SCOTUS Reports

Tag: Assignment of Contract

  • Stavisky v. Commissioner, 27 T.C. 147 (1956): Treatment of Payments for Assignment of “When Issued” Securities Contracts

    Stavisky v. Commissioner, 27 T.C. 147 (1956)

    Payments made to assign a “when issued” securities contract are treated as sales or exchanges of capital assets, determining whether resulting losses are capital or ordinary losses.

    Summary

    The Tax Court addressed whether a payment made by a taxpayer to transfer a portion of a “when issued” stock sale contract resulted in a capital loss or an ordinary loss. The taxpayer entered contracts to buy and sell “when issued” Missouri Pacific Railroad preferred stock. Due to rising prices, he paid a third party to assume part of his selling contract. The court determined that this was a sale or exchange of a capital asset, resulting in a long-term capital loss because the initial contract was entered into before the effective date of the applicable tax code provision. The court rejected the taxpayer’s argument that the payment was merely a release from an obligation, emphasizing the bilateral nature of the contract and the transfer of rights and liabilities.

    Facts

    Meyer J. Stavisky contracted to sell 10,000 shares of “when issued” Missouri Pacific Railroad preferred stock. The following day, he contracted to buy 10,000 shares of the same stock. Due to rising prices, Stavisky was required to deposit substantial cash to meet “mark to market” requirements. In December 1951, he transferred 40% of his selling contract to Sutro Bros. & Co., paying $31,150. In January 1952, he transferred 40% of his purchase contract to Ira Haupt & Co., receiving $29,975. The reorganization plan for Missouri Pacific Railroad failed in December 1954, and the “when issued” contracts were canceled.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in the taxpayer’s 1951 income tax return, disallowing the deduction claimed for the payment to Sutro as an ordinary loss. The Tax Court reviewed the Commissioner’s determination.

    Issue(s)

    1. Whether the payment made by the taxpayer to Sutro for the transfer of a portion of the sales contract constituted a sale or exchange of a capital asset.

    2. If the transaction was a sale or exchange, whether the resulting loss was a long-term or short-term capital loss.

    Holding

    1. Yes, because the transfer of the contract rights and liabilities constituted a sale or exchange of a capital asset.

    2. Yes, because the initial contract was entered into before the effective date of the relevant provision of the Internal Revenue Code, therefore the loss was long-term.

    Court’s Reasoning

    The court rejected the argument that the payment was merely a release from an obligation, emphasizing the bilateral nature of the “when issued” contracts. The court pointed out that the taxpayer possessed both rights and obligations under the contract. The court held that the transfer of a portion of the contract’s rights and liabilities to a third party constituted a sale or exchange. The court cited I.T. 3721, a Revenue Ruling holding that transfers of rights under “when issued” contracts constitute sales or exchanges of capital assets. The court distinguished the taxpayer’s situation from a simple release from liability and applied the principle that the taxpayer had sold a portion of their contract rights. The court then analyzed the length of time the asset was held. The court found the relevant date to determine long-term versus short-term treatment was the date the initial contract was made. Since the contract was made before the 1950 Revenue Act, the loss was treated as a long-term capital loss.

    Practical Implications

    This case clarifies that payments made for the assignment of “when issued” contracts are treated as sales or exchanges. This impacts the tax treatment of such transactions. Lawyers advising clients who engage in these types of securities transactions must understand the implications of Section 117 of the Internal Revenue Code and related regulations. This means carefully analyzing when the original contract was made, and whether the transfer meets the criteria of a sale or exchange. The court’s focus on the bilateral nature of contracts has implications for similar financial instruments. Later cases dealing with assignments or sales of contractual rights would likely cite this case. Business planners and tax advisors need to understand the timing of entering into contracts and the potential tax ramifications of assignments or transfers.

  • Humphrey v. Commissioner, 1941 WL 265 (T.C. 1941): Income Tax on Assigned Contracts

    1941 WL 265 (T.C. 1941)

    A taxpayer cannot avoid income tax liability on commissions earned under a personal services contract by informally assigning the contract to a corporation he controls, especially when the contract explicitly prohibits assignment.

    Summary

    Humphrey contracted with Amoco to sell petroleum products and receive commissions. He argued that he orally assigned these contracts to his corporation, which performed the work. The Tax Court held that the commissions were taxable to Humphrey, because the contracts were explicitly non-assignable and because the arrangement functioned as a subcontract, with the corporation performing Humphrey’s duties. Humphrey was allowed to deduct payments made to the corporation as business expenses in some years, offsetting his commission income, but substantiation was required.

    Facts

    Humphrey entered into contractor’s agreements with Amoco to sell and deliver petroleum products, receiving commissions based on the amount and class of products delivered. The contracts specified that they were personal and non-assignable. Humphrey was also the president of a corporation. He claimed to have orally assigned the Amoco contracts to the corporation, which performed the contractual duties using its own employees and equipment. Humphrey endorsed the commission checks to the corporation, which reported the sums as income. The corporation paid Humphrey a salary, which was substantially increased after the alleged assignment.

    Procedural History

    The Commissioner of Internal Revenue determined that the commissions paid by Amoco were taxable income to Humphrey, resulting in deficiencies for the tax years 1937, 1938, and 1939. Humphrey contested this determination in the Tax Court, arguing that he neither earned, received, nor enjoyed the income because the contracts were assigned to his corporation.

    Issue(s)

    1. Whether commissions paid by Amoco under the contractor’s agreements constituted income to Humphrey, despite his claim of oral assignment to his corporation.
    2. Whether Humphrey was entitled to deduct from his commission income the expenses incurred by the corporation in performing the contractual duties.

    Holding

    1. Yes, because the contracts were explicitly non-assignable, and the arrangement between Humphrey and his corporation constituted a subcontract rather than a valid assignment.
    2. Yes, for the years 1938 and 1939, because the amounts paid to the corporation represented ordinary and necessary business expenses. No, for 1937, because Humphrey failed to provide sufficient evidence of such expenses.

    Court’s Reasoning

    The court reasoned that the contracts were legally non-assignable. Quoting Williston on Contracts, the court emphasized that an assignment requires the right to have performance rendered directly to the assignee, which was absent here. Amoco was not notified to send payments directly to the corporation, and reports to Amoco continued to be made in Humphrey’s name. The court found that the corporation’s performance was due to its contractual duty to Humphrey, not to Amoco, characterizing the arrangement as a subcontract. The payments to the corporation were therefore considered Humphrey’s expenses in fulfilling his contractual obligations. The court distinguished Clinton Davidson, 43 B. T. A. 576, allowing Humphrey to deduct a reasonable portion of the commissions paid to the corporation, as they were considered ordinary and necessary expenses. However, the court disallowed deductions for 1937 due to insufficient evidence. The court also upheld the Commissioner’s adjustments for travel and entertainment expenses and contributions for 1938 due to lack of substantiation.

    Practical Implications

    This case illustrates that taxpayers cannot avoid personal income tax liability by informally assigning contracts for personal services to controlled entities, particularly when the contract contains an explicit non-assignment clause. The arrangement will be scrutinized to determine whether it constitutes a true assignment or merely a subcontract. Furthermore, the case reinforces the importance of maintaining meticulous records to substantiate business expense deductions. Taxpayers must demonstrate that expenses are ordinary and necessary and that they directly relate to the earning of income. Later cases applying this ruling would likely focus on the substance of the arrangement, not just the form, to determine the proper tax treatment of income and expenses related to personal service contracts.

  • Montgomery v. Commissioner, 1 T.C. 1000 (1943): Tax Liability and Corporate Entity Recognition

    1 T.C. 1000 (1943)

    A corporation is generally treated as a separate taxable entity from its stockholders, and this distinction is disregarded only in exceptional circumstances where the corporation serves no legitimate business purpose or is a mere sham.

    Summary

    P.O’B. and Frances Montgomery created a corporation after P.O’B. secured a construction contract with the State of Texas. They assigned the contract to the corporation and gifted shares to their children. The corporation completed the work, paid taxes on its profits, and distributed dividends, which were also taxed. The Commissioner argued the corporation was a sham and the profits should be taxed to the Montgomerys. The Tax Court held the corporation was a legitimate entity, served a business purpose, and its income should be taxed accordingly, not to the Montgomerys individually.

    Facts

    P.O’B. Montgomery contracted with the State of Texas on December 30, 1935, to build a state building for $993,000.

    On July 1, 1936, the Montgomerys formed P. O’B. Montgomery, Inc., a Texas corporation.

    P.O’B. Montgomery assigned the construction contract to the corporation in exchange for the corporation assuming all losses and liabilities.

    The Montgomerys gifted 32 shares of the corporation’s stock to each of their three minor children.

    The corporation completed the building project around September 1936 and earned a profit.

    Dividends were paid to all shareholders, including the children, and taxes were paid on these dividends.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in the Montgomerys’ income tax, arguing that the profits earned by the corporation after the contract assignment should be included in the Montgomerys’ income.

    The Montgomerys petitioned the Tax Court for a redetermination of the deficiency.

    Issue(s)

    Whether the construction contract was for personal services such that it was non-assignable, thus requiring the profits to be taxed to the assignor (P.O’B. Montgomery)?

    Whether the corporate entity should be disregarded, and the corporation’s income attributed to the Montgomerys, because the corporation was merely a conduit or a sham?

    Holding

    No, because the contract was not for personal services that would make it non-assignable, and the assignment was expressly authorized by the contract terms. The profits are taxed to the assignee (the corporation).

    No, because the corporation was a legitimate entity that served a business purpose and was not merely a conduit or sham for tax avoidance.

    Court’s Reasoning

    The court reasoned the construction contract was not strictly for personal services rendering it non-assignable. The contract itself bound assignees to its covenants, implying assignability.

    The income was earned by the corporation after a valid assignment for consideration, making it taxable to the corporation, not the individual.

    The court emphasized the general rule that corporations are separate taxable entities, only to be disregarded in exceptional circumstances. The court stated, “The corporate entity may not be disregarded where the corporation serves legitimate business purposes, even including the reduction of tax liability.”

    The corporation was properly organized, had paid-in capital, issued shares of stock, and conducted business operations in a normal manner. It was more than a mere conduit, as payments were made to the corporation, and dividends were distributed to all shareholders, including the Montgomerys’ children.

    The court distinguished cases where the corporation was a mere agent or tool of the stockholder, finding that this corporation had real substance and business purpose.

    The court acknowledged that taxpayers have the right to minimize their tax liability through legal means. “[A] taxpayer has a legal right to decrease or altogether avoid tax liability by any means which the law permits…” Since the corporation was legally formed and operated, its separate existence must be respected for tax purposes.

    Practical Implications

    This case reinforces the principle that a properly formed and operated corporation is generally recognized as a separate taxable entity, even if one of the motivations for forming the corporation is tax reduction. The court focused on whether the corporation had real economic substance and served a legitimate business purpose.

    Attorneys should advise clients that forming a corporation solely for tax avoidance purposes, without any real business activity, is likely to be disregarded by the IRS. To ensure recognition of the corporate entity, it is crucial to maintain proper corporate formalities (e.g., holding meetings, keeping minutes, issuing stock), capitalize the corporation adequately, and conduct actual business activities.

    The case clarifies that assigning income-generating contracts to a legitimate corporation can shift the tax liability to the corporation, provided the assignment is valid and the corporation is not merely a sham.

    Subsequent cases often cite Montgomery for its discussion of when corporate entities can be disregarded for tax purposes. It helps define the boundary between legitimate tax planning and impermissible tax avoidance.