## Facts

- Hyman H. Berghash owned all stock of Delavan‑Bailey Drug Co., Inc., which operated a retail drugstore in Buffalo, New York.
- Delavan‑Bailey’s manager, Sidney Lettman, sought a 50% ownership interest but had only $25,000, insufficient to buy half of Delavan‑Bailey’s outstanding stock.
- Berghash and Lettman formed a new corporation, Dorn’s Drugs, Inc., with 200 shares: Lettman bought 100 shares for $25,000, and Delavan‑Bailey would receive 100 shares as part of an asset transfer.
- Delavan‑Bailey transferred all operating assets (including fixtures, inventory, and goodwill) to Dorn’s in exchange for a $96,101.64 promissory note and 100 shares of Dorn’s stock.
- Delavan‑Bailey adopted a plan of complete liquidation and distributed to Berghash: 100 shares of Dorn’s, the promissory note, and $49,313.17 cash; Delavan‑Bailey then dissolved.
- At dissolution, Delavan‑Bailey had accumulated earnings and profits of $122,050.11, and the business continued under the new corporation (which later changed its name to Delavan‑Bailey Drug Co., Inc.).
- The Berghashes reported the liquidation as long‑term capital gain.
- The Commissioner determined deficiencies, asserting (1) the liquidation proceeds were ordinary dividend income to the extent of earnings and profits, or alternatively (2) the corporation recognized long‑term capital gain on the asset transfer.

## Issues

1. Whether the asset transfer to the new corporation followed by liquidation constituted a reorganization under I.R.C. § 368(a)(1)(D) or (F).
2. If not a reorganization, whether the shareholder’s liquidating distributions were treated as payment in exchange for stock under I.R.C. §§ 346(a)(1) and 331(a), or instead as dividend income to the extent of earnings and profits.
3. Whether the liquidating corporation recognized gain on the asset sale to the new corporation, or whether nonrecognition applied under I.R.C. § 337.

## Decision

- The Tax Court held the transaction was not a reorganization under § 368(a)(1)(D) or (F).
- The Tax Court held the shareholder’s receipts were distributions in complete liquidation treated as payment in exchange for stock under §§ 346(a)(1) and 331(a), producing capital gain treatment rather than dividend income.
- The Tax Court held the liquidating corporation did not recognize gain on the asset sale because § 337 applied to the liquidation-related disposition.

## Legal Principles

- A transaction that introduces a new 50% owner and materially changes ownership interests may fail to qualify as a § 368 “D” reorganization (control/continuity requirements) and may exceed the scope of a “mere change” under a § 368 “F” reorganization.
- Distributions made pursuant to a plan of complete liquidation are treated under §§ 346(a)(1) and 331(a) as amounts received in exchange for stock, generally yielding capital gain or loss to the shareholder rather than dividend treatment.
- When a corporation adopts a plan of complete liquidation and disposes of property within the statutory period, § 337 can prevent recognition of corporate-level gain on liquidation-related sales, even if the business continues in a new corporation, so long as the statutory requirements are satisfied.
- Bona fide business motivations and non-sham implementation support applying the literal liquidation and nonrecognition provisions rather than recharacterizing the steps as a reorganization or dividend distribution.

## Conclusion

The Tax Court treated the restructuring as a bona fide complete liquidation rather than a § 368 reorganization, granting § 331 capital gain treatment to the shareholder on liquidating distributions and § 337 nonrecognition to the corporation on the asset sale to the successor entity.


Berghash v. Commissioner, 43 T.C. 743 (1965)