## Facts

- Old Plantation Patterns, Inc., an Alabama wrought-iron furniture manufacturer, was acquired in 1962 through a newly formed corporation, Plantation Patterns, Inc. (“New Plantation”).
- New Plantation’s stock was issued in Marie Jemison’s name for $5,000, but the courts treated the shares as effectively owned by John S. Jemison, Jr. (nominee ownership).
- The acquisition was financed largely with instruments issued to the selling shareholders: approximately $609,878.33 in 5.5% serial notes and $150,000 in subordinated 6.5% debentures, with only a small equity base.
- Jemison personally guaranteed the notes; Jemison Investment Co., Inc. (wholly owned by him) also guaranteed them.
- After the stock purchase, Old Plantation was liquidated into New Plantation under a plan qualifying under I.R.C. § 334(b)(2), and New Plantation continued the business.
- The IRS determined deficiencies against New Plantation (fiscal years ending in 1963–1965) and against John and Marie Jemison (1963), disallowing interest deductions on the notes and treating note payments as dividends to Jemison.
- The Tax Court upheld the IRS determinations, finding the notes functioned as equity supported by Jemison’s indirect capital contribution through his guarantee; New Plantation and the Jemisons appealed.

## Issues

1. Whether New Plantation’s 5.5% serial notes constituted true corporate indebtedness or equity for federal income tax purposes.
2. If the notes were equity in substance, whether the indirect capital contribution was attributable to John S. Jemison, Jr., rather than to Jemison Investment Co., Inc. or the sellers.
3. Whether payments labeled as “interest” on the notes were deductible by New Plantation and whether such payments were taxable to Jemison as dividends.

## Decision

- The Fifth Circuit affirmed the Tax Court.
- The court held the serial notes were properly treated as equity rather than debt, given New Plantation’s extreme thin capitalization and the transaction’s economic reality.
- The court upheld the finding that Jemison’s personal guarantee supplied the real capital support and therefore constituted an indirect capital contribution by Jemison.
- As a result, New Plantation could not deduct “interest” on the notes, and the payments were treated as dividend distributions to Jemison (followed by his payments to the sellers).

## Legal Principles

- Federal tax characterization of an instrument as debt or equity turns on economic substance, not labels, and requires consideration of the full set of surrounding facts.
- Extreme thin capitalization supports treating purported debt as equity, particularly when repayment depends on the success of the business or on shareholder support rather than on adequate corporate capital.
- When sellers rely primarily on a controlling shareholder’s personal guarantee to secure payment, the guarantee may be treated as an indirect equity contribution by that shareholder.
- If an instrument is recharacterized as equity, amounts paid as “interest” are not deductible as interest on indebtedness and may be treated as distributions with respect to stock (dividends) to the shareholder.

## Conclusion

The Fifth Circuit sustained the IRS’s and Tax Court’s substance-over-form recharacterization of acquisition notes as equity where a thinly capitalized corporation’s obligations were effectively secured by the controlling shareholder’s guarantee, leading to denial of corporate interest deductions and dividend treatment to the shareholder.


Plantation Patterns, Inc. v. Commissioner, 462 F.2d 712 (5th Cir. 1972)