Fulman v. United States
434 U.S. 528 (1978)

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U.S. Supreme Court

Fulman v. United States, 434 U.S. 528 (1978)

Fulman v. United States

No. 76-1137

Argued November 29, 1977

Decided February 22, 1978

434 U.S. 528

CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

Syllabus

The provision of Treas.Reg. § 1.562-1(a) that a personal holding company's distribution of appreciated property to its shareholders results, under §§ 561 and 562 of the Internal Revenue Code of 1954, in a dividends-paid deduction limited to an amount that is the adjusted tax basis of the property in the hands of the company at the time of the distribution held valid as having a reasonable basis, as against the contention that such deduction should be equal in amount to the fair market value of the property distributed. Given the fact that § 27(d) of the Internal Revenue Code of 1939 expressly provided the "adjusted basis" measure for valuation of dividends paid in appreciated property, rather than money, and the ambiguity surrounding the legislative history of § 562 of the 1954 Code, which sets forth the rules applicable in determining dividends eligible for the dividends-paid deduction but contains no counterpart to § 27(d) of the 1939 Code, no "weighty reason" justifying setting aside the regulation in question can be identified. Pp. 434 U. S. 530-539.

545 F.2d 268, affirmed.

BRENNAN, J., delivered the opinion of the Court, in which BURGER, C.J., and STEWART, WHITE, MARSHALL, and REHNQUIST, JJ., joined. STEVENS, J., filed an opinion concurring in the judgment and concurring in part, post, p. 434 U. S. 539. POWELL, J., filed a dissenting opinion, post, p. 434 U. S. 539. BLACKMUN, J., took no part in the consideration or decision of the case.

Page 434 U. S. 529

MR. JUSTICE BRENNAN delivered the opinion of the Court.

The question presented in this case is the validity of the provision of Treas.Reg. § 1.562-1(a), 26 CFR § 1.562-1(a) (1977), that a personal holding company's distribution of appreciated property to its shareholders results, under § 561 and 562 of the Internal Revenue Code of 1954, 26 U.S.C. §§ 561 and 562, in a dividends-paid deduction limited to an amount that is "the adjusted basis of the property in the hands of the distributing corporation at the time of the distribution." [Footnote 1] The Court of Appeals for the First Circuit sustained the validity of the provision in this case, 545 F.2d 268 (1976), disagreeing with the Court of Appeals for the Sixth Circuit in H. Wetter Mfg. Co. v. United States, 458 F.2d 1033 (1972), which had concluded that the limitation on the dividends-paid deduction is invalid, and that a personal holding company is entitled to a deduction equal in amount to the fair market

Page 434 U. S. 530

value of property distributed. [Footnote 2] We granted certiorari to resolve the conflict. 431 U.S. 928 (1977). We agree with the Court of Appeals for the First Circuit that the limitation on the dividends-paid deduction provided by the regulations is valid, and therefore affirm its judgment.

I

The maximum income tax rate applied to corporations has for many years been substantially below marginal tax rates applicable to high-income individuals. As early as 1913, Congress recognized that this disparity provided an incentive for individuals to create corporations solely to avoid taxes. In response, Congress imposed a tax on the shareholders of any corporation "formed or fraudulently availed of" for the purpose of avoiding personal income taxes. Tariff Act of 1913, § II-A, Subdivision 2, 38 Stat. 166; see Ivan Allen Co. v. United States,422 U. S. 617, 422 U. S. 624-625, and n. 8 (1975). Section 220 of the Revenue Act of 1921, 42 Stat. 247, shifted the incidence of this tax to the corporation itself, where it has remained to this day. See Ivan Allen Co. v. United States, supra at 422 U. S. 625 n. 8.

Early statutes designed to combat abuse of the corporate form were not notably successful, however, and, in 1934, Congress concluded that the "incorporated pocketbook" -- a closely held corporation formed to receive passive investment property and to accumulate income accruing with respect to that property -- had become a major vehicle of tax avoidance. [Footnote 3]

Page 434 U. S. 531

Congress' response was the personal holding company tax, enacted in 1934, and now codified as §§ 541-547 and 561-565 of the Internal Revenue Code of 1954, [Footnote 4] 26 U.S.C. §§ 541-547 and 561-565 (1970 ed. and Supp. V).

The object of the personal holding company tax is to force corporations which are "personal holding companies" [Footnote 5] to pay in each tax year dividends at least equal to the corporation's undistributed personal holding company income -- i.e. its adjusted taxable income less dividends paid to shareholders of the corporation, see § 545 -- thus ensuring that taxpayers cannot escape personal taxes by accumulating income at the corporate level. This object is effectuated by imposing on a personal holding company both the ordinary income tax applicable to its operation as a corporation and a penalty tax of 70% on its undistributed personal holding company income. See §§ 541, 545, 561. Since the penalty tax rate equals or exceeds the highest rate applicable to individual taxpayers, see 26 U.S.C. § 1 (1970 ed. and Supp. V), it will generally be in the interest of those controlling the personal holding company to distribute all personal holding company income, thereby avoiding the 70% tax at the corporate level by reducing to zero the tax base against which it is applied. [Footnote 6]

II

Petitioners are the successors to Pierce Investment Corp. In 1966, the Commissioner audited Pierce and determined that it was a personal holding company for the tax years 1959, 1960,

Page 434 U. S. 532

1962, and 1963. Deficiencies in personal holding company taxes of $26,571.30 were assessed against Pierce. In response to the audit, Pierce entered an agreement with the Commissioner pursuant to § 547 of the Code which provides that a corporation in Pierce's position may enter such an agreement, acknowledging its deficiency and personal holding company status, and may within 90 days thereafter make "deficiency dividend" payments that become a deduction against personal holding company income in the years for which a deficiency was determined and reduce that deficiency. Shares of stock Pierce held in other companies were promptly distributed as deficiency dividends. The fair market value of this stock at the time of distribution is agreed to have been $32,535; its adjusted tax basis, $18,725.11.

Pierce then filed a claim for a deficiency-dividend deduction, as required by § 547(e), indicating that the value of dividends distributed for the tax years in question was $32,535. The Commissioner, relying on Treas.Reg. § 1.562-1(a), allowed this claim only to the extent of Pierce's adjusted basis in the stock, and he determined a new deficiency after reducing Pierce's personal holding company income by the amount of the deficiency dividends allowed. Pierce paid this tax and the Commissioner denied its claim for a refund.

Petitioners as Pierce's successors thereafter brought a refund suit in the United States District Court for the District of Massachusetts, arguing that the deficiency dividends should have been valued at their fair market value. The District Court on cross-motions for summary judgment denied relief, 407 F.Supp. 1039 (1976), and the Court of Appeals for the First Circuit affirmed. Each court found the Treasury Regulation to be a reasonable interpretation of the personal holding company tax statute, and each expressly refused to follow the contrary holding of H. Wetter Mfg. Co. v. United States, supra. [Footnote 7] Accordingly, a refund was denied.

Page 434 U. S. 533

III

"[I]t is fundamental . . . that as 'contemporaneous constructions by those charged with administration of' the Code, [Treasury] Regulations 'must be sustained unless unreasonable and plainly inconsistent with the revenue statutes,' and 'should not be overruled except for weighty reasons.'"

Bingler v. Johnson,394 U. S. 741, 394 U. S. 749-750 (1969), quoting Commissioner v. South Texas Lumber Co.,333 U. S. 496, 333 U. S. 501 (1948); accord, United States v. Correll,389 U. S. 299, 389 U. S. 306-307 (1967). This rule of deference is particularly appropriate here, [Footnote 8] since, while obviously some rule of valuation must be applied, Congress, as we shall see, failed expressly to provide one. See United States v. Correll, supra; 26 U.S.C. § 7805(a).

Section 547(a) of the Code requires that a taxpayer who like Pierce pays dividends after a determination of liability by the Commissioner "shall be allowed"

"a deduction . . . for the amount of deficiency dividends (as defined in subsection (d)) for the purpose of determining the personal holding company tax."

Subsection 547(d) in turn provides that

"the term 'deficiency dividends' means the amount of the dividends paid by the corporation . . . , which would have been includible in the computation of the deduction for dividends paid under section 561 for the taxable year with respect to which the liability for personal holding

Page 434 U. S. 534

company tax exists, if distributed during such taxable year."

Continuing this chain of definitions, § 561(a) provides that the deduction for dividends "shall be the sum of," inter alia, dividends paid during the taxable year; and § 561(b)(1) points to § 562 as the source of a rule for valuing such dividends. Section 562, however, provides only exceptions to a basic rule said to be provided by § 316 of the Code, 26 U.S.C. § 316. But when we turn to § 316, the trail of definitions finally turns cold, for that section states only that a dividend is a "distribution of property made by a corporation to its shareholders" out of current or accumulated earnings or, in the case of personal holding companies, out of its current personal holding company income. Inexplicably, moreover, the draftsmen refer us back to § 562 for "[r]ules applicable in determining dividends eligible for dividends paid credit deduction." See Cross References following § 316.

Petitioners suggest that the way out of this circularity is to adopt the valuation rules for distributions of property found in § 301 of the Code, 26 U.S.C. § 301. We cannot agree, for § 301 deals not with the problem of valuing the distribution with respect to the distributing corporation, but establishes rules governing the valuation with respect to distributees. This is not to deny the logical force of petitioners' argument that, since the purpose of the personal holding company tax is to force individuals to include personal holding company income in their individual returns, the corporate distributor should get a deduction at the corporate level equal to the income generated by the distribution at the shareholder level as defined by § 301, that is, the fair market value of the appreciated property in this case. [Footnote 9] See 26 U.S.C. § 301(b)

Page 434 U. S. 535

(1)(A). Indeed, H. Wetter Mfg Co. v. United States, 458 F.2d 1033 (1972), and Gulf Inland Corp. v. United States, 75-2 USTC

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