Miller Bros. Elec., Inc.
v.
Comm'r of Internal Revenue

Tax Court of the United States.Jan 31, 1968
49 T.C. 446 (U.S.T.C. 1968)
49 T.C. 446T.C.

Docket No. 6431-65.

1968-01-31

MILLER BROS. ELECTRIC, INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Dermot R. Long, for the petitioner. Roger Rhodes, for the respondent.


Dermot R. Long, for the petitioner. Roger Rhodes, for the respondent.

Under California law, community property transferred to a partnership becomes specific partnership property and loses its character as community property. In 1962, a partnership, which had been capitalized in 1954 with community property, transferred all of its assets to petitioner in exchange for all of petitioner's stock which was issued to the partners in their individual names. Held, sec. 351, I.R.C. 1954, applies, and petitioner is not entitled to a stepped-up basis for the transferred assets.

FEATHERSTON, Judge:

Respondent determined deficiencies in petitioner's Federal corporate income tax as follows:

+---------------------------+ ¦Taxable ¦ ¦ +--------------+------------¦ ¦year ended ¦Deficiency ¦ +--------------+------------¦ ¦ ¦ ¦ +--------------+------------¦ ¦June 30, 1960 ¦$3,693.70 ¦ +--------------+------------¦ ¦June 30, 1962 ¦4,991.92 ¦ +---------------------------+

Petitioner having conceded certain adjustments, the only issue remaining for decision is whether petitioner's basis for assets transferred by a partnership in exchange for stock plus cash should be computed by reference to the fair market value of the assets on the date of transfer, as contended by petitioner, or by reference to the partnership's basis for the assets, as contended by respondent.

FINDINGS OF FACT

Some of the facts have been stipulated and are incorporated herein by this reference.

Miller Bros. Electric, Inc. (hereinafter referred to as petitioner), filed its Federal corporate income tax returns for the fiscal year ended June 30, 1960, June 30, 1962, and June 30, 1963, with the district director of internal revenue at Los Angeles, Calif.

On or about February 15, 1954, Miller Bros. Electric Co., a partnership (hereinafter referred to as the partnership) was formed under the laws of California for the purpose of engaging in electrical contracting work. At all times relevant to this proceeding the following persons were general partners, each holding the partnership interest indicated:

In 1961 the name of the partnership was changed to Miller Bros. Leasing Co.

+-----------------------------------+ ¦ ¦Partnership ¦ +---------------------+-------------¦ ¦ ¦interest ¦ +---------------------+-------------¦ ¦Partner ¦Percent ¦ +---------------------+-------------¦ ¦ ¦ ¦ +---------------------+-------------¦ ¦Douglas E. Miller, Sr¦5 ¦ +---------------------+-------------¦ ¦Josie E. Miller ¦5 ¦ +---------------------+-------------¦ ¦Douglas E. Miller, Jr¦45 ¦ +---------------------+-------------¦ ¦John B. Miller ¦45 ¦ +-----------------------------------+

Douglas E. Miller, Sr., and Josie E. Miller were the parents of Douglas E. Miller, Jr., and John B. Miller. Prior to the formation of the partnership, and at all times relevant to this proceeding, Douglas E. Miller, Jr., was married to Gene Miller, and John B. Miller was married to Helen Miller. All property contributed by the brothers to the partnership was community property under the laws of California.

The partnership business became successful, and the partners decided that it would be advantageous to transact business as a corporation. Accordingly, they caused the petitioner to be incorporated under the laws of California on or about April 25, 1959. The initial capitalization was 1,000 shares of stock with a par value of $10 per share, or a total sum of $10,000. The stock was issued on September 21, 1959, in the following names and amounts:

+---------------------------------+ ¦ ¦Number of ¦ +---------------------+-----------¦ ¦Name ¦shares ¦ +---------------------+-----------¦ ¦ ¦ ¦ +---------------------+-----------¦ ¦Douglas E. Miller, Sr¦50 ¦ +---------------------+-----------¦ ¦Josie E. Miller ¦50 ¦ +---------------------+-----------¦ ¦Douglas E. Miller, Jr¦450 ¦ +---------------------+-----------¦ ¦John B. Miller ¦450 ¦ +---------------------------------+

At all times material to this proceeding the 1,000 shares remained in the names set forth above. No other stock was issued until after September 13, 1962.

By letter dated December 18, 1961, the partnership offered to ‘sell’ to the petitioner its operating assets for the total sum of $62,281.73, that being the asserted fair market value of the assets as of that month. Payment was to be effectuated by the payment of cash in the sum of $2,281.73 to the respective partners in their partnership-ownership percentage, with the balance of $60,000 to be paid by the issuance of 6,000 shares of corporate stock at a par value of $10 per share, to be delivered to the individual partners in amounts determined by their partnership-ownership percentages. This ‘offer’ was ‘accepted’ by the petitioner, and the books and records of both the partnership and the petitioner reflect that as of January 2, 1962, all operating assets of the partnership were transferred to the petitioner.

It was intended that the assets of the partnership be transferred in exchange for stock in the petitioner. However, the stock could not be issued until approval was obtained from the California corporation commissioner. Pending such approval the petitioner set up an account payable in the amount of $62,281.73.

On July 31, 1962, the petitioner filed an application with the California corporation commissioner for a permit to issue 6,000 shares of $10 par value stock to the shareholders (this being in addition to the initial capitalization of 1,000 shares).

On September 13, 1962, the California corporation commissioner issued a permit authorizing the issuance to Douglas E. Miller, Jr., John B. Miller, Douglas E. Miller, Sr., and Josie E. Miller an aggregate of not to exceed 6,000 shares of stock.

On September 17, 1962, 6,000 shares of stock of the petitioner were issued in the following names and amounts:

+---------------------------------+ ¦ ¦Number of ¦ +---------------------+-----------¦ ¦Name ¦shares ¦ +---------------------+-----------¦ ¦ ¦ ¦ +---------------------+-----------¦ ¦Douglas E. Miller, Jr¦2,700 ¦ +---------------------+-----------¦ ¦John B. Miller ¦2,700 ¦ +---------------------+-----------¦ ¦Douglas E. Miller, Sr¦300 ¦ +---------------------+-----------¦ ¦Josie E. Miller ¦300 ¦ +---------------------------------+

As of January 2, 1962, the following entry was made in the general journal of the partnership:

+---------------------------------------------------------------+ ¦Advance from corporation ¦$2,281.73 ¦ ¦ +----------------------------------+------------+---------------¦ ¦Investment—account 122 ¦60,000.00 ¦ ¦ +----------------------------------+------------+---------------¦ ¦Sale of capital assets ¦ ¦$62,281.73 ¦ +---------------------------------------------------------------¦ ¦“To record sale of all equipment to Miller Bros. Electric, Inc”¦ +---------------------------------------------------------------+

Although the partnership ceased doing business and became inactive following the transfer of its operating assets on January 2, 1962, its books and records were never completely closed out. As of the date of the trial of this case, account No. 122 ‘Investments' reflects the following:

+--------------------------------------------+ ¦40 shares California Investing ¦$490.85 ¦ +----------------------------------+---------¦ ¦Guaranty Trust New York ¦100.00 ¦ +----------------------------------+---------¦ ¦Miller Bros. Electric, Inc., stock¦10,000.00¦ +----------------------------------+---------¦ ¦United Service Fund ¦500.00 ¦ +----------------------------------+---------¦ ¦Miller Bros. Electric, Inc., stock¦60,000.00¦ +----------------------------------+---------¦ ¦ ¦71,090.85¦ +--------------------------------------------+

The final Federal tax return (Form 1065) of the partnership was filed for the year 1962. The only income reflected on that return resulted from the alleged sale of the partnership assets to the petitioner.

In making the transfer in question, the partners intended that the business previously conducted by the partnership would be transferred to the petitioner, and that the partnership would then cease to exist.

The adjusted basis of the assets transferred by the partnership on January 2, 1962, was $21,701.54. On its partnership tax return for 1962, the partnership reported long-term capital gain in the amount of $40,580.19.

On its Federal corporate income tax return for fiscal year ending June 30, 1962, petitioner deducted depreciation and amortization in the amount of $15,948.65. Depreciation on the assets transferred from the partnership was computed on the basis of the fair market value of the assets rather than from the adjusted basis of the partnership.

On its Federal corporate income tax return for fiscal year ending June 30, 1963, petitioner deducted $20,784.49 for depreciation. Depreciation on the assets transferred from the partnership was computed on the basis of the fair market value of the assets rather than from the adjusted basis of the partnership. The petitioner reported a loss for this fiscal year, and its application for loss carryback to fiscal year ending June 30, 1960, was tentatively approved.

Respondent's notice of deficiency disallowed a portion of the depreciation claimed on the following grounds:

It is determined that automotive equipment and shop equipment acquired January 2, 1962 from Miller Bros. Electric Company, a co-partnership, was received in a transaction to which section 351 applies and therefore the basis for depreciation of such equipment, as set forth in section 362, is the same as it was in the hands of the transferor on such transfer.

+----------------------------------------------------------------------------+ ¦Adjusted basis of trucks in hands of transferor ¦ ¦$14,400.73¦ +-------------------------------------------------------+---------+----------¦ ¦Adjusted basis of shop equipment in hands of transferor¦$7,300.81¦ ¦ +-------------------------------------------------------+---------+----------¦ ¦Gain recognized to transferor ¦2,281.73 ¦9,582.54 ¦ +-------------------------------------------------------+---------+----------¦ ¦Your basis as corrected ¦ ¦23,983.27 ¦ +----------------------------------------------------------------------------+

OPINION

Under section 351 of the 1954 Code, no gain or loss is recognized if property is transferred to a corporation solely in exchange for stock or securities and the transferors are in control of the corporation immediately after the transfer. If section 351 would apply but for the receipt of money or other property by the transferors, then gain is recognized to the extent of the money received plus the fair market value of the property received.

SEC. 351. TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.(a) GENERAL RULE.— No gain or loss shall be recognized if property is transferred to a corporation (including, in the case of transfers made on or before June 30, 1967, an investment company) by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation. For purposes of this section, stock or securities issued for services shall not be considered as issued in return for property.(b) RECEIPT OF PROPERTY.— If subsection (a) would apply to an exchange but for the fact that there is received, in addition to the stock or securities permitted to be received under subsection (a), other property or money, then—(1) gain (if any) to such recipient shall be recognized, but not in excess of— (A) the amount of money received, plus (B) the fair market value of such other property received; and(2) no loss to such recipient shall be recognized.

‘Control,‘ for purposes of section 351, is defined by section 368(c) as ownership of stock possessing at least 80 percent of the voting power of the voting shares, plus 80 percent of the total number of shares of all other classes.

SEC. 368. DEFINITIONS RELATING TO CORPORATE REORGANIZATIONS.(c) CONTROL.— For purposes of part I (other than section 304), part II, and this part, the term ‘control’ means the ownership of stock possessing at lease 80 percent of the total combined voting power of all classes of stock entitled to vote and at lease 80 percent of the total number of shares of all other classes of stock of the corporation.

Where section 351 applies, the basis of property transferred to a corporation, under section 362, is the basis of the property to the transferors, increased by the amount of gain recognized. Where section 351 does not apply, the basis of the transferred property, as a general rule, is the fair market value of the transferred property.

SEC. 362. BASIS TO CORPORATIONS.(a) PROPERTY ACQUIRED BY ISSUANCE OF STOCK OR AS PAID-IN SURPLUS.— If property was acquired on or after June 22, 1954, by a corporation—(1) in connection with a transaction to which section 351 (relating to transfer of property to corporation controlled by transferor) applies, or(2) as paid-in surplus or as a contribution to capital,then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain recognized to the transferor on such transfer.

Petitioner contends that the transfer of the specific assets of the Miller Bros. Leasing Co. partnership was a transaction to which section 351 does not apply because the 80 percent control provisions were not met. Its argument is based on the provisions of the California partnership and community property laws.

The general rule in California is, of course, that property purchased with community funds is community property. This general rule, however, is modified by the California version of the Uniform Partnership Act which provides that ‘A partner is co-owner with his partners of specific partnership property holding as a tenant in partnership’ and that ‘A partner's right in specific partnership property * * * is not community property.’ Cal. Corp. Code secs. 15025(1) and 15025(2)(e). The community property exception in section 15025(2)(e) as to specific partnership assets does not apply, however, to corporate stock acquired with community funds. Such stock is community property, and a wife has an interest ‘present, existing and equal’ to that of her husband, regardless of the name of the stock certificate. See Cal. Civ. Code sec. 161a.

As petitioner views the transaction, the Miller brothers, as tenants in partnership, owned 90 percent of the specific partnership property transferred to the corporation. When this property was transferred, the brothers received 90 percent of the corporate stock as individuals. Since the stock was not issued to the partnership but rather to the individual partners, the wives of the partners through the California community property laws had an immediate undivided one-half interest in the stock. Thus, petitioner concludes, the brothers owned only 45 percent of the stock, less than the amount required to constitute ‘control’ under section 351.

But there are fatal defects in petitioner's argument. As the California courts have interpreted Corporations Code section 15025(2)(e), the effect of a transfer of community property to a partnership is merely to suspend the wife's interest in such property as long as the assets remain in the partnership. In re Duncan's Estate, 9 Cal.2d 207, 70 P.2d 174 (1937). In exchange for this temporary loss of her interest in the specific assets she acquires an interest in her husband's share in the partnership. See Hill v. Hill, 82 Cal.App.2d 682, 187 P.2d 28 (Dist. Ct. A-p., 2d Dist. (1947)); Rosenthal v. Rosenthal, 240 Cal.App.2d 927, 50 Cal.Rptr. 385 (Dist. Ct. App., 2d Dist.(1966)). The purpose of the ‘suspension’ is simply to prevent disruption of the partnership business if the marital state is dissolved by divorce or by death of the wife. When the assets leave the partnership the reason for the exception of California Corporation Code section 15025(2)(e) ceases, and the community property status of such assets reattaches instanter.

Petitioner's argument thus fails to recognize that when the property moved from the partnership to the petitioner it moved as community property. See In re Duncan's Estate, supra. The group of owners of the transferred property at the time of the transfer included the wives of the partners, and this is true as to the funds used to purchase the stock as well as the assets transferred. This group, petitioner concedes, owned the stock of petitioner immediately after the transfer. The control requirement of section 351 was therefore met, and the section applies regardless of the intent of the transferors and the transferee. Houck v. Hinds, 215 F.2d 673 (C.A. 10, 1954); Gus Russell, Inc., 36 T.C. 965 (1961).

Even if we accept petitioner's argument that the wives were not part of the transferor group we think the same result would be reached under partnership law, for while it is within the power of partners to convert firm property into individual property, Cal. Corp. Code sec. 15008, such a conversion requires the joint act of all the partners. See Cal. Corp. Code sec. 15025(2)(a)-(b); Kohler v. Greenberg, 152 A.2d 552 (Md. 1959). If the transfer here is viewed as an exchange solely by the partners as tenants in partnership, the following essential components emerge: (1) Decision by the partnership to transfer its assets for stock; (2) transfer of the assets and receipt of the stock, actually or constructively, by the partnership; (3) distribution by the partnership of the stock to the partners as individuals and attachment of the wives' community interests. Thus under this approach the control requirements of section 351 would be met.

As a matter of law, we do not see how partners could transfer partnership property to a corporation in exchange for stock issued to them as individuals without either (1) a conversion of the partnership property to individual property immediately prior to transfer to the corporation, or (2) actual or constructive receipt by the partnership of the stock prior to its distribution to the individuals. In either case, the control requirements of section 351 would be met. The fact that the partnership as such never had physical possession of the stock is irrelevant for the purposes of section 351. Compare Pacific Refrigerating Co. v. Commissioner, 100 F.2d 30 (C.A. 9, 1938), affirming a Memorandum Opinion of this Court; Royal Marcher, 32 B.T.A. 76, 80-81 (1935), appeal dismissed (C.A. 2, Feb. 4, 1936).

We conclude, therefore, that the basis of the property transferred to petitioner is the basis in the hands of the transferors.

Decision will be entered for the respondent.