Henry T. Patterson Trust v. United States

Henry T. Patterson, Sr., was the chief executive officer of Puritan Laundry and Dry Cleaning Company (Puritan). In 1969 Henry gave 40 shares of Puritan stock to his children, Ellen, John, and Hank. Henry retained 200 shares of Puritan stock. In 1970 Henry stepped away from the company and designated Ellen’s husband, Bill Hicks, to act as Puritan’s president. In 1971 Henry died. That same year, Hicks and Puritan’s board of directors had a disagreement, and Hicks resigned. Puritan suffered immediately, and Hicks returned to the company after receiving a salary increase and option to purchase 80 newly issued shares of Puritan stock. Hicks acquired five shares and left his option open with regard to the remaining 75 shares. Henry’s wife, Ella, was placed in charge of the Henry T. Patterson Trust (the trust) (plaintiff). Eventually, Ella agreed to redeem the 200 shares of Puritan stock that were owned by the trust for $190,000. The trust reported the gains from the redemption as capital gains. The Commissioner of Internal Revenue (the Commissioner) (defendant) determined that the redemption was a dividend that was taxable as ordinary income. In making his determination, the Commissioner held that the trust constructively owned Ella, Ellen, Hank, and John’s shares. When Puritan redeemed the trust’s 200 shares, the trust still controlled Puritan through the other shares. Therefore, the redemption was not a meaningful reduction of the trust’s ownership. In making his calculations, the Commissioner did not include the 75 option shares that Hicks had in the total number of Puritan shares, because Hicks had not yet exercised the options. Without Hicks’s shares, the redemption decreased the trust’s ownership of stock from 97 percent to 93 percent. The district court reversed, finding that the trust’s ownership of Puritan had been reduced from 80 percent to 62.8 percent, a meaningful reduction. The district court factored Hicks’s option shares in the total number of Puritan shares. The Commissioner appealed.