Towne v. Eisner
245 U.S. 418 (1918)
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Rule of Law:
A stock dividend, representing a transfer of corporate surplus to capital, is not considered taxable "income" to the shareholder under the Income Tax Act because it does not alter the shareholder's proportional interest in the corporation or add to their wealth.
Facts:
- A corporation earned substantial profits before January 1, 1913, which it held as surplus.
- On December 17, 1913, the corporation's board voted to transfer $1,500,000 from its surplus account to its capital account.
- Simultaneously, the corporation decided to issue fifteen thousand new shares of stock to represent this increase in capital.
- On January 2, 1914, the corporation distributed these new shares to its existing stockholders.
- The plaintiff, Towne, received 4,174.5 new shares as his proportional share of this distribution.
- The total value of Towne's original shares and the new dividend shares combined was equal to the value of his original shares before the dividend was issued.
Procedural Posture:
- The government compelled plaintiff Towne to pay an income tax on a stock dividend he received.
- Towne paid the tax under duress and subsequently filed a suit against Eisner, a tax collector, in U.S. District Court to recover the payment.
- The District Court sustained the government's demurrer (a motion to dismiss the case), holding that the stock dividend was taxable income under the 1913 act.
- Final judgment was entered for the defendant, Eisner.
- Towne appealed the District Court's decision to the Supreme Court of the United States.
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Issue:
Does a stock dividend, which represents a corporation's conversion of surplus profits into capital, constitute taxable "income" to a shareholder under the Income Tax Act of 1913?
Opinions:
Majority - Mr. Justice Holmes
No. A stock dividend does not constitute taxable income to the shareholder. A stock dividend takes nothing from the property of the corporation and adds nothing to the interests of the shareholders; the corporation is no poorer and the stockholder is no richer. The proportional interest of each shareholder remains the same, with the only change being in the evidence that represents that interest. The court reasons that the transaction is merely a bookkeeping adjustment that recharacterizes a portion of the company's value from surplus to capital. This is analogous to splitting a single stock certificate into multiple certificates of smaller denominations, an act that does not create income.
Concurring - Mr. Justice McKenna
Mr. Justice McKenna concurs in the result.
Analysis:
This decision provided a foundational interpretation of the term "income" under the new federal income tax regime. It established the principle that a mere change in the form of a shareholder's investment, without an actual realization of gain severed from the corporate assets, is not income. This case distinguished a stock dividend from a cash dividend, setting a precedent that would be constitutionally solidified two years later in Eisner v. Macomber. The ruling created an important distinction between unrealized appreciation in capital and realized income, influencing corporate finance and tax law for decades.
