Lentz v. Commissioner , 28 T.C. 1157 ( 1957 )

George J. Lentz and Genevieve Lentz, et al., ¹ Petitioners, v. Commissioner of Internal Revenue, Respondent

Lentz v. Commissioner

Docket Nos. 59044, 59045, 59046, 59081

United States Tax Court

28 T.C. 1157; 1957 U.S. Tax Ct. LEXIS 93; 1957 WL 1147;

September 13, 1957, Filed

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">*93 Decisions will be entered under Rule 50.

Upon the liquidation of Huntoon, Paige and Company, Inc., rights to receive future commissions, contingent upon the completion of commitment contracts arranged by the company, were distributed to the stockholders. These rights had no ascertainable fair market value at the time of liquidation. Held, the commissions, when realized, were capital gain to the stockholder-distributees.

Samuel Markowitz, Esq., and James E. O'Kane, Esq., for the petitioners.

Joseph F. Lawless, Jr., Esq., for the respondent.

Van Fossan, Judge.

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VAN FOSSAN

">*1157 The Commissioner">*94 determined deficiencies in the petitioners' income tax as follows:

	1950	1951	1952	Total
Lentz	$ 2,928.28	$ 12,057.46	$ 761.70	$ 15,747.44
Huntoon	3,078.02	12,616.94	804.28	16,499.24
Russell	3,587.87	13,032.70	862.50	17,483.07
King	3,049.40	12,283.82	389.46	15,722.68

The sole question presented is whether amounts received by stockholder-distributees of a liquidated corporation, under contingent rights to future commissions distributed as liquidating dividends, constituted capital gain or ordinary income.

Other issues were stipulated to turn upon the decision of the principal question. Effect will be given to these stipulations in the computation under Rule 50.

FINDINGS OF FACT.

Most of the facts were stipulated. The stipulation and attached exhibits are incorporated herein by this reference.

">*1158 Petitioners George J. Lentz and Genevieve Lentz, husband and wife, are individuals residing in Glen Rock, New Jersey. They filed joint income tax returns with, and paid taxes in the amounts reported thereon to, the collector of internal revenue for the second district of New York for each of the years 1950 and 1951, and with the director of internal">*95 revenue for the lower Manhattan district of New York for the year 1952.

Petitioners Josiah P. Huntoon and Lila G. Huntoon, husband and wife, are individuals residing in Oakland, New Jersey. They filed joint income tax returns with, and paid taxes in the amounts reported thereon to, the collector of internal revenue for the second district of New York for each of the years 1950 and 1951, and with the director of internal revenue for the lower Manhattan district of New York for the year 1952.

Petitioners Walter Russell and Helen Y. Russell, husband and wife, are individuals residing in Paterson, New Jersey. They filed joint income tax returns with, and paid taxes in the amounts reported thereon to, the collector of internal revenue for the fifth district of New Jersey for each of the years 1950 and 1951, and with the director of internal revenue for the district of Newark for the year 1952.

Petitioners Edward Travers B. King and Madge King are husband and wife. They filed joint income tax returns with, and paid taxes in the amounts reported thereon to, the collector of internal revenue for the second district of New York for each of the years 1950 and 1951, and with the director ">*96 of internal revenue for the lower Manhattan district of New York for the year 1952.

For convenience, George J. Lentz, Josiah P. Huntoon, Walter Russell, and Edward Travers B. King will hereinafter be designated as petitioners.

Huntoon, Paige and Company, Inc. (hereinafter sometimes referred to as company), organized under the laws of the State of New York, was incorporated on January 14, 1949. The original issued capital stock consisted of 400 shares of common capital stock with a par value of $ 10 a share. Each of the petitioners, as stockholders, paid $ 10,000 into the treasury of the company -- $ 1,000 in exchange for stock and $ 9,000 as paid-in capital surplus. Consequently, the petitioners each owned 25 per cent of all the issued capital stock.

The company engaged in the business of acting as real estate broker in the sale of mortgages insured by the United States Federal Housing Administration (hereinafter referred to as F. H. A.) or guaranteed by the United States Veterans' Administration (hereinafter referred to as V. A.).

The business was conducted as follows. From time to time owners of real estate first mortgages on apartment houses, proposed homes, and ">*1159 homes">*97 under construction, which were to be insured by the F. H. A. or to be guaranteed by the V. A., desired to dispose of these instruments to eligible purchasers. Savings banks, insurance companies, and other purchasers eligible under the law desired to acquire such mortgages. The company, acting as an intermediary, submitted offerings of such mortgages from prospective sellers to prospective purchasers. If the purchaser and seller reached an agreement for a purchase and assignment they exchanged writings, usually called a "commitment." In this commitment the seller or the purchaser agreed to pay the company, as a commission for its services, a fee of either one-quarter or one-half per cent of the unpaid principal of the mortgages, calculated as of the time of delivery and payment. This commission was not payable until the buildings were completed, the insured or guaranteed mortgages placed, and purchaser's conditions, such as credit approval, title search, legal approval, and the like, satisfied. Payment was further contingent upon assignment and delivery of the mortgages to the ultimate purchaser and payment by the purchaser to the seller. No enforcible liability to the company">*98 for commissions arose until actual delivery and payment. Before delivery of the mortgages either the seller or the purchaser could cancel the commitment without liability to the company. The company was not required to perform any substantial service after the commitment was made.

A memorandum ledger of the commitments to which the company was a party was kept, but no value was assessed to them. There was no entry made on the general books of account until the mortgages were delivered and paid for and the commissions paid. The commissions were then taken into income on the company's books in accordance with the cash method of accounting and were reported on its income tax returns in conformity with the cash method for each year.

The business was carried on by the company from its main office in New York, New York, by its New England representative in Worcester, Massachusetts, and by its west coast representative in Los Angeles, California. In all, it transacted business or made sales contacts in at least 20 States.

On November 15, 1950, the company was liquidated and dissolved by its stockholders. A certificate of dissolution was issued by the secretary of state of the State">*99 of New York on January 5, 1951.

Directly after the liquidation of Huntoon, Paige and Company, Inc., a partnership, Huntoon, Paige and Company, was organized to carry on the business. The partnership consisted of the four former stockholders of Huntoon, Paige and Company, Inc., plus a fifth partner, Philip O'Connell.

As of November 15, 1950, all the company's assets, subject to its liabilities, were distributed in kind as liquidating dividends to its ">*1160 stockholders in exchange for all of its stock. These liquidating dividends were reported by the company on Treasury Form 1099 L, filed in February 1951. Each petitioner, as a stockholder, received a liquidating dividend consisting of 25 per cent of the total cash of $ 31,061.15 and other net assets having a total fair market value of $ 27,375.18 as follows:

	Cash and
	other net assets
	having fair market
Stockholder	value
George J. Lentz	$ 14,609.08
Josiah P. Huntoon	14,609.09
Walter Russell	14,609.08
Edward Travers B. King	14,609.08
Total	58,436.33

Also included in the distribution were certain rights to receive future commissions from commitments made prior to, but culminating in completed mortgage">*100 transactions after, the liquidation of the company. The right to receive these future commissions was assigned to the petitioners, as stockholders, in equal parts. At the time of the liquidation on November 15, 1950, these rights to receive future commissions had no ascertainable fair market value.

Following the dissolution of the company the petitioners opened a bank account in their names. They also maintained a general ledger, a memorandum ledger, and general books of account. As the commissions came in they were deposited in the account and periodically distributed.

All of the petitioners received commissions subsequent to the November 15, 1950, liquidation upon consummation of commitments made prior to that date. These sums, less co-brokers' commissions, taxes, and other minor expenses, were reported by the petitioners as tenants in common on a partnership information return of income on Form 1065 for the period November 15 to December 31, 1950, and for each of the calendar years 1951 and 1952. All of the petitioners reported the commissions received by them in the years 1950, 1951, and 1952 as receipts from the sale or exchange of capital assets and reported the excess">*101 received over the amounts paid for their original shares of capital stock as long-term capital gains, as follows:

For the Year 1950
	Cash and	Cost of		Add: Long-term
	other net	capital stock	Long-term	capital
Stockholder	assets	of the	capital gain	gain from
	received in	company		Form 1065
	liquidation
George J. Lentz	$ 14,609.08	$ 10,000	$ 4,609.08	$ 12,439.23
Josiah P. Huntoon	14,609.09	10,000	4,609.09	12,439.22
Walter Russell	14,609.08	10,000	4,609.08	12,439.22
Edward Travers B. King	14,609.08	10,000	4,609.08	12,439.23

">*1161

For the Year 1951
George J. Lentz	$ 53,447.36
Josiah P. Huntoon	53,447.36
Walter Russell	53,447.36
Edward Travers B. King	53,447.36
For the Year 1952
George J. Lentz	$ 6,619.46
Josiah P. Huntoon	6,619.47
Walter Russell	6,619.46
Edward Travers B. King	6,619.46

In the statement attached to the notices of deficiency the respondent determined that the total amounts of $ 49,756.90, $ 213,789.44, and $ 26,477.85 received by all the petitioners during the calendar years 1950, 1951, and 1952, respectively, for commissions on mortgage commitments, constituted ordinary income.

OPINION.

">*102 The question presented is whether sums paid to stockholder-distributees of a liquidated corporation as commissions on mortgage commitments previously arranged by the corporation constituted ordinary income or capital gain, when the rights to receive these commissions were contingent upon the fruition of mortgage commitments, were distributed to the stockholders as liquidating dividends, and had no ascertainable fair market value at the date of distribution.

Petitioners were the sole stockholders of Huntoon, Paige and Company, Inc., mortgage brokers. The company arranged commitments between purchasers and sellers of mortgages, charging a commission for its services, payable when a mortgage transaction was actually concluded. The company did not engage in the purchase or sale of mortgages. Its work was substantially completed when the commitments were arranged.

On November 15, 1950, the company was liquidated and its assets distributed to the stockholders. Among the dividends distributed were contingent rights to future commissions on mortgage transactions, the commitments for which had been arranged by the company prior to its liquidation but which had not theretofore culminated">*103 in completed sales. These rights to receive future commissions had no ascertainable fair market value at the time of liquidation. All of the stockholders received commissions subsequent to November 15, 1950, upon consummation of some of these commitments. Each of the stockholders reported the sums realized as long-term capital gains.

">*1162 The petitioners contend that under section 115 (c), I. R. C. 1939, ² the exchange of their stock for the assets of Huntoon, Paige and Company, Inc., resulted in capital gain and, since the rights to receive future commissions had had no ascertainable fair market value, the subsequent receipts were simply additional capital gain from the liquidation. We agree with this contention.

">*104 It has been repeatedly held that when contractual rights having no ascertainable fair market value are received in exchange for stock, no gain is realized until payments exceed the cost basis and thereafter the payments are fixed as capital gains. J. C. Bradford, 22 T.C. 1057 (1954); Westover v. Smith, 173 F.2d 90 (1949); Susan J. Carter, 9 T.C. 364, affd. 170 F.2d 911 (1948). The foundation stone of these cases is Burnet v. Logan, 283 U.S. 404">283 U.S. 404 (1931).

In the above-cited cases the rights to receipt of future payment were subject to a contingency which rendered their value unascertainable. In each, nothing remained to be done by the company to earn the sums involved, but the amounts to be received were contingent upon an act or acts to be performed by others.

It is this factor of unascertainable valuation which caused the courts to hold the liquidation transactions open until the returns were received, thus allowing an accurate monetary valuation to be affixed to the rights. Westover v. Smith, supra;">*105 283 U.S. 404">Burnet v. Logan, supra.

In the instant case the contingency involved the completion of mortgage transactions by others, pursuant to commitments arranged by Huntoon, Paige and Company, Inc. This situation falls clearly within the limits of the above decisions. It is immaterial that the rights to future commissions did not acquire a mantle of enforcibility until the mortgage transactions were completed.

Therefore, following the theory first advanced in 283 U.S. 404">Burnet v. Logan, supra, the subsequent receipt of commissions by the stockhold-distributees should be treated as part of the liquidation transaction.

Since the total value of cash and assets previously received by the distributees exceeded the cost basis of their stock, the total amount of ">*1163 the commissions received later constituted capital gain. Sec. 111 (a), I. R. C. 1939. ³

">*106 The organization of a partnership to carry on the brokerage business does not defeat the petitioners' claim. Addition of a new member was sufficient reason for a change in form of the business organization.

Mace Osenbach, 17 T.C. 797, affd. 198 F.2d 235 (1952), relied upon by the respondent, held a corporate liquidation to be a closed transaction and amounts subsequently received under contractual rights to be ordinary income. The case is not in point. The liquidation in that case was carried out under section 112 (b) (7), an elective provision providing for the postponement of recognition of capital gain. That section is not involved here.

Jud Plumbing & Heating, Inc. v. Commissioner, 153 F.2d 681 (1946), and United States v. Lynch, 192 F.2d 718 (1951), certiorari denied 343 U.S. 934">343 U.S. 934, also cited by the respondent, can be distinguished on their facts. Huntoon, Paige and Company, Inc., operated on the cash method of accounting. The Jud Plumbing case involved the completed contracts method and the Lynch case the ">*107 accrual method. In both, the right to receive income was fixed, and in the Jud case income had already been received.

Lee v. Commissioner, 119 F.2d 946 (1941), and Fairbanks v. United States, 306 U.S. 436">306 U.S. 436 (1939), can also be distinguished on their facts.

We hold that the amounts received by petitioners during the years 1950, 1951, and 1952 as commissions on mortgage commitments constituted capital gains.

Decisions will be entered under Rule 50.

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Footnotes

• 1. Proceedings of the following petitioners are consolidated herewith: Josiah P. Huntoon and Lila G. Huntoon, Docket No. 59045; Walter Russell and Helen Y. Russell, Docket No. 59046; Edward Travers B. King and Madge King, Docket No. 59081.↩

• 2. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.

  (c) Distribution in Liquidation. -- Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111↩, but shall be recognized only to the extent provided in section 112. In the case of amounts distributed (whether before January 1, 1939, or on or after such date) in partial liquidation (other than a distribution to which the provisions of subsection (h) of this section are applicable) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits. * * *

• 3. SEC. 111. DETERMINATION OF AMOUNT OF, AND RECOGNITION OF, GAIN OR LOSS.

  (a) Computation of Gain or Loss. -- The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.↩