## Facts

- Metal Moulding Corporation, a Michigan corporation, had substantial accumulated earnings and liquid assets and was concerned about tax on accumulated earnings.
- C. P. Chamberlin (majority shareholder) and other shareholders sought to reduce corporate surplus without receiving ordinary cash dividends taxable at high individual rates.
- The corporation created a new class of preferred stock and distributed it pro rata to common shareholders as a stock dividend.
- The preferred stock carried cumulative 4.5% dividends, was redeemable at par plus premiums and accrued dividends, and was subject to mandatory retirement over approximately 7.5 years.
- As part of the overall plan, shareholders sold the preferred shares shortly after receipt to several insurance companies for cash.
- Shareholders reported the stock dividend as nontaxable and reported cash received from selling the preferred stock as long-term capital gain.
- The Commissioner treated the cash proceeds as ordinary dividend income on the theory the steps were, in substance, a cash distribution from corporate earnings.
- The Tax Court sustained the resulting deficiencies; the shareholders petitioned for review.

## Issues

1. Whether a preferred stock dividend followed by a planned sale to third parties should be characterized as a nontaxable stock dividend with capital-gain consequences on sale, or as a taxable cash dividend in substance.
2. Whether the prearranged, near-contemporaneous sale of the preferred shares to insurance companies alters the tax character of the initial stock dividend distribution.

## Decision

- The Sixth Circuit reversed the Tax Court.
- The preferred stock distribution qualified as a nontaxable stock dividend under then-existing doctrine.
- The subsequent shareholder sale to insurance companies did not convert the stock dividend into a taxable cash dividend.
- Shareholders could treat the sale proceeds as arising from a disposition of stock (capital gain treatment), rather than as ordinary dividend income.

## Legal Principles

- A properly structured, pro rata stock dividend that does not distribute corporate assets for shareholders’ separate use is not taxable upon receipt.
- A corporation’s distribution of stock and a shareholder’s later sale of that stock to third parties are distinct tax events unless the law provides a basis to recharacterize them as a single dividend distribution.
- Tax-avoidance motive, without statutory authority to disregard a bona fide stock dividend, does not by itself permit recharacterization of the transaction as an ordinary cash dividend.

## Conclusion

The court held that the shareholders received a nontaxable preferred stock dividend and realized capital gain upon selling the preferred shares to insurance companies, rejecting the Commissioner’s attempt to treat the integrated plan as a constructive cash dividend.


Chamberlin v. Commissioner, 207 F.2d 462 (6th Cir. 1953)