Corporate Distributions—Liquidating and Dividend
by ERNEST H. KENYON Principal, Omaha Office
Presented before the 10th Annual Institute on Taxation of the Texas Society
of Certified Public Accountants, Houston and Dallas—October 1963
ONE OF THE definitions of pitfall is "a danger, difficulty, or error
into which one may fall unsuspectingly." There is a connotation here of blamelessness or innocence. This is the meaning intended when the word is used with reference to the shareholders.
A pitfall has also been defined as "a snare for the unwary," and unwary as being "careless, heedless, or not vigilant." It is in this context that the term will undoubtedly be applied if it is used with reference to trouble spots that should have been avoided by us in our role of professional advisors.
The decision rendered by the Western District Court of Louisiana in Bancroft v. Indemnity Insurance Company of North America is particularly
T. P. Bancroft was the owner of controlling stock in two corporations.
On two separate occasions he sold stock of one company to the other. Before the sales he had been assured in writing by his certified public accountants that the transactions would not result in any income tax liability. Although this was not reported as a tax case, it is apparent that one corporation was used to redeem the stock of a related corporation. Under such circumstances, sections 304 and 302 may be applicable, and the corporate distribution can be considered equivalent to a dividend. Such treatment was evidently appropriate with respect to the proceeds of the Bancroft sales because subsequently, as a result of the transactions, he was required to pay income tax deficiencies exceeding $35,000.
Mr. Bancroft brought action to recover the additional assessment from the accountants' professional liability insurer and won his case. The presiding judge discounted the contention that accountants were not qualified to answer questions of tax law and stated that the court was protecting innocent clients against a CPA's professional negligence.
The basic problems in this area of corporate distributions can be stated in terms of both cause and effect. As to cause, we are concerned with—