## Facts

- Nathan Cummings, a corporate executive and MGM director, purchased 51,500 shares of MGM stock amid management changes and joined MGM’s board.
- On April 17, 1961, he sold 3,400 MGM shares for $227,648.28 and reported the resulting profit as long-term capital gain on his 1961 joint return.
- Between September 18 and October 2, 1961, he repurchased 3,000 MGM shares for $146,960.89, creating potential “short-swing profit” liability under § 16(b) of the Securities Exchange Act of 1934.
- The difference between sale and repurchase prices ($53,870.81) was the amount recoverable by MGM under § 16(b).
- After the SEC advised that any § 16(b) profits would require disclosure in MGM’s proxy materials, Cummings paid $53,870.81 to MGM to satisfy the potential § 16(b) obligation.
- Cummings claimed the payment as an ordinary and necessary business expense deduction under I.R.C. § 162(a); the IRS recharacterized it as a long-term capital loss and assessed a deficiency.

## Issues

1. Whether a corporate insider’s payment to disgorge § 16(b) short-swing profits is deductible as an ordinary and necessary business expense under I.R.C. § 162(a).
2. Whether the § 16(b) payment must instead be treated as a long-term capital loss because it directly relates to a transaction that produced long-term capital gain.

## Decision

- The Second Circuit reversed the Tax Court.
- The court held the § 16(b) payment must be treated as a long-term capital loss, not an ordinary and necessary business expense.
- The case was remanded for proceedings consistent with that characterization.

## Legal Principles

- A disgorgement payment under § 16(b) that returns profits from a stock transaction is characterized for tax purposes by the nature of the underlying transaction that generated the profit.
- Where the taxpayer reported the original profit as long-term capital gain, the compelled repayment of that profit is properly treated as a long-term capital loss to preserve symmetry within the capital gain/loss regime.
- Ordinary deduction treatment is inappropriate when the payment’s origin is a capital transaction rather than a routine cost of carrying on a trade or business.
- Characterizing § 16(b) disgorgement as a capital loss aligns with § 16(b)’s deterrent purpose by preventing the insider from broadly offsetting the repayment against ordinary income.

## Conclusion

The Second Circuit required matching tax treatment between the capital gain from the insider’s stock sale and the later § 16(b) disgorgement of that gain, holding that the repayment is a long-term capital loss rather than a deductible ordinary business expense.


Cummings v. Comm’r, 506 F.2d 449 (2d Cir. 1974), cert. denied, 421 U.S. 913 (1975)