## Facts

- North Star Woolen Mills Co. was a closely held corporation long controlled by William Northup and family shareholders.
- Advisors warned that Northup’s death could leave corporate control with family members viewed as inexperienced, creating concerns about continuity and control.
- In 1941, shareholders approved a recapitalization creating 14,000 shares: 8,000 voting common shares (par $50) and 6,000 non-par preferred shares with a $5 cumulative dividend.
- The preferred stock was nonvoting while dividends were current but gained voting rights if a year’s dividend was omitted.
- Shareholders could exchange one share of existing $50-par stock for 1¼ shares of new preferred stock; the preferred was redeemable at $100 per share.
- The Commissioner asserted the transaction was intended to route corporate surplus to preferred holders and treated the exchange as producing taxable gain.
- The shareholders petitioned for redetermination, arguing the transaction was a legitimate recapitalization qualifying as a nonrecognition reorganization.

## Issues

1. Whether the 1941 transaction qualified as a statutory “recapitalization” reorganization, making the stock exchange a nonrecognition event.
2. If not a reorganization, whether shareholders realized taxable gain measured by the value of preferred stock received over their basis in the old stock.

## Decision

- The Tax Court held the transaction was a recapitalization and therefore a tax-free reorganization.
- The shareholders’ exchange of old stock for the new preferred stock was a nonrecognition exchange.
- The Commissioner’s asserted deficiencies based on recognized gain were not sustained.

## Legal Principles

- A genuine restructuring of a corporation’s capital structure through an exchange of existing equity for new classes of equity can qualify as a “recapitalization” within the reorganization provisions.
- Nonrecognition treatment is supported where shareholders maintain continuity of proprietary interest and do not receive a cash-out or corporate property other than altered equity interests.
- The presence of a legitimate corporate business purpose supports reorganization treatment and weighs against recharacterizing the transaction as a disguised distribution of earnings and profits.
- A recapitalization is not treated as a constructive dividend merely because it may affect how future corporate earnings are allocated among shareholders.

## Conclusion

The Tax Court treated North Star’s 1941 stock-for-stock restructuring as a bona fide recapitalization reorganization, so the shareholders recognized no gain on exchanging their old shares for the new preferred stock and the Commissioner’s deficiency determinations failed.


Dean v. Commissioner, 10 T.C. 19 (1948)