TAXATION-FEDERAL INCOME TAX-TAX AVOIDANCE BY USE OF PREFERRED STOCK ''BAIL-OUT"

In 1946 petitioner received a pro-rata dividend of preferred stock of the distributing corporation, paid on its voting common, the only class of stock then outstanding. The dividend stock was immediately sold to certain insurance companies pursuant to prior informal agreements between the insurance companies, the corporation, and the shareholders. Provision was made for the mandatory redemption of the preferred stock over a period of eight years. The transactions were the culmination of a series of negotiations intended to eliminate the large accumulated surplus of the corporation, in order to avoid the imposition of a penalty surtax thereon.

In reporting the sale of the preferred stock in their 1946 income tax returns, petitioner and other shareholders reported their proportion of the proceeds from the sale as a net long-term capital gain, using a substituted basis as the cost basis of the preferred stock. The Commissioner's determination that the issuance of the preferred stock constituted a dividend taxable as ordinary income was affirmed by the Tax Court. On appeal, held, reversed. Despite tax-avoidance purpose and apparent prior negotiations for sale, a non-taxable stock dividend does not become a taxable cash dividend upon its sale by the recipient.

Chamberlin v. Commissioner, ( 6th Cir. 1953) 207 F. (2d) 462.