Berghash v. Commissioner

Hyman Berghash (plaintiff) owned all 200 shares of common stock in Delavan-Bailey Drug Co., Inc. (Delavan-Bailey) (plaintiff). Sidney Lettman, a manager for Delavan-Bailey, expressed a desire to leave Delavan-Bailey unless he acquired a 50 percent interest in Delavan-Bailey. However, Lettman had only $25,000 in capital—an insufficient amount to purchase 100 shares. Berghash and Lettman entered into a contract under which they agreed to form a new corporation, Dorn’s Drugs, Inc. (Dorn’s), in which Lettman would own half of the 200 shares of common stock. Pursuant to the contract, Lettman paid $25,000 for 100 shares of Dorn’s common stock. Meanwhile, Delavan-Bailey sold the entirety of its assets—including fixtures, inventory, and goodwill—to Dorn’s, which paid Delavan-Bailey with a promissory note for $96,101.64 and the other 100 shares of its common stock. Delavan-Bailey then made a distribution in liquidation to Berghash. This distribution included the 100 shares of Dorn’s stock, the promissory note, and $49,313.17 in cash. Delavan-Bailey was dissolved, at which point it had accumulated earnings and profits of $122,050.11. The corporate name of Dorn’s was subsequently changed to Delavan-Bailey Drug Co., Inc. Berghash reported a long-term capital gain on the old Delavan-Bailey liquidation. However, the Commissioner of Internal Revenue (the commissioner) (defendant) determined that Berghash had realized dividend income in the amount of the old Delavan-Bailey’s earnings and profits. The commissioner also assessed a deficiency against Delavan-Bailey for the capital gain realized on the sale of its fixtures and goodwill. Berghash and Delavan-Bailey challenged the assessments in the United States Tax Court.