Commissioner v. Clark
489 U.S. 726, 103 L. Ed. 2d 753, 1989 U.S. LEXIS 1576 (1989)
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Rule of Law:
When a shareholder receives cash 'boot' in a corporate reorganization, the determination of whether it has the 'effect of the distribution of a dividend' under § 356(a)(2) is made by viewing the transaction as a whole. The boot is treated as if it were received in a post-reorganization redemption of stock from the acquiring corporation, and if this hypothetical redemption results in a meaningful reduction of the shareholder's interest, the boot is treated as capital gain.
Facts:
- For approximately 15 years, Donald E. Clark was the president of Basin Surveys, Inc. (Basin), and by January 1978, he had become its sole shareholder.
- In 1978, N. L. Industries, Inc. (NL), a publicly owned corporation in which Clark had no prior interest, initiated negotiations to acquire Basin.
- On April 3, 1979, the parties agreed to a 'triangular merger' where Basin would merge into a wholly owned subsidiary of NL.
- In exchange for his Basin shares, Clark was offered a choice between 425,000 shares of NL common stock, or a combination of 300,000 shares of NL stock and $3,250,000 in cash.
- Clark chose the second option, receiving the 300,000 shares and $3,250,000 cash boot.
- The 300,000 shares Clark received represented approximately 0.92% of NL's outstanding common shares.
- Had Clark accepted the all-stock offer of 425,000 shares, he would have held approximately 1.3% of NL's outstanding common shares.
Procedural Posture:
- Donald Clark reported the $3,250,000 cash payment as a long-term capital gain on his 1979 joint federal income tax return.
- The Commissioner of Internal Revenue audited the return, determined the payment was a dividend taxable as ordinary income, and assessed a tax deficiency of $972,504.74.
- Clark, the taxpayer-respondent, petitioned the United States Tax Court for review.
- The Tax Court, in a reviewed decision, held in favor of Clark.
- The Commissioner, as appellant, appealed the Tax Court's decision to the U.S. Court of Appeals for the Fourth Circuit.
- The Court of Appeals affirmed the Tax Court's decision, siding with Clark.
- The Commissioner petitioned the Supreme Court of the United States for a writ of certiorari, which was granted to resolve a conflict among the circuit courts.
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Issue:
Does a cash payment ('boot') received by a sole shareholder in a stock-for-stock corporate reorganization have the effect of the distribution of a dividend under Internal Revenue Code § 356(a)(2) when the shareholder's interest in the acquiring corporation is meaningfully reduced compared to what it would have been in an all-stock transaction?
Opinions:
Majority - Justice Stevens
No. The cash payment does not have the effect of the distribution of a dividend and is properly treated as a capital gain. The determination under § 356(a)(2) requires an examination of the entire exchange, not just the boot payment in isolation. The proper way to analyze the transaction is to treat it as if the shareholder received only stock and then had a portion of that stock redeemed by the acquiring corporation in a 'post-reorganization redemption.' In this case, we imagine Clark received 425,000 shares of NL stock and that NL then immediately redeemed 125,000 of those shares for $3,250,000. This hypothetical redemption reduced Clark's potential interest in NL from 1.3% to 0.92%, a reduction of approximately 29%. This easily satisfies the 'substantially disproportionate' test of § 302(b)(2), meaning it is not equivalent to a dividend. This approach aligns with the statute's purpose, which is to prevent shareholders from using reorganizations as a ruse to siphon off corporate earnings, a concern not present in this arm's-length transaction with an unrelated party.
Dissenting - Justice White
Yes. The cash payment has the effect of the distribution of a dividend. The majority's 'post-reorganization redemption' analysis is a legal fiction that recasts the transaction into a form that Clark explicitly rejected when he turned down the all-stock offer. The hallmark of a dividend is a pro rata distribution of corporate earnings to shareholders. As the sole shareholder of Basin, Clark's receipt of cash was necessarily a pro rata distribution from the enterprise's value, which exceeded Basin's accumulated earnings and profits. The statute requires looking at the 'effect' of the distribution, and the effect here was a classic bailout of corporate earnings. The majority's holding creates an automatic non-dividend rule for sole shareholders in reorganizations, contrary to the purpose of § 356(a)(2).
Analysis:
This decision resolved a significant circuit split by rejecting the IRS's 'prereorganization redemption' test from Shimberg and formally adopting the taxpayer-friendly 'postreorganization redemption' test from Wright. This ruling provides greater certainty in structuring acquisitions, making it much more likely that shareholders of a target company can receive cash boot taxed at favorable capital gains rates. By integrating the redemption principles of § 302 into the reorganization context of § 356, the Court created a unified and predictable framework that focuses on the change in the shareholder's interest in the new, combined enterprise rather than their historical interest in the defunct target company.
