## Facts

- A taxpayer purchased cumulative, nonvoting preferred stock of Columbia Steel Corporation in 1924 and 1926.
- The preferred stock entitled holders to an annual $7 dividend payable in cash or, at the corporation’s option, in one share of common stock per preferred share.
- From 1925 to 1928, the corporation had sufficient surplus to pay the preferred dividends in cash but elected to pay the dividends in common voting shares.
- The common stock carried voting rights and a residual claim on assets after satisfaction of the preferred stock’s fixed dividend and liquidation preferences.
- In 1930, the corporation redeemed the preferred shares for $105 per share plus accrued dividends.
- In computing gain on redemption, the Commissioner allocated part of the taxpayer’s original preferred-stock cost basis to the common shares received as dividends, reducing the preferred stock’s remaining basis and increasing the taxable gain on redemption.
- The Board of Tax Appeals held the common-share distributions were taxable income and did not reduce the preferred stock’s cost basis.
- The court of appeals reversed, approving the Commissioner’s basis-allocation method; the Supreme Court granted review to resolve a circuit conflict.

## Issues

1. Whether common voting shares distributed as dividends to holders of cumulative, nonvoting preferred stock are taxable income rather than a nonrecognition stock dividend or return of capital under the Revenue Acts of 1926 and 1928.
2. If the distributions are income, whether any portion of the preferred stock’s original cost basis must be apportioned to the distributed common shares when computing gain or loss on a later sale or redemption of the preferred stock.
3. Whether Treasury regulations may require basis apportionment that effectively recharacterizes income as a return of capital contrary to the statutory scheme.

## Decision

- The Supreme Court reversed the court of appeals.
- The Court held that common voting shares received as dividends by preferred shareholders were taxable income, not a return of capital.
- The Court held that no portion of the preferred stock’s original cost basis could be allocated to the common shares received as dividends for purposes of computing gain or loss on the later disposition of the preferred stock.
- The Court rejected the Commissioner’s regulation-based allocation method because it conflicted with the governing statutes and would effectively turn an income tax into a capital levy.

## Legal Principles

- When a distribution gives shareholders an interest with materially different rights (e.g., voting power and residual equity), it may constitute taxable income rather than a nonrecognition stock dividend.
- If a distribution is taxable as income when received, the recipient does not reduce or apportion the cost basis of the original shares by treating the distribution as a return of capital.
- Gain or loss on disposition of property is determined by comparing the amount realized with the taxpayer’s basis in the property disposed of; basis is not reduced by separate items taxed as income.
- Treasury regulations cannot amend clear statutory directives or impose a method that recharacterizes income as capital in a manner inconsistent with an unambiguous statute.

## Conclusion

The Court held that common voting shares distributed as “dividends” to nonvoting preferred shareholders were taxable income, and it barred any apportionment of the preferred stock’s original cost basis to those dividend shares when computing gain on the preferred stock’s later redemption, emphasizing that regulations cannot override clear statutory rules.


Koshland v. Helvering, 298 U.S. 441 (1936)