Dunn v. Commissioner

Georgia Dunn (plaintiff) was a shareholder of Bresee Chevrolet Company, Inc. (company), which was a closely held corporation. Dunn’s children held the remainder of the shares. Dunn entered into a stock purchase agreement with the company to sell or redeem all of her stock for a promissory note for payments, with interest, over a 10-year period. As part of the agreement, the payments would not be made or would be reduced or postponed if such payments would interfere with the company’s franchise agreement with General Motors, which required the company to maintain a minimum net working capital. In accordance with the agreement, the company redeemed all of Dunn’s stock and made the first payment in June 1970; a second, reduced payment was made in June 1971. After the agreement, Dunn was not an officer, director, or employee of the company. The commissioner of the Internal Revenue Service (defendant) assessed tax against the income as constructive dividends rather than capital gains on the redemption of stock. The commissioner contended that, under Treasury Regulation § 1.302-4(d), Dunn was not merely a creditor because the payments on the debt were dependent upon the company’s earnings. The United States Tax Court ruled in favor of Dunn, holding that the amounts received were a complete redemption of her stock and thus capital gains. The commissioner appealed to the United States Court of Appeals for the Second Circuit.