Commissioner of Internal Revenue v. Fender Sales, Inc.

Donald Randall and Leo Fender (plaintiffs) were employees as well as the sole shareholders of Fender Sales, Inc. (corporation) (plaintiff). Each received a set salary as well as a percentage of annual sales as compensation. The corporation began to have financial problems and was no longer able to pay the salaries of Randall and Fender. In order to cancel the debt of $45,000 owed to each man for three years’ unpaid salaries, the corporation issued 450 shares of common stock to each in 1956. The corporation issued another 150 shares each to Randall and Fender in 1958 for additional unpaid salaries of 1957 and 1958. The receipt of the stock was not reported as income by Randall and Fender. Likewise, the corporation did not report the cancellation of debt on its tax returns. The commissioner of the Internal Revenue Service (defendant) assessed Randall and Fender for taxable salary income on the receipt of the stock and further contended that, if the receipt of the stock was not taxable, the corporation received taxable income from the discharge of debt. Randall, Fender, and the corporation appealed the assessment to the United States Tax Court, which held that neither the receipt of the stock nor the cancellation of debt was taxable. The Tax Court reasoned that the receipt of additional shares did not change the proportion of ownership by Fender and Randall. The commissioner appealed to the United States Court of Appeals for the Ninth Circuit.