PAULSEN V. COMMISSIONER, 469 U. S. 131 (1985)

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U.S. Supreme Court

Paulsen v. Commissioner, 469 U.S. 131 (1985)

Paulsen v. Commissioner

No. 83-832

Argued October 29, 1984

Decided January 8, 1985

469 U.S. 131


Pursuant to a merger plan whereby Commerce Savings and Loan Association, a state-chartered stock savings and loan association, was merged in 1976 into Citizens Federal Savings and Loan Association, a federally chartered mutual savings and loan association, petitioners, husband and wife, exchanged their "guaranty stock" in Commerce for passbook savings accounts and time certificates of deposit in Citizens representing share interests in Citizens. Relying on §§ 354(a)(1) and 368(a)(1)(A) of the Internal Revenue Code, which provide an exception to recognizing a gain on the sale or exchange of property for corporate reorganizations, petitioners did not report on their 1976 income tax return the gain they realized on the exchange, because they considered the merger to be a tax-free reorganization. The Commissioner of Internal Revenue, however, issued a notice of deficiency and found petitioners liable for tax on the entire gain. Petitioners then sought redetermination of the deficiency in the Tax Court, which rendered a decision in petitioners' favor. The court reasoned that the savings accounts and certificates of deposit were the only forms of equity in Citizens, and held that the requisite continuity of interest existed under the rule that, even though the literal terms of the reorganization provisions of the statute are satisfied, the statute also requires that the taxpayer's ownership interest in the prior organization must continue in a meaningful fashion in the reorganized enterprise, and the retained interest must represent a substantial part of the value of the thing transferred, Helvering v. Minnesota Tea Co., 296 U. S. 378. The Court of Appeals reversed, holding that, despite certain equity characteristics, the Citizens savings accounts and certificates of deposit were indistinguishable from ordinary savings accounts and were essentially the equivalent of cash.

Held: Petitioners were not entitled to treat the Commerce-Citizens merger as a tax-free reorganization under §§ 354(a)(1) and 368(a)(1)(A), and thus are taxable on the gain they realized on the exchange in question. Pp. 469 U. S. 137-143.

(a) Petitioners' Citizens passbook accounts and certificates of deposit were cash equivalents. The debt characteristics of Citizens' shares (the passbook accounts and certificates of deposit are not subordinated to

Page 469 U. S. 132

creditors' claims, the deposits are not considered permanent contributions to capital, the shareholders have a right to withdraw the face amount of their deposits in cash, and in practice Citizens pays a fixed, preannounced rate on all accounts) greatly outweigh their equity characteristics (the shares are the only ownership instruments in the association, the shareholders have the right to vote, and they receive dividends rather than interest on their accounts and pro rata distribution of assets in the event of a solvent dissolution). Pp. 469 U. S. 137-140.

(b) Petitioners have failed to satisfy the continuity of interest required to qualify the merger as a tax-free reorganization. The debt value of the Citizens shares was the same as the face value; because no one would pay more than this for the shares, the incremental value attributable to the equity features was, practically, zero. Thus, this retained equity interest in the reorganized enterprise was not a "substantial" part of the value of the Commerce stock that was given up. Pp. 469 U. S. 140-142.

(c) To characterize petitioners' Citizen shares as debt does not conflict with Tcherepnin v. Knight, 389 U. S. 332. P. 469 U. S. 143.

716 F.2d 563, affirmed.

REHNQUIST, J., delivered the opinion of the Court, in which BRENNAN, WHITE, MARSHALL, BLACKMUN, and STEVENS, JJ., joined. O'CONNOR, J., filed a dissenting opinion, in which BURGER, C.J.,joined, post, 469 U. S. 144. POWELL, J., took no part in the decision of the case.

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