## Facts

- Joseph R. Holsey and Eleanor T. Holsey filed a joint federal income tax return for 1951; the disputed income concerned Joseph Holsey.
- J. R. Holsey Sales Company (Holsey Company), a New Jersey corporation operating an Oldsmobile dealership, was organized in 1936 with 20 shares of no-par common stock issued (out of 2,500 authorized).
- Those shares were issued to Greenville Auto Sales Company (Greenville) in exchange for Greenville’s Oldsmobile franchise-related assets; Holsey’s father (Charles V. Holsey) controlled Greenville.
- In 1936, Greenville granted Joseph Holsey an option to buy 50% of Holsey Company for $11,000, plus a further option to buy the remaining shares later.
- In 1939, Holsey exercised the first option and acquired 50% of Holsey Company.
- In 1946, the remaining-shares option was revised to allow Holsey to purchase the balance by June 28, 1951 for $80,000; the option was nonassignable except to a corporation in which Holsey owned at least 50% of the voting stock.
- In 1948, Holsey Company declared a 3-for-1 stock dividend, increasing the number of outstanding shares.
- In 1951, Holsey assigned the option to Holsey Company, which then exercised it and paid Greenville $80,000 to acquire (redeem) the remaining shares.
- After the redemption, Holsey owned 100% of Holsey Company’s outstanding stock.
- The Commissioner determined a 1951 deficiency, treating the corporation’s $80,000 redemption payment as a constructive dividend to Holsey; the Tax Court sustained the deficiency.

## Issues

1. Whether Holsey Company’s $80,000 payment to redeem stock from Greenville, after Holsey assigned his purchase option to the corporation, was “essentially equivalent to the distribution of a taxable dividend” to Holsey and thus a constructive dividend.

## Decision

- The Third Circuit reversed the Tax Court.
- The court held the $80,000 payment to Greenville to redeem Holsey Company’s stock was not a constructive dividend taxable to Holsey.
- The court reasoned that the corporation paid Greenville, not Holsey, and the payment did not discharge any legal obligation of Holsey to purchase the shares.
- The court further concluded that any indirect benefit to Holsey (including increased value of his remaining shares and resulting sole ownership) did not constitute realized income absent a distribution or sale.
- The court emphasized that the redemption’s effect was a change in proportional ownership (from 50% to 100%), unlike a dividend, which generally leaves proportional interests unchanged.

## Legal Principles

- A corporate payment may be treated as a constructive dividend to a shareholder only when it amounts to a distribution to the shareholder or is made for the shareholder’s direct benefit, such as by discharging the shareholder’s legal obligation.
- Stock appreciation or other indirect economic benefits to a shareholder from a corporate transaction, without realization through distribution or sale, do not themselves create taxable income.
- In evaluating whether a stock redemption is “essentially equivalent to a dividend,” the transaction’s effect—particularly on shareholders’ proportional interests—matters more than the parties’ motives.

## Conclusion

The court held that a corporation’s use of corporate funds to redeem another shareholder’s stock, where the remaining shareholder neither receives the funds nor has a personal legal duty satisfied by the payment, is not treated as a constructive dividend to the remaining shareholder even if the shareholder’s ownership becomes complete and the shares may increase in value.


Holsey v. Comm’r, 258 F.2d 865 (3d Cir. 1958)