Intermountain Lumber Company v. Commissioner Analysis: Sections 351 and 368 Tax Implications
Introduction
Disputes that take place within the judicial system have considerable consequences for all involved parties and future arguments. For instance, Intermountain Lumber Company v. Commissioner is a legal quarrel involving matters of depreciation, financial transfer, taxation, and control in business (Abrams & Leatherman, 2019; Cohen, 2021). Although the case has been influential to a certain extent, the validity of some of its statements has been argued (Cohen, 2021). Intermountain Lumber Company v. Commissioner, 65 T.C. 1023 (1976) was correctly decided based on the judgment regarding sections 351 and 368.
Background
To comprehend why the case’s judgment is considered accurate, one must understand the situation’s background. Mr. Dee Shook was the owner of a sawmill where Mr. Milo Wilson had logs processed into rough lumber for a fee (Intermountain, 1976). The two men also co-owned a separate finishing plant where the sawmill’s rough lumber was processed into finished lumber (Intermountain, 1976). When, in 1964, the sawmill was damaged by fire, Shook and Wilson decided to replace it with a larger facility (Intermountain, 1976). Wilson was persuaded to guarantee a $200,000 loan for financing but demanded to have an equal voice during the rebuilding and have an opportunity to be an equal shareholder with Shook (Intermountain, 1976).
Consequently, the two men, alongside two other individuals, incorporated S&W Sawmill, Inc., and Shook announced that one-half of their stock would be sold to Wilson (Intermountain, 1976). Shook deeded his sawmill site to S&W and received all of the company’s 364 shares (Intermountain, 1976). Accordingly, from being involved in one business, Shook and Wilson intended to become partners in a new enterprise.
Furthermore, S&W’s operations caused a legal issue concerning property transfer. Shook and Wilson entered an agreement, according to which Shook was supposed to sell Wilson 182 shares of the corporation (Intermountain, 1976). The conditions were as follows: $500 per share, interest for unpaid payment, and shares put in escrow (Cohen, 2021; Intermountain, 1976). Wilson was given the full power to vote his shares for the next 14 months (Cohen, 2021; Intermountain, 1976). When, in August of 1964, S&W borrowed $200,000, Shook and Wilson were referred to as the company’s “principal officers and stockholders” (Abrams & Leatherman, 2019, p. 28; Cohen, 2021, p. 369). In 1967, Intermountain Lumber Company (ILC) purchased all of S&W’s stock, but Wilson still owed Shook $91,000 for the initial 182 shares (Intermountain, 1976).
Later, the Commissioner of Internal Revenue found deficiencies in ILC’s tax returns in relation to S&W. Intending to dispute the trouble, ILC argued that Shook’s initial transfer to S&W was a taxable sale since section 351 of the Internal Revenue Code (IRC) was inapplicable (Intermountain, 1976). Consequently, the case centered around whether a certain property transfer was liable to be taxed.
Sections 351 and 368
To understand the significance of sections 351 and 368 for the decision in the reviewed dispute, one must know the specifics of the statutes. The regulation applies to all existing and new businesses and reviews transfers to corporations (Narotzki & McCoskey, 2022b). According to the general rule, a transferor does not realize any gain or loss when property is transferred to an enterprise in exchange for stock (26 USC 351, 1986; Narotzki & McCoskey, 2022a; Narotzki & McCoskey, 2022b). However, the transferor must, immediately after the exchange, take the position of control of the corporation as defined in section 368(c) (26 USC 351, 1986; Narotzki & McCoskey, 2022a; Narotzki & McCoskey, 2022b).
Section 368 covers corporate reorganizations and related terminology (26 USC 368, 1986; Ganor, 2018). According to the statute’s part c, control means having a minimum of 80% ownership of the business’s voting stock (26 USC 368, 1986; Narotzki & McCoskey, 2022b). Therefore, to prevail in its claim, ILC had to prove that the transferor did not satisfy the requirement of transferring property in exchange for stock while immediately gaining control of the corporation’s 80% voting stock.
Application to the Case
Consequently, the decision was accurate due to how the Court connected section 351 to the situation. The Court pointed out that if, during the transaction, the transferee has irrevocably foregone or relinquished the right to determine whether to retain the shares, ownership is lacking for section 351’s purposes (Intermountain, 1976). Some argue that the Court’s interpretation of certain parts of the statute is of questionable validity, yet the judiciary has correctly utilized the section’s reasoning (Cohen, 2021).
Shook had relinquished his legal privilege to decide whether to keep the acquired stock because, before deeding the sawmill, Shook was already obligated to sell the assets to Wilson (Intermountain, 1976). Notably, Wilson had the liberty to prepay the principal and obtain all 182 shares at any time in advance (Intermountain, 1976). The Court emphasized that both Shook and Wilson perceived themselves as co-owners of S&W and that the sale of the business’s stock was a paramount part of the incorporation transaction (Intermountain, 1976). Consequently, section 351 did not apply to the situation since Shook was not individually in control, as he aimed to sell half of his shares before transferring property to S&W.
Conclusion
To summarize, Intermountain Lumber Company v. Commissioner was correctly decided because Dee Shook did not have complete ownership of S&W and intended to vend his stock as part of the same transaction. IRC’s sections 351 and 368 state that a transferor recognizes no gain or loss when the property is repositioned to a corporation in return for stock and must have 80% of the corporation’s voting stock. However, Shook agreed to sell half of his shares to Wilson and then deeded the sawmill to the newly incorporated S&W, thus losing control of the business and making the transfer taxable.
References
26 USC 351: Transfer to corporation controlled by transferor. (1986). Web.
26 USC 368: Definitions relating to corporate reorganizations. (1986). Web.
Abrams, H. E., & Leatherman, D. (2019). Federal income taxation of corporations and partnerships. Aspen Publishing.
Cohen, P. G. (2021). Thoughts regarding the application of the step transaction doctrine to the section 351 control requirement and Complex Media, Inc. v. Commissioner. William & Mary Business Law Review, 13(2), 33-404.
Ganor, M. (2018). Recoupling founders with their IP-improving innovation by rationalizing IRC section 351. Journal of Corporation Law, 44(3), 493-512.
Intermountain Lumber Company v. Commissioner, 65 T.C. 1023 (1976). Web.
Narotzki, D., & McCoskey, M. (2022a). Code section 304: A roadmap, an updated analysis, and policy considerations. Virginia Law and Business Review, 16(3), 471-504.
Narotzki, D., & McCoskey, M. (2022b). The Code section 267 related party rules: When do they apply to section 351 transactions? Journal of Taxation, 136(02), 1-3.