## Facts

- A family partnership operated a quarrying and construction-materials business using the cash method and a calendar year.
- The partnership did not include uncollected accounts receivable in income at year-end and deducted inventory costs as incurred, resulting in an effective zero tax basis in inventory.
- On March 1, 1957, the partners incorporated and transferred all business assets, including approximately $662,820 in accounts receivable and about $350,000 in physical inventory, to the corporation in exchange for all its stock.
- The corporation continued the business, used a fiscal year beginning March 1, and initially continued using the cash method.
- The IRS treated the transaction as a nonrecognition exchange under I.R.C. § 351(a) with carryover basis, including a zero basis in the transferred inventory.
- The Commissioner determined the corporation’s method did not clearly reflect income for fiscal years ending February 28, 1958 and 1959, and assessed deficiencies that (i) taxed the corporation when it collected the transferred receivables and (ii) increased income by using a zero opening inventory basis.
- The taxpayer paid the deficiencies, filed administrative refund claims, and then brought a refund suit after disallowance.
- The district court granted summary judgment for the United States, including on the ground that an inventory “tax-benefit” theory was not properly raised in the administrative claim.

## Issues

1. Whether accounts receivable transferred from a cash-basis partnership to a corporation for stock are “property” within I.R.C. § 351(a), making the corporation taxable on the receivables when collected.
2. Whether the transferee corporation could increase the opening basis of transferred inventory under a tax-benefit theory despite the partnership’s prior deductions producing a zero basis.
3. Whether a refund suit may proceed on an inventory/tax-benefit theory not fairly presented in the administrative refund claim.

## Decision

- The Third Circuit affirmed summary judgment for the United States.
- The court held that the transferred accounts receivable were “property” under § 351(a) and that the corporation properly recognized income upon collection.
- The court sustained the IRS’s inventory treatment: the corporation took a zero basis in inventory deducted by the partnership, and no tax-benefit doctrine basis increase was allowed.
- The court agreed that the district court lacked jurisdiction to entertain a materially new refund theory not adequately raised in the administrative claim.

## Legal Principles

- “Property” in I.R.C. § 351(a) is construed broadly and includes identifiable, valuable, transferable intangible rights such as accounts receivable transferred as part of an ongoing business.
- In a qualifying § 351 exchange, nonrecognition applies at transfer, and the transferee generally takes a carryover basis; subsequent collections of transferred receivables by a cash-method transferee can generate taxable income to the transferee.
- Where a transferor previously deducted inventory costs, the inventory’s carryover tax basis is zero in the transferee absent statutory authorization for an adjustment.
- The tax-benefit doctrine generally addresses inclusion of recovered previously deducted items; it does not authorize creating or increasing basis to offset prior deductions in this context.
- Refund litigation is constrained by the variance rule: the grounds for recovery in court must be fairly encompassed within the administrative refund claim; otherwise, the court lacks jurisdiction to consider the new theory.

## Conclusion

The court held that receivables transferred in a § 351 incorporation are “property” and are taxable to the corporation when collected, upheld a zero carryover basis for inventory previously expensed by the partnership, and enforced strict limits on raising new refund theories beyond the administrative claim.


Hempt Bros., Inc. v. United States, 490 F.2d 1172 (3d Cir. 1974)