## Facts

- Isidore Himmel and two others incorporated H. A. Leed Co. in 1946; each initially held common stock, and Himmel served as president until early 1956.
- From 1946 to 1948, Himmel advanced funds to the corporation as loans, recorded as “Loans Payable,” with an expectation of repayment when feasible.
- In late 1948, the corporation recapitalized to improve credit: Himmel’s $37,600 debt claim was cancelled in exchange for Class A 2% cumulative nonvoting preferred stock and Class B 2% cumulative voting preferred stock; Class B could not be redeemed until all Class A was redeemed.
- In 1950, Himmel transferred his common shares to his two sons, leaving him primarily as a preferred shareholder by the time of the later redemptions.
- The corporation redeemed 50 Class A preferred shares in 1957 and 70 Class A preferred shares in 1958, when it had earnings and profits exceeding the redemption prices.
- Himmel did not report the redemption proceeds on his 1957 and 1958 returns.
- The Commissioner assessed deficiencies, treating the redemption payments as ordinary dividend income under I.R.C. § 302(b)(1); the Tax Court sustained the deficiencies.

## Issues

1. Whether the 1957 and 1958 redemptions of Himmel’s Class A preferred stock were “essentially equivalent to a dividend” under I.R.C. § 302(b)(1), making the proceeds taxable as ordinary income rather than as exchange proceeds.

## Decision

- The Second Circuit reversed the Tax Court.
- The court held the redemptions were not essentially equivalent to dividends under § 302(b)(1).
- The redemption proceeds were treated as amounts received in exchange for stock rather than as dividend distributions.

## Legal Principles

- Whether a redemption is “essentially equivalent to a dividend” under I.R.C. § 302(b)(1) is a question of law applying the statutory standard to the found facts.
- Dividend equivalence turns on the substantive effect of the redemption on the shareholder’s relationship to the corporation, not solely on the presence of earnings and profits.
- When preferred stock was issued as a substitute for a bona fide debt position and later redeemed as part of restoring that creditor-type interest, the redemption may qualify for exchange treatment under § 302(b)(1) rather than dividend treatment.

## Conclusion

The court concluded that redeeming preferred stock originally received in cancellation of genuine corporate indebtedness functioned more like repayment of a creditor-type interest than a distribution of corporate earnings to an equity owner, so the redemptions were not “essentially equivalent to a dividend” and received exchange (capital) treatment under § 302(b)(1).


Himmel v. Comm’r, 338 F.2d 815 (2d Cir. 1964)