SCOTUS Reports

Tag: Written Plan Requirement

  • Rickey v. Commissioner, 54 T.C. 680 (1970): Payments in Year of Sale and Installment Method Accounting

    54 T.C. 680 (1970)

    Payments offset against a taxpayer’s debt to the purchaser in the year of sale are considered ‘payments’ received in the year of sale for the purposes of the installment method of accounting, even if the formal offset occurs after the close of the taxable year.

    Summary

    John H. Rickey sold stock in two corporations to Hyatt Corporation. The sale agreement stipulated that Hyatt would offset debts Rickey owed to the corporations (and thus to Hyatt after the acquisition) against the purchase price payments. Although the formal offset of a substantial portion of the payment was scheduled for January of the following year, the Tax Court held that this amount was constructively received in the year of sale because the debt offset was predetermined and the taxpayer never had control over those funds. As a result, payments in the year of sale exceeded 30% of the selling price, disqualifying Rickey from using the installment method of reporting gain. The court also denied ordinary loss treatment under Section 1244 for separate stock, finding the written plan requirement was not met.

    Facts

    Petitioner John H. Rickey owned all stock of Rickey Enterprises and 50% of Rickey’s Studio Inn Hotel. In 1962, Rickey negotiated to sell these stocks to Hyatt. The sale contract, executed March 31, 1962 and closed April 2, 1962, set a purchase price and payment terms. A key term involved offsetting debts Rickey and related companies owed to Enterprises and Studio Inn against the purchase price. An audit revealed Rickey owed a substantial net amount. While 29% of the purchase price was structured for payment in 1962 (cash at closing and within 30 days post-audit), a larger portion was nominally due January 2, 1963. However, due to the offset, a significant portion of the January 1963 payment was effectively cancelled against Rickey’s debt. Rickey sought to report the gain on the installment method.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in Rickey’s income tax for 1962 and 1964, disallowing installment sale treatment and ordinary loss deductions. Rickey petitioned the Tax Court. The Tax Court addressed two issues: the propriety of installment method reporting and the eligibility for ordinary loss treatment under Section 1244. The Tax Court ruled against Rickey on both issues.

    Issue(s)

    1. Whether payments received in the year of sale, including amounts offset against the seller’s debt to the buyer, exceeded 30 percent of the selling price, thereby precluding installment method reporting under Section 453.
    2. Whether the taxpayer was entitled to ordinary loss treatment under Section 1244 on the worthlessness of stock in Rick’s Swiss Chalet, Inc.

    Holding

    1. No, because the payment due January 2, 1963, was effectively received in 1962 due to the offset agreement, causing total payments in the year of sale to exceed 30% of the selling price.
    2. No, because the stock was not issued pursuant to a written plan that met the requirements of Section 1244, specifically regarding the offering period.

    Court’s Reasoning

    Installment Method: The court emphasized substance over form. It found that the deferral of the January 2, 1963 payment was a mere formality to circumvent the 30% rule. The offset mechanism ensured Rickey would never actually receive the January payment in cash; it was immediately applied to reduce his debt to Hyatt. The court quoted Commissioner v. Court Holding Co., stating, “To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress.” The court likened the situation to cases where taxpayers received constructive payments via debt cancellation or prearranged offsets in the year of sale, citing James Hammond and United States v. Ingalls. The court concluded that the $193,541.48 offset was effectively received in 1962.

    Section 1244 Loss: The court found that the corporate minutes and stock permit did not constitute a qualifying written plan under Section 1244. The resolution lacked any indication of awareness of Section 1244 or intent to offer its tax advantages. Furthermore, the plan did not specify a period, ending within two years, for offering the stock. While the permit had a termination date, it was renewable, failing to establish a definitive two-year limit from the plan’s adoption. The court cited Godart v. Commissioner, emphasizing the need for “some substantially contemporary objective evidence that the plan was adopted with ยง 1244 in view.” Such evidence was absent.

    Practical Implications

    Rickey v. Commissioner serves as a crucial reminder that the IRS and courts scrutinize the substance of transactions, especially in tax planning. For installment sales, structuring payments to fall just under the 30% threshold in the year of sale is insufficient if other aspects of the transaction indicate constructive receipt of additional payments. Debt offsets, especially prearranged ones, are treated as actual payments in the year of sale. Legal professionals must advise clients that complex payment schemes designed solely to manipulate tax outcomes are vulnerable to being recharacterized based on economic reality. For Section 1244 stock, meticulous documentation of a written plan, explicitly referencing Section 1244 and adhering strictly to the regulatory requirements regarding offering periods, is essential to ensure ordinary loss treatment for stock losses. This case reinforces the importance of clear, contemporaneous evidence of intent to comply with Section 1244 when establishing a plan to issue small business stock.

  • Godart v. Commissioner, 51 T.C. 937 (1969): Requirements for Section 1244 Stock and Ordinary Loss Treatment

    51 T.C. 937 (1969)

    To qualify for ordinary loss treatment under Section 1244, stock must be issued pursuant to a written plan that strictly adheres to statutory and regulatory requirements, including specifying a limited offering period and a maximum dollar amount the corporation can receive for the stock.

    Summary

    Pierre Godart sought to deduct an ordinary loss on worthless stock, claiming it was Section 1244 stock. The Tax Court disagreed, holding that the stock of French-American-British Woolens Corp. (FAB) did not meet the strict requirements of Section 1244. The court found that the purported written plan (lease-and-license agreement and board minutes) failed to specify a period ending within two years for the stock offering and did not state a maximum dollar amount the corporation could receive for the stock. Additionally, FAB was not considered a ‘small business corporation’ under Section 1244 due to its authorized capital stock exceeding regulatory limits.

    Facts

    Petitioner Pierre Godart, involved with T.S.M. Corp. (TSM), entered into a lease-and-license agreement with S. Stroock & Co. (Stroock) to form FAB Corp. FAB was intended to take over Stroock’s textile business and be financed by Stroock and Rusch & Co. The agreement outlined stock subscriptions: one-third to Stroock and two-thirds to Godart and TSM for $375,000. FAB was incorporated in December 1960. FAB’s corporate minutes from December 30, 1960, authorized the stock issuance to Stroock, TSM, and Godart as per the agreement. Godart received 1,000 shares, paid for by Rusch & Co., and immediately pledged the stock to Rusch & Co. as security. FAB’s stock became worthless in 1962, and Godart claimed an ordinary loss deduction.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in the petitioners’ income tax for 1962. Initially, the notice of deficiency did not adjust the claimed FAB stock loss. However, in their petition to the Tax Court, the Godarts argued that the FAB stock qualified as Section 1244 stock, entitling them to an ordinary loss. The Tax Court proceeding focused solely on whether the FAB stock met the requirements of Section 1244.

    Issue(s)

    1. Whether the stock issued by FAB Corp. to Pierre Godart qualified as ‘section 1244 stock’ under Section 1244 of the Internal Revenue Code.
    2. Whether the lease-and-license agreement and corporate minutes constituted a ‘written plan’ that met the requirements of Section 1244 and related regulations.
    3. Whether the purported written plan ‘specified’ a period for the stock offering ending not later than two years after the plan’s adoption.
    4. Whether the purported written plan ‘specifically stated, in terms of dollars, the maximum amount to be received’ by FAB for the stock.
    5. Whether FAB Corp. qualified as a ‘small business corporation’ under Section 1244 at the time of the plan’s adoption.

    Holding

    1. No, the stock issued by FAB Corp. did not qualify as Section 1244 stock.
    2. No, the lease-and-license agreement and corporate minutes, even when considered together, did not constitute a ‘written plan’ that satisfied the requirements of Section 1244 and its regulations because they were incomplete and required external references.
    3. No, the purported plan did not specify a period of offering ending within two years; the closing date reference was too indefinite and required external inference.
    4. No, the purported plan did not specifically state the maximum dollar amount FAB could receive for the stock; it only restricted stock issuance before closing but not afterward.
    5. No, FAB Corp. was not a ‘small business corporation’ because its authorized capital stock and potential offering exceeded the $500,000 limit under Section 1244 regulations.

    Court’s Reasoning

    The court strictly interpreted Section 1244 and its regulations, emphasizing that preferential ordinary loss treatment for small business stock requires strict adherence to the statutory requirements. The court found the alleged ‘written plan’ deficient in several respects. First, it failed to explicitly specify a period for the stock offering ending within two years of plan adoption. The court stated, “Nowhere in the documents petitioner calls a plan is a period of offering ‘specified’ as required by the statute and respondent’s regulation.” The reference to a closing date shortly after stockholder approval was deemed too vague and not a ‘specified period.’ Second, the plan did not state a maximum dollar amount FAB could receive for the stock. The limitation on pre-closing stock issuance did not restrict post-closing issuances, failing to cap the total offering amount. The court also determined FAB was not a ‘small business corporation’ because its authorized capital of $1,000,000, with 10,000 authorized shares, exceeded the regulatory limits for Section 1244 stock at the time, even though only 3,750 shares were initially issued. The court relied on precedent like James A. Warner and Bernard Spiegel, which similarly required strict compliance with Section 1244’s written plan requirements.

    Practical Implications

    Godart v. Commissioner underscores the necessity of meticulous planning and documentation when seeking ordinary loss treatment for small business stock under Section 1244. Attorneys advising clients on Section 1244 stock issuances must ensure the written plan explicitly and unambiguously states: (1) a period for the stock offering that ends within two years of plan adoption, and (2) the maximum dollar amount the corporation can receive from the stock issuance. Vague or implied terms, or reliance on external documents to complete the plan, are insufficient. Furthermore, careful consideration must be given to the definition of ‘small business corporation,’ particularly regarding authorized capital stock, to ensure compliance with Section 1244 requirements. This case serves as a cautionary example of how failing to strictly adhere to these formal requirements can result in the denial of ordinary loss deductions and treatment as a less favorable capital loss.