corporation of Toledo, Ohio, entered into agreements in 1946 with her son and daughter whereby she purportedly sold one-half of such stock to each of her children. The purchase price of the stock was to be paid from dividends received thereon, but a minimum payment of $ 4,000 annually was required even though the dividends fell below that amount. Petitioner agreed to pay the increased income taxes of her children resulting from inclusion of the dividends in their income. The agreements were not intended to be bona fide arm's-length transactions. Held, the Commissioner did not err in determining that the dividends from such stock were includible in petitioner's gross income for the years 1946 and 1947.
*78 The respondent determined deficiencies in income tax for the calendar years 1946 and 1947 in the amounts of $ 7,203.18 and $ 8,981.90, respectively. The question presented is whether dividends paid on 1034 3/8 shares of*68 the common stock of the Jennison-Wright Corporation are includible in the petitioner's gross income for the calendar years 1946 and 1947. The respondent argues in the alternative that, if the Court finds that the 1947 dividends are not includible in her *79 gross income, the 1946 dividends are includible because petitioner was a stockholder of record on the date the 1946 dividends were payable.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein.
Petitioner, an individual, resides in New York, New York. For the taxable years 1946 and 1947, she filed her income tax returns with the collector of internal revenue for the second district of New York.
Petitioner was the owner of 1034 3/8 shares (approximately 20 per cent of the total of 5403 3/4) of the common stock of the Jennison-Wright Corporation of Toledo, Ohio (hereinafter referred to as the Company). The Company's chief products are road tar for black-top surfacing, wood-block flooring, treated timber used in highway construction, and creosoted railroad ties.
On December 16, 1946, petitioner executed an agreement whereby she purportedly sold 517 3/16 shares of*69 the stock to her daughter, Jane Baker Willoughby, for $ 77,578.12 ($ 150 per share). The agreement provided that the purchaser would pay the purchase price at the rate of $ 4,000 per year, with the further proviso "that the amount of all dividends on said stock, less an amount reasonably estimated by the party of the second part [purchaser] to cover the increase in her Federal and state income taxes by reason of the receipt of such dividend or dividends, shall be applied by the party of the first part [seller] on account of the payment of the purchase price for said stock, and the amount so applied shall be credited in reduction of the minimum annual payment of $ 4,000 for the year in which received by the party of the first part."
If the buyer should sell or otherwise dispose of the stock, the entire unpaid purchase price would immediately become due and payable.
The buyer acknowledged receipt of stock certificates representing 517 3/16 shares, together with properly executed stock powers transferring the stock to her.
The agreement further recited that the buyer should redeliver the stock certificates to the seller, as collateral security for payment of the purchase price. The*70 petitioner (the seller) was to hold the stock as collateral and was to receive all dividends on it until the entire purchase price had been paid. The petitioner could not sell or otherwise dispose of or encumber the stock on her own behalf.
In the event of a default in payment of the purchase price, or if a petition in bankruptcy or for the appointment of a receiver should be filed by or against the buyer, or if attachment should be levied against *80 the stock certificates, the petitioner could sell the stock and apply the net proceeds to the payment of the balance of the purchase price. The buyer was to remain liable for any deficiency remaining but was to receive any excess. The petitioner was to vote the stock as directed in writing by the buyer. Upon payment of the purchase price, the petitioner was to deliver the certificates, properly endorsed, to the buyer.
On the same date, petitioner made an identical agreement with her son, William Baker.
At the time the above-mentioned agreements were entered into, petitioner's son was 22 years of age, and her daughter was 25 years of age.
A special meeting of the board of directors of the Company was held on December 17, 1946, *71 one day after the execution of such agreement. The board declared a $ 15 dividend per share of common stock at that meeting. The resolution relating thereto, which is incorporated in the Company's minute book, is as follows:
Resolved, that there be and hereby is declared from surplus profits of the corporation, a dividend of $ 15.00 per share on the common stock of the corporation, payable on the 21st day of December, 1946, to holders of record of said stock at the close of business on the 19th day of December, 1946.
The dividend record of the Company and its predecessor is as follows:
Preferred Stock -- $ 6 per share from 1928 through the years in question.
| Common stock | |
| Year | -- per share |
| 1928 | $ 15.00 |
| 1929 | 15.00 |
| 1930 | 15.00 |
| 1931 | 0 |
| 1932 | 1.00 |
| 1933 | 1.00 |
| 1934 | 1.00 |
| 1935 | 1.00 |
| 1936 | 5.00 |
| 1937 | 5.00 |
| 1938 | 1.00 |
| 1939 | 1.00 |
| 1940 | 6.00 |
| 1941 | 8.00 |
| 1942 | 8.00 |
| 1943 | 6.00 |
| 1944 | 6.00 |
| 1945 | 6.00 |
| 1946 | 15.00 |
| 1947 | 17.50 |
| 1948 | 18.50 |
| 1949 | 10.00 |
The $ 15 dividend in 1946 was 2 1/2 times the dividend for each of the three preceding years.
Petitioner's husband, James Fitz Gibbon, regularly kept books for petitioner reflecting her various securities. These books show the sale *72 of the stock covered by the agreements of December 16, 1946. They reflect a debit to the account of Jane Baker Willoughby entered on December 16, 1946, for the full purchase price of the stock, $ 77,578.12. The books also show the receipt by petitioner, beginning on December 23, 1946, and running through 1950, of the dividends paid on the stock sold to her daughter in the aggregate amount of $ 40,340.63. These *81 payments, as received, were credited as "Payment on Note." The books also reflect debits to Jane Baker Willoughby's account during the years 1947 through 1951 in the aggregate amount of $ 11,600 for amounts advanced by petitioner to pay Jane's income taxes. There are entries similar to all of the above on the books for the account of William Baker.
On December 21, 1946, petitioner transmitted certificates for 1034 3/8 shares of stock, together with duly executed stock powers, to C. H. Schwab, vice president and treasurer of the Company. In this letter, petitioner directed that certificates for 517 3/16 shares be issued to Jane Baker Willoughby and the same number to William Baker. She enclosed stock powers from Jane and William and requested that the certificates*73 in their names be canceled and that two stock certificates be issued in petitioner's name each for 517 3/16 shares, which was done. Accompanying each such transfer was a certificate signed by petitioner's daughter and son reading as follows:
IT IS HEREBY CERTIFIED THAT the transfer of the attached Certificates for Five Hundred Seventeen and three-sixteenths shares of the Common Capital Stock of Jennison Wright Corporation to Jeanette Wright FitzGibbon is made in connection with a deposit of stock as collateral security for money loaned thereon.
The petitioner treated the transaction on December 16, 1946, as an installment sale of stock and showed an allocable portion of her gain on such sales in her income tax returns for 1946 and 1947, in which she reported net income of $ 24,039.77 and $ 16,093.22, respectively. She did not report the amounts received as dividend income. Respondent determined that the dividends were income to petitioner and adjusted her net income for such years to $ 37,663.18 and $ 32,943.79, respectively. Jane and William reported the dividends as ordinary income in their income tax returns for 1946 and 1947.
The stock of the Company was closely held, and *74 the price of $ 150 per share was arrived at upon the basis of a letter to petitioner from the treasurer of the company as follows:
Mrs. Jeannette W. FitzGibbon,
18 East 73rd St.,
New York, City, N. Y. (21)
Dear Mrs. FitzGibbon:
With reference to a possible sale price of The Jennison-Wright Corporation Common Stock.
Practically no shares of this stock have changed ownership since the death of Mrs. Wright and the settlement of her estate. There have been no offers of purchase or offers of sale of this stock that have come to my knowledge any time recently.
I understand that the taxing authorities placed a value of $ 120.00 per share on this stock in the settlement of Mrs. Belle G. Wright's estate. The value of $ 120.00 per share was determined by the taxing authorities, apparently some time during 1942 or 1943.
*82 Taking this figure as a basis, it would be my judgment that the present value should be determined at approximately $ 150.00 per share.
Due to the fact that the Common Shares of this Corporation are not listed, and in addition are closely held, it necessarily is rather difficult to determine a sale or purchase value on the Common Shares.
Yours very truly,
THE *75 JENNISON-WRIGHT CORPORATION
C. H. SchwabCHS:MKF
Treasurer.
Petitioner introduced in evidence two letters from brokerage houses in Toledo, Ohio, which were in answer to letters she had written. Neither the original nor a copy of her letters was offered in evidence by petitioner. The material part of one of the letters dated December 12, 1946, reads as follows:
Dear Mrs. Fitz-Gibbon:
Beg to advise you that we know of no market for JENNISON WRIGHT CO. stock, nor have we ever heard of a share being bought or sold in the local market.
The other letter dated December 13, 1946, reads in material part as follows:
Dear Mrs. Fitz-Gibbon:
Regarding your request for a price on Jennison-Wright common stock, I talked to my partners in Toledo where the headquarters of the company are located. The stock is so closely held that there is no trading in it. As far as I am able to find out there has not been a sale in the stock in some years. I am therefore unable to give you a price on it.
Petitioner had acquired 834 3/8 shares of the stock on December 7, 1941, at $ 120 per share. She had acquired 200 shares in 1927 at the same price.
The petitioner executed a will in 1937 or 1938 which*76 had remained unaltered at the date of the hearing of this proceeding. In her will, petitioner provided that all of her securities, which included the stock in question here, be divided equally between her two children. Prior to December 16, 1946, the petitioner had given her children securities in a limited amount, believing that she was restricted by some governmental regulation in the amount she was allowed to give at any one time.
The petitioner had discussions for several years with her husband and her lawyer concerning the disposition of her stock in the Company. The discussions usually included some conversation relating to the possibility of petitioner's son eventually becoming associated with the Company.
No down payment was required by the agreements of December 16, 1946, and the first payment thereunder was not to be made until December 15, 1947, although legal title was purportedly transferred on the date of execution. Neither of the agreements provided for *83 interest on any unpaid balance due to petitioner. The agreements made no provision with respect to whom the 1946 dividends of the Company were to be paid, but one-half of such dividends were credited on*77 petitioner's books to her son and one-half to her daughter.
The net reduction of the alleged unpaid purchase price was the amount of the dividends declared on each block of the stock less the estimated increase in the Federal and state income taxes of the two children because of the inclusion in their respective incomes of the dividends on each block of stock.
The petitioner continued to receive the dividends from the Company in 1946 and subsequent years, and in 1949 the petitioner received $ 5,171.88 in dividends on each block of 517 3/16 shares of stock. In the early part of 1950, the petitioner paid to each of her children $ 1,300 for the estimated increase in the Federal and state income taxes because of the inclusion in their incomes of the 1949 dividends. This reduced the payments required under the agreements to a net of $ 3,871.88 for that year, whereas the agreements required a minimum of $ 4,000 each year.
Each child of petitioner was given the same amount to cover his respective increased income taxes for the years 1946 through 1949, but the record fails to disclose what their incomes were or whether they were the same.
The agreements provided that the petitioner would*78 vote the stock as directed in writing by her children. The petitioner gave proxies to vote the stock in the same manner as she had given them prior to the December 16, 1946, agreements.
The book value of the common stock (net assets less par of the preferred stock) of the Company at the end of the year 1941 was $ 204.96 per share; $ 220.68 per share in 1942; $ 233.77 per share in 1943; $ 240.63 per share in 1944; $ 248.47 per share in 1945; and $ 292.93 per share in 1946. The balance sheets for the above years do not list any good will.
The earnings (before taxes) per share of common stock (net profits less the dividend on the preferred stock) of the Company for the years 1941 through 1946 were as follows:
| Year | Earnings |
| 1941 | $ 110.17 |
| 1942 | 97.55 |
| 1943 | 24.97 |
| 1944 | 25.96 |
| 1945 | 31.14 |
| 1946 | 66.21 |
The agreements did not constitute a bona fide arm's-length transaction for Federal income tax purposes.
*84 OPINION.
Transactions within a family group are subject to special scrutiny in order to determine if they are in economic reality what they appear to be on their face. This is not to say, however, that all arrangements between members of a family which affect their tax*79 liabilities will be disregarded. It is authoritatively established that where a taxpayer attempts to transfer property and the end result of such transfer does not effect a complete shift in the economic incidents of ownership of such property, the transaction will be disregarded for Federal income tax purposes. This is true because the transferor in such cases retains such control over the property that he is the one who derives the real benefit from the economic gain thereon. The foregoing principles are so fundamental and have been reiterated in so many previous decisions that no citation of authorities is required.
In this case, petitioner relies on three cases: ; ; and , certiorari denied . All three cases involved a sale of stock, part of the purchase price for which was to be paid out of dividends from the stock. The Moore and De Guire cases arose out of the same*80 transaction, and it was held that the dividends were not income to Moore, the seller, but to De Guire, the purchaser. In that case, $ 43,904 was paid in cash by De Guire, and the remainder was evidenced by four interest-bearing notes. The notes and the stock were placed in escrow, and as each note was paid, the stock allocated thereto was turned over to De Guire. Moore retained certain limited voting rights. All dividends on the stock were to be received by Moore and credited on the principal and interest of the notes. If any note was unpaid, the stock allocated thereto was to be returned to Moore. In 1936, a dividend of $ 28,000 was paid on the stock which was sufficient to cover two of the notes, and the stock allocated to such notes was turned over to De Guire. It was held that the 1936 dividends were includible in De Guire's gross income. In 1937, the dividends on the stock were not sufficient to cover the interest and principal on the two remaining notes, and De Guire paid Moore the amount not covered by the dividends. The court held that De Guire received the dividends conditionally in both 1936 and 1937, and they were, therefore, includible in his income for those *81 years. In the Levy case, the facts were substantially similar to the facts in the Moore and De Guire cases, except that, in the Levy case, no down payment was made.
An important distinction between those cases and the instant case is that the parties in those cases were not related, whereas, here, we have a transaction between a mother and her two children. Also, in *85 this case, there was no down payment, no interest was required to be paid on the unpaid balance, and the first installment was not required to be made until one year after the agreements had been executed. Another important distinction between this case and the cited cases is that, here, the petitioner paid the increased income taxes of her children. It is also to be noted that the cited cases all involved an interpretation of the instrument to determine the tax liabilities of the parties. The bona fides of the transaction was not an issue. For other cases similar to those cited by petitioner, see , certiorari denied ; and .*82
In , affirming a Memorandum Opinion of this Court, the Commissioner's determination that dividends from a certain corporation were taxable to the taxpayer-father rather than his son who held title to the stock of the corporation was upheld. The taxpayer was the president and a substantial stockholder of a bank. He and another individual organized a corporation to engage in the fish business. Each individual purchased 50 shares of stock for $ 5,000. Two months later, 40 shares of stock were transferred from the father to the son for which the son paid $ 4,000 borrowing that amount from his father's bank to make the purchase. During the two months that had elapsed, the business had been profitable, and there was reason to believe it would continue to be profitable. In December of the same year (1941), the corporation declared and paid a 100 per cent dividend. The son deposited the $ 4,000 in his bank, and on the same day made a loan of $ 3,500 to his father. The son included the $ 4,000 dividend in his 1941 income. In 1942, the corporation paid a 50 per cent dividend, and a check for $ *83 2,000 was delivered to the son. On the same day, the son advanced $ 1,750 to his father. Both advances were secured by stock of the father's bank. The taxpayer discharged the two advances in 1946, but at the time the case was heard by this Court, the taxpayer was indebted to his son in the sum of $ 5,100 by virtue of other borrowings. The Court of Appeals held that sufficient evidence was present for this Court's findings and pointed out that the initiative for the sale of the stock came solely from the taxpayer, that the son was unable to pay for the stock at the time he purchased it, that the son exercised no control over the stock, and that the father actually enjoyed the dividends on the stock. All of the factors emphasized by the Court of Appeals in that case are present in this case, except the inability to pay for the stock.
As shown in our findings of fact, the agreements made no provision with respect to whom the 1946 dividends of the Company were to be paid. However, one-half of such dividends were credited on petitioner's *86 books to her son and one-half to her daughter. No explanation was given to the Court as to why those dividends were credited on the alleged*84 purchase price when it was not required by the agreements. In 1949, the $ 4,000 minimum annual payment provided for in the agreements was not paid to petitioner when the $ 1,300 she gave to each of them for their increased income taxes is taken into consideration. The record does not disclose that either of the children made any other payment out of their own funds; and we must, therefore, assume that they did not. Neither does the record show that any demand was ever made on the children to make up the difference for that year; and we must assume, again, that no such demand was made. Under the agreements, the petitioner was to vote the stock as directed in writing by her children. There is no convincing evidence in the record that either of her children ever gave petitioner written instructions to vote the stock. The petitioner continued to vote the stock in the same manner as she had voted it prior to the execution of the agreements, and she exercised the same control over it as she had before such execution.
The two letters from Toledo brokers, introduced by petitioner evidently to corroborate her testimony that she had sought other buyers for the stock, indicate, to our *85 mind, that she was merely attempting to get a price for the stock to guide her in fixing its value for purposes of the agreements. Petitioner did not offer in evidence copies of her letters to the brokers.
For the seven years 1940 through 1946, the stock paid an average dividend of $ 7.93 a share which, at $ 150 a share, was a return of approximately 5.3 per cent. For the years 1946 and 1947, the taxable years here in question, the stock paid an average dividend of $ 16.25 a share which, at $ 150 a share, was a return of approximately 10.8 per cent. The book value of the stock, as shown in our findings of fact for the years 1941 through 1946, was considerably higher than $ 150. The earnings record of the company was good, and it had efficient management. After careful study of the entire record, the conclusion seems inescapable that if the sale of the stock had been to a person outside the family in an arm's-length transaction, the petitioner would have demanded and received a much higher price for it.
The parties to the agreements in this case treated them with such informality that we must conclude from the record as a whole that they did not intend to be bound by the provisions*86 contained therein, and that, while the agreements passed technical title to the stock, they did not constitute a bona fide arm's-length transaction for Federal income tax purposes.
In view of our conclusion, it is unnecessary to consider respondent's alternative argument that the 1946 dividends were includible in petitioner's income for that year in any event.
Decision will be entered for the respondent.