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WILKINS v. UNITED STATES

October 20, 1960

EDYTHE L. WILKINS, PLAINTIFF,
v.
UNITED STATES OF AMERICA, DEFENDANT.



The opinion of the court was delivered by: Mercer, Chief Judge.

Plaintiff, Edythe L. Wilkins, prosecutes this suit against the United States for a judgment for moneys allegedly overpaid by her for the taxable year 1954 pursuant to a deficiency assessment by the District Director of Internal Revenue. The cause is submitted to the court for trial without a jury upon a stipulation of facts. The only issue presented for decision is the question of the interpretation and application to the stipulated facts of the provisions of Sec. 112(b) (11) of the Internal Revenue Code of 1939, as amended, 26 U.S.C.A. (I.R.C. 1939) § 112(b) (11).

The basic facts giving rise to the deficiency assessment, and, ultimately, to this suit, arise out of the reorganization of Wilkins Pipe & Supply Co., a corporation having its principal place of business in the City of Peoria, Illinois, and hereinafter referred to as Wilkins Pipe. From 1934 to 1953, Wilkins Pipe conducted a business for the wholesaling of plumbing fixtures and supplies, industrial valves, pipes and fittings, and related products upon premises commonly known as 1008-10 South Adams Street, Peoria, Illinois. The corporation was the owner of the real estate and improvements thereon, which was used in its entirety to house the corporation's wholesale business. From 1934 until the time of his death in 1954, plaintiff's husband, Charles L. Wilkins, was either the sole shareholder or the controlling shareholder of Wilkins Pipe, and at all times material to this cause he was the sole shareholder of that corporation. Also, during that whole period of time, Mr. Wilkins actively controlled the whole of the business operation of the corporation.

On November 20, 1953, a special meeting of the board of directors of Wilkins Pipe was held, at which a resolution was adopted recommending to the shareholders of the corporation that a new corporation under the name of Charles L. Wilkins, Inc., which is hereinafter referred to as Wilkins, be organized, and that Wilkins Pipe would transfer to such new corporation all lands, buildings and nonbusiness assets of Wilkins Pipe in exchange for all of Wilkins' common stock. That resolution further provided that Wilkins Pipe would then transfer all of the stock of Wilkins to its shareholders pro rata. On the same day, at a special shareholders' meeting, Mr. Wilkins approved the recommendation of the board of directors and, thereafter, on November 23, 1953, the board of directors of Wilkins Pipe authorized certain named persons to organize a new corporation and to subscribe to its capital stock. Wilkins was then incorporated under the laws of the State of Illinois, and its board of directors, by resolution, authorized the issuance of 565 shares of common stock to Wilkins Pipe in exchange for the lands and buildings commonly known as 1008-10 South Adams Street, which had a book value of $87,202.50. That resolution also provided that the premises, when conveyed to Wilkins would be leased back to Wilkins Pipe for use in the conduct of its business. On May 7, 1954, the reorganization was completed when Wilkins Pipe delivered its warranty deed conveying the premises to Wilkins, and received as consideration therefor all of the authorized issue of Wilkins' capital stock, namely, 565 shares. The two corporations then entered into a lease agreement whereby the premises were leased back to Wilkins Pipe. Due to certain income tax adjustments, the book value of the real estate was increased, and Wilkins issued an additional 64 shares of its common stock to Wilkins Pipe to compensate the latter corporation for the increased book value.

In the meantime, and prior to the formal completion of the plan of reorganization, Mr. Wilkins died, testate, on February 20, 1954. Plaintiff, pursuant to the provisions of Mr. Wilkins' will, was appointed executor of his estate. By his will, Mr. Wilkins bequeathed all of his stock in Wilkins Pipe to plaintiff. Upon the death of Mr. Wilkins, plaintiff, first as executor of his estate, and finally as transferee of the shares of Wilkins Pipe, took over the affairs of her deceased husband, including the reorganization of Wilkins Pipe.

Simultaneously with the issuance to it of the Wilkins shares, Wilkins Pipe transferred the certificates representing such shares, i.e., for 565 shares and 64 shares, respectively, to plaintiff.

Plaintiff, as executor of the estate of Charles L. Wilkins, deceased, filed a fiduciary income tax return for the period from February 20, 1954 to December 31, 1954, but did not report any income to the estate on account of the receipt by her of the Wilkins stock. She did not report any income to herself on account of the receipt of those shares in her personal income tax returns for either of the years 1954 or 1955.

The District Director of Internal Revenue determined that plaintiff, as transferee of the Wilkins stock, had received a corporate dividend which was taxable as income under the provisions of the Internal Revenue Code. On December 29, 1958, the District Director, by 90-day letter, assessed a deficiency in the income tax paid by plaintiff for the year 1954 in the amount of $63,931.23. Thereafter, on January 14, 1959, plaintiff paid the alleged deficiency in full, together with interest thereon to January 15, 1959, to the District Director in the aggregate amount of $78,315.74. Plaintiff then filed her claim for refund of latter sum with the District Director, contending that the organization of Wilkins was a spin-off reorganization of Wilkins Pipe which was tax free under the provisions of Section 112(b) (11) of the Internal Revenue Code of 1939, as amended; her claim for refund was denied and this suit was instituted praying judgment against the United States for the amount paid by plaintiff pursuant to the deficiency assessment, plus statutory interest.

Section 112(b) (11) provides as follows:

    "(11) Distribution of stock not in liquidation. If
  there is distributed, in pursuance of a plan of
  reorganization, to a shareholder of a corporation
  which is a party to the reorganization, stock (other
  than preferred stock) in another corporation which is
  a party to the reorganization, without the surrender
  by such shareholder of stock, no gain to the
  distributee from the receipt of such stock shall be
  recognized unless it appears that (A) any corporation
  which is a party to such reorganization was not
  intended to continue the active conduct of a trade or
  business after such reorganization, or (B) the
  corporation whose stock is distributed was used
  principally as a device for the distribution of
  earnings and profits to the shareholders of any
  corporation a party to the reorganization."

The government concedes that the transaction in which Wilkins was organized was a reorganization of Wilkins Pipe within the meaning of Section 112(g)(1)(D) of the Code, 26 U.S.C.A. (I.R.C. 1939) § 112(g)(1)(D), and that Wilkins' activities of owning and leasing real estate is "the active conduct of a trade or business" within the commonly understood meaning of that phrase The reorganization here involved cannot be construed as being, principally, a device for the distribution of earnings and profits to the shareholders of Wilkins Pipe as the stipulated facts, as hereinafter further summarized, clearly reveal. The government, however, stresses the phrase "to continue" contained in exception (A) of the subsection, and contends that the tax-exemption provisions of the subsection do not apply unless the new corporation which is born in the reorganization continues the active conduct of a trade or business previously conducted by the original corporation from which the assets of the new corporation were "spun-off".

In order better to define the relationship of that issue to the stipulated facts of this case, the background of the reorganization of Wilkins Pipe is summarized as follows. At all pertinent times, Mr. Wilkins had been the sole shareholder of Wilkins Pipe. From the organization of that corporation until his death, Mr. Wilkins had assumed all responsibility for active management of the business and assets of the corporation and had operated the business, in that respect, in the manner of a sole proprietorship. In 1953 Mr. Wilkins had advanced in age, was in ill health and had been advised by his physician that his health required that he reduce his business responsibilities. At that time, also, the wholesale business of Wilkins Pipe had increased to such extent that it was deemed necessary that the burden of management be spread among a number of personnel. In that year Mr. Wilkins employed George Fry & Associates, hereinafter referred to as Fry, to make a survey of the corporation, its organization and business and to make recommendations in aid of lessening the managerial duties of Mr. Wilkins. Fry's report, based upon its survey of Wilkins Pipe, was submitted to the corporation under date of October 27, 1953. The Fry report concluded that the continued expansion and healthy operation of the business required that the younger key men of Wilkins Pipe be placed in responsible positions of management and that the ownership and operation of that corporation be broadened by the transfer of a part of the shares thereof to such younger key personnel, or to outside interests. The report further concluded that the established wholesale business was not readily saleable either to the younger personnel of the corporation or to outside interests, because the assets of the corporation were top-heavy with fixed assets, by comparison with liquid operating assets; that outside capital would be difficult, or impossible, to obtain because of the substantial proportion of total assets of Wilkins Pipe represented by the real estate which that corporation owned and occupied. The Fry report finally recommended that all land and improvements thereon be separated from the corporation, and that only the operating assets be retained. By that device, the report suggested that the capitalization of Wilkins Pipe could be lowered and thus lessen the size of the initial investment required to purchase all or a part of the operating business, and would increase the working capital available to the expansion of its business.

On November 20, 1953, the Fry report was considered by the board of directors of Wilkins Pipe and a resolution was then adopted which found its fruition in the reorganization as hereinabove summarized. Further evidence of the business nature of the whole reorganization is found in an agreement executed July 30, 1956, between plaintiff, who was then the sole shareholder of Wilkins Pipe, and five of the executives of that corporation, whereby plaintiff agreed to sell and transfer to such executives 2,300 of the 4,402 shares of Wilkins Pipe then outstanding.

With the business motive of the reorganization thus stipulated, and in the light of the government's concession that Wilkins has, since the reorganization, engaged in the active conduct of a trade or business, does the statute contain the implication that the trade or business conducted by Wilkins must be the continuation of a trade or business which had ...


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