## Facts

- Frederick A. Sansome bought shares in a New Jersey corporation on January 1, 1921.
- On April 1, 1921, the corporation transferred all assets to a new New Jersey corporation, which assumed liabilities and issued stock to the old shareholders in the same ownership proportions (with a fivefold increase in shares and no par value).
- The new corporation’s charter largely matched the old, except it permitted additional manufacturing lines; there was no other material change in financial structure.
- The predecessor had a large surplus and undivided profits accumulated before 1921; the successor carried that amount on its books (reduced by 1922 losses).
- The successor had no profits and dissolved in 1923.
- In 1923, Sansome received liquidation payments that did not exhaust the remaining carried-over surplus and undivided profits.
- The Commissioner treated the 1923 liquidation payments as taxable dividends under § 201 of the Revenue Act of 1921.
- The Board of Tax Appeals ruled for Sansome, treating the payments as return of capital on the theory that the successor had no earnings and profits of its own.

## Issues

1. Whether, under § 201 of the Revenue Act of 1921, a successor corporation’s liquidation payments are taxable dividends to the extent of accumulated surplus and undivided profits carried over from a predecessor in a tax-free reorganization.
2. Whether a shareholder may apply liquidation payments first to recover stock basis when accumulated earnings and profits remain available to support dividend treatment.

## Decision

- The Second Circuit reversed the Board of Tax Appeals.
- The court held the 1923 liquidation payments were taxable dividends to the extent of accumulated earnings and profits reflected in the carried-over surplus and undivided profits.
- The court treated the reorganization as preserving continuity for earnings-and-profits purposes, so the predecessor’s accumulated surplus remained available for dividend taxation in the successor.
- The court rejected Sansome’s position that liquidation payments should first reduce basis before any dividend taxation while earnings and profits remained.

## Legal Principles

- In a tax-free reorganization where no gain or loss is recognized, the corporate enterprise is treated as continuous for purposes of accumulated earnings and profits.
- Accumulated earnings and profits of the transferor corporation carry over to the transferee (successor) corporation for determining whether later distributions are dividends.
- Under § 201 of the Revenue Act of 1921, distributions made in liquidation can be taxed as dividends to the extent they are made out of accumulated earnings and profits; basis recovery does not precede dividend treatment while such earnings and profits remain.
- A formal distinction between separate corporate entities does not prevent carried-over earnings and profits from supporting dividend characterization when the reorganization preserves shareholder continuity and financial continuity.

## Conclusion

The court held that a tax-free reorganization does not eliminate accumulated earnings and profits for dividend purposes; therefore, liquidation payments by the successor corporation were taxable as dividends to the extent of the predecessor’s carried-over surplus under the Revenue Act of 1921.


Comm’r v. Sansome, 60 F.2d 931 (2d Cir. 1932)