## Facts

- Chandler-Singleton Co., a closely held corporation, operated a department store until 1946.
- In 1946, it sold the merchandise, fixtures, furniture, and lease associated with the department-store operation.
- The corporation continued operating a smaller ladies’-wear store at a different location.
- After the sale, the corporation held cash exceeding operating needs.
- Shareholders authorized what they described as a partial liquidation to distribute excess cash and reduce capital.
- The corporation redeemed one-half of all outstanding shares on a pro rata basis, paying cash based on book value.
- The redemption did not change any shareholder’s relative ownership percentage or control; each retained the same proportionate interest.
- Shareholders reported the proceeds as received in partial liquidation, treating the transaction as a sale or exchange and recognizing capital gain to the extent proceeds exceeded basis.
- The Commissioner determined the redemption was essentially equivalent to a taxable dividend under § 115(g) of the Internal Revenue Code of 1939 and asserted deficiencies.

## Issues

1. Whether the corporation’s pro rata redemption of one-half of its outstanding shares was a distribution in partial liquidation taxable as a sale or exchange under § 115(c), or a dividend-equivalent redemption taxable as ordinary income under § 115(g) (to the extent of earnings and profits).

## Decision

- The Tax Court ruled for the Commissioner.
- The court held the pro rata redemption was essentially equivalent to a taxable dividend under § 115(g).
- The amounts received were taxable as dividends to the extent of the corporation’s earnings and profits, not as capital gains from a partial liquidation.

## Legal Principles

- A stock redemption may be taxed as a dividend if, in substance, it is essentially equivalent to a dividend distribution (§ 115(g), 1939 Code).
- Amounts distributed in partial liquidation may be treated as received in exchange for stock (§ 115(c)), but characterization depends on the transaction’s substance.
- A pro rata redemption that leaves shareholders’ proportionate interests unchanged is strong evidence of dividend equivalence, particularly when funded from earnings and profits.
- A claimed business contraction does not control if the distribution functionally serves to distribute corporate surplus while the corporation continues and ownership rights remain materially unchanged.
- Labels used by the corporation (e.g., “partial liquidation”) do not determine tax consequences; the controlling inquiry is economic effect.

## Conclusion

The Tax Court treated the corporation’s pro rata, cash-funded redemption—executed after a reduction in operations but without altering shareholders’ relative ownership—as a dividend-equivalent distribution taxable as ordinary income to the extent of earnings and profits, rather than a partial liquidation eligible for capital-gain exchange treatment.


Estate of Chandler v. Comm’r, 22 T.C. 1158 (1954)