Furthermore, it is not easy even to imagine what part of the basis of each individual partner for his partnership interests would be applied against his share of the amount realized from the sale in question which involved some but not all of the partnership assets. No such method of computing a gain is authorized for Federal tax purposes. The stipulated facts show that the partners made no effort to sell and Chase did not buy their individual interests in the partnership or any part of those interests, but, on the contrary, the subject of the sale was a part of the partnership assets subject to a part of the partnership liabilities. The partnership was not terminated by the sale. It retained some of its assets and the amount realized from the sale. Later it distributed its assets to the individual partners in liquidation. The sale was reported and the gain computed on the partnership return for its fiscal year as a partnership transaction and each individual partner merely reported on his separate return on a calendar year basis a part of the gain from the sale as a part of his distributive share of the net income of the partnership. The only change made by the Commissioner was to hold that a part of the gain was ordinary income rather than a capital gain. The stipulated facts do not support the petitioners' contention that the gain of the partnership should be taxed to the partners as capital gain upon the theory that they sold a portion of their partnership interests, which interests were capital assets. The Commissioner did not err. Decisions will be entered for the respondent. LESTER LUMBER COMPANY, INC., PETITIONER, ET AL.,1 v. Docket Nos. 17788, 17482, 17483, 17484, 17485, 17486, 17487, 17488, 17489, 17490, 17491, 17492, 17493, 17494, 14480. Promulgated February 23, 1950. 1. The stockholders of a corporation had personal accounts standing on the books of the corporation against which they could draw at any time. At the annual meeting they agreed to have the surplus credited pro rata to their accounts and 1,971 shares of previously authorized stock issued and charged to such accounts at par. One stockholder received stock for less than his pro rata share of the surplus; the others received stock in excess of their pro rata shares of surplus. Held, the distribution of the surplus was a taxable dividend. 1 Proceedings of the following petitioners are consolidated herewith: Christine Lester; Darwin Lester, (Deceased); Doris Lester; G. T. Lester, Jr., and Annie Lester; George T. Lester, Sr.; George W. Lester; Lottie Lester; Tilden Lester; George D. Oakley and Julia Oakley; Robert H. Oakley and Lula P. Oakley; J. A. Richardson and Ida Z. Richardson; Henry J. Turner and Ruth Turner; Leslie E. Wells and Mable Lester Wells; and Robert E. Bell and Myrtle Bell. 2. One petitioner omitted to report on his return $10,160 of interest credited to his account on the corporation's books and capital gain derived from a transfer of land. Imposition of 5 per cent penalty for negligence is sustained. Robert Ash, Esq., John Y. Merrell, Esq., W. T. Durant, Esq., and Leslie Kimble, C. P. A., for the petitioners. Paul E. Waring, Esq., for the respondent. These 15 consolidated cases involve the taxability of a distribution of surplus in 1943 which the individual petitioners contend was a nontaxable stock dividend. Petitioner George T. Lester, Sr., also contests a 5 per cent negligence penalty asserted by the respondent in the amount of $714.10. The issue in the corporation's case concerns the computation of its equity invested capital for excess profits tax purposes, as this may be affected by the decision on the stock dividend question. Income tax deficiencies were determined by the respondent as follows: Petitioner Lester Lumber Co. is a corporation organized under the laws of the State of Virginia in 1917. It is a wholesale dealer in or manufacturer of lumber, roofing, cement, lime, and plaster. Its principal office is at Martinsville, Virginia. Its books are kept and its tax returns prepared on the accrual basis. It filed income and excess profits tax returns for the calendar years 1942 and 1943 with the collector of internal revenue at Richmond, Virginia. Its stock is closely held by members of the Lester family and others who are, or were, its key employees. Prior to December 20, 1943, the authorized capital stock was 5,000 shares of common stock of the par value of $100 per share, and 3,029 shares were issued and outstanding and were held by 15 persons. Petitioners George T. Lester, Sr., Lottie Lester, George T. Lester, Jr., and Annie Lester, George W. Lester, Christine Lester, Doris Lester, Tildon Lester, George D. Oakley and Julia Oakley, Robert H. Oakley and Lula P. Oakley, J. A. Richardson and Ida Z. Richardson, Henry J. Turner and Ruth Turner, and Leslie E. Wells and Mable Lester Wells, are individuals residing at Martinsville, Virginia. Darwin Lester, now deceased, was a resident of Martinsville, Virginia. These petitioners filed income tax returns for the calendar year 1943 with the collector of internal revenue at Richmond, Virginia. Petitioners Robert E. Bell and Myrtle Bell are residents of Kingstree, South Carolina. The record does not disclose where their return for the calendar year 1943 was filed. Each stockholder of Lester Lumber Co. had an open account on the corporation's books. To this account were credited salaries, dividends, and interest on the balance in the account, and withdrawals for personal use were charged to it. As a general practice the stockholder could withdraw the amount standing to his credit at any time. It was the practice of the corporation to credit interest at the current rate upon the credit balances of the stockholders' accounts. This rate in December, 1943, was 6 per cent per annum. On July 29, 1943, there was filed with the State Corporation Commission a statement made by Lester Lumber Co. as to the issuance of stock on which it is stated that the corporation proposes to issue 1,971 shares of common stock, $100 par value per share, in one issue to be paid for in money. The statement was sworn to by G. T. Lester, Jr., president, on July 22, 1943. On December 20, 1943, the corporation had a surplus of $94,268.54, and on or about that date the annual meeting of the stockholders was held. The minutes of this meeting state: Pursuant to notice the stockholders of Lester Lumber Co. Inc., held their 28th annual meeting at their office, Franklin St., Martinsville, Va. Mr. Geo. T. Lester Sr. Chairman of board, called the meeting to order. General business conditions, war and past war was discussed [sic]. All stock was bought by stockholders, increasing capital stock of company to $500,000.00 all common stock. This was handled by J. M. Clingenspeel with the State Corporation Commission and approved by all stockholders. The stock was all sold for cash to give the corporation more working capital. 4% dividend was ordered paid on all shares of outstanding stock. Also ordered that G. T. Lester, Jr., be continued as financial agent of the Lester Lumber Co. Inc., and empowered to borrow funds, receive and discharge the obligations of the company. Motion by Geo. T. Lester, Sr., seconded by R. H. Oakley that directors be elected as a whole for next year. Elected unanimously. Due to the death of H. L. Byrd the following changes was [sic] made in the officers of the corporation as G. T. Lester, Jr., Treas., H. J. Turner, Vice Pres., Lawson L. Lester, Sec., and B. Marvin Byrd, asst. sec. All officers and stockholders were present * The minutes do not cover all the action taken at the meeting. In addition to the action reported in the minutes the stockholders agreed to distribute the surplus to the stockholders' accounts. Pursuant to this arrangement, George T. Lester, Jr., who had charge of the corporation's books, made a debit entry on the cash book reading: "Surplus exchange to stockholders for new stock, $94,268.54," and credited the account of each stockholder with his share. Each account was also credited with salary due the stockholder, interest on the credit balance, a 4 per cent dividend on the stock held, and in some instances a gift from George T. Lester, Sr. At the same time each account was debited for an amount of new stock issued to the stockholder. New stock amounting to 1,971 shares was issued to the stockholders. Thirty shares were issued to Victor Lester in exchange for his note for $3,000. Victor Lester was not previously a stockholder. The remaining shares were charged at par to the accounts of the stockholders. The amounts of surplus credited and of stock charged to each were as follows: In the distribution as recorded on the books a part of the surplus allocable to George T. Lester, Sr., was, at his direction, allotted to George W. Lester in order that the latter might acquire a larger number of new shares. The Lester Lumber Co. had sufficient credit on December 20, 1943, to borrow cash in excess of $100,000. George T. Lester, Sr., acquired 300 shares of timberland in 1903 at a cost of $3,000. In 1943, desiring to make a gift to his wife and children, he deeded this land to the corporation, and in consideration thereof the corporation was to issue 300 shares of stock to his wife and children. Pursuant to this arrangement, $10,000 was credited to the account of Lottie Lester, his wife, and $20,000 was divided among the accounts of his children for use in effecting purchase of the stock allotted to them. During and prior to the transfer of the land George T. Lester, Sr., realized $695.66 from the sale of timber cut from this land. He realized capital gain from this transaction. There was credited to the account of George T. Lester, Sr., and, with his knowledge, the amount of $10,160 for interest on the balance of his open account with the corporation. George T. Lester, Sr., failed to report on his income tax for 1943 any amount for this credit of interest or on account of gain resulting from this sale of land. A part of the deficiency in Docket No. 17486 was due to negligence or intentional disregard of rules and regulations, but without intent to defraud. OPINION. ARNOLD, Judge: Immediately prior to December 20, 1943, the Lester Lumber Co. had authorized common capital stock of 5,000 shares, par value $100 each, of which 3,029 were outstanding and 1,971 were unissued, and it had a surplus of at least $94,268.54. The stock was held by 15 individuals, each of whom had an open account on the corporation's books. As of December 20, 1943, there was credited to each stockholder's account a 4 per cent dividend on his stock, interest on his credit balance at 6 per cent, and a share of the surplus, and, in some cases, an amount representing a gift from George T. Lester, Sr. Each account was charged with the par value of a part of the previously unissued stock then issued and allotted to these stockholders. Except for 30 shares issued to Victor Lester for his note, the entire 1,971 shares were issued and charged to the several accounts at par value. The individual petitioners contend that, to the extent of the surplus, this was a nontaxable stock dividend, the balance of the stock issued being purchased for cash. Respondent contends that the crediting of the surplus to the stockholders was equivalent to a cash dividend and the 1,971 shares were all sold for cash. * Respondent relies upon the wording of the minutes of the meeting of the stockholders of December 20, 1943, to the effect that "all stock was bought by stockholders, increasing capital stock of Company to $500,000, all common stock. * The stock was all sold for cash to give the corporation more working capital." Respondent also points out that the surplus was credited to the stockholders' open accounts and the stock was charged to such accounts without distinction as to what portion of the credit balance applied to the stock represented interest, wages, gifts, dividends, or surplus, and that there was no declaration of a stock dividend. Respondent argues that from the moment the surplus was credited to the stockholders it became their property; that each stockholder understood the corporation's capital stock was to be increased and each stockholder's account was |