ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA (D.C. Civil No. 71-1735).
Van Dusen, Gibbons and Hunter, Circuit Judges.
The United States appeals from a final judgment in favor of taxpayers Thomas P. Stanton and Wanda S. Stanton for a refund of income tax paid for the tax year 1966.*fn1 The claimed overpayment depends upon the proper tax treatment to be afforded to Mr. Stanton's 1966 decision to terminate a Subchapter R election*fn2 which he had made in 1964. By virtue of that election his sole proprietorship, Stanton Refractory Sales Company, was taxed as if it were a corporation. Stanton chose to terminate because Congress, in 1966, had repealed the provision in the Internal Revenue Code which had permitted the election. Act of April 14, 1966, Pub. L. No. 89-389, § 4, 80 Stat. 115, amending Int. Rev. Code § 1361 (now Int. Rev. Code § 1361(n)). The repealing legislation provided that any election not terminated on or before December 31, 1968 would be terminated by operation of law on January 1, 1969. Taxpayers were given the right to terminate Subchapter R elections voluntarily by the December 31st date.
Along with his decision to terminate, which was made as of November 1, 1966, Stanton decided to form a new corporation. This decision grew out of discussions he had had, prior to the termination date, with E. M. Harvey, President of North State Pyrophyllite Co., a North Carolina refractory manufacturer. The proprietorship was the exclusive sales representative for North State to both the United States and Canadian steel industries. The discussions dealt with the desirability of incorporating so that there would be continuity in the operation of the business in the event of Stanton's death. Harvey had expressed the preference that Mrs. Wanda Stanton, who was an active participant in the business of the proprietorship, have an ownership interest in any corporation that might be formed. But there were other motivations for incorporation unrelated to Mrs. Stanton.*fn3
As planned, Stanton was to transfer some, but not all, of the assets of the Subchapter R proprietorship to the new corporation, and Mrs. Stanton was to receive 49% of the newly-issued stock. This was precisely how the new corporation was formed. On November 1, 1966, the date of the Subchapter R termination, Stanton caused the incorporation of Stanton Refractories, Inc., and transferred the operating assets of the proprietorship to it. The stock of the corporation was issued 51% to Mr. Stanton and 49% to Mrs. Stanton. The opening balance sheet of the corporation, as of November 1, 1966, reflected the following:
Accounts Receivable 4,263.97
(Net of depreciation) 10,242.75