May v. Commissioner

*1414 These proceedings, consolidated for hearing, are for the redetermination of deficiencies in income tax for 1927, as follows:

*1149 The allegations of error stated in the first four petitions enumerated above are identical and as follows:

(a) The respondent erred in adjusting the capital net gain of petitioners by eliminating from their basis or cost of the assets sold, the basis or cost of the preferred stock of May Drug Company, which was included in the assets sold.

(b) The respondent erred in determining the capital net gain of petitioners on the sale of 12,550 shares of common stock of May Drug Stores Corporation (received in exchange for certain stock including said preferred stock of May Drug Company) to be $67,917.46, instead of $59,455.62, as reported by petitioners.

(c) The respondent erred in determining the tax liability of the petitioners to be $8,489.68, and determining a deficiency of $1,057.73 against them, whereas the said liability was $7,431.45, which was discharged by petitioners, and there was no deficiency.

In addition to the questions presented by the allegations of error in the four above mentioned petitions, the following additional questions are presented by the last two petitions:

(a) Whether, under the Revenue Act of 1926, certain property which was received by the petitioners*1150 from the estate of their father, Barney May, should have a base or cost value, for the purpose of determining gain or loss, as of the date of their father's death.

(b) Inasmuch as the preferred stock dividend above referred to was not declared by the corporation until almost two years after the deathe of their father, should this stock in particular which they received from the estate of their father have a base or cost as of the date prior to its existence?

FINDINGS OF FACT.

1. The petitioners in the first four docket numbers are trusts with offices in the city of Pittsburgh, Pennsylvania. Barney May, the creator of the trust in Docket No. 55808, was the father of Edwin C. May, Herbert L. May, Walter A. May, and Estelle May Affelder.

2. The above mentioned trusts were all created under a declaration of trust dated October 1, 1917.

*1415 3. On December 19, 1922, each of the four petitioners was the owner of 1,255 shares of the common capital stock of the May Drug Company, a corporation engaged in the business of operating retail drug stores in the city of Pittsburgh, pennsylvania, and 25,100 shares of May's Trade Rights Trusteeship, a certain trust owning*1151 valuable trademarks and rights used by the May Drug Company under a license agreement.

4. On March 1, 1913, the May Drug Company had a surplus from prior earnings of $134,857.10.

5. The net surplus as of December 19, 1922, of the May Drug Company was $508,748.39. On the last mentioned date the May Drug Company issued a stock dividend of 50,000 shares of preferred stock of a par value of $10 per share. The book surplus, after the payment of such stock dividend, was $8,748.39.

6. The market or fair value of each share of preferred stock at the time of the declaration of said stock dividend was $10.

7. On May 4, 1927, each of the first four named petitioners was the owner of 1,255 shares of the common stock of May Drug Company, 6,275 shares of the preferred stock of May Drug Company, and 25,100 shares of May's Trade Rights Trusteeship.

8, On May 4, 1927, each of the four petitioner first named sold one-half of the securities referred to in the preceding paragraph or 627.5 shares of said common stock, 3,137.5 shares of said preferred stock, and 12,550 shares of said May's Trade Rights Trusteeship, for the sum of $213,350.

9. In their income-tax returns for 1927, *1152 each of the four petitioners first named excluded from taxable income such part of the profits realized upon the sales of the shares of stock made on May 4, 1927, as represented such portion of the surplus on March 1, 1913, as was claimed to be included in the stock dividend paid in 1922,

10. The respondent in the determination of the deficiencies involved in the first four petitions disallowed the exclusion from gross income of any portion of the profits claimed to have been reflected by the stock dividend and computed the gains in accordance with his regulations.

11. In the case of Estelle May Affelder, Docket No. 55809, the petitioner under the residuary clause of the will of her father, Barney May, received in distribution from his estate on January 15, 1923, 200 shares of the common stock of May Drug Company, and on April 18, 1927, 1,000 shares of the preferred stock of said company and 4,000 shares of May's Trade Rights Trusteeship, and on May 4, 1927, sold 53.575 per cent of the aforesaid securities for the sum of $30,524.68.

12. In the case of Herbert L. May, Docket No. 55810, the petitioner was the owner prior to March 1, 1913, of 800 shares of the *1416 *1153 common stock of the May Drug Company and 13,500 shares of May's Trade Rights Trusteeship. Under the residuary clause of the will of his father, Barney May, he received a distribution from his estate on January 15, 1923, of 200 shares of the common stock of May Drug Company, and on April 18, 1927, 1,000 shares of the preferred stock of said company and 4,000 shares of May's Trade Rights Trusteeship. On May 4, 1927, this petitioner was the owner of 233 1/3 shares of common stock and of 5,250 shares of preferred stock of the May Drug Company, and of 17,500 shares of May's Trade Rights Trusteeship. On May 4, 1927, he sold the same fractional part of each class of the above named securities for the sum of $108,405.20.

13. In the determination of deficiencies in the case of the two petitioners last mentioned, the respondent used as the basis the fair market value on the date of the death of their father of the securities received from his estate in determining profits upon the sales of fracional parts of their holdings in 1927.

OPINION.

1. $2.522 per share of the amount realized from the sale of the shares of the points as supported by the evidence introduced at the hearing.

*1154 1. $2,522 per share of the amount realized from the sale of the hsares of the preferred stock of the May Drug Company represented a distribution of earnings of the company accumulated prior to March 1, 1913, and should be deducted from the amount realized through the sale in determining the gain incurred in said sale.

2. The base or cost value of the property which came to taxpayers, Herbert L. May and Estelle May Affelder, from the estate of their father, Barney May, deceased, should be the value as of the date of the actual distribution to them, and, particularly, on the preferred stock dividend of the May Drug Company which was not declared or created until two years after the death of their father.

As we understand the pleadings in these proceedings the petitioners do not question the accuracy of the respondent's computations, provided the principles invoked by him are correct. The petitioners contend that they are not correct in the two particulars above pointed out, namely, that inasmuch as the May Drug Company had a surplus of $134,867.10 on March 1, 1913, and the declaration of the stock dividend in December, 1922, impinged upon that surplus to the extent of $126,108, *1155 a portion of the profit realized upon the sales of the preferred stock in 1927 must be held to be taxexempt income; secondly, that the respondent has used as the value of stock inherited from the father of the two petitioners last named the value thereof on the date of the death of their father, rather than the value of those shares at the time actually received by them.

*1417 The contention of the petitioners that a stock dividend distributes any part of the assets of a corporation to the stockholders is without foundation. The point was settled by the Supreme Court in , in which the court said: "A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interest of the stockholders. Its property is not diminished and their interests are no increased. The proportional interest of each stockholder remains the same." This observation is fundamental and was the basis of the decision of the court in , in which it was held that the declaration of a stock dividend which represents surplus profits transferred to the capital account is*1156 not taxable income within the meaning of the Income Tax Act of 1913. In , we held that where a corporation in 1920 declared and paid a stock dividend, the par value of which exceeded the earnings or profits of such corporation accumulated since February 28, 1913, and thereafter in 1920 declared and paid a cash dividend in an amount less than the amount of such earnings or profits, the cash dividend is deemed to have been made from earnings or profits accumulated subsequent to February 28, 1913. This decision was predicated upon the determination that the stock dividend distributed nothing to the stockholders. The assets of the corporation remained the same after the payment of the stock dividend as before. All that happens by the declaration and payment of a stock dividend is that the stockholder's interest in the corporation, not increased or diminished thereby, is represented by a larger number of shares. The basis of the Supreme Court's holding that the recipient of the stock dividend receives no net income is that the stock dividend distributes nothing to the stockholder.

*1157 Applying the above mentioned, well established principle to the proceedings at bar, it must be held that the stock dividend declared in December, 1922, did not serve to distribute anything to the stockholders and did not render any part of the profit received on the sale of shares tax-exempt income. Cf. Case et al.,. So far as appears, the Commissioner has applied the principles for the computation of the gain in accordance with . He has treated the stock dividend simply as a dilution of shares of stock held by each of the petitioners and has reduced the base in accordance with the above mentioned case and his regulations. The respondent's method of computing profits upon the sales of the securities is therefore approved.

The only other question in issue in the last two docket number is whether the respondent has correctly used the date of the death *1418 of Barney May (February 12, 1921) as the basic date for determining the fair market value of the securities sold. The petitioners contend that this is not the correct date, at least on the preferred stock*1158 sold, since the preferred stock sold was declared as a stock dividend subsequent to the death of Barney May.

It must be held, in accordance with the decision of the Supreme Court in , that the date of acquisition of the petitioners' interests in the shares of stock acquired from their father's estate was the date of the death of the decedent. That case is decisive of the issue involved. So far as appears the respondent correctly determined the deficiencies of the petitioners in accordance with

Judgment will be entered for the respondent.