Commissioner of Internal Revenue v. Carter
37 A.F.T.R. (P-H) 573, 170 F.2d 911, 1948 U.S. App. LEXIS 4168 (1948)
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Rule of Law:
When a taxpayer receives contract rights with no ascertainable fair market value in a complete corporate liquidation, the liquidation is treated as an "open transaction." Subsequent payments received under those contracts are characterized as capital gains from the original liquidation, not as ordinary income.
Facts:
- Mrs. Carter owned all the stock of a corporation for ten years.
- On December 31, 1942, the corporation was completely dissolved.
- Upon dissolution, all corporate assets were distributed to Mrs. Carter, who assumed all liabilities.
- In the distribution, she received property that resulted in a capital gain of approximately $20,000, which she reported and paid tax on.
- She also received 32 oil brokerage contracts, which provided for commission payments contingent on future oil deliveries.
- The parties stipulated that these contracts had no ascertainable fair market value at the time of the distribution because the future payments were uncertain.
- The contracts required no further services to be performed by Mrs. Carter.
- In 1943, Mrs. Carter collected $34,992.20 in commissions under these contracts.
Procedural Posture:
- The taxpayer, Mrs. Carter, reported the $34,992.20 collected on the contracts in 1943 as a long-term capital gain on her tax return.
- The Commissioner of Internal Revenue determined the amount was ordinary income and assessed a tax deficiency.
- The taxpayer challenged the Commissioner's determination in the U.S. Tax Court.
- The Tax Court held in favor of the taxpayer, ruling that the income was taxable as capital gain.
- The Commissioner, as appellant, appealed the Tax Court's decision to the U.S. Court of Appeals for the Second Circuit.
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Issue:
Are subsequent collections on contracts with no ascertainable fair market value, received in a corporate liquidation, taxed as ordinary income rather than as part of the capital gain from the initial liquidation?
Opinions:
Majority - Swan, Circuit Judge
No. Subsequent collections on contracts that had no ascertainable fair market value at the time of a corporate liquidation are treated as part of the capital gain from the liquidation transaction, not as ordinary income. The court extended the "open transaction" doctrine from Burnet v. Logan, which involved a sale of stock, to corporate liquidations. The court reasoned that since tax law treats gains from liquidations and sales similarly, the same principle should apply. Because the oil contracts had no ascertainable value, the liquidation transaction was not closed. Therefore, the later collections were part of the amount realized from the original exchange of stock, a capital asset. The court distinguished these payments from ordinary income like interest or rent, noting that each commission payment depleted the value of the contracts, unlike interest on a bond which leaves the principal intact. Treating the payments as ordinary income would be unjust as it would prevent the taxpayer from properly recouping her capital investment.
Analysis:
This decision solidifies the application of the "open transaction doctrine" to corporate liquidations, providing a significant benefit to taxpayers. It establishes that when the value of distributed property is too speculative to ascertain, the tax consequences of the liquidation remain open. This allows taxpayers to characterize future receipts from such property as capital gains, which are typically taxed at a lower rate than ordinary income. The ruling creates a narrow but important exception for contingent payment obligations, influencing how such assets are treated in corporate dissolutions and asset sales.
