Commissioner of Internal Revenue v. Fink et al.
483 U.S. 89 (1987)
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Rule of Law:
A dominant shareholder who voluntarily surrenders a portion of their shares to the corporation, but retains control, does not sustain an immediate loss deductible from taxable income. Instead, the shareholder must reallocate their basis in the surrendered shares to the shares they retain.
Facts:
- Peter and Karla Fink were the principal shareholders of Travco Corporation, owning a combined 72.5% of its stock.
- In the mid-1970s, Travco experienced financial difficulties and urgently needed new capital.
- To 'increase the attractiveness of the corporation to outside investors,' the Finks voluntarily surrendered a portion of their shares to Travco without receiving any consideration.
- Mr. Fink surrendered 116,146 shares in December 1976, and Mrs. Fink surrendered 80,000 shares in January 1977.
- No other shareholders surrendered any of their stock.
- Following the surrender, the Finks' combined ownership stake was reduced to 68.5%, leaving them still in control of the corporation.
- The effort to attract new investors was ultimately unsuccessful, and Travco Corporation was eventually liquidated.
Procedural Posture:
- Peter and Karla Fink claimed ordinary loss deductions on their 1976 and 1977 joint federal income tax returns for the basis of the surrendered shares.
- The Commissioner of Internal Revenue disallowed the deductions, determining the surrender was a contribution to the corporation's capital.
- The Finks petitioned the United States Tax Court for a redetermination of the deficiency.
- The Tax Court sustained the Commissioner's determination, siding with the IRS.
- The Finks, as appellants, appealed the Tax Court's decision to the United States Court of Appeals for the Sixth Circuit.
- A divided panel of the Court of Appeals reversed the Tax Court, holding that the Finks were entitled to an immediate loss deduction.
- The Commissioner of Internal Revenue, as petitioner, successfully petitioned the Supreme Court of the United States for a writ of certiorari.
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Issue:
Does a dominant shareholder's voluntary, non-pro-rata surrender of stock to the issuing corporation, where the shareholder retains control, generate an immediately deductible ordinary loss?
Opinions:
Majority - Justice Powell
No. A dominant shareholder's voluntary surrender of shares to the corporation to bolster its financial position is not a taxable event that creates an immediate loss; it is treated as a contribution to capital. The surrendering shareholder must add the basis of the surrendered shares to the basis of their remaining shares. The court reasoned that the surrender is not a final disposition of an asset creating a loss, but rather an action intended to protect and enhance the value of the shareholder's remaining investment. Allowing an immediate deduction would not accurately reflect the economic reality of the transaction, which is akin to an additional investment, and could encourage shareholders to convert eventual capital losses into immediate ordinary losses before a company fails.
Dissenting - Justice Stevens
Yes. The Finks should be entitled to an immediate deduction because they acted in reliance on over 40 years of settled tax law. The dissent argues that for decades, the Tax Court had consistently held that such surrenders were deductible as ordinary losses, a position to which the IRS had long acquiesced. Overturning such a long-standing and relied-upon interpretation of the tax code is a task that should be left to Congress, not the courts. The principles of stare decisis and fairness to taxpayers who reasonably relied on the previous rule should have been decisive.
Concurring - Justice White
No. While joining the majority opinion, this concurrence suggests that the court's rationale should apply equally even if the stock surrender causes the shareholder to lose control of the corporation. The opinion finds no principled ground in the majority's reasoning to distinguish a loss-of-control case from the present one, suggesting the footnote reserving that question is of little substance.
Concurring - Justice Scalia
No. The surrender does not generate an immediate loss, but for a different reason than the majority's. The stock surrender was not a contribution to capital but rather an expenditure for 'betterments made to increase the value of... property' under 26 U.S.C. § 263(a)(1). As such, it is a capital expenditure intended to make the remaining shares more valuable and is not entitled to treatment as a current deduction.
Analysis:
This decision resolved a circuit split by establishing a uniform federal rule disallowing immediate loss deductions for non-pro-rata stock surrenders by controlling shareholders. It endorsed a 'unitary' view of stock ownership for this purpose, treating a shareholder's stake as a single, indivisible investment rather than a 'fragmented' collection of individual shares. The ruling prevents shareholders of struggling companies from using stock surrenders to strategically convert future capital losses into more favorable immediate ordinary losses, thereby closing a potential tax loophole and reinforcing the distinction between investment adjustments and final dispositions of property.
