## Facts

- Two shareholders of a closely held corporation caused a recapitalization intended to reduce taxes.
- The corporation replaced 1,000 shares of common stock with 2,000 shares: 1,000 Class A and 1,000 Class B.
- The husbands retained all Class A shares and transferred all Class B shares to their wives.
- Class A shares carried all voting power, received a $10 per-share noncumulative preferred dividend before any Class B dividend, and held essentially all liquidation value beyond $1 per Class B share.
- Class B shares had no voting rights, had only $1 per share liquidation value, and received most dividends above the $10-per-A threshold (four-fifths of excess dividends).
- A later agreement restricted the wives’ ability to dispose of the Class B shares so they could not realize more than $1 per share from a sale.
- Over several years, Class B shares received substantially larger dividends than Class A shares, while Class A retained high book value and the residual claim on corporate assets.
- The Commissioner determined that dividends paid to the wives were, in substance, income to the husbands and asserted: (i) gift tax deficiencies and a 25% penalty against Overton for years involving dividends paid to his wife, and (ii) an income tax deficiency against Oliphant for a year in which his wife received dividends.
- The Tax Court sustained the deficiencies; the Second Circuit affirmed.

## Issues

1. Whether dividends paid to a shareholder’s spouse on Class B stock titled in the spouse’s name were taxable to the shareholder when the shareholder retained control and the substantial capital interest in the corporation.
2. Whether the arrangement and dividend payments to the spouse gave rise to gift tax deficiencies (and a statutory penalty) against the shareholder based on a transfer characterized as a diversion of dividend income rather than a substantive transfer of capital.

## Decision

- The Second Circuit affirmed the Tax Court.
- The court held that the recapitalization, transfer of Class B shares, and sale restrictions did not transfer a substantial capital interest to the wives but operated as an assignment of future dividend income.
- The court treated the dividends paid to the wives on the Class B shares as taxable income to the husbands.
- The court sustained the gift tax deficiencies and the 25% penalty assessed against Overton.

## Legal Principles

- Federal tax liability turns on substance rather than formal labels; courts examine control, residual ownership, risk, and economic rights.
- A taxpayer cannot avoid income tax through an anticipatory assignment of income while retaining the underlying property or capital interest generating the income.
- Where a purported stock transfer gives the transferee only a limited right to receive earnings, coupled with minimal liquidation value, lack of control, and restrictions on alienation, dividends may be reattributed to the transferor as the true earner/owner for income tax purposes.
- Gift tax consequences and related penalties may apply when a taxpayer diverts an income stream to another person without properly reporting the transfer and the substance supports gift treatment.

## Conclusion

The court upheld reattribution of dividends to the husbands because the recapitalization and transfer of Class B shares left the husbands with corporate control and the residual capital interest, making the arrangement an anticipatory assignment of dividend income; it also sustained associated gift tax deficiencies and penalties.


Overton v. Commissioner, 162 F.2d 155 (2d Cir. 1947)