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Estate of Helen Baker Jenner v. Commissioner of Internal Revenue

decided: June 16, 1978.


Appeal from the United States Tax Court.

Fairchild and Bauer, Circuit Judges, and Jameson,*fn* Senior District Judge.

Author: Jameson

JAMESON, Senior District Judge.

The executor of the estate of Helen Baker Jenner, deceased, appeals from a decision of the Tax Court holding that the commission the estate paid to the underwriters for the public sale of a large block of stock through a registered secondary offering was not a deductible administrative expense under section 2053(a)(2) of the Internal Revenue Code of 1954.*fn1 1977 T.C. Memo 54, 36 T.C.M. (CCH) 241 (1977). This court has jurisdiction pursuant to section 7482 of the Code. We reverse.

Factual Background

Helen Baker Jenner, a resident of Illinois, died testate on March 24, 1971. The decedent owned 226,800 shares of the common stock of Baker, Fentress & Co. (B-F) and 53,760 shares of the common stock of Consolidated Finance Corporation (CFC). B-F and CFC were closed-end investment companies registered with the Securities and Exchange Commission (SEC). B-F was the largest shareholder in CFC, and both were controlled by interlocking management. B-F stock was not traded publicly, while CFC was traded in a thin over-the-counter market.

Prior to decedent's death, B-F and CFC had resolved to merge CFC into B-F. The merger was completed, with SEC approval, on or about March 31, 1971. Following the merger the estate held 319,347 shares of B-F, representing more than 11% of the stock outstanding.

During the course of administration, the executor concluded that in order to satisfy debts, taxes, and expenses of the estate and effect distributions it would be necessary to raise an additional $5,800,000 to $8,800,000 in cash. The executor decided to sell 300,000 shares of the B-F stock to obtain the necessary funds. Because of the large number of shares and the large percentage that block represented of the total outstanding stock, the executor determined, after conferring with brokerage firms, that the only viable method for selling the stock would be through a registered secondary offering.*fn2 On May 11, 1972, the executor entered into a firm commitment*fn3 underwriting agreement with Blyth & Co., Inc., which represented an underwriting syndicate of 69 other underwriters.

Under the terms of the underwriting agreement, the estate agreed to deliver to the underwriters a total of 300,000 shares of B-F stock and the underwriters agreed to pay the estate $38.85 per share. The estate was obligated to pay all costs and expenses incident to registration of the offering with the SEC and under state Blue Sky laws. The agreement also provided that the underwriters unilaterally could terminate the contract in the event of certain enumerated contingencies, including, inter alia, a "material adverse change" in the net asset value of B-F between the date of the most recent prospectus and the proposed date of sale.

Although it is clear that the stock was to be offered to the public at $42.00 per share, there is nothing in the underwriting agreement which fixes that amount. Nor is there any requirement that the estate pay the underwriters a commission or discount. However, the registration statement, which was dated the same day as the agreement, listed the price to the public as $42.00 for a total sales figure of $12,600,000.*fn4 The registration statement also reported that there was an "Underwriting discount" of $3.15 per share, so that the "Proceeds to the Selling Stockholder" would amount to $38.85, which equals the per share figure stated in the underwriting agreement.

On May 17, Blyth delivered to the executor a check for $12,600,000, representing the total paid by the public for the 300,000 shares at $42.00 per share. The executor, in return, delivered a check for $945,000 to Blyth. The receipt for that check describes the payment as an "Underwriting discount of $3.15 per share in connection with public offering of 300,000 shares of Baker, Fentress & Company common stock." The executor also paid other incidental costs of the offering amounting to $236,170.32. In its accounting to the probate court, the executor reported both the $945,000 and the $236,170.32 as expenses of the secondary offering, making a total of $1,181,170.32. The Probate Division of the Circuit Court of Cook County, pursuant to Illinois law, approved the accounting, including the total expenditures for the public offering of the stock, on May 1, 1973.

The Commissioner has conceded that the incidental expenses of $236,170.32 were properly deducted. The deduction of $945,000 paid to Blyth was denied by the Tax Court.

The Tax Court Decision

The Tax Court found that the deductibility of the underwriters' discount or commission was controlled by its decision in Estate of Marcellus F. Joslyn, 63 T.C. 478 (1975). (Joslyn II). In that case the Tax Court had denied the deduction of the underwriters' discount on the sale of a large block of stock through, as here, a registered secondary offering made pursuant to a firm commitment underwriting agreement. The Tax Court in Joslyn II viewed the transaction as a sale to the underwriters and the discounted amount as the ...

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