Before GOODRICH, MCLAUGHLIN, and HASTIE, Circuit Judges.
The Tax Court has sustained the Commissioner of Internal Revenue and disagreed with the taxpayer, A.J. Diebold, on the proper calculation of taxable net gain for income tax purposes on taxpayer's 1945 sale of shares of capital stock of Diebold Investment Company. To determine net gain on this transaction the taxpayer deducted from the sale price not only the original cost of the stock to him but also 1/7 of the total value of a bequest and devise made to Diebold Investment Company in 1927 by taxpayer's brother F.X. Diebold. The Tax Court ruled that this was improper, reasoning that the bequest and devise to the corporation did not increase taxpayer's basis for his stock in that corporation. The present petition for review contests that ruling.
In greater detail the facts are these. Diebold Investment Company is a Pennsylvania business corporation organized in 1915. It is a family enterprise. At organization 96 shares of capital stock were issued; 12 to M. Diebold and 12 to each of his seven sons of whom taxpayer was one and F.X. Diebold another. Thereafter, M. Diebold died having disposed of his 12 shares by gift and bequest to his daughter.
The stockholders were also the directors of the corporation. Pursuant to their unanimous agreement, all of the stock was deposited with the treasurer of the corporation and made subject to release only upon the consent of five directors.
This situation of corporate ownership and control by the seven brothers and their sister equally and exclusively continued until F.X. Diebold died unmarried in 1927. He bequeathed and devised his residuary estate to Diebold Investment Company. This residue included his 12 shares of stock of Diebold Investment Company and, in addition, certain real property, miscellaneous stocks and bonds of other corporations, and other personalty.
Thereafter, the ownership and control of the corporation continued in the six surviving brothers and their sister. The corporation paid stock dividends in 1930 and 1937 which increased the holdings of each stockholder to 200 shares. In 1945, the taxpayer sold 150 of his 200 shares of stock. It is the gain on that transaction which is now in controversy.
Section 111 of the Internal Revenue Code provides that gain on the sale of property "shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b) for determining gain". 26 U.S. Code, 1946 ed., Section 111.For present purposes, the adjusted basis for determining gain is defined in Section 113(b) by reference back to Section 113 (a) (5) as "the cost of such property; except that * * * (5) if the property was acquired by bequest, devise, or inheritance, * * * the basis shall be the fair market value of such property at the time of such acquisition." 26 U.S. Code, 1946 ed., Section 113.
The parties agree that the 1930 and 1937 stock dividends do not affect the legal analysis of the matter in dispute. Therefore, for simplicity, we will ignore them, considering only the 96 shares which constituted all of the capital stock originally issued by the corporation. We shall further simplify our analysis by speaking as if taxpayer had sold all of his stock in 1945 rather than 3/4 of it. In terms of this simplified picture, it is the position of the Tax Court and the Commissioner that the property sold was 12 shares of Diebold Investment Company stock. The taxpayer purchased these shares before his brother's death and thereafter continued to own only these shares until he sold them. Therefore, the Tax Court reasons, none of the property sold was acquired by bequest and no adjustment of the taxpayer's basis beyond original cost is warranted. In this analysis the devise of F.X. Diebold to the corporation is no more significant than any other transaction which in the course of the affairs of the corporation may have increased its assets and thus increased the value of outstanding stock.
We think, however, that when valid and familiar conceptions of the nature and ownership of corporate stock are employed in relating the facts of this case to the quoted provisions of the Internal Revenue Code a picture more favorable to the taxpayer emerges.
In some circumstances, analysis of that form of property which we call corporate stock need not proceed beyond the certificate itself and the number of shares it represents. In other situations it is neither realistic nor proper to stop there. For beyond its status as paper of monetary value, the share of stock represents rights of corporate ownership and control. Indeed, where corporate structure is not complicated by various classes of stock and shares are not sold freely as commodities, issued capital stock is significant primarily as the embodiment of proportional interests of ownership and control of the corporate enterprise by those to whom the stock belongs.
We have such a case here. Each of eight members of a family enjoyed, as an owner, a one-eighth interest in the corporate enterprise. This was the essential meaning of each unit of 12 shares viewed as property. In this situation the bequest which effected the surrender and elimination of F.X. Diebold's 1/8 interest resulted immediately in an increase of the proprietary rights of each surviving stockholder to a 1/7 interest in the corporate enterprise. It is true that each survivor still had 12 shares of stock. But it is equally true and more significant that his proportional proprietary interest increased from 7/56 to 8/56. And if this gain in ownership rights to each survivor was the purpose of the devise it is realistic and proper to say that each survivor who originally purchased a 7/56 interest in the corporation acquired as an immediate and necessary legal result of the bequest an additional 1/56 interest.
We recognize that in applying the provisions of the Internal Revenue Code relevant to the determination of a taxpayer's basis for property, distinction must be made between an acquisition of some part of the property and an increase in the value of property already held. But we also think that the foregoing analysis which makes a 1/56 proprietary interest in the corporation new property of the ...