Albers, Executor, Et Al. v. Commissioner of Internal Revenue

Background

Five shareholders owned almost all stock of a small barge company, A & S Transportation. The Federal Maritime Commission required the company to obtain $150,000 in private capital before guaranteeing a bank loan. The shareholders bought nonvoting, nondividend, noncumulative preferred stock the Commission demanded. After the loan was paid in 1964, the company redeemed the preferred stock in 1965–66 and returned each shareholder the exact amount they had invested. The IRS treated those redemptions as ordinary income under §302(b)(1), and the Tax Court and the Third Circuit agreed.

Reasoning

The central question was whether the redemptions were “essentially equivalent to a dividend” or simply returns of capital. The Supreme Court declined to review the appeals, so it did not change the existing rule from United States v. Davis that often treats such redemptions as dividends in closely held companies. In a dissent, Justice Powell argued the Davis rule is too rigid here because the preferred shares were issued at the regulator’s insistence, there was a clear business purpose, no sign of tax evasion, and the shareholders merely recovered capital.

Real world impact

Because the Court refused review, lower-court rulings stand and similar shareholders may be taxed at ordinary-income rates when they recover capital forced into a business. The decision was procedural — not a new ruling on the merits — so the issue could be revisited in a future case. The opinion highlights how Davis’ per se approach can produce harsh results for small, closely held companies.

Dissents or concurrances

Justice Powell, joined by Justices Douglas and Blackmun, dissented from denial and would have granted review to reconsider Davis’ per se rule.