Rev. Rul. 57-357

Reconsideration has been given to the action of the Commissioner in the decision of the Tax Court of the United States in George M. Gross and Anna Gross, et al. v. Commissioner , 23 T.C. 756, nonacquiescence, C.B. 1955-2, 10, in view of the decision of the United States Court of Appeals for the Second Circuit, entered August 29, 1956, affirming the decision of the Tax Court, with the result that it has been decided to substitute acquiescence therein with respect to the dividend issue. See page 5.

The principal issue involved in the Gross case is whether the excess of the loans insured by the Federal Housing Administration over the cost of construction of the property covered by the loans, which was distributed by the corporation to its stockholders, constituted a taxable dividend under section 115(a) of the Internal Revenue Code of 1939, or whether such distributions should be applied against and reduce the adjusted basis of the stock as provided for by section 115(d) of the Code.

The taxpapers there involved are stockholders in several corporations, some organized to hold land and some to build and operate apartment developments thereon. The plans, financing, and construction of the developments were approved by the Federal Housing Administration which, pursuant to section 608 of the National Housing Act, as amended, 12 U.S.C. 1747, insured the mortgages given by the operating companies to finance construction. The actual cost of construction was less than that estimated by the Federal Housing Administration and less than the amounts received by the corporations under the insured mortgages.

In 1948 and 1949, some of the operating companies made cash distributions to their stockholders from the excess of mortgage receipts over construction costs, from premiums on mortgage bonds issued, and from gross rents. Other operating companies made distributions out of depreciation reserves. The land-holding companies placed mortgages on their lands, which had appreciated in value, and distributed some of the mortgage proceeds to the stockholders. The distributions exceeded the earnings and profits of the distributing corporations. The stock of the corporations had been held, by the taxpayers involved, for more than six months prior to such distributions.

On the basis of the facts described, the court held that the distributions in excess of earnings and profits should, pursuant to section 115(d) of the 1939 Code, be applied against and reduce the adjusted basis of the stock, and that the excess thereof over such basis is taxable as long-term capital gain. The effect of the decision is to hold that such distributions constitute dividends under section 115(a) of the Code only to the extent that there are earnings and profits accumulated since March 1, 1913. Further, the court held, on the facts, that such distributions, which were in proportion to stock holdings, did not constitute salaries for the officer-stockholders although no amounts were paid or accrued as salaries of the officers during the taxable years 1948 and 1949.

The decision concerned only the taxable years ending prior to 1950. Therefore, the question of whether the corporations constituted collapsible corporations was not involved, since the provisions of section 117(m) of the Code are applicable only with respect to distributions made after December 31, 1949. However, it is the position of the Internal Revenue Service that distributions to stockholders made after December 31, 1949 (the effective date of section 117(m) of the 1939 Code), must be taken into consideration in determining whether the corporation constitutes a collapsible corporation within the meaning of, and subject to, the provisions of section 117(m) of the 1939 Code, or section 341 of the 1954 Code. See Raymond C. Burge et ux. v. Commissioner , 28 T.C.No. 26.

Accordingly, it is the position of the Service that distributions made by a corporation, prior to June 23, 1954 (the effective date of section 312(j) of the 1954 Code which specifically prescribes the treatment in the case of the distribution of proceeds of loans insured by the United States), of the excess of Federal Housing Administration insured mortgage loan proceeds over the cost of construction of the property covered by the loan, constitute dividends to the extent that earnings and profits, as provided in section 115(a) of the 1939 Code, are available for such distribution. In general, any distribution in excess of earnings and profits is to be applied against and reduce the adjusted basis of the corporate stock and any excess remaining is taxable as a capital gain. However, such distributions to stockholders, which are made after December 31, 1949, are to be considered in determining whether the corporation constitutes a collapsible corporation and whether any gain to the stockholders is subject to the provisions of section 117(m) of the 1939 Code or section 341 of the 1954 Code.

Where such distributions, received by the stockholders, are determined to be compensation or fees for services rendered to or in behalf of the distributing corporation or for the use of equipment and materials, such amounts are taxable to the recipients as ordinary income and are outside the purview of section 115(a) of the 1939 Code or subchapter C, Chapter I of subtitle A of the 1954 Code.