## Facts

- William H. Bloch and Audrey H. Bloch paid assessed federal income tax deficiencies and interest for 1960–1961 and sought a refund after their administrative claims were denied.
- The assessments stemmed from (1) amounts Bloch received in a corporate stock redemption by Southern Elevator and Storage Company, Inc. (“Southern”) and (2) an installment sale of law office equipment (the government conceded the installment-sale issue).
- Southern was a Texas corporation operating a grain storage facility.
- Ownership before the redemption was: Bloch 45%, B.F. Bryan 45%, and Lee Harris 10%.
- Southern’s management sought to give Harris and plant manager William Parrish an ownership interest.
- Southern redeemed 15% of the outstanding stock from Bloch and Bryan pro rata to their holdings; each received a no-interest corporate promissory note for $35,700, payable within three years.
- Southern then reoffered the redeemed shares to Harris and Parrish at a lower price; Parrish bought two-thirds of the shares and Harris bought one-third.
- Bloch reported payments received on the note as long-term capital gain from a stock redemption treated as a sale or exchange.
- The IRS treated the redemption proceeds as dividends taxable as ordinary income and assessed deficiencies for 1960–1961.

## Issues

1. Whether Southern’s redemption payments to Bloch were “essentially equivalent to a dividend” and taxable as ordinary income, or instead were payments “in exchange for stock” entitled to capital-gain treatment.

## Decision

- The district court entered judgment for the Blochs on the stock-redemption issue and ordered a refund for the tax and interest attributable to treating the redemption proceeds as dividends.
- The court held the redemption distributions were not essentially equivalent to a dividend and were properly treated as received in exchange for stock.
- The Fifth Circuit affirmed the judgment.

## Legal Principles

- A stock redemption is treated as a dividend to the extent it is essentially equivalent to a dividend; otherwise, it may be treated as a sale or exchange of stock for capital-gain purposes.
- Dividend equivalence is evaluated by the transaction’s net effect, including whether the shareholder’s proportionate interest remains substantially the same after the redemption.
- A non-pro rata redemption undertaken for a genuine corporate purpose, coupled with a meaningful shift in ownership interests, supports sale-or-exchange characterization rather than dividend treatment.
- The substance of the overall transaction—including subsequent resale of redeemed shares to new or continuing participants and resulting dilution of controlling shareholders—governs characterization more than labels used by the parties.
- Use of a fixed corporate obligation issued in exchange for surrendered shares may be consistent with sale treatment when the transaction functions as a purchase of stock rather than a distribution of earnings.

## Conclusion

Because the redemption and immediate resale of shares to Harris and Parrish effectuated a real change in ownership and proprietary interests and was not merely a distribution of earnings to Bloch, the court held the payments were not essentially equivalent to a dividend and were taxable as capital gain, entitling the Blochs to a refund for the disputed portion of the assessments.


Bloch v. United States, 261 F. Supp. 597 (S.D. Tex. 1966)